May 2009 Examinations

Managerial Level

Paper P2 – Management Accounting – Decision Management

Question Paper 2

Examiner’s Brief Guide to the Paper 22

Examiner’s Answers 23

The answers published here have been written by the Examiner and should provide a helpful
guide for both tutors and students.

Published separately on the CIMA website (www.cimaglobal.com/students) from August is a

Post Examination Guide for the paper which provides much valuable and complementary
material including indicative mark information.

© The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical,
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© The Chartered Institute of Management Accountants 2009

 Management Accounting Pillar

P2 – Decision Management
Managerial Level Paper

P2 – Management Accounting -
Decision Management
20 May 2009 – Wednesday Morning Session
Instructions to candidates
You are allowed three hours to answer this question paper.

You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to open the answer book and start writing or use
your calculator during the reading time.

You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is, all parts and/or sub-
questions). The requirements for the questions in Sections B and C are
contained in a dotted box.

ALL answers must be written in the answer book. Answers or notes written
on the question paper will not be submitted for marking.

Answer the ONE compulsory question in Section A. This has eight sub-
questions and is on pages 2 to 4.

Answer ALL THREE compulsory questions in Section B on pages 5 to 7.

Answer TWO of the three questions in Section C on pages 8 to 13.

Maths Tables and Formulae are provided on pages 15 to 17. These pages
are detachable for ease of reference.

The list of verbs as published in the syllabus is given for reference on the
inside back cover of this question paper.

Write your candidate number, the paper number and examination subject title
in the spaces provided on the front of the answer book. Also write your
contact ID and name in the space provided in the right hand margin and seal
to close.

Tick the appropriate boxes on the front of the answer book to indicate which
questions you have answered.

TURN OVER

P2 2 May 2009
SECTION A – 20 MARKS
[the indicative time for answering this section is 36 minutes]
ANSWER ALL EIGHT SUB-QUESTIONS

Instructions for answering Section A:

The answers to the eight sub-questions in Section A should ALL be written in your
answer book.

Your answers should be clearly numbered with the sub-question number and then
ruled off, so that the markers know which sub-question you are answering. For
multiple choice questions, you need only write the sub-question number and
the letter of the answer option you have chosen. You do not need to start a
new page for each sub-question.

For sub-questions 1.7 and 1.8 you should show your workings as marks are
available for the method you use.

Question One

1.1 A company manufactures three products using the same machine which has limited time
available. The following cost and selling price details relate to the three products:

Product F G H
$/unit $/unit $/unit
Selling price 35 31 47

Direct material 15 7 12
Direct labour 6 10 14
Variable overhead 4 6 7
Fixed overhead 7 5 10

Profit 6 3 4

Minutes per unit Minutes per unit Minutes per unit

Machine time 30 14 24

The correct rank order for the three products so that the company maximises its profits, as
measured using throughput accounting is

A FHG
B HFG
C HGF
D GHF
(2 marks)

May 2009 3 P2
1.2 An investment project, with an initial outlay of $150,000, has a net present value of
$28,000 when it is discounted at 5%. The present value of the sales revenue of the
investment project is $262,500. The sensitivity of the investment to changes in the sales
revenue is closest to:

A $112,500
B $234,500
C 10%
D 11%
(2 marks)

1.3 The following table shows the daily cost estimates that a bank has made for a new
banking service, together with their respective probabilities. The probabilities for each
cost are independent.

Variable costs Fixed costs

$ Probability $ Probability
4,000 30% 2,500 20%
5,000 50% 3,000 35%
6,000 20% 3,500 45%

Calculate the expected value of total costs.

(2 marks)

1.4 A project is discounted at 6% and has a positive net present value of $124,230. When the
same project is discounted at 13% it has a negative net present value of $35,760.

Calculate the internal rate of return of the project to the nearest 0·1%

(2 marks)

1.5 The following incremental cash inflows relate to a new machine which has an initial
purchase cost of $45,000:

Year Incremental cash flow

1 $14,000
2 $22,000
3 $19,000
4 $11,000

Calculate the payback period to the nearest 0·1 years.

(2 marks)

1.6 A company is launching a new product. The product is made using a labour intensive
process. The first unit took 12 minutes to complete. The total time taken for the first 16
units was 54·5 minutes.

Calculate the rate of learning that occurred.

(2 marks)

TURN OVER

P2 4 May 2009
1.7 The following data have been extracted from the records of SW:

Output Total Cost Inflation Index

February 3,400 $20,197 104
March 2,800 $18,312 105

Calculate the total cost expected for a month when output is forecast to be 3,300 and the
inflation index is expected to be 107.
(4 marks)

1.8 A company is reviewing the price of one of its products. The product has a marginal cost
of $28 per unit and is currently sold for $65 per unit. At this price the demand for the
product is 800 units per week. A market research study shows that for each reduction in
the selling price by $5 per unit the weekly demand would increase by 40 units, and that
for each increase in the selling price by $5 per unit the weekly demand would decrease
by 40 units.

Calculate the optimal selling price.

Note: If Price P = a-bx then Marginal Revenue = a-2bx

(4 marks)

(Total for Section A = 20 marks)

Reminder
All answers to Section A must be written in your answer book.
Answers to Section A written on the question paper will not be
submitted for marking
End of Section A. Section B starts on the next page

May 2009 5 P2
SECTION B – 30 MARKS
[the indicative time for answering this section is 54 minutes]
ANSWER ALL THREE QUESTIONS. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.

