ICAN SKILLS LEVEL PERFORMANCE MANAGEMENT MOCK EXAMINATION SOLUTION FOR NOV 2015 DIET.

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1 ICA SKILLS LEVEL PERFORMACE MAAGEMET MOCK EXAMIATIO SOLUTIO FOR OV 2015 DIET. QUESTIO 1 BRISTOLE LIMITED (a) Traditional Budgeting lacks flexibility and does not encourage efficiency or economy. This statement actually sums up the limitations of traditional budgeting otherwise referred to as conventional budgeting. Traditional budgeting concentrates on expenditures by budget centres under conventional cost headings normally regarded as line item budgets as there is a line for each expenditure item. The challenges that are prevalent with traditional budgeting include the following: (i) It fails to deal with fast changing environment and consequently becomes out-of-date before the start of the budget period. (ii) It focuses more on the achievement of short-term financial targets rather than things that create values for the business. (iii) It is based on business functions and encourages incremental philosophy of adding percentages by rule of thumb, resulting in padding or budget slacks. (iv) It considers all budget information fixed for activities without relating the driving effect of such activity to the budget. As a result of the failure of the traditional budgeting approach, modern techniques of budgeting are now in vogue to address the problems of traditional budgeting technique. (b) The approaches needed to be adopted by the Company to surmount the problems of the traditional budgeting technique include the following: (i) Activity-Based Budgeting is a method of budgeting based on an activity framework and utilizes cost driver information in the budget setting and variance feedback processes. This approach encourages relevant performance measures as well as promoting continuous improvement. (ii) The flexible budgeting technique is a budgeting technique which ensures that budgets are designed to change in accordance with changing levels of activities by analyzing budgets costs into variable and fixed elements. This technique is useful for all purposes. Page 1

2 (iii) The Zero-Based Budgeting (ZBB) approach is a budgeting approach that requires each cost element in a budget to be justified from on set, rather than a dwell on the traditional incremental budgeting system. Using the 2013 budget information, the company budget under the traditional budgeting method is as follows: A B TOTAL Quantity Produced/Sold 60,000 80,000 Sales 3,000,000 8,000,000 11,000,000 Variable Cost 1,800,000 5,600,000 7,400,000 Fixed Cost (Rule of thumb) 1,200,000 1,200,000 2,400,000 et profit 1,200,000 1,200,000 The budgeted profit statement incorporating the modern techniques of Activity- Based Budgeting, Flexible Budgeting and Zero-Based Budgeting method, will be as follows: 100% 90% A B Total A B Total Sales 3,000,000 8,000,000 11,000,000 2,700,000 7,200,000 9,900,000 Less Variable Cost 1,800,000 5,600,000 7,400,000 1,620,000 5,040,000 6,660,000 Contribution 1,200,000 2,400,000 3,600,000 1,080,000 2,160,000 3,240,000 Fixed Costs 840,000 1,560,000 2,400, ,000 1,560,000 2,400,000 et Profit 360, ,000 1,200, , , ,000 Page 2

3 The profit statement, drawn up under the conventional budgeting technique depicts a fixed structure which did not take account of the changing scenario that the business can be forced to operate under 90% level of activity. Hence it did not make room for this change. Also, the impact of the storage activity on the fixed cost was not reflected. The resultant effect is that product A is portrayed as unprofitable. Reflecting the modern techniques of budgeting with the flexed level of activity, management decision can be improved as both products can be retained by Management even at 90% operational level. It is advisable to adopt the modern techniques of budgeting to address the hiccups associated with traditional budgeting techniques. Workings PRODUCT A B TOTAL Quantity sold 60,000 80,000 umber of weeks per product 2 weeks 6 weeks Total weeks 120, , ,000 50% of Budgeted Fixed Cost = ½ x 2,400,000 = 1,200,000 Apportionment of fixed cost using storage facility as cost driver is calculated as follows: A = 120,000/ 600,000 x 1,200,0001 = 240,000 B = 480,000/600,000 x 1,200,0001 = 960,000 Fixed Costs A B Unapportioned 600, ,000 Apportioned 240, , ,000 1,560,000 Page 3

