General Comments This sitting produced a reasonably good pass rate although lower than in the last two main exam sittings. Performance varied considerably by section and from previous sittings. There were very few marginal candidates with most candidates either passing reasonably well or failing badly. Many candidates passed the paper largely as a result of good performance on Question 3, the Activity Based Costing question. Candidates scored reasonably well in the multiple choice questions with most candidates scoring at least six marks but the remainder of Question 1 was not particularly well done. Question 1.8 was particularly badly done with very few candidates able to answer the question and the majority scoring zero marks. It once again highlights the tendency for candidates to rote learn rather than to understand what they are calculating and what it means. Question 1.7 on time series analysis was also not particularly well done even though this is certificate level material. Question 2 was not as well done as in the previous few sittings. There were fairly poor attempts at the narrative questions in this section especially Q2(b) and Q2(d), where some candidates failed to address the question asked, possibly as a result of lack of knowledge. The computational questions were fairly well done. Question 4 presented some difficulties for candidates as the NPV was negative. This was further exacerbated when some candidates failed to treat a cost saving as a positive cash flow. Many candidates wasted valuable time trying to work out why they hadn t derived a positive net present value. The second part of the question was a payback calculation and candidates saw this as further evidence that a negative NPV must be incorrect. Despite this candidates scored reasonably well on the question. The overall performance of candidates was encouraging with some candidates producing very high scoring scripts. There are however some areas that are very weak. Some candidates are still unable to calculate even the basic variances and have little idea of what they are calculating. The narrative aspects of Question 3 and Question 4 were generally very poorly handled which suggests that candidates do not understand why they are carrying out calculations and are unable to comment on the strengths and weaknesses of what they are calculating. The Chartered Institute of Management Accountants 2013 Page 1
Section A 20 marks ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION Question 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) The correct answer is C. Workings Discounted value of cash inflow = $100k x 3.791 =$379.1k Sensitivity = $320k / $379.1k = 84.4% Question 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) The correct answer is A. The Chartered Institute of Management Accountants 2013 Page 2
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 440 470 560 Project B 400 550 580 Project C 360 400 480 Project D 320 380 420 Question 1.3 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) The correct answer is A. Workings The minimum outcome for Project A is $440k The minimum outcome for Project B is $400k The minimum outcome for Project C is $360k The minimum outcome for Project D is $320k Therefore if the company wants to maximise the minimum it will choose Project A. The Chartered Institute of Management Accountants 2013 Page 3
Question 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) The correct answer is B. Workings The maximum that can be achieved is $580k for Project B. Question 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) The correct answer is D. The Chartered Institute of Management Accountants 2013 Page 4
Question 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 2011 2010 $000 $000 Non-current assets 6,400 5,600 Inventories 1,200 1,120 Trade receivables 800 840 Cash 200 40 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 1,480 840 3,880 3,240 Summary Income Statement for PQ for the years 2011 2010 $000 $000 Sales 12,000 10,000 Cost of sales 6,400 5,200 Operating profit 2,400 1,800 Required: 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) Workings Receivables days = (800/12,000) x 365 = 24.3 days Payables days = (1,120/(6,400 +1,200-1,120) x 365 = 63.1 days Inventory days = (1,200/6,400) x 365 = 68.4 days The Chartered Institute of Management Accountants 2013 Page 5
Or alternatively Receivables days = (((800+ 840)/2)/12,000) x 365 = 24.9 days Payables days = (((1,120 + 1,160)/2)/(6,400 +1,200-1,120)) x 365 = 64.2 days Inventory days = (((1,200+ 1,120)/2)/6,400) x 365 = 66.2 days Question 1.7 KL has determined from past experience that the following equation provides a reliable estimate of its future sales volume: y = 15,000 + 2,200x 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 2 110 Quarter 3 120 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) Workings The third quarter of Year 6 is time period 23 Expected sales volume based on the trend equation = 15,000 + (2,200 x 23) = 65,600 units Forecast sales volume after allowing for seasonal variation = 65,600 x 1.2 = 78,720 units The Chartered Institute of Management Accountants 2013 Page 6
Question 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 $108.06. Required: Calculate the coupon rate on the bond. (4 marks) Workings The yield to maturity is 6% therefore the net present value of the cash flow when discounted at 6% will be equal to zero. Year(s) Description Cash flow Discount factor (6%) Present value $ 0 Purchase (108.06) 1.000 (108.06) 1-3 Interest 9 2.673 24.06 3 Redemption 100 0.840 84.00 NPV 0 To achieve a NPV of zero the present value of the total interest paid has to be $24.06 therefore the annual interest payments are $9 which is a coupon rate of 9% The Chartered Institute of Management Accountants 2013 Page 7
