P1 – Performance Operations November 2014 examination

1 The Chartered Institute of Management Accountants 2013 Operational Level Paper P1 Performance Operations November 2014 examination Examiner s Answers Note: Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike. These Examiner s answers should be reviewed alongside the question paper for this examination which is now available on the CIMA website at The Post Exam Guide for this examination , which includes the marking guide for each question , will be published on the CIMA website by early February at SECTION A Answer to question One Rationale question One consists of eight objective test sub-questions. These are drawn from all sections of the syllabus. They are designed to examine breadth across the syllabus and thus cover many learning outcomes. The correct answer is C. The correct answer is C.

2 Performance Operations 2 November 2014 Product X Product Y Product Z Total Annual production 160,000 200,000 100,000 Batch size (units) 100 50 25 Number of batches 1,600 4,000 4,000 Number of inspections per batch 3 4 6 Total number of inspections 4,800 16,000 24,000 44,800 Cost driver rate = $150,000 / 44,800 = $ per inspection Cost per unit of Product Y = ($ x 16,000) / 200,000 = $ The correct answer is D. (Actual sales volume budgeted sales volume) x standard contribution per unit (1,630 1,500) x ($400 x ) = $15,600 F The correct answer is A. At the breakeven point, contribution is equal to fixed costs therefore the contribution to sales ratio is $320,000 / $800,000 40% To earn a profit of $200,000 the required contribution is equal to the fixed costs plus the required profit ($320,000 + $200,000) / = $1,300,000 The correct answer is B. Net present value of the project = $240,000 Present value of the annual cash outflow = $120,000 x = $432,600 $240,000/$432,600 = The managers would reject the project if the annual cash flows decrease by more than Accounts receivable days ((6/28) x 365) = Days Inventory days (4/(28 x )) x 365 = Accounts payable days (3/(28 x )) x 365 = ( ) 99,9 The cash operating cycle is 100 days.

3 November 2014 3 Performance Operations Quarter Trend sales units Actual sales units Variation 1 18,000 20,250 + 2 21,000 19,425 3 24,000 25,200 + 4 27,000 24,300 Forecast sales Year 2 Quarter 1 = 15,000 + (3,000 x 5) = 30,000 + = 33,750 units Year 2 Quarter 2 = 15,000 + (3,000 x 6) = 33,000 - = 30,525 units Year 2 Quarter 3 = 15,000 + (3,000 x 7) = 36,000 + = 37,800 units Year 2 Quarter 4 = 15,000 + (3,000 x 8) = 39,000 - = 35,100 units Performance Operations 4 November 2014 SECTION B Answer to question Two (a) Rationale The question assesses learning outcome E1(g) analyse the impacts of alternative policies for stock management. It examines candidates ability to explain the benefits of a decentralised purchasing system. Suggested Approach Candidates should consider the potential benefits to a company of using a decentralised purchasing system compared to the current system and explain clearly what the benefits are and why they arise under this system.

4 The benefits of a decentralised purchasing system are as follows: It may result in reduced transport costs with a consequential impact on the environment. A decentralised purchasing system is likely to be less bureaucratic and able to respond quickly to inventory shortages. A local buyer may be more flexible and able to respond to temporary reductions in local prices that a central buying manager may be unaware of. Local buyers may be able to develop stronger relationships with local suppliers thus possibly ensuring greater reliability of supply and the opportunity for JIT purchasing and reduced levels of inventory. Local suppliers may offer varied products thus enabling differentiation of finished products. The opportunity is available to delegate responsibility for aspects of the management of the business and there may be benefits in terms of management development. Managers who have been given responsibility for the financial management of their particular operating unit will be able to make decisions regarding purchasing and inventory management.

5 November 2014 5 Performance Operations (b) Rationale Part (i) assesses learning outcome E1(f) analyse the impacts of alternative debtor and creditor policies. It examines candidates ability to calculate the net cost of a change to a company s credit policy. Suggested Approach Candidates should first calculate the change in the level of investment in trade receivables if the early settlement discount is offered. The benefit of this, in terms of the reduction in overdraft interest, can then be calculated. This should then be compared to the cost of the cash discount offered and the additional credit control costs. Current level of investment in trade receivables $000 $000 ($25 million x 60/365) 4,110 Proposed level of investment in trade receivables ($15 million x 30/365) (1,233) ($10 million x 50/365) (1,370) Reduction in trade receivables (2,603) 1,507 The reduction in overdraft interest as a result of the reduction in trade receivables will be $1,507,000 x 14% = $210,980 Cost of cash discount offered ($25m x 60% x ) 375 Additional credit control costs 405 30 Interest charge savings Net cost of change in policy (211) 194* Or alternatively: Current cost of investment in trade receivables: $000 $000 $25m x 60/365 x 14% 575 Cost if proposed policy implemented.