4 SOLUTIO 2 Standard product cost for one unit of product XY Direct materials (8kg (W2) at 1.50(W1) per kg Direct wages (2 hours (W4) at 4 (W3) per hour) 8.00 Variable overhead (2 hours (W4) at 1 (W5) per hour) 2.00 Workings: (W1) Actual quantity of materials purchased at standard price is (actual cost plus favourable material price variance) 210, ,000 = 225,000 Therefore standard price = (225,000/150,000kg) = 1.50 (W2) Material usage variance = (9,000/1.50 standard price) = 6,000kg Therefore standard quantity for actual production = 150,000 6,000 kg = 144,000kg Therefore standard quantity per unit = (144,000kg/18,000 units) = 8kg (W3) Actual hours worked at standard rate = (136,000-8,000) = 128,000 Therefore standard rate per hour = (128,000/32,000 hours) = 4 (W4) Labour efficiency variance = ( 16,000/4) = 4,000 hours Therefore standard hours for actual production = 32, ,000 = 36,000 hours Therefore standard hours per unit = (36,000 hours/18,000 units) =2 hours Page 4

5 SOLUTIO 3 BOLA BOLIGTO (a) o of pairs of shoes BEP (unit) = fixed cost + desired profit/ contribution margin Contribution margin = Selling Price Variable Cost = = 20 Desired profit = 20% ( 1,050,000) = 210,000 = ( 450, ,000)/20 = 33,000 pairs (b) Capital Turnover = Turnover/ capital employed or average assets = 1,150,000 /1,050,555 = 1.1 (c) Operating Income % of aira sales Operating income/sales x 100 = 210,000/ 1,155,000 x 100 =18.18% (d) Residual Income Profit 210,000 Less Imputed charge: (12% of 1,050,000) 126,000 84,000 (e) If sales volume is 15,000 pairs of shoes, the rate of return to be earned on available asset is: Sales (15,000 x 35) 525,000 Page 5

6 Less: ,000 Contribution 300,000 Less: fixed cost 450,000 Income/(Loss) (150,000) Rate of return = (150,000)/1,050,000 x 100 (14.29%) Page 6

7 SOLUTIO 4 FEDICO ALUMIIUM SYSTEMS LIMITED (a) Price elasticity of demand = % change in quantity/ % change in price = 1.5 When the company price fell by 4% in real terms, demand increased by 4% x 1.5= 6% When the company s price falls by 6% in real terms demand will increase by 6% x 1.5 = 9% Determination of fixed and variable costs Adjust current period s costs to previous period s prices: = 4,309.76/1,04 = 4,144 Using high/low method to determine fixed/variable cost Period Units Cost 000 Current 212,000 4,144 Previous 200,000 4,000 12, Variable cost per unit = 12 Total cost per unit = 4,000,000/ 200,000 = 20 Fixed cost = 200,000 (20-12) = 1,600,000 Variable cost per unit next period = 12 x 1.04 x 1.06 = Fixed cost next period = 1,600,000 x 1.04 x 1.06 = 1,763,840 BUDGETED POSITIO PRICE 26 Page 7

8 SALES 212,000 x 1.09 x 26 = 6,008,080 VARIABLE COST 212,000 X x 1.09 = 3,056,911 COTRIBUTIO = 2,951,169 Less: FIXED COST = (1,763,840) PROFIT = 1,187,329 (b) Budgeted Position at 26 plus 6% SALES 212,000 x 26 x ,842,720 VARIABLE COST 212,000 x ,804,523 COTRIBUTIO 3,038,197 FIXED COST (1,763,840) PROFIT 1,274,357 (b) TO: THE BOARD OF DIRECTORS FROM: MAAGEMET ACCOUTAT DATE: 16 OVEMBER 2011 SUBJECT: DECISIO TO ICREASE SELLIG PRICE The above subject matter refers. Based on the calculations above, it was reflected that profit of 1,274,357 derived from the increase in price was higher than the original profit of 1,187, In view of this, it is hereby recommended that the Company should increase its selling price from to provided that all other things remain constant. Signed MAAGEMET ACCOUTAT Page 8

9 (d) Typical assumptions include: i) Changes in volume are solely a function of price changes ii) Changes in volume are not influenced by advertising, consumer preferences, general economic conditions, etc iii) The decision makers i.e consumers, are rational and are making decisions on purely economic factors iv) The fixed /variable cost split is constant over time v) The fixed and variable costs are both affected by inflation to the same degree vi) The estimates of the elasticity of demand are correct Page 9

10 SOLUTIO 5 (a) Calculation of product contributions Paster Baster Caster Daster Selling price Variable costs: Material Labour A Labour B Labour C Overhead Contribution (c) The objective is to maximize contribution subject to constraints on the three types of labour Let a = the number of units of production Paster to be made Let b = the number of units of product Baster to be made Let c = the number of units of product Caster to be made Let d = the number of units of product Daster to be made Objective function: Maximise 17a + 12b + 40c + 30d Page 10

11 Subject to constraints on: Grade A labour 10a + 6b 9,000 Grade B Labour 10c + 20d 14,500 Grade C Labour 12c +6d 12,000 Products Paster and Baster use only grade A labour, whilst products Caster and Daster are the only users of grade B and grade C labour. In order words, production of products Paster and Baster and production of product Caster and Daster are independent of each other. The problem can be formulated then as two separate linear programming problems. Thus: (i) (ii) Maximise 17a + 12b Subject to 10a + 6b 9,000 Maximise 40c + 30d Subject to 10c + 20d 14,500 12c + 6d 12,000 (c) The problem can be solved using the contribution per key factor. Thus: Contribution from Product = Paster Key factor (constraints) = 10 hours of Grade A Contribution per key factor = 17/10 = 1.70 per hour Contribution from Product = Baster Page 11

12 Key factor (constraints) = 6 hours of Grade A Contribution per key factor = 12/6 = 2.00 per hour It is, therefore, clearly better to manufacture product Baster in preference to product Paster and, if this is done, the 9,000 hours maximum hours of grade A labour would produce 9,000/6 = 1,500 units of product Baster given contribution of 1,500 x 12 = 18,000 Maximum possible output for product Caster if total available hours of grade B are devoted to its production = 14,500/10 = 1,450 units Similarly, maximum possible output for product Daster using grade B labour = 14,500/20 = 725 units Maximum possible output using grade C labour: Product Caster = 12,000/12 = 1,000 units (d) Optimal Strategy: Product Daster = 12,000/6 = 2,000 units Produce 1,500 units of Baster (1,500 X 12) = 18, units of Caster (850 x 40) = 34, units of Daster (300 x 30) = 9,000 Total Contribution = 61,000 Less fixed overhead = 35,500 Profit = 25,500 (d) Since Product Baster yields 2 per hour of grade A labour used, then the contribution of product Paster must be the same for it to be a worthwhile item for sale. Product Paster uses 10 hours of grade A labour per unit, and therefore its contribution should be at least 10 x 2 = 20, that is an increase of 3. The minimum selling price should be = 58. Page 12

13 QUESTIO 6 (a) Computation of Return on Investment (ROI) Project A 131,000/750,000 x 100 = 17% B 162,000/600,000 x 100 = 27% C 151,000/500,000 x 100 = 30% D 148,000/700,000 x 100 = 21% (b) Project C will be selected because it has the highest ROI of 30% (c) Since the cost of capital is 20%, only Projects B, C and D would be accepted while Project A, with a lower ROI of 17%, will result in negative residual income and thereby rejected. Residual Income for the division is 101,000 as computed below: Total Returns (162, , ,000) 461,000 Less Imputed Cost (600, , ,000)20% 360, ,000 (d) Projects B, C and D and Residual Income approach are preferred. Page 13

14 QUESTIO 7 (a) The expected PV of the three sets are: Set EPV () 1 337, , ,400 1,770,100 Average EPV = 1,770,100/ 3 = 590, Therefore, the project is viable, since it has a positive EPV (b) The merits of the Deterministic Simulation Model are as follows: (i) It looks at risk from a new angle, thus recognizing that the component aspect of an investment can all vary from what is expected. (ii) It seeks to provide the decision-maker with more than just a good or no good conclusion that aims to bring in all the may bes and ifs. (iii) It helps in determining how much factor would need to change so as to make the project break-even. (iv) It assists in presenting the decision-maker with a report that justifies the acceptance of a project. (v) It simplifies forecasting future occurrences. Workings (a) Calculation of Expected et Present Value SET 1 Years Items CF () DCF@ 10% PV () 0 Initial Outlay (800,000) (800,000) Page 14

15 1-5 Revenue 1,000, ,791, Running Costs (700,000) (2,653,700) PV 337,300 SET 2 Years Items CF () DCF@ 10% PV () 0 Initial Outlay (800,000) (800,000) 1-5 Revenue 1,000, ,791, Running Costs (600,000) (2,274,600) PV 716,400 SET 3 Years Items CF () DCF@ 10% PV () 0 Initial Outlay (800,000) (800,000) 1-5 Revenue 1,000, ,170, Running Costs (700,000) (2,653,700) PV 716,400 (2) Allocation of tag numbers to revenue and running costs. (i) Page 15

16 Revenue Probability Cum. Probability Range Selected Range 800, ,000, Sets 1 & 2 1,100, Set 3 1,200, Page 16

17 (ii) Running Costs Probability Cum. Probability Range Selected Range 500, , Set 2 700, Set 1&3 Page 17