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Institute of Certified Management Accountants of Sri LankaProfessional II Stage – Strategic Management Accounting (SMA / 803) – September 2010 CMA Examination

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© Copyright Reserved Serial No………………

Institute of Certified Management Accountants of Sri Lanka

Professional II Stage

September 2010 Examination

Examination Date : 25th September 2010 Number of Pages : 07

Examination Time: 9.30 a:m. 12.30 p:m. Number of Questions: 06

Instructions to candidates:

1. Time allowed is three (3) hours.

2. Answer all questions in Section A, any two (2) questions from Section B and any one (1)

question from Section C

3. Answers should be entirely in the English language.

Subject Subject Code

Strategic Management Accounting (SMA / 803)

Section A

Question No: 1 (40 Marks)

The Hospital Instruments Division of MedLife Technology Corporation manufactures a variety of

electric mechanical components. The principal product of the Hospital Instruments Division is a

sophisticated instrument for measuring and graphically displaying a variety of medical phenomena,

such as heart and respiration rates. The culture throughout the division was primarily engineering-

oriented. One result of this culture was that the corporation’s design engineers generally designed new

products from scratch rather than relying on modification of a current design. While this approachusually resulted in an “elegant” design from an engineering standpoint, it often resulted in the use of

new or unique parts that were not already being used in the corporation’s other products. The strategy

of the Hospital Instruments Division’s management was to position the division as a product

differentiator and price leader, not as the industry’s low-cost producer. This means that the division

generally led the medical instruments market with new products that exhibited greater functionally

than competing products and that the products were priced at a premium. The corporation’s

competitors would then emulate a new product, produce it at a lower cost, and undercut the MedLife

Technology price. However, by then MedLife Technology had moved on to a new product with even

greater functionality. This strategy had been quite successful until the Japanese entered the medical

instruments market in a major way. MedLife Technology’s new competitors were able to set product prices approximately 25% below those of MedLife Technology, while maintaining close to the same

level of functionality. In order to compete, the Hospital Instruments Division had to lower its prices

below its reported product costs. This resulted in significant losses for the division.




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To remedy the situation, the Hospital Instruments Division’s management began an extensive continuous

improvement program. The division changed its production and inventory management system to a JIT

system, ideas of total quality control were aggressively pursued and management attempted to develop an

empowered workforce. All of these efforts paid off dramatically. However, production costs were still

relatively high for the industry, and cycle times were considered too long by management. The general

feeling was that in order to remain competitive in the long run, the division would have to further lower its

production costs and shorten its production cycle times. As management contemplated the high production

costs, one problem that kept coming up was the division’s part number proliferation. As the engineering-dominated company continued to introduce new products, the number of different parts and components

that had to be stocked in inventory continued to increase. Some members of management felt that the

division’s cost-reduction goals could be achieved, at least partially by solving the problem of part number

proliferation.

As management was pondering the division’s cost reduction goal, the controller was contemplating on the

introduction of a new cost-accounting system. The controller was thinking about introducing Activity

Based Costing (ABC) and Activity Based Management (ABM) in the Hospital Instruments Division.

You are required to:

(a) Explain how the problem of part number proliferation could increase the division’s production costs.

(04 Marks)

(b) Explain how long production cycle times could increase the division’s production costs. (03 Marks)

(c) How could an ABC system be used to help reduce costs by tackling the problem of part number

proliferation?

Hint: Allow yourself to contemplate on an entirely new role for ABC that is quite different from the

conventional objective of more accurate product costs. The following questions may help in

completing this requirement.

(i) What is the division’s strategy in the market place?

(ii) How are prices currently being determined?

(iii) Does management really need more accurate product costs, given its strategy and the reality of

market-driven prices?

(iv) What is the current goal of management?

(v) What causes, at least partly, the high production cost?

(vi) Who is, at least partially responsible for high production costs?

(vii) How could an ABC system help solve the problem and reduce production costs?

(7 × 3 Marks = 21 Marks)

(d) Following your answer to requirement (c), what cost drivers could be contemplated for use for

solving the problem of part number proliferation? Which cost driver would work best? Explain your

answer. (06 Marks)

(e) How could an ABC system help highlight and solve the problem of production cycle times being too

long? (06 Marks)

(Total 40 Marks)

End of Section A




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Section B

Answer any two (2) questions

Question No. 2 (20 Marks)

The executive directors and the seven divisional managers of PQR Group spent a long weekend at a

country house debating the company’s goals. They concluded that PQR had multiple goals, and that

performance of senior managers should be assessed in terms of all of the goals.

