This Paper Is Not To Be Removed From The Examination Halls

This paper is not to be removed from the Examination Halls
UNIVERSITY OF LONDON 279 0097 ZA
BSc degrees and Diplomas for Graduates in Economics, Management, Finance and
the Social Sciences, the Diploma in Economics and Access Route for Students in the
External Programme
Management Accounting
Tuesday, 25 May 2010 : 10.00am to 1.15pm
Candidates should answer FOUR of the following EIGHT questions: TWO from Section
A, ONE from Section B and ONE further question from either section. All questions carry
equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.
8-column accounting paper is provided at the end of this question paper. If used, it must be
detached and fastened securely inside the answer book.
A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.
© University of London 2010

UL10/0215 PLEASE TURN OVER
D01 Page 1 of 7
SECTION A
Answer two questions from this section and not more than one further question from this section. (You
are reminded that four questions in total are to be attempted with at least one from Section B.)
1. Reichelstein, quoted in Horngren C. Datar S. and Foster C. (“Cost Accounting a Managerial

Emphasis” 13th Edition P.832), has demonstrated that “Net present value of all cashflows of an
investment equals the net present value of the project’s Residual Income”.
A company offering professional services has a capital expenditure project with the following
cashflows:
Initial capital investment £5,000,000.
Cash receipts Cash

Year
from sales expenses
Year 1 1,600,000 300,000
Year 2 2,000,000 500,000
Year 3 2,200,000 550,000
Year 4 2,200,000 550,000
Year 5 1,500,000 420,000
The initial investment will have no resale value at the end of the 5 years and is to be depreciated on
a straight line basis. Assume that the cash received from sales and paid for expenses equals the
sales and expenses for the year on an accrual basis.
Required:
(a) Using the above capital expenditure project and assuming a cost of capital of 12%, illustrate
the statement by Reichelstein. (The capital charge for the Residual Income calculation should
be based on asset values at the beginning of each year). (12 marks)
(b) Using the example you have calculated in (a), discuss the problems that arise when
companies use Residual Income as their only appraisal measure and take a short term
approach when rewarding managers. (5 marks)
(c) Succinctly discuss ways in which companies can create reward systems which overcome
these problems. (8 marks)

Present value of £1
Year 12%
1 0.89286
2 0.79719
3 0.71178
4 0.63552
5 0.56743
UL10/0215
D01 Page 2 of 7
2. Custom Boats Ltd works on contracts to customers’ specification for pleasure boats. The company
has been approached by Harbour Tours Ltd to accept a contract to build a boat for a fixed price of
£3,000,000.
The resources needed would be as follows:
Labour
Grade 1 30,000 hours
Grade 2 60,000 hours
Materials
Wood 10,000 square metres
Glass 100 square metres
Personalised Fitments £200,000
Grade 1 labour is highly skilled and although it is currently under-utilised in the company it is
Custom Boats Ltd’s policy to continue to pay Grade 1 labour in full. Acceptance of the contract
would reduce the idle time of Grade 1 labour. Idle time payments are treated as production
overheads. Grade 2 is unskilled labour with a high turnover and is considered a variable cost.
The costs to Custom Boats Ltd of each type of labour are:
Grade 1 £16 per hour

The wood and glass required to fulfil the contract would be drawn from materials already in
inventory. The wood is widely used within the company and amounts used for this contract will
need to be replaced. The glass was purchased to fulfil an expected order which did not proceed; if
the glass is not used for this contract it will be sold. For accounting purposes FIFO is used. The
various values and costs for wood and glass are:
Wood - Per Glass - per

