general comments - cima docs/2010 syllabus docs/… · will follow through these errors and award...

Paper P1 – Performance Operations Post Exam Guide November 2010 Exam

© The Chartered Institute of Management Accountants

General Comments Candidate performance in this diet was generally better than in the May 2010 diet. Improvements in performance were evident in all sections of the paper and particularly in Section B. Section C included a question on Activity Based Costing which seemed to come as a surprise to many candidates. Candidates should be aware that the full range of the syllabus will be examined and that they should not rely on conjecture in student magazines and by tutors about what topics will be included in any particular diet. There is still evidence of lack of preparation for the examination and a general lack of knowledge in some areas. A number of questions were very badly answered, in particular Q2(a) on zero based budgeting and Q4(d) on the conflicts that can arise between NPV and IRR when choosing between mutually exclusive projects. As all questions in the paper are compulsory it is important that candidates’ knowledge extends to the full range of the syllabus. Basic exam technique is very poor for a number of reasons:

a) Candidates do not read the question properly which invariably result in wasting valuable time and the loss of marks. See comments below for questions 3 and 4.

b) Candidates do not answer the question that is asked, instead giving an answer to the question they would like to have been asked. This will result in the award of no marks.

c) Poor time management is evident for many questions. If a question is worth five marks it does not require two pages of narrative to answer it. In most cases, full marks can be achieved for a five mark question if five well explained points are given.

d) Candidates ignore the verb that is used in the question. If the question asks the candidate to ‘explain’, marks will only be awarded if clear explanations are given.

e) Candidates fail to show workings to computational questions. Marks are available for ‘own figures’ where a candidate has made an error in a previous calculation. Markers will follow through these errors and award marks for method where appropriate. If workings are not shown however, it is impossible for markers to award any marks.

f) Workings are scattered over the script making it difficult for markers to follow and consequently award marks.

g) Answers to computational questions are poorly laid out.



Section A – 20 marks ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION

Question 1.1 Invoice discounting is: A Reducing or discounting the amount owed by a customer in order to ensure payment. B Writing off a debt because the customer is not expected to pay. C Selling invoices to a finance company that then collects the cash from the customer.

D Selling invoices to a finance company for less than their face value while continuing to collect the cash from the customer.

(2 marks)

The correct answer is D Question 1.2 A project with a five year life requires an initial investment of $120,000 and generates a net present value (NPV) of $50,000 at a discount rate of 10% per annum.

The project cash flows are as follows.

$000 per annum Variable material cost 30 Variable labour cost 10 Incremental fixed cost 5

The costs and activity levels are expected to remain the same for each year of the project. Ignore taxation and inflation. The sensitivity of the investment decision to changes in the variable costs is: A 131.9% B 44.0%

C 33.0%

D 29.3%

(2 marks)

The correct answer is C



Workings $40,000 x 3.791 = $151,640 $50,000 / $151,640 = 0.3297 = 33.0%

Question 1.3 The data in the table below has been extracted from a company’s cost accounting records. It shows the total costs and the inflation index for the periods in which the costs were incurred. Cost behaviour patterns are the same in both periods.

Output level Total cost Inflation index 6,000 units $10,500 1.05 8,000 units $13,390 1.03

The variable cost per unit, to the nearest $0.01, at an inflation index of 1.06 is: A $1.45 B $1.59

C $1.53

D $1.50

(2 marks)

The correct answer is B Workings $10,500 / 1.05 = $10,000 $13,390 / 1.03 = $13,000 Using the high-low method ($13,000 – $10,000) / (8,000 – 6,000) = $ 1.50 per unit At inflation index of 1.06 = $1.50 x 1.06 = $1.59



The following data are given for sub-questions 1.4 and 1.5 below The budgeted selling price of one of C’s range of chocolate bars was $6.00 per bar. At the beginning of the budget period market prices of cocoa increased significantly and C decided to increase the selling price of the chocolate bar by 10% for the whole period. C also decided to increase the amount spent on marketing and as a result actual sales volumes increased to 15,750 bars which was 5% above the budgeted volume. The standard contribution per bar was $2.00 however a contribution of $2.25 per bar was actually achieved.

