ACCA - P5 Study text - Emile Woolf INT

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Answers

Conclusion: Strategies 1, 2 and 3 together will successfully close the profit gap, if

the targets for each of the strategies can be achieved.

20 Zero based budgeting

Zero based budgeting is most useful when:

 There is a lot of budget slack, and wasteful spending. Zero based budgeting can

be much more effective than incremental budgeting in identifying and

eliminating unnecessary expenditure in a budget.

 There is a shortage of resources for ‘overhead’ spending, and decisions have to

be made about priorities for spending.

Zero based budgeting is more effective for the planning and control of overhead

spending on overhead activities than for controlling direct costs of production.

A zero based budgeting operation can be time-consuming and expensive. It should

not be needed every year. A ZBB approach to the budget might be sufficient, say,

every three or four years.

21 Marginal

(a) When p = 250, q = 400,000.

The quantity sold will fall by 20,000 for every $10 increase in price.

Therefore the price when q = 0 will be 250 + [(400,000/20,000) × $10] = 450

The price function can be stated as:

= 450 – (10/20,000)q = 450 – 0.0005q.

Total revenue = pq = (450 – 0.0005q)q = 450q – 0.0005q

Marginal revenue = 450 – (2 × 0.0005 × q) = 450 – 0.001q

Marginal cost = variable cost per unit = 210.

Profit is maximised where MR = MC:

450 – 0.001q = 210

0.001q = 240

q = 240,000 units.

At this volume of sales, p = 450 – 0.0005 (240,000) = 330.

Profit is maximised at a price of $330 per unit, and annual sales will be 240,000

units.

$000

Sales (240,000 × 330)

79,200

Variable costs (240,000 × 210)

50,400

Contribution 28,800

Fixed costs 20,000

Profit 8,800

The annual profit will be $8,800,000.

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(b) Profit = Total revenue – Total costs

= (450q – 0.0005q

) – (210q + 20,000,000)

= – 0.0005q

+ 240q – 20,000,000

At break-even point, profit = 0:

- 0.0005q

+ 240q – 20,000,000 = 0

Re-arranging:

0.0005q

2 –

240q + 20,000,000 = 0

The break-even points can be calculated as the values for x that solve the

following equation:

x =

−b +/− b

− 4ac

q =

+240+/ − (240)

− 4(0.0005)(20,000,000)

2(0.0005)

The two break-even points

(1) q = (+ 240 + 132.67)/0.0010 = 372,670 [and p = 450 – 0.0005(372,670) =

$263.67]

(2) q = (+ 240 – 132.67)/0.0010 = 107,330 [and p = 450 – 0.0005(107,030) =

$396.34]

22 MC = MR

(a) The demand falls by 1,000 units for every $20 increase in price.

Demand will be 0 when the sales price is $50 + $20 × (1,000/1,000) = $70.

The quantity demanded rises by 20/1,000 = 0.02 for every unit of demand.

The

demand curve can therefore be expressed as:

P = 70 – 0.02Q

(b)

Total revenue = PQ = (70 – 0.02Q)Q

= 70Q – 0.02Q

Marginal cost = 8

Profit is maximised where MC = MR

8 = 70 – 0.04Q

Q = 62/0.04 = 1,550

P = 70 – 0.02Q = 70 – 0.02 (1,550) = 39.

Answers

The profit is maximised at a price of $39, when demand will be 1,550 units.

Contribution per unit will be $31 ($39 – $8).

Total contribution will be $48,050 ($31 × 1,550).

23 Snap Company

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

$000

Direct materials 12

Direct labour 8

Direct cost 20

Production overheads (100% of direct cost)

Full production cost

Administrative and marketing overheads (25%)

Full cost of sale 50

Profit (20% of full cost of sale)

Selling price for order (5,000 units)

Sales price per unit = $12.

(ii) Price to maintain budgeted profit of $50,000

If sales of SP8 falls are 25% below budget, the expected profit will be as

follows:

$000

Direct costs

75% × 100,000

75.0

Variable overheads

75%

50,000

37.5

Total variable costs

112.5

Fixed production overhead

50.0

Other fixed overheads

50.0

Total costs

212.5

Sales

75%

300,000

225.0

Profit

12.5

In order to make a profit of $50,000 for the year, the simplified units of

SP8 must make $37,500 contribution to profit. The price for the order

should be as follows:

$000

Materials 12.0

Labour 8.0

Direct cost 20.0

Variable overhead (see note)

10.0

Variable cost 30.0

Contribution 37.5

Selling price 67.5

Note: Variable overheads are assumed to vary with direct materials cost.

