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P1 Performance Operations
March 2013 examination
Examiners Answers
Note: Some of the answers that follow are fuller and more comprehensive than would be
expected from a well-prepared candidate. They have been written in this way to aid teaching,
study and revision for tutors and candidates alike.
These Examiners answers should be reviewed alongside the question paper for this
examination which is now available on the CIMA website at www.cimaglobal.com/p1papers
The Post Exam Guide for this examination, which includes the marking guide for each
question, will be published on the CIMA website by early April at
www.cimaglobal.com/P1PEGS
SECTION A
Rationale
Question One consists of 8 objective test sub-questions. These are drawn from all sections
of the syllabus. They are designed to examine breadth across the syllabus and thus cover
many learning outcomes.
Therefore if the committee wants to maximise the minimum cash inflow it will set a fee
of $800.
Membership level
Membership fee Low Average High
$000 $000 $000
$600 40 0 0
$800 0 40 60
$900 40 75 45
$1,000 80 100 120
4
1.5 Investment A = (1.017) = 6.975%
2
Investment B = (1.034) = 6.916%
12/9
Investment C = (1.054) = 7.264%
Investment D = 7%
1.6 Using the high-low method to separate fixed and variable costs:
Variable cost per unit = ($392,000 - $304,000) / (35,000 24,000) = $8 per unit
At 45,000 units
P1 2 March 2013
1.7 Yield to maturity of similar bonds is 10%, therefore use 10% as the
discount rate.
Alternatively:
Units
Opening inventory (6,000)
Sales 36,000
Closing inventory 3,000 i.e. 36,000 / 12
Production 33,000
kg
Opening inventory (2,000)
Production 66,000 i.e. 33,000 x 2kg
Closing inventory 6,000 i.e. 3,000 x 2kg
Purchases 70,000
March 2013 3 P1
SECTION B
(a)
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
each feature of the investment in terms of its risk, return and liquidity.
Treasury Bills
These are issued by the government for terms of up to three months and therefore have
minimal capital risk as they are backed by the government. The bills are sold by tender each
week at a discount to their nominal value. They are redeemed at their nominal value giving an
implied interest rate. They are therefore subject to interest rate risk since if market rates
increase the holder loses the opportunity for higher rates.
Treasury bills are also traded on the money market and so the holder can sell them to obtain
immediate cash at any time giving excellent liquidity. If sold before maturity however the
holder would also be exposed to capital risk as the value of the investment changes in
response to market interest rate movements.
(b)
Rationale
The question assesses learning outcome C1(f) apply sensitivity analysis to cash flow
parameters to identify those to which net present value is particularly sensitive. It examines
candidates ability to calculate the sensitivity of the net present value of a project to a change
in the cost of capital.
Suggested Approach
Candidates should firstly calculate the net present value of the project when discounted at the
companys cost of capital. They should then calculate the net present value of the project at a
higher discount rate. Interpolation should then be used to calculate the IRR of the project.
The percentage increase in the companys cost of capital which would result in the IRR of the
project, i.e. a net present value of zero, should then be calculated.
P1 4 March 2013
Year Cash Discount Present Discount Present
flow factor value factor value
$ @ 8% $ @ 20% $
0 Initial (70,000) 1.000 (70,000) 1.000 (70,000)
investment
1-3 Cash inflows 30,000 2.577 77,310 2.106 63,180
per annum
3 Residual value 10,000 0.794 7,940 0.579 5,790
IRR by interpolation:
If the companys cost of capital increases to more than 19.2% the investment will no longer be
viable. Thus it can increase by 140% before the investment is no longer viable.
(c)
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 material mix variance and a material
yield variance.
Suggested Approach
In part (i) candidates should calculate the material mix variance by comparing the actual
material quantity in the standard mix with the actual material quantity in the actual mix. The
variance calculated in kg for each of the materials should then be multiplied by the standard
cost per kg to calculate the variance for each material. These should then be summed to
calculate the total mix variance. In part (ii) the actual units of output should be multiplied by
the standard kg of input per unit of output. This should then be compared to the actual kg of
material input. The resultant variance in kg should then be multiplied by the standard
weighted average cost per kg of input.