The goals identified were:

(i) to maintain a high market share;

(ii) to increase productivity, annually;

(iii) to offer an up-to-date product range of high quality and proven reliability;

(iv) to be known as responsible employers;

(v) to acknowledge social responsibilities;

(vi) to generate a reasonable financial return for shareholders;

(vii) to grow and survive independently.

The finance director was asked to prepare a follow-up paper, setting out the implications of the abovegoals. He has asked you, to prepare comments on important issues, for his consideration, as required

below:

You are required to set out briefly, with reasons:

(a) Suitable measures of performance for each of the above stated goals, for which you consider this

to be possible. (14 Marks)

(b) An overall comment as to whether any of the stated goals can be considered to be sufficiently

general, to incorporate all the goals of PQR. (06 Marks)

(Total 20 Marks)


L plc and M plc are subsidiaries of the same group of companies. L plc produces a branded product

sold in drums at a price of Rs.4,000/- per drum.

Direct product costs per drum are:

− Raw material from M plc: at a transfer price of Rs.1,800/- for 25 litres.

− Other products and services from outside the group: at a cost of Rs.600/-.

L plc’s fixed costs are Rs.8,000,000/- per month. These costs include process labour whose costs willnot alter until L plc’s output reaches twice its present level. A market research study has indicated that

L plc’s market could increase by 80% in volume if it were to reduce its price by 20%.

M plc produces a fairly basic product which can be converted into a wide range of end products. It

sells one third of its output to L plc and the remainder to customers outside the group. M plc’s

production capacity is 1000 kilolitres per month. However competition is such, it budgets to sell no

more than 750 kilolitres per month for the year ending 31st March 2011. Its variable costs are

Rs.40,000/- per kilolitre and its fixed costs are Rs.12,000,000/- per month.

The current policy of the group is to use market prices, where known, as the transfer price between its

subsidiaries. This is the basis of the transfer price between M plc and L plc.




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(a) Calculate the monthly profit for L plc and M plc if the sales of L plc are;

(i) At their present level, and

(ii) At the higher potential level indicated by the market research, with a cut in price of 20%.

(08 Marks)

(b) (i) To explain why the use of a market price as the transfer price produces difficulties under theconditions outlined in (a) (ii) above.

(ii) To explain briefly what factors existing and new, you would consider in arriving at a proposal

to overcome these difficulties to go for a new method or alteration of the existing market based

method. (08 Marks)

(c) To recommend, with supporting calculation, what transfer prices you would propose. (04 Marks)

(Total 20 Marks)


Following a strategy of product differentiation, Westwood Company makes a high end kitchen range hood,

KE8. Westwood’s data for 2008 and 2009 are given below:

2008 2009

1. Units of KE8 produce and sold 40,000 42,000

2. Selling price Rs.100 Rs.110

3. Direct material ( square feet) 120,000 123,000

4. Direct material cost per square foot Rs.10 Rs.11

5. Manufacturing capacity for KE8 50,000 units 50,000 units

6. Conversion cost Rs.1,000,000 Rs.1,100,000

7. Conversion cost per unit of capacity Rs.20 Rs.22

8. Selling and customer‐service capacity 30 customers 29 customers

9. Selling and

Customer

‐service

costs Rs.720,000

Rs.725,000

10. Cost per customer of selling and customer‐ service capacity Rs.24,000 Rs.25,000

Westwood produced no defective units and reduced direct material usage per unit of KE8 in 2009.

Conversion costs in each year are tied to manufacturing capacity. Selling and customer service costs are

related to the number of customers that the selling and service functions are designed to support.

Westwood had 23 customers (wholesalers) in 2008 and 25 customers in 2009.


(a) Describe briefly the elements you would include in Westwood’s balanced scorecard (BSC).