Section B 30 marks ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE Question 2(a) (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, email 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) Rationale The question assesses learning outcome E1(e) analyse trade debtor and creditor information. In part (i) it examines candidates ability to prepare an aged debt analysis and in part (ii) it examines candidates ability to determine what action should be taken as a result of the information given in the analysis. Suggested Approach Candidates should firstly establish which invoices remain unpaid by netting off the receipts and credit notes. They should then prepare a table showing the aging of the outstanding invoices and the total outstanding balance. In part (ii) candidates should state further actions that the company could take to recover the outstanding debt. Marking Guide (i) ½ mark each invoice in correct month ½ mark balance (ii) They may decide to take legal action to collect the debt. They may decide to stop further supplies or credit to the customer. They may decide to reduce the credit limit available to the customer. They may decide to charge interest They may decide to hire a debt collection agency Maximum marks awarded Marks 3 marks each action Max 2 marks 5 marks Examiner s comments This question was reasonably well answered although many candidates didn t seem to know what an aged debt analysis was. This was particularly surprising since it is a certificate level topic and similar questions have been asked in previous sittings. Candidates lost marks in part (i) either for just showing the totals for each period rather than the individual invoices outstanding or for not including the total balance. The weaker candidates often simply reproduced all the transactions rather than showing only the outstanding invoices. For part (ii) common incorrect suggestions included offering a discount for early The Chartered Institute of Management Accountants 2013 Page 8
payment and using a factor; some candidates also wanted to write off the debt. Common errors Failure to show individual outstanding invoices Failure to show the total balance Suggesting actions which would not result in recovery of the debt or were not feasible at this stage of the process The Chartered Institute of Management Accountants 2013 Page 9
Question 2(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) Rationale The question assesses learning outcome E2(b) identify alternatives for investment of short-term cash surpluses. It examines candidates ability to describe two potential short-term investment opportunities in terms of their risk, return and liquidity. Suggested Approach Candidates should describe each of the investments and clearly indicate the implication of the features of the investment in terms of its risk, return and liquidity. Marking Guide Certificates of deposit Issued by a bank as an acknowledgement that funds have been deposited therefore low risk. Traded on the money market and so the holder can sell them to obtain immediate cash and they are therefore a suitable option in terms of liquidity. Interest is paid on the deposit at a fixed rate based on current market interest rates at the date of issue but this will reflect the low risk involved. The company however would be exposed to capital risk as the value of the investment changes in response to market interest rate movements. They normally have maturities from three months to five years and the lower end of this time range would be most appropriate for the company s circumstances. However because of the marketability the upper end of this time range gives flexibility. Marks per valid point Max 3 marks per investment Bills of exchange Bills of exchange are tradeable and have a short date normally within 180 days therefore liquidity is good. There is a particularly active market in bills that are payable by top-quality banks therefore liquidity for these is good and the risk is low. It is also possible to buy bills that have been accepted by trading companies but at higher risk They are issued at a discount to the face value with the yield on the bill dependent on the credit worthiness of the drawee. They are also subject to default risk depending on the credit worthiness of the drawee. The Chartered Institute of Management Accountants 2013 Page 10
Maximum marks awarded 5 marks Examiner s comments Question 2(b) was not well answered. Some candidates may have misinterpreted the question as rather than discussing Certificates of Deposit and Bills of Exchange they discussed all manner of alternative investments such as stocks and shares, bonds, treasury bills etc. Those that referred to the specific investments did not explain their risk, return and liquidity. There was a distinct lack of knowledge shown in this question. Common errors 1. Failure to consider the investments listed 2. Failure to consider the investments risk, return and liquidity 3. Failure to justify statements regarding risk, return and liquidity The Chartered Institute of Management Accountants 2013 Page 11
Question 2(c) (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) Rationale The question assesses learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and sales variances, distinguishing between planning and operational variances. It examines candidates ability to calculate a sales mix contribution variance and a sales quantity contribution variance. Suggested Approach In part (i) candidates should calculate the sales mix variance in units by comparing the actual sales quantity at the budgeted mix with the actual sales quantity at the actual mix. The variance calculated in units for each of the products should then be multiplied by the standard contribution per unit to calculate the variance for each product. These should then be summed to calculate the total mix variance. In part (ii) the budgeted sales quantity should be compared to the actual sales quantity at the budgeted