(i)
March 2013 5 P1
Or alternatively:
(ii)
Or alternatively:
3,600kg should yield 3,600kg/50kg = 72 units
Actual yield = 76 units
Yield variance = 4 units F
Standard material cost per unit = $328
Yield variance = 4 units x $328 = $1,312 F
(d)
Rationale
The question assesses learning outcome E1(f) analyse the impacts of alternative debtor and
creditor policies. It examines candidates ability to discuss the advantages and disadvantages
of different methods that could be used to collect overdue debts.
Suggested Approach
Candidates should identify two possible actions that the company could take to collect the
overdue debts and clearly explain the advantages and disadvantages of each.
Examiners note: the question asks for two other actions. Examples of actions that would be
rewarded are given below.
The credit control department can put the customer on the stop list for further orders. This
can encourage rapid settlement of debts particularly if the customer has no other sources
P1 6 March 2013
of supply for the goods or services. It will avoid any further outstanding debt but may not
result in payment of the existing debt if the customer can obtain supply of goods or
services from other suppliers.
The credit control department could use a debt collection agency to collect the debt from
the customer. This should result in rapid settlement of the debt and allow the credit control
department to concentrate on other customers. It would however involve further expense
as the agency would charge a fee for the collection. The quality of service varies
considerably and the company must be careful to select an agent whose approach to the
customer does not result in damage to the companys reputation.
The credit control department could take legal action to recover the debt. This is normally
seen as a last resort. The first step could be to send a solicitors letter which may prompt
payment and would avoid the need to go to court. It may not be cost effective to take court
action but it may discourage other customers from delaying payment.
(e)
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. Part
(i) of the question examines candidates ability to calculate the expected value of sales
revenue using information about possible levels of demand and their associated probability.
Part (ii) of the question assesses candidates ability to use joint probabilities to calculate the
probability of achieving a particular outcome.
Suggested Approach
In part (i) candidates should calculate the expected value of the sales demand at different
selling prices and multiply the expected values by the relevant selling prices. In part (ii)
candidates should calculate the contribution that would be earned from each of the possible
combinations of sales demand and variable costs. The joint probability of each of the possible
outcomes should then be calculated. The probability of any of the outcomes over $1.1million
should then be summed.
(i)
(ii)
The possible outcomes and the probability of them occurring are given below:
March 2013 7 P1
The probability of achieving a contribution of greater than $1.1million is therefore
0.42 + 0.21 + 0.09 = 0.72 i.e. 72%
(f)
Rationale
The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It
examines candidates ability to explain the benefits to a hospital from using a zero based
budgeting system.
Suggested Approach
Candidates should clearly explain why setting budgets using zero based budgeting may be
beneficial to a hospital.
A zero based budgeting (ZBB) system requires all costs to be specifically justified by the
benefits to be expected. It therefore avoids the problems of incremental budgeting where it is
assumed that the current activities will continue and that current expenditure is adding value
to customers. A ZBB approach requires all activities to be justified and prioritised before a
decision is made to allocate resources to the activity. This encourages a questioning
approach by focusing attention not only on the costs involved but on the benefits that each
activity provides. The ZBB approach requires the managers to prepare a number of
alternative decision packages for each activity at different spending levels and to rank the
decision packages in order of their contribution towards the hospitals strategic objectives.
This process makes the managers consider alternative approaches to achieving the hospitals
strategic objectives.
P1 8 March 2013
SECTION C
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 group. Part (b) 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 how companies may use the information obtained
from an activity based 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 the circumstances under which an activity based
costing system would produce similar product costs to a traditional absorption costing
system.
Suggested Approach
In part (a)(i) candidates should identify the gross profit for each product group and then
calculate the overhead absorption rate. This rate can then be applied to each product group
and the total 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 group. The total profit for each product group can then be
recalculated. In part (b) candidates need to clearly explain how the activity based costing
information could be used by management. In part (c) the circumstances under which an
activity based costing system would produce similar product costs to a traditional absorption
costing system should be clearly explained.