(08 Marks)

(b) Calculate growth, price-recovery and productivity components that explain the change in operatingincome from 2008 to2009. (04 Marks)

(c) Suppose during 2009, the market size for high-end kitchen range hoods grew 3% in terms of number

of units and all increases in market share (that is, increases in the number of units sold greater than

3%) are due to Westwood’s product-differentiation strategy, calculate how much of the change in

operating income from 2008 to 2009 is due to the industry-market-size, cost leadership, and product

differentiation. (05 Marks)

(d) How successful has Westwood been in implementing its strategy? Explain your answer. (03 Marks)

(Total 20 Marks)

End of Section B




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Section C

Answer one (1) question only


Summit Equipment specializes in the manufacture of medical equipment, a field that has become

increasingly competitive. Approximately two years ago, Kusal Perera, president of Summit, decided to

revise the bonus plan (based, at the time, entirely on operating income) to encourage division

managers to focus on areas that were important to customers and those that added value without

increasing costs, reduced sales returns and increased on-time deliveries.

Bonus is calculated and awarded semiannually on the following basis: A base bonus is calculated at

2% of operating income; this amount is then adjusted as follows:

a. (i) Reduce by excess of rework costs over and above 2% of operating income.

(ii) No adjustment if rework costs are less than or equal to 2% of operating income.

b. (i) Increase by Rs.500,000/‐ if more than 98% of deliveries are on time, and by Rs.200,000/‐ if

96% to

98%

of

deliveries

are

on

time.

(ii) No adjustment if on‐time deliveries are below 96%.

c. Increase by Rs 300,000 if sales returns are less than or equal to 1.5% of sales.

d. Decrease by 50% of excess of sales returns over 1.5% of sales.

If the calculation of the bonus results in a negative value for a particular period, the manager simply

receives no bonus and the negative amount is not carried forward to the next period.

Result for summit’s Charter Division and Mesa Division for 2009, the first year under the new bonus

plan, are given below.

In 2008, under the old bonus plan, the Charter Division manager earned a bonus of Rs.2,706,000/-

and Mesa Division manager, a bonus of Rs.2,244,000/-.

Charter Division Mesa Division

01/01/2009 –

30/06/2009

01/07/2009 –

31/12/2009

01/01/2009 –

30/06/2009

01/07/2009 –

31/12/2009

Sales (Rs.) 420,000,000 440,000,000 280,500,000 290,000,000

Operating income (Rs.) 46,200,000 44,000,000 34,200,000 40,600,000

On‐time delivery 95.4% 97.3% 98.2% 94.6%

Rework costs (Rs.) 1,150,000 1,100,000 600,000 800,000

Sales returns (Rs.) 8,400,000 7,000,000 4,475,000 4,250,000

You are required to explain:

(a) Why did Kusal Perera need to introduce these new performance measures? (04 Marks)

(b) Calculate the bonus earned by each manager for the six-month period above and for 2009.

(06 Marks)

(c) What effect did the change in the bonus plan have on each manager’s behavior? Did the new

bonus plan achieve what Kusal Perera desired? What changes, if any, would you introduce to

the new bonus plan? (10 Marks)

(Total 20 Marks)




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Worldwide Cell Phone (WCP) has developed a cell phone that can be used anywhere in the world.

WCP has been receiving complaints about the cell phone. For the past two years, WPC has been test

marketing the phones and gathering nonfinancial information related to actual and perceived aspects of

the cell phone’s quality. They expect that, given the absence of much competition in this market,

increasing the quality of the cell phone will result in higher sales and thereby higher profits.

Quality related data for 2008 and 2009 include the following:

2008 2009

Cell phones produced and shipped 2,000 10,000

Number of defective units shipped 100 400

Number of customer complaints 150 700

Units reworked before shipping 120 700

Manufacturing lead time 15 days 16 days

Average customer response time 30 days 28 days

You are required to explain:

(a) For each year, 2008 and 2009, calculate:

(i) Percentage of defective units shipped.

(ii) Customer complaints as a percentage of units shipped.

(iii) Percentage of units reworked during production.

(iv) Manufacturing lead time as a percentage of total time from order to delivery. (08 Marks)

(b) Referring to the information computed in requirement (a), explain whether WCP’s quality and

timeliness have improved. (08 Marks)

(c) Why would manufacturing lead time have increased while customer response time decreased?

(04 Marks)

(Total 20 Marks)

End of Section C




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Present value table

Present value of 1.00 unit of currency, that is (1 + r )-n

where r = interest rate; n = number of periods until paymentor receipt.

Periods (n) Interest rates (r)

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 0.9092 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 0.23916 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 (n) Interest rates (r)

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 0.6943 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

End of Question Paper

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