mix. The resultant variance in units should then be multiplied by the standard contribution per unit to calculate the sales quantity contribution variance for each product. These should then be summed to calculate the total sales quantity contribution variance. Marking Guide (i) Actual sales at budgeted mix Variance in units Variance in units multiplied by standard contribution (ii) Variance in units Variance in units multiplied by standard contribution Maximum marks awarded Marks 5 marks Examiner s comments Most candidates could calculate a mix variance and achieved a pass on this question. The calculation of the quantity variance was less well done with many candidates calculating a volume variance instead. Common errors 1. Using actual sales at actual contribution to calculate the mix variance 2. Giving the sales volume variance in part (ii) instead of the sales quantity variance 3. In part (ii) multiplying the total quantity variance in units of 300F by $170 or $170/3 The Chartered Institute of Management Accountants 2013 Page 12
Question 2(d) Required: 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. Explain the potential difficulties that the hospital s managers may face when setting budgets using zero based budgeting. (5 marks) Rationale The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It examines the candidates ability to explain the difficulties that a not-for-profit organisation may experience when using a zero based budgeting system. Suggested Approach Candidates should clearly explain why setting budgets using zero based budgeting may be difficult in a not-for-profit organisation. Marking Guide The hospital has previously used an incremental budgeting system and therefore the potential difficulties with setting a budget using a zero based budgeting system are as follows: Marks per valid point Time/resources Zero based budgeting is extremely time consuming and costly The hospital may not have the resources available to enable a full zero based budget to be prepared within the timescale required. Lack of skills It may also require skills that the current management of the hospital do not possess All activities carried out by the hospital will need to be reviewed and justified. Identification of activities / cost drivers There may be difficulty in identifying the activities undertaken by the hospital May be a tendency to try to cut costs rather than identifying the main drivers behind costs. Ranking process The ranking process can be very difficult as value judgements are required. Widely different activities cannot be compared on quantitative measurement alone. Maximum marks awarded 5 marks The Chartered Institute of Management Accountants 2013 Page 13
Examiner s comments Most candidates gave very detailed definitions of both incremental and zero based budgeting which showed good knowledge but unfortunately didn t answer the specific question. Candidates didn t then go on to explain the difficulties other than the fact that ZBB would be more time consuming and perhaps the staff wouldn t have the skills. There were however some good answers where candidates considered the hospital environment and did discuss the problems with ranking and prioritising different medical departments over other departments. This showed really good application of knowledge. Common errors 1. Failure to address the specific question 2. Lack of detail in answers given. The Chartered Institute of Management Accountants 2013 Page 14
Question 2(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 0 3 80 60 30 Good 0 5 100 90 80 Excellent 0 2 150 150 120 Variable costs are expected to be $20 per ticket irrespective of market conditions. Required: Demonstrate, using a decision tree and based on expected value, which ticket price RS should choose. (5 marks) Rationale The question assesses learning outcome D1(f) apply decision trees. It examines candidates ability to use decision trees to evaluate a decision where there is uncertainty regarding expected cash flows. Suggested Approach Candidates should firstly draw the decision tree and then using the various contribution levels for each branch of the tree work back to calculate the expected contribution at each node. They should then clearly indicate the most profitable decision. Marking Guide Calculation of expected value of contribution at ticket prices of $80, $90 and $100 Decision Format Maximum marks awarded Marks each 5 marks Examiner s comments This question was well done with most candidates scoring at least three marks. The format of the decision tree was normally correct with only the very weakest candidates showing the decision being to select market conditions rather than ticket prices. Common errors 1. Calculating the expected value of sales revenue rather than contribution. 2. Calculating the expected value of ticket numbers rather than contribution. 3. Not applying the probabilities to the $20 variable costs. The Chartered Institute of Management Accountants 2013 Page 15
Question 2(f) Explain the meaning of expected value and the limitations of using expected values for decision making. (5 marks) Rationale The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating expected values and standard deviations together with probability tables and histograms. It examines the candidates ability to explain the meaning of expected value and its limitations when used in decision making. Suggested Approach Candidates should clearly explain the meaning of expected value and the limitations of its use in decision making. Marking Guide (i) Expected value is calculated by weighting each of the possible outcomes by their associated probability. The expected value is therefore the weighted average of the possible outcomes based on management s estimates of their probability. (ii) Expected value has a number of limitations as follows: The probabilities used are usually very subjective; The expected value is merely a weighted average and therefore has little meaning for a one-off project; The expected value gives no indication of the dispersion of possible outcomes around the expected value i.e. the risk; The expected value may not correspond to any of the actual possible outcomes. Marks 2 marks per valid point Maximum marks awarded 5 marks Examiner s comments The performance on this question was very varied with some candidates scoring well and others showing very little knowledge either of the definition of expected value (despite the fact that they had just calculated it in the previous question) or its limitations. Common errors 1. Inability to clearly explain the meaning of expected value. 