6 Cash discounts ($25m x 60% x ) 375 Cost of investment in trade receivables $15m x 30/365 x 14% 173 $10m x 50/365 x 14% 192 Credit control costs 30 770 Net cost of change in policy 195* *Rounding differences only Performance Operations 6 November 2014 (c) Rationale The question assesses learning outcome B3(a) prepare a budget for any account in the master budget, based on projections/forecasts and managerial targets. It examines candidates ability to prepare a cash budget based on information about the timing of cash flows. Suggested Approach Candidates should first prepare a format for the cash budget with months along the top and receipts and payments down the side. They should then work out the timing of the cash flows for each of the items. The cash receipts and cash payments should be summed and the net cash flow for each month should be calculated. The opening cash balance and closing cash balance for each month can then be calculated.

7 Cash budget January February March $ $ $ Receipts 80% credit sales 128,000 128,000 136,000 20% credit sales 30,000 32,000 32,000 Total receipts 158,000 160,000 168,000 Payments Purchases 42,500 45,000 47,500 Labour & overheads 71,000 74,000 76,000 Machinery 100,000 Total payments 113,500 119,000 223,500 Opening balance 15,000 59,500 100,500 Net cash flow 44,500 41,000 (55,500) Closing balance 59,500 100,500 45,000 November 2014 7 Performance Operations (d) Rationale The question assesses learning outcome E2(b) identify alternatives for investment of short-term cash surpluses. It examines candidates ability to compare and contrast two short term investment opportunities in terms of their risk, return and liquidity. Suggested Approach Candidates should describe each of the investments and indicate clearly how each of them compares in terms of their risk, return and liquidity. Treasury bills These are issued by the government for terms of up to three months and therefore have minimal capital risk as they are backed by the government.

8 The bills are sold by tender each week at a discount to their nominal value. They are redeemed at their nominal value giving an implied interest rate. They are therefore subject to interest rate risk since if market rates increase the holder loses the opportunity to earn higher rates. Treasury bills are also traded on the money market and so the holder can sell them to obtain immediate cash at any time giving excellent liquidity. However if sold before maturity the holder would also be exposed to capital risk as the value of the bill changes in response to market interest rate movements. Money market deposit A money market deposit is riskier than an investment in treasury bills however as the money market is used largely by banks and other financial institutions the risk is relatively low. The return on money market deposits will be higher than the return on treasury bills. Similar to treasury bills, the deposit is subject to interest rate risk. Money invested in a money market deposit cannot be withdrawn until the deposit matures and is therefore less liquid than treasury bills.

9 However the investment can be made for very short periods of time. Performance Operations 8 November 2014 (e) Rationale The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating expected values and standard deviations together with probability tables and histograms. It examines candidates ability to calculate the expected value of a decision. Suggested Approach Candidates should first calculate the expected value of the number of visitors and the expected value of the contribution from sales of souvenirs and refreshments. The total contribution can then be calculated and the specific fixed costs deducted from this to calculate the expected contribution towards general fixed overheads. Expected value of number of visitors: = (800 x ) + (900 x ) + (1,000 x ) = 870 Expected value of contribution from sales of souvenirs and refreshments: = ($8 x ) + ($10 x ) + ($12 x ) = $ Expected contribution to general overheads: Contribution = ($25 + $ ) x 870 = $30,276 Less specific fixed costs Additional contribution $30,000 $ 276 November 2014 9 Performance Operations (f) Rationale Part (i) of the question assesses learning outcome D1(d) prepare expected value tables.

10 It examines candidates ability to prepare a two way data table . Part (ii) of the question assesses learning outcome D1(c) analyse risk and uncertainty by calculating expected values and standard deviations together with probability tables and histograms. It examines candidates ability to determine the probability of a particular outcome using joint probabilities. Suggested Approach In part (i) candidates should calculate the contribution to general fixed overheads, for each of the possible outcomes, by multiplying the number of visitors by the selling price of the ticket plus the contribution from the sales of souvenirs and refreshments. The specific fixed costs should then be deducted from the total contribution. The figures should then be presented in the form of a two way data table . In part (ii) candidates should calculate the joint probability of each of the possible outcomes that produce a positive contribution. The total probability of making a positive contribution can then be calculated.