P2 PEG M2008 Final Version

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Paper P2 Management Accounting Decision ManagementPost Exam GuideMay 2008 Exam

General Comments

The overall average mark and the percentage of candidates passing the exam were abovethe level achieved in the previous diet. The paper contained questions that covered a large

proportion of the syllabus, and candidates who undertook a review of previous papers wouldhave noticed a repeat of several important topics with TQM/JIT, investment appraisal, thelearning curve and the principles of limiting factors, again being tested.

It is important to bring to the attention of candidates a number of issues that singularly andcollectively had an adverse impact on the final marks awarded.

1. Many candidates appear to be unable to interpret a question i.e. they do notunderstand the verb being used. When preparing for the examinations candidatesneed to know what is meant by such words as identify and explain (Q.3), brieflydiscuss (Q.3), recommend (Q.7).

2. Candidates are recommended to show all workings and refer to them clearly,especially when two figures have been added together and then included in a table of

figures in the final answer (e.g. question 6, production and non-production costs). Amark cannot be awarded for an incorrect total figure if its make-up is not shown.3. All candidates taking this examination, especially those who have been awarded an

exemption from C1 and P1, are advised to ensure they have a good understanding ofthe syllabus of these two papers.

4. Candidates are advised to make full use of the 20 minutes allowed for planning. Timespent planning answers and planning the order in which to answer the questions istime well spent, especially if this reduces overall writing time and duplication ofrepetitive workings.

5. Candidates are also advised not to waste time rewriting the question at the start oftheir answer. This expends valuable time and serves no useful purpose.

6. When answering written questions some candidates submitted answers that weredifficult to read. In addition, some aspects of grammar were poor. Candidates are

advised to practice questions that require written answers.7. Candidates at this level should be capable of establishing what is required and

planning their answers accordingly.8. Where required (Q2 & Q3) narrative answers should be related to the question

scenario.

The Chartered Institute of Management Accountants Page 1


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Section A 20 marks

Question 1.1A project has an initial investment of $140,000 and a Net Present Value of $42,500. The present value of

the sales revenue generated by the project is $385,000.

The sensitivity of the investment to changes in the value of sales revenue is closest to

A 36%

B $342,500

C 89%

D 11%(2 marks)

The answer is D

Workings$42,500/$385,000 = 11%

Question 1.2A company produces three products (X, Y and Z) from a common process. Each of these products maythen be further processed in separate processes, which do not incur any incremental fixed costs.

When deciding whether or not to further process Product Z, the information required is:

(i) The common costs of the joint process

(ii) The further processing costs of Product Z

(iii) The unit selling price of Product Z at the point of separation

(iv) The unit selling price of Product Z after further processing

(v) The percentage losses of further processing Product Z

(vi) The actual output of Product Z from the common process

A (i), (ii), (iii) and (iv) only

B (ii), (iii), (iv) and (vi) only

C (ii), (iii), (iv), and (v) only

D All of the above(2 marks)

The answer is C



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Question 1.3

A company has a real cost of capital of 600% per annum and inflation is currently 400% per annum.

The companys annual money cost of capital is closest to

A 1024%

B 1000%

C 200%

D 192%(2 marks)

The answer isA

Workings106 x 104 = 11024

The following data is to be used when answering questions 1.4 & 1.5

A company is considering investing in a new machine. The machine will cost $15,000 andhas an expected life of five years with a residual value of $3,000. The machine will increasethe operating cashflows of the company as follows:

Year Increase inoperating cashflow

$

1 2,5002 3,0003 5,5004 4,0005 3,000

Question 1.4

Calculate the payback period of the new machine to the nearest 01 years.(2 marks)

Workings

Year CumulativeCashflow

($)1 2,5002 5,5003 11,0004 15,000

Payback period = 40 years



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Question 1.5Calculate the average Annual Accounting Rate of Return over the lifetime of the investment in the newmachine.