(a)(i)
March 2013 9 P1
Overhead cost workings:
Food Clothing Homeware Total
$000 $000 $000 $000
(a)(ii)
Overhead
Activity Cost Driver Cost driver rate
$000
P1 10 March 2013
Clothing Electrical Homeware
$000 $000 $000
(b)
Using an activity based costing (ABC) system the cost drivers that cause a change to the cost
of activities are identified. These cost drivers provide information to management to enable
them to take actions to improve the overall profitability of the company. Cost driver analysis
will provide information to management about how costs can be controlled and managed.
Variance analysis will also be more useful as it is based on more accurate 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.
In this example the use of an ABC system has resulted in different levels of profit for each of
the product groups. It is apparent that the Clothing product group is less profitable than
thought and that both Electrical and Homeware are more profitable using the ABC system
than using the absorption costing system. This information will enable management to make
important decisions regarding pricing of the product groups. The prices in both the Electrical
and Homeware product groups could potentially be reduced to make them more competitive
and increase volumes. The prices in the Clothing product group could be increased to make
the product group more profitable. Before making any decisions however managers would
need to review market prices and consider the effect of any adjustment on the companys
market position. If market conditions would not allow an increase in price they could look at
ways to reduce costs of clothing in particular. ABC gives more detailed information about how
costs are incurred and the potential for cost reduction by reducing activity levels. The
company may also consider the possibility of discontinuing the clothing product group as it is
loss-making or allocating less store space to that product group.
An activity based costing system can be extended beyond product costing to a range of cost
management applications known as activity based management. These include the
identification of value added and non value added activities and performance management in
terms of measuring efficiency through cost driver rates.
(c)
Using an activity based costing (ABC) system 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. However in some circumstances an
activity based costing system will produce similar product costs to those produced using a
traditional absorption costing system as follows:
March 2013 11 P1
Answer to Question Four
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 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) 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 how probability
analysis and sensitivity analysis could be used to assess risk. Part (c) assesses learning
outcome C2(c) prioritise projects that are mutually exclusive, involve unequal lives and/or are
subject to capital rationing. It examines candidates ability to determine the optimum
replacement cycle for an item of equipment.
Suggested Approach
In part (a) candidates should firstly calculate the contribution for years 1-4 based on the
expected utilisation of the vans. The contribution forgone from the depot sales should then be
calculated. 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 12% to calculate the NPV of the project. In part (b)
candidates should clearly explain how the two techniques could be used to assess the risk of
the project. In part (c) candidates should calculate the net present value for a three, four and
five year replacement cycle. The net present value should then be divided by the annuity rate
to calculate the annualised equivalent cost. The replacement cycle with the lowest annualised
equivalent cost should then be selected.
(a)
Contribution years 1 4
P1 12 March 2013
Cash flows
Year 1 Year 2 Year 3 Year 4
$m $m $m $m
Contribution 24.2 27.6 31.1 31.1
Taxation
Year 1 Year 2 Year 3 Year 4
$m $m $m $m
Net cash flows 9.1 10.8 12.5 12.5
Tax (6.0) (4.5) (3.4) (8.1)
depreciation
Taxable profit 3.1 6.3 9.1 4.4
Taxation @ 0.9 1.9 2.7 1.3
30%
(b)
March 2013 13 P1
(i) The net present value (NPV) of the project, if all high, low or medium estimates
occurred, can be calculated along with the combined probabilities of their
occurrence.
(ii) The probabilities can be combined to calculate the expected value of each cash
flow element and of the project as a whole.
(iii) The NPVs of a sample range of possible outcomes and the probability of each
NPV can be calculated. If a sufficiently large sample is taken the distribution of
outcomes can be used to calculate the standard deviation of the NPVs and the
probability of success of the project.
All, or some, of the above can be used to provide some assessment of risk and to enable
a more informed decision.
(c)
Year Discount Operating Present Residual Present
Factor costs value value value
$000 $000 $000 $000
1 0.893 90 80.4
2 0.797 100 79.7
3 0.712 110 78.3 121 86.2
4 0.636 132 84.0 88 56.0
5 0.567 154 87.3 66 37.4
P1 14 March 2013