Question 1.4 The sales price variance for the period was: A $9,450 A B $9,450 F C $9,000 A

D $9,000 F

(2 marks)

The correct answer is B

Workings The sales price variance is: ($6.60 – $6.00) x 15,750 = $9,450 Favourable

Question 1.5 The sales volume contribution variance for the period was: A $1,500.00 F B $3,937.50 F C $3,750.00 F

D $1,687.50 F

(2 marks)

The correct answer is A

Workings The sales volume contribution variance is: (15,750 – 15,000) x $2.00 = $1,500 Favourable Budgeted sales were 15,750/1.05 = 15,000 units



Question 1.6 H has a budgeted production for the next budget year of 12,000 units spread evenly over the year. It expects the same production level to continue for the next two years. Each unit uses 4kg of material. The estimated opening raw material inventory at the start of the next budget year is 3,000kg. H’s future policy will be to hold sufficient raw material inventory at the end of each month to cover 110% of the following month’s production. The budgeted material cost is $8 per kg for purchases up to 49,000kg. The excess of purchases over 49,000kg in a year will be at a cost of $7.50 per kg. Calculate the material purchases budget for the year in $.

(3 marks) Workings

Materials Usage 12,000 units x 4kg = 48,000kg

Opening inventory = 3,000kg Closing inventory = 12,000/12 x 4kg x 1.1 = 4,400kg

Material Purchases Budget (kg)

Material usage 48,000kg Plus closing inventory 4,400kg Less opening inventory (3,000)

49,400kg kg

Material Purchases Budget ($)

49,000kg x $8 = $392,000 400kg x $7.50 = Total $395,000

$3,000



Question 1.7 An unquoted bond has a coupon rate of 6% per annum and will repay its face value of $100 on its maturity in 4 years’ time. The yield to maturity on similar bonds is estimated to be 3% per annum. The annual interest has just been paid for the current year. Calculate the current expected market value of the bond.

(3 marks)

Workings Yield to maturity of similar bonds is 3%, therefore use 3% as the discount rate.

Year(s) Description Cash flow $

Discount Factor (3%)

Present Value $

1-4 Interest 6 3.717 22.3 4 Redemption 100 0.888 88.8 0 Market value 111.1

The current expected market value of the bond is therefore $111.10



Question 1.8 A company has to choose between three mutually exclusive projects. Market research has shown that customers could react to the projects in three different ways depending on their preferences. There is a 30% chance that customers will exhibit preferences 1, a 20% chance they will exhibit preferences 2 and a 50% chance they will exhibit preferences 3. The company uses expected value to make this type of decision. The net present value of each of the possible outcomes is as follows:

Probability Project A Project B Project C

$000 $000 $000

Preferences 1 0.3 400 800 500

Preferences 2 0.2 500 300 600

Preferences 3 0.5 700 200 400 A market research company believes it can provide perfect information about the preferences of customers in this market. Calculate the maximum amount that should be paid for the information from the market research company.

(4 marks) Workings

Probability Project A Project B Project C

$000 $000 $000

Preferences 1 0.3 400 800 500

Preferences 2 0.2 500 300 600

Preferences 3 0.5 700 200 400

Expected Value 570 400 470 Project A is the best choice (without the benefit of perfect information) as it has the highest expected value (EV) of the NPV of $570k. With perfect information: If market research say preferences 1: select B and earn $800k – probability 0.3 If market research say preferences 2: select C and earn $600k – probability 0.2 If market research say preferences 3: select A and earn $700k – probability 0.5 EV (with perfect information) = ($800k x 0.3) + ($600k x 0.2) + ($700k x 0.5) = $710k Value of perfect information is $710k – $570k = $140,000



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) Explain the stages in the budget setting process for a company that uses a zero-based budgeting system.