2. Invalid suggestions for its limitations e.g. not taking account of inflation or the payback period. The Chartered Institute of Management Accountants 2013 Page 16
Section C 50 marks ANSWER BOTH QUESTIONS Question 3 (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) Rationale Part (a)(i) of the question assesses learning outcome A1(a) compare and contrast marginal (or variable), throughput and absorption accounting methods in respect of profit reporting and stock valuation. It examines candidates ability to calculate the cost of a product using a traditional method of overhead absorption. Part (a)(ii) assesses learning outcome A1(c) discuss activity-based costing as compared with traditional marginal and absorption costing methods, including its relative advantages and disadvantages as a system of cost accounting. It requires candidates to be able to apply activity based costing to the calculation of the cost of a product. Part (b) assesses learning outcome A1(c) discuss activity-based costing as compared with traditional marginal and absorption costing methods, including its relative advantages and disadvantages as a system of cost accounting. It examines candidates ability to explain why activity based costing may result in more accurate product costs compared to a traditional absorption costing system. Part (c) also assesses learning outcome A1(c) discuss activity-based costing as compared with traditional marginal and absorption costing methods, including its relative advantages and disadvantages as a system of cost accounting. It examines candidates ability to explain other benefits to a company of introducing an activity based costing system. Suggested Approach In part (a)(i) candidates should identify the direct costs for each product and then calculate the overhead absorption rate. This rate can then be applied to each product and the gross profit calculated. In part (a)(ii) candidates need to calculate a cost driver rate for each of the activities and then apply this cost driver rate to calculate the overhead cost for each activity per product. The gross profit for each product can then be recalculated. In part (b) candidates need to clearly explain why activity based costing may produce more accurate product costs. In part (c) the potential benefits to the company of activity based costing in the areas of planning, decision making and control should be explained. The Chartered Institute of Management Accountants 2013 Page 17
Marking Guide (a)(i) Total fixed production overheads Total machine hours Production overheads for each model Gross profit for each model (a)(ii) Cost driver rate machining, stores receiving, stores issuing Cost driver rate set-ups, quality inspections Application of cost driver rate to each model machining, stores receiving, stores issuing Application of cost driver rate to each model set-ups, quality inspections Gross profit each model (b) The various support activities that are involved in making products or providing services are identified. ABC recognises that there are many different drivers of cost not just production or sales volume. The cost drivers are identified in order to recognise a causal link between activities and costs. They are then used as the basis to attach activity costs to a particular product or service. Marks ½ mark ½ mark 1 ½ marks 1 ½ marks each 2 marks each ½ mark each each ½ mark each per valid point (c) Cost drivers identified provide information to management to enable them to improve profitability. Cost driver analysis provides information to management on how costs can be controlled and managed. Variance analysis will also be more useful as it is based on more accurate product costs. The establishment of more accurate product costs should also help managers to assess product profitability and make better decisions concerning pricing and product mix. per benefit for further explanation or example Examiner s comments This question was particularly well done. Candidates generally performed better in the ABC calculation and it was surprising how few could calculate the profit correctly using traditional absorption costing. Candidates who had not revised ABC scored very badly while those who had generally scored highly. Parts (b) and (c) were reasonably well answered but for what were fairly straightforward narrative questions I would have expected better answers. Common errors Part (a)(i) 1. Using the machine hours per boat of 100, 200 and 300 to give $116 ($69,600/600) i.e. not multiplied by the number of each type of boat to derive the absorption rate. 2. Failure to check that the total overhead cost absorbed came back to $69,600k, which should be a basic check. Part (a)(ii) 1. For machining, dividing by the number of machine hours per boat i.e. 600 apportioned 100/200/300, or dividing by the number of boats i.e. 3000 apportioned 1000/1200/800. 2. The number of set ups was often divided just by the boats per production run which totalled 11 in the ratio 5/4/2 3. For the quality inspections costs were divided by 60 in the ratio 10/20/30. The Chartered Institute of Management Accountants 2013 Page 18
