LCCI International Qualifications

Management Accounting Level 3

Model Answers
Series 4 2010 (3024)

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Management Accounting Level 3

How to use this booklet Model Answers have been developed by EDI to offer additional information and guidance to Centres, teachers and candidates as they prepare for LCCI International Qualifications. The contents of this booklet are divided into 3 elements: (1) (2) Questions Model Answers reproduced from the printed examination paper summary of the main points that the Chief Examiner expected to see in the answers to each question in the examination paper, plus a fully worked example or sample answer (where applicable) where appropriate, additional guidance relating to individual questions or to examination technique

(3)

Helpful Hints

Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success. EDI provides Model Answers to help candidates gain a general understanding of the standard required. The general standard of model answers is one that would achieve a Distinction grade. EDI accepts that candidates may offer other answers that could be equally valid.

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QUESTION 1 A company has prepared the following estimate of costs for a contract that will take one year to complete: Notes Material P Material Q Material R Unskilled labour Skilled labour Supervision labour Lease of machine Depreciation of machinery General overhead Notes 1 2 3 Material P is in continual use and there are 3,000 kilos of material in stock, which was purchased at 26.00 per kilo. The current cost of the material is 32 per kilo Material Q has not yet been ordered; its current cost is 37 per kilo. Material R was purchased a few years ago at a cost of 41 per kilo, but it does not have an alternative use. If not used for the contract, the existing stock of 7,000 kilos could be sold for 28.00 per kilo. However, costs of 6,000 would be incurred in getting the material to the customer. Unskilled labour is only employed when such workers are required. The existing skilled workers are fully employed on various contracts, but would be willing to work overtime for the required hours at one and a quarter times their hourly pay rate. Alternatively, additional skilled labour could be hired for the duration of the contract at 21.00 per hour. Supervision labour cost includes the salaries of two supervisors. The first supervisor, who is paid 42,000 per annum, is due to retire immediately, but will be willing to work specifically on the contract for another year. The second supervisor is paid 50,000 per annum for working on existing contracts. If she specifically supervises the contract, her replacement will cost 44,000 for the duration of the contract. Two machines are required for the contract. The first machine was purchased four years ago at a cost of 300,000 with an annual straight-line depreciation of 60,000. The machine has no scrap value and is due to be dismantled at a cost of 5,000. However, if it is used for the contract, the dismantling cost is expected to be 8,000 when the contract is completed. The second machine would need to be leased at a cost of 40,000 for the duration of the contract. General overheads are absorbed on the basis of skilled labour hours used on the contract. The variable element of general overheads is 11.60 per hour. (15,000 hours 21.50 per hour) (9,000 kilos (5,000 kilos (7,000 kilos (8,000 hours (15,000 hours 26 per kilo) 37 per kilo) 41 per kilo) 7 per hour) 18 per hour) 234,000 185,000 287,000 56,000 270,000 92,000 40,000 60,000 322,500 1 2 3 4 5 6 7 7 8

4 5

REQUIRED (a) (b) Prepare a revised estimate of costs for the contract, using a relevant cost basis. (14 marks) Explain the meaning of the terms opportunity cost and relevant cost used in the context of decision-making. (6 marks) (Total 20 marks)

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MODEL ANSWER TO QUESTION 1 (a) 000 Material Material P Material Q Material R (9,000 kilos 32.00 per kilo) (5,000 kilos 37.00 per kilo) (7,000 kilos 28.00 per kilo) Less disposal cost 000 288 185 ( 196 6) 190 663 Labour Unskilled labour (8,000 hours 7.00 per hour) Skilled labour (15,000 hours 21.00 per hour) st Supervision labour 1 supervisor nd 2 supervisor replacement Overheads st Dismantling cost of 1 machine (8,000 5,000) nd Lease of 2 machine Incremental variable costs (15,000 11.60) Total relevant costs (b) 000

56 315 42 44 86 457 3 40 174 217 1,337

An opportunity cost is the benefit sacrificed in favour of an alternative course of action. Every decision, which involves making a choice between two or more mutually exclusive alternatives, has an opportunity cost. The concept of opportunity cost plays a crucial role in ensuring that scarce resources are used efficiently. A relevant cost is a future cash flow arising as a direct consequence of the decision under review. Decisions involve making choices among alternative courses of action. Because decisions relate to what will happen in the future, the consequences of each course of action are the future costs that are expected to arise for the different choices.