(5 marks) Rationale The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It examines the candidates’ ability to explain the different stages in a budget setting process for a company that uses zero based budgeting. Suggested Approach Candidates should clearly explain each of the separate stages involved in setting a budget when using zero based budgeting. Marking Guide

Marks

1 mark per valid point Up to 3 marks for each part of the process

Maximum marks awarded 5 marks Examiner’s comments This question was badly done by the majority of candidates with most scoring only one mark. Candidates failed to answer the question; many discussed instead the advantages and disadvantages of zero based budgeting. Those that did refer to a budget setting process did so in a very general way rather than specifically discussing zero based budgeting. In terms of the zero based budgeting process, few candidates got further than to state that the budget started from scratch and that all expenditure had to be justified. Common errors 1. Failure to answer the question 2. Discussion of the budget setting process in general terms without referring specifically to zero based budgeting. 3. Discussion of the advantages and disadvantages of zero based budgeting.



Question 2(b) AP sells fruit in a market where the level of demand is uncertain. AP has to order the fruit before the demand level is known. The payoff table below shows the profits AP can expect depending on the level of order that is placed and the level of demand that occurs.

Demand level Level of order High Medium Low

Good $600 $300 $100

Average $200 $400 $100

Poor $(100) $300 $200

Required:

(i) Identify which order level would be selected if AP applied:

a. the maximin decision criterion b. the maximax decision criterion

(2 marks)

(ii) Identify, using a minimax regret table, the order level that would be selected if AP applied the minimax regret decision criterion.

(3 marks)

(Total for sub-question (b) = 5 marks)

Rationale The question assesses learning outcome D1(a) analyse the impact of uncertainty and risk on decision models that may be based on relevant cash flows, learning curves, discounting techniques etc. It examines candidates’ ability to apply various decision making criteria to a particular decision. Suggested Approach In part (i) candidates should review the payoff matrix to determine the order level that the decision maker would select if they applied the maximin and maximax decision criteria. In part (ii) candidates should produce a regret matrix, determine the maximum regret at each of the order levels and then select the order level that minimises the maximum regret. Marking Guide

Marks

Identification of the order level applying the maximin decision criterion Identification of the order level applying the maximax decision criterion Preparation of a regret table Identification of the order level applying the minimax regret decision criterion

1 mark 1 mark 2 marks 1 mark

Maximum marks awarded 5 marks



Examiner’s comments This question was reasonably well done with many candidates achieving full marks. Weaker candidates struggled to produce an accurate regret table. A number of candidates added the figures in the regret table therefore losing marks as it was difficult to determine the basis on which the selection had been made. Common errors

1. Selecting a demand level rather than an order level 2. Stating an amount rather than an order level 3. Totalling the columns in the regret table



Question 2(c) “Decision rules based on expected values assume that the decision maker is risk neutral”. Required:

(i) Explain the above statement. (2 marks)

(ii) Describe TWO other attitudes to risk.

(3 marks)

(Total for sub-question (c) = 5 marks)

Rationale The question assesses learning outcome D1(a) analyse the impact of uncertainty and risk on decision models that may be based on relevant cash flows, learning curves, discounting techniques etc. It examines candidates’ ability to explain the effect that a decision maker’s attitude to risk will have on the chosen decision. Suggested Approach In part (i) candidates should explain why a risk neutral decision maker is likely to make decisions based on expected value. In part (ii) candidates should describe a decision maker who is risk averse and a decision maker who is risk seeking.

Marking Guide

Marks

(i) 1 mark per valid point (ii) 1 mark per valid point

2 marks 3 marks

Maximum marks awarded 5 marks Examiner’s comments Candidates struggled with part (i) of the question with many defining a risk neutral decision maker as someone between a risk averse and risk seeking decision maker. The question asked for an explanation of the statement but few explained what was meant by ‘expected value’. Part (ii) was much better done with most candidates able to describe two other attitudes to risk and explain the link between risk and return. Common errors

1. Inability to explain what was meant by the term ‘risk neutral’. 2. No explanation given of ‘expected value’. 3. Describing a ‘risk averse’ decision maker as a ‘risk adverse’ decision maker.



