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STUDY QUESTION BANK
ACCA
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Paper F5 | PERFORMANCE MANAGEMENT
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ACCA
PL PAPER F5
PERFORMANCE MANAGEMENT
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STUDY QUESTION BANK
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Acknowledgement
Past ACCA examination questions are the copyright of the Association of Chartered Certified
Accountants and have been reproduced by kind permission.
(ii) 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
CONTENTS
FORMULAE
COST ACCOUNTING
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ACTIVITY BASED COSTING
3 PLB Co 3 1004 12
4 Egerton Manufacturing Co 3 1004 20
5
6
7
Flopro
Telmat
8
9
10
Ennerdale Co
Z Co
Parser Co (ACCA D01)
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Environmental management accounting
4
5
6
6
7
8
1007
1009
1010
1011
1011
1013
25
10
8
10
13
13
12 BVX 10 1015 10
13 Optimal production plan 10 1016 10
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PRICING
14 Rothwell Co 11 1017 10
15 Slade 11 1018 8
16 Tabular approach (ACCA D03) 12 1018 10
17 Albany (ACCA D01) 12 1018 10
18 Mr Ellis 13 1020 16
19 Decision Trees 13 1021 20
BUDGETING
20 ZBB 14 1022 25
21 Hotel Excel 15 1025 20
22 BRT Co 15 1027 20
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. (iii)
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
23 Tomkins Co 16 1028 5
24 Velo Racers 17 1028 20
25 Portland Co 18 1030 10
26 Dallas Co 19 1033 10
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27 Wiffy Co 19 1035 18
28 Pan Ocean Chemicals (ACCA PP) 20 1036 25
29
30
Denzel Co
PERFORMANCE MEASUREMENT
31
32
Darth Co
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EGJ Products Co
23
24
1039
1041
1043
1044
18
15
16
25
33 Cadco 25 1048 18
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34 Value for money 26 1049 20
35 Bank operations 26 1051 15
36 Two-minds Co 27 1052 14
37 Bablings (89) Co 27 1053 20
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TRANSFER PRICING
38 Musent Co 29 1057 20
39 Able and Baker 29 1059 18
40 Hotelco 30 1060 12
(iv) 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Formulae Sheet
Learning curve
Y = axb
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Demand curve
P = a bQ
change in price
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change in quantity
a = price when Q = 0
MR = a 2bQ
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2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. (v)
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
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(vi) 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Abbot Manufacturing has two departments, each making a single standardised product.
The data for unit cost and selling price of these products are as follows:
Department Department
Alpha Beta
$ $
Direct material cost 4 6.00
Direct labour cost 2 4.00
Variable manufacturing overheads 2 4.00
Fixed manufacturing overheads 12 16.00
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Factory cost 20 30.00
Profit mark-up 50% 10 25% 7.50
Selling price 30 37.50
inventory.
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The factory cost figures are used in the departmental accounts for the valuation of finished goods
The departmental income statements have been prepared for the year to 30 June. These are given below
separately for the two halves of the year.
Factory cost of production 236 570 192 612
Add: Opening inventory of finished goods 60 210 120 180
296 780 312 792
Less: Closing inventory of finished goods (120) (180) (20) (300)
Factory cost of goods sold 176 600 292 492
Administrative and selling costs 30 100 30 100
Cost of sales 206 700 322 592
Net profit 94 50 53 83
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 1
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
The total sales revenue was the same in each six monthly period but in the second half of the year the
company increased the sales of Department Alpha (which has the higher profit mark-up) and reduced
the sales of Department Beta (which has the lower profit mark-up). An increase in company profits for
the second six months was anticipated but the profit achieved was $8,000 lower for the second half of
the year than for the first half. The profit for Department Alpha fell by $41,000, while the profit for
Department Beta rose by $33,000. There has been no change in prices of inputs or outputs.
Required:
(a) Explain the situation described in the last paragraph. Illustrate your answer with
appropriate supporting calculations. (8 marks)
(b) Redraft the departmental income statements using marginal cost to value unsold
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inventory. (7 marks)
(15 marks)
Direct labour PL
Sunshine Sales Co is drafting a budget on the basis of the following data:
Direct material
In order to build up inventory in anticipation of an increase in demand that is expected later in the year,
production is to exceed sales in the first three months of the year as follows:
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Month 1 Month 2 Month 3
Production 6,500 9,000 10,000
Sales 5,000 8,500 9,500
Required:
(a) Prepare two profit statements, both in comparative columnar form, covering each of
the three months
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(20 marks)
2 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Question 3 PLB CO
PLB Co is a company producing bulk meat substitutes for the vegetarian food industry. It produces
three meat types: pork (P), lamb (L) and beef (B).
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The company has just completed an activity based costing exercise. For the year just ended, the
following activities, along with their associated costs were identified:
Inventory orders
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Tonne days of storage (000)
990
106
Total drivers associated with each of these activities have been identified, and are shown in the table
below, along with the number of units of each driver used by each of the three products:
Production runs
P
8
20
45
L
15
25
18
B
9
30
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Packing costs are incurred on a per tonne basis, and are the same per tonne for all three products.
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Required:
Calculate the cost of the finished products using activity based costing.
(12 marks)
Egerton Manufacturing Co produces a range of products at seven separate sites. Each site produces a
maximum of four products. The directors have decided to introduce Activity Based Costing (ABC) and
have asked each site manager to obtain and analyse the relevant data for their site. Product costs are
currently calculated using absorption costing, with overheads being absorbed on a machine hour basis.
As part of the process of introducing ABC, the directors wish to assess the profitability of individual
products, with the possibility that the product range may be reduced. You are the Manager of the
Brumley site and you have obtained the following data:
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 3
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Product A B C
$ $ $
Selling price per unit 300 530 435
Direct material per unit 55 67 98
Direct labour per unit 41 54 57
Overheads per unit 11720 293 11720
Total cost per unit 21320 414 27220
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The budgeted overheads of the site for the period are:
(a)
(b)
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Machine hours are limited to 1,140 hours per period.
Required:
(ii) Discusses the other factors that should be considered before a final decision
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is made. (4 marks)
(20 marks)
Question 5 FLOPRO
(a) Flopro makes and sells two products A and B, each of which passes through the same
automated production operations. The following estimated information is available for
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period 1:
(ii) Budgeted production/sales of products A and B are 120,000 units and 45,000
units respectively. The selling prices per unit for A and B are $60 and $70
respectively.
(iii) Maximum demand for each product is 20% above the budgeted sales levels.
4 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
One of the production operations has a maximum capacity of 3,075 hours that has been
identified as a bottleneck that limits the overall production/sales of products A and B. The
bottleneck hours required per product unit for products A and B are 002 and 0015
respectively.