square metre square metre
£ £
Book value 40 130
Replacement cost 48 136
Net realisable value 36 110
The personalised fitments will only be purchased if the contract goes ahead.
Variable production overheads are £12 per productive labour hour using both skilled and unskilled
labour. A single recovery rate for fixed factory overheads is used throughout the company. The
overhead is recovered per productive labour hour (skilled and unskilled). Estimates of the year’s
activity show budgeted annual fixed production overheads of £3,600,000 and budgeted productive
labour hours of 450,000.
(question continues on next page)
UL10/0215
D01 Page 3 of 7
A special machine is required for this contract. The fixed costs of running and depreciating the
machine are included in production overhead. Accepting the contract would not cause these costs to
change but using the machine time would mean that Custom Boats Ltd would not be able to make
100 basic rowing boats, which are in regular demand, thus decreasing the total expected sales.
Details of revenues and cost for the rowing boats’ are as shown below.
Per boat
Sales price £4,800
Labour – grade 2 50 hours
Materials – relevant variable costs £280
Custom Boats Ltd uses full absorption job costing to derive a profit figure for each contract, so the
contract with Harbour Tours Ltd will be treated as a separate job for routine costing purposes.
Required:
(a) Advise Custom Boats Ltd on whether to accept the contract on financial grounds. Support
your advice with calculations. (8 marks)
(b) Show how the contract, if accepted, will be reported in the routine job costing system used by
Custom Boats Ltd. (5 marks)
(c) Explain how each of the two methods (a) and (b) above are used by businesses.
(4 marks)
(d) Calculate the difference in profit revealed in your answers to (a) and (b) above.
Since the company uses a routine job costing system, if the contract were accepted, the
difference in profit would affect costs and revenues elsewhere in the system. Draw up a
schedule to explain which costs and revenues would be affected by the decision (The total of
your schedule should agree with the difference between the profits calculated above).
(8 marks)
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D01 Page 4 of 7
3. Super Mechanics plc has various divisions making equipment for the building trade. Division D
makes complex electronic components that recognise dampness in wood and concrete structures.
These are sold to outside customers and to Division M. Division M uses the components in the
production of damp meters which it sells to outside customers.
The market price for each electronic component sold by Division D is £800 and the transfer price to
Division M has been set at market price, in line with company transfer pricing policy.
Division D’s production capacity is 2,400 units per month, but current sales are only 1,000 units per
month to external customers and 600 units per month to Division M.
Division M sells the completed meters for £1,500 each.
Other data relevant to the operation are:
Division D M
£ £
Variable costs of manufacture (excluding transfer price) 400 200
Fixed costs per month 300,000 150,000
Division M wishes to expand sales and has performed market research to determine the effect of
demand to changes in price. The results are as follows:
Price per Estimated
meter sales units
£1,600 450
£1,500 600
£1,400 750
£1,300 900
£1,200 1050
£1,100 1200
£1,000 1350
Required:
(a) i. Prepare estimated profit statements for one month at current output for each division
based on the transfer price of £800 per component.
ii. Calculate the total profits earned by the two divisions. (5 marks)
(b) Determine the quantity and price at which Division M should sell the damp meter:
i. to maximise Divisional M’s profit at the existing transfer price.
ii. to maximise the profit of Super Mechanics plc. (10 marks)
(c) Prepare estimated profit statements for one month for each division and for the impact on the
profits of Super Mechanics plc as a whole, based on your answers to (b) i. & ii. above.
(6 marks)
(d) Provide a considered view of the effectiveness of company’s existing transfer pricing policy
(using market price) and discuss one other alternative basis that can be used.
(4 marks)
UL10/0215
D01 Page 5 of 7
4. Garden Plastics Ltd is a small company selling a variety of stackable garden chairs to the trade and
retail stores. The company has identified three major cost pools, ordering, storage and shipping.
The following information relates to actual activities in the year ended 30th April 2010:
Activity Cost driver Quantity of usage of Cost of cost driver
(number of) costs driver variable fixed
Ordering Orders 5,000 orders £100 per order £720,000
Storage Loads moved 20,000 loads £60 per load £1,200,000
Shipping Shipments 16,000 shipments £70 per shipment £800,000
The general fixed costs were £2,000,000. The sales were 5,000,000 chairs at £10 per chair and the
average purchase price was £7.50 per chair.
For year ended 30th April 2011, Garden Plastics Ltd plans to sell the same number of chairs as
2010. However competitive conditions will require a reduction in unit selling prices of 5% in order
to achieve these sale volumes. Suppliers have agreed to a price reduction of 4%. Through additional
negotiations with suppliers and reconfiguration of their internal operations Garden Plastics Ltd
forecasts that the following can be achieved:
Activity Cost driver Quantity of usage of cost Cost of cost driver
(number of) driver variable fixed
Storage Loads moved 15,000 loads £60 per load £1,200,000
General fixed cost would remain the same as in the year ended 30th April 2010.
The company wishes to achieve at least as much profit in year ended 30th April 2011 as in 2010.
Required:
(a) Calculate the net income and the net income as a percentage of sales made by Garden Plastics
Ltd for the year ended 30th April 2010. (5 marks)
(b) Assuming that general fixed costs are allocated based on numbers of chairs ordered and using
appropriate cost drivers, calculate the contribution, the Activity Based Cost net income, and
the net income as a percentage of sales, for each of the following two orders:
Sales Order 672 Sales Order 680
Chairs ordered 80,000 1,000
Ordering 3 different orders 40% of 8 different orders
Storage 4 loads moved 12 loads moved
Shipping 1 shipment 2 shipments
(8 marks)
(c) Compare the two orders and comment on the reasons for differences in profitability.
(3 marks)
(d) Using the figures provided above create a budget for year ended 30th April 2011.
(4 marks)
(e) Garden Plastics Ltd wishes to make a fixed charge on small sales orders (of 1,000 chairs or
less). If 2,000 small sales orders are expected in the year ended 30th April 2011, calculate the
charge per order which will be needed to meet Garden Plastics Ltd’s profit target. Using
information from (b) above discuss a different way of setting a charge for complicated orders.
(5 marks)
UL10/0215
D01 Page 6 of 7
SECTION B
Answer one question from this section and not more than one further question form this section. (You
are reminded that four questions in total are to be attempted with at least two from Section A.)
5. Companies need to forecast in order to make both long-term and short-term decisions. Discuss the
role that management accounting plays in forecasting in large organisations.