Question 2(d) RX has a balance outstanding on its trade receivables account at the start of the year of $83,000 after allowing for bad debts. RX forecasts sales revenue for the next year of $492,750. All sales are on credit. Based on past experience, RX anticipates that bad debts will represent 5% of sales for the year. Trade receivable days at the end of the year are expected to be 60 days. Required:

(i) Calculate the expected receipts from customers during the year.

(3 marks)

(ii) Describe TWO methods that RX could use to reduce the possibility of bad debts occurring. (2 marks)

(Total for sub-question (d) = 5 marks)

Rationale The question assesses learning outcome E1(e) analyse trade debtor and creditor information. Part (i) of the question examines candidates’ ability to calculate expected cash receipts from credit customers given information relating to bad debts and trade receivable days. Part (ii) of the question examines candidates’ ability to describe methods that a company could use to reduce the occurrence of bad debts. Suggested Approach In part (i) candidates should firstly calculate the trade receivables outstanding at the end of the period based on the trade receivable days given in the question. Candidates should then calculate the expected bad debts. The cash receipts should then be calculated by using the sales revenue figures and adjusting for opening and closing trade receivables and bad debts. In part (ii) candidates should clearly describe two methods that a company could use to reduce the possibility of bad debts occurring. Marking Guide

Marks

(i) Trade receivable at end of the year = $492,750 / 365 x 60 = $81,000 Bad debts = ($492,750 – $81,000) x 5% = $20,587.50 Cash collected = $83,000 + $492,750 - $81,000 - $20,587.50 = $474,162.50 (ii) 1 mark per valid method

1 mark

1 mark

1 mark

2 marks

Maximum marks awarded 5 marks Examiner’s comments Part (i) was reasonably well done but few candidates achieved full marks. Most candidates managed to describe two methods in part (ii) but some thought that it was enough just to make a statement such as ‘improve credit control’ without actually describing how this would be done. Similarly many candidates suggested that factoring could be used but did not detail how this would reduce bad debts. Common errors

1. Incorrect calculation of bad debts by applying 95% to the opening balance when bad debts had already been taken into account.

2. Forgetting to include the opening balance in the cash collected.



3. Failing to adequately describe the methods for reducing the incidence of bad debts.



Question 2(e)

A company has forecast that it will have surplus funds to invest for a 12 month period. It is considering two investments as follows: Investment 1 Invest in a bank deposit account that has a variable rate of interest. The current rate of interest on the account is 1.1% per quarter. Investment 2 Buy a 12 month fixed dated government bond. The bond has a coupon rate of 2.5% payable every six months. Required:

Explain the advantages AND disadvantages to the company of each of the investments. You should consider the return offered and the level and type of risk involved with each investment. You should assume that there are no other investments available and that these investments are only available now.

(5 marks)

Rationale The question assesses learning outcome E2(b) identify alternatives for investment of short-term cash surpluses. It examines candidates’ ability to compare two potential short term investment opportunities and explain the advantages and disadvantages of each. Suggested Approach Candidates should firstly calculate the return on each of the investments and then explain the advantages and disadvantages that the company would need to consider before making the investment decision.

Marking Guide

Marks

The annual return on the deposit account is (1.011)4 = 1.044731 or 4.47% The annual return on the bond is 2.5% x 2 = 5% 1 mark per valid point

1 mark 1 mark 3 marks

Maximum marks awarded 5 marks



Examiner’s comments This question was generally well answered with most candidates able to discuss the advantages and disadvantages of the investments. Some candidates did not explain the points they were making despite the fact that the question clearly stated that explanation was required. It is not enough to state that one investment has higher risk than the other without explaining why this is the case. The calculation of the return on the investment was not so well done as candidates did not seem to understand when compounding was required and when it was not. Common errors

1. Failure to clearly explain the points made. 2. Calculating the return on investment 1 as 4.4% i.e. 1.1% x 4 3. Calculating the return on investment 2 as 5.06% i.e. (1+ 0.025)²



Question 2(f) An extract from WCC’s trial balance at the end of its financial year is given below:

$000 Sales revenue (80% on credit) 1,400 Cost of sales 1,215 Purchases of materials (95% on credit) 915 Inventories at end of year Raw materials 85 Finished goods 90 Trade receivables 185 Trade payables 125

Required: Calculate the length of WCC’s working capital cycle to the nearest 0.1 of a day.

