Paper 3.

3
Performance
Management

PART 3

FRIDAY 10 DECEMBER 2004

QUESTION PAPER

Time allowed 3 hours

This paper is divided into two sections

Section A BOTH questions are compulsory and MUST be

Section B TWO questions ONLY to be answered

Present Value and Annuity Tables are on pages 8 and 9

Do not open this paper until instructed by the supervisor

The Association of Chartered Certified Accountants

1 Alocin plc is a well-established manufacturer of high quality consumer durables. The company has recently developed
a state of the art ‘travel system’ i.e. baby carriage for infant children. The travel system, named the ‘Cruiser’ is
manufactured from a rare substance (CLO), which gives it superior strength to any other travel system that is currently
on the market. The marketing director believes that the fact the ‘Cruiser’ weighs less than half of the weight of all
currently available travel systems will give the company a considerable competitive advantage. Alocin plc also
manufactures another travel system called the ‘Glider’ which is manufactured from material DMP.
The following information is available in respect of the year ending 31 December 2005:
(1) Each Cruiser requires 2 kilograms of CLO.
(2) Alocin plc has access to a maximum of 990 tonnes of CLO during the year. Each kilogram of CLO costs £60.
NB 1 tonne = 1,000 kilograms.
(3) The labour cost of manufacturing a ‘Cruiser’ is estimated at £40 per unit.
(4) Variable overheads are estimated to be £20 per unit.
(5) Incremental fixed costs relating to the ‘Cruiser’ are estimated to be £31·5 million.
(6) The nature of CLO means that it cannot be stored for future use. The only alternative use for any surplus CLO
during the period is in the manufacture of an alternative version of the ‘Glider’.
(7) (i) The marketing director has estimated that at a selling price of £500 per Cruiser, an annual sales volume of
500,000 would be achieved. He has further estimated that an increase/decrease in price of £20 will cause
quantity demanded to decrease/increase by 25,000 units. He has provided you with the following formulae:
Price function: Pq = P0 – bq
Total revenue (TR) function: = P0q – bq2
Marginal revenue (MR) function: = P0 – 2bq
Where P0 = Price at zero units of demand
Pq = Price at q units of demand
b = price:demand relationship
q = Units of demand.
(ii) Where the relevant matching of total revenue and total cost functions is expressed as the quadratic equation
ax2 + bx + c = 0, the break-even point(s) in units may be calculated using the formula:

–b ± b2 – 4ac
x=
2a

N.B. This formula is independent of those formulae stated in (i) above.

Required:
(a) Calculate the profit maximising output level for sales of the ‘Cruiser’ and the profit that would arise from
those sales during the period ending 31 December 2005. (6 marks)

(b) Calculate the output level(s) of ‘Cruisers’ and associated selling prices at which Alocin plc will breakeven.
(6 marks)

The alternative version of the ‘Glider’ is called the ‘Super Glider’. Each ‘Super Glider’ unit would require 1·5 kilograms
of CLO which would be substituted for three kilograms of Material DMP, which costs £45 per kilogram.
Three models of the ‘Super Glider’ could be manufactured. These are the ‘Gold’, ‘Silver’ and ‘Bronze’ models. The
marketing director is confident that all units manufactured would be sold during the year.

2
Revenue and quantity information relating to the ‘Super Glider’ is as follows:
Model Incremental revenue % of total
per unit (£’s) sales units
Gold 50 20
Silver 40 50
Bronze 30 30
Each ‘Super Glider’ unit has labour and variable overhead costs of £30 and £18 respectively.

(c) Calculate the incremental contribution arising from the sale of the ‘Super Glider’. (4 marks)

(d) Explain why the board of directors of Alocin plc may choose not to use the profit maximising model (per (a))
in order to derive a selling price for the ‘Cruiser’. You should include reference to demand being a function
of a range of endogenous and exogenous variables as part of your answer. (8 marks)

(e) Explain ways in which each of the following may affect the pricing strategies that the management of
Alocin plc might adopt for the ‘Cruiser’:
(i) Cost leadership
(ii) Product differentiation
(iii) Niche marketing. (8 marks)

(f) Explain the benefits and potential limitations of the use of SWOT analysis by the management of
Alocin plc. Your answer should include a brief comment with respect to the formulation of a pricing strategy
for the ‘Cruiser’. (8 marks)

(40 marks)

3 [P.T.O.
2 Ride Ltd is engaged in the manufacturing and marketing of bicycles. Two bicycles are produced. These are the
‘Roadster’ which is designed for use on roads and the ‘Everest’ which is a bicycle designed for use in mountainous
areas. The following information relates to the year ending 31 December 2005:
(1) Unit selling price and cost data is as follows:
Roadster Everest
£ £
Selling price 200 280
Material cost 80 100
Variable production conversion costs 20 60
(2) Fixed production overheads attributable to the manufacture of the bicycles will amount to £4,050,000.
(3) Expected demand is as follows:
Roadster 150,000 units
Everest 70,000 units
(4) Each bicycle is completed in the finishing department. The number of each type of bicycle that can be completed
in one hour in the finishing department is as follows:
Roadster 6·25
Everest 5·00
There are a total of 30,000 hours available within the finishing department.
(5) Ride Ltd operates a just in time (JIT) manufacturing system with regard to the manufacture of bicycles and aims
to hold very little work-in-progress and no finished goods stocks whatsoever.