In the original budget variable overheads, are $50,000 and direct

material costs are $60,000. Variable overheads are therefore 50/60 ×

material costs. For the simplified units, variable overheads will be

$12,000 × 50/60 = $10,000.

The selling price per unit would need to be $67,500/5,000 units = $13.50.

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(b) Advice

The price of SP8 is currently $15 ($300,000/20,000 units). The price for the

simplified units of SP8 must be lower than this; otherwise the customer will

not buy them.

A price of $13.50 is needed to achieve the budgeted profit, but the customer

may be unwilling to pay this amount. A price of $12 will give a profit of 20%

on full cost, using the budgeted absorption rates for overhead, but there will

be some under-absorbed overheads.

Any price in excess of the minimum price of $30,000 ($6 per unit) will make

profit higher than it will be if the simplified units are not sold to the customer.

However, the company must think of the longer term. Will the customer want

to buy more units of the simplified product next year? If so, the company will

want to charge a price at which it will make satisfactory profits.

The recommendation should therefore be to negotiate with the customer. If

the agreed price is lower than $13.50, Snap Co might want to warn the

customer than more units of the simplified SP8 might not be available in the

future, except at a higher price.

24 Bridge Company

(a) Budgeted variable production costs

Cost in

current year

Inflation

Cost next year

Current material New material

$ %

Direct material 30

36.0 31.25

Direct labour 10

10.5 10.50

Variable o’hd 10

10.5 10.50

57.0 52.25

Cost of rejected units (5%)

2.75

55.00

Using the cheaper substitute material will reduce the variable unit cost by $2,

but fixed costs will increase by $30,000. Since annual sales at the current price

will be 20,000 units, it will be more profitable to use the cheaper material.

The unit variable cost will be $55.

Annual fixed costs will be:

Costs in the current year ($10 × 20,000 units)

200,000

Add inflation (10%) 20,000

Inspection costs 30,000

Total fixed costs for the year

250,000

(b) Optimal selling price

Method 1

It is assumed that the only sales prices to be considered are those in the sales

manager’s estimates of sales demand.

The variable cost will be $55 per unit.

Answers

Price Contribution/unit Sales Total contribution

$ $ 000 units $000

625

667

693

700

703

697

100

675

Contribution will be maximised at a price of $92, and sales will be 19,00 units.

Total contribution 703,000

Fixed costs 250,000

Profit

453,000

Method 2

It is assumed that the sales manager has identified a straight-line demand

curve, and any sales price on this curve may be selected.

Sales demand falls by 1,000 units for every $2 increase in the sales price.

Sales demand will be 0 when the sales price is $130 [$100 + (15 × $2)]

Demand curve:

P = 130 – 2Q, where Q is sales demand in 000s units

Total revenue TR = (130 – 2Q)Q = 130Q – 2Q

Marginal revenue MR = 130 – 4Q

Marginal cost MC = variable cost per unit = 55.

Profit is maximised when MR = MC

130 – 4Q = 55

Q = 18.75

Price = 130 – 2(18.75) = $92.50.

Profit will be maximised at a price of $92.50, and the contribution per unit will

be $37.50.

Total contribution (18,750 × $37.50)

703,125

Fixed costs 250,000

Profit 453,125

25 Responsibility

(a) We are told that decisions about capital investment and borrowing are taken

at head office. It would therefore be appropriate to look at the performance of

the division over which the managing director has control – sales revenue and

operating costs, but not depreciation or interest.

Sales revenue minus operating costs provides a measure of

profit or earnings

before interest, depreciation and amortisation (EBITDA).

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Year 1 Year 2 Year 3 Year 4

$000 $000 $000 $000

Sales revenue 172

646

810

1,792

Operating costs 167

620

718

1,490

EBITDA

302

This indicates improving performance over each year of the four-year period.

(b) Controllable performance has been improving each year. There has also been

a continuing improvement in the ratio of EBITDA to sales revenue.

On the basis of the information available, the managing director’s view is

justified.

However, senior management should assess the return that the company is

obtaining on its investment in the Fenland Division. Presumably, there was an

investment plan for the project, containing an estimate of the profits that the

division should be expected to make.