Question Two

A restaurant chain is considering when to replace its ovens. Each oven has a purchase cost of
$14,000. The restaurant needs to decide whether to replace its ovens after one year, after two
years or after three years.

The following forecast data have been collected for a single oven:

Year of ownership 1 2 3
$ $ $
Operating costs 5,000 6,000 6,500
Maintenance costs 1,000 2,000 3,000
Trade-in value at the end of the year 10,000 7,000 5,000

The company’s cost of capital for this type of decision is 12% per annum.

Ignore taxation.

Required:

(a) Prepare calculations to show the optimum replacement cycle for the restaurant’s
ovens and state your recommendation.
(7 marks)

(b) Explain two limitations of your solution to (a) above.

(3 marks)

(Total for Question Two = 10 marks)

TURN OVER

P2 6 May 2009
Question Three

A software development company sells three software products: AXPL1, FDR2 and VBG3. The
company’s marketing department adds a 25% mark-up to product costs to calculate the selling
prices of the company’s products. The current selling prices are based on the product costs that
were calculated using a traditional absorption costing system. The company has just installed an
activity based costing system and consequently changed its working practices with the result
that all costs are now treated as effectively variable. The marketing department has not yet
been informed about the revised product costs.

The company has carried out some market research and there is a linear relationship between
the price it charges for its software products and the resulting market share. The research
shows that a change in price causes there to be a proportionate change in market share. A
summary of the research shows that for every $2 increase in selling price there would be a 3%
reduction in market share and for every $2 decrease in selling price there would be a 3%
increase in market share. For example, if the selling price of AXPL1 were to be increased to
$52 per unit its market share would reduce to 42%.

The following data relate to the three software products:

AXPL1 FDR2 VBG3

Current unit selling price ($) 50·00 75·00 65·00

Current market share % 45% 15% 80%

Market size for the remaining life of 2,500 3,000 4,000

the product (units)

Activity based cost per unit ($) 48.00 42.00 75.00

Required:

(a) Explain, using the above information, why VBG3 currently has a high market
share.
(3 marks)

(b) The marketing department is now considering using the new product costings to
set the selling price by adding 25% mark-up to the unit Activity Based Cost.

Calculate the impact on the remaining lifetime profits of each software product
and the company as a result of the marketing department using this approach.

(7 marks)

(Total for Question Three = 10 marks)

May 2009 7 P2
Question Four

You have recently been appointed as a company’s Assistant Management Accountant. The
company has recently begun operating a just-in-time production system but is having problems
in meeting the demands of its customers because of quality failures within its production
function. Previously, the company used to hold sufficient levels of finished goods inventory so
that quality problems did not lead to lost sales. However, it was costly to hold high inventories
and, as a result, the company decided to adopt the just-in-time approach. The Production
Director believes that higher expenditure on Compliance costs is necessary to avoid the costs of
Non-compliance, but he is having difficulty convincing the Managing Director and seeks your
help.

Required:
Prepare a report addressed to the Managing Director that

• explains briefly the principles of Total Quality Management,

• explains the four categories of quality costs
• and explains the relationship between Compliance and Non-compliance costs in
the context of Total Quality Management.

(Total for Question Four = 10 marks)

(Total for Section B = 30 marks)

End of Section B

Section C starts on page 8

TURN OVER

P2 8 May 2009
SECTION C – 50 MARKS
[the indicative time for answering this section is 90 minutes]
ANSWER TWO QUESTIONS OUT OF THREE. YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.

Question Five

The ZYX Chemical Processing Company manufactures three liquid soaps (Z, Y and X) from the
same common process. One of these (Z) may then be sold or further processed in a separate
process into a luxury soap (ZS). At the moment all output of Z is processed further to produce
ZS.

Common Process
The common process account for April 2009 is as follows:

Litres $000 Litres $000

Opening balance 500 1,000 Normal loss 500 500
Material 1 1,500 750 Output Z 2,000 6,932
Material 2 3,500 5,000 Output Y 1,500 4,159
Labour 4,000 Output X 1,000 4,159
Overhead 6,000 Closing balance 500 1,000

Totals 5,500 16,750 5,500 16,750

The outputs from this common process may be sold for the following prices per litre:

Z $5·00 Y $4·00 X $6·00

The managers of the company consider that the results of the common process for April 2009
are similar to those that were expected, and that they may be used as a reliable basis for future
decisions.

Further Process
The manager responsible for products Z and ZS seeks your help in advising her whether or not
products should continue to be further processed. It is almost the start of a new financial year
and she must decide now whether or not to sign a new 12 month contract for the rent of the
building that is used for the further processing. The monthly rent is included in the specific costs
shown below. If she decides not to continue with the further process, the specific cost can be
avoided, but any realisable value associated with the further processing equipment will be
cancelled out by the costs of its removal from the building. Over the past three months, when
the level of inflation has been insignificant, the number of litres of Z input into the further process
has varied slightly and the specific costs and other data of the process have been recorded as:

Input volume (litres) Specific costs

$000
March 2009 2,200 7,070
February 2009 1,900 6,515
January 2009 2,100 6,885

The selling price of product ZS is expected to be $9·50 per litre.