Required:
(a) Using marginal costing principles, calculate the mix (units) of each type of bicycle which will maximise net
profit and state the value of that profit. (6 marks)

(b) Calculate the throughput accounting ratio for each type of bicycle and briefly discuss when it is worth
producing a product where throughput accounting principles are in operation. Your answer should assume
that the variable overhead cost amounting to £4,800,000 incurred as a result of the chosen product mix in
part (a) is fixed in the short-term. (5 marks)

(c) Using throughput accounting principles, advise management of the quantities of each type of bicycle that
should be manufactured which will maximise net profit and prepare a projection of the net profit that would
be earned by Ride Ltd in the year ending 31 December 2005. (5 marks)

(d) Explain two aspects in which the concept of ‘contribution’ in throughput accounting differs from its use in
marginal costing. (4 marks)

(20 marks)

4
Section B – TWO questions ONLY to be attempted

3 (a) Explain the contingency theory of management accounting and expand on ways in which its components
highlight and allow explanations of differences in management accounting control systems. (10 marks)

(b) (i) Explain the term ‘Business process re-engineering’ and how its application might enable overall business
performance to be improved. (7 marks)

(ii) Briefly discuss potential problems which may be encountered in the implementation of a business
re-engineering programme. (3 marks)

(20 marks)

5 [P.T.O.
4 Woods Ltd is a well-established company which manufactures and markets domestic kitchen appliances. One of its
current products is a refrigerator called the ‘Super kooler’. A sales volume of 180,000 units will be achieved during
the year ending 31 December 2004.
The board of directors is aware that the government recently announced that the disposal and manufacture of large
kitchen appliances such as refrigerators would be the subject of future legislation that will take effect from 1 January
2009. The legislation will require that a percentage of all new products such as refrigerators will be manufactured
from recycled products.
The board of directors had anticipated this change but had not been aware of the date that the new legislation would
take effect. The new product development team within Woods Ltd has designed a new refrigerator called the ‘Ultimate’
which will comply with all aspects of the forthcoming legislation.
The board of directors recently engaged Prospero, a market research consultancy to undertake a study of the likely
demand for the ‘Ultimate’, for which a fee of £50,000 was paid. Their findings revealed that consumer tastes have
changed insofar as they now seek more energy-efficient kitchen appliances. The consultants produced the following
estimate of annual sales volumes that may be achieved at the intended launch price of £200 per unit together with
their associated probabilities:
Sales units per annum Probability
125,000 0·30
100,000 0·40
75,000 0·30
The board of directors has decided that expected value of sales units should be applied in all calculations.
The board of directors are considering when to replace the ‘Super kooler’ with the ‘Ultimate’ model and have asked
you to advise them accordingly. The following information is available to you:
(1) The current selling price per unit of the ‘Super kooler’ is £160. It will not be possible to achieve any further
increases in selling price during the remainder of the product’s life. The variable cost of manufacturing the ‘Super
kooler’ is £100 per unit.
(2) The manufacture of the ‘Ultimate’ requires a change in manufacturing technology that will require an immediate
capital outlay of £1,200,000. The capital outlay will ensure that Woods Ltd has sufficient manufacturing capacity
to cope with whatever level of demand should arise.
(3) It will not be possible to manufacture both models as only one type of manufacturing technology can be housed
in the factory of Woods Ltd at any one time.
(4) The variable cost of manufacturing the ‘Ultimate’ is expected to be £110 per unit.
(5) The introduction of the ‘Ultimate’ model will increase fixed costs by £150,000 per annum.
(6) The board of directors uses a cost of capital of 9% per annum to evaluate new investments.
(7) The board of directors expects a decline in sales volume to occur during each year that they continue to market
the ‘Super kooler’. However, the board is uncertain as to the rate of decline in sales volume that will occur. The
marketing director has stated that the minimum reduction in sales volume that will occur in the year ending
31 December 2005 is 10,000 units and that for each additional year that manufacture takes place a further
minimum reduction of 10,000 units will occur.

6
 Required:
(a) (i) Prepare an evaluation of the proposed replacement of the ‘Super kooler’ by the ‘Ultimate’ on 1 January
2005 on purely financial grounds (using a NPV approach). (5 marks)
(ii) Calculate the minimum reduction in sales volume of the ‘Super kooler’ which will apply in the year
ending 31 December 2005 and for each additional year thereafter (i.e. which will replace the 10,000
units stated in note 7 above), in order to justify the withdrawal of the ‘Super kooler’ from the market
with effect from 1 January 2005. (5 marks)

(b) (i) Explain the limitations of the analysis performed in part (a) and suggest how the board of directors could
address those limitations before making a decision regarding when to cease manufacture of the ‘Super
kooler’. (7 marks)
(ii) Explain the potential benefits that may arise as a consequence of a decision by the board of directors to
cease the manufacture of the ‘Super kooler’ with immediate effect, irrespective of the financial
consequences of such a decision. (3 marks)
Assume that all cash flows other than where stated will take place at the end of each year.

(20 marks)

5 ‘Responsibility accounting is based on the application of the controllability principle.’

Required:
(a) Explain the ‘controllability’ principle and why its application is difficult in practice. (6 marks)

(b) Explain how the management of an organisation can attempt to overcome the difficulties inherent in the
practical application of the controllability principle. (8 marks)

(c) Explain the following approaches that can be used to set financial targets within an organisation:
(i) Engineered approach
(ii) Historical approach
(iii) Negotiated approach. (6 marks)

(20 marks)

7 [P.T.O.
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End of Question Paper