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QUESTION 2 A company is preparing a budget for the single product which it manufactures and sells for 280 per unit. The standard costs data for each unit of the product are as follows: Direct material Direct labour Fixed production overhead 4 kilos at 27.50 per kilo 5 hours at 14.80 per hour 5 hours at 8.60 per hour

Non-production overhead costs are budgeted at 12,000 per period. The budgeted sales figures for the next four periods are: Period 6 Period 7 Period 8 Period 9 450 units 350 units 500 units 400 units

Stocks of raw materials and finished goods at the beginning of Period 6 are: Raw materials Finished goods 1,950 kilos 420 units

The company has an end of period stocking policy of holding 90% of the following periods budgeted sales units and 110% of the following periods raw materials required for production. There are no stocks of work-in-progress at the end of any period. REQUIRED (a) Prepare the following budgets for each of Period 6 and Period 7: (i) (ii) (iii) (iv) (b) sales () (2 marks) production (units) (4 marks) materials purchases (kilos and ) (6 marks) direct labour (hours and ) (3 marks) Prepare a combined profit budget for Periods 6 and 7. (5 marks) (Total 20 marks)

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MODEL ANSWER TO QUESTION 2 (a) (i) Sales budget () Budgeted sales units Selling price per unit Budgeted sales (ii) Production budget (units) Budgeted sales units Add Closing stock Period 6 450 0.9) 315 765 420 345 Period 7 350 0.9) 450 800 315 485 Period 6 450 280 126,000 Period 7 350 280 98,000

(350

(500

Less: Opening stock Budgeted production units (iii)

Materials purchases budget (kilos and ) Budgeted production units Material required per unit Kilos required for production Add Closing stock (1,940 Less Opening stock Budgeted purchases (kilos) Cost of material per kilo Budgeted purchases (cost) Period 6 345 4 1,380 1.1) 2,134 3,514 1,950 1,564 27.50 43,010 Period 7 485 4 1,940 1.1) 1,804 3,744 2,134 1,610 27.50 44,275 4 = 1,640 kilos

(1,640*

*Kilos required in Period 8 = [500 + (400 (iv) Direct labour budget (hours and ) Period 6 Budgeted production units Hours required per unit Budgeted labour hours Cost of labour per hour Budgeted labour cost (b) 345 5 1,725 14.80 25,530

0.9 = 360) 450] = 410

Period 7 485 5 2,425 14.80 35,890

Budgeted profit for Periods 6 and 7 Sales (800 280) Less Production cost of sales Direct material (800 4 27.50) Direct labour (800 5 14.80) Fixed overhead (800 5 8.60) Gross profit Less: Non-production overhead Budgeted profit (2 88,000 59,200 34,400 12,000) 224,000

181,600 42,400 24,000 18,400

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QUESTION 3 A company manufactures a single product which sells for 475 per unit. The products standard cost card for Period 7 contains the following information: per unit Direct material Direct labour Fixed production overhead (3.25 kilos (7.5 hours (7.5 hours 48.00 per kilo) 16.50 per hour) 9.90 per hour) 156.00 123.75 74.25

Actual results for the period are as follows: Production and sales Sales Direct material costs (16,124 kilos) Direct labour costs Fixed production overhead 5,560 units 2,689,372 830,386 650,520 388,840

The following variances were extracted from the companys control records for Period 7: Sales volume profit 29,040 Adverse Direct labour rate 10,008 Favourable Direct labour efficiency 27,522 Favourable Fixed overhead expenditure Fixed overhead volume 17,820 Adverse REQUIRED (a) Calculate the following variances for Period 7: (i) (ii) (iii) (b) sales price (2 marks) direct material price (2 marks) direct material usage. (3 marks) Calculate the following for Period 7: (i) (ii) (iii) (c) budgeted production units (3 marks) actual direct labour hours worked (4 marks) average actual direct labour rate per hour (2 marks) Define the terms: ideal standard and attainable standard. (4 marks) (Total 20 marks)