May 2009 9 P2
Losses are expected to arise at the end of the further process, although the percentage loss is
uncertain. The following probabilities relate to the different amounts of loss that could occur:

Loss (% of input) Probability

10 30%
12 45%
15 25%

The losses from this process have no value.

The input volumes of 1,900 litres, 2,000 litres, 2,100 litres, and 2,200 litres all have equal
probability of occurring.

Required:

(a) Prepare a two-way data table in respect of the further process for product Z, with
separate columns for each of the four input volumes, that shows

(i) the financial gains or losses that could result from further processing; and
(ii) their respective probabilities
(13 marks)

(b) Evaluate your two-way data table and recommend to the product manager
whether or not to further process product Z.

(8 marks)

(c) The product manager is concerned at the level of process losses occurring in the further
process and has been investigating alternative methods of reducing the losses. One
solution is to implement a quality test on the output of the common process. It is believed
that its implementation would reduce the level of further processing losses by 50%.

Required:

Calculate, using an expected value basis, the maximum monthly cost of the quality
test that would be acceptable.
(4 marks)

(Total for Question Five = 25 marks)

Section C continues on the next page

TURN OVER

P2 10 May 2009
Question Six

PL is a manufacturing company that prepares its annual accounts to 30 June each year. It has
been developing a new product at a total cost of $100,000. The company is now ready to begin
full scale production in July 2009.

The product will be manufactured using a number of machines which will need to be purchased
at a cost of $1,500,000. This cost will be incurred on 1 July 2009 and the machines will be
installed during July 2009. Production will commence during July 2009 and output volumes will
gradually increase as the employees become more skilled at operating the machines.

Initial Batch Cost

The products are to be manufactured in batches of 100 units and the cost of the first batch is
expected to be as follows:

$
Direct labour ($20 per hour) 200·00
Direct material ($30 per kg) 150·00
Variable overhead 150·00
500·00

Direct Labour
It is expected that there will be a 90% learning curve effect on the direct labour cost for the first
64 batches. Thereafter the direct labour hours for each batch will be the same as that of the 64th
batch until the total production equals 256 batches (25,600 units). After this it is expected that
more employees will be recruited to enable the production volume to be increased to meet sales
demand. The average time for each batch in excess of 256 batches is then expected to be 6
hours.

Direct Material
It is expected that the direct material usage for each batch will reduce to 4kg after the first 16
batches have been completed.

Required:

(a) Calculate the labour hours expected for the 64th batch.

(4 marks)
(b) Calculate the total number of labour hours for the first 256 batches.

(4 marks)

Note:
The learning index for a 90% learning curve is -0·152

(Total for requirements (a) and (b) = 8 marks)

May 2009 11 P2
Variable Overhead
Variable overhead costs are expected to vary in direct proportion to direct labour costs.

Production & Sales

The company does not plan to start selling the product until October 2009. This is to allow time
to build up sufficient inventory of the product to enable the company to meet demand. For
accounting and taxation purposes each unit of inventory is valued at a cost of $10. The
company has produced the following schedule of production and sales volumes for each of the
three years of the product’s life.

Year commencing 1 July 2009 2010 2011

Production (units) 50,000 100,000 80,000
Sales (units) 40,000 90,000 100,000

Selling Prices
The initial selling price of the product will be $40 per unit in 2009. As the product becomes well
known and in order to exclude competitors from the market, the price will be reduced at the start
of July 2010 to $20 per unit. It is expected that the company can continue to charge this price for
the remaining life of the product.

Fixed Overhead Costs

The product is expected to incur specific fixed costs of $1m for each year of its life. This includes
some specific non-production costs, but does not include the depreciation cost of the machines.

Capital Costs
The machines will be used solely for the new product and will be purchased on 1 July 2009 at a
cost of $1,500,000. They have an expected residual value of $300,000 on 30 June 2012 and
qualify for tax depreciation at the rate of 20% per annum on a reducing balance basis.

Taxation
PL is liable to pay corporation tax at the rate of 30% of its profits. One half of its tax is payable in
the year in which the profit is earned and the remainder is payable in the following year.

Inflation
It is believed that the effects of inflation on the investment are insignificant and can be ignored.

Cost of Capital
PL uses a post tax cost of capital of 12% to evaluate investments of this type.

Required:

(c) Calculate the Net Present Value of the investment proposal and advise PL
whether or not the investment should proceed.
(17 marks)

(Total for Question Six = 25 marks)

TURN OVER

P2 12 May 2009
Question Seven

A company has been asked to provide a quotation for an engineering project that will take one
year to complete. An analysis of the project has already been completed and the following
resource requirements have been identified:

(1) A specialised machine will be required for a total of 10 weeks. Two of these weeks are at
the start of the project and three of them are at the end. The machine could be hired in
from a reputable supplier, who would guarantee its availability when it is required, for
$4,000 per week. Alternatively it could be purchased at a cost of $250,000. If it were
purchased it could be sold in one year’s time for $150,000. If the machine were
purchased it could be hired out to other companies for $2,500 per week and it is believed
that it would be hired out for a total of 30 weeks.

(2) The machinery has a running cost of $720 per week. This cost is incurred by the user of
the machine.

(3) It is company policy to depreciate non-current assets by 25% per year on a reducing
balance basis.