4. In general the weaker candidates simply used the further analysis table provided in the question for the number of cost drivers without adjusting this data. Part (b) 1. Failure to answer the specific question. 2. Lack of detail in answer. Part (c) 1. Lack of detail in answer. 2. Repeating the answer given in part (b). The Chartered Institute of Management Accountants 2013 Page 19
Question 4 (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) Rationale Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis to long-run projects that continue for several years and learning outcome C2(a) evaluate project proposals using the techniques of investment appraisal. It examines candidates ability to identify the relevant costs of a project and then apply discounted cash flow analysis to calculate the net present value of the project. Part (b)(i) assesses learning outcome C2(a) evaluate project proposals using the techniques of investment appraisal. It examines candidates ability to calculate the payback period of a project. Part (b)(ii) assesses learning outcome C2(b) compare and contrast the alternative techniques of investment appraisal. It examines the candidates ability to discuss the advantages and disadvantages of payback. Part (c) assesses learning outcome C1(g) prepare decision support information for management, integrating financial and non-financial considerations. It examines candidates ability to explain two factors relating to environmental issues that the company should consider before making a decision regarding the project Suggested Approach In part (a) candidates should firstly calculate the expected future environmental failure costs and compare this to the current level of costs to identify the future cost savings as a result of the investment. They should then identify the other relevant cash flows for each year of the project. The tax depreciation and tax payments should then be calculated. The net cash flows after tax should be discounted at the rate of 12% to calculate the NPV of the project. In part (b)(i) the project cash flows before discounting from part (a) should be used to calculate the payback period. In part (b)(ii) candidates should discuss the advantages and disadvantages of payback. In part (c) candidates should clearly explain two environment related factors that the company should consider. Marking Guide Part (a) Depreciation Other fixed costs excluding deprecation Expected future environmental failure costs Expected cost saving Marks The Chartered Institute of Management Accountants 2013 Page 20
Income/cost savings Maintenance costs Tax depreciation Tax payments Investment/ residual value Present value Net present value Decision Part (b) (i) Correct cash flows Cumulative cash flows Payback period Part (b) (ii) Simple evaluation method and is easy to understand. It does not take account of the time value of money. This problem can be overcome by calculating the payback using discounted cash flows It favours projects that pay back early thus recognising the importance of liquidity Early payback means that the funds can be reinvested in other profitable projects It ignores cash flows, both positive and negative, after the payback point It recognises the uncertainty involved with forecasting cash flows in the future It minimise the risk associated with long time horizons Payback may result in many profitable investments being overlooked Part (c) The company may place an intangible value on the cost savings particularly in view of its commitment and previous proactive approach to minimising negative environmental impact. Potential impact on the company image and future sales from being seen as an environmentally friendly company. Potential savings in environmental costs relating to pollution and the consequential cost to health care and the global environment. Potential saving in future compliance costs if the government changes the compliance levels required. The pressure from government, shareholders and other stakeholders to improve environmental management. Maximum marks awarded ½ mark ½ mark 2 marks 2 marks Total 13 marks Total 3 marks per valid point Total 5 marks 2 marks per factor Total 4 marks 25 marks Examiner s comments The performance on Question 4 was better than in some previous sittings but some of the difficulties have been explained above. Part (a) was reasonably well done by most candidates although candidates got very confused when trying to calculate tax where they had negative cash flows. Part (b) required the calculation of payback but many candidates seemed unable to do this even when they had positive cash flows. Part (c) required consideration of environmental factors that may influence the decision but many candidates struggled with this even though there were many pointers in the question. Common errors Part (a) 1. Including depreciation as a cash flow 2. Incorrect calculation of depreciation The Chartered Institute of Management Accountants 2013 Page 21
3. Including the expected value of environmental failure costs of $12.4m as a cash outflow 4. Failure to include the savings in environmental failure costs 5. Treating the tax on negative cash flows as a tax payment rather than a tax credit 6. Treating the tax depreciation figures as a cash flow 7. Failure to calculate the correct balancing allowance for year 6 8. Failure to extend the tax payments into year 7 9. Failure to state a decision about the investment Part (b)(ii) 1. Use of cash inflows only rather than net cash flows 2. Use of discounted cash flows 3. Failure to state that a project did not pay back over its life where net cash flows were negative Part (b)(ii) 1. Lack of sufficient detail in answers Part (c) 1. Failure to answer the question asked 2. Lack of sufficient detail in answers 3. Reference to the financial calculations in part (a) rather than environmental factors The Chartered Institute of Management Accountants 2013 Page 22