ACCA F5 Performance Management - 2010 - Study text

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Practice questions

There is no inventory of finished goods at the beginning of the year.

Required

Use the graphical method of linear programming to identify the quantities of

Mark 1 and Mark 2 that should be made and sold during the year in order to

maximise profit and contribution.

Calculate the amount of contribution that will be earned.

(b) Suppose that the maximum available amount of direct materials next year is

$24,001, not $24,000.

Required

(i) Identify the quantities of Mark 1 and Mark 2 that should be made and

sold during the year in order to maximise profit and contribution.

(ii) Calculate the amount of contribution that will be earned.

(iii) Compare the total contribution you have calculated in (b) with the total

contribution that you calculated in (a), to calculate the shadow price per

$1 of direct materials.

12 Price

A company has developed a new product that it wishes to introduce to the market.

The cost per unit is expected to be as follows, assuming annual sales of 40,000 units.

Cost per unit

Direct materials:

Material M1 (2 litres at $15) 30

Material M2 (0.5 litres at $8) 4

Direct labour (3 hours at $10) 30

Fixed overheads (3 hours at $12) 36

Full cost 100

It has been company policy to price products to achieve a profit of 16.67% (one-

sixth) on the sales price.

Required

(a) Calculate the selling price that would be charged if the company applies its

normal pricing policy.

(b) If the company decided to price products at marginal cost plus, what mark-up on

the marginal cost would be required to obtain the same selling price as in (a)?

price for the product.

Paper F5: Performance management

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13 Marginal

The marketing director of a company selling home entertainment products has

estimated that at a sales price of $250, a new product (the Blaze) will sell 400,000

units in the next year. He also estimates that for every $10 increase or reduction in

price, annual sales will fall or increase by 20,000 units below or above this 400,000

units level.

The production engineer has estimated that the costs of making the Blaze will be a

variable cost of $210 per unit sold and annual fixed costs of $20 million.

You are given the following formulae:

Price function: P

= P

– bq

Total revenue function (TR): P

q – bq

Marginal revenue function (MR): P

– 2bq

where

= Price at zero units of demand

= Price at q units of demand

b = relationship between price and demand

q = units of annual demand

Required

(i) Calculate the price at which the Blaze should be sold in order to maximise

profit for the year.

(ii) Calculate the quantity of units that will be sold in the year, if the marketing

director’s forecast is correct.

(iii) Calculate the annual profit that will be made from selling the Blaze.

14 MC = MR

A business entity has estimated that it faces the following price/quantity

relationship:

Sales price Quantity demanded

$ Units

50 1,000

30 2,000

10 3,000

Required

(a) Calculate a formula for the demand curve, assuming that the demand curve

can be drawn as a straight line on a graph.

(b) Find the formula for total revenue.

maximised.

Practice questions

15 Snapco

Snapco Company makes product SP8 in department C. For the year commencing

1 January Year 7 the following budget has been formulated for department C:

$000

Direct costs

Materials 60

Labour 40

100

Production overheads 100

Full production cost 200

Administrative and marketing overheads 50

Full cost of sale 250

Profit 50

Revenue (see note) 300

Note: This revenue is from budgeted sales of 20,000 units.

Production overheads are absorbed on the basis of 100% of direct costs. However,

half of these costs are fixed, and the other half are variable. It is assumed that they

vary with the cost of materials.

The administrative and marketing overheads are based on 25% of factory costs and

do not vary within wide ranges of activity. A profit margin of 20% is applied to the

full cost of sale. This also results in a price that appears to be fair to customers.

Halfway through the year to 31 December Year 7, it became clear that actual sales of

SP8 would be 25% below budget. At about the same time that this shortfall in sales

became evident, a customer asked about buying 5,000 units of a simplified version

of product SP8. If Snapco were to produce this simplified model for the customer,

the direct material and labour costs would be lower. It is estimated that materials

costing $12,000 and direct labour of $8,000 would be required to produce the 5,000

units. As the production could take place within the firm’s existing capacity, fixed

costs would not be affected.

Required

(a) Calculate the prices that Snapco should quote to the customer for each unit of

the simplified product, assuming that the following pricing policies are

applied:

(i) Full cost plus pricing, on the current basis.

(ii) A price that would enable the company to achieve its original budgeted

profit.

(b) Give your advice on the price that should be quoted to the customer.

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15 Bridon

The following costs per unit relate to the production and sale of 20,000 of a product

by Bridon Company, for the financial year that has just ended:

$ per unit

Direct material 30

Direct labour 10

Overheads:

Variable 10

Fixed 10

It has been estimated that major cost increases will apply to the following year,

assuming that production and sales volumes are still 20,000 units.

Increase

Direct material 20%

Direct labour 5%

Variable overhead 5%

Fixed overhead 10%

It would be possible to substitute a cheaper grade of direct material, allowing the

cost of direct materials to be $31.25 per unit. However, a rejection rate of 5% will

arise. (There are currently no rejected units.) This would require an additional

annual inspection cost of $30,000.