(4) Skilled labour would be required for a total of 9,000 hours during the year. The labour
required could be recruited at an hourly rate of $12. Alternatively some of the employees
currently working on other projects within the company could be transferred to this project.
Their hourly rate is $10 per hour. If these existing employees were to be transferred to
this project then they would need to be replaced on their existing project work.
Replacements for their existing project work would cost $11 per hour.

(5) Unskilled labour would be required for a total of 12,000 hours during the year. These
employees would need to be recruited on a one year contract at a cost of $8 per hour.

(6) The project would need to be supervised and it is estimated that there would be a total of
500 hours of supervision required during the year. One of the existing supervisors could
undertake this work, but if he did so he would have to work a total of 300 hours overtime
during the year to carry out the supervision on this project as well as his existing duties.
The supervisor earns a salary of $50,000 per year for working 2,000 hours and is not paid
for overtime work. If this project goes ahead the supervisor will be paid a bonus of $500,
which would not be paid if the project is not undertaken.

(7) The direct materials required for the project are as follows:

Material A
The total amount required for the project would have to be purchased at a cost of
$15,000.

Material B
The total amount required would be 10,000 square metres. The company purchased
25,000 square metres of this material for a project two years ago at a total cost of
$100,000. The earlier project used 20,000 square metres of the material and the
remainder is currently held in inventory. The company does not foresee any other use for
this material in the future and could sell it for $2 per square metre. The current purchase
price of the material is $5 per square metre.

(8) The company has already incurred expenditure of $25,000 in analysing the resource
requirements of the project.

(9) It is company policy to attribute overhead costs to projects using an absorption rate of
40% of prime costs.

(10) It is company policy to add a 25% profit mark-up to total costs when setting its prices.

May 2009 13 P2
 Required:

(a) Prepare a statement that shows the relevant cost of the project. For each of the
resources indicated in notes (1) to (10) you must clearly explain the reason for
the cost value that you have used.

Ignore the time value of money and taxation.

(20 marks)

(b) Assume that the company used your calculations as the basis of the quotation
and then added $125,000 for profit. Also assume that all costs incurred were
the same as forecast.

Explain why the financial profit reports at the end of the year would not show a
profit of $125,000 for the engineering project.

(5 marks)

(Total for Question Seven = 25 marks)

(Total for Section C = 50 marks)

End of Question Paper

Maths Tables and Formulae are on pages 15 to 17

TURN OVER

P2 14 May 2009
 [This page is blank]

May 2009 15 P2
 PRESENT VALUE TABLE

Present value of $1, that is (1 + r )

−n
where r = interest rate; n = number of periods until
payment or receipt.
Periods Interest rates (r)
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Periods Interest rates (r)

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065
16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

P2 16 May 2009
Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n
1− (1+ r ) − n
years r

Periods Interest rates (r)

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606
16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824
17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201
19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365
20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Periods Interest rates (r)

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675
16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730
17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775
18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812
19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843
20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870

May 2009 17 P2
 FORMULAE

Time series

Additive model:
Series = Trend + Seasonal + Random
Multiplicative model:
Series = Trend*Seasonal*Random

Regression analysis

The linear regression equation of Y on X is given by:

Y = a + bX or Y – Y = b(X – X ),
where:
Covariance ( XY ) n ∑ XY − ( ∑ X )( ∑ Y )
b= = 2 2
Variance ( X ) n ∑ X − (∑ X )

and a= Y –bX
or solve
∑ Y = na + b ∑ X
∑ XY = a ∑ X + b ∑ X
2

Exponential Y = abx
Geometric Y = aXb

Learning curve

Yx = aXb
where:
Yx = the cumulative average time per unit to produce X units;
a = the time required to produce the first unit of output;
X = the cumulative number of units;
b = the index of learning.

The exponent b is defined as the log of the learning curve improvement rate divided by log 2.

P2 18 May 2009
 [this page is blank]

May 2009 19 P2
LIST OF VERBS USED IN THE QUESTION REQUIREMENTS
A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for
each question in this paper.

It is important that you answer the question according to the definition of the verb.
LEARNING OBJECTIVE VERBS USED DEFINITION
1 KNOWLEDGE
What you are expected to know. List Make a list of
State Express, fully or clearly, the details of/facts of
Define Give the exact meaning of

2 COMPREHENSION
What you are expected to understand. Describe Communicate the key features
Distinguish Highlight the differences between
Explain Make clear or intelligible/State the meaning of
Identify Recognise, establish or select after
consideration
Illustrate Use an example to describe or explain
something

3 APPLICATION
How you are expected to apply your knowledge. Apply To put to practical use
Calculate/compute To ascertain or reckon mathematically
Demonstrate To prove with certainty or to exhibit by
practical means
Prepare To make or get ready for use
Reconcile To make or prove consistent/compatible
Solve Find an answer to
Tabulate Arrange in a table

4 ANALYSIS
How you are expected to analyse the detail of Analyse Examine in detail the structure of
what you have learned. Categorise Place into a defined class or division
Compare and contrast Show the similarities and/or differences
between
Construct To build up or compile
Discuss To examine in detail by argument
Interpret To translate into intelligible or familiar terms
Produce To create or bring into existence

5 EVALUATION
How you are expected to use your learning to Advise To counsel, inform or notify
evaluate, make decisions or recommendations. Evaluate To appraise or assess the value of
Recommend To advise on a course of action

P2 20 May 2009
 Management Accounting Pillar

Managerial Level

P2 – Management Accounting –
Decision Management

May 2009

Wednesday Morning Session

May 2009 21 P2
 The Examiner for Management Accounting – Decision Management offers to future
candidates and to tutors using this booklet for study purposes, the following
background and guidance on the questions included in this examination paper.