(5 marks)

Rationale The question assesses learning outcome E1(b) interpret working capital ratios for business sectors. It examines candidates’ ability to calculate working capital ratios and the working capital cycle. Suggested Approach Candidates should firstly calculate the trade receivable days, trade payable days and raw material and finished goods inventory days. The resulting figures should then be used to calculate the working capital cycle. Marking Guide

Marks

Component Calculation Days

Raw material inventory days 85/915 x 365 33.9

Finished goods inventory days 90/1215 x 365 27.0

Receivable days 185/(0.80 x 1,400) x 365 60.3

Payables days 125/(0.95 x 915) x 365 -52.5

Working capital cycle 68.7

1 mark per component 1 mark working capital cycle

Maximum marks awarded 5 marks Examiner’s comments

It was disappointing to see how many candidates were unable to calculate basic working capital ratios. Most candidates were able to calculate the working capital cycle.



Common errors 1. Calculating raw material inventory days using cost of sales rather than purchases as the

denominator. 2. Failing to adjust sales and purchases to credit sales and credit purchases. 3. Adding payable days and deducting receivable days when calculating the working capital cycle.



Section C – 50 marks ANSWER BOTH THE TWO QUESTIONS

Question 3

(a) Calculate the profit per procedure for each of the three procedures, using the current basis for charging the costs of support activities to procedures.

(5 marks)

(b) Calculate the profit per procedure for each of the three procedures using activity-

based costing.

(13 marks)

(c) Discuss the ways in which the information obtained by the project team may be of benefit to the management of the company.

(7 marks)

(Total for Question Three = 25 marks)

Rationale Part (a) 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 service using a traditional method of overhead absorption. 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 requires candidates to be able to apply activity based costing to the calculation of service costs. Part (c) 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 the potential benefits of the information for management decision making. Suggested Approach In part (a) candidates should identify the direct costs for each procedure and then calculate the overhead absorption rate. This rate can then be applied to each procedure and the profit calculated. In part (b) 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 procedure. In part (c) the profit per procedure can then be recalculated using the overhead costs per procedure calculated in (b). In part (c) candidates need to clearly explain how the information collected by the project team and the results of the calculations in parts (a) and (b) would be of benefit to management.

Marking Guide

Marks

(a) Fees charged to patients

½ mark

Direct costs 2 marks Overhead costs 2 marks Profit per procedure ½ mark (b) Cost driver rates

5 marks



Application of cost driver rates 6 marks Revised profit per procedure using ABC 2 marks (c) 1 mark per valid point

7 marks

Maximum marks awarded 25 marks Examiner’s comments

This question was generally very well done although some calculations caused difficulty, in particular the calculation of follow up fees in part (a) and theatre preparation costs in part (b). Candidates lost marks and time because they did not read the question properly. In part (a) some candidates apportioned the overhead by activity which wasted a lot of valuable time and gained no marks. Some candidates failed to show workings in part (b) which potentially lost them marks. Too many candidates are still not laying out workings in a clear, structured way, potentially resulting in the loss of marks. Part (c) was well answered by the majority of candidates. Common errors

1. Failure to calculate follow-up fees correctly, using instead a flat rate of $300. 2. Allocating overhead costs based on units sold rather than on sales revenue. 3. Calculating the number of cost drivers for theatre preparations as 3,600 rather than 1,200. 4. Multiplying the cost driver rate for theatre preparation by 2, 1 and 4 respectively rather than

dividing by 2, 1 and 4.