6. Describe the four different categories into which the costs and benefits of activities to improve
quality within organisations are often divided. Give examples of the costs which would appear in
each category. Explain how benefits can be quantified financially and describe how non - financial
benefits can be identified and measured.
7. (a) In relation to responsibility accounting and the budgetary process explain the meanings of the
following terms and the contexts in which they are used:
i. cost centre
ii. revenue centre
iii. profit centre
iv. investment centre. (10 marks)
(b) Identify and explain six factors which need to be considered when interpreting variances.
(15 marks)
8. (a) Many of the techniques developed for decision making assume that costs can be correctly
divided into fixed and variable costs. Explain the techniques which companies can use to
calculate the fixed and variable elements of cost and discuss the difficulties which can arise in
obtaining accurate results. (12 marks)
(b) Using examples explain the difference between variable costs and direct costs and explain
why it is important that users of cost information know and understand the difference
between the two. (5 marks)
(c) Define the term “Opportunity Cost” and explain why opportunity costs are rarely captured by
a company’s accounting information system. (8 marks)
END OF PAPER
UL10/0215
D01 Page 7 of 7
Examiners’ commentaries 2010

97 Management accounting – Zone A
Important note
This commentary reflects the examination and assessment arrangements
for this unit in the academic year 2009–10. The format and structure of
the examination may change in future years, and any such changes will
be publicised on the virtual learning environment (VLE).
Specific comments on questions

Candidates should answer FOUR of the following EIGHT questions:
TWO from Section A, ONE from Section B and ONE further question
from either section. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any
necessary assumptions introduced in answering a question are to be stated.
8-column accounting paper is provided at the end of this question paper. If
used, it must be detached and fastened securely inside the answer book.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.
Section A
Answer two questions from this section and not more than one further
question from this section. (You are reminded that four questions in total
are to be attempted with at least one from Section B.)
Question 1
Reichelstein, quoted in Horngren C. Datar S. and Foster C. (‘Cost Accounting: a
managerial emphasis’ 13th edition p.832), has demonstrated that ‘Net present
value of all cashflows of an investment equals the net present value of the project’s
Residual Income’… [For full question please refer to the examination paper]
Required:
a. Using the above capital expenditure project and assuming a cost of capital
of 12%, illustrate the statement by Reichelstein. (The capital charge for the
Residual Income calculation should be based on asset values at the beginning
of each year). (12 marks)
Reading for this question
Subject guide, Chapter 9, pp.97–98; Horngren et al. (13th edition) Chapter 23,
p.832.
Approaching the question
This question requires a good knowledge of the figures required for the
calculation of NPV and residual income. As usual with such questions,
marks are awarded for any correct aspects. Although this question is
unusual, it draws on knowledge of how to calculate outcomes using the
two techniques and, if set out logically, should lead to the correct answer.
1
97 Management accounting
Net present value calculations at 12% cost of capital
Net cash Discount Net present