Section A – Question One – Compulsory

Question One comprises eight sub-questions in objective testing format. Some of the questions
provide a choice of answers of which only one is correct while others require solution by the
candidate. This question covers a number of syllabus areas and learning outcomes and is
designed to complement the syllabus coverage of the remaining questions on the paper.

Section B – Questions Two, Three and Four – Compulsory

Question Two This question tests candidates’ ability to solve an asset replacement problem
and to explain the limitations of the method they have used. This question addresses the
learning outcome: evaluate and rank projects that might be mutually exclusive, involve unequal
lives and/or be subject to capital rationing.

Question Three This question tests candidates’ ability to apply Activity Based Costs to the
measurement of profitability when selling prices are changed and this results in different sales
volumes. This question addresses the learning outcomes: apply the techniques of activity based
management in identifying cost drivers/activities and explain how process re-engineering can be
used to eliminate non-value adding activities and reduce activity costs and apply an approach to
pricing based on profit maximization in imperfect markets and evaluate the financial
consequences of alternative pricing strategies.

Question Four This question tests candidates’ knowledge of total quality management. This
question addresses the learning outcome: explain the concepts of continuous improvement and
Kaizen costing that are central to total quality management and prepare cost of quality reports.

Section C – answer two of three questions

Question Five This question tests candidates’ ability to solve a process further problem
involving uncertainty as to the level of input into the second process and the amount of loss that
occurs within the second process. This question addresses the learning outcomes: Apply
variable/fixed cost analysis in multiple product contexts to break-even analysis and product mix
decision making, including circumstances where there are multiple constraints and linear
programming methods are needed to reach “optimal” solutions and Evaluate the impact of
uncertainty and risk on decision models that may be based on CVP analysis, relevant
cashflows, learning curves, discounting techniques, etc.

Question Six This question tests candidates’ ability in parts (a) and (b) to calculate the labour
hours required for a new product and in part (c) to calculate the net present value of an
investment proposal from the data provided. This question addresses the learning outcomes:
Explain and apply learning and experience curves to estimate time and cost for new products
and services and Calculate project cash flows, accounting for tax and inflation, and apply
perpetuities to derive “end of project” value where appropriate.

Question Seven This question tests candidates’ ability to analyse the data provided to
determine the relevant cost of a project and then in part (b) to explain why the financial reported
profit may differ from that expected from the quotation. This question addresses the learning
outcomes: Discuss the principles of decision making including the identification of relevant cash
flows and their use alongside non-quantifiable factors in making rounded judgements; and
evaluate the impact of uncertainty and risk on decision models that may be based on CVP
analysis, relevant cash flows, learning curves, discounting techniques etc. and Explain the
possible conflicts between cost accounting for profit reporting and stock valuation and the
convenient availability of information for decision making.

P2 22 May 2009
 Managerial Level Paper

P2 – Management Accounting – Decision

Management
Examiner’s Answers

SECTION A

Answer to Question One

1.1
F G H
$/unit $/unit $/unit
Selling price 35 31 47
Material costs 15 7 12
Throughput per unit 20 24 35

Machine time 30 14 24
(Minutes per unit)

Throughput per minute of 0·67 1·72 1·46

machine time

Rank order 3rd 1st 2nd

The answer is D

1.2 Sensitivity = $28,000 / $262,500 = 10·67%

The answer is D

1.3 Expected value of variable costs

= ($4,000 x 30%) + ($5,000 x 50%) + ($6,000 x 20%) = $4,900

Expected value of fixed costs

= ($2,500 x 20%) + ($3,000 x 35%) + ($3,500 x 45%) = $3,125

Expected value of total costs $8,025

1.4 IRR = 6% + {[$124,230/($124,230 + $35,760)] x (13% - 6%)} = 11·4%

May 2009 23 P2
1.5 Payback period = 2 full years + $9,000 / $19,000 of year three = 2·5 years

1.6 Average time per unit for 16 units = 54·5 minutes / 16 = 3·4063 minutes.

This is equal to 3·4063 / 12 = 28·39% of the time for the initial unit.

The level of output has doubled four times since the initial unit was produced.

Thus 28·39% is the fourth root of the learning rate.

The learning rate = 73%

1.7 Before using the high low method the costs have to be adjusted for inflation. Uninflated
costs are as follows:

February $20,197 / 1·04 = $19,420

March $18,312 / 1·05 = $17,440

Thus there is a difference of $1,980 for the extra 600 units.