41,810 Favourable

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MODEL ANSWER TO QUESTION 3 (a) (i) Sales price variance Actual units) (Actual price 5,560 units) 2,689,372 2,641,000 2,689,372 Direct material price variance (Standard price (48.00 (Standard price (475.00 Actual units) = 48,372 Favourable

(ii)

(iii)

Actual usage) (Actual price Actual usage) 16,124 kilos) 830,386 773,952 830,386 = 56,434 Adverse Direct material usage variance (Standard price Standard usage) (Standard price Actual usage) [48.00 (5,560 3.25 kilos)] (48.00 16,124 kilos) 867,360 773,952 = 93,408 Favourable

(b) (i)

Budgeted production units Actual fixed production overhead Add Fixed overhead expenditure variance Budgeted fixed production overhead 388,840 41,810 430,650 = 5,800 units

Budgeted units = Budgeted fixed production overhead = 430,650 Fixed overhead absorption rate 74.25 (ii) Actual direct labour hours worked Actual direct labour costs Add Direct labour rate variance Standard cost of actual labour hours 650,520 10,008 660,528

Actual hours = Standard cost of actual labour hours = 660,528 Standard direct labour rate per hour 16.50 (iii) Average actual direct labour rate per hour Actual rate = Actual direct labour costs Actual direct labour hours worked = 650,520 40,032

= 40,032 hours

= 16.25 per hour (2 marks)

(c)

An ideal standard is a standard that can be attained only under the most efficient operating conditions. It makes no allowance for normal loss, waste or machine downtime. An attainable standard is a standard that assumes efficient levels of operation but which includes allowance for normal loss, waste and machine downtime.

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QUESTION 4 A company is considering investing in new plant and equipment to introduce a new product with an estimated lifespan of 5 years. The plant and equipment is expected to cost 2,150,000 with a residual value of 250,000 after five years. The sales forecast for the product is as follows: Year 1 2 3 4 5 000 1,200 1,680 3,040 2,560 1,920

The product is expected to have a constant contribution/sales ratio of 37.5% and budgeted annual incremental fixed costs of 160,000 (excluding straight-line depreciation of new plant and equipment). Assume that net cash inflows occur at the end of the years to which they relate. The companys cost of capital is 15% per annum. Discount factors: Year 1 2 3 4 5 10% 0.909 0.826 0.751 0.683 0.621 12% 0.893 0.797 0.712 0.636 0.567 15% 0.870 0.756 0.658 0.572 0.497 18% 0.847 0.718 0.609 0.516 0.437 20% 0.833 0.694 0.579 0.482 0.402

REQUIRED (a) Calculate, in relation to the investment in new plant and equipment, the: (i) (ii) (iii) (b) accounting rate of return (using the average investment value); (8 marks) net present value; (6 marks) internal rate of return. (3 marks) Advise the company on whether the investment in new plant and equipment is worthwhile, on the basis of the net present value and internal rate of return in part (a). (3 marks) (Total 20 marks)

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MODEL ANSWER TO QUESTION 4 (a) (i) Accounting rate of return (ARR) Contribution Fixed cost = Net operating cash flows Depreciation = Accounting profit Year 1 Year 2 Year 3 Year 4 Year 5 (1,200 (1,680 (3,040 (2,560 (1,920 0.375) 450 0.375) 630 0.375) 1,140 0.375) 960 0.375) 720 = 160 160 160 160 160 = = = = = 290 470 980 800 560 380* 380* 380* 380* 380* = = = = = (90,000) 90,000 600,000 420,000 180,000

* Annual depreciation

(2,150 250) =

5 years = 380,000 = 240,000

Average annual accounting profit Average investment value ARR (ii) Net present value (NPV) Year 0 1 2 3 4 5 Net cash flow 000 (2,150) 290 470 980 800 810** = =