Year Inflows Outflows
flows factor 12% value
Year 0 £5,000,000 (5000,000) 1.000 -5,000,000
Year 1 1,600,000 300,000 1,300,000 0.89286 1,160,718
Year 2 2,000,000 500,000 1,500,000 0.79719 1,195,785
Year 3 2,200,000 550,000 1,650,000 0.71178 1,174,437
Year 4 2,200,000 550,000 1,650,000 0.63552 1,048,608
Year 5 1,500,000 420,000 1,080,000 0.56743 612,824
192,372*
Residual income calculation
Assets at Net cash Capital Residual Residual income.

Year Depn 12%
start of year flows charge income Net present value
Year 1 5,000,000 1,300,000 1,000,000 600,000 -300,000 0.89286 -267858.0
Year 2 4,000,000 1,500,000 1,000,000 480,000 20,000 0.79719 15943.8
Year 3 3,000,000 1,650,000 1,000,000 360,000 290,000 0.71178 206416.2
Year 4 2,000,000 1,650,000 1,000,000 240,000 410,000 0.63552 260563.2
Year 5 1,000,000 1,080,000 1,000,000 120,000 -40,000 0.56743 -22697.2
192,368*
* Difference due to rounding
b. Using the example you have calculated in (a), discuss the problems that arise
when companies use Residual Income as their only appraisal measure and
take a short term approach when rewarding managers. (5 marks)
pp.824–46.
A good answer to this part would highlight the difference between long
range decision making and short-run appraisal methods. It could also
briefly refer to the issue of lead and lag performance measures. The
answer should include reference to the figures calculated in part a) e.g.:
As can be seen from the table above the residual income on which the
manager would be rewarded is a loss in Year 1. This is mainly due to the
project taking some time to generate revenues and also the high value
of fixed assets at the beginning of the project, leading to a high capital
charge. This could result in the manager rejecting the opportunity as
rewards would be affected in the first year.
c. Succinctly discuss ways in which companies can create reward systems which
overcome these problems. (8 marks)
Present value of £1
Year 12%
1 0.89286
2 0.79719
3 0.71178
4 0.63552
5 0.56743
2

pp.824–46.
This part could discuss the problems highlighted by the question and ways
of improving the financial measures used by designing and using financial
measures more appropriately.
For example, many companies do not only use the all embracing methods
such as ROI for monitoring aspects of their operations. They may use
revenue generated, gross income, net income or EBITDA and ratios which
indicate ability to monitor and control costs. This often focuses manager’s
minds more on the reasons for the results rather than the results
themselves. If ROI, RI or EVA is used as part of the system, the appraisal
can be improved by using average investment or taking a view of financial
performance over several years. This would be fairer, more realistic and
more effective.
Horngren et al. suggest the following as a framework for choosing
appropriate appraisal methods (see textbook p.826):
i. choose performance measures that align with top management’s
financial goals
ii. choose the time horizon of each performance measure (i.e. consider
only one year or multiple years)
iii. choose a definition of the components of each performance measure
(e.g. should assets be defined as net assets or total assets, profit before
or after central charges, tax etc.?)
iv. choose a measurement alternative for each performance measure (e.g.
are assets valued at historical costs or current cost?)
v. choose a target level of performance (e.g. should all units have the
same target or be tailored to their circumstances?)
vi. choose the timing of feedback (e.g. daily, weekly, monthly, yearly).
Students may discuss the advantages and limitations of using a mixture of
financial and non-financial measures (for example, the balance scorecard
approach).
Question 2
Custom Boats Ltd works on contracts to customers’ specification for pleasure
boats. The company has been approached by Harbour Tours Ltd to accept a
contract to build a boat for a fixed price of £3,000,000… [For full question
please refer to the examination paper]
Required:
a. Advise Custom Boats Ltd on whether to accept the contract on financial
grounds. Support your advice with calculations. (8 marks)
Subject guide, Chapter 2, pp.18–22 and Chapter 6, pp.65–68; Horngren et al.
(13th edition) Chapter 4, pp.126–31; Chapter 11, pp.413–19 and Chapter 12,
pp.455–60.
This part requires the calculation of the relevant costs to compare with the
price.
3
Custom Boats Ltd – Statement to Determine Contract Desirability
Contract – 1628 Relevant Values