In the past, the selling price has been set using a mark-up of 50% on full cost and a

price of $90 per unit was charged in the current year. However, the sales manager

has estimated the price/demand relationships as follows:

Price $80

$84

$88

$90

$92 $96 $100

Demand (000s units) 25

19 17 15

Required

(a) Decide whether the product should use the regular or the cheaper grade of

material.

(b) Calculate the price that should be charged for the product to maximise the

annual profit, and the profit that should be expected.

17 Materials and relevant costs

A company is considering whether to agree to do a job for a customer. It has

sufficient spare capacity to take on this job.

To do the job, three different direct materials will be required, Material X, Material Y

and Material Z. Data relating to these materials is as follows:

Practice questions

Material

Quantity

needed

for the job

Quantity

currently

held as

inventory

Original cost

of units

currently held

as inventory

Current

purchase

price

Current

disposal

value

units units

$ per unit

$ per unit $ per unit

X 800 200

23 22

Y 600 400

19 12

Z 500 300

40 20

Material X is regularly used by the company for other work. Material Y is no longer

in regular use, and the units currently held as inventory have no alternative use.

Material Z is also no longer in regular use, but if the existing inventory of the

material is not used for this job, they can be used as a substitute material on a

different job, where the contribution would be $25 per unit of Material Z used.

Required

Calculate the total relevant costs of the materials for this job for the customer.

18 Printing leaflets

(a) The manager of a small printing business has received enquires about printing

three different types of advertising leaflet, type A, type B and type C. Selling

price and cost information for these leaflets is shown below:

Leaflet type: Type A

Type B

Type C

Selling price, per 1,000 leaflets 300

660

1,350

Estimate printing costs:

Variable costs, per 1,000 leaflets 120

210

390

Specific fixed costs per month 7,200

12,000

28,500

In addition to the specific fixed costs, $12,000 per month will be incurred in

general fixed costs.

Required

Assuming that fixed orders have been received to print 50,000 of Leaflet A and

50,000 of Leaflet B each month, calculate the quantity of Leaflet C that must be

sold to produce an overall profit, for all three leaflets combined, of $5,400 per

month.

(b) The printing business now receives an enquiry from a customer about

printing 30,000 of a different type of leaflet. The customer is willing to pay

$25,000. The variable labour and overhead costs of producing these leaflets

would be $80 per 1,000 leaflets.

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The leaflets would be printed on a special type of paper. This costs $500 per

1,000 leaflets. However, there are already sufficient quantities of the paper in

inventory for 20,000 of the leaflets. This special paper was purchased three

months ago for a customer who then cancelled his order. The material has a

disposal value of $1,500, but it could also be used to produce 20,000 units of

leaflet C. The cost of normal paper for leaflet C is $300 per 1,000 leaflets.

Required

Calculate the relevant costs of making the leaflets for this special order, and

indicate by how much profit would increase as a result of undertaking the

order.

19 JB

JB is a small specialist manufacturer of electronic components and much of its

output is used by the makers of aircraft. One of the small number of aircraft

manufacturers has offered a contract to Company JB for the supply of 400 identical

components over the next twelve months.

The data relating to the production of each component is as follows:

(a) Material requirements:

3 kilograms material M1: see note 1 below

2 kilograms material P2: see note 2 below

1 Part No. 678: see note 3 below

Note 1

Material M1 is in continuous use by the company. 1,000 kilograms are

currently held in stock at a carrying amount of $4.70 per kilogram but it is

known that future purchases will cost $5.50 per kilogram.

Note 2

1,200 kilograms of material P2 are held in inventory. The original cost of the

material was $4.30 per kilogram but as the material has not been required for

the last two years it has been written down to $1.50 per kilogram (scrap

value). The only foreseeable alternative use is as a substitute for material P4

(in current use) but this would involve further processing costs of $1.60 per

kilogram. The current cost of material P4 is $3.60 per kilogram.

Note 3

It is estimated that the Part No. 678 could be bought for $50 each.

Practice questions

(b) Labour requirements

Each component would require five hours of skilled labour and five hours of

semi-skilled. An employee possessing the necessary skills is available and is

currently paid $5 per hour. A replacement would, however, have to be

obtained at a rate of $4 per hour for the work that would otherwise be done by

the skilled employee. The current rate for semi-skilled work is $3 per hour and

an additional employee could be appointed for this work.

JB absorbs overhead by a machine hour rate, currently $20 per hour of which

$7 is for variable overhead and $13 for fixed overhead. If this contract is

undertaken it is estimated that fixed costs will increase for the duration of the

contract by $3,200. Spare machine capacity is available and each component

would require four machine hours.

A price of $145 per component has been suggested by the large aircraft

manufacturer.

Required

State whether or not the contract should be accepted and support your

conclusion with appropriate figures for presentation to management.

20 Product B22

BB Company has received an enquiry from a customer for the supply of 500 units of

a new product, product B22. Negotiations on the final price to charge the customer

are in progress and the sales manager has asked you to supply relevant cost

information.