(2 marks)

WorkingsARR = Average Annual Profit/Average Investment value

= [(18,000 12,000)/5]/[(15,000 + 3,000)/2] = 133%

Question 1.6A company is considering its costs in respect of a new product. The following tables show the predictions

made by the company, together with their associated probabilities:

Fixed costs$ Probability

100,000 035130,000 045160,000 020

Variable costs$ Probability

70,000 04090,000 035

110,000 025

Calculate the expected value of total costs.(2 marks)

Workings

Expected value of fixed costs:($100,000 x 035) + ($130,000 x 045) + ($160,000 x 020) = $125,500

Expected value of variable costs:($70,000 x 040) + ($90,000 x 035) + ($110,000 x 025) = $87,000

Expected value of total costs = $125,500 + $87,000 = $212,500



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Question 1.7A company is considering the following investments for the year ending 30 June 2009:

Investment Capital required NPV

$ $W 100,000 56,000X 150,000 75,000Y 140,000 68,000Z 190,000 91,000

None of the investments are divisible. They cannot be undertaken more than once within each year. Thecompany has only $350,000 available to invest in the year to 30 June 2009. There are no otherinvestments available at this time.

Which investments (if any) should the company undertake?(2 marks)

WorkingsPossible Combinations NPV ($)W & X only 131,000W & Y only 124,000W & Z only 147,000X & Y only 143,000X & Z only 166,000 AnswerY & Z only 159,000



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Question 1.8A company is considering a short-term pricing decision to utilise some spare capacity. The item to bemanufactured and sold would use 1,500kgs of raw material Q.

Material Q is in regular use by the company. It currently has 1,000kgs in inventory, which was purchasedlast month at a cost of $4 per kg. The current replacement cost of material Q is $480 per kg and thecurrent inventory could be sold for $430 per kg.

Calculate the relevant cost of material Q for the purposes of this decision.(2 marks)

Workings

1,500 kgs x $480 = $7,200

Question 1.9A company is considering the price of a new product. It has determined that the variable cost of makingthe item will be $24 per unit. Market research has indicated that if the selling price were to be $60 per unitthen the demand would be 1,000 units per week.

However, for every $10 per unit increase in selling price, there would be a reduction in demand by 50units; and for every $10 reduction in selling price, there would be an increase in demand of 50 units.

Calculate the optimal selling price.(4 marks)

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

WorkingsP0 = $60 + ($10 x 1,000/50) = $260

P = $260 - 02q

MR = $260 - 04q

MC = $24

Optimum solution:

24 = 260 - 04q236 = 04q590 = q

P = $260 - 02q= $260 - (02 x 590)

= $142

Note: P0 = price at which demand equals zeroP = priceq = quantity

MR = marginal revenueMC = marginal cost



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Examiners comments

It is pleasing to note that the average mark for this question was slightly higher than in previous diets. Thepresentation of the answers, i.e. presenting the answer as requested in the question, showed a markedimprovement compared with previous experience. No individual question was ignored and there did notappear to be a particular question that was poorly answered. When answering Q.1.7 many candidatesfailed to note, or did not understand, the phrase none of the investments are divisible and opted for twoinvestments and a portion of a third investment.

The topics included and tested in this question related to many important aspects of the syllabus, andwere similar to questions that had appeared in previous papers.

Common Errors1. Failure to note exactly what was requested2. Failure to show workings for question 1.9



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Section B 30 marks ANSWERALL THREE QUESTIONS

Question 2

You are the Management Accountant of XY, an engineering company that assembles components intoengines for sale to the automotive industry. The company is constantly under pressure from its customersto provide more efficient engines, which are also less damaging to the environment. The company usesvalue chain analysis as a tool in the management of its activities.

The Managing Director of XY has recently been invited to a conference to give a presentation entitledThe concept of the Value Chain and the management of profits generated throughout the chain in XY.

Required:

Prepare a report for the Managing Director explaining the points that should be covered in the

presentation.(Total for Question Two = 10 marks)

RationaleThis question tests candidates ability to demonstrate their understanding of the Value Chain. Thisquestion addresses the learning outcome: explain the concept of the value chain and discuss themanagement of contribution/profit generated throughout the chain.

Suggested Approach

Carefully read the scenario provided and identify the key elements of a Value Chain Explain by a diagram or otherwise the elements of a Value Chain Explain how value for the customer is created throughout the Value Chain, resulting in the

management of profits generated throughout the chain

Marking Guide MarksReport formatExplain Value ChainDiscuss contribution

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Examiners CommentsIn most cases this question was poorly answered for several reasons:

1. A report format was requested (to, from, date, etc.) but many candidates ignored this request.2. The answer needed to address two specific points. Firstly a description/explanation of the

concept of the Value Chain and secondly the management of profits generated throughout thechain.

