PART A – COSTING

SESSION 1: ABC
QUESTION 1 (6/2008 – Q4)
The directors are keen to introduce ABC for the coming year and have provided the following cost
and selling price data:
1. The paper used costs $2 per kg for a CB but the TJ paper costs only $1 per kg. The CB uses 400g of
paper for each book, four times as much as the TJ uses.
2. Printing ink costs $30 per litre. The CB uses one third of the printing ink of the larger TJ. The TJ
uses 150ml of printing ink per book.

3. The CB needs six minutes of machine time to produce each book, whereas the TJ needs 10
minutes per book. The machines cost $12 per hour to run.

4. The sales prices are to be $9·30 for the CB and $14·00 for the TJ

As mentioned above there are three main overheads, the data for these are:

Overhead Annual cost for the coming year

$
Property costs 2,160,000
Quality control 668,000
Production set up costs 52,000
––––––––––
Total 2,880,000
––––––––––
The CB will be inspected on 180 occasions next year, whereas the TJ will be inspected just 20 times.

Jola Publishing will produce its annual output of 1,000,000 CBs in four production runs and
approximately 10,000 TJs per month in each of 12 production runs.

Required:

(a) Calculate the cost per unit and the margin for the CB and the TJ using machine hours
to absorb the overheads. (5 marks)

(b) Calculate the cost per unit and the margin for the CB and the TJ using activity based costing
principles to absorb the overheads. (8 marks)

1
QUESTION 2 (6/2010 – Q1)

Brick by Brick (BBB) is a building business that provides a range of building services to the public.
Recently they have been asked to quote for garage conversions (GC) and extensions to properties
(EX) and have found that they are winning fewer GC contracts than expected.

BBB has a policy to price all jobs at budgeted total cost plus 50%. Overheads are currently absorbed
on a labour hour basis. BBB thinks that a switch to activity based costing (ABC) to absorb overheads
would reduce the cost associated to GC and hence make them more competitive.

You are provided with the following data:

Overhead Annual Activity driver Total number

category overheads $ of activities per
year
Supervisors 90,000 Site visits 500
Planners 70,000 Planning documents 250
Property related 240,000 Labour hours 40,000
––––––––
Total 400,000
––––––––
A typical GC costs $3,500 in materials and takes 300 labour hours to complete. A GC requires only
one site visit by a supervisor and needs only one planning document to be raised. The typical EX
costs $8,000 in materials and takes 500 hours to complete. An EX requires six site visits and fi ve
planning documents. In all cases labour is paid $15 per hour.

Required:

(a) Calculate the cost and quoted price of a GC and of an EX using labour hours to absorb the
overheads. (5 marks)

(b) Calculate the cost and the quoted price of a GC and of an EX using ABC to absorb the
overheads. (5 marks)

2
QUESTION 3 (6/2014 – Q1)

1 Duff Co manufactures three products, X, Y and Z. Demand for products X and Y is relatively elastic
whilst demand for product Z is relatively inelastic. Each product uses the same materials and the
same type of direct labour but in different quantities. For many years, the company has been using
full absorption costing and absorbing overheads on the basis of direct labour hours. Selling prices are
then determined using cost plus pricing. This is common within this industry, with most competitors
applying a standard mark-up.

Budgeted production and sales volumes for X, Y and Z for the next year are 20,000 units,
16,000 units and 22,000 units respectively.

The budgeted direct costs of the three products are shown below:
Product X Y Z
$ per unit $ per unit $ per unit
Direct materials 25 28 22
Direct labour ($12 per hour) 30 36 24
In the next year, Duff Co also expects to incur indirect production costs of $1,377,400, which are
analysed as follows:
Cost pools $ Cost drivers
Machine set up costs 280,000 Number of batches
Material ordering costs 316,000 Number of purchase orders
Machine running costs 420,000 Number of machine hours
General facility costs 361,400 Number of machine hours
1,377,400
The following additional data relate to each product:
Product X Y Z
Batch size (units) 500 800 400
No of purchase orders per batch 4 5 4
Machine hours per unit 1.5 1.25 1.4
Duff Co wants to boost sales revenue in order to increase profits but its capacity to do this is limited
because of its use of cost plus pricing and the application of the standard mark-up. The finance
director has suggested using activity based costing (ABC) instead of full absorption costing, since this
will alter the cost of the products and may therefore enable a different price to be charged.

Required:

(a) Calculate the budgeted full production cost per unit of each product using Duff Co’s
current method of absorption costing. All workings should be to two decimal places. (3 marks)

(b) Calculate the budgeted full production cost per unit of each product using activity based
costing. All workings should be to two decimal places. (11 marks)

(c) Discuss the impact on the selling prices and the sales volumes OF EACH PRODUCT which a
change to activity based costing would be expected to bring about. (6 marks)

3
QUESTION 4 (6/2015 – Q1)

Beckley Hill (BH) is a private hospital carrying out two types of procedures on patients. Each type of
procedure incurs the following direct costs:

Procedure A B
$ $
Surgical time and materials 1,200 2,640
Anaesthesia time and materials 800 1,620
BH currently calculates the overhead cost per procedure by taking the total overhead cost and
simply dividing it by the number of procedures, then rounding the cost to the nearest 2 decimal
places. Using this method, the total cost is $2,475·85 for Procedure A and $4,735·85 for Procedure B.

Recently, another local hospital has implemented activity-based costing (ABC). This has led the
finance director at BH to consider whether this alternative costing technique would bring any
benefits to BH. He has obtained an analysis of BH’s total overheads for the last year and some
additional data, all of which is shown below:

Cost Cost driver $

Administrative costs Administrative time per procedure 1,870,160
Nursing costs Length of patient stay 6,215,616
Catering costs Number of meals 966,976
General facility costs Length of patient stay 8,553,600
–––––––––––
Total overhead costs 17,606,352
–––––––––––
Procedure A B

No. of procedures 14,600 22,400

Administrative time per procedure (hours) 1 1·5
Length of patient stay per procedure (hours) 24 48
Average no. of meals required per patient 1 4
Required:

(a) Calculate the full cost per procedure using activity-based costing. (6 marks)

(b) Making reference to your findings in part (a), advise the finance director as to whether activity-
based costing should be implemented at BH. (4 marks)

4
SESSION 2: TARGET COSTING
QUESTION 1 (12/2007 – Q1)

1 Edward Co assembles and sells many types of radio. It is considering extending its product range to
include digital radios. These radios produce a better sound quality than traditional radios and have a
large number of potential additional features not possible with the previous technologies (station
scanning, more choice, one touch tuning, station identification text and song identification text etc).

Edward Co is considering a target costing approach for its new digital radio product.

A selling price of $44 has been set in order to compete with a similar radio on the market that has
comparable features to Edward Co’s intended product. The board have agreed that the acceptable
margin (after allowing for all production costs) should be 20%.

Cost information for the new radio is as follows:

Component 1 (Circuit board) – these are bought in and cost $4·10 each. They are bought in batches
of 4,000 and additional delivery costs are $2,400 per batch.

Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed radio.
However, there is some waste involved in the process as wire is occasionally cut to the wrong length
or is damaged in the assembly process. Edward Co estimates that 2% of the purchased wire is lost in
the assembly process. Wire costs $0·50 per metre to buy.

Other material – other materials cost $8·10 per radio.

Assembly labour – these are skilled people who are difficult to recruit and retain. Edward Co has
more staff of this type than needed but is prepared to carry this extra cost in return for the security
it gives the business. It takes 30 minutes to assemble a radio and the assembly workers are paid
$12·60 per hour. It is estimated that 10% of hours paid to the assembly workers is for idle time.

Production Overheads – recent historic cost analysis has revealed the following production
overhead data:

Total production overhead Total assembly labour hours

$
Month 1 620,000 19,000
Month 2 700,000 23,000
Fixed production overheads are absorbed on an assembly hour basis based on normal annual
activity levels. In a typical year 240,000 assembly hours will be worked by Edward Co.

Required:

(d) Calculate the expected cost per unit for the radio and identify any cost gap that might exist. (13
marks)

5
QUESTION 2 (12/2009)

Big Cheese Chairs (BCC) manufactures and sells executive leather chairs. They are considering
a new design of massaging chair to launch into the competitive market in which they operate.

They have carried out an investigation in the market and using a target costing system have targeted
a competitive selling price of $120 for the chair. BCC wants a margin on selling price of 20% (ignoring
any overheads).

The frame and massage mechanism will be bought in for $51 per chair and BCC will upholster it in
leather and assemble it ready for despatch.

Leather costs $10 per metre and two metres are needed for a complete chair although 20% of all
leather is wasted in the upholstery process.

BCC estimates that the chair will take two hours to prepare. The cost of labour is $15 per hour.

Required:

(a) Calculate the average cost and identify any cost gap that may be present at that stage. (5
marks)

(b) Assuming that a cost gap for the chair exists suggest four ways in which it could be closed. (6
marks)

6
SESSION 3: LIFE CYCLE COSTING
QUESTION 1 (6/2013 – Q3)

3 Cam Co manufactures webcams, devices which can provide live video and audio streams via
personal computers. It has recently been suffering from liquidity problems and hopes that these will
be eased by the launch of its new webcam, which has revolutionary audio sound and visual quality.
The webcam is expected to have a product life cycle of two years. Market research has already been
carried out to establish a target selling price and projected lifetime sales volumes for the product.
Cost estimates have also been prepared, based on the current proposed product specification.
Cam Co uses life cycle costing to work out the target costs for its products, believing it to be more
accurate to use an average cost across the whole lifetime of a product, rather than
potentially different costs for different years. You are provided with the following relevant
information for the webcam:

Projected lifetime sales volume 50,000 units

Target selling price per unit $200
Target profit margin (35% selling price) $70
Target cost per unit $130
Estimated lifetime cost per unit (see note below for detailed breakdown) $160
Note: Estimated lifetime cost per unit:
$ $
Manufacturing costs
Direct material (bought in parts) 40
Direct labour 26
Machine costs 21
Quality control costs 10
Rework costs 3
–––
100
Non-manufacturing costs
Product development costs 25
Marketing costs 35
–––
60
––––
Estimated lifetime cost per unit 160
––––
The average market price for a webcam is currently $150.

The company needs to close the cost gap of $30 between the target cost and the estimated lifetime
cost. The following information has been identified as relevant:

1. Direct material cost: all of the parts currently proposed for the webcam are bespoke parts.
However, most of these can actually be replaced with standard parts costing 55% less. However,
three of the bespoke parts, which currently account for 20% of the estimated direct material cost,
cannot be replaced, although an alternative supplier charging 10% less has been sourced for these
parts.

7
2. Direct labour cost: the webcam uses 45 minutes of direct labour, which costs $34·67 per hour. The
use of more standard parts, however, will mean that whilst the first unit would still be expected to
take 45 minutes, there will now be an expected rate of learning of 90% (where ‘b’ = –0·152). This will
end after the first 100 units have been completed.

3. Rework cost: this is the average rework cost per webcam and is based on an estimate of 15% of
webcams requiring rework at a cost of $20 per rework. With the use of more standard parts, the
rate of reworks will fall to 10% and the cost of each rework will fall to $18.

Required:

(a) Recalculate the estimated lifetime cost per unit for the webcam after taking into account
points 1 to 3 above. (12 marks)

8
QUESTION 2 (12/2011 – Q3)

Fit Co specialises in the manufacture of a small range of hi-tech products for the fitness market. They
are currently considering the development of a new type of fitness monitor, which would be the first
of its kind in the market. It would take one year to develop, with sales then commencing at the
beginning of the second year. The product is expected to have a life cycle of two years, before it is
replaced with a technologically superior product. The following cost estimates have been made.

Year 1 Year 2 Year 3

Units manufactured and sold 100,000 200,000
Research and development costs $160,000
Product design costs $800,000
Marketing costs $1,200,000 $1,000,000 $1,750,000
Manufacturing costs:
Variable cost per unit $40 $42
Fixed production costs $650,000 $1,290,000
Distribution costs:
Variable cost per unit $4 $4·50
Fixed distribution costs $120,000 $120,000
Selling costs:
Variable cost per unit $3 $3·20
Fixed selling costs $180,000 $180,000
Administration costs $200,000 $900,000 $1,500,000

Note: You should ignore the time value of money.

Required:

(a) Calculate the life cycle cost per unit. (6 marks)

(b) After preparing the cost estimates above, the company realises that it has not taken into
account the effect of the learning curve on the production process. The variable manufacturing
cost per unit above, of $40 in year 2 and $42 in year 3, includes a cost for 0·5 hours of labour. The
remainder of the variable manufacturing cost is not driven by labour hours. The year 2 cost
per hour for labour is $24 and the year 3 cost is $26 per hour.

Subsequently, it has now been estimated that, although the first unit is expected to take 0·5
hours, a learning curve of 95% is expected to occur until the 100th unit has been completed.

Calculate the revised life cycle cost per unit, taking into account the effect of the learning curve.

Note: the value of the learning co-efficient, b, is –0·0740005. (10 marks)

(c) Discuss the benefits of life cycle costing. (4 marks)

9
SESSION 4: THROUGHPUT ACCOUNTING
QUESTION 1 (6/2009 – Q1)

Yam Co is involved in the processing of sheet metal into products A, B and C using three
processes, pressing, stretching and rolling. Like many businesses Yam faces tough price competition
in what is a mature world market.

The factory has 50 production lines each of which contain the three processes: Raw material for the
sheet metal is first pressed then stretched and finally rolled. The processing capacity varies for each
process and the factory manager has provided the following data:

Processing time per metre in hours

Product A Product B Product C
Pressing 0·50 0·50 0·40
Stretching 0·25 0·40 0·25
Rolling 0·40 0·25 0·25
The factory operates for 18 hours each day for five days per week. It is closed for only two weeks of
the year for holidays when maintenance is carried out. On average one hour of labour is needed for
each of the 225,000 hours of factory time. Labour is paid $10 per hour.

The raw materials cost per metre is $3·00 for product A, $2·50 for product B and $1·80 for product C.
Other factory costs (excluding labour and raw materials) are $18,000,000 per year. Selling prices per
metre are $70 for product A, $60 for product B and $27 for product C.

Yam carries very little inventory.

Required:

(a) Identify the bottleneck process and briefly explain why this process is described as a
‘bottleneck’. (3 marks)

(b) Calculate the throughput accounting ratio (TPAR) for each product assuming that the
bottleneck process is fully utilised. (8 marks)

(c) Assuming that the TPAR of product C is less than 1:

(i) Explain how Yam could improve the TPAR of product C. (4 marks)

(ii) Briefly discuss whether this supports the suggestion to cease the production of product C and
briefly outline three other factors that Yam should consider before a cessation decision is taken. (5
marks)

10
QUESITON2 (12/2013 – Q2)

2 Solar Systems Co (S Co) makes two types of solar panels at its manufacturing plant: large panels for
commercial customers and small panels for domestic customers. All panels are produced using the
same materials, machinery and a skilled labour force. Production takes place for five days per week,
from 7 am until 8 pm (13 hours), 50 weeks
of the year. Each panel has to be cut, moulded and then assembled using a cutting machine
(Machine C), a moulding machine (Machine M) and an assembly machine (Machine A).
As part of a government scheme to increase renewable energy sources, S Co has guaranteed not to
increase the price of small or large panels for the next three years. It has also agreed to supply a
minimum of 1,000 small panels each year to domestic customers for this three-year period.
Due to poor productivity levels, late orders and declining profits over recent years, the finance
director has suggested the introduction of throughput accounting within the organisation, together
with a ‘Just in Time’ system of production.
Material costs and selling prices for each type of panel are shown below.
Large panels Small panels
$ $
Selling price per unit 12,600 3,800
Material costs per unit 4,300 1,160

Total factory costs, which include the cost of labour and all factory overheads, are $12 million each
year at the plant. Out of the 13 hours available for production each day, workers take a one
hour lunch break. For the remaining 12 hours, Machine C is utilised 85% of the time and
Machines M and A are utilised 90% of the time. The unproductive time arises either as a result
of routine maintenance or because of staff absenteeism, as each machine needs to be manned by
skilled workers in order for the machine to run. The skilled workers are currently only trained to
work on one type of machine each. Maintenance work is carried out by external contractors who
provide a round the clock service (that is, they are available 24 hours a day, seven days a week),
should it be required.
The following information is available for Machine M, which has been identified as the bottleneck
resource:
Large panels Small panels
Hours per unit Hours per unit
Machine M 1.4 0.6

There is currently plenty of spare capacity on Machines C and A. Maximum annual demand for large
panels and small panels is 1,800 units and 1,700 units respectively.
Required:
(a) Calculate the throughput accounting ratio for large panels and for small panels and
explain what they indicate to S Co about production of large and small panels. (9 marks)
(b) Assume that your calculations in part (a) have shown that large panels have a higher
throughput accounting ratio than small panels.
Required:

11
Using throughput accounting, prepare calculations to determine the optimum production mix and
maximum profit of S Co for the next year. (5 marks)
(c) Suggest and discuss THREE ways in which S Co could try to increase its production capacity and
hence increase throughput in the next year without making any additional investment in
machinery. (6 marks)

12
QUESTION 3 (6/2011 – Q5)

5 Thin Co is a private hospital offering three types of surgical procedures known as A, B and C. Each
of them uses a pre-operative injection given by a nurse before the surgery. Thin Co currently
rent an operating theatre from a neighbouring government hospital. Thin Co does have an
operating theatre on its premises, but it has never been put into use since it would cost $750,000 to
equip. The Managing Director of Thin Co is keen to maximise profits and has heard of something
called ‘throughput accounting’, which may help him to do this. The following information is
available:
1 All patients go through a five step process, irrespective of which procedure they are having:
– step 1: consultation with the advisor;
– step 2: pre-operative injection given by the nurse;
– step 3: anaesthetic given by anaesthetist;
– step 4: procedure performed in theatre by the surgeon;
– step 5: recovery with the recovery specialist.
2 The price of each of procedures A, B and C is $2,700, $3,500 and $4,250 respectively.
3 The only materials’ costs relating to the procedures are for the pre-operative injections given by
the nurse, the anaesthetic and the dressings. These are as follows:
Procedure A Procedure B Procedure C
$ per procedure $ per procedure $ per procedure
Pre-operative
nurse’s injections 700 800 1,000
Anaesthetic 35 40 45
Dressings 5·60 5·60 5·60
4 There are five members of staff employed by Thin Co. Each works a standard 40-hour week for 47
weeks of the year, a total of 1,880 hours each per annum. Their salaries are as follows:
– Advisor: $45,000 per annum;
– Nurse: $38,000 per annum;
– Anaesthetist: $75,000 per annum;
– Surgeon: $90,000 per annum;
– Recovery specialist: $50,000 per annum.
The only other hospital costs (comparable to ‘factory costs’ in a traditional manufacturing
environment) are general overheads, which include the theatre rental costs, and amount to
$250,000 per annum.
5 Maximum annual demand for A, B and C is 600, 800 and 1,200 procedures respectively. Time spent
by each of the five different staff members on each procedure is as follows:
Procedure A Procedure B Procedure C
Hours Hours Hours
per procedure per procedure per procedure
Advisor 0·24 0·24 0·24
Nurse 0·27 0·28 0·30
Anaesthetist 0·25 0·28 0·33
Surgeon 0·75 1 1·25
Recovery specialist 0·60 0·70 0·74
Part hours are shown as decimals e.g. 0·24 hours = 14·4 minutes (0·24 x 60).
Surgeon’s hours have been correctly identified as the bottleneck resource.
Required:

13
(a) Calculate the throughput accounting ratio for procedure C.
Note: It is recommended that you work in hours as provided in the table rather than minutes. (6
marks)
(b) The return per factory hour for products A and B has been calculated and is $2,612·53
and $2,654·40 respectively. The throughput accounting ratio for A and B has also been
calculated and is 8·96 and 9·11 respectively.
Calculate the optimum product mix and the maximum profit per annum. (7 marks)
(c) Assume that your calculations in part (b) showed that, if the optimum product mix is adhered to,
there will be
excess demand for procedure C of 696 procedures per annum. In order to satisfy this excess
demand, the company is considering equipping and using its own theatre, as well as continuing to
rent the existing theatre. The company cannot rent any more theatre time at either the existing
theatre or any other theatres in the area, so equipping its own theatre is the only option. An
additional surgeon would be employed to work in the newly equipped theatre.
Required:
Discuss whether the overall profit of the company could be improved by equipping and
using the extra theatre. (7 marks)

14
QUESTION 4 (12/2014 – Q2)
Chair Co has developed a new type of luxury car seat. The estimated labour time for the first unit is
12 hours but a learning curve of 75% is expected to apply for the first eight units produced. The cost
of labour is $15 per hour. The cost of materials and other variable overheads is expected to total
$230 per unit.
Chair Co plans on pricing the seat by adding a 50% mark-up to the total variable cost per seat, with
the labour cost being based on the incremental time taken to produce the 8th unit.
Required:
(a) Calculate the price which Chair Co expects to charge for the new seat.
Note: The learning index for a 75% learning curve is –0·415. (5 marks)
(b) The first phase of production has now been completed for the new car seat. The first
unit actually took 12·5 hours to make and the total time for the first eight units was 34·3 hours, at
which point the learning effect came to an end. Chair Co are planning on adjusting the price to
reflect the actual time it took to complete the 8th unit.
Required:
(i) Calculate the actual rate of learning and state whether this means that the labour force actually
learnt more quickly or less quickly than expected. (3 marks)
(ii) Briefly explain whether the adjusted price charged by Chair Co will be higher or lower than the
price you calculated in part (a) above. You are NOT required to calculate the adjusted price. (2
marks)

15
PART B: DECISION MAKING

SESSION 1: CPV ANALYSIS

QUESTION 1 (12.2012 – Q1)

Hair Co manufactures three types of electrical goods for hair: curlers (C), straightening irons (S) and
dryers (D.) The budgeted sales prices and volumes for the next year are as follows:
C S D
Selling price $110 $160 $120
Unit 20,000 22,000 26,000
Each product is made using a different mix of the same materials and labour. Product S also uses
new revolutionary technology for which the company obtained a ten-year patent two years ago. The
budgeted sales volumes for all the products have been calculated by adding 10% to last year’s sales.
The standard cost card for each product is shown below.
C S D
Material 1 12 28 16
Material 2 8 22 26
Skilled labor 16 34 22
Unskilled labor 14 20 28

Both skilled and unskilled labour costs are variable. The general fixed overheads are expected to be
$640,000 for the next year.
Required:
(a) Calculate the weighted average contribution to sales ratio for Hair Co.
Note: round all workings to 2 decimal places. (6 marks)
(b) Calculate the total break-even sales revenue for the next year for Hair Co.
Note: round all workings to 2 decimal places. (2 marks)
(c) Using the graph paper provided, draw a multi-product profit-volume (PV) chart showing clearly
the profit/loss lines assuming:
(i) you are able to sell the products in order of the ones with the highest ranking contribution to
sales ratios first; and
(ii) you sell the products in a constant mix.
Note: only one graph is required. (9 marks)
(d) Briefly comment on your findings in (c). (3 marks)

16
QUESTION 2 (12/2015 – Q4)
4 Cardio Co manufactures three types of fitness equipment: treadmills (T), cross trainers (C) and
rowing machines (R).
The budgeted sales prices and volumes for the next year are as follows:
T C R
Selling price $1,600 $1,800 $1,400
Units 420 400 380
The standard cost card for each product is shown below.
T C R
Material 430 500 360
Labour 220 240 190
Variable overheads 110 120 95
Labour costs are 60% fixed and 40% variable. General fixed overheads excluding any fixed labour
costs are expected to be $55,000 for the next year.
Required:
(a) Calculate the weighted average contribution to sales ratio for Cardio Co. (4 marks)
(b) Calculate the margin of safety in $ revenue for Cardio Co. (3 marks)
(c) Using the graph paper provided and assuming that the products are sold in a CONSTANT
MIX, draw a multi-product breakeven chart for Cardio Co. Label fully both axes, any lines drawn
on the graph and the breakeven point. (6 marks)
(d) Explain what would happen to the breakeven point if the products were sold in order of the
most profitable products first.
Note: You are NOT required to demonstrate this on the graph drawn in part (c). (2 marks)
(15 marks)

17
QUESTION 3 (6/2018)

The Alka Hotel is situated in a major city close to many theatres and restaurants.

The Alka Hotel has 25 double bedrooms and it charges guests $180 per room per night, regardless of
single or double occupancy. The hotel’s variable cost is $60 per occupied room per night.

The Alka Hotel is open for 365 days a year and has a 70% budgeted occupancy rate. Fixed costs are
budgeted at $600,000 a year and accrue evenly throughout the year.

During the first quarter (Q1) of the year the room occupancy rates are significantly below the levels
expected at other times of the year with the Alka Hotel expecting to sell 900 occupied room nights
during Q1. Options to improve profitability are being considered, including closing the hotel for the
duration of Q1 or adopting one of two possible projects as follows:

Project 1 – Theatre package

For Q1 only the Alka Hotel management would offer guests a ‘theatre package’. Couples who pay for
two consecutive nights at a special rate of $67·50 per room night will also receive a pair of theatre
tickets for a payment of $100. The theatre tickets are very good value and are the result of long
negotiation between the Alka Hotel management and the local theatre. The theatre tickets cost the
Alka Hotel $95 a pair. The Alka Hotel’s fixed costs specific to this project (marketing and
administration) are budgeted at $20,000.

The hotel’s management believes that the ‘theatre package’ will have no effect on their usual Q1
customers, who are all business travellers and who have no interest in theatre tickets, but will still
require their usual rooms.

Project 2 – Restaurant

There is scope to extend the Alka Hotel and create enough space to operate a restaurant for the
benefit of its guests. The annual costs, revenues and volumes for the combined restaurant and hotel
are illustrated in the following graph:

Note: The graph does not include the effect of the ‘theatre package’ offer.

Breakeven chart for combined restaurant and hotel operations

18
Required:

(a) Using the current annual budgeted figures, and ignoring the two proposed projects, calculate
the breakeven number of occupied room nights and the margin of safety as a percentage. (4
marks)

(b) Ignoring the two proposed projects, calculate the budgeted profit or loss for Q1 and explain
whether the hotel should close for the duration of Q1. (4 marks)

(c) Calculate the breakeven point in sales value of Project 1 and explain whether the hotel should
adopt the project. (4 marks)

(d) Using the graph, quantify and comment upon the financial effect of Project 2 on the Alka
Hotel.

Note: There are up to four marks available for calculations.

19
SESSION 2: DECISION MAKING WITH LIMITING FACTORS
QUESTION 1 (6/2008 – Q1)

Higgins Co (HC) manufactures and sells pool cues and snooker cues. The cues both use the same
type of good quality wood (ash) which can be difficult to source in sufficient quantity. The supply of
ash is restricted to 5,400 kg per period. Ash costs $40 per kg.

The cues are made by skilled craftsmen (highly skilled labour) who are well known for their
workmanship. The skilled craftsmen take years to train and are difficult to recruit. HC’s craftsmen
are generally only able to work for 12,000 hours in a period. The craftsmen are paid $18 per hour.

HC sells the cues to a large market. Demand for the cues is strong, and in any period, up to 15,000
pool cues and 12,000 snooker cues could be sold. The selling price for pool cues is $41 and the
selling price for snooker cues is $69.

Manufacturing details for the two products are as follows:

Pool cues Snooker cues

Craftsmen time per cue 0·5 hours 0·75 hours
Ash per cue 270 g 270 g
Other variable costs per cue $1·20 $4·70
HC does not keep inventory.
Required:

(a) Calculate the contribution earned from each cue. (2 marks)

(b) Determine the optimal production plan for a typical period assuming that HC is seeking to
maximise the contribution earned. You should use a linear programming graph (using the graph
paper provided), identify the feasible region and the optimal point and accurately calculate the
maximum contribution that could be earned using whichever equations you need. (12 marks)

Some of the craftsmen have offered to work overtime, provided that they are paid double time for
the extra hours over the contracted 12,000 hours. HC has estimated that up to 1,200 hours per
period could be gained in this way.

Required:

(c) Explain the meaning of a shadow price (dual price) and calculate the shadow price of
both the labour (craftsmen) and the materials (ash). (5 marks)

(d) Advise HC whether to accept the craftsmens’ initial offer of working overtime, discussing the
rate of pay requested, the quantity of hours and one other factor that HC should consider. (6
marks)

(25 marks)

20
QUESTION 2 (6/2010 – Q3)
Cut and Stitch (CS) make two types of suits using skilled tailors (labour) and a delicate and unique
fabric (material). Both the tailors and the fabric are in short supply and so the accountant at
CS has correctly produced a linear programming model to help decide the optimal production
mix.
The model is as follows:
Variables:
Let W = the number of work suits produced
Let L = the number of lounge suits produced
Constraints
Tailors’ time: 7W + 5L ≤ 3,500 (hours) – this is line T on the diagram
Fabric: 2W + 2L ≤ 1,200 (metres) – this is line F on the diagram
Production of work suits: W ≤ 400 – this is line P on the diagram
Objective is to maximise contribution subject to:
C = 48W + 40L
On the diagram provided the accountant has correctly identifi ed OABCD as the feasible region and
point B as the optimal point.

Required:
(a) Find by appropriate calculation the optimal production mix and related maximum
contribution that could be earned by CS. (4 marks)
(b) Calculate the shadow prices of the fabric per metre and the tailor time per hour. (6 marks)
The tailors have offered to work an extra 500 hours provided that they are paid three
times their normal rate of $1·50 per hour at $4·50 per hour.

21
 Required:
(c) Briefly discuss whether CS should accept the offer of overtime at three times the normal rate.
(6 marks)
(d) Calculate the new optimum production plan if maximum demand for W falls to 200 units. (4
marks)

22
QUESTION 3 (12/2013 – Q3)

Mic Co produces microphones for mobile phones and operates a standard costing system.
Before production commenced, the standard labour time per batch for its latest microphone
was estimated to be 200 hours. The standard labour cost per hour is $12 and resource allocation
and cost data were therefore initially prepared on this basis.

Production of the microphone started in July and the number of batches assembled and sold each
month was as follows:

Month No of batches assembled and sold

July 1
August 1
September 2
October 4
November 8
The first batch took 200 hours to make, as anticipated, but, during the first four months of
production, a learning effect of 88% was observed, although this finished at the end of October. The
learning formula is shown on the formula sheet and at the 88% learning rate the value of b is –
0·1844245.

Mic Co uses ‘cost plus’ pricing to establish selling prices for all its products. Sales of its new
microphone in the first five months have been disappointing. The sales manager has blamed the
production department for getting the labour cost so wrong, as this, in turn, caused the price
to be too high. The production manager has disclaimed all responsibility, saying that, ‘as usual,
the managing director prepared the budgets alone and didn’t consult me and, had he bothered to do
so, I would have told him that a learning curve was expected.’

Required:

(a) Calculate the actual total monthly labour costs for producing the microphones for each of the
five months from July to November. (9 marks)

(b) Discuss the implications of the learning effect coming to an end for Mic Co, with regard to
costing, budgeting and production. (4 marks)

(c) Discuss the potential advantages and disadvantages of involving senior staff at Mic Co in the
budget setting process, rather than the managing director simply imposing the budgets on them.
(7 marks)

23
QUESTION 4 (6/2014 – Q2)

2 Tablet Co makes two types of tablet computer, the Xeno (X) and the Yong (Y). X currently
generates a contribution of $30 per unit and Y generates a contribution of $40 per unit. There are
three main stages of production: the build stage, the program stage and the test stage. Each of these
stages requires the use of skilled labour which, due to a huge increase in demand for tablet
computers over recent months, is now in short supply. The following information is available for the
two products:

Stage Xeno (X) Yong (Y)

Minutes per unit Minutes per unit

Build ($10 per hour) 24 20

Program ($16 per hour) 16 14

Test ($12 per hour) 10 4

Tablet Co is now preparing its detailed production plans for the next quarter. During this period it
expects that the skilled labour available will be 30,000 hours (1,800,000 minutes) for the build
stage, 28,000 hours (1,680,000 minutes) for the program stage and 12,000 hours (720,000 minutes)
for the test stage. The maximum demand for X and Y over the three-month period is expected to be
85,000 units and 66,000 units respectively. Fixed costs are $650,000 per month.

Due to rapid technological change, the company holds no inventory of finished goods.

Required:

(a) On the graph paper provided, use linear programming to calculate the optimum number of
each product which Tablet Co should make in the next quarter assuming it wishes to maximise
contribution. Calculate the total profit for the quarter. (14 marks)

(b) Calculate the amount of any slack resources arising as a result of the optimum production plan
and explain the implications of these amounts for decision-making within Tablet Co. (6 marks)

24
QUESTION 5 (9/2016)

CSC Co is a health food company producing and selling three types of high-energy products: cakes,
shakes and cookies, to gyms and health food shops. Shakes are the newest of the three products and
were first launched three months ago. Each of the three products has two special ingredients,
sourced from a remote part the world. The first of these, Singa, is a super-energising rare type
of caffeine. The second, Betta, is derived from an unusual plant believed to have miraculous
health benefits.

CSC Co’s projected manufacture costs and selling prices for the three products are as follows:

Cakes Cookies Shakes

Per unit $ $ $
Selling price 5·40 4·90 6·00
Costs:
Ingredients: Singa ($1·20 per gram) 0·30 0·60 1·20
Ingredients: Betta ($1·50 per gram) 0·75 0·30 1·50
Other ingredients 0·25 0·45 0·90
Labour ($10 per hour) 1·00 1·20 0·80
Variable overheads 0·50 0·60 0·40
––––– ––––– –––––
Contribution 2·60 1·75 1·20
––––– ––––– –––––
For each of the three products, the expected demand for the next month is 11,200 cakes,
9,800 cookies and 2,500 shakes. The total fixed costs for the next month are $3,000. CSC Co has just
found out that the supply of Betta is going to be limited to 12,000 grams next month. Prior to this,
CSC Co had signed a contract with a leading chain of gyms, Encompass Health, to supply it with 5,000
shakes each month, at a discounted price of $5·80 per shake, starting immediately. The order for the
5,000 shakes is not included in the expected demand levels above.

Required:

(a) Assuming that CSC Co keeps to its agreement with Encompass Health, calculate the shortage of
Betta, the resulting optimum production plan and the total profit for next month. (6 marks)

One month later, the supply of Betta is still limited and CSC Co is considering whether it should
breach its contract with Encompass Health so that it can optimise its profits.

Required:

(b) Discuss whether CSC Co should breach the agreement with Encompass Health.

Note: No further calculations are required. (4 marks)

Several months later, the demand for both cakes and cookies has increased significantly to 20,000
and 15,000 units per month respectively. However, CSC Co has lost the contract with Encompass
Health and, after suffering from further shortages of supply of Betta, Singa and of its labour force,
CSC Co has decided to stop making shakes at all. CSC Co now needs to use linear programming to
work out the optimum production plan for cakes and cookies for the coming month. The variable ‘x’
is being used to represent cakes and the variable ‘y’ to represent cookies.

25
The following constraints have been formulated and a graph representing the new production
problem has been drawn:

Singa: 0·25x + 0·5y ≤ 12,000

Betta: 0·5x + 0·2y ≤ 12,500
Labour: 0·1x + 0·12y ≤ 3,000
x ≤ 20,000
y ≤ 15,000
x, y ≥ 0

Required:

(c) (i) Explain what the line labelled ‘C = 2·6x + 1·75y’ on the graph is and what the area
represented by the points 0ABCD means. (4 marks)

(ii) Explain how the optimum production plan will be found using the line labelled ‘C = 2·6x +
1·75y’ and identify the optimum point from the graph. (2 marks)

(iii) Explain what a slack value is and identify, from the graph, where slack will occur as a result of
the optimum production plan. (4 marks)

Note: No calculations are needed for part (c).

26
SESSION 3: RELEVANT COSTING
SESSION 3.1 ONE OFF CONTRACT
QUESTION 1 (12/2014 – Q3)
3 The Hi Life Co (HL Co) makes sofas. It has recently received a request from a customer to provide a
one-off order of sofas, in excess of normal budgeted production. The order would need to be
completed within two weeks. The following cost estimate has already been prepared:
Direct materials: Note $
Fabric 200 m2 at $17 per m2 1 3,400
Wood 50 m at $8·20 per m2 2 410
Direct labour: Skilled 200 hours at $16 per hour 3 3,200
Semi-skilled 300 hours at $12 per hour 4 3,600
Factory overheads 500 hours at $3 per hour 5 1,500
Total production cost 12,110
Administration overheads at 10% of total production cost 6 1,211
Total cost 13,321
Notes
1 The fabric is regularly used by HL Co. There are currently 300 m2 in inventory, which cost $17 per
m2. The current purchase price of the fabric is $17·50 per m2.
2 This type of wood is regularly used by HL Co and usually costs $8·20 per m2. However, the
company’s current supplier’s earliest delivery time for the wood is in three weeks’ time. An
alternative supplier could deliver immediately but they would charge $8·50 per m 2 . HL Co already
has 500 m 2 in inventory but 480 m 2 of this is needed to complete other existing orders in the next
two weeks. The remaining 20 m 2 is not going to be needed until four weeks’ time.
3 The skilled labour force is employed under permanent contracts of employment under which they
must be paid for 40 hours’ per week’s labour, even if their time is idle due to absence of orders.
Their rate of pay is $16 per hour, although any overtime is paid at time and a half. In the next
two weeks, there is spare capacity of 150 labour hours.
4 There is no spare capacity for semi-skilled workers. They are currently paid $12 per hour or time
and a half for overtime. However, a local agency can provide additional semi-skilled workers for $14
per hour.
5 The $3 absorption rate is HL Co’s standard factory overhead absorption rate; $1·50 per hour
reflects the cost of the factory supervisor’s salary and the other $1·50 per hour reflects general
factory costs. The supervisor is paid an annual salary and is also paid $15 per hour for any overtime
he works. He will need to work 20 hours’ overtime if this order is accepted.
6 This is an apportionment of the general administration overheads incurred by HL Co.
Required: Prepare, on a relevant cost basis, the lowest cost estimate which could be used as the
basis for the quotation. (Explain briefly your reasons for including or excluding each of the costs in
your estimate) (10 marks)

27
QUESTION 2 (12.2011 – Q1)

The Telephone Co (T Co) is a company specialising in the provision of telephone systems for
commercial clients. There are two parts to the business:
– installing telephone systems in businesses, either first time installations or replacement
installations;
– supporting the telephone systems with annually renewable maintenance contracts.
T Co has been approached by a potential customer, Push Co, who wants to install a telephone
system in new offices it is opening. Whilst the job is not a particularly large one, T Co is hopeful of
future business in the form of replacement systems and support contracts for Push Co. T Co is
therefore keen to quote a competitive price for the job. The following information should be
considered:
1. One of the company’s salesmen has already been to visit Push Co, to give them a demonstration
of the new system, together with a complimentary lunch, the costs of which totalled $400.
2. The installation is expected to take one week to complete and would require three engineers,
each of whom is paid a monthly salary of $4,000. The engineers have just had their annually
renewable contract renewed with T Co. One of the three engineers has spare capacity to complete
the work, but the other two would have to be moved from contract X in order to complete this one.
Contract X generates a contribution of $5 per engineer hour.
There are no other engineers available to continue with Contract X if these two engineers are taken
off the job. It would mean that T Co would miss its contractual completion deadline on Contract X by
one week. As a result, T Co would have to pay a one-off penalty of $500. Since there is no other work
scheduled for their engineers in one week’s time, it will not be a problem for them to complete
Contract X at this point.
3. T Co’s technical advisor would also need to dedicate eight hours of his time to the job. He is
working at full capacity, so he would have to work overtime in order to do this. He is paid an hourly
rate of $40 and is paid for all overtime at a premium of 50% above his usual hourly rate.
4. Two visits would need to be made by the site inspector to approve the completed work. He is an
independent contractor who is not employed by T Co, and charges Push Co directly for the work. His
cost is $200 for each visit made.
5. T Co’s system trainer would need to spend one day at Push Co delivering training. He is paid a
monthly salary of $1,500 but also receives commission of $125 for each day spent delivering training
at a client’s site.
6. 120 telephone handsets would need to be supplied to Push Co. The current cost of these is $18·20
each, although T Co already has 80 handsets in inventory. These were bought at a price of $16·80
each. The handsets are the most popular model on the market and frequently requested by T Co’s
customers.
7. Push Co would also need a computerised control system called ‘Swipe 2’. The current market price
of Swipe 2 is $10,800, although T Co has an older version of the system, ‘Swipe 1’, in inventory,
which could be modified at a cost of $4,600. T Co paid $5,400 for Swipe 1 when it ordered it in error
two months ago and has no other use for it. The current market price of Swipe 1 is $5,450, although
if T Co tried to sell the one they have, it would be deemed to be ‘used’ and therefore only worth
$3,000.
8. 1,000 metres of cable would be required to wire up the system. The cable is used frequently by T
Co and it has 200 metres in inventory, which cost $1·20 per metre. The current market price for the
cable is $1·30 per metre.

28
9. You should assume that there are four weeks in each month and that the standard working week
is 40 hours long.
Required:
(a) Prepare a cost statement, using relevant costing principles, showing the minimum cost that T
Co should charge for the contract. Make DETAILED notes showing how each cost has been arrived
at and EXPLAINING why each of the costs above has been included or excluded from your cost
statement. (14 marks)
(b) Explain the relevant costing principles used in part (a) and explain the implications of the
minimum price that has been calculated in relation to the final price agreed with Push Co. (6
marks)
(20 marks)

29
SESSION 3.2 MAKE OR BUY
QUESTION 1 (12/2011)

2 Bath Co is a company specialising in the manufacture and sale of baths. Each bath consists of a
main unit plus a set of bath fittings. The company is split into two divisions, A and B. Division A
manufactures the bath and Division B manufactures sets of bath fittings. Currently, all of Division A’s
sales are made externally. Division B, however, sells to Division A as well as to external customers.
Both of the divisions are profit centres.

The following data is available for both divisions:

Division A

Current selling price for each bath $450

Costs per bath:
Fittings from Division B $75
Other materials from external suppliers $200
Labour costs $45
Annual fixed overheads $7,440,000
Annual production and sales of baths (units) 80,000
Maximum annual market demand for baths (units) 80,000

Division B

Current external selling price per set of fittings $80

Current price for sales to Division A $75
Costs per set of fittings:
Materials $5
Labour costs $15
Annual fixed overheads $4,400,000
Maximum annual production and sales of sets of fittings (units) 200,000
(including internal and external sales)
Maximum annual external demand for sets of fittings (units) 180,000
Maximum annual internal demand for sets of fittings (units) 80,000

The transfer price charged by Division B to Division A was negotiated some years ago between the
previous divisional managers, who have now both been replaced by new managers. Head Office only
allows Division A to purchase its fittings from Division B, although the new manager of Division A
believes that he could obtain fittings of the same quality and appearance for $65 per set, if he was
given the autonomy to purchase from outside the company. Division B makes no cost savings from
supplying internally to Division A rather than selling externally.

Required:

(a) Under the current transfer pricing system, prepare a profit statement showing the profit
for each of the divisions and for Bath Co as a whole. Your sales and costs figures should be split
into external sales and inter-divisional transfers, where appropriate. (6 marks)

30
(b) Head Office is considering changing the transfer pricing policy to ensure maximisation of
company profits without demotivating either of the divisional managers. Division A will be given
autonomy to buy from external suppliers and Division B to supply external customers in priority to
supplying to Division A. Calculate the maximum profit that could be earned by Bath Co if transfer
pricing is optimised. (8 marks)

(c) Discuss the issues of encouraging divisional managers to take decisions in the interests of the
company as a whole, where transfer pricing is used. Provide a reasoned recommendation of a
policy Bath Co should adopt. (6 marks)

(20 marks)

31
QUESTION 2 (6/2012 – Q1)

Robber Co manufactures control panels for burglar alarms, a very profitable product. Every product
comes with a one year warranty offering free repairs if any faults arise in this period.
It currently produces and sells 80,000 units per annum, with production of them being restricted by
the short supply of labour. Each control panel includes two main components – one key pad and one
display screen. At present, Robber Co manufactures both of these components in-house.
However, the company is currently considering outsourcing the production of keypads and/or
display screens. A newly established company based in Burgistan is keen to secure a place in the
market, and has offered to supply the keypads for the equivalent of $4·10 per unit and the display
screens for the equivalent of $4·30 per unit. This price has been guaranteed for two years.
The current total annual costs of producing the keypads and the display screens are:
Keypads Display screens
Production 80,000 units 80,000 units
$’000 $’000
Direct materials 160 116
Direct labour 40 60
Heat and power costs 64 88
Machine costs 26 30
Depreciation and insurance costs 84 96
Total annual production costs 374 390
Notes:
1. Materials costs for keypads are expected to increase by 5% in six months’ time; materials costs for
display screens are only expected to increase by 2%, but with immediate effect.
2. Direct labour costs are purely variable and not expected to change over the next year.
3. Heat and power costs include an apportionment of the general factory overhead for heat and
power as well as the costs of heat and power directly used for the production of keypads and
display screens. The general apportionment included is calculated using 50% of the direct labour
cost for each component and would be incurred irrespective of whether the components are
manufactured in-house or not.
4. Machine costs are semi-variable; the variable element relates to set up costs, which are based
upon the number of batches made. The keypads’ machine has fixed costs of $4,000 per annum and
the display screens’ machine has fixed costs of $6,000 per annum. Whilst both components are
currently made in batches of 500, this would need to change, with immediate effect, to batches of
400.
5. 60% of depreciation and insurance costs relate to an apportionment of the general factory
depreciation and insurance costs; the remaining 40% is specific to the manufacture of keypads and
display screens.
Required:
(a) Advise Robber Co whether it should continue to manufacture the keypads and display screens
in-house or whether it should outsource their manufacture to the supplier in Burgistan, assuming
it continues to adopt a policy to limit manufacture and sales to 80,000 control panels in the
coming year. (8 marks)
(b) Robber Co takes 0·5 labour hours to produce a keypad and 0·75 labour hours to produce a
display screen. Labour hours are restricted to 100,000 hours and labour is paid at $1 per hour.

32
Robber Co wishes to increase its supply to 100,000 control panels (i.e. 100,000 each of keypads and
display screens).
Advise Robber Co as to how many units of keypads and display panels they should either
manufacture and/or outsource in order to minimise their costs. (7 marks)
(c) Discuss the non-financial factors that Robber Co should consider when making a decision about
outsourcing the manufacture of keypads and display screens. (5 marks)
(20 marks)

33
SESSION 3.3 FUTHER PROCESSING
QUESTION 1 (12/2013 – Q1)

Process Co has two divisions, A and B. Division A produces three types of chemicals: products L, M
and S, using a common process. Each of the products can either be sold by Division A to the external
market at split-off point (after the common process is complete) or can be transferred to Division B
for individual further processing into products LX, MX and SX.

In November 2013, which is a typical month, Division A’s output was as follows:

Product Kg
L 1,200
M 1,400
S 1,800
The market selling prices per kg for the products, both at split-off point and after further processing,
are as follows:

$ $
L 5.6 LX 6.7
M 6.5 MX 7.9
S 6.1 SX 7.9
The specific costs for each of the individual further processes are:
$
Variable cost of $0·50 per kg of LX
Variable cost of $0·70 per kg of MX
Variable cost of $0·80 per kg of SX
Further processing leads to a normal loss of 5% at the beginning of the process for each of
the products being processed.
Required:

(a) Calculate and conclude whether any of the products should be further processed in Division B
in order to optimise the profit for the company as a whole. (10 marks)

(b) It has been suggested that Division A should transfer products L and M to Division B for further
processing, in order to optimise the profit of the company as a whole. Divisions A and B are both
investment centres and all transfers from Division A to Division B would be made using the
actual marginal cost. As a result, if Division A were to make the transfers as suggested, their
divisional profits would be much lower than if it were to sell both products externally at split-off
point. Division B’s profits, however, would be much higher.

Required:

Discuss the issues arising from this suggested approach to transfer pricing. (5 marks)

34
QUESTION 2 (6/2009 – Q4)

Bits and Pieces (B&P) operates a retail store selling spares and accessories for the car market. The
store has previously only opened for six days per week for the 50 working weeks in the year, but
B&P is now considering also opening on Sundays.

The sales of the business on Monday through to Saturday averages at $10,000 per day with average
gross profit of 70% earned.

B&P expects that the gross profit % earned on a Sunday will be 20 percentage points lower than the
average earned on the other days in the week. This is because they plan to offer substantial
discounts and promotions on a Sunday to attract customers. Given the price reduction, Sunday sales
revenues are expected to be 60% more than the average daily sales revenues for the other days.
These Sunday sales estimates are for new customers only, with no allowance being made for those
customers that may transfer from other days.

B&P buys all its goods from one supplier. This supplier gives a 5% discount on all purchases if annual
spend exceeds $1,000,000.

It has been agreed to pay time and a half to sales assistants that work on Sundays. The normal
hourly rate is $20 per hour. In total five sales assistants will be needed for the six hours that the
store will be open on a Sunday. They will also be able to take a half-day off (four hours) during the
week. Staffing levels will be allowed to reduce slightly during the week to avoid extra costs being
incurred.

The staff will have to be supervised by a manager, currently employed by the company and paid an
annual salary of $80,000. If he works on a Sunday he will take the equivalent time off during the
week when the assistant manager is available to cover for him at no extra cost to B&P. He will also
be paid a bonus of 1% of the extra sales generated on the Sunday project.

The store will have to be lit at a cost of $30 per hour and heated at a cost of $45 per hour. The
heating will come on two hours before the store opens in the 25 ‘winter’ weeks to make sure it is
warm enough for customers to come in at opening time. The store is not heated in the other weeks

The rent of the store amounts to $420,000 per annum.

Required:

(a) Calculate whether the Sunday opening incremental revenue exceeds the incremental costs
over a year (ignore inventory movements) and on this basis reach a conclusion as to
whether Sunday opening is financially justifiable. (12 marks)

(b) Discuss whether the manager’s pay deal (time off and bonus) is likely to motivate him. (4
marks)

(c) Briefly discuss whether offering substantial price discounts and promotions on Sunday is a good
suggestion. (4 marks)

QUESTION 3 (12/2007 – Q4)

35
Sniff Co manufactures and sells its standard perfume by blending a secret formula of
aromatic oils with diluted alcohol. The oils are produced by another company following a lengthy
process and are very expensive. The standard perfume is highly branded and successfully sold at a
price of $39·98 per 100 millilitres (ml).

Sniff Co is considering processing some of the perfume further by adding a hormone to appeal to
members of the opposite sex. The hormone to be added will be different for the male and female
perfumes. Adding hormones to perfumes is not universally accepted as a good idea as some people
have health concerns. On the other hand, market research carried out suggests that a premium
could be charged for perfume that can ‘promise’ the attraction of a suitor. The market research has
cost $3,000.

Data has been prepared for the costs and revenues expected for the following month (a test month)
assuming that a part of the company’s output will be further processed by adding the hormones.

The output selected for further processing is 1,000 litres, about a tenth of the company’s normal
monthly output. Of this, 99% is made up of diluted alcohol which costs $20 per litre. The rest is a
blend of aromatic oils costing $18,000 per litre. The labour required to produce 1,000 litres of
the basic perfume before any further processing is 2,000 hours at a cost of $15 per hour.

Of the output selected for further processing, 200 litres (20%) will be for male customers and 2 litres
of hormone costing $7,750 per litre will then be added. The remaining 800 litres (80%) will be for
female customers and 8 litres of hormone will be added, costing $12,000 per litre. In both cases the
adding of the hormone adds to the overall volume of the product as there is no resulting processing
loss.

Sniff Co has sufficient existing machinery to carry out the test processing.

The new processes will be supervised by one of the more experienced supervisors currently
employed by Sniff Co. His current annual salary is $35,000 and it is expected that he will spend 10%
of his time working on the hormone adding process during the test month. This will be split evenly
between the male and female versions of the product. Extra labour will be required to further
process the perfume, with an extra 500 hours for the male version and 700 extra hours for the
female version of the hormone-added product. Labour is currently fully employed, making the
standard product. New labour with the required skills will not be available at short notice. Sniff Co
allocates fixed overhead at the rate of $25 per labour hour to all products for the purposes of
reporting profits.

The sales prices that could be achieved as a one-off monthly promotion are:

– Male version: $75·00 per 100 ml

– Female version: $59·50 per 100 ml

Required:

(a) Outline the financial and other factors that Sniff Co should consider when making a
further processing decision.

36
Note: no calculations are required. (4 marks)

(b) Evaluate whether Sniff Co should experiment with the hormone adding process using the data
provided. Provide a separate assessment and conclusion for the male and the female versions of
the product. (15 marks)

(c) Calculate the selling price per 100 ml for the female version of the product that would
ensure further processing would break even in the test month. (2 marks)

(d) Sniff Co is considering outsourcing the production of the standard perfume. Outline the main
factors it should consider before making such a decision. (4 marks)

37
SESSION 3.4 SHUT DOWN DECISION
QUESTION 1 (12/2009)
Stay Clean manufactures and sells a small range of kitchen equipment. Specifically the product range
contains a dishwasher (DW), a washing machine (WM) and a tumble dryer (TD). The TD is of a rather
old design and has for some time generated negative contribution. It is widely expected that in one
year’s time the market for this design of TD will cease, as people switch to a washing machine that
can also dry clothes after the washing cycle has completed.
Stay Clean is trying to decide whether or not to cease the production of TD now or in 12 months’
time when the new combined washing machine/drier will be ready. To help with this decision the
following information has been provided:
1. The normal selling prices, annual sales volumes and total variable costs for the three products are
as follows:
DW WM TD
Selling price per unit $200 $350 $80
Material cost per unit $70 $100 $50
Labour cost per unit $50 $80 $40
Contribution per unit $80 $170 –$10
Annual sales 5,000 units 6,000 units 1,200 units
2. It is thought that some of the customers that buy a TD also buy a DW and a WM. It is estimated
that 5% of the sales of WM and DW will be lost if the TD ceases to be produced.
3. All the direct labour force currently working on the TD will be made redundant immediately if TD
is ceased now. This would cost $6,000 in redundancy payments. If Stay Clean waited for 12 months
the existing labour force would be retained and retrained at a cost of $3,500 to enable them to
produce the new washing/drying product. Recruitment and training costs of labour in 12 months’
time would be $1,200 in the event that redundancy takes place now.
4. Stay Clean operates a just in time (JIT) policy and so all material cost would be saved on the TD for
12 months if TD production ceased now. Equally, the material costs relating to the lost sales on the
WM and the DW would also be saved. However, the material supplier has a volume based discount
scheme in place as follows:
Total annual expenditure ($) Discount
0–600,000 0%
600,001–800,000 1%
800,001–900,000 2%
900,001–960,000 3%
960,001 and above 5%
Stay Clean uses this supplier for all its materials for all the products it manufactures. The figures
given above in the cost per unit table for material cost per unit are net of any discount Stay Clean
already qualifies for.
5. The space in the factory currently used for the TD will be sublet for 12 months on a short-term
lease contract if production of TD stops now. The income from that contract will be $12,000.
6. The supervisor (currently classed as an overhead) supervises the production of all three
products spending approximately 20% of his time on the TD production. He would continue to be
fully employed if the TD ceases to be produced now.
Required:

38
(a) Calculate whether or not it is worthwhile ceasing to produce the TD now rather than waiting 12
months (ignore any adjustment to allow for the time value of money). (13 marks)
(b) Explain two pricing strategies that could be used to improve the financial position of the
business in the next 12 months assuming that the TD continues to be made in that period. (4
marks)
(c) Briefly describe three issues that Stay Clean should consider if it decides to outsource the
manufacture of one of its future products. (3 marks)

39
SESSION 4: DECISION MAKING WITH RISK AND UNCERTAINTY
QUESTION 1 (6/2011 – 1)

Cement Co is a company specialising in the manufacture of cement, a product used in the building
industry. The company has found that when weather conditions are good, the demand for cement
increases since more building work is able to take place. Last year, the weather was so good, and the
demand for cement was so great, that Cement Co was unable to meet demand. Cement Co is now
trying to work out the level of cement production for the coming year in order to maximise profits.
The company doesn’t want to miss out on the opportunity to earn large profits by running out of
cement again. However, it doesn’t want to be left with large quantities of the product unsold at the
end of the year, since it deteriorates quickly and then has to be disposed of. The company has
received the following estimates about the probable weather conditions and corresponding demand
levels for the coming year:

Weather Probability Demand

Good 25% 350,000 bags

Average 45% 280,000 bags

Poor 30% 200,000 bags

Each bag of cement sells for $9 and costs $4 to make. If cement is unsold at the end of the year, it
has to be disposed of at a cost of $0·50 per bag.

Cement Co has decided to produce at one of the three levels of production to match forecast
demand. It now has to decide which level of cement production to select.

Required:

(a) Construct a pay off table to show all the possible profit outcomes. (8 marks)

(b) Decide the level of cement production the company should choose, based on the following
decision rules:

(i) Maximin (1 mark)

(ii) Maximax (1 mark)

(iii) Expected value (4 marks)

You must justify your decision under each rule, showing all necessary calculations.

(c) Describe the ‘maximin’ and ‘expected value’ decision rules, explaining when they might be
used and the attitudes of the decision makers who might use them. (6 marks)

(20 marks)

40
QUESTION 2 (6/2014 – Q4)

4 Gam Co sells electronic equipment and is about to launch a new product onto the market. It needs
to prepare its budget for the coming year and is trying to decide whether to launch the product at a
price of $30 or $35 per unit. The following information has been obtained from market research:

Price per unit $30 Price per unit $35

Probability Sales volume Probability Sales volume
0·4 120,000 0·3 108,000
0·5 110,000 0·3 100,000
0·1 140,000 0·4 94,000
Notes

1 Variable production costs would be $12 per unit for production volumes up to and including
100,000 units each year. However, if production exceeds 100,000 units each year, the variable
production cost per unit would fall to $11 for all units produced.

2 Advertising costs would be $900,000 per annum at a selling price of $30 and $970,000 per annum
at a price of $35.

3 Fixed production costs would be $450,000 per annum.

Required:

(a) Calculate each of the six possible profit outcomes which could arise for Gam Co in the coming
year. (8 marks)

(b) Calculate the expected value of profit for each of the two price options and recommend, on
this basis, which option Gam Co would choose. (3 marks)

(c) Briefly explain the maximin decision rule and identify which price should be chosen by
management if they use this rule to decide which price should be charged. (3 marks)

(d) Discuss the factors which may give rise to uncertainty when setting budgets. (6 marks)

(20 marks)

41
QUESTION 3 (12/2008)

Shifters Haulage (SH) is considering changing some of the vans it uses to transport crates for
customers. The new vans come in three sizes; small, medium and large. SH is unsure about which
type to buy. The capacity is 100 crates for the small van, 150 for the medium van and 200 for the
large van.

Demand for crates varies and can be either 120 or 190 crates per period, with the probability of the
higher demand figure being 0·6.

The sale price per crate is $10 and the variable cost $4 per crate for all van sizes subject to the fact
that if the capacity of the van is greater than the demand for crates in a period then the variable cost
will be lower by 10% to allow for the fact that the vans will be partly empty when transporting
crates.

SH is concerned that if the demand for crates exceeds the capacity of the vans then customers will
have to be turned away. SH estimates that in this case goodwill of $100 would be charged against
profits per period to allow for lost future sales regardless of the number of customers that are
turned away.

Depreciation charged would be $200 per period for the small, $300 for the medium and $400 for the
large van. SH has in the past been very aggressive in its decision-making, pressing ahead with rapid
growth strategies. However, its managers have recently grown more cautious as the business has
become more competitive.

Required:

(a) Explain the principles behind the maximax, maximin and expected value criteria that are
sometimes used to make decisions in uncertain situations. (4 marks)

(b) Prepare a profits table showing the SIX possible profit figures per period. (9 marks)

(c) Using your profit table from (b) above discuss which type of van SH should buy taking into
consideration the possible risk attitudes of the managers. (6 marks)

(d) Describe THREE methods other than those mentioned in (a) above, which businesses can use to
analyse and assess the risk that exists in its decision-making. (6 marks)

(25 marks)

42
Question 4 (6/2013 – Q1)

1 Gym Bunnies (GB) is a health club. It currently has 6,000 members, with each member paying a
subscription fee of $720 per annum. The club is comprised of a gym, a swimming pool and a small
exercise studio. A competitor company is opening a new gym in GB’s local area, and this is
expected to cause a fall in GB’s membership numbers, unless GB can improve its own facilities.
Consequently, GB is considering whether or not to expand its exercise studio in a hope to improve its
membership numbers. Any improvements are expected to last for three years.

Option 1

No expansion. In this case, membership numbers would be expected to fall to 5,250 per annum for
the next three years. Operational costs would stay at their current level of $80 per member per
annum.

Option 2

Expand the exercise studio. The capital cost of this would be $360,000.The expected effect on
membership numbers for the next three years is as follows:

Probability Effect on membership numbers

0·4 Remain at their current level of 6,000 members per annum

0·6 Increase to 6,500 members per annum

The effect on operational costs for the next three years is expected to be:

Probability Effect on operational costs

0·5 Increase to $120 per member per annum

0·5 Increase to $180 per member per annum

Required:

(a) Using the criterion of expected value, prepare and fully label a decision tree that shows the
two options available to GB. Recommend the decision that GB should make.

Note: Ignore time value of money. (12 marks)

(b) Calculate the maximum price that GB should pay for perfect information about the expansion’s
exact effect on MEMBERSHIP NUMBERS. (6 marks)

(c) Briefly discuss the problems of using expected values for decisions of this nature. (2 marks)

(20 marks)

43
SESSION 5: PRICING DECISION
QUESTION 1 (6/2011 – Q1)

2 Heat Co specialises in the production of a range of air conditioning appliances for industrial
premises. It is about to launch a new product, the ‘Energy Buster’, a unique air conditioning unit
which is capable of providing unprecedented levels of air conditioning using a minimal amount of
electricity. The technology used in the Energy Buster is unique so Heat Co has patented it so that no
competitors can enter the market for two years. The company’s development costs have been high
and it is expected that the product will only have a five-year life cycle.

Heat Co is now trying to ascertain the best pricing policy that they should adopt for the Energy
Buster’s launch onto the market. Demand is very responsive to price changes and research has
established that, for every $15 increase in price, demand would be expected to fall by 1,000 units. If
the company set the price at $735, only 1,000 units would be demanded.

The costs of producing each air conditioning unit are as follows:

$
Direct materials 42
Labour 12 (1·5 hours at $8 per hour. See note below)
Fixed overheads 6 (based on producing 50,000 units per annum)
–––
Total cost 60
–––
Note
The first air conditioning unit took 1·5 hours to make and labour cost $8 per hour. A 95% learning
curve exists, in relation to production of the unit, although the learning curve is expected to finish
after making 100 units. Heat Co’s management have said that any pricing decisions about the Energy
Buster should be based on the time it takes to make the 100th unit of the product. You have been
told that the learning co-efficient, b = –0·0740005.

All other costs are expected to remain the same up to the maximum demand levels.

Required:

(a) (i) Establish the demand function (equation) for air conditioning units; (3 marks)

(ii) Calculate the marginal cost for each air conditioning unit after adjusting the labour cost as
required by the note above; (6 marks)

(iii) Equate marginal cost and marginal revenue in order to calculate the optimum price and
quantity. (3 marks)

(b) Explain what is meant by a ‘penetration pricing’ strategy and a ‘market skimming’
strategy and discuss whether either strategy might be suitable for Heat Co when launching the
Energy Buster. (8 marks)

44
QUESTION 2 (6/2015 – Q4)

4 ALG Co is launching a new, innovative product onto the market and is trying to decide on the right
launch price for the product. The product’s expected life is three years. Given the high level of costs
which have been incurred in developing the product, ALG Co wants to ensure that it sets its price at
the right level and has therefore consulted a market research company to help it do this. The
research, which relates to similar but not identical products launched by other companies, has
revealed that at a price of $60, annual demand would be expected to be 250,000 units.

However, for every $2 increase in selling price, demand would be expected to fall by 2,000 units and
for every $2 decrease in selling price, demand would be expected to increase by 2,000 units.

A forecast of the annual production costs which would be incurred by ALG Co in relation to the new
product are as follows:

Annual production (units) 200,000 250,000 300,000 350,000

$ $ $ $
Direct material 2,400,000 3,000,000 3,600,000 4,200,000
Direct labour 1,200,000 1,500,000 1,800,000 2,100,000
Overheads 1,400,000 1,550,000 1,700,000 1,850,000
Required:

(a) Calculate the total variable cost per unit and total fixed overheads. (3 marks)

(b) Calculate the optimum (profit maximising) selling price for the new product AND calculate the
resulting profit for the period.

Note: If P = a – bx then MR = a – 2bx. (7 marks)

(c) The sales director is unconvinced that the sales price calculated in (b) above is the right one to
charge on the initial launch of the product. He believes that a high price should be charged at launch
so that those customers prepared to pay a higher price for the product can be ‘skimmed off’ first.

Required:

Discuss the conditions which would make market skimming a more suitable pricing strategy for
ALG, and recommend whether ALG should adopt this approach instead. (5 marks)

(15 marks)

45
QUESITON 3 (12/2017)

TR Co is a pharmaceutical company which researches, develops and manufactures a wide range of

drugs. One of these drugs, ‘Parapain’, is a pain relief drug used for the treatment of headaches and
until last month TR Co had a patent on Parapain which prevented other companies from
manufacturing it. The patent has now expired and several competitors have already entered the
market with similar versions of Parapain, which are made using the same active ingredients.

TR Co is reviewing its pricing policy in light of the changing market. It has carried out some market
research in an attempt to establish an optimum price for Parapain. The research has established that
for every $2 decrease in price, demand would be expected to increase by 5,000 batches, with
maximum demand for Parapain being one million batches.

Each batch of Parapain is currently made using the following materials:

Material Z: 500 grams at $0·10 per gram

Material Y: 300 grams at $0·50 per gram

Each batch of Parapain requires 20 minutes of machine time to make and the variable running costs
for machine time are $6 per hour. The fixed production overhead cost is expected to be $2 per batch
for the period, based on a budgeted production level of 250,000 batches.

The skilled workers who have been working on Parapain until now are being moved onto the
production of TR Co’s new and unique anti-malaria drug which cost millions of dollars to develop. TR
Co has obtained a patent for this revolutionary drug and it is expected to save millions of lives. No
other similar drug exists and, whilst demand levels are unknown, the launch of the drug is eagerly
anticipated all over the world.

Agency staff, who are completely new to the production of Parapain and cost $18 per hour, will be
brought in to produce Parapain for the foreseeable future. Experience has shown there will be a
significant learning curve involved in making Parapain as it is extremely difficult to handle. The first
batch of Parapain made using one of the agency workers took 5 hours to make. However, it is
believed that an 80% learning curve exists, in relation to production of the drug, and this will
continue until the first 1,000 batches have been completed. TR Co’s management has said that any
pricing decisions about Parapain should be based on the time it takes to make the 1,000th batch of
the drug.

Note: The learning co-efficient, b = –0·321928

Required:

(a) Calculate the optimum (profit-maximising) selling price for Parapain and the resulting annual
profit which TR Co will make from charging this price.

Note: If P = a – bQ, then MR = a – 2bQ (12 marks)

(b) Discuss and recommend whether market penetration or market skimming would be the most
suitable pricing strategy for TR Co when launching the new anti-malaria drug. (8 marks)

46
PART C BUDGETING
SESSION 1: QUANTITATIVE IN BUDGETING
QUESTION 1 (6/2009 – Q5)
Northland’s major towns and cities are maintained by local government organisations (LGO), which
are funded by central government. The LGOs submit a budget each year which forms the basis of the
funds received.
You are provided with the following information as part of the 2010 budget preparation.
Overheads
Overhead costs are budgeted on an incremental basis, taking the previous year’s actual expenditure
and adding a set % to allow for inflation. Adjustments are also made for known changes. The details
for these are:
Overhead cost category 2009 cost ($) Known changes Inflation adjustment
between 2009 and 2010
Property cost 120,000 None +5%
Central wages 150,000 Note 1 below +3%
Stationery 25,000 Note 2 below 0%
Note 1: One new staff member will be added to the overhead team; this will cost $12,000 in 2010
Note 2: A move towards the paperless office is expected to reduce stationery costs by 40% on the
2009 spend
Road repairs
In 2010 it is expected that 2,000 metres of road will need repairing but a contingency of an extra
10% has been agreed.
In 2009 the average cost of a road repair was $15,000 per metre repaired, but this excluded any cost
effects of extreme weather conditions. The following probability estimates have been made in
respect of 2010:
Weather type predicted Probability Increase in repair cost
Good 0·7 0
Poor 0·1 +10%
Bad 0·2 +25%
Inflation on road repairing costs is expected to be 5% between 2009 and 2010.
New roads

New roads are budgeted on a zero base basis and will have to compete for funds along with other
capital projects such as hospitals and schools.

Required:

(a) Calculate the overheads budget for 2010. (3 marks)

(b) Calculate the budgets for road repairs for 2010. (6 marks)

(c) Explain the problems associated with using expected values in budgeting by an LGO and
explain why a contingency for road repairs might be needed. (8 marks)

47
QUESTION 2 (6/2013 – Q5)

Newtown School’s head teacher has prepared the budget for the year ending 31 May 2014. The
government pays the school $1,050 for each child registered at the beginning of the school year,
which is June 1, and $900 for any child joining the school part-way through the year. The school does
not have to refund the money to the government if a child leaves the school part-way through the
year. The number of pupils registered at the school on 1 June 2013 is 690, which is 10% lower than
the previous year. Based on past experience, the probabilities for the number of pupils starting the
school part-way through the year are as follows:

Probability No. of pupils joining late

0·2 50
0·3 20
0·5 26
The head teacher admits to being ‘poor with numbers’ and does not understand probabilities so,
when calculating budgeted revenue, he just calculates a simple average for the number of pupils
expected to join late. His budgeted revenue for the year ending 31 May 2014 is therefore as follows:

Pupils Rate per pupil Total income

Pupils registered at beginning of school year 690 $1,050 $724,500
Average expected number of new joiners 32 $900 $28,800
–––––––––
$753,300
–––––––––
The head teacher uses incremental budgeting to budget for his expenditure, taking actual
expenditure for the previous year as a starting point and simply adjusting it for inflation, as shown
below.

Note Actual cost Inflationary Budgeted cost for

for y/e 31 May 2013 adjustment y/e 31 May 2014
$ $
Repairs and maintenance 1 44,000 +3% 45,320
Salaries 2 620,000 +2% 632,400
Capital expenditure 3 65,000 +6% 68,900
––––––––
Total budgeted
expenditure
746,620
––––––––
Budget surplus
6,680
––––––––

Notes

1. $30,000 of the costs for the year ended 31 May 2013 related to standard maintenance checks and
repairs that have to be carried out by the school every year in order to comply with government
health and safety standards. These are expected to increase by 3% in the coming year. In the year
ended 31 May 2013, $14,000 was also spent on redecorating some of the classrooms. No
redecorating is planned for the coming year.

48
2. One teacher earning a salary of $26,000 left the school on 31 May 2013 and there are no plans to
replace her. However, a 2% pay rise will be given to all staff with effect from 1 December 2013.

3. The full $65,000 actual costs for the year ended 31 May 2013 related to improvements made to
the school gym. This year, the canteen is going to be substantially improved, although the extent of
the improvements and level of service to be offered to pupils is still under discussion. There is a 0·7
probability that the cost will be $145,000 and a 0·3 probability that it will be $80,000. These costs
must be paid in full before the end of the year ending 31 May 2014.

Required:

(a) Considering the views of the board of governors, recalculate the budget surplus/deficit for the
year ending 31 May 2014. (6 marks)

49
QUESTION 3 (12/2008)

Henry Company (HC) provides skilled labour to the building trade. They have recently been asked by
a builder to bid for a kitchen fitting contract for a new development of 600 identical apartments. HC
has not worked for this builder before. Cost information for the new contract is as follows:

Labour for the contract is available. HC expects that the first kitchen will take 24 man-hours to fit but
thereafter the time taken will be subject to a 95% learning rate. After 200 kitchens are fitted the
learning rate will stop and the time taken for the 200th kitchen will be the time taken for all the
remaining kitchens. Labour costs $15 per hour.

Overheads are absorbed on a labour hour basis. HC has collected overhead information for the last
four months and this is shown below:

Hours worked Overhead cost $

Month 1 9,300 115,000

Month 2 9,200 113,600

Month 3 9,400 116,000

Month 4 9,600 116,800

HC normally works around 120,000 labour hours in a year.

HC uses the high low method to analyse overheads.

The learning curve equation is y = axb , where B= -0.074

Required:

(a) Describe FIVE factors, other than the cost of labour and overheads mentioned above, that HC
should take into consideration in calculating its bid. (10 marks)

(b) Calculate the total cost including all overheads for HC that it can use as a basis of the bid for
the new apartment contract. (13 marks)

(c) If the second kitchen alone is expected to take 21·6 man-hours to fit demonstrate how the
learning rate of 95% has been calculated. (2 marks)

(25 marks)

50
QUESTION 4 (6/2009 – Q3)

Noble is a restaurant that is only open in the evenings, on SIX days of the week. It has eight
restaurant and kitchen staff, each paid a wage of $8 per hour on the basis of hours actually worked.
It also has a restaurant manager and a head chef, each of whom is paid a monthly salary of $4,300.
Noble’s budget and actual figures for the month of May was as follows:
Budget Actual
Number of meals 1,200 1,560
$ $ $ $
Revenue: Food 48,000 60,840
Drinks 12,000 11,700
––––––– ––––––––
60,000 72,540
Variable costs:
Staff wages (9,216) (13,248)
Food costs (6,000) (7,180)
Drink costs (2,400) (5,280)
Energy costs (3,387) (3,500)
(21,003) (29,208)
––––––– ––––––––
Contribution 38,997 43,332
Fixed costs:
Manager’s and chef’s pay (8,600) (8,600)
Rent, rates and depreciation (4,500) (13,100) (4,500) (13,100)
––––––– –––––––– ––––––– ––––––––
Operating profit 25,897 30,232
––––––– ––––––––
The budget above is based on the following assumptions:
1 The restaurant is only open six days a week and there are four weeks in a month. The average
number of orders each day is 50 and demand is evenly spread across all the days in the month.
2 The restaurant offers two meals: Meal A, which costs $35 per meal and Meal B, which costs $45
per meal. In addition to this, irrespective of which meal the customer orders, the average customer
consumes four drinks each at $2·50 per drink. Therefore, the average spend per customer is either
$45 or $55 including drinks, depending on the type of meal selected. The May budget is based on
50% of customers ordering Meal A and 50% of customers ordering Meal B.
3 Food costs represent 12·5% of revenue from food sales.
4 Drink costs represent 20% of revenue from drinks sales.
5 When the number of orders per day does not exceed 50, each member of hourly paid staff is
required to work exactly six hours per day. For every incremental increase of five in the average
number of orders per day, each member of staff has to work 0·5 hours of overtime for which they
are paid at the increased rate of $12 per hour. You should assume that all costs for hourly paid staff
are treated wholly as variable costs.
6 Energy costs are deemed to be related to the total number of hours worked by each of the hourly
paid staff, and are absorbed at the rate of $2·94 per hour worked by each of the eight staff.
Required: Prepare a flexed budget for the month of May, assuming that the standard mix of
customers remains the same as budgeted. (12 marks)

51
QUESTION 2 (12/2014 – Q1)
Chair Co has developed a new type of luxury car seat. The estimated labour time for the first unit is
12 hours but a learning curve of 75% is expected to apply for the first eight units produced. The cost
of labour is $15 per hour. The cost of materials and other variable overheads is expected to total
$230 per unit.
Chair Co plans on pricing the seat by adding a 50% mark-up to the total variable cost per seat, with
the labour cost being based on the incremental time taken to produce the 8th unit.
Required:
(a) Calculate the price which Chair Co expects to charge for the new seat.
Note: The learning index for a 75% learning curve is –0·415. (5 marks)
(b) The first phase of production has now been completed for the new car seat. The first
unit actually took 12·5 hours to make and the total time for the first eight units was 34·3 hours, at
which point the learning effect came to an end. Chair Co are planning on adjusting the price to
reflect the actual time it took to complete the 8th unit.
Required:
(i) Calculate the actual rate of learning and state whether this means that the labour force actually
learnt more quickly or less quickly than expected. (3 marks)
(ii) Briefly explain whether the adjusted price charged by Chair Co will be higher or lower than the
price you calculated in part (a) above. You are NOT required to calculate the adjusted price. (2
marks)

52
SESSION 2: TYPES OF BUDGETING
QUESTION 1 (6/2015 – Q5)

Lesting Regional Authority (LRA) is responsible for the provision of a wide range of services in the
Lesting region, which is based in the south of the country ‘Alaia’. These services include, amongst
other things, responsibility for residents’ welfare, schools, housing, hospitals, roads and waste
management.

Over recent months the Lesting region experienced the hottest temperatures on record, resulting in
several forest fires, which caused damage to several schools and some local roads. Unfortunately,
these hot temperatures were then followed by flooding, which left a number of residents
without homes and saw higher than usual numbers of admissions to hospitals due to the
outbreak of disease. These hospitals were full and some patients were treated in tents. Residents
have been complaining for some years that a new hospital is needed in the area.

Prior to these events, the LRA was proudly leading the way in a new approach to waste
management, with the introduction of its new ‘Waste Recycling Scheme.’ Two years ago, it began
phase 1 of the scheme and half of its residents were issued with different coloured waste bins for
different types of waste. The final phase was due to begin in one month’s time. The cost of providing
the new waste bins is significant but LRA’s focus has always been on the long-term savings both to
the environment and in terms of reduced waste disposal costs.

The LRA is about to begin preparing its budget for the coming financial year, which starts in one
month’s time. Over recent years, zero-based budgeting (ZBB) has been introduced at a number of
regional authorities in Alaia and, given the demand on resources which LRA faces this year, it is
considering whether now would be a good time to introduce it.

Required:

(a) Describe the main steps involved in preparing a zero-based budget. (3 marks)

(b) Discuss the problems which the Lesting Regional Authority (LRA) may encounter if it decides to
introduce and use ZBB to prepare its budget for the coming financial year. (9 marks)

(c) Outline THREE potential benefits of introducing zero-based budgeting at the LRA. (3 marks)

53
QUESTION 2 (12/2017)

Spike Co manufactures and sells good quality leather bound diaries. Each year it budgets for its
profits, including detailed budgets for sales, materials and labour. If appropriate, the departmental
managers are allowed to revise their budgets for planning errors.

In recent months, the managing director has become concerned about the frequency of budget
revisions. At a recent board meeting he said ‘There seems little point budgeting any more. Every
time we have a problem the budgets are revised to leave me looking at a favourable operational
variance report and at the same time a lot less profit than promised.’

Required:

(a) Describe the circumstances when a budget revision should be allowed and when it should be
refused. (5 marks)

Two specific situations have recently arisen, for which budget revisions were sought:

Materials

A local material supplier was forced into liquidation. Spike Co’s buyer managed to find another
supplier, 150 miles away at short notice. This second supplier charged more for the material and a
supplementary delivery charge on top. The buyer agreed to both the price and the delivery charge
without negotiation. ‘I had no choice’, the buyer said, ‘the production manager was pushing me
very hard to find any solution possible!’ Two months later, another, more competitive, local
supplier was found.

A budget revision is being sought for the two months where higher prices had to be paid.

Labour

During the early part of the year, problems had been experienced with the quality of work being
produced by the support staff in the labour force. The departmental manager had complained in his
board report that his team were ‘unreliable, inflexible and just not up to the job’.

It was therefore decided, after discussion of the board report, that something had to be done. The
company changed its policy so as to recruit only top graduates from good quality universities. This
has had the effect of pushing up the costs involved but increasing productivity in relation to that
element of the labour force.

The support staff departmental manager has requested a budget revision to cover the extra costs
involved following the change of policy.

Required:

(b) Discuss each request for a budget revision, putting what you see as both sides of the argument
and reach a conclusion as to whether a budget revision should be allowed. (8 marks)

54
QUESTION 3 (12/2012 – Q4)

Designit is a small company providing design consultancy to a limited number of large clients. The
business is mature and fairly stable year on year. It has 30 employees and is privately owned by its
founder. Designit prepares an annual fixed budget. The company’s accounts department consists
of one part-qualified accountant who has a heavy workload. He prepares the budget using
spreadsheets. The company has a November year end.

Designit pays each of its three sales managers an annual salary of $150,000, plus an individual bonus
based on sales targets set at the beginning of the year. There are always two levels of bonus that can
be earned, based on a lower and an upper level of fee income. For the year ended 30 November
2012, for example, each of the sales managers was given a lower target of securing $1·5m of fee
income each, to be rewarded by an individual bonus equating to 20% of salary. If any of the
managers secured a further $1·5m of fee income, their bonus would increase by 5% to the upper
target of 25%. None of the managers achieved the upper target but all of them achieved the lower
one.

This is the same every year and Designit finds that often the managers secure work from several
major clients early in the year and reach the $1·5m target well before the year has ended. They then
make little effort to secure extra fees for the company, knowing that it would be almost impossible
to hit the second target. This, together with a few other problems that have arisen, has made the
company consider whether its current budgeting process could be improved and whether the bonus
scheme should also be changed.

Designit is now considering replacing the fixed budget with a monthly rolling budget, which Designit
believes will make the budgeting process more relevant and timely and encourage managers to
focus on the future rather than the past. It would also prevent the problem of targets being met too
early on in the year by the sales managers because the targets would be set for monthly
performance rather than annual performance. For example, a manager could be given a target of
securing $200,000 fee income in the first month for a reward of 2% of salary. Then, depending on
what is happening both within the business and in the economy as a whole, at the end of the first
month, a different target fee income could be set for the second month.

Required:

(a) Explain what a monthly rolling budget is and how it would operate at Designit. (4 marks)

(b) Discuss the problems that may be encountered if Designit decides to introduce monthly
rolling budgets together with a new bonus scheme, such as the one outlined above. (6 marks)

(c) Discuss the problems with the current bonus scheme and, assuming that the company
decides against introducing rolling budgets, describe and justify an alternative, more effective
bonus scheme that could be introduced. (6 marks)

(d) Discuss the risk of using the company accountant’s own spreadsheets for budgeting. (4 marks)

55
PART D VARIANCE ANALYSIS

SESSION 1: BASIC VARIANCE

QUESTION 1 (6/2010 – Q2)
In May 2010 the budgeted sales were 19,000 bats and the standard cost card is as follows:
Std cost Std cost
$ $
Materials (2kg at $5/kg) 10
Labour (3hrs at $12/hr) 36
Marginal cost 46
Selling price 68
Contribution 22
In May 2010 the following results were achieved:
40,000kg of wood were bought at a cost of $196,000, this produced 19,200 cricket bats. No
inventory of raw materials is held. The labour was paid for 62,000 hours and the total cost
was $694,000. Labour worked for 61,500 hours.
The sales price was reduced to protect the sales levels. However, only 18,000 cricket bats were sold
at an average price of $65.
Required: Calculate the materials, labour and sales variances for May 2010 in as much detail as
the information allows. (13 marks)

56
SESSION 2: PLANNING AND OPERATING VARIANCE
QUESTION 2 (12/2009)
Secure Net (SN) manufacture security cards that restrict access to government owned buildings
around the world. The standard cost for the plastic that goes into making a card is $4 per kg and
each card uses 40g of plastic after an allowance for waste. In November 100,000 cards were
produced and sold by SN and this was well above the budgeted sales of 60,000 cards.
The actual cost of the plastic was $5·25 per kg and the production manager (who is responsible for
all buying and production issues) was asked to explain the increase. He said ‘World oil price
increases pushed up plastic prices by 20% compared to our budget and I also decided to use a
different supplier who promised better quality and increased reliability for a slightly higher price. I
know we have overspent but not all the increase in plastic prices is my fault’ The actual usage of
plastic per card was 35g per card and again the production manager had an explanation. He said
‘The world-wide standard size for security cards increased by 5% due to a change in the card reader
technology, however, our new supplier provided much better quality of plastic and this helped to cut
down on the waste.’
SN operates a just in time (JIT) system and hence carries very little inventory.
Required:
(a) Calculate the total material price and total material usage variances ignoring any possible
planning error in the figures. (4 marks)
(b) Analyse the above total variances into component parts for planning and operational variances
in as much detail as the information allows. (8 marks)
(c) Assess the performance of the production manager. (8 marks)

57
QUESTION 3 (12/2010 – Q1)
Carad Co is an electronics company which makes two types of televisions – plasma screen TVs and
LCD TVs. It operates within a highly competitive market and is constantly under pressure to reduce
prices. Carad Co operates a standard costing system and performs a detailed variance analysis of
both products on a monthly basis. Extracts from the management information for the month of
November are shown below:
Note
(1) The budgeted total sales volume for TVs was 1,180 units, consisting of an equal mix of plasma
screen TVs and LCD screen TVs. Actual sales volume was 750 plasma TVs and 650 LCD TVs. Standard
sales prices are $350 per unit for the plasma TVs and $300 per unit for the LCD TVs. The
actual sales prices achieved during November were $330 per unit for plasma TVs and $290 per
unit for LCD TVs. The standard contributions for plasma TVs and LCD TVs are $190 and $180 per unit
respectively.
(2) The sole reason for this variance was an increase in the purchase price of one of its key
components, X. Each plasma TV made and each LCD TV made requires one unit of component X, for
which Carad Co’s standard cost is $60 per unit. Due to a shortage of components in the market
place, the market price for November went up to $85 per unit for X. Carad Co actually paid $80 per
unit for it.
(3) Each plasma TV uses 2 standard hours of labour and each LCD TV uses 1·5 standard hours of
labour. The standard cost for labour is $14 per hour and this also reflects the actual cost per labour
hour for the company’s permanent staff in November. However, because of the increase in sales and
production volumes in November, the company also had to use additional temporary labour at the
higher cost of $18 per hour. The total capacity of Carad’s permanent workforce is 2,200 hours
production per month, assuming full efficiency. In the month of November, the permanent
workforce were wholly efficient, taking exactly 2 hours to complete each plasma TV and exactly 1·5
hours to produce each LCD TV. The total labour variance therefore relates solely to the temporary
workers, who took twice as long as the permanent workers to complete their production.
Required:
(a) Calculate the following for the month of November, showing all workings clearly:
(i) The sales price variance and sales volume contribution variance; (6 marks)
(ii) The material price planning variance and material price operational variance; (2 marks)
(iii) The labour rate variance and the labour efficiency variance. (7 marks)
(b) Explain the reasons why Carad Co would be interested in the material price planning
variance and the material price operational variance. (5 marks)

58
QUESTION 2 (12/2012 – Q2)

2 Truffle Co makes high quality, hand-made chocolate truffles which it sells to a local retailer. All
chocolates are made in batches of 16, to fit the standard boxes supplied by the retailer. The
standard cost of labour for each batch is $6·00 and the standard labour time for each batch is half an
hour. In November, Truffle Co had budgeted production of 24,000 batches; actual production was
only 20,500 batches. 12,000 labour hours were used to complete the work and there was no idle
time. All workers were paid for their actual hours worked. The actual total labour cost for

November was $136,800. The production manager at Truffle Co has no input into the budgeting
process. At the end of October, the managing director decided to hold a meeting and offer staff the
choice of either accepting a 5% pay cut or facing a certain number of redundancies. All staff
subsequently agreed to accept the 5% pay cut with immediate effect.

At the same time, the retailer requested that the truffles be made slightly softer. This
change was implemented immediately and made the chocolates more difficult to shape. When
recipe changes such as these are made, it takes time before the workers become used to working
with the new ingredient mix, making the process 20% slower for at least the first month of the new
operation.

The standard costing system is only updated once a year in June and no changes are ever made to
the system outside of this.

Required:

(a) Calculate the total labour rate and total labour efficiency variances for November, based on the
standard cost provided above. (4 marks)

(b) Analyse the total labour rate and total labour efficiency variances into component parts for
planning and operational variances in as much detail as the information allows. (8 marks)

(c) Assess the performance of the production manager for the month of November. (8 marks)

59
QUESTION 3 (12/2013 – Q5)

Bedco manufactures bed sheets and pillowcases which it supplies to a major hotel chain. It uses a
just-in-time system and holds no inventories.

The standard cost for the cotton which is used to make the bed sheets and pillowcases is $5 per m2.
Each bed sheet uses 2 m2 of cotton and each pillowcase uses 0·5 m2. Production levels for bed
sheets and pillowcases for November were as follows:

Budgeted production Actual production

levels (units) levels (units)
Bed sheets 120,000 120,000
Pillowcases 190,000 180,000

The actual cost of the cotton in November was $5·80 per m2. 248,000 m2 of cotton was used to
make the bed sheets and 95,000 m2 was used to make the pillowcases.

The world commodity prices for cotton increased by 20% in the month of November. At the
beginning of the month, the hotel chain made an unexpected request for an immediate design
change to the pillowcases. The new design required 10% more cotton than previously. It also
resulted in production delays and therefore a shortfall in production of 10,000 pillowcases in total
that month.

The production manager at Bedco is responsible for all buying and any production issues which
occur, although he is not responsible for the setting of standard costs.

Required:
(a) Calculate the following variances for the month of November, for both bed sheets and pillow
cases, and in total:
(i) Material price planning variance; (3 marks)
(ii) Material price operational variance; (3 marks)
(iii) Material usage planning variance; (3 marks)
(iv) Material usage operational variance. (3 marks)
(b) Assess the performance of the production manager for the month of November. (8 marks)
(20 marks)

60
QUESTION 4 (6/2015 – Q3)
3 Bokco is a manufacturing company. It has a small permanent workforce but it is also reliant on
temporary workers, whom it hires on three-month contracts whenever production requirements
increase. All buying of materials is the responsibility of the company’s purchasing department and
the company’s policy is to hold low levels of raw materials in order to minimise inventory holding
costs. Bokco uses cost plus pricing to set the selling prices for its products once an initial cost card
has been drawn up. Prices are then reviewed on a quarterly basis. Detailed variance reports are
produced each month for sales, material costs and labour costs. Departmental managers are then
paid a monthly bonus depending on the performance of their department.
One month ago, Bokco began production of a new product. The standard cost card for one unit was
drawn up to include a cost of $84 for labour, based on seven hours of labour at $12 per hour. Actual
output of the product during the first month of production was 460 units and the actual time taken
to manufacture the product totalled 1,860 hours at a total cost of $26,040.
After being presented with some initial variance calculations, the production manager has realised
that the standard time per unit of seven hours was the time taken to produce the first unit and that
a learning rate of 90% should have been anticipated for the first 1,000 units of production. He has
consequently been criticised by other departmental managers who have said that, ‘He has no idea of
all the problems this has caused.’
Required:
(a) Calculate the labour efficiency planning variance and the labour efficiency operational variance
AFTER taking account of the learning effect.
Note: The learning index for a 90% learning curve is –0·1520 (5 marks)
(b) Discuss the likely consequences arising from the production manager’s failure to take
into account the learning effect before production commenced. (5 marks)
(10 marks)

61
QUESTION 5 (6/2017)

The School Uniform Company (SU Co) manufactures school uniforms. One of its largest contracts is
with the Girls’ Private School Trust (GPST), which has 35 schools across the country, all with the
same school uniform.

After a recent review of the uniform at the GPST schools, the school’s spring/summer dress has been
re-designed to incorporate a dropped waistband. Each new dress now requires 2·2 metres of
material, which is 10% more material than the previous style of dress required. However, a new
material has also been chosen by the GPST which costs only $2·85 per metre which is 5% cheaper
than the material used on the previous dresses. In February, the total amount of material used and
purchased at this price was 54,560 metres.

The design of the new dresses has meant that a complicated new sewing technique needed to be
used. Consequently, all staff required training before they could begin production. The manager of
the sewing department expected each of the new dresses to take 10 minutes to make as compared
to 8 minutes per dress for the old style. SU Co has 24 staff, each of whom works 160 hours per
month and is paid a wage of $12 per hour. All staff worked all of their contracted hours in February
on production of the GPST dresses and there was no idle time. No labour rate variance arose in
February.

Activity levels for February were as follows:

Budgeted production and sales (units) 30,000

Actual production and sales (units) 24,000

The production manager at SU Co is responsible for all purchasing and production issues which
occur. SU Co uses standard costing and usually, every time a design change takes place, the standard
cost card is updated prior to production commencing. However, the company accountant
responsible for updating the standards has been off sick for the last two months. Consequently, the
standard cost card for the new dress has not yet been updated.

Required:

(a) Calculate the material variances in as much detail as the information allows for the month of
February. (7 marks)

(b) Calculate the labour efficiency variances in as much detail as the information allows for
the month of February. (5 marks)

(c) Assess the performance of the production manager for the month of February. (8 marks)

(20 marks)

62
SESSION 3: MARKET SIZE AND MARKET SHARE VARIANCE
QUESTION 1 (12/2007 – Q3)
The market for leather bound diaries has been shrinking as the electronic versions become more
widely available and easier to use. Spike Co has produced the following data relating to leather
bound diary sales for the year to date:
Budget
Sales volume 180,000 units
Sales price $17·00 per unit
Standard contribution $7·00 per unit
The total market for diaries in this period was estimated in the budget to be 1·8m units. In fact, the
actual total market shrank to 1·6m units for the period under review.
Actual results for the same period
Sales volume 176,000 units
Sales price $16·40 per unit
Required:
(c) Calculate the total sales price and total sales volume variance. (4 marks)
(d) Analyse the total sales volume variance into components for market size and market share. (4
marks)
(e) Comment on the sales performance of the business. (4 marks)

63
QUESTION 2 (6/2012 – Q4)
4 Lock Co makes a single product – a lock – and uses marginal costing. The standard cost card for one
unit is as follows:
Standard cost card $
Selling price 80
–––
Direct materials (4 kg at $3 per kg) 12
Direct labour (2 hours at $10 per hour) 20
Variable overhead (2 hours at $2 per hour) 4
–––
Marginal cost 36
–––
A junior member of the accounts team produced the following variance statement for the month of
May.
Budget Actual Variances
(1,000 units) (960 units)
$ $ $
Sales 80,000 76,800 3,200 Adv
Less: Marginal cost
Direct materials (12,000) (11,126) 874 Fav
Direct labour (20,000) (18,240) 1,760 Fav
Variable overheads (4,000) (3,283) 717 Fav
––––––– ––––––– ––––
Contribution 44,000 44,151 151 Fav
––––––– ––––––– –––––––
Lock Co used 3,648 kg of materials in the period and the labour force worked – and was paid for –
1,824 hours. Until now, Lock Co has had a market share of 25%. In the month of May, however, the
market faced an unexpected 10% decline in the demand for locks.
Required:
(a) Prepare a statement which reconciles budgeted contribution to actual contribution in as
much detail as possible. Do not calculate the sales price and the labour rate variances, since both
of these have a value of nil. Clearly show all other workings. (12 marks)

64
SESSION 4: MATERIAL MIX AND YIELD VARIANCE
QUESTION 1 (6/2009 – Q3)

In April 2009 the following data applied:

Standard cost card for one cake (not adjusted for the organic ingredient change)

Ingredients Kg $
Flour 0·10 0·12 per kg
Eggs 0·10 0·70 per kg
Butter 0·10 1·70 per kg
Sugar 0·10 0·50 per kg
Total input 0·40
Normal loss (10%) (0·04)
Standard weight of a cake 0·36
Standard sales price of a cake 0·85
Standard contribution per cake after all variable costs 0·35

The budget for production and sales in April was 50,000 cakes. Actual production and sales was
60,000 cakes in the month, during which the following occurred:

Ingredients used Kg $
Flour 5,700 $741
Eggs 6,600 $5,610
Butter 6,600 $11,880
Sugar 4,578 $2,747
Total input 23,478 $20,978
Actual loss (1,878)
Actual output of cake mixture 21,600
Actual sales price of a cake $0·99
All cakes produced must weigh 0·36 kg as this is what is advertised.
Required:
(b) Calculate the material price, mix and yield variances and the sales price and sales
contribution volume variances for April. You are not required to make any comment on the
performance of the managers. (13 marks)

65
QUESTION 2 (12/2011)
5 Choc Co is a company which manufactures and sells three types of biscuits in packets. One of them
is called ‘Ooze’ and contains three types of sweeteners: honey, sugar and syrup. The standard
materials usage and cost for one unit of ‘Ooze’ (one packet) is as follows:

$
Honey 20 grams at $0·02 per gram 0·40
Sugar 15 grams at $0·03 per gram 0·45
Syrup 10 grams at $0·025 per gram 0·25
1.10

In the three months ended 30 November 2011, Choc Co produced 101,000 units of ‘Ooze’ using
2,200 kg of honey, 1,400 kg of sugar and 1,050 kg of syrup. Note: there are 1,000 grams in a kilogram
(kg).

Required:

(a) Calculate the following variances for materials in Ooze:

(i) Total materials usage variance; (4 marks)

(ii) Total materials mix variance; (4 marks)

(iii) Total materials quantity (yield) variance. (4 marks)

66
SESSION 5: SALE MIX AND QUANTITY VARIANCE
QUESTION 1 (6/2013 – Q4)
4 Block Co operates an absorption costing system and sells three types of product – Commodity 1,
Commodity 2 and Commodity 3. Like other competitors operating in the same market, Block Co is
struggling to maintain revenues and profits in face of the economic recession which has engulfed the
country over the last two years. Sales prices fluctuate in the market in which Block Co operates.
Consequently, at the beginning of each quarter, a market specialist, who works on a consultancy
basis for Block Co, sets a budgeted sales price for each product for the quarter, based on his
expectations of the market. This then becomes the ‘standard selling price’ for the quarter. The sales
department itself is run by the company’s sales manager, who negotiates the actual sales prices with
customers. The following budgeted figures are available for the quarter ended 31 May 2013.
Product Budgeted production Standard selling price Standard variable
and sales units per unit production costs per unit
Commodity 1 30,000 $30 $18
Commodity 2 28,000 $35 $28·40
Commodity 3 26,000 $41·60 $26·40
Block Co uses absorption costing. Fixed production overheads are absorbed on the basis of direct
machine hours and the budgeted cost of these for the quarter ended 31 May 2013 was
$174,400. Commodity 1, 2 and 3 use 0·2 hours, 0·6 hours and 0·8 hours of machine time
respectively.
The following data shows the actual sales prices and volumes achieved for each product by Block Co
for the quarter ended 31 May 2013 and the average market prices per unit.
Product Actual production and Actual selling price Average market
price
sales units per unit per unit
Commodity 1 29,800 $31 $32·20
Commodity 2 30,400 $34 $33·15
Commodity 3 25,600 $40·40 $39·10
The following variances have already been correctly calculated for Commodities 1 and 2:
Sales price operational variances
Commodity 1: $35,760 Adverse
Commodity 2: $25,840 Favourable
Sales price planning variances
Commodity 1: $65,560 Favourable
Commodity 2: $56,240 Adverse
Required:
(a) Calculate, for Commodity 3 only, the sales price operational variance and the sales price
planning variance. (4 marks)
(b) Using the data provided for Commodities 1, 2 and 3, calculate the total sales mix variance and
the total sales quantity variance. (11 marks)

67
QUESTION 2 (6/2014 – Q5)
Valet Co is a car valeting (cleaning) company. It operates in the country of Strappia, which has been
badly affected by the global financial crisis. Petrol and food prices have increased substantially in the
last year and the average disposable household income has decreased by 30%. Recent studies have
shown that the average car owner keeps their car for five years before replacing it, rather than three
years as was previously the case. Figures over recent years also show that car sales in Strappia are
declining whilst business for car repairs is on the increase.
Valet Co offers two types of valet – a full valet and a mini valet. A full valet is an extensive clean of
the vehicle, inside and out; a mini valet is a more basic clean of the vehicle. Until recently, four
similar businesses operated in Valet Co’s local area, but one of these closed down three months ago
after a serious fire on its premises. Valet Co charges customers $50 for each full valet and $30 for
each mini valet and this price never changes. Their budget and actual figures for the last year were
as follows:
Budget Actual
Number of valets:
Full valets 3,600 4,000
Mini valets 2,000 3,980
$ $ $ $
Revenue 240,000 319,400
Variable costs:
Staff wages (114,000) (122,000)
Cleaning materials (6,200) (12,400)
Energy costs (6,520) (9,200)
–––––––– ––––––––
(126,720) (143,600)
–––––––– ––––––––
Contribution 113,280 175,800
Fixed costs:
Rent, rates and depreciation (36,800) (36,800)
–––––––– ––––––––
Operating profit 76,480 139,000
–––––––– ––––––––
The budgeted contribution to sales ratios for the two types of valet are 44·6% for full valets and 55%
for mini valets.
Required:
(a) Using the data provided for full valets and mini valets, calculate:
(i) The total sales mix contribution variance; (4 marks)
(ii) The total sales quantity contribution variance. (4 marks)
(b) Briefly describe the sales mix contribution variance and the sales quantity contribution
variance. (2 marks)
(c) Discuss the SALES performance of the business for the period, taking into account your
calculations from part (a) AND the information provided in the scenario. (10 marks)
(20 marks)

68
QUESTION 3 (12/2014)
5 The Safe Soap Co makes environmentally-friendly soap using three basic ingredients. The standard
cost card for one batch of soap for the month of September was as follows:
Material Kilograms Price per kilogram ($)
Lye 0.25 10
Coconut oil 0.6 4
Shea butter 0.5 3

The budget for production and sales in September was 120,000 batches. Actual production and sales
were 136,000 batches. The actual ingredients used were as follows:
Material Kilograms
Lye 34,080
Coconut oil 83,232
Shea butter 64,200

Required:
(a) Calculate the total material mix variance and the total material yield variance for September. (8
marks)
(b) In October the materials mix and yield variances were as follows:
Mix: $6,000 adverse
Yield: $10,000 favourable
The production manager is pleased with the results overall, stating:
‘At the beginning of September I made some changes to the mix of ingredients used for the soaps.
As I expected, the mix variance is adverse in both months because we haven’t yet updated our
standard cost card but, in both months, the favourable yield variance more than makes up for this.
Overall, I think we can be satisfied that the changes made to the product mix are producing good
results and now we are able to produce more batches and meet the growing demand for our
product.’
The sales manager, however, holds a different view and says:
‘I’m not happy with this change in the ingredients mix. I’ve had to explain to the board why the
sales volume variance for October was $22,000 adverse. I’ve tried to explain that the quality of the
soap has declined slightly and some of my customers have realised this and simply aren’t happy but
no-one seems to be listening. Some customers are even demanding that the price of the soap be
reduced and threatening to go elsewhere if the problem isn’t sorted out.’
Required:
(i) Briefly explain what the adverse materials mix and favourable materials yield variances indicate
about production at Safe Soap Co in October.
Note: You are NOT required to discuss revision of standards or operational and planning variances.
(4 marks)
(ii) Discuss whether the sales manager could be justified in claiming that the change in the
materials mix has caused an adverse sales volume variance in October. (3 marks)
(15 marks)

69
QUESTION 4 (12/2015)
3 The Organic Bread Company (OBC) makes a range of breads for sale direct to the public. The
production process begins with workers weighing out ingredients on electronic scales and then
placing them in a machine for mixing. A worker then manually removes the mix from the machine
and shapes it into loaves by hand, after which the bread is then placed into the oven for baking.
All baked loaves are then inspected by OBC’s quality inspector before they are packaged up and
made ready for sale.
Any loaves which fail the inspection are donated to a local food bank.
The standard cost card for OBC’s ‘Mixed Bloomer’, one of its most popular loaves, is as follows:
$
White flour 450 grams at $1·80 per kg 0·81
Wholegrain flour 150 grams at $2·20 per kg 0·33
Yeast 10 grams at $20 per kg 0·20
Total 610 grams 1·34
Budgeted production of Mixed Bloomers was 1,000 units for the quarter, although actual
production was only 950 units. The total actual quantities used and their actual costs were:
Kg $ per kg
White flour 408.5 1.9
Wholegrain flour 152 2.1
Yeast 10 20
Total 570.5

Required:
(a) Calculate the total material mix variance and the total material yield variance for OBC for the
last quarter. (7 marks)
(b) Using the information in the question, suggest THREE possible reasons why an ADVERSE
MATERIAL YIELD variance could arise at OBC. (3 marks)
(10 marks)

70
QUESTION 5 (9/2018 – Q32)

Kappa Co produces Omega, an animal feed made by mixing and heating three ingredients: Alpha,
Beta and Gamma.

The company uses a standard costing system to monitor its costs.

The standard material cost for 100 kg of Omega is as follows:

Input Kg Cost per kg Cost per 100 kg of

Omega
($) ($)
Alpha 40 2 80
Beta 60 5 300
Gamma 20 1 20
120 400
Notes

(1) The mixing and heating process is subject to a standard evaporation loss.

(2) Alpha, Beta and Gamma are agricultural products and their quality and price varies significantly
from year to year. Standard prices are set at the average market price over the last five years. Kappa
Co has a purchasing manager who is responsible for pricing and supplier contracts.

(3) The standard mix is set by the finance department. The last time this was done was at the
product launch which was five years ago. It has not changed since.

Last month 4,600 kg of Omega was produced, using the following inputs:

Input Kg Cost per kg Total cost

($) ($)
Alpha 2,200 1.8 3,960
Beta 2,500 6 15,000
Gamma 920 1 920
5,620 19,880
At the end of each month, the production manager receives a standard cost operating statement
from Kappa Co’s performance manager. The statement contains material price and usage variances,
labour rate and efficiency variances, and overhead expenditure and efficiency variances for the
previous month. No commentary on the variances is given and the production manager receives no
other feedback on the efficiency of the Omega process.

Required:

(a) Calculate the following variances for the last month:

(i) the material usage variance for each ingredient and in total; (4 marks)

(ii) the total material mix variance; (4 marks)

(iii) the total material yield variance. (3 marks)

(b) Discuss the problems with the current system of calculating and reporting variances for
assessing the performance of the production manager. (9 marks)

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SESSION 6: COMMENT ON VARIANCE
QUESTION 1 (6/2008 – Q2)

Chaff Co processes and sells brown rice. It buys unprocessed rice seeds and then, using a relatively
simple process, removes the outer husk of the rice to produce the brown rice. This means that there
is substantial loss of weight in the process. The market for the purchase of seeds and the sales of
brown rice has been, and is expected to be, stable.

Chaff Co uses a variance analysis system to monitor its performance.

There has been some concern about the interpretation of the variances that have been calculated in
month 1.

1. The purchasing manager is adamant, despite criticism from the production director, that he has
purchased wisely and saved the company thousands of dollars in purchase costs by buying the
required quantity of cheaper seeds from a new supplier.

2. The production director is upset at being criticised for increasing the wage rates for month 1; he
feels the decision was the right one, considering all the implications of the increase. Morale was
poor and he felt he had to do something about it.

3. The maintenance manager feels that saving $8,000 on fixed overhead has helped the
profitability of the business. He argues that the machines’ annual maintenance can wait for another
month without a problem as the machines have been running well.

The variances for month 1 are as follows:

$
Material price 48,000 (Fav)
Material usage 52,000 (Adv)
Labour rate 15,000 (Adv)
Labour efficiency 18,000 (Fav)
Labour idle time 12,000 (Fav)
Variable overhead expenditure 18,000 (Adv)
Variable overhead efficiency 30,000 (Fav)
Fixed overhead expenditure 8,000 (Fav)
Sales price 85,000 (Adv)
Sales volume 21,000 (Adv)
Fav = Favourable, Adv = Adverse
Chaff Co uses labour hours to absorb the variable overhead.

Required:

(a) Comment on the performance of the purchasing manager, the production director and
the maintenance manager using the variances and other information above and reach a
conclusion as to whether or not they have each performed well. (9 marks)

(c) Briefly discuss the performance of the business and, in particular, that of the sales manager for
the quarter ended 31 May 2013. (5 marks)
(20 marks)

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QUESTION 2 (6/2009 – Q3A)
Crumbly Cakes make cakes, which are sold directly to the public. The new production manager (a
celebrity chef) has argued that the business should use only organic ingredients in its cake
production. Organic ingredients are more expensive but should produce a product with an improved
flavour and give health benefits for the customers. It was hoped that this would stimulate demand
and enable an immediate price increase for the cakes.
Crumbly Cakes operates a responsibility based standard costing system which allocates
variances to specific individuals. The individual managers are paid a bonus only when net
favourable variances are allocated to them.
The new organic cake production approach was adopted at the start of March 2009, following a
decision by the new production manager. No change was made at that time to the standard costs
card. The variance reports for February and March are shown below (Fav = Favourable and Adv =
Adverse)
Manager responsible Allocated variances February March
Variance $ Variance $
Production manager
Material price
(total for all ingredients) 25 Fav 2,100 Adv
Material mix 0 600 Adv
Material yield 20 Fav 400 Fav
Sales manager
Sales price 40 Adv 7,000 Fav
Sales contribution volume 35 Adv 3,000 Fav
The production manager is upset that he seems to have lost all hope of a bonus under the new
system. The sales manager thinks the new organic cakes are excellent and is very pleased with the
progress made.
Crumbly Cakes operate a JIT stock system and holds virtually no inventory.
Required:
(a) Assess the performance of the production manager and the sales manager and indicate
whether the current bonus scheme is fair to those concerned. (7 marks)

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PART E PERFORMANCE MEASUREMENT
SESSION 1: OVERALL ASSESSMENT OF PERFORMANCE
QUESTION 1 (5 – 12/2009)
Thatcher International Park (TIP) is a theme park and has for many years been a successful business,
which has traded profitably. About three years ago the directors decided to capitalise on their
success and reduced the expenditure made on new thrill rides, reduced routine maintenance
where possible (deciding instead to repair equipment when it broke down) and made a
commitment to regularly increase admission prices. Once an admission price is paid customers can
use any of the facilities and rides for free.

These steps increased profits considerably, enabling good dividends to be paid to the owners and
bonuses to the directors. The last two years of financial results are shown below.

2008 2009
$ $
Sales 5,250,000 5,320,000
Less expenses:
Wages 2,500,000 2,200,000
Maintenance – routine 80,000 70,000
Repairs 260,000 320,000
Directors salaries 150,000 160,000
Directors bonuses 15,000 18,000
Other costs (including depreciation) 1,200,000 1,180,000
–––––––––– ––––––––––
Net profit 1,045,000 1,372,000
–––––––––– ––––––––––
Book value of assets at start of year 13,000,000 12,000,000
Dividend paid 500,000 650,000
Number of visitors 150,000 140,000
TIP operates in a country where the average rate of inflation is around 1% per annum.

Required:

(a) Assess the financial performance of TIP using the information given above. (14 marks)

During the early part of 2008 TIP employed a newly qualified management accountant. He
quickly became concerned about the potential performance of TIP and to investigate his concerns
he started to gather data to measure some non-financial measures of success. The data he has
gathered is shown below:

Table 1
2008 2009
Hours lost due to breakdown of rides (see note 1) 9,000 hours 32,000 hours
Average waiting time per ride 20 minutes 30 minutes
Note 1: TIP has 50 rides of different types. It is open 360 days of the year for 10 hours each day

Required:

(b) Assess the quality of the service that TIP provides to its customers using Table 1 and any other
relevant data and indicate the risks it is likely to face if it continues with its current policies. (6
marks)

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QUESTION 2 (6/2009 – Q2)

Oliver is the owner and manager of Oliver’s Salon which is a quality hairdresser that
experiences high levels of competition. The salon traditionally provided a range of hair services to
female clients only, including cuts, colouring and straightening

A year ago, at the start of his 2009 financial year, Oliver decided to expand his operations to include
the hairdressing needs of male clients. Male hairdressing prices are lower, the work simpler (mainly
hair cuts only) and so the time taken per male client is much less.

The prices for the female clients were not increased during the whole of 2008 and 2009 and the mix
of services provided for female clients in the two years was the same.

The latest financial results are as follows:

2008 2009
$ $ $ $
Sales 200,000 238,500
Less cost of sales:
Hairdressing staff costs 65,000 91,000
Hair products – female 29,000 27,000
Hair products – male 8,000
––––––– –––––––
94,000 126,000
–––––––– ––––––––
Gross profit 106,000 112,500
Less expenses:
Rent 10,000 10,000
Administration salaries 9,000 9,500
Electricity 7,000 8,000
Advertising 2,000 5,000
––––––– –––––––
Total expenses 28,000 32,500
–––––––– ––––––––
Profit 78,000 80,000
–––––––– ––––––––
Oliver is disappointed with his financial results. He thinks the salon is much busier than a year ago
and was expecting more profit. He has noted the following extra information:

1. Some female clients complained about the change in atmosphere following the introduction of
male services, which created tension in the salon.

2. Two new staff were recruited at the start of 2009. The first was a junior hairdresser to support the
specialist hairdressers for the female clients. She was appointed on a salary of $9,000 per annum.
The second new staff

member was a specialist hairdresser for the male clients. There were no increases in pay for existing
staff at the start of 2009 after a big rise at the start of 2008 which was designed to cover two years’
worth of increases.

Oliver introduced some non-financial measures of success two years ago.

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 2008 2009
Number of complaints 12 46
Number of male client visits 0 3,425
Number of female client visits 8,000 6,800
Number of specialist hairdressers for female clients 4 5
Number of specialist hairdressers for male clients 0 1
4Required:

(a) Calculate the average price for hair services per male and female client for each of the years
2008 and 2009. (3 marks)

(b) Assess the financial performance of the Salon using the data above. (11 marks)

(c) Analyse and comment on the non-financial performance of Oliver’s business, under the
headings of quality and resource utilisation. (6 marks)

(20 marks)

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QUESTION 3 (12/2007 – Q2)

2 Ties Only is a new business, selling high quality imported men’s ties via the internet. The managers,
who also own the company, are young and inexperienced but they are prepared to take risks. They
are confident that importing quality ties and selling via a website will be successful and that the
business will grow quickly. This is despite the well recognised fact that selling clothing is a very
competitive business.

They were prepared for a loss-making start and decided to pay themselves modest salaries (included
in administration expenses in table 1 below) and pay no dividends for the foreseeable future.

The owners are so convinced that growth will quickly follow that they have invested enough money
in website server development to ensure that the server can handle the very high levels of predicted
growth. All website development costs were written off as incurred in the internal management
accounts that are shown below in table 1.

Significant expenditure on marketing was incurred in the first two quarters to launch both
the website and new products. It is not expected that marketing expenditure will continue to be as
high in the future. Customers can buy a variety of styles, patterns and colours of ties at different
prices.

The business’s trading results for the first two quarters of trade are shown below in table 1

Table 1

Quarter 1 Quarter 2
$ $
Sales 420,000 680,000
less Cost of Sales (201,600) (340,680)
–––––––– ––––––––
Gross Profit 218,400 339,320
less expenses
Website development 120,000 90,000
Administration 100,500 150,640
Distribution 20,763 33,320
Launch marketing 60,000 40,800
Other variable expenses 50,000 80,000
–––––––– ––––––––
Total expenses (351,263) (394,760)
–––––––– ––––––––
Loss for quarter (132,863) (55,440)
–––––––– ––––––––
Required:

(a) Assess the financial performance of the business during its first two quarters using only the
data in table 1 above. (12 marks)

The owners are well aware of the importance of non-financial indicators of success and therefore
have identified a small number of measures to focus on. These are measured monthly and then
combined to produce a quarterly management report.

The data for the first two quarters management reports is shown below:

Table 2

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 Quarter 1 Quarter 2
Website hits* 690,789 863,492
Number of ties sold 27,631 38,857
On time delivery 95% 89%
Sales returns 12% 18%
System downtime 2% 4%
* A website hit is automatically counted each time a visitor to the website opens the home page of
Ties Only.

The industry average conversion rate for website hits to number of ties sold is 3·2%. The industry
average sales return rate for internet-based clothing sales is 13%.

Required:

(c) Comment on each of the non-financial data in table 2 above taking into account, where
appropriate, the industry averages provided, providing your assessment of the performance of the
business. (9 marks)

78
QUESTION 4 (6/2010 – Q5)

Jump has a network of sports clubs which is managed by local managers reporting to the main
board. The local managers have a lot of autonomy and are able to vary employment contracts with
staff and offer discounts for membership fees and personal training sessions. They also control their
own maintenance budget but do not have control over large amounts of capital expenditure.

A local manager’s performance and bonus is assessed relative to three targets. For every one of
these three targets that is reached in an individual quarter, $400 is added to the manager’s bonus,
which is paid at the end of the year. The maximum bonus per year is therefore based on 12 targets
(three targets in each of the four quarters of the year). Accordingly the maximum bonus that could
be earned is 12 x $400 = $4,800, which represents 40% of the basic salary of a local manager. Jump
has a 31 March year end.

The performance data for one of the sports clubs for the last four quarters is as follows

Qtr to Qtr to Qtr to Qtr to

30 June 2009 30 September 31 December 31 March 2010
2009 2009
Number of members 3,000 3,200 3,300 3,400
Member visits 20,000 24,000 26,000 24,000
Personal training sessions 310 325 310 339
booked
Staff days 450 480 470 480
Staff lateness days 20 28 28 20
Days in quarter 90 90 90 90
Agreed targets are:

1. Staff must be on time over 95% of the time (no penalty is made when staff are absent from work)

2. On average 60% of members must use the clubs’ facilities regularly by visiting at least 12 times
per quarter

3. On average 10% of members must book a personal training session each quarter

Required:

(a) Calculate the amount of bonus that the manager should expect to be paid for the latest
financial year. (6 marks)

(b) Discuss to what extent the targets set are controllable by the local manager (you are required
to make a case for both sides of the argument). (9 marks)

(c) Describe two methods as to how a manager with access to the accounting and other records
could unethically manipulate the situation so as to gain a greater bonus. (5 marks)

79
SESSION 2:BALANCE SCORECARD
QUESTION 1 (6/2013 – Q2)

Squarize is a large company which, for many years, operated solely as a pay-tv broadcaster.
However, five years ago, it started product bundling, offering broadband and telephone services to
its pay-tv customers. Customers taking up the offer were then known in the business as ‘bundle
customers’ and they had to take up both the broadband and telephone services together with the
pay-tv service. Other customers were still able to subscribe to pay-tv alone but not to broadband
and telephone services without the pay-tv service.

All contracts to customers of Squarize are for a minimum three-month period. The pay-tv box is sold
to the customer at the beginning of the contract; however, the broadband and telephone
equipment is only rented to them.

In the first few years after product bundling was introduced, the company saw a steady increase in
profits. Then, Squarize saw its revenues and operating profits fall. Consequently, staff bonuses were
not paid, and staff became dissatisfied. Several reasons were identified for the deterioration of
results:

1. In the economy as a whole, discretionary spending had been severely hit by rising unemployment
and inflation. In a bid to save cash, many pay-tv customers were cancelling their contracts after the
minimum three-month period as they were then able to still keep the pay-tv box. The box comes
with a number of free channels, which the customer can still continue to receive free of charge, even
after the cancellation of their contract.

2. The company’s customer service call centre, which is situated in another country, had been the
cause of lots of complaints from customers about poor service, and, in particular, the number of
calls it sometimes took to resolve an issue.

3. Some bundle customers found that the broadband service that they had subscribed to did not
work. As a result, they were immediately cancelling their contracts for all services within the 14 day
cancellation period permitted under the contracts.

In a response to the above problems and in an attempt to increase revenues and profits, Squarize
made the following changes to the business:

1. It made a strategic decision to withdraw the pay-tv–broadband–telephone package from the

market and, instead, offer each service as a standalone product.

2. It guaranteed not to increase prices for a 12-month period for each of its three services.

3. It transferred its call centre back to its home country and increased the level of staff training given
for call centre workers.

4. It investigated and resolved the problem with customers’ broadband service.

It is now one year since the changes were made and the finance director wants to use a balanced
scorecard to assess the extent to which the changes have been successful in improving the
performance of the business.

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Required:

(a) For each perspective of the balanced scorecard, identify two goals (objectives) together with a
corresponding performance measure for each goal which could be used by the company to assess
whether the changes have been successful. Justify the use of each of the performance measures
that you choose. (16 marks)

(b) Discuss how the company could reduce the problem of customers terminating their pay-tv
service after only three months. (4 marks)

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QUESTION 2 (12/2014 – Q4)
Jamair was founded in September 2007 and is one of a growing number of low-cost airlines in the
country of Shania.
Jamair’s strategy is to operate as a low-cost, high efficiency airline, and it does this by:
– Operating mostly in secondary cities to reduce landing costs.
– Using only one type of aircraft in order to reduce maintenance and operational costs. These planes
are leased rather than bought outright.
– Having only one category of seat class.
– Having no pre-allocated seats or in-flight entertainment.
– Focusing on e-commerce with customers both booking tickets and checking in for flights online.
The airline was given an ‘on time arrival’ ranking of seventh best by the country’s aviation authority,
who rank all 50 of the country’s airlines based on the number of flights which arrive on time at their
destinations. 48 Jamair flights were cancelled in 2013 compared to 35 in 2012. This increase was due
to an increase in the staff absentee rate at Jamair from 3 days per staff member per year to 4·5 days.
The average ‘ground turnaround time’ for airlines in Shania is 50 minutes, meaning that, on average,
planes are on the ground for cleaning, refuelling, etc for 50 minutes before departing again.
Customer satisfaction surveys have shown that 85% of customers are happy with the standard of
cleanliness on Jamair’s planes.
The number of passengers carried by the airline has grown from 300,000 passengers on a total of
3,428 flights in 2007 to 920,000 passengers on 7,650 flights in 2013. The overall growth of the airline
has been helped by the limited route licensing policy of the Shanian government, which has given
Jamair almost monopoly status on some of its routes. However, the government is now set to
change this policy with almost immediate effect, and it has become more important than ever to
monitor performance effectively.
Required:
(a) Describe each of the four perspectives of the balanced scorecard. (6 marks)
(b) For each perspective of the balanced scorecard, identify one goal together with a
corresponding performance measure which could be used by Jamair to measure the company’s
performance. The goals and measures should be specifically relevant to Jamair. For each pair of
goals and measures, explain why you have chosen them. (9 marks)

82
SESSION 1.3 BUILDING BLOCK MODEL
QUESTION 1 (9/2018)

The One Stop Car Co (OSC Co) offers a range of services for car owners at its 55 service centres
across the country.

The car maintenance business is extremely competitive in all regions across the country. Each service
centre operates autonomously and managers are able to choose how to package up the services
they offer. OSC Co’s aim is to ‘make the task of car maintenance a pleasure and not a chore’.

Its national website states the following:

– Range of service packs available, including express service and full valet
– ‘We work whilst you wait’ service, with average wait times of only two hours
– Watch our friendly, experienced mechanics producing high quality work
– Freshly made tea and coffee and free internet in our comfortable lounges
– Monthly free prize draw for all customers completing an online feedback form
Customers initially access the national website, but depending on their location, they are
automatically redirected to the website of their nearest service centre so that they can view the
offers available at that centre. All bookings are made through the OSC website.

Results for one of the service centres, the Midlands Service Centre (MSC), for the year which has
just ended are given below. The column headed ‘OSC’ shows the average figures for all of OSC Co’s
55 service centres:

Notes MSC OSC

Average
Sales revenue ($) 760,500 890,365
Gross profit ($) 304,200 328,146
Number of mechanics: senior 1 7 7.8
Number of mechanics: junior 2 5 5.2
Number of new service packs developed 3 3 2
Number of website hits 14,000 18,260
Total number of jobs booked and completed 9,506 11,870
Number of jobs from repeat customers only 1,500 1,660
Total time spent completing jobs (hours) 23,100 24,800
Percentage of customer feedback forms 4 80% 70%
showing score of 9 or 10
Notes:

(1) Mechanics are classified as ‘senior’ if they have been qualified for more than five years.
(2) ‘Junior’ mechanics includes both trainee mechanics who are unqualified and mechanics who
have been qualified for less than five years.
(3) The MSC introduced three new service packs during the year:
– free valets for orders over $100
– a safety check costing only $20, instead of the usual $40, for all customers booking a full service

83
 – a $10 air conditioning efficiency check, which usually costs $20, for all customers booking an oil
change.
These three new service packs produced revenues of $66,000, $58,000 and $54,000
respectively. Two comparable new service packs developed by other centres produced revenues of
$44,000 and $42,000.
(4) The online feedback form asks customers to rate the centre from 1 to 10, with 10 being the
best.
The CEO of OSC Co has recently attended a business seminar and heard about Fitzgerald and
Moon’s building block model of performance management. The CEO is interested in how the
dimensions block could be applied at OSC Co. The dimensions of performance identified in the
model are: competitiveness, financial performance, quality of service, flexibility, resource utilisation
and innovation.
Required:

(a) For each of the dimensions of the building block model, calculate one performance indicator
for MSC and one for the OSC average using the data available. Briefly justify your choice of
performance indicator and discuss MSC’s performance relative to the other OSC service centres.
(16 marks)

(b) Explain how the standards and rewards blocks support the dimensions block in Fitzgerald and
Moon’s building block model. (4 marks)

84
SESSION 2: DIVISIONAL PERFORMANCE
SESSION 2.1. ROI & RI
QUESTION 1 (6/2011 – Q4B)

Brace Co is split into two divisions, A and B, each with their own cost and revenue streams. Each of
the divisions is managed by a divisional manager who has the power to make all investment
decisions within the division. The cost of capital for both divisions is 12%. Historically, investment
decisions have been made by calculating the return on investment (ROI) of any opportunities and at
present, the return on investment of each division is 16%.

A new manager who has recently been appointed in division A has argued that using residual income
(RI) to make investment decisions would result in ‘better goal congruence’ throughout the company.

Each division is currently considering the following separate investments:

Project for Division A Project for Division B

Capital required for investment $82·8 million $40·6 million

Sales generated by investment $44·6 million $21·8 million

Net profit margin 28% 33%

The company is seeking to maximise shareholder wealth.

Required:

Calculate both the return on investment and residual income of the new investment for each of
the two divisions. Comment on these results, taking into consideration the manager’s views about
residual income. (10 marks)

85
QUESTION 2 (6/2012 – Q5)

The Biscuits division (Division B) and the Cakes division (Division C) are two divisions of a large,
manufacturing company. Whilst both divisions operate in almost identical markets, each
division operates separately as an investment centre. Each month, operating statements must be
prepared by each division and these are used as a basis for performance measurement for the
divisions.

Last month, senior management decided to recharge head office costs to the divisions.
Consequently, each division is now going to be required to deduct a share of head office costs in its
operating statement before arriving at ‘net profit’, which is then used to calculate return on
investment (ROI). Prior to this, ROI has been calculated using controllable profit only. The
company’s target ROI, however, remains unchanged at 20% per annum. For each of the last three
months, Divisions B and C have maintained ROIs of 22% per annum and 23% per annum respectively,
resulting in healthy bonuses being awarded to staff. The company has a cost of capital of 10%.

The budgeted operating statement for the month of July is shown below:

B C
$’000 $’000
Sales revenue 1,300 1,500
Less variable costs (700) (800)
–––––– ––––––
Contribution 600 700
Less controllable fixed costs (134) (228)
–––––– ––––––
Controllable profit 466 472
Less apportionment of head office costs (155) (180)
–––––– ––––––
Net profit 311 292
–––––– ––––––
Divisional net assets $23·2m $22·6m
Required

(a) Calculate the expected annualised Return on Investment (ROI) using the new method as
preferred by senior management, based on the above budgeted operating statements, for each of
the divisions. (2 marks)

(b) The divisional managing directors are unhappy about the results produced by your calculations in
(a) and have heard that a performance measure called ‘residual income’ may provide more
information.