 If sales are lower than expected, or if costs are higher than expected, the

managing director of the division might be asked to give reasons why

performance has not been better.

 If the size of the investment or the cost of borrowing has been more than

expected, the poor performance should be attributed to the managers

responsible for the investment and borrowing decisions.

26 Crosstreets Hotel

A well-designed management information system should provide relevant, accurate

and timely information to all levels of management. Hence the introduction of a

new system should not only allow the directors to monitor performance, but may

actively help to address the issue of declining profits by providing greater feedback

to tactical and operational managers. There should be an online link between each

hotel and head office so that data and information can be transmitted quickly in

both directions.

(a) and (b) Periodic reports

The computerisation of hotel records and an online link to head office allow

the head office to acquire and assimilate large volumes of data rapidly. This

would permit monthly financial statements to be produced for each hotel in

time for directors to review them and action their findings whilst the

implications are still relevant.

The statements should comprise balance sheet, cash flow and income

statement, and would enable directors to gain an overview of the effects of

local management decisions and the effectiveness of corporate policy on a

regional basis.

These periodic reports should include comparative data in addition to actual

data. Figures could be included for budget/previous periods/industry data.

Variances could be reported.

Answers

Demand reports

The new system should also be capable of producing a range of reports on

demand, so that senior management can assess high-risk aspects of the

business by obtaining information whenever they need it.

(i) Room occupancy report

This report gives details of the proportion or percentage of a hotel’s

available rooms that were occupied. By using information from

registration cards, it should be possible to split this figure between

business and non-business users.

The incorporation of room charge-out rates into the same report would

enable management to:

 assess the accuracy of revenues from room-letting

 identify whether variations in regional rates have a significant impact

on occupancy rates and overall profitability

 identify any trends in business/non-business usage and the

opportunity for differential pricing and attracting more guests.

Room rates should also be compared to a centralised master file of

approved rates and discounts to ensure hotel managers are not offering

rooms at below cost in an attempt to attract business.

To ensure all income from rooms is recorded, the room occupancy

report should compare rooms for which income has been recorded to a

housekeeper’s report giving details of the rooms cleaned.

(ii) Late payments report

It is assumed that some regular business customers are given credit. A

late payments report should highlight all receivables that are more than,

say, 60 days overdue.

Bad debts could be a major contributor to declining profits, particularly

if the hotels catering for business travellers are taking block corporate

bookings.

As an additional control to ensure that all reported bookings are

genuine, this report should also include a comparison of revenues with a

direct room cost such as laundry bills.

(iii) Restaurant sales report

This report should compare total revenues from the restaurant to the

room occupancy rate and also the number of restaurant table bookings,

thereby allowing the directors to ascertain if unduly preferential

arrangements are being allowed by some of their hotels.

Differentiation should also be made between billings to residents and

non-residents, as this will enable attention to be focused on this separate

revenue source. This is important if the restaurant is not being operated

at capacity such that non-residents could be a useful source of income.

(iv) Bar sales report

Total bar sales should be compared for restaurant sales, but without the

division between residents and non-residents (because reliable

information about this division would be difficult to obtain in view of

the large number of cash transactions).

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(v) Restaurant and bar inventories report

Physical control over bar and restaurant inventories is difficult to

maintain and yet losses could have a potentially significant effect on

profits.

An official from head office should attend a physical count at each hotel,

and this figure should then act as the benchmark for subsequent

movements and be “enforced” by random spot checks.

The inventories report should compare the verified figure as adjusted

for subsequent purchases and sales to occupancy rate and highlight any

significant percentage variation from preceding months (indicating

pilferage and misappropriation). The overall holding of inventory in

each hotel should be compared to inventory turnover to ensure the

former does not represent an excessive usage of working capital.

(vi) Cash availability report

Many of the bar and restaurant takings of each hotel will be in cash; as

with inventories, cash is easily susceptible to misappropriation.

The head office directors will require a report that summarises the cash

takings and receipts, and makes a comparison between hotels making

allowances for differences in the number and type of resident (for

example, business users may utilise corporate client cards rather than

their own cash).

(vii) Wages report

Given that wages, often casual wages, represent a significant item of

cash expenditure for hotels and one which can be directly related to

revenue, a report should be produced detailing the number of wage-

earning staff per week and their wages.

This could then be compared to revenue reports to identify any

significant departures from the expected relationship. This may indicate

general inefficiency capable of improvement or fraud.