Most candidates were able to demonstrate a basic understanding of one of the forms of the Value Chain,some by use of a diagram. However a good answer needed to develop and explain that each link of thechain should add value in some way to generate outputs for customers and also to generate highercontribution for the company. The answer further needed to explain that a feature of any part of the ValueChain comprised the quality of the product as perceived by the customer.

A large number of answers transformed the question to read Write all you know about Value Analysis,

and continued to describe esteem value and utility value. This was not the question asked and suchanswers did not attract any marks.



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Common Errors1. Failure to present the answer in a report format2. Not answering the question. For example, writing about Value Analysis and Value Engineering as

opposed to the Value Chain.3. Showing no understanding of the Value Chain.



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Question 3A company experiences changing levels of demand, but produces a constant number of units during eachquarter. The company allows inventory levels to rise and fall to satisfy the differing quarterly demand

levels for its product.

Required:

(a) Identify and explain the reasons for THREE cost changes that would result if the companychanged to a Just-In-Time production method for 2009.Assume there will be no inventory at the start and end of the year.

(6 marks)

(b) Briefly discuss the importance of Total Quality Management to a company that operates aJust-In-Time production method.

(4 marks)

(Total for Question Three = 10 marks)

RationaleThis question tests candidates knowledge of Just In Time production. In part (a) candidates are requiredto explain the reasons for three additional costs / cost savings that would occur if the company were tochange to a Just In Time production method. In part (b) candidates are required to discuss the importanceof Total Quality Management to a company that operates a Just In Time production method. This questionaddresses the learning outcome: evaluate the impacts of just-in-time production, the theory of constraintsand total quality management on efficiency, inventory and cost.

Suggested Approach

Carefully read the scenario to identify the key factors associated with changing to a Just In Time (JIT)production method

Explain three cost changes that will occur as a result of the introduction of JIT production Explain the importance of quality in a JIT production method

Marking Guide Marks(a)Resource planningInflationary savings

Inventory holding costs

(b)Lack of safety netQuality responsibility

22

2

22



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Examiners CommentsPart (a) was generally well answered although many answers lacked imagination in that candidates putforward three valid cost reductions which all related to the same reason e.g. a reduction in inventory

holding costs, lower levels of obsolescence and reduced insurance costs. These cost changes all relatedto a reduction in inventory. Most candidates simply treated part (b) as an extension to part (a). Theiranswers contained discussions/issues relating to cost implications of the introduction of JIT. Theexaminer however was looking for candidates to develop two particular issues. Firstly, that with theintroduction of JIT there is no inventory to act as a buffer or safety net, whereby a stoppage in productionwould lead to delayed/lost sales. Secondly, that the company would need to adopt a philosophy of TotalQuality Management so that every person in the production system takes responsibility for the quality oftheir own output.

Common Errors1. Lacking imagination when answering part (a).2. Not fully understanding/appreciating what was needed for part (b).3. Failure to develop items put forward e.g. providing a bullet point instead of a developed sentence



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Question 4A company has developed a new product that it will manufacture in its workshop. The product is highlyspecialised and initially will be produced to order only. The product will be manufactured in batches. The

estimated labour time required for the first batch is 40 hours, but due to the nature of the product and themanufacturing method to be used, it is expected that an 80% learning curve will apply.

Required:

(a) Calculate the expected time for the eighth batch.(3 marks)

(b) When production commenced the first batch took 45 hours. The actual learning ratesobserved were as follows:

Month Total batches produced Actual learning rateto date

1 12 2 75%3 4 75%4 8 90%

For each of months 2 and 4, state possible reasons why the actual learning rates differedfrom the expected rates.

(3 marks)

(c) The total time taken to produce the first eight batches was 18225 hours.Calculate the cumulative learning rate up to the end of Month 4. (Remember that the firstbatch took 45 hours).

(4 marks)

(Total for Question Four = 10 marks)

RationaleThis question tests candidates knowledge of learning curves. It addresses the learning outcome: explainand apply learning and experience curves to estimate time and cost for new products and services.