The following information is available:

(1) Each unit of product B22 requires the following raw materials:

Raw material type

X 4 kg

Y 6 kg

(2) The company has 5,000 kg of material X currently in stock. This was

purchased last year at a cost of $7 per kg. If not used to make product B22, this

stock of X could either be sold for $7.50 per kg or converted at a cost of $1.50

per kg, so that it could be used as a substitute for another raw material,

material Z, which the company requires for other production. The current

purchase price per kilogram for materials is $9.50 for material Z and $8.25 per

kg for material X.

(3) There are 10,000 kilograms of raw material Y in inventory, valued on a FIFO

basis at a total cost of $142,750. Of this current inventory, 3,000 kilograms

were purchased six months ago at a cost of $13.75 per kg. The rest of the

inventory was purchased last month. Material Y is used regularly in normal

production work. Since the last purchase of material Y a month ago, the

company has been advised by the supplier that the price per kilogram has

been increased by 4%.

Paper F5: Performance management

(4) Each unit of product B22 requires the following number of labour hours in its

manufacture:

Type of labour:

Skilled: 5 hours

Unskilled: 3 hours

Skilled labour is paid $8 per hour and unskilled labour $6 per hour.

(5) There is a shortage of skilled labour, so that if production of B22 goes ahead it

will be necessary to transfer skilled workers from other work to undertake it.

The other work on which skilled workers are engaged at present is the

manufacture of product B16. The selling price and variable cost information

for B16 are as follows:

$/unit

Selling price

100

Less: variable costs of

production

Skilled labour (3 hours) 24

Other variable costs 31

(6) The company has a surplus of unskilled workers who are paid a fixed wage

for a 37-hour week. It is estimated that there are 900 hours of unused unskilled

labour time available during the period of the contract. The balance of the

unskilled labour requirements could be met by working overtime, which is

paid at time and a half.

(7) The company absorbs production overheads by a machine hour rate. This

absorption rate is $22.50 per hour, of which $8.75 is for variable overheads and

the balance is for fixed overheads. If production of product B22 is undertaken,

it is estimated that an extra $4,000 will be spent on fixed costs. Spare

machining capacity is available and each unit of B22 will require two hours of

machining time in its manufacture using the existing equipment. In addition,

special finishing machines will be required for two weeks to complete the B22.

These machines will be hired at a cost of $2,650 per week, and there will be no

overhead costs associated with their use.

(8) Cash spending of $3,250 has been incurred already on development work for

the production of B22. It is estimated that before production of the B22 begins,

another $1,750 will have to be spent on development, making a total

development cost of $5,000.

Required

Calculate the minimum price that the company should be prepared to accept for the

500 units of product B22. Explain briefly but clearly how each figure in the

minimum price calculation has been obtained.

Practice questions

(Note: The minimum price is the price that equals that the total relevant costs of

producing the items. Any price in excess of the minimum price will add to total

profit).

20 Make or buy

Stamba makes two components, A and B, for which costs in the next year are

expected to be as follows:

Production (units) 30,000

20,000

Variable costs per unit: $

Direct materials 6

Direct labour 3

Variable production overheads 1

Variable production cost 10

Direct labour is paid $12 per hour. There will be only 19,500 hours of direct labour

time available next year, and any additional components must be purchased from

an external supplier.

Total fixed costs per annum are expected to be as follows:

Incurred as a direct consequence of making A 40,000

Incurred as a direct consequence of making B 50,000

Other fixed costs 30,000

120,000

An external supplier has offered to supply units of A for $12.50 and units of B for

$23.

Required

(a) Recommend whether Stamba should shut down internal production of

Component A or Component B and switch to external purchasing.

(b) Recommend the quantities that Stamba should make of the components, and

the quantities that it should buy externally, in order to obtain the required

quantities of both components at the minimum cost. Calculate what the total

annual cost will be.

Tutorial note. To answer part (b), you will need to consider that labour is a limiting

factor.

Paper F5: Performance management

22 Villaco

Villaco produces two products with the following costs and revenue per unit:

Product A

Product B

Sales price 20

Variable cost 8

Fixed cost 4

units

Sales demand 2,000

3,000

There are only 7,000 machine hours available, and Product A requires 4 machine

hours per unit and Product B requires 1 machine hour per unit

Required

(a) Calculate the profit-maximising production and sales mix.

(b) Assume that all the data is the same, except that we are able to sub-contract

the products for an additional variable cost of $1 per unit for A and $0.50 per

unit for B.

What is the profit-maximising decision?

23 Payoff table

A baker pays $0.10 for buns and sells them for $0.30. At the end of a day, any

pastries that have not been sold must be thrown away. On any particular day, the

probability distribution of sales demand is as follows:

Number of pastries demanded by customers 20

40 60

Probability 0.3

0.5 0.2

Required

a) Construct a payoff matrix to show all the possible outcomes

b) How many buns should the baker make if he bases his decision on expected

value?

24 Grab

Grab is a company that engages in site clearance and site preparation work.

Information about its operations is as follows:

(1) It is Grab‘s policy to hire all the plant and machinery it needs, rather than to

purchase its own plant and machinery.

ACCA F5 Performance Management - 2010 - Study text - Emile Woolf Publishing

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