The variable cost is thus $1,980 / 600 = $3·30 per unit and the fixed cost is therefore:
$17,440 – (2,800 x $3·30) = $8,200

The cost for the future period is therefore:

[(3,300 x $3·30) + $8,200] x 1·07 = $20,426

1.8 Price at which demand equals zero = $65 + (800/40 x $5) = $165

Price = $165 – 0·125q

Marginal Revenue = $165 – 0·25q

Marginal Cost = $28

Equating Marginal Cost and Marginal Revenue:

28 = 165 – 0·25x
137 = 0·25x
548 = x

Price = $165 – (0·125 x 548) = $96·50

P2 24 May 2009
 SECTION B

Answer to Question Two

(a) One year cycle

$ DF Present value
$
Initial Cost 14,000 1·000 14,000
Operating and maintenance costs 6,000 0·893 5,358
Trade in (10,000) 0·893 (8,930)
10,428

Annual equivalent cost = $10,428 / 0·893 = $11,677

Two year cycle

$ DF Present value
$
Initial Cost 14,000 1·000 14,000
Operating and maintenance costs 6,000 0·893 5,358
Operating and maintenance costs 8,000 0·797 6,376
Trade in (7,000) 0·797 (5,579)
20,155

Annual equivalent cost = $20,155 / 1·690 = $11,926

Three year cycle

$ DF Present value
$
Initial Cost 14,000 1·000 14,000
Operating and maintenance costs 6,000 0·893 5,358
Operating and maintenance costs 8,000 0·797 6,376
Operating and maintenance costs 9,500 0·712 6,764
Trade in (5,000) 0·712 (3,560)
28,938

Annual equivalent cost = $28,938 / 2·402 = $12,047

The optimum replacement cycle is annual.

(b) There are a number of limitations of the solution shown above.

One limitation is that the method assumes zero inflation in respect of all costs and trade-in
and replacement values throughout the replacement cycles. It is most unlikely that there
will be zero inflation, or that the same rate of inflation will apply to all input values.

A second limitation is that the method assumes that the replacement oven is identical to
the original. This is most unlikely since technology continues to improve and as a result it
is likely that the replacement oven would be of a different specification from the original.

May 2009 25 P2
Answer to Question Three

(a) The company determined its selling prices by adding 25% to its unit absorption cost;
however, the ABC unit cost is more likely to be a truer cost of the product. If the same
mark-up were to be added to the ABC unit costs, then the selling price of VBG3 would
increase.

This would reduce the percentage market shares being enjoyed by the company. It
seems that the market share of VBG3 is particularly high because the selling price does
not reflect the true cost, indeed it seems that a unit loss arises from the sale of this
product.

(b) Current lifetime profitability:

AXPL1 FDR2 VBG3

Current Unit selling price ($) 50·00 75·00 65·00

Activity based cost per unit ($) 48·00 42·00 75·00

Profit per unit ($) 2·00 33·00 (10·00)

Market share (%) 45% 15% 80%

Market size for life of the product (units) 2,500 3,000 4,000

Lifetime profit/(loss) $2,250 $14,850 ($32,000)

Total Lifetime profit/(loss) ($14,900)

As can be seen from the calculations above the company is currently making an overall loss on
these products.

Revised lifetime profitability if ABC is adopted:

AXPL1 FDR2 VBG3

Revised Unit selling price ($) 60·00 52·50 93·75

Activity based cost per unit ($) 48·00 42·00 75·00

Revised profit per unit ($) 12·00 10·50 18·75

Revised market share (%) 30% 48·75% 36·875%

Market size for life of the product (units) 2,500 3,000 4,000

Revised market share (units) 750 1,462·5 1,475

Lifetime profit $9,000 $15,351 $27,656·25

Total Lifetime profit $52,007·25

P2 26 May 2009
Workings:

Revised selling price equals ABC cost per unit plus 25% mark-up.

Market share changes:

AXPL1 selling price has increased by $10 per unit so market share will reduce by 3% for every
$2 increase = 15%, revised market share = 45% - 15% = 30%

FDR2 selling price has reduced by $22·50 per unit so market share will increase by 3% for every
$2 reduction = 33·75%, revised market share = 15% + 33·75% = 48·75%

VBG3 selling price has increased by $28·75 per unit so market share will reduce by 3% for
every $2 increase = 43·125%, revised market share = 80% - 43·125% = 36·875%

Revised lifetime profitability if ABC Pricing is adopted:

AXPL1 FDR2 VBG3

Lifetime profit $9,000 $15,351 $27,656·25

Current lifetime profitability based on Absorption Pricing:

AXPL1 FDR2 VBG3

Lifetime profit/(loss) $2,250 $14,850 ($32,000)

Increase in profitability $6,750 $501 $59,656·25

Overall increase in profitability $66,907·25

May 2009 27 P2
Answer to Question Four

REPORT

To: Managing Director

From: Assistant Management Accountant

Subject: Total Quality Management

Date: May 2009

Introduction

Further to your recent request I set out below some guidance on the principles of Total Quality
Management and the different classifications of quality costs.

Total Quality Management

The underlying principle of Total Quality Management (TQM) is that of getting it right first time.
This is because the costs of correction are usually far greater than the costs of doing it right in
the first place. In order for TQM to be successful a number of other principles need to be
followed. These include:

• Involving everyone within the organisation in the TQM philosophy so that everyone is
committed to the objective of good quality;
• Giving everyone responsibility for achieving quality results in the work that they do; and
• Encouraging everyone to make suggestions to improve quality within the company.

Quality Costs

The four classifications of quality costs are as follows:

Prevention costs
These are the costs incurred in order to prevent poor quality. They include staff training and
routine machine maintenance.