Suggested Approach

Calculate the average times for 8 batches and 7 batches

Calculate the total times for 8 batches and 7 batches Calculate the time taken for the 8

thbatch

Compare the learning rates provided and give possible reasons for the difference Calculate the average rate of learning by comparing the average time for the eight batches with the

time for the first batch and recognising that the output doubles three times between the first and eighthbatches

Marking Guide Marks



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(a)Time for 8 batchesTime for 7 batchesTime for eighth batch

(b)Three reasons ( 1 mark each)

(c)Calculate rate of learning

111

3

4

Examiners CommentsPart (a) was generally well answered.

Part (b) was only worth three marks but the answers put forward by most candidates were poor. In factthe answers were totally incorrect. Most candidates incorrectly believed a movement in the learning curverate from 80% to 75% was a worsening situation, and a movement up to 90% was an improvement. It is

obvious from the answers put forward by many candidates that the principles relating to the learning curvehave not been fully understood.

Part (c) was worth four easy marks for those candidates who quickly realised that the average time for thefirst 8 batches of 22.78 hours was 51% of the initial time 45 hours, and that the third root of 51% was 80%.

Common Errors1. Failure to recognise that the learning curve (LC) formula was needed to answer part (a) of the

question, as opposed to the doubling effect procedure.2. Not appreciating that an increase in the LC percentage was a worsening effect.3. Not fully understanding the workings of the LC formula.



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Section C 50 marksANSWER TWO QUESTIONS OUT OF THREE

Question 5

(a) Prepare calculations to show the most profitable course of action for the company for the nextthree months, assuming that there are no other suppliers of material M1, and advise thecompany on THREE other factors that it should consider before making its decision.

(14 marks)

(b) Calculate the maximum prices that the company should pay to obtain further supplies ofmaterial M1 from an alternative supplier, and the quantities of material M1 to which each ofthese prices apply.

(6 marks)

The company has now become aware of a contract that it has already accepted, for the immediatedelivery of 500 units of P4 at a selling price of $125 per unit. This contract has a financial penalty clausefor non-delivery. This contract is in addition to the 2,000 units of estimated demand for P4 statedpreviously. Assume that there is no alternative supplier of material M1.

(c) Calculate the minimum financial penalty that would change your recommendation.

(5 marks)

RationaleThis question tests candidates ability to solve a scarce resource problem involving products and

components, where the components could be bought from an external supplier instead of manufacturingthem internally. This question addresses the learning outcome:Apply variable/fixed cost analysis inmultiple product contexts to break-even analysis and product mix decision making, includingcircumstances where there are multiple constraints and linear programming methods are needed to reachoptimal solutions.



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Suggested Approach

Carefully read the scenario to realise that contribution can be earned by the sale of products and alsoby saving costs by manufacturing components

Determine the contribution earned per square metre of the scarce material Determine the optimum plan for the use of the material Explain other factors that should be considered before finalising the decision Calculate the maximum prices that should be paid for additional units of the scarce material Determine the value of the financial penalty by comparing the contribution values under the alternative

solutions

Marking Guide Marks(a)Contribution values per square metreRankingOptimum plan

Three other factors (two marks each)

(b)Maximum prices for each level (two marks each)

(c)ExplanationCalculation of penalty

413

6

6

23

Examiners CommentsIn part (a) the majority of candidates did not appreciate that in a question that called upon the principlesassociated with limiting factors, a contribution per limiting factor can be measured alongside an

opportunity cost per limiting factor i.e. the buying in price compared to the variable cost to the manufactureof an item. Most candidates simply ignored components C3 and C5 and therefore earned minimal marksfor part (a). Even though some candidates did not attain a good mark for part (a) the marking principle ofthe own figure rule was applied so that candidates could still earn marks for parts (b) and (c).Unfortunately the attempts at these two parts of the question were generally poor.

Common Errors1. Demonstrating a complete lack of understanding of the principles associated with limiting factors and

opportunity cost.2. Failure to present clear answers.3. Failure to appreciate that the own figure rule is applied by markers (i.e. candidates should attempt part

(b) & (c) of a question even though the answer to part (a) is incorrect).



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Question 6

(a) Calculate the Net Present Value (NPV) of the project (to the nearest $000).