Error/exception reports

A unique feature of computerised systems is their ability to search through

large volumes of data and extract only those figures of significance to users.

These exception reports should be produced automatically to highlight

matters such as:

 hotel revenue falling below budget (for example, by more than 10%)

 group cash reserves/funding requirements exceeding available limits

 hotels selling room accommodation below the approved room rate.

27 Three services

(a) Workings

Revenue:

Service A: contract customers – 350,000 × 60% × $9 × 1.03 = $1,946,700

Service A: non-contract customers – 350,000 × 40% × $9 × 1.30 × 1.03 =

$1,687,140

Answers

Service B: contract customers – 250,000 × 60% × $15 × 1.03 = $2,317,500

Service B: non-contract customers – 250,000 × 40% × $15 × 1.50 × 1.03 =

$2,317,500

Service C: contract customers – 20,000 × 80% × $300 × 1.03 = $4,944,000

Service C: non-contract customers 20,000 × 20% × $300 × 1.20 × 1.03 =

$1,483,200

Salaries: $45,000 × 85 employees × 1.05 = $4,016,250

Sundry operational costs: $4,000,000 × 1.05 = $4,200,000

Fuel

Services A and B – 400 km × 50 vehicles × 300 days × $0.40 = $2,400,000

Service C – 600 km × 18 vehicles × 300 days × $0.80 = $2,592,000

Budgeted income statement for the year to 31 December Year 2

Service A Service B Service C Total

Revenue: $ $ $ $

Contract customers 1,946,700

2,317,500

4,944,000 9,208,200

Non-contract

customers

1,687,140

2,317,500

1,483,200 5,487,840

Total revenue 3,633,840

4,635,000

6,427,200 14,696,040

Costs:

Salaries

4,016,250

Fuel:

Services A and B

2,400,000

Service C

2,592,000

4,992,000

Sundry operational costs

4,200,000

Total costs

13,208,250

Net profit

1,487,790

(b) Vehicle utilisation

There is no information about weight carried, only about distance travelled.

All vehicles were used for 300 days in the year. Presumably, vehicles might be

used for 365 days per year, indicating an overall utilisation ratio for all

vehicles of 82.2%.

Other utilisation measure: a revenue measure might be used as an indication

of the utilisation of vehicles.

Services A and B Service C

Revenue per vehicle ($8,268,840/50) ($6,427,200/18)

$165,377

$357,067

Kilometres travelled each year might also be a measure of utilisation:

 Service A and B vehicles travel on average (400 × 300) = 120,000 kilometres

each year.

 Service C vehicles travel on average (600 × 300) = 180,000 kilometres each

year.

Paper P5: Advanced performance management

28 Private medical practice

Workings

Total number of patients per year = 5 doctors × 18 patients per day × 5 days per

week × 46 weeks per year = 20,700.

Patients

Total Adults Children 65 years and over

20,700 (45%) = 9,315 (25%) = 5,175 (30%) = 6,210

Treatment

None: 20%

1,863.0

1,035.0

1,242

Minor: 70%

6,520.5

3,622.5

4,347

Major: 10%

931.5

517.5

621

Revenue:

Adults, no treatment: 1,863 × $50 = $93,150

Adults, minor treatment: 6,520.5 × $200 = $1,304,100

Adults, major treatment: 931.5 × $600 = $558,900

Children, no treatment: 1,035 × $30 = $31,050

Children, minor treatment: 3,622.5 × $120 = $434,700

Children, major treatment: 517.5 × $280 = $144,900

65 years and over, no treatment: 1,242 × $30 = $37,260

65 years and over, minor treatment: 4,347 × $120 = $521,640

65 years and over, major treatment: 621 × $280 = $173,880.

Budgeted income statement for the year to […]

Adults

Children

Aged 65

years and

over

Total

Revenue: $ $ $ $

No treatment 93,150

31,050

37,260 161,460

Minor treatment

1,304,100

434,700

521,640 2,260,440

Major treatment

558,900

144,900

173,880 877,680

Total revenue 1,956,150

610,650

732,780 3,299,580

Costs:

Salaries

Doctors (5 × $240,000)

1,200,000

Assistants (5

$100,000)

500,000

Administrators (2 × $80,000)

160,000

1,860,000

Bonus

93,000

1,953,000

Materials costs

414,300

Other costs

733,600

Total costs

3,100,900

Net profit

198,680

ACCA - P5 Study text - Emile Woolf INT - 2010

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