Required:
Calculate the mix (units) of products A and B that will maximise net profit and the value
($) of the maximum net profit. (8 marks)
(b) The bottleneck situation detailed in (a) still applies. Flopro has decided to determine the
profit maximising mix of products A and B based on the throughput accounting principle
of maximising the throughput return per production hour of the bottleneck resource. This
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may be measured as: Throughput return per production hour = (selling price material
cost)/bottleneck hours per unit.
All other information detailed in (a) still applies, except that the variable overhead cost as per
(a) is now considered to be fixed for the short/intermediate term, based on the value ($) which
applied to budgeted production/sales.
Required:
(i)
(ii)
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Calculate the mix (units) of products A and B that will maximise net profit and
the value of that net profit. (8 marks)
Calculate the throughput accounting ratio for product B which is calculated as:
throughput return per hour of bottleneck resource for product B/overall total
overhead cost per hour of bottleneck resource. (3 marks)
(iii) Comment on the interpretation of throughput accounting ratios and their use
as a control device. You should refer to the ratio for product B in your answer.
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(6 marks)
(25 marks)
Question 6 TELMAT
Telmat is a company that manufactures mobile phones. This market is extremely volatile and
competitive and achieving adequate product profitability is extremely important. Telmat is a mature
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company that has been producing electronic equipment for many years and has all the costing systems
in place that one would expect in such a company. These include a comprehensive overhead absorption
system, annual budgets and monthly variance reports and the balanced scorecard for performance
measurement.
Required:
Discuss the advantages (or otherwise) that this specific company is likely to gain from these two
systems.
(10 marks)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 5
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
There are three reasons why implementing an environmental management accounting system makes
sense- cost savings, improved environmental reporting and minimising environmental risk.
Required
(b) Explain how good environmental behaviour may help an organisation to achieve
each of the following:
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(ii) Improved environmental reporting;
(iii) Minimising environmental risk.
(6 marks)
(8 marks)
Question 8 ENNERDALE CO
is available:
Materials
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Ennerdale Co has been asked to quote a price for a one-off contract. The companys management
accountant has asked for your advice on the relevant costs for the contract. The following information
The contract requires 3,000 kg of material K, which is a material used regularly by the company in
other production. The company has 2,000 kg of material K currently in stock that had been purchased
last month for a total cost of $19,600. Since then the price per kilogram for material K has increased by
5%.
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The contract also requires 200 kg of material L. There are 250 kg of material L in stock, which are not
required for normal production. This material originally cost a total of $3,125. If not used on this
contract, the stock of material L would be sold for $11 per kg.
Labour
The contract requires 800 hours of skilled labour. Skilled labour is paid $950 per hour. There is a
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shortage of skilled labour and all the available skilled labour is fully employed in the company in the
manufacture of product P. The following information relates to product P:
6 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Required:
(a) Prepare calculations showing the total relevant costs for making a decision about the
contract in respect of the following cost elements:
(b) Explain how you would decide which overhead costs would be relevant in the
financial appraisal of the contract. (3 marks)
(10 marks)
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Question 9 Z CO
Z is one of a number of companies that produce three products for an external market. The three
products, R, S and T may be bought or sold in this market.
Inputs:
Material A
Material B
Material C
Direct labour
Variable overhead
Fixed cost
PL Kg
1,000
2,000
1,500
$
3,500
2,000
3,000
6,000
2,000
1,000
Normal loss
Outputs:
Product R
Product S
Product T
Kg
500
800
2,000
1,200
$
3,500
8,750
5,250
0
$
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R 3.00
S 5.00
T 3.50
RZ 6.00
SZ 5.75
TZ 6.75
Required:
(a) Produce calculations to determine whether any of the intermediate products should
be further processed before being sold. Clearly state your recommendations together
with any relevant assumptions that you have made. (6 marks)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 7
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
(i) Assuming that there is an external market for products R, S and T; and
(ii) Assuming that there is not an external market for products R, S and T.
(13 marks)
Question 10 PARSER CO
The managing director of Parser Co, a small business, is considering undertaking a one-off contract and
has asked her inexperienced accountant to advise on what costs are likely to be incurred so that she can
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price at a profit. The following schedule has been prepared:
Notes $
Direct wages 1 28,500
Notes:
Supervisor costs
General overheads
Machine overheads
Materials
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Machine depreciation
2
3
4
5
6
11,500
4,000
2,300
18,000
34,000
______
98,300
______
(1) Direct wages comprise the wages of two employees, particularly skilled in the labour
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process for this job, who could be transferred from another department to undertake work
on the special order. They are fully occupied in their usual department and sub-contracting
staff would have to be bought-in to undertake the work left behind. Subcontracting costs
would be $32,000 for the period of the work. Different subcontractors who are skilled in
the special order techniques are available to work on the special order and their costs
would amount to $31,300.
(2) A supervisor would have to work on the special order. The cost of $11,500 is comprised
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of $8,000 normal payments plus $3,500 additional bonus for working on the special order.
Normal payments refer to the fixed salary of the supervisor. In addition, the supervisor
would lose incentive payments in his normal work amounting to $2,500. It is not
anticipated that any replacement costs relating to the supervisors work on other jobs
would arise.
(4) Machine depreciation represents the normal period cost based on the duration of the
contract. It is anticipated that $500 will be incurred in additional machine maintenance
costs.
(5) Machine overheads (for running costs such as electricity) are charged at $3 per hour. It is
estimated that 6000 hours will be needed for the special order. The machine has 4000
hours available capacity. The further 2000 hours required will mean an existing job is
taken off the machine resulting in a lost contribution of $2 per hour.
8 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
(6) Materials represent the purchase costs of 7,500 kg bought some time ago. The materials
are no longer used and are unlikely to be wanted in the future except on the special order.
The complete Inventory of materials (amounting to 10,000 kg), or part thereof, could be
sold for $420 per kg. The replacement cost of material used would be $33,375.
Because the business does not have adequate funds to finance the special order, a bank overdraft
amounting to $20,000 would be required for the project duration of three months. The overdraft would
be repaid at the end of the period. The company uses a cost of capital of 20% to appraise projects. The
banks overdraft rate is 18%.
The managing director has heard that, for special orders such as this, relevant costing should be used
that also incorporates opportunity costs. She has approached you to create a revised costing schedule
based on relevant costing principles.
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Required:
(b) Adjust the schedule prepared by the accountant to a relevant cost basis,
A company manufactures and sells three products which currently have the following annual trading
performance:
A
Product
B C
(13 marks)
For each product, units produced and sold were the same in the period.