(15 marks)

(b) Calculate the post tax money cost of capital at which H would be indifferent toaccepting/rejecting the project.

(4 marks)

(c) Explain your treatment of inflation in your solution to part (a) above and describe analternative method that would have provided the same NPV.

(6 marks)

(Total for Question Six = 25 marks)

RationaleThis question tests candidates ability in part (a) to calculate the net present value of an investmentproposal from the data provided, in part (b) to calculate the internal rate of return and in part (c) to explainthe treatment of inflation in evaluating the proposal. This question addresses the learning outcome:Calculate project cash flows, accountingfor tax and inflation, and apply perpetuities to derive end ofproject value where appropriate.

Suggested Approach

Carefully read the scenario to determine the incremental nature of the decision being made Identify the cost and revenue changes that will occur as a result of the decision and the timing of

those changes Determine the tax consequences of those incremental costs and revenues Evaluate the proposal using net present value Calculate the internal rate of return Explain the method used to include inflation in the solution to part (a) and an alternative approach

that would result in the same conclusion

Marking Guide Marks(a)SalesProduction costsNon-production costsCapital valuesTaxationTax depreciationDiscountingCalculate NPV

(b)Selecting a lower discount rateCalculate NPVCalculate IRR

(c)Explanation of solution method

Explanation of alternative

23212311

121

3

3



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Examiners CommentsPart (a) was a familiar investment appraisal question, similar to questions that have appeared in previouspapers. The most important aspect of this question related to the candidates ability to subject the 2008

figures to compound inflation percentages as well as apply index figures relating to growth in future years.Most candidates who chose this question made a reasonable attempt and there were some excellent, welllaid out answers.

Part (b) was also reasonably well answered with most candidates realising that the question called for thecalculation of the Internal Rate of Return. The use of the own figure rule was again in evidence with thispart of the question.

Part (c) was generally well answered.

Common Errors1. Providing poorly laid out answers with no reference to workings.2. Providing no workings to explain how figures had been derived.

3. Using rules relating to interpolation incorrectly (part b).



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Question 7

(a) Recommend which course of action the bank should take by preparing calculations to show

the annual profits from:

(i) continuing with the existing bank account

(ii) each of the two account options described above.

(12 marks)

(b)

(i) Prepare a two-way data table that shows profit that would be earned by the bank for each ofthe NINE possible outcomes that are expected to arise as a result of the advertisingcampaign.

(8 marks)

(ii) State any other factors the bank should consider before making its decision and advise thebank on whether or not it should carry out the advertising campaign.

(5 marks)

(Total for Question Seven = 25 marks)

RationaleThis question tests candidates ability to analyse the data provided to determine the optimal solution to acharging structure for a bank and then in part (b) to prepare and explain a two-way data table to solve a

problem involving the use of advertising to increase the volume of the banks loan business. This questionaddresses the learning outcomes: Discuss the principles of decision making including the identification ofrelevant cash flows and their use alongside non-quantifiable factors in making rounded judgements; andevaluate the impact of uncertainty and risk on decision models that may be based on CVP analysis,relevant cash flows, learning curves, discounting techniques etc.

Suggested Approach

Carefully read the scenario and identify the implications for costs and revenues of each alternativeoption

Determine the costs and revenues of each option and advise the bank Determine the net revenues of the possible outcomes of the advertising campaign Advise the bank as to whether or not to proceed with the advertising campaign

Marking Guide Marks(a)Calculate existing situation and two alternatives: (four marks each)RecommendationMAXIMUM 12 MARKS

(b)StructureData valuesDiscussion (range, risk, resources, conclusion)

121

265

Examiners Comments



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This was the least popular optional question. Most candidates made a good attempt at part (a) althoughvery few realised they needed to calculate and include a figure to represent the investment incomeforgone for options 1 and 2.

Part (b) was well answered although some candidates were confused with the wording in the question

relating to sensitivity of the number of loans, and the increase in the average loan balances. The answerto part b(ii) needed to be related to the figures in the table compared to the existing profit.

Common Errors1. Not including a figure for investment income forgone.2. Failure to show workings for the figures submitted in the two-way table.3. Failure to relate the other factors to the figures shown in the two-way table.


P2 PEG M2008 Final Version

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