Appraisal costs
These are the costs of testing the products to ensure that they meet the appropriate quality
standards. They include the staff costs of testing departments and the running costs of test
equipment.

Internal Failure costs

These are the costs of correcting quality failures that are discovered before the items are
despatched to customers. They include the costs of re-working and wastage of failed goods.

External Failure costs

These are the costs arising from quality failures that are discovered after the items were
despatched to customers. They include replacement costs and the cost of re-building customer
goodwill.

Compliance & Non-Compliance costs

The four categories of quality cost identified above can also be grouped into those that relate to
compliance with quality standards (Prevention costs and Appraisal costs) and those that occur
as a result of non-compliance (Internal and External Failure costs).

It is generally accepted that there is a trade-off between expenditure in these two categories.
Therefore most organisations have to accept that some failures will occur, thus incurring non-

P2 28 May 2009
compliance costs, but they will seek to minimise these costs by incurring quality compliance
costs.

Conclusion

I hope that the above summary is a useful start to our discussion when we meet next week.

May 2009 29 P2
Answer to Question Five

(a)

Input % 1,900 % 2,000 % 2,100 % 2,200

volumes
(litres)

Loss % $ $ $ $
10 7·50 230 7·50 400 7·50 570 7·50 740
12 11·25 (131) 11·25 20 11·25 171 11·25 322
15 6·25 (672) 6·25 (550) 6·25 (427) 6·25 (305)

Workings
$ $ $ $
Process cost 6,515 6,700 6,885 7,070
Revenue foregone 9,500 10,000 10,500 11,000
16,015 16,700 17,385 18,070

Final revenue 10% 16,245 17,100 17,955 18,810

12% 15,884 16,720 17,556 18,392
15% 15,343 16,150 16,958 17,765

(b) The two-way data table shows that there are 12 possible outcomes. Seven of these show
a positive result from further processing and five are negative.

By applying the probability values we can determine that the total probability of the
negative outcomes is made up as follows:

Input litres Probability Process loss Probability Combined

probability
1,900 0·25 12% 0·45 0·1125
1,900 0·25 15% 0·25 0·0625
2,000 0·25 15% 0·25 0·0625
2,100 0·25 15% 0·25 0·0625
2,200 0·25 15% 0·25 0·0625
0·3625

This shows that there is a 36·25% chance that the outcome from further processing would
be negative and therefore a 63·75% chance that it would be positive. However, one of the
positive outcomes (input 2000 litres with a loss percentage of 12%) results in a very
marginal positive outcome. This one outcome has a probability of 11·25% so if there were
to be a small error within the assumptions, this combination could easily produce a
negative result. The decision whether or not to process further therefore depends very
much on the risk attitude of the manager. Based on the values shown it would seem that
further processing should occur because the probability of gains is higher than the
probability of losses. However there is also an argument not to process further because
the potential benefits are unclear.

(c) Expected value of process loss = (10% x 30%) + (12% x 45%) + (15% x 25%) = 12·15%

Expected value of monthly input = (1,900 + 2,000 + 2,100 + 2,200) /4 = 2,050 litres

Process loss saved = 2,050 litres x 12·15% x 50% = 124·5375 litres

Maximum monthly cost = additional revenue generated = 124·5375 litres x $9·50 = $1,183

An alternative approach

P2 30 May 2009
The expected value from the present situation can be calculated as follows:

Input Probability Loss Probability Combined Outcome Expected

probability value
1,900 0·25 10% 0·30 0·0750 230 17·25
1,900 0·25 12% 0·45 0·1125 (131) (14·74)
1,900 0·25 15% 0·25 0·0625 (672) (42·00)
2,000 0·25 10% 0·30 0·0750 400 30·00
2,000 0·25 12% 0·45 0·1125 20 2·25
2,000 0·25 15% 0·25 0·0625 (550) (34·38)
2,100 0·25 10% 0·30 0·0750 570 42·75
2,100 0·25 12% 0·45 0·1125 171 19·24
2,100 0·25 15% 0·25 0·0625 (427) (26·69)
2,200 0·25 10% 0·30 0·0750 740 55·50
2,200 0·25 12% 0·45 0·1125 322 36·23
2,200 0·25 15% 0·25 0·0625 (305) (19·06)
66·35

If the loss percentage were to be halved, then the revised expected value would be:

Input Probability Loss Probability Combined Outcome Expected

probability value
1,900 0·25 5% 0·30 0·0750 1,132·50 84·94
1,900 0·25 6% 0·45 0·1125 952·00 107·10
1,900 0·25 7·5% 0·25 0·0625 681·75 42·61
2,000 0·25 5% 0·30 0·0750 1,350·00 101·25
2,000 0·25 6% 0·45 0·1125 1,160·00 130·50
2,000 0·25 7·5% 0·25 0·0625 875·00 54·69
2,100 0·25 5% 0·30 0·0750 1,567·50 117·56
2,100 0·25 6% 0·45 0·1125 1,368·00 153·90
2,100 0·25 7·5% 0·25 0·0625 1,069·25 66·83
2,200 0·25 5% 0·30 0·0750 1,785·00 133·88
2,200 0·25 6% 0·45 0·1125 1,576·00 177·30
2,200 0·25 7·5% 0·25 0·0625 1,262·50 78·91
1,249·47

The maximum monthly cost is the difference between the expected values = $1,183·12