[ (90) + 90 + 600 + 420 + 180 ] 5 years = 1,200,000 = 20%

2,150 + 250 2 240,000 1,200,000

100%

Disc. Factor @ 15% 1.000 0.870 0.756 0.658 0.572 0.497 NPV

Present values 000 (2,150.00) 252.30 355.32 644.84 457.60 402.57 = ( 37.37)

**560,000 + 250,000 (residual value) (iii) Internal rate of return (IRR) Year 0 1 2 3 4 5 IRR (b) = Net cash flow 000 (2,150) 290 470 980 800 810 Disc. Factor @ 12% 1.000 0.893 0.797 0.712 0.636 0.567 NPV Present values 000 (2,150.00) 258.97 374.59 697.76 508.80 459.27 = 149.39 = 14.4%

12% + {3% [149.39 (149.39 + 37.37)]}

The investment should not be undertaken by the company since it generates a negative NPV and earns an IRR of 14.4% which is lower than the cost of capital of 15%.

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QUESTION 5 Investment Centre A operates as a retailing division in a company. The investment centres financial information for the past two years is presented as follows: Year 4 000 Fixed assets (net book value) Current assets Current liabilities Stock of finished goods Trade debtors Sales Cost of sales Net profit 399 403 167 202 170 765 536 131 Year 3 000 267 278 112 135 109 650 455 119

All sales were made on credit terms, and a constant gross profit margin of 30% was earned throughout the two-year period. Assume that 1 year = 365 days REQUIRED (a) Calculate, in relation to Investment Centre A, the following ratios for each of Year 4 and Year 3: (i) (ii) (iii) (iv) (v) (vi) (vii) (b) net profit to sales (%) (2 marks) net asset turnover (number of times) (2 marks) return on capital employed (%) (2 marks) stock turnover (number of times) (2 marks) debtors payment period (rounded to whole days) (2 marks) current (2 marks) acid test (quick) (2 marks) Using the ratios calculated in part (a), comment on the investment centres performance in terms of its profitability, asset utilisation and liquidity over the two-year period. (6 marks) (Total 20 marks)

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MODEL ANSWER TO QUESTION 5 (a) Year 4 000 (i) Net profit Sales 100% 131 765 765 635 100% = 17.1% Year 3 000 119 650 650 433 100% = 18.3%

(ii)

Sales Capital employed*

1.2 times

1.5 times

*Capital employed = Fixed assets + Current assts Current liabilities (iii) Net profit Capital employed Cost of sales Stock of goods Trade debtors Sales Current assets Current liabilities Current assets Stock Current liabilities 365 100% 131 635 536 202 170 765 403 167 100% = 20.6% 119 433 455 135 109 650 278 112 = 100% = 27.5%

(iv)

2.7 times

3.4 times

(v)

365 =

81 days

365 = 61 days

(vi)

2.4 : 1

2.5 : 1

(vii)

403 202 167

1.2 : 1

278 135 112

1.3 : 1

(b) Profitability ratios There is a decline in both net profit ratio and return on capital employed ratio, despite a significant increase in sales over the two-year period. The substantial rise in sales may be attributed to the investment centres pricing policies, product mix, increased terms granted to customers or increase in market share. However, the lack of control on costs and operating expenses is likely to be the cause of the decline in the profitability ratios. Asset Utilisation The utilisation of assets compared to the sales generated has declined over the two-year period. The net asset turnover has fallen, from 1.5 times in Year 3 to 1.2 times in Year 4, thereby indicating the inefficient use of the investment centres capital. The stock turnover ratios drop, from 3.4 times in Year 3 to 2.7 times in Year 4, is an indication of over-stocking or the holding of out-dated or slow-moving stock items.

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QUESTION 5 CONTINUED The increase in debtors collection period of 20 days may be due to increased credit terms granted to some or all of the investment centres trade customers; this, partly, might have accounted for the significant rise in sales over the two-year period. However, the increase in debtors collection period may indicate the investment centres failure to follow up its debts efficiently. Liquidity ratios Both current ratio and acid-test (quick) ratio demonstrate healthy liquidity situation, although the two ratios are fairly high (i.e. they are above the ideal levels of 2:1 and 1:1, respectively).

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