£000 £000
Sales 3,000
Labour: grade 1 (not relevant – underutilised) –
grade 2 60,000 hours x £8 (480)
Wood Replacement cost – £48 x 10,000 (480)
Glass Opportunity cost – £110 x 100 (11)
not selling
Variable production o/head £12 x 90,000 hours (1,080)
Fixed production o/head –
Personalised fitments (200)
Product Y
Lost sales 100 x £4,800 (480)
Cost avoided: Labour 50hrs x 100 x £8 40
Materials £280 x 100 28
Variable overheads 50hrs x 100 x £12 60
Contribution forgone (352)
Total costs (2,603)
Net advantage of 397
accepting
b. Show how the contract, if accepted, will be reported in the routine job
costing system used by Custom Boats Ltd. (5 marks)
As for part a) above.
A job costing approach is required using FIFO method for materials,
charging for all labour hours used at normal rates and charging for
overheads in the manner described in the question.
Full absorption cost approach – Contract 1628
£000 £000
Sales 3,000
Costs:
Labour grade 1 30,000 hrs x £16 (480)
grade 2 60,000 hrs x £8 (480)
Wood x £40 x 10,000 sq metres (400)
Glass 1 x £130 x 100sq metres (13)
Personalised fitments (200)
Variable overheads 90,000 hrs x £12 (1,080)
Fixed overheads 90,000 hrs x £8* (720) (3,373)
Net loss on contract (373)
4
c. Explain how each of the two methods (a) and (b) above are used by
businesses. (4 marks)
The answer to this part of the question requires an explanation of the
principles underlying the two methods. An answer which explained
the rationale behind each amount entered in the statements is not
appropriate. The answer could include the following:
Calculations in a) indicate the future cash cost/revenue impact of taking
the contract and show that a future positive cash flow would result. This
information is most useful when non-routine situations occur (e.g. spare
capacity or constrained capacity). In this case, assuming that it would
not lead to expectations by the customer of a similar price for subsequent
work, this contract should be accepted as the company will be more
profitable by accepting this work, in this situation.
Calculations in b) use full-absorption costing to trace all resources used
by the product at historical cost and include an average amount of fixed
overhead based on expected costs and activity. It shows this contract to be
unprofitable under normal circumstances. If the company regularly works
at expected capacity and overhead and profit margins are accurately set,
this pricing method should generate expected profits. In using this method
companies always need to compare the cost/price with the competition
and lower or raise their prices in order to maximise profits and stay
competitive. Where situations change from the original assumptions, this
method is not sensitive enough to guarantee that optimal decisions will be
made.
d. Calculate the difference in profit revealed in your answers to (a) and (b)
above. (8 marks)
Since the company uses a routine job costing system, if the contract
were accepted, the difference in profit would affect costs and revenues
elsewhere in the system. Draw up a schedule to explain which costs and
revenues would be affected by the decision (The total of your schedule
should agree with the difference between the profits calculated above).
This part of the question proves the validity of the relevant cost
approach by showing how, although the full cost approach shows a loss,
improvements recorded in other areas of the costing system will improve
in ways which are not easily seen at the time of making the decision.
The difference between the two calculations is £397 + £373 = £770.
5
If the contract is accepted, the changes will appear as follows:
£000
Actual production overheads reduced by the idle time not charged 480
(£16 x 30,000hrs)
Fixed overhead absorption will be increased by (£8 x 90,000) 720
Fixed overhead absorption will be decreased by not making rowing boats (40)
(50hrs x £8 x 100)
Wood difference between historical and replacement cost will be shown as (80)
a lower profit on the jobs which use the replaced material (£8 x 10,000)
Glass will not be sold which will save a loss on stockholding £20 x 100 2
Loss of profit from product Y as above £352 – £40 allocated overhead (312)
770
Question 3
Super Mechanics plc has various divisions making equipment for the building
trade. Division D makes complex electