DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO. Performance Pillar. P1 Performance Operations. 21 November 2012 Wednesday Morning Session

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1 DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO Performance Pillar P1 Performance Operations 21 November 2012 Wednesday Morning Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is all parts and/or subquestions). ALL answers must be written in the answer book. Answers written on the question paper will not be submitted for marking. You should show all workings as marks are available for the method you use. ALL QUESTIONS ARE COMPULSORY. Section A comprises 8 sub-questions and is on pages 2 to 5. Section B comprises 6 sub-questions and is on pages 6 to 8. Section C comprises 2 questions and is on pages 10 to 13. Maths tables and formulae are provided on pages 15 to 18. The list of verbs as published in the syllabus is given for reference on page 19. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. P1 Performance Operations TURN OVER The Chartered Institute of Management Accountants 2012

2 SECTION A 20 MARKS [You are advised to spend no longer than 36 minutes on this question.] ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION Instructions for answering Section A: The answers to the eight sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. For sub-questions 1.6 to 1.8 you should show your workings as marks are available for the method you use to answer these sub-questions. Question One 1.1 A five year investment project has a positive net present value of $320,000 when discounted at the cost of capital of 10% per annum. The project includes annual net cash inflows of $100,000 which occur at the end of each of the five years. The percentage reduction in the annual net cash inflow that would result in the project not being financially viable is: A 31.25% B 118.5% C 84.4% D 18.5% (2 marks) 1.2 A company s working capital cycle can be calculated as: A B C D Inventory days plus accounts receivable days less accounts payable days Accounts receivable days plus accounts payable days less inventory days Inventory days plus accounts payable days less accounts receivable days Accounts payable days plus accounts receivable days plus inventory days (2 marks) Performance Operations 2 November 2012

3 The following data are given for sub-questions 1.3 and 1.4 below XY can choose from four mutually exclusive projects. The projects will each last for one year and their net cash inflows will be determined by market conditions. The forecast net cash inflows for each of the possible outcomes are shown below. Market Conditions Poor Average Good $000 $000 $000 Project A Project B Project C Project D If the company applies the maximin criterion the project chosen would be: A B C D Project A Project B Project C Project D (2 marks) 1.4 If the company applies the maximax criterion the project chosen would be: A B C D Project A Project B Project C Project D (2 marks) Section A continues on the next page TURN OVER November Performance Operations

4 1.5 JK has budgeted sales for next year of 24,000 units and inventory levels are expected to remain constant throughout the year. Each unit produced will require 3 labour hours and the budgeted labour rate will be $15 per hour. It is estimated that 10% of units produced will be wasted. It is expected that 15% of the total hours worked will be paid at overtime rates. 10% of the total hours will be paid at the basic rate plus an overtime premium of 50% of the basic rate. 5% of the total hours will be paid at the basic rate plus an overtime premium of 100% of the basic rate. The labour cost budget for next year is: A $ 1,350,000 B $ 1,306,800 C $ 1,188,000 D $ 1,320,000 (2 marks) 1.6 RS reviews the financial performance of potential customers before setting a credit limit. The summarised financial statements for PQ, a potential major customer operating in the retail industry, are shown below. Summary Statement of Financial Position for PQ at year end $000 $000 Non-current assets 6,400 5,600 Inventories 1,200 1,120 Trade receivables Cash Trade payables (1,120) (1,160) Non-current liabilities (3,600) (3,200) Net assets 3,880 3,240 Share capital 2,400 2,400 Retained earnings 1, ,880 3,240 Required: Summary Income Statement for PQ for the years $000 $000 Sales 12,000 10,000 Cost of sales 6,400 5,200 Operating profit 2,400 1,800 Calculate the following ratios, to the nearest 0.1 days, for PQ for 2011 (i) (ii) (iii) Receivables days Payables days Inventory days (3 marks) Performance Operations 4 November 2012

5 1.7 KL has determined from past experience that the following equation provides a reliable estimate of its future sales volume: y = 15, ,200x where y is the total sales units per quarter, and x is the time period KL has also derived the following set of seasonal variation index values for each quarter using the multiplicative model: Quarter 1 80 Quarter Quarter Quarter 4 90 Required: Calculate the forecast sales units for the third quarter of year 6 using the above model and assuming that the first quarter of year 1 is time period 1. (3 marks) 1.8 A $100 bond has a yield to maturity of 6% per annum and is due to mature in three years time. The next interest payment is due in one year s time. Today s market value of the bond is $ Required: Calculate the coupon rate on the bond. (4 marks) (Total for Section A = 20 marks) Reminder All answers to Section A must be written in your answer book. Answers to Section A written on the question paper will not be submitted for marking. End of Section A. Section B begins on page 6 TURN OVER November Performance Operations

6 SECTION B 30 MARKS [You are advised to spend no longer than 9 minutes on each sub-question in this section.] ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE. Question Two (a) FG is concerned that the payment record of one of its customers is extremely poor. An extract from the trade receivable account for the customer, for the period 1 July to 31 October, is shown below: Date Narrative Debit Credit Balance $ $ $ 01/07/2011 Balance b/fwd /07/2011 Invoice No /07/2011 Invoice No /07/2011 Credit note No. C85 (Balance b/fwd) /07/2011 Receipt No. R69 (Balance b/fwd and Invoice No. 345) /08/2011 Invoice No /08/2011 Invoice No /08/2011 Invoice No /09/2011 Receipt No. R92 (Invoice No. 558) /09/2011 Invoice No /09/2011 Invoice No /10/2011 Receipt No. R121 (Invoice No. 489) /10/2011 Invoice No Required: (i) Prepare an aged debt analysis showing the outstanding debt of the customer at 31 October analysed by month. (3 marks) The credit control department has been chasing the outstanding invoices by telephone, and post. (ii) State TWO further actions that FG may take after reviewing the information shown in the aged debt analysis prepared in part (i). (2 marks) (Total for sub-question (a) = 5 marks) Performance Operations 6 November 2012

7 (b) A company has recently sold part of its trading operations and is reviewing potential long term investment opportunities for the funds. Until a suitable opportunity is identified the funds are being held in a bank deposit account but the company is considering the following alternative short-term investments: (i) (ii) Certificates of deposit Bills of exchange Required: Describe the alternative short-term investments in terms of their risk, return and liquidity. (5 marks) (c) The following data are available for Products A, B and C: Budget Actual Product A Product B Product C Product A Product B Product C Sales units 6,000 8,400 9,600 6,400 9,200 8,700 Selling price per unit $150 $160 $70 $142 $168 $77 Variable cost per unit $75 $90 $45 $69 $92 $48 Required: (i) (ii) Calculate the total sales mix contribution variance. Calculate the total sales quantity contribution variance. (3 marks) (2 marks) (Total for sub-question (c) = 5 marks) (d) The managers of a hospital are in the process of preparing the annual budget for the next financial year using incremental budgeting. The hospital s directors are concerned that the approach used will result in a budget that does not reflect the aims and objectives of the hospital. They have requested that the budget should be produced using zero based budgeting. Required: Explain the potential difficulties that the hospital s managers may face when setting budgets using zero based budgeting. (5 marks) Section B continues on the next page TURN OVER November Performance Operations

8 (e) RS is a travel company providing daily tours of a major European capital city. The market is highly competitive and RS has commissioned some market research to help with the pricing decision for a new tour. The research identified the probability of three possible market conditions and the number of tickets that would be sold each day at three different price levels. Ticket Price $80 $90 $100 Market Probability No. of tickets No. of tickets No. of tickets Weak Good Excellent Required: Variable costs are expected to be $20 per ticket irrespective of market conditions. Demonstrate, using a decision tree and based on expected value, which ticket price RS should choose. (5 marks) (f) Explain the meaning of expected value and the limitations of using expected values for decision making. (5 marks) (Total for Section B = 30 marks) End of Section B. Section C begins on page 10 Performance Operations 8 November 2012