Fixed production overheads are absorbed at a rate of $0.30 per unit for each product. Non-production
overheads include certain costs that vary with activity at, a rate of 10% of sales value. The remaining
non-production overheads are fixed costs.
Required:
(a) Prepare a statement, in marginal costing format, showing the sales, costs, and profit
contribution of each product expressed both in $ per unit (to three decimal places) and
also as a % of sales (to one decimal place) (8 marks)
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 9
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
(b) Calculate, based on the current mix of sales, the sales required of each product (to the
nearest $000) in order to generate a total contribution of $3.75m per annum.
(6 marks)
(14 marks)
Question 12 BVX
BVX manufactures three garden furniture products chairs, benches and tables. The budgeted unit cost
and resource requirements of each of these items are detailed below:
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Timber cost 5.00 15.00 10.00
Direct labour cost 4.00 10.00 8.00
Variable overhead cost 3.00 7.50 6.00
Fixed overhead cost 4.50 11.25 9.00
16.50 43.75 33.00
PL
Budgeted volumes per annum
4,000
2,000
These volumes are believed to equal the market demand for these products.
1,500
Fixed overhead costs are attributed to the three products on the basis of direct labour hours.
The labour rate is $4.00 per hour.
The cost of the timber is $2.00 per square metre.
The products are made from a specialist timber. A memo from the purchasing manager advises you
that because of a problem with the supplier, it is to be assumed that this specialist timber is limited in
supply to 20,000 square metres per annum.
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The sales director has already accepted an order for 500 chairs, 100 benches and 150 tables which if not
supplied would incur a financial penalty of $2,000. These quantities are included in the market demand
estimates above.
Chair $20.00
Bench $50.00
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Table $40.00
Required:
(a) Determine the optimum production plan and state the net profit that this should yield
per annum. (6 marks)
(b) Calculate and explain the maximum price which should be paid per square metre in
order to obtain extra supplies of the timber. (4 marks)
(10 marks)
A company uses linear programming to establish an optimal production plan in order to maximise
profit. The company finds that for the next year materials and labour are likely to be in short supply.
Details of the companys products are as follows:
10 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
A B
$ $
Materials (at $2 per kg) 6 8
Labour (at $6 per hour) 30 18
Variable overheads (at $1 per hour) 5 3
Variable cost 41 29
Selling price 50 52
Contribution 9 23
There are only 30,000 kg of materials and 36,000 labour hours available. The company also has an
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agreement to supply 1,000 units of product A which must be met.
Required:
(a) Formulate the objective function and constraint equations for this problem. (4 marks)
(b)
Question 14 ROTHWELL CO
PL
Plot the constraints on a suitable graph and determine the optimal production plan.
(6 marks)
Rothwell Co makes various novelty items that are sold to wholesalers particularly in the toy trade. It
has just decided to produce a new line, namely small umbrellas to decorate cocktails, which will be sold
to various chains of cocktail bars and called a bar brolly.
(10 marks)
It has provided you with the following information concerning the total cost of annual production and
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the prices at which that production could be sold:
Question 15 SLADE
Hill Co has recently developed a new product, the Slade. Its parent company, Powell, requires that
subsidiaries achieve of 16% a return on opening capital employed on all new investment.
Financial data regarding the development and production of the Slade is as follows:
The development of the product took three years and cost $120,000. It is anticipated that demand for
the product will be 4,000 units per annum and that it will last six years.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 11
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Investment in machinery will amount to $200,000 and this will be scrapped at the end of the products
life for $20,000.
Incremental cash fixed costs will be $40,000 per year and the unit variable cost of production is
expected to be $50.
Required:
Calculate a price which, based on the above data, will achieve the target ROCE of 16%.
(8 marks)
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A company manufactures a single product, product Y. It has documented levels of demand at certain
selling prices for this product as follows:
Required:
1,100
1,200
1,300
1,400
PL 48
46
45
42
22
21
20
19
Using a tabular approach calculate the marginal revenues and marginal costs for product Y at
the different levels of demand, and so determine the selling price at which the company profits
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are maximised.
(10 marks)
Question 17 ALBANY
Albany has recently spent some time on researching and developing a new product for which they are
trying to establish a suitable price. Previously they have used cost plus 20% to set the selling price.
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$
Direct materials
Material 1 10 (4 kg at $250/kg)
Material 2 7 (1 kg at $7/kg)
Direct labour 13 (2 hours at $650/hour)
Fixed overheads 7 (2 hours at $350/hour)
37
Required:
(a) Using the standard costs calculate two different cost plus prices using two different bases
and explain an advantage and disadvantage of each method. (6 marks)
12 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
(b) Give two other possible pricing strategies that could be adopted and describe the impact
of each one on the price of the product. (4 marks)
(10 marks)
Question 18 MR ELLIS
Mr Ellis, the manager of the ice rink is trying to decide what price per person to charge for a five-week
ice skating course that would be held on Saturday mornings. He is considering three possible prices-
$20, $30 or $50.
Roddy Dean, a local ice skating dancer is competing in an International Competition, and this has
increased interest in skating. If Mr Dean wins the competition, Mr Ellis believes that demand for the
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courses will be high. If Mr Dean reaches the finals, but does not win the competition, demand would be
medium and if Mr Dean does not reach the finals, demand would be low.
A decision on what price to charge has to be taken before the results of the competition are known as
the sports complex wishes to start to advertise the course.
PL
Mr Ellis has provided you with a table showing his estimates of the number of people who would attend
the course, based on the price charged and the level of demand:
Price charged
20
Demand (number of persons)
High
35
Medium
35
Low
35
30 30 25 20
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50 20 10 10
Required:
Determine which price Mr Ellis should charge for the course based on the following decision
making rules. Your answer should include a brief explanation of the meaning of each rule, and
what type of risk taker would use it.
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(i) Maximax;
(ii) Maximin;
(iii) Minimax regret.
(16 marks)
An oil company has recently acquired rights in a certain area to conduct surveys and geological test
drillings that may lead to lifting oil where it is found in commercially exploitable quantities.
The area is already considered to have good potential for finding oil in commercial quantities. At the
outset the company has the choice to conduct further geological tests or to carry out a drilling
programme immediately. On the known conditions, the company estimates that there is a 70% chance
of further tests indicating that a significant amount of oil is present.
Whether the tests show the possibility of oil or not, or even if no tests are undertaken at all, the
company could still pursue its drilling programme or alternatively consider selling its rights to drill in
the area.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 13
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Thereafter, however, if it carries out the drilling programme, the likelihood of final success or failure in
the search for oil is considered dependent on the foregoing stages. Thus:
(i) If the tests indicated that oil was present, the expectation of success in drilling is given as
80%.