Calculate the annualised residual income (RI) for each of the divisions, based on the net profit
figures for the month of July. (3 marks)

(c) Discuss the expected performance of each of the two divisions, using both ROI and RI, and
making any additional calculations deemed necessary. Conclude as to whether, in your opinion,
the two divisions have performed well. (6 marks)

86
(d) Division B has now been offered an immediate opportunity to invest in new machinery at a cost
of $2·12 million. The machinery is expected to have a useful economic life of four years, after which
it could be sold for $200,000. Division B’s policy is to depreciate all of its machinery on a straight-line
basis over the life of the asset. The machinery would be expected to expand Division B’s
production capacity, resulting in an 8·5% increase in contribution per month.

Recalculate Division B’s expected annualised ROI and annualised RI, based on July’s budgeted
operating statement after adjusting for the investment. State whether the managing director will
be making a decision that is in the best interests of the company as a whole if ROI is used as the
basis of the decision. (5 marks)

(e) Explain any behavioural problems that will result if the company’s senior management insist
on using solely ROI, based on net profit rather than controllable profit, to assess divisional
performance and reward staff. (4 marks)

87
QUESTION 3 (12/2008 – Q1)

Pace Company (PC) runs a large number of wholesale stores and is increasing the number of these
stores all the time. It measures the performance of each store on the basis of a target return on
investment (ROI) of 15%. Store managers get a bonus of 10% of their salary if their store’s annual
ROI exceeds the target each year. Once a store is built there is very little further capital expenditure
until a full four years have passed.

PC has a store (store W) in the west of the country. Store W has historic financial data as follows
over the past four years:

2005 2006 2007 2008

Sales ($’000) 200 200 180 170
Gross profit ($’000) 80 70 63 51
Net profit ($’000) 13 14 10 8
Net assets at start of year ($’000) 100 80 60 40

The market in which PC operates has been growing steadily. Typically, PC’s stores generate a 40%
gross profit margin.

Required:

(a) Discuss the past financial performance of store W using ROI and any other measure you feel
appropriate and, using your findings, discuss whether the ROI correctly reflects Store W’s actual
performance. (8 marks)

(b) Explain how a manager in store W might have been able to manipulate the results so as to gain
bonuses more frequently. (4 marks)

PC has another store (store S) about to open in the south of the country. It has asked you for help in
calculating the gross profit, net profit and ROI it can expect over each of the next four years. The
following information is provided:

Sales volume in the first year will be 18,000 units. Sales volume will grow at the rate of 10% for years
two and three but no further growth is expected in year 4. Sales price will start at $12 per unit for
the first two years but then reduce by 5% per annum for each of the next two years.

Gross profit will start at 40% but will reduce as the sales price reduces. All purchase prices on goods
for resale will remain constant for the four years.

Overheads, including depreciation, will be $70,000 for the first two years rising to $80,000 in years
three and four.

Store S requires an investment of $100,000 at the start of its first year of trading.

PC depreciates non-current assets at the rate of 25% of cost. No residual value is expected on these
assets.

Required:

(c) Calculate (in columnar form) the revenue, gross profit, net profit and ROI of store S over each
of its first four years. (9 marks)

(d) Calculate the minimum sales volume required in year 4 (assuming all other variables remain
unchanged) to earn the manager of S a bonus in that year. (4 marks)

88
QUESTION 4 (12/2015)

Cardale Industrial Metal Co (CIM Co) is a large supplier of industrial metals. The company is split into
two divisions:
Division F and Division N. Each division operates separately as an investment centre, with each one
having full control over its non-current assets. In addition, both divisions are responsible for their
own current assets, controlling their own levels of inventory and cash and having full responsibility
for the credit terms granted to customers and the collection of receivables balances. Similarly, each
division has full responsibility for its current liabilities and deals directly with its own suppliers.
Each divisional manager is paid a salary of $120,000 per annum plus an annual performance-related
bonus, based on the return on investment (ROI) achieved by their division for the year. Each
divisional manager is expected to achieve a minimum ROI for their division of 10% per annum. If a
manager only meets the 10% target, they are not awarded a bonus. However, for each whole
percentage point above 10% which the division achieves for the year, a bonus equivalent to 2% of
annual salary is paid, subject to a maximum bonus equivalent to 30% of annual salary.
The following figures relate to the year ended 31 August 2015:
Division F Division N
$’000 $’000
Sales 14,500 8,700
Controllable profit 2,645 1,970
Less apportionment of Head Office costs (1,265) (684)
–––––– ––––––
Net profit 1,380 1,286
Non-current assets 9,760 14,980
Inventory, cash and trade receivables 2,480 3,260
Trade payables 2,960 1,400

During the year ending 31 August 2015, Division N invested $6·8m in new equipment including a
technologically advanced cutting machine, which is expected to increase productivity by 8% per
annum. Division F has made no investment during the year, although its computer system is badly in
need of updating. Division F’s manager has said that he has already had to delay payments to
suppliers (i.e. accounts payables) because of limited cash and the computer system ‘will just have to
wait’, although the cash balance at Division F is still better than that of Division N.
Required:
(a) For each division, for the year ended 31 August 2015, calculate the appropriate closing return
on investment (ROI) on which the payment of management bonuses will be based. Briefly justify
the figures used in your calculations.
Note: There are 3 marks available for calculations and 2 marks available for discussion. (5 marks)
(b) Based on your calculations in part (a), calculate each manager’s bonus for the year ended 31
August 2015. (3 marks)
(c) Discuss whether ROI is providing a fair basis for calculating the managers’ bonuses and the
problems arising from its use at CIM Co for the year ended 31 August 2015. (7 marks)

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QUESTION 5 (12/2017)

Sports Co is a large manufacturing company specialising in the manufacture of a wide range of sports
clothing and equipment. The company has two divisions: Clothing (Division C) and Equipment
(Division E). Each division operates with little intervention from Head Office and divisional managers
have autonomy to make decisions about long-term investments.

Sports Co measures the performance of its divisions using return on investment (ROI), calculated
using controllable profit and average divisional net assets. The target ROI for each of the divisions is
18%. If the divisions meet or exceed this target the divisional managers receive a bonus.

Last year, an investment which was expected to meet the target ROI was rejected by one of the
divisional managers because it would have reduced the division’s overall ROI. Consequently, Sports
Co is considering the introduction of a new performance measure, residual income (RI), in order to
discourage this dysfunctional behaviour in the future. Like ROI, this would be calculated using
controllable profit and average divisional net assets.

The draft operating statement for the year, prepared by the company’s trainee accountant, is
shown below:

Division C Division E
$’000 $’000
Sales revenue 3,800 8,400
Less variable costs (1,400 ) (3,030 )
–––––– ––––––
Contribution 2,400 5,370
Less fixed costs (945 ) (1,420 )
–––––– ––––––
Net profit 1,455 3,950
–––––– ––––––
Opening divisional controllable net assets 13,000 24,000
Closing divisional controllable net assets 9,000 30,000
Notes:
(1) Included in the fixed costs are depreciation costs of $165,000 and $460,000 for Divisions C and
E respectively. 30% of the depreciation costs in each division relates to assets controlled but
not owned by Head Office. Division E invested $2m in plant and machinery at the beginning of the
year, which is included in the net assets figures above, and uses the reducing balance method to
depreciate assets. Division C, which uses the straight-line method, made no significant additions to
non-current assets. It is the policy of both divisions to charge a full year’s depreciation in the year of
acquisition.
(2) Head Office recharges all of its costs to the two divisions. These have been included in the fixed
costs and amount to $620,000 for Division C and $700,000 for Division E.
(3) Sports Co has a cost of capital of 12%.
Required:
(a) (i) Calculate the return on investment (ROI) for each of the two divisions of Sports Co. (6
marks)

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 (ii) Discuss the performance of the two divisions for the year, including the main reasons why
their ROI results differ from each other. Explain the impact the difference in ROI could have on the
behaviour of the manager of the worst performing division. (6 marks)
(b) (i) Calculate the residual income (RI) for each of the two divisions of Sports Co and briefly
comment on the results of this performance measure. (4 marks)
(ii) Explain the advantages and disadvantages of using residual income (RI) to measure
divisional performance. (4 marks)
(20 marks)

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SESSION 2.2 TRANSFER PRICING
QUESTION 1 (6/2014 – Q3)

The Rotech group comprises two companies, W Co and C Co.

W Co is a trading company with two divisions: The Design division, which designs wind turbines and
supplies the designs to customers under licences and the Gearbox division, which manufactures
gearboxes for the car industry.

C Co manufactures components for gearboxes. It sells the components globally and also
supplies W Co with components for its Gearbox manufacturing division.

The financial results for the two companies for the year ended 31 May 2014 are as follows:

W Co C Co
Design division Gearbox division
$’000 $’000 $’000
External sales 14,300 25,535 8,010
Sales to Gearbox division 7,550
–––––––
15,560
–––––––
Cost of sales (4,900) (16,200)* (5,280)
Administration costs (3,400) (4,200) (2,600)
Distribution costs – (1,260) (670)
––––––– ––––––– –––––––
Operating profit 6,000 3,875 7,010
––––––– ––––––– –––––––
Capital employed 23,540 32,320 82,975
* Includes cost of components purchased from C Co.

C Co is currently working to full capacity. The Rotech group’s policy is that group companies and
divisions must always make internal sales first before selling outside the group. Similarly, purchases
must be made from within the group wherever possible. However, the group divisions and
companies are allowed to negotiate their own transfer prices without interference from Head Office.

C Co has always charged the same price to the Gearbox division as it does to its external customers.
However, after being offered a 5% lower price for similar components from an external supplier, the
manager of the Gearbox division feels strongly that the transfer price is too high and should be
reduced. C Co currently satisfies 60% of the external demand for its components. Its variable costs
represent 40% of revenue.

Required:

Advise, using suitable calculations, the total transfer price or prices at which the components
should be supplied to the Gearbox division from C Co. (10 marks)

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QUESTION 2 (6/2015 – Q2)

2 Mobe Co manufactures electronic mobility scooters. The company is split into two divisions:
the scooter division (Division S) and the motor division (Division M). Division M supplies electronic
motors to both Division S and to external customers. The two divisions run as autonomously as
possible, subject to the group’s current policy that Division M must make internal sales first before
selling outside the group; and that Division S must always buy its motors from Division M. However,
this company policy, together with the transfer price which Division M charges

Division S, is currently under review.

Details of the two divisions are given below.

Division S

Division S’s budget for the coming year shows that 35,000 electronic motors will be needed. An
external supplier could supply these to Division S for $800 each.

Division M

Division M has the capacity to produce a total of 60,000 electronic motors per year. Details of
Division M’s budget, which has just been prepared for the forthcoming year, are as follows:

Budgeted sales volume (units) 60,000

Selling price per unit for external sales of motors $850
Variable costs per unit for external sales of motors $770
The variable cost per unit for motors sold to Division S is $30 per unit lower due to cost savings on
distribution and packaging.

Maximum external demand for the motors is 30,000 units per year.

Required:

Assuming that the group’s current policy could be changed, advise, using suitable calculations, the
number of motors which Division M should supply to Division S in order to maximise group profits.
Recommend the transfer price or prices at which these internal sales should take place.

Note: All relevant workings must be shown.

(10 marks)

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QUESTION 6/2018

The Portable Garage Co (PGC) is a company specialising in the manufacture and sale of a range of
products for motorists. It is split into two divisions: the battery division (Division B) and the adaptor
division (Division A). Division B sells one product – portable battery chargers for motorists which can
be attached to a car’s own battery and used to start up the engine when the car’s own battery fails.
Division A sells adaptors which are used by customers to charge mobile devices and laptops by
attaching them to the car’s internal power source.

Recently, Division B has upgraded its portable battery so it can also be used to rapidly charge
mobile devices and laptops. The mobile device or laptop must be attached to the battery using a
special adaptor which is supplied to the customer with the battery. Division B currently buys the
adaptors from Division A, which also sells them externally to other companies.

The following data is available for both divisions:

Division B
Selling price for each portable battery, including adaptor $180
Costs per battery:
Adaptor from Division A $13
Other materials from external suppliers $45
Labour costs $35
Annual fixed overheads $5,460,000
Annual production and sales of portable batteries (units) 150,000
Maximum annual market demand for portable batteries (units) 180,000
Division A
Selling price per adaptor to Division B $13
Selling price per adaptor to external customers $15
Costs per adaptor:
Materials $3
Labour costs $4
Annual fixed overheads $2,200,000
Current annual production capacity and sales of adaptors – both internal and
external sales (units) 350,000
Maximum annual external demand for adaptors (units) 200,000
In addition to the materials and labour costs above, Division A incurs a variable cost of $1 per
adaptor for all adaptors it sells externally.

Currently, Head Office’s purchasing policy only allows Division B to purchase the adaptors from
Division A but Division A has refused to sell Division B any more than the current level of adaptors it
supplies to it.

The manager of Division B is unhappy. He has a special industry contact who he could buy the
adaptors from at exactly the same price charged by Division A if he were given the autonomy to
purchase from outside the group.

After discussions with both of the divisional managers and to ensure that the managers are not
demotivated, Head Office has now agreed to change the purchasing policy to allow Division B to buy
externally, provided that it optimises the profits of the group as a whole.

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 Required:

(a) Under the current transfer pricing system, prepare a profit statement showing the
profit for each of the divisions and for The Portable Garage Co (PGC) as a whole. Your sales and
costs figures should be split into external sales and inter-divisional transfers, where appropriate.
(9 marks)

(b) Assuming that the new group purchasing policy will ensure the optimisation of group profits,
calculate and discuss the number of adaptors which Division B should buy from Division A and the
number of adaptors which Division A should sell to external customers.

Assume now that no external supplier exists for the adaptors which Division B uses.

(c) Calculate and discuss what the minimum transfer price per unit would be for any additional
adaptors supplied above the current level by Division A to Division B so that Division B can meet
its maximum annual demand for the new portable batteries.

Note: There are 2 marks available for calculations and 3 marks available for discussion. (5
marks)

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SESSION 3: NOT FOR PROFIT ORGANIZATION PERFORMANCE
QUESTION 1 (12/2015 – Q2)
2 Bus Co is a large bus operator, operating long-distance bus services across the country. There are
two other national operators in the country. Bus Co’s mission is to ‘be the market leader in long-
distance transport providing a greener, cleaner service for passengers nationwide’. Last month, an
independent survey of 40,000 passengers was carried out, the results of which are shown in the
table below:
Table: Bus passenger satisfaction % by national operator
Operator Overall Value for money Punctuality Journey time
satisfaction

Bus * 67 80 82
Prime * 58 76 83
Express * 67 76 89

* denotes that the percentage has not yet been calculated.

The ‘overall satisfaction’ percentages, which have not yet been inserted into the table, are calculated
using a weighted average which reflects the importance customers place on each of the other three
criteria above. The weightings used are as follows:
Value for money 40%
Punctuality 32%
Journey time 28%
The managing director (MD) of Bus Co has said: ‘Independent research has shown that our
customers are the most satisfied of any national bus operator. We are now leading the way on what
matters most to customers – value for money and punctuality.’
Required:
(a) Calculate the ‘overall satisfaction’ percentage for each operator. (2 marks)
(b) Taking into account all the data in the table and your calculations from part (a), discuss
whether the managing director’s statement is true. (4 marks)
(c) When measuring performance using a ‘value for money’ approach, the criteria of
economy, efficiency and effectiveness can be used.
Required:
Briefly define ‘efficiency’ and ‘effectiveness’ and suggest one performance measure for EACH,
which would help Bus Co assess the efficiency and effectiveness of the service it provides. (4
marks)

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Contents
PART A – COSTING .................................................................................................................................. 1
SESSION 1: ABC ................................................................................................................................... 1
SESSION 2: TARGET COSTING.............................................................................................................. 5
SESSION 3: LIFE CYCLE COSTING ......................................................................................................... 7
SESSION 4: THROUGHPUT ACCOUNTING ......................................................................................... 10
PART B: DECISION MAKING................................................................................................................... 16
SESSION 1: CPV ANALYSIS ................................................................................................................. 16
SESSION 2: DECISION MAKING WITH LIMITING FACTORS ................................................................ 20
SESSION 3: RELEVANT COSTING........................................................................................................ 27
SESSION 3.1 ONE OFF CONTRACT ................................................................................................. 27
SESSION 3.2 MAKE OR BUY ........................................................................................................... 30
SESSION 3.3 FUTHER PROCESSING ............................................................................................... 34
SESSION 3.4 SHUT DOWN DECISION............................................................................................. 38
SESSION 4: DECISION MAKING WITH RISK AND UNCERTAINTY ....................................................... 40
SESSION 5: PRICING DECISION .......................................................................................................... 44
PART C BUDGETING .............................................................................................................................. 47
SESSION 1: QUANTITATIVE IN BUDGETING ...................................................................................... 47
SESSION 2: TYPES OF BUDGETING .................................................................................................... 53
PART D VARIANCE ANALYSIS ................................................................................................................. 56
SESSION 1: BASIC VARIANCE ............................................................................................................. 56
SESSION 2: PLANNING AND OPERATING VARIANCE ......................................................................... 57
SESSION 3: MARKET SIZE AND MARKET SHARE VARIANCE .............................................................. 63
SESSION 4: MATERIAL MIX AND YIELD VARIANCE ............................................................................ 65
SESSION 5: SALE MIX AND QUANTITY VARIANCE ............................................................................. 67
SESSION 6: COMMENT ON VARIANCE .............................................................................................. 72
PART E PERFORMANCE MEASUREMENT .............................................................................................. 74
SESSION 1: OVERALL ASSESSMENT OF PERFORMANCE ................................................................... 74
SESSION 2:BALANCE SCORECARD ..................................................................................................... 80
SESSION 1.3 BUILDING BLOCK MODEL ............................................................................................. 83
SESSION 2: DIVISIONAL PERFORMANCE ........................................................................................... 85
SESSION 2.1. ROI & RI ................................................................................................................... 85

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 SESSION 2.2 TRANSFER PRICING ................................................................................................... 92
SESSION 3: NOT FOR PROFIT ORGANIZATION PERFORMANCE ........................................................ 96

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