Question 4

(a) Calculate for Project 1 the relevant cash flows that the accountant should have used for year 1 when appraising the project. All workings should be shown in $000.

(6 marks)

(b) Calculate for Project 2:

(i) the net present value (NPV) (ii) the internal rate of return (IRR) All workings should be shown in $000.

(10 marks)

(c) Advise the company directors which of the two investment projects should be undertaken.

(4 marks)

(d) A company is considering two alternative investment projects both of which have a positive net present value. The projects have been ranked on the basis of both net present value (NPV) and internal rate of return (IRR). The result of the ranking is shown below:

Project A Project B NPV 1st 2nd IRR 2nd 1st

Discuss potential reasons why the conflict between the NPV and IRR ranking may have arisen.

(5 marks)

(Total for Question Four = 25 marks)

Rationale Parts (a) and (b) of the question assess learning outcomes C1(a) explain the processes involved in making long-term decisions and C2(a) evaluate project proposals using the techniques of investment appraisal. They examine candidates’ ability to identify relevant costs and calculate the net present value and IRR of a project. Part (c) of the question assesses learning outcome C2(a) evaluate project proposals using the techniques of investment appraisal. It examines candidates’ ability to evaluate two investment projects based on their NPV and IRR. Part d) of the question assesses learning outcome C2(c) prioritise projects that are mutually exclusive, involve unequal lives and/or are subject to capital rationing. It requires candidates to discuss the reasons why conflicts arise between the ranking of projects based on their IRR and NPV.



Suggested Approach In part (a) candidates should identify the expected cost saving from internal failure costs, external failure costs and material costs that would arise in Year 1 if the new quality control process was implemented. In part (b) candidates should identify the relevant cash flows for each year of the project and discount these at the discount rate of 8% to calculate the NPV of the project. The same cash flows should then be discounted at a higher discount rate and the IRR calculated using interpolation. In part (c) candidates should explain that investment decisions should be based on NPV. However candidates should also recognise that one project required less investment than the other and that this and other non-financial factors should be considered before making a final decision. In part (d) candidates should clearly explain the reasons why conflict may arise when ranking a project on the basis of IRR and NPV.



Marking Guide

Marks

(a) Internal failure cost savings External failure cost savings Raw material cost savings (b) (i) Initial investment Working capital Expected cost savings Year 1 Increase in cost savings Year 2 – 5 Fixed costs Discounting cash flows (b) (ii) Discounting cash flows at higher discount rate Net present value Interpolation (c) 1 mark per valid point (d) 1 mark per valid point

2 marks 2 marks 2 marks ½ mark 1 mark 1 mark ½ mark 2 marks 2 marks 1 mark 1 mark 1 mark 4 marks 5 marks

Examiner’s comments Part (a) and (b) were reasonably well done although there were a lot of fairly basic errors. Many candidates wasted valuable time in part (a) as they did not read the question properly and gave cash flows for all five years. In some cases they even carried out a discounted cash flow analysis. In part (b) some candidates failed to appreciate that the benefits from an investment can be in terms of cost savings and decided to make up sales revenue to put into the analysis. Parts (c) and (d) were not well answered with few candidates scoring more than one or two marks. It was not clear whether candidates had run out of time or just had a general lack of knowledge, particularly in part (d). Common errors

1. Giving cash flows for five years instead of only Year 1. 2. Including 20% of cost saving rather than 80%. 3. Failing to increase the production volume by 4% in Year 1. 4. Failing to include the working capital as a cash inflow in Year 5 5. Increasing the fixed costs by $5,000k each year. 6. Treating depreciation as a cash flow. 7. Using a second discount rate higher than 8%, to calculate IRR even though the candidates’

original calculation at 8% incorrectly gave a negative NPV. Using the NPV for project 1 to calculate the IRR for project 2.

8. Failing to state the superiority of NPV when choosing between mutually exclusive projects 9. Inability to explain the conflict that can arise between NPV and IRR.

general comments - cima docs/2010 syllabus docs/… · will follow through these errors and award...

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