May 2009 31 P2
Answer to Question Six

(a)
Average time for 64 batches:
10 x (64-0.152) = 5·314 hours

Total time for 64 batches 340·1 hours

Average time for 63 batches:

10 x (63-0.152) = 5·327 hours

Total time for 63 batches 335·6 hours

Time for the 64th batch 4·5 hours

(b)
64 batches take 340·1 hours
192 batches take 4·50 hours each 864·0 hours

Total time for 256 batches 1,204·1 hours

(c)

Year 2008 2009 2010 2011

$000 $000 $000 $000
Sales 1,600 1,800 2,000

Direct labour 53 120 96

Direct material 60 120 96
Variable overhead 40 90 72
Fixed overhead 1,000 1,000 1,000
Total cost 1,153 1,330 1,264

Operating Cashflow 447 470 736

Corporation Tax on profits 82 167 166 80

Capital investment -1,500

Capital residual value 300
Corporation tax saved on tax
depreciation 45 81 135 99

Net cashflow -1,500 410 384 1005 19

Discount factor @ 12% 1·000 0·893 0·797 0·712 0·636

Present Value -1,500 366 306 716 12

Net Present value -101

The project should not proceed because it has a negative Net Present Value.

P2 32 May 2009
Cost Workings
2009

Production = 50,000 units = 500 batches

Direct Labour
1st 256 batches (answer b) 1204·1 hours
Other 244 batches x 6 hours each 1464·0 hours
Total 2668·1 hours

2668·1 hours x $20 per hour $53,362

Direct Material
1st 16 batches x 5 kg 80 kg
Other 484 batches x 4kg 1936 kg
2,016 kg

2,016 kg x $30 per kg $60,480

Variable Overhead $40,022

75% of Direct Labour cost = 75% x $53,362

For 2010 and 2011 the same principles apply except that each batch produced requires 6 hours
of direct labour and 4kg of direct material.

Tax payable on profits

2009 2010 2011 2012
$ $ $ $
Operating cashflow 447 470 736
Inventory adjustment
(Production units – sales units) x $10 100 100 (200)

Taxable Profit 547 570 536

Tax Due @ 30% 164 171 160

Payable - current year 82 85 80

- next year 82 86 80

Tax payable for cashflow 82 167 166 80

Tax saved on tax depreciation

Year Tax cost b/fwd Tax Tax cost c/fwd Tax saved @
depreciation 30%
2009 $1,500,000 $300,000 $1,200,000 $90,000
2010 $1,200,000 $240,000 $960,000 $72,000
2011 $960,000 $660,000 $NIL $198,000

The tax saved converts into tax cashflows in the same way as the tax on profits, i.e. 50% in the
current year and the remaining 50% in the following year.

May 2009 33 P2
Answer to Question Seven

(a) The relevant cost of the project is as follows:

$
(1) Specialised machine
Hire cost $4,000 x 10 weeks = $40,000

Net cost if purchased

Original cost $250,000
Residual value $150,000 $100,000

Less Rental income:

$2,500 x 30 weeks $75,000
$25,000
The relevant cost is the lower cost option. This
is to buy the machine and rent it out when it is
not being used 25,000

(2) Machinery running cost

10 weeks x $720 per week
The relevant cost is the running cost that is to
be incurred in the future if the project goes
ahead 7,200

(3) Depreciation
This is not relevant as it is not a cash cost

(4) Skilled Labour

External project labour:
9,000 hours x $12 £108,000

External replacement labour

9,000 hours x $11 £99,000

The existing hourly rate is irrelevant as the

company would continue to pay its existing
employees regardless of the decision. The
relevant cost is the lower cost option 99,000

(5) Unskilled labour would have to be

recruited for the project. This is the relevant
cost because it is only incurred if the project
goes ahead:
12,000 hours x $8 96,000

(6) Supervision
Existing salary would be unchanged so this is
irrelevant. Overtime would be worked but this is
unpaid so this is also irrelevant. The bonus is
only paid if the project goes ahead so is a
relevant cost 500

(7) Material A
The relevant cost is the cost if t would have to 15,000
be purchased at a cost of

(7) Material B
The current inventory can be used on this
project, the relevant cost is its resale value of

P2 34 May 2009
 $2 per square metre

5,000 square metres x $2 = $10,000

The remainder will need to be bought

$25,000 35,000
5,000 square metres x $5
The original cost of the inventory is irrelevant
as it is a past (sunk) cost.

(8) Analysis cost

This is not relevant because it is a past (sunk)
cost.

(9) Overhead costs

These are not relevant unless they are specific
to the project. Overheads that are absorbed
are non-specific to the project. They are not
incremental costs.

(10) Profit
This is not relevant because it is not a cost

Total relevant cost 277,700

(b) The accounting method known as absorption costing will determine the cost of the project
based not upon its relevant cost but upon the cost of the resources used in completing
the project.

In some cases these two values will be the same. For example the cost of the unskilled
labour, will be $96,000 because this is an incremental cost to be incurred.

However, in other cases the financial accounting cost will differ. For example in the case
of material B, the cost reported under absorption costing will be based on its historical
inventory value rather than its resale value.

In addition there will be some costs that are included under absorption costing which
would not be included under relevant costing because they will be incurred regardless of
the decision. Examples include a proportion of the supervision and overhead costs.

May 2009 35 P2