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10 SECTION C 50 MARKS [You are advised to spend no longer than 45 minutes on each question in this section.] ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE. Question Three GH produces three models of speedboat for sale to the retail market. GH currently operates a standard absorption costing system. Budgeting information for next year is given below: Model of speedboat Superior Deluxe Ultra Total $000 $000 $000 $000 Sales 54,000 86, , ,400 Direct material 17,600 27,400 40,200 85,200 Direct labour 10,700 13,400 16,600 40,700 Production overhead Gross profit Superior Deluxe Ultra Production / sales (number of boats) 1,000 1, Machine hours per boat The production overhead cost is absorbed using a machine hour rate. 69,600 46,900 GH is considering changing to an activity based costing system. The main activities and their associated cost drivers and overhead cost have been identified as follows: Activity Cost Driver Production overhead cost $000 Machining Machine hours 13,920 Set up Number of set ups 23,920 Quality inspection Number of quality inspections 14,140 Stores receiving Number of component deliveries 6,840 Stores issue Number of issues from stores 10,780 69,600 The analysis also revealed the following information: Superior Deluxe Ultra Budgeted production (number of boats) 1,000 1, Boats per production run Quality inspections per production run Number of component deliveries Number of issues from stores 4,000 5,000 7,000 The machines are set up for each production run of each model. Performance Operations 10 November 2012

11 Required: (a) Calculate the total gross profit for each model of speedboat: (i) using the current absorption costing system; (ii) using the proposed activity based costing system. (4 marks) (12 marks) (b) (c) Explain why an activity based costing system may produce more accurate product costs than a traditional absorption costing system. (3 marks) Explain the possible other benefits to the company of introducing an activity based costing system. You should use the figures calculated in part (a) to illustrate your answer. (6 marks) (Total for Question Three = 25 marks) Section C continues on the next page TURN OVER November Performance Operations

12 Question Four JK is a profitable international pharmaceutical company that develops, produces and markets drugs that are licensed as medication. The pharmaceutical industry has grown rapidly and faces challenges in preventing and controlling environmental pollution. Over the past few years there has been growing pressure on the industry from government, shareholders and other stakeholders to improve its environmental management performance. JK has taken a proactive approach to environmental management and has invested significant resources introducing pollution prevention and clean manufacturing practices into its operation in order to reduce waste and minimise negative environmental impacts. The company has used marketing and advertising campaigns to develop an image as a company that is at the cutting edge of green technology. As part of its environmental management programme, JK is considering investing in a new system that will significantly reduce hazardous emissions and waste. The estimates for the proposed investment are as follows: Initial investment Useful life Residual value Annual income from sale of recycled waste Annual savings in waste disposal costs Annual fixed maintenance costs per annum Other annual fixed operating costs per annum (including depreciation) $60 million 6 years $12 million $5 million $5.5 million $1.5 million $10.6 million JK has experienced a number of external environmental failures over the past few years which have resulted in total costs to JK, including government fines, of $20 million per annum. The environmental officer has estimated that, as a direct result of this investment, future external environmental failure costs that will be borne by JK and their associated probabilities are as follows: Annual external environmental failure costs Probability $18 million 30% $12 million 25% $10 million 35% $5 million 10% The company uses expected value for this type of analysis. Depreciation of the initial investment will be calculated using the straight line method and has been included in other fixed operating costs. The company s financial director has provided the following taxation information: Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in the year of disposal. Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year. The company uses a cost of capital of 12% per annum to evaluate projects of this type. Ignore inflation. Performance Operations 12 November 2012

13 Required: (a) (b) Evaluate the investment in the proposed system using net present value as the basis of your evaluation. Your workings should be shown in $m to one decimal place. (13 marks) (i) Calculate the payback period for the investment. (3 marks) (ii) Discuss the advantages and disadvantages of payback as a method of investment appraisal. (5 marks) (c) Explain TWO factors related to JK s approach to environmental issues that should be considered before making a final decision about the project. (4 marks) (Total for Question Four = 25 marks) (Total for Section C = 50 marks) End of question paper Maths tables and formulae are on pages 15 to 18 November Performance Operations

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15 PRESENT VALUE TABLE Present value of $1, that is ( 1+ r ) n where r = interest rate; n = number of periods until payment or receipt. Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% November Performance Operations

16 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years n 1 (1+ r ) r Periods (n) Interest rates (r) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods (n) Interest rates (r) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Performance Operations 16 November 2012

17 FORMULAE PROBABILITY A B = A or B. A B = A and B (overlap). P(B A) = probability of B, given A. Rules of Addition If A and B are mutually exclusive: P(A B) = P(A) + P(B) If A and B are not mutually exclusive: P(A B) = P(A) + P(B) P(A B) Rules of Multiplication If A and B are independent:: P(A B) = P(A) * P(B) If A and B are not independent: P(A B) = P(A) * P(B A) E(X) = (probability * payoff) DESCRIPTIVE STATISTICS Arithmetic Mean x = x n fx x = (frequency distribution) f Standard Deviation SD = INDEX NUMBERS ( x x) n SD = fx x (frequency distribution) f Price relative = 100 * P 1/P 0 Quantity relative = 100 * Q 1/Q 0 P1 w P o Price: x 100 w Q1 w Q o Quantity: x 100 w TIME SERIES Additive Model Multiplicative Model Series = Trend + Seasonal + Random Series = Trend * Seasonal * Random November Performance Operations

18 FINANCIAL MATHEMATICS Compound Interest (Values and Sums) Future Value S, of a sum of X, invested for n periods, compounded at r% interest S = X[1 + r] n Annuity Present value of an annuity of $1 per annum receivable or payable for n years, commencing in one year, discounted at r% per annum: PV = r [1 + r ] n Perpetuity Present value of $1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum: PV = r 1 LEARNING CURVE Y x = ax b where: Y x = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2. INVENTORY MANAGEMENT Economic Order Quantity EOQ = 2C D where: C o = cost of placing an order C h = cost of holding one unit in inventory for one year D = annual demand C o h Performance Operations 18 November 2012

19 LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE VERBS USED DEFINITION Level 1 - KNOWLEDGE What you are expected to know. List Make a list of State Express, fully or clearly, the details/facts of Define Give the exact meaning of Level 2 - COMPREHENSION What you are expected to understand. Describe Communicate the key features Distinguish Highlight the differences between Explain Make clear or intelligible/state the meaning or purpose of Identify Recognise, establish or select after consideration Illustrate Use an example to describe or explain something Level 3 - APPLICATION How you are expected to apply your knowledge. Level 4 - ANALYSIS How are you expected to analyse the detail of what you have learned. Level 5 - EVALUATION How are you expected to use your learning to evaluate, make decisions or recommendations. Apply Calculate Demonstrate Prepare Reconcile Solve Tabulate Analyse Categorise Compare and contrast Construct Discuss Interpret Prioritise Produce Advise Evaluate Recommend Put to practical use Ascertain or reckon mathematically Prove with certainty or to exhibit by practical means Make or get ready for use Make or prove consistent/compatible Find an answer to Arrange in a table Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between Build up or compile Examine in detail by argument Translate into intelligible or familiar terms Place in order of priority or sequence for action Create or bring into existence Counsel, inform or notify Appraise or assess the value of Advise on a course of action November Performance Operations

20 Performance Pillar Operational Level Paper P1 Performance Operations November 2012 Wednesday Morning Session Performance Operations 20 November 2012