(ii) If the tests indicated that there was insufficient oil present, then the expectation of success
in drilling is given as 20%.
(iii) If no tests have been carried out at all, the expectation of finding commercially viable
quantities of oil is given as 55%.
Costs and revenues have been estimated for all possible outcomes and the net present value of each is
given below:
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Outcome Net present value
$ million
Geological testing (10)
Drilling cost (50)
Required:
(a)
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Success in finding oil
Sale of exploitation rights:
Tests indicate oil is present
Tests indicate no oil
Without geological tests
65
15
40
(8 marks)
(b) For the management of the company, calculate its best course of action. (7 marks)
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(c) Explain the value of decision trees in providing management with guidance for decision-
making. Illustrate examples of any situations where you consider their use would be of
benefit. (5 marks)
(20 marks)
Question 20 ZBB
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(a) Explain why zero-based budgeting (ZBB) might be a useful tool to employ to ensure
that budgetary requirements are kept up to date. (4 marks)
(b) Describe the steps necessary to implement a ZBB system for the following:
(c) Critically assess the use of zero-based budgeting as a tool that might be used to
motivate employees. (6 marks)
(25 marks)
14 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
You are the general manager of the Hotel Excel. It is the hotels policy that rolling budgets are
prepared, using a six month time horizon. You are about to prepare the budget for JulyDecember
2010, and have collated the following information:
(i) the hotel has 90 bedrooms, each of which can accommodate one or two guests;
(ii) during the months of July, August and December (high season), standard room rates will
be $110 per night;
(iii) during the months of September, October and November (low season), standard room rates
will be $95 per night;
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(iv) the rates above apply to each room, regardless of whether there are one or two guests;
(v) average room occupancy per night at standard rates is expected to be:
high season 80%
low season 50%
(vi)
(vii)
(viii)
(ix)
PL
the company is registered with a number of internet-based hotel providers. It is expected
that, subject to capacity, an average of 20 rooms per night can be sold through these
facilities. These sales will be in addition to the occupancy levels noted in point (v). The
internet based provider pays 40% of the standard rate for all bookings;
it is forecast that the average additional spending by guests will be $40 per room night, and
that the gross margin earned on this additional spending will be 35%;
variable costs are estimated to be $17 per room night;
fixed costs are estimated to be $40,000 per month;
M
(x) when occupancy is above 90%, additional staff costs of $150 per night are forecast.
Required:
(a) For the six month period to 31 December 2010, calculate the Hotels budgeted:
(b) Explain the benefits and drawbacks of using rolling budgets. (7 marks)
(20 marks)
Question 22 BRT CO
BRT Co makes a range of glassware ornaments. The marketing plan for 2011 is based on the three
products that have proved most popular in the past: Dog, Bunny and Cat. The expected sales for
each product and selling price are as follows:
Dog Bunny Cat
Sales 10,000 20,000 5,000
Price $10 $5 $20
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
(a) Explanation
The situation described in the question arises from the method of inventory valuation used
by Abbot, together with the fluctuations in the level of finished goods inventory that have
occurred in the periods under review. The firm is using an absorption costing basis for
inventory valuation purposes. This method attaches part of the fixed production costs to
each item held in inventory. In the case of department Beta it is $16. In the income
statement the matching concept requires the use of an inventory adjustment process to
adapt the cost of production figure to a cost of goods sold figure.
When levels of inventory are fluctuating, this process of bringing forward fixed costs from
E
past periods and carrying forward fixed costs to future periods can have a considerable
effect on the profit calculations. The following table shows the effect of the inclusion of
fixed factory overheads in inventory valuations.
Profit increased by
Profit reduced by
PL
Fixed overheads brought forward in
opening inventory of finished goods
Fixed overheads carried forward in
closing inventory of finished goods
36
72
36
94
$000
112
96
16
50
$000
72
12
60
53
$000
96
160
64
83
M
Profit prior to inventory adjustment 58 66 113 19
These unadjusted profit figures are in line with the changes in the sale mix between the
two periods.
The important aspect of the effect that the different inventory valuations have on profit is
that, under marginal costing, profit depends only on the level of sales (all other things
SA
being equal). Under an absorption costing convention, profit depends on both the level of
sales and also on production levels.
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
E
Add: Opening inventory of finished goods 24 98 48 84
128 364 108 392
Less: Closing inventory of finished goods (48) (84) (8) (140)
Factory cost of goods sold 80 280 100 252
Total contribution
Net profit
PL
Less: Fixed overheads
Factory overheads
Administration and selling
220
(132)
(30)
58
470
(304)
(100)
66
275
(132)
(30)
113
423
(304)
(100)
19
These profit figures are those under the absorption-costing basis before making the
M
adjustment for fixed factory overhead in the inventory valuations.
Tutorial note: The important aspect of examination technique here is to look at all (both)
requirements before reading the body of the text and before answering any part of the question. In
this way, if you cannot get the clues of what is required for part (a) from the last paragraph, part (b)
tells you what the examiner is driving at. This then leaves the problem of making sure that you do
not answer part (b) in your answer to (a) which just needs a little planning.
SA
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
E
149,500 207,000 230,000
Add: Opening inventory 34,500 46,000
149,500 241,500 276,000
Less: Closing inventory (34,500) (46,000) (57,500)
Contribution
Fixed costs
Profit
(ii)
PL
Absorption costing basis
$
(115,000)
35,000
(27,000)
8,000
Month 1
$
(195,500)
Month 2
$
59,500
(27,000)
32,500
$
(218,500)
Month 3
$
66,500
(27,000)
39,500
$
Sales 150,000 255,000 285,000
M
Cost of production
Materials 65,000 90,000 100,000
Labour 32,500 45,000 50,000
Variable expenses 52,000 72,000 80,000
Fixed costs 27,000 27,000 27,000
176,500 234,000 257,000
Add: Opening inventory 39,000 52,000
SA
176,500 273,000 309,000
Less: Closing inventory (39,000) (52,000) (65,000)
Cost of sales (137,500) (221,000) (244,000)
Profit 12,500 34,000 41,000
(b) Reconciliation of profits
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Answer 3 PLB CO
P L B
$ $ $
Materials 500 700 850
Labour 120 140 80
Set up costs (W1) 4,000 10,000 5,000
Material orders (W2) 300 500 500
Storage (W3) 450 240 400
Packing (W4) 40 40 40
E
5,410 11,620 6,870
WORKINGS
P L B Total
(1) Production run 8 15 9 32
(2)
Cost
Cost/run
Cost/product
Cost/tonne
Material orders
Cost
Cost/order
Cost/product
Cost/tonne
PL $4,000,000
$4,000
$300,000
$300
20
$7,500,000
$10,000
$375,000
$500
25
$4,500,000
$5,000
$450,000
$500
30
$16,000,000
$500,000
75
$1,125,000
$15,000
Product A B C
$ $ $
Direct material per unit 55 67 98
Direct labour per unit 41 54 57
Overheads per unit: (W4) 114.61 204.09 302.78
Total cost per unit 21061 32509 45778
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
WORKINGS
Product A B C Total
Machine hours per unit 06 15 06
Budgeted production volume 600 units 400 units 200 units
Total machine hours 360 600 120 1,080
Machine costs $78,560
Cost per machine hour $7274
Total costs apportioned: 26,186.40 43,644.0 8,728.8 78,559.2
E
Product A B C Total
Production runs in period 32 40 25 97
Set up costs $82,900
Cost per set up $85464
Total costs apportioned 27,348.48 34,185.60 21,366.00 82,900.08
(3)
Product
Material deliveries
Material handling costs
Cost per delivery
Total costs apportioned
PL
Material handling cost
15,230.80
8
B
2
3,807.70
C
16
30,461.60
Total
26
$49,500
$1,90385
49,500.10
Overhead cost per unit 114.61 204.09 302.78
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
As requested, I have calculated the cost per unit for each of the products manufactured at the
Brumley site. When the unit cost is compared with the selling price, the results are as
follows:
A B C
$ $ $
Selling price per unit 30000 53000 43500
E
Cost per unit 21060 32509 45778
Profit/(Loss) per unit 8940 20491 (2278)
From this it can be clearly seen that production of Product C should cease, as this product is
unprofitable.
PL
At first sight, product B appears to be the most attractive, yielding a unit profit of over $200.
This seems to suggest that the production of product B should be maximised.
However, such an approach ignores the fact that machine hours are limited to 1,140 in each
production period. This means that an assessment of which product is more favourable
should be based on the profit per unit of limiting factor, rather than the profit per unit of
output. Carrying out such a calculation:
Product
Profit per unit
A
$8940
B
$20491
Machine hours per unit 06 15
Profit per machine hour $14898 $13661
M
This means that Product A is preferable, and should be produced up to the maximum market
demand. Product B should be produced only when demand for Product A is satisfied.
The interdependence of products from Brumley with products of other sites would
also need to be considered.
Market demand should be confirmed to ensure that there are no factors that will lead
to reduced sales volumes.
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
The stage of each product in the product life cycle may affect the decision. If A is a
mature product, there may be a declining market. Concentrating production on a
mature product may be placing too much reliance on a market that could soon
disappear.
It would also be prudent to review current practices to assess whether the cost
structure of products B and C can be amended, leading to a reduction in unit cost.
The accuracy of the results of activity based costing is entirely dependent on the use
of appropriate cost drivers. If the cost drivers selected do not actually influence the
total cost incurred, decisions will be made based on inaccurate information. It is
therefore essential that the cost drivers have been correctly identified.
E
It should also be noted that the analysis of costs in activity based costing assumes
that all costs are amenable to control over the long term. If the objective is to
maximise short-term profit, activity based costing is not an appropriate technique.
Only when you are fully satisfied on these points should production of C (and possibly B)
cease.
Answer 5 FLOPRO
A B
Contribution per unit $30 $26
M
Bottleneck hours per unit 002 0015
Contribution per bottleneck hour $1,500 $1,733
Ranking
Therefore produce and sell product B up to its maximum demand and then product A with the
remaining capacity:
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
A = $60 2 = $58
B = $70 40 = $30
A B
Throughput per unit $58 $30
Bottleneck hours per unit 002 0015
Throughput return per bottleneck hour $2,900 $2,000
E
Flopro should sell product A up to its maximum demand and then product B using the
remaining capacity.
$
8,352,000
390,000
_________
8,742,000
(3,540,000)
Fixed (1,470,000)
_________
M
Net profit 3,732,000
_________
Throughput return per hour of bottleneck for product B was calculated in part (i) as $2,000.
1008 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
(iii) Interpretation
Where throughput accounting principles are applied, a product is worth producing and selling
so long as its throughput return per bottleneck hour is greater than the production cost per
throughput hour. This may be measured by the throughput accounting ratio. Where the ratio
is less than 100, return exceeds cost and the focus should be on improving the size of the
ratio.
Efforts may be made to improve the position for each product and in total by focusing on
areas such as
Improved throughput ($) per unit by increasing selling price or reducing material
cost per unit. Product B has a very high material element ($40 per unit)
E
Improving the throughput ($) per unit by reducing the time required on the
bottleneck resource. Reducing the time for product B from 0015 hours to 001
hours through methods change would improve its ratio.
Improving the overall position by reducing the cost of spare capacity. This may be
PL
achieved by operational re-design aimed at reducing or eliminating the impact of
any bottlenecks.
The throughput ratio for product B is 12275 which is greater than 100 and therefore
acceptable. Its ratio is considerably less than that of product A, which is 1780 ($2,900
$1,62927). The product ratio may be used as a basis for the monitoring of trend, by product
and in total.
Answer 6 TELMAT
In the rapidly changing business environment, customer requirements, economic factors and technology
can all change very fast. Telmat is in a particularly volatile business since technology is changing
M
rapidly as text messaging develops and digital telephones take over. Both life cycle costing and target
costing are systems that should help the company cope with this. These systems should help Telmat to
compete in terms of cost and product development in the telecoms market.
Standard costs are too rigid for cost reduction and control. They usually need to be
set for a year at a time, but Telmats environment is too fast moving. Target costing
is more flexible, so targets can change/reduce from month to month.
Standard costing focuses on internal costs while target costing takes into account the
competitive market and the price customers are prepared to pay. The organisation
has to be outward rather than inward looking. For Telmat, the final customer as
well as the system supplier must be considered. (Standard costing tends to focus on
internal costs.)
Target costing usually involves other techniques, such as value analysis and value
engineering, which should simplify production methods and reduce cost. As Telmat
has short product life cycles, this is very important.
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Staff can be highly motivated by target costing if used correctly. It helps to break
down any artificial functional barriers as staff at all levels and in all functions are
involved.
Estimating life cycle costs and revenues will highlight which products can generate
profits quickly. As the life cycle of Telmats products is likely to be short because
of changing technology, this is very important.
Life cycle costing focuses on the time to market as well as money. This is often a
key factor in generating profit. Telmat will probably have to bring new products to
market quickly and on time in order to achieve a profit.
E
If costs and benefits are monitored over the life cycle, a project can be stopped early
if events have changed or not turned out as planned.
The research and development and design costs are likely to be quite high and will
need to be recovered quickly, so life cycle costing, with its emphasis on timescale
(a)
PL
should be very beneficial.
Probably the company should adopt both target costing and life cycle costing.
While there is no unique definition of the term environmental management accounting, the
term is generally taken to mean providing management with information about the
environmental impact of the organisations activities. This includes both physical and
monetary information. Physical information would include things such as the amount of
M
scarce resources, such as energy and water that are used (and wasted). Monetary information
includes things such as money saved or spent on becoming more environmentally friendly.
Traditional management accounting was not concerned with environmental issues. In recent
years, however, the environment has become an important issue, and businesses in need to be
aware of how their environmental impact of their activities so that they can be managed.
Good environmental behaviour often brings cost savings through a reduction in the waste of
energy and water. Many organisations have made huge saving on energy costs, for example,
by implementing more efficient energy processes, and insulation. Many companies have also
reduced printing costs by issuing newsletters and other such items through e-mail, in order to
reduce the use of paper.
In traditional management accounting, many environmental related costs were simply lumped
in with other overheads, so management were not aware of them. To have environmental
management accounting means that the accounting systems will now show such costs as a
separate category. This will not only help management to be aware of them, but will also
help with external reporting.
1010 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Environmental risk relates to the potential adverse effects of bad environmental behaviour.
This may include fines for pollution, costs of cleaning up and lost sales if the organisation
gets a reputation for being a harmer of the environment. Environmental management
accounting makes such risks clearer to management, so they can be better managed.
Answer 8 ENNERDALE CO
(i) Materials
$
E
K 3,000 kg at ($19,600 2,000) 105 30,870
L 200 kg at $11 2,200
33,070
(ii) Skilled labour
(b)
Labour cost
Overhead costs
PL
800 hours at $950
Opportunity cost of labour 800 hours at ($40 4)
Any variable overhead costs associated with the contract would be relevant because they
would represent additional or incremental costs caused directly by the contract.
$
7,600
8,000
15,600
Fixed overhead costs would only be relevant if the total fixed overhead costs of the company
M
increased as a direct consequence of the contract being undertaken. In that case the relevant
amount would be the specific increase in the total fixed overhead costs caused by the
acceptance of the contract.
Arbitrary apportionments of existing fixed overhead costs would not be relevant. Similarly
sunk and committed costs would not be relevant.
Answer 9 Z CO
SA
On financial grounds, further processing is worthwhile if the further processing cost is less
than the incremental revenue.
Evaluation of further processing based on March 2011 output and assuming no losses in the
further process:
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Taking each product individually, it can be seen that products R and T should be converted as
the incremental revenue exceeds the incremental cost of further processing. In the case of T
this assumes that the March 2011 output is representative of other months and that the
quantity produced is sufficient to ensure that the incremental revenue covers both the fixed
and variable costs. However, as TZ can be sold for a relatively high price, volumes would
have to drop considerably for this to become an issue.
This is not true of S. Considered in isolation product S should not be converted. However
there may be other reasons for producing all three products, in particular marketing
considerations such as whether the company needs to supply all three products in order to sell
the two profitable products, RZ and TZ.
E
(i) If there is an external market for R, S and T
Assuming that all March 2011 output can be sold at the prices given:
R
S
T PL $
3.00
5.00
3.50
kgs
800
2,000
1,200
Loss in March 2011 = $900 and therefore the common process is not financially viable.
$
2,400
10,000
4,200
16,600
Further costs:
RRZ 800 $1.40 1,120
SSZ 2,000 $0.90 1,800
TTZ 1,200 $1.00 1,200
Fixed 600 1,800 4,720 22,220
2,180
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Answer 10 PARSER CO
Opportunity costs represent the value of the loss or sacrifice when choosing between scarce
alternatives. Lack of scarcity implies zero opportunity cost.
Notes $
Subcontractor costs 1 31,300
Supervisor costs 2 1,000
General overheads 3 1,000
E
Machine maintenance 4 500
Machine overheads 5 22,000
Materials 6 31,500
Interest costs 7 900
______
88,200
Notes:
(1)
(2)
(3)
PL
The choice lies between the two subcontractor costs that have to be employed
because of the shortage of existing labour. The minimum cost is to have
subcontractors employed who are skilled in the special process.
Only the difference between the bonus and the incentive payment represents an
additional cost that arises due to the special order. Fixed salary costs do not change.
(4) Depreciation is a period cost and is not related to the special order. Additional
M
maintenance costs are relevant.
(5) The relevant costs are the variable overheads ($3 6,000 hours) that will be
incurred, plus the displacement costs of $2 2,000 hours making a total of $22,000.
(6) Since the materials are no longer used the replacement cost is irrelevant. The
historic cost of $34,000 is a sunk cost. The relevant cost is the lost sale value of the
inventory used in the special order which is: 7,500 kg $420 per kg = $31,500.
SA
(7) Full opportunity costing will also allow for imputed interest costs on the
incremental loan. The correct interest rate is the overdraft rate since this represents
the incremental cost the company will pay. Simple interest charges for three
months are therefore: (3/12) $20,000 18% = $900.
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
E
Contribution 0.624 40.0 0.530 31.2 0.625 50.0
Notes
3
PL Production cost of sales ($)
$/unit variable production cost =
sales units
(e.g. Product A
1,242
1,150
0.3 = $0.78)
Contribution 3,358.6
_______
$000
3,750
Sales required: 8,484 9,473
3,358.6
1,794
Product A 9,473 2,003
8,484
3,740
Product B 9,473 4,176
8,484
2,950
Product C 9,473 3,294
8,484
_____
9,473
_____
1014 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Answer 12 BVX
E
demand/production resources 3,500 233 1,350
Timber used for production
above minimum units 8,750 1,747.5 6,750 17,247.5
Timber used 19,997.5
Timber available
4,000 $8.00
333 $17.50
1,500 $16.00
333 1,500
$
32,000.00
5,827.50
24,000.00
61,827.50
20,000
Since the optimum plan includes production of sufficient quantities of each item to meet the
order comprising the minimum demand, and production of the most profitable items already
meets the maximum demand, there is no need to consider the financial penalty.
The maximum price which should be paid for the timber, a scarce resource, is also known as
its shadow price.
The shadow price is the price at which the purchaser makes a nil contribution from its use.
Therefore to answer the question it is necessary to consider the use of any additional timber
acquired.
The present situation is that demand for chairs and tables is fully satisfied from the existing
resources, but there is some unsatisfied demand for benches. Thus any additional timber
would be used to manufacture more benches.
Based on the current input cost of $2.00 per m2 each m2 of timber earns a contribution of
$2.33. Thus the maximum price to be paid is the sum of these values; $4.33 per m2.
However, there is no benefit in obtaining more timber than can be used to satisfy the total
demand for benches, so this shadow price of $4.33 per m2 only applies for up to 12,500 m2 of
timber. Thereafter there is no use for the timber, so its shadow price is nil.
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 1015
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Constraints:
Non-negativity b0
Restriction on A a 1,000
Materials 3a + 4b 30,000
E
Labour 5a + 3b 36,000
(b) Graphical solution
b units a = 1,000
000
14
13
12
11
PL
10
M
9
5a + 3b = 36,000
8
6
SA
4
3a + 4b = 30,000
3 Iso-contribution
line
2
0
1 2 3 4 5 6 7 8 9 10 11 12
a units
000
1016 2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
a = 1,000; and
materials constraint 3a + 4b = 30,000.
(3 1,000) + 4b = 30,000
3,000 + 4b = 30,000 therefore 4b = 30,000 3,000 giving 4b = 27,000
so b = 27,000 4,000 therefore b= 6,750 units
The optimal production plan is to make 1,000 units of A and 6,750 units of B.
E
Answer 14 ROTHWELL CO
Tabulated below are the total cost and revenue figures together with profit at each activity level to
determine optimal selling price. The same result has been reached by comparing marginal cost and
revenue figures.
2,500
5,000
7,500
10,000
12,500
15,000
PL revenue
$000
177.0
333.5
468.75
583.0
677.5
750.0
cost
$000
100.3
186.3
287.8
405.0
537.8
686.3
$000
76.7
147.2
180.95
178.0
139.7
63.7
cost
$000
86.0
101.5
117.2
132.8
148.5
revenue
$000
156.5
135.25
114.25
94.5
72.5
45.8 17,500 801.5 850.3 (48.8) 164.0 51.5
M
It can be seen from the profit column that profit is maximised where the selling price is set at $62.5, as
this gives the highest profit of $180.95.
Tutors note: For learning purposes only, the marginal cost and marginal revenue has been shown in
the last two columns. It is not necessary to calculate these to solve the question. The marginal cost
column simply shows the increase in total cost by moving from one level of output to the next. For
example, if production rises from 5,000 units to 7,500 units, total costs rise from $186.3 to $287.8, an
increase of $101.5. So this is the marginal cost at the 7,500 units level. Similarly, as production rises
SA
from 5,000 units to 7,500 units, total revenue increases by $135.25, so this is the marginal cost at the
7,500 units level. Whenever the marginal revenue from increasing output is higher than the marginal
cost increasing output increases profits. This is always the case until output reaches 7,500 units. It
can be seen that the marginal cost of moving from 7,500 to 10,000 is higher than the marginal revenue
however, so it is not worth producing and selling beyond 7,500 units. To maximise output therefore,
Rothwell should produce 7,500 units.
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Answer 15 SLADE
E
Variable costs (4,000 50) 200,000
290,000
Required revenue = Costs + Profit
= $(290,000 + 51,200) = $341,200
Unit price
Demand
Units
Selling price
per unit
$
PL = $341,200 4,000 = $85.30
Total
revenue
$
Marginal
revenue
$
Cost
per unit
$
Total
cost
$
Marginal
cost
$
= units = units
unit selling cost per unit
M
price
1,100 48 52,800 52,800 22 24,200 24,200
1,200 46 55,200 2,400 21 25,200 1,000
1,300 45 58,500 3,300 20 26,000 800
1,400 42 58,800 300 19 26,600 600
SA
MR MC at 1,300 units, therefore profits will be maximised at this point which is a selling price of
$45.
Answer 17 ALBANY
Advantage
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Disadvantage
Advantage
E
Disadvantage
Fixed costs need to be allocated to the cost unit which may be ambiguous.
Ignores price/demand relationship.
PL
Price skimming tends to lead to a high price initially, useful if the product is
completely new.
Penetration pricing go to market with a low price initially to gain market share.
Price discrimination use two different prices in two different markets if there are
barriers between the markets (e.g. age, time and location).
M
Premium pricing charging a higher price than the competitors as the product can
be differentiated.
Cost plus pricing leads to a price that will cover costs although care needs to be
taken with regard to marginal cost plus to ensure that the plus is large enough to
cover fixed costs.
Market price leads to an acceptable price but one which may vary.
SA
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Answer 18 MR ELLIS
Table of revenues
Demand (number of persons)
High Medium Low
Price charged
E
50 1,000 500 500
Maximax involves choosing the decision with the highest potential return. People who use
(ii)
PL
this method of decision-making are risk seekers. They are prepared to accept a high level
of risk on the basis that they have the possibility of making a higher return.
It can be seen from the table above that the highest potential revenue is $1,000. This would
be gained if the ice rink manager charges $50 for the course, and the demand is high.
Maximin decision makers are risk averse. They wish to limit the down side of their decision,
so they select the decision that has the highest worst-case scenario. Such decision makers are
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pessimistic in outlook.
50 500
A minimax decision maker would choose a price of $20 as this gives the highest worst
outcome of $700.
Minimax regret decision makers fear making a decision which could turn out to be very
different from what would have been the best decision. They therefore look at each of the
possible outcomes, and see what would be the best decision if that outcome occurs. They
then calculate the regrets for the other decisions. Regrets are the differences between the
best decision and the actual output if the other decisions had been made. They choose the
decision that has the lowest potential regret.
In order to calculate the decision under minimax regret, it is first necessary to calculate a table
of regrets.
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
Table of regrets
Demand
High Medium Low
Price Regret
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20 300
30 100
50 250
A minimax decision maker would therefore choose a price of $30, as this has the lowest
maximum regret.
(a) Diagram PL 70
Drill (50)
120 0.8
0.2
Find oil
150
No oil
Sell Rights 15
43.5
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Sell Rights 40
0.45
No oil
= Path to follow
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
The company should undertake geological tests. If the tests indicate that oil is present then a
drilling programme should be carried out. However, if the tests indicate that there is no oil
then the company should sell the drilling rights.
The main value of a decision tree is that it maps out clearly all the decisions and uncertain
events and exactly how they are interrelated. They are especially beneficial where the
outcome of one decision affects another decision. For example in the above, the probability
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of eventual success changes depending on the test outcomes. The analysis is made clearer by
annotating the tree with probabilities, cash flows, and expected values so that the optimum
decisions (based on expected values) can be clearly seen.
However, drawing a tree diagram is only one way of undertaking a decision. It is based on
the concept of expected value and as such suffers from the limitations of this technique. For
(a)
PL
example, in this example, if the test drilling proves positive, the tree indicated the company
should drill, as opposed to selling the rights. But if it does there is a 20% chance of it losing
$50 million. A risk-averse company may well decide to accept the safer option and sell the
rights and settle for $65 million.
Answer 20 ZBB
Usefulness
There are a series of steps that would ordinarily be taken in order to implement an effective
ZBB system.
The development of a questioning attitude to activities that incur costs is the first step to
ensuring that costs are kept to most efficient levels. It is important to recall that ZBB, in the
short term, can only change costs over which the organisation has short-term control. Longer
term, or period costs, can only be changed over a longer horizon. Taxes and other regulatory
costs cannot be the focus of ZBB because they are difficult to influence.
Thus ZBB can be immediately effective where costs can be related to identifiable activities.
The questions that might emerge in such situations are as follows:
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
An even more basic question is to ask how important the activity is to the business
and what, if the costs can be identified, is the total cost saving that might result
should the activity be stopped. In this respect, it is important to identify effects on
costs elsewhere in the business. If the activity to be stopped absorbed fixed costs,
then the fixed costs will have to be re-apportioned without absorption to the activity
that is to be stopped. Moreover, there may be joint costs such that stopping one
activity may have an uncertain effect on joint costs incurred with another activity;
Is the activity in question the cheapest way of providing the service or contribution
to production? Thus, it is important not to ask simply if the costs relating to the
activity are the most efficient, but are there alternatives that might reduce costs still
further and still maintain a given level of service or production;
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A more fundamental question about conducting ZBB processes is whether the
benefits of employing ZBB outweigh the costs. It is important to appreciate that
conducting a ZBB exercise is not a costless process if, as will inevitably be the case,
management time is consumed.
PL
Budgeted activities should be capable of being monitored and controlled. If an activity is
recognised as a budget centre, and is going to be subject to a ZBB process, then it is important
that management undertake the task of monitoring costs in relation to activity and taking
corrective action when appropriate. Thus, if an activity consumes resources and is capable of
being monitored and controlled then it should be provided with a budget. This will then make
the activity subject to ZBB processes.
Decision packages are sometimes referred to in the context of ZBB and activities. These
relate to how activities can be described when thinking about how ZBB can be used to judge
an activity. There are two types of decision activity:
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Mutually exclusive decisions: when ZBB assessments are made of an activity,
alternative courses of action are sometimes benchmarked against existing activities.
A choice is then made over which activity might be the preferable course of action.
The preferred choice will involve budgeted information, but may also involve other
factors such as product quality and service level provision.
Incremental decisions: ZBB assessments are often related to the level of activity in a
budget centre. Thus, there will be a minimum level of activity that provides the
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essential level of product or service. This is often referred to as the base activity.
Further levels of activity are then incremental and, subject to correctly identifying
and isolating the variable costs related to an activity, ZBB assessments can be made
separately of both the base and the incremental activities. This division might then
provide management with an understanding of the degree of flexibility the
organisation has.
The allocation of scarce resources is a key management task. Scarce resources will have to be
allocated to the activities of a business in terms of providing appropriate labour and materials,
along with any other costs related to an activity. Whilst ZBB is most often applied to support
activities, the technique can also be applied to a production process.
Some sorting of ranking will have to be applied in order to determine which activities are
funded by a budget against those that are not. The key question for budgeting purposes
relates to:
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PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
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Essentially, a judgement has to be made by management of the benefit of the activity to the
organisation. Theoretically, this is best achieved by determining deprival value. In practice,
deprival values are difficult tools and some level of arbitrary judgement has to take place in
which non-financial factors might play a significant role.
PL
The motivation of employees is one of the most difficult tasks facing management since the
problems are complex and not always referable to financial performance indicators. To the
extent that employees are not responsive to financial performance indicators then ZBB is
going to be less effective as a device to motivate employees.
The problem of employee motivation is one of achieving goal congruence with the
organisational objectives. ZBB can be useful in this respect as a method of tackling the
problem of motivating employees to achieve targeted performance when a clear
understanding of the activities and their related decision packages is essential for the
management tasks of monitoring and controlling an activity.
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In this respect ZBB has the following advantages
It ensures that only forward-looking objectives are addressed. This limits the
potential for historical abuses in budget setting to be established. Employees can be
set targets that are consistent with the future objectives of the organisation.
Building budget slack is minimised because, in principle, the entire costs of an
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activity are reviewed at each budget setting stage. Employees are then set realistic
targets that relate to activity levels that are the most efficient.
Managers are made to understand, as part of the ZBB process, the activity itself.
This reduces tension between those who decide (management) and those who have
to implement manager decisions. Claims that management do not really understand
the nature of an activity are thus reduced.
ZBB encourages flexibility in employees since they know that potentially activities
may be stopped. Flexibility induces goal consistency by enabling incentive
schemes to reflect activity. In other words, employees are more likely to be
responsive to management directives if they are aware and trust that the budget
setting process encourages and supports payments that are responsive to flexibility.
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STUDY QUESTION BANK PERFORMANCE MANAGEMENT (F5)
An informed budget setting process such that management are aware of the detail of
budgeted activities as provided by the people who work daily in the budgeted
activity;
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Employees become aware and more involved in the management activities of the
organisations. To the extent that they become more aware, then a greater
understanding of the needs of the organisation as a whole is reached;
improved;
PL
Budgetary slack may be reduced as management become more aware of the
operational activities in an activity;
When budgets are not met management are more likely to have a deeper knowledge
of the operational issues involved;
(a)
August 31 October 31
December 31 November 30
93 91
Occupancy % 80 50
Rooms/night 72 45
On-line sales 18 (max available) 20
Revenue:
Room letting
72 rooms at $110 per night 93 nights $736,560
18 rooms at $44 per night 93 nights $73,656
45 rooms at $95 per night 91 nights $389,025
20 rooms at $38 per night 91 nights $69,160
2014DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 1025
PERFORMANCE MANAGEMENT (F5) STUDY QUESTION BANK
Additional spending:
90 rooms at $40 per night 93 nights $334,800
65 rooms at $40 per night 91 nights $236,600
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Low $26 65 rooms 91 nights $153,790
(b)
Total costs
(iii)
Profit
PL
Budgeted profit
$1,839,801 $868,205
Benefits
$868,205
$971,596
As budgeted results are prepared more frequently, assumptions must be made for a shorter
time period. This should make the budget more accurate.
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The budget will therefore reflect up-to-date assumptions regarding both internal resources and
external influences.
The period covered by available budget data will be longer, as the period covered by the
budget is continually rolled out. This will aid planning.
A rolling budget emphasises the continuous nature of business.
SA
Managers will therefore be encouraged to regard planning as an on-going, rather than a one-
off, activity.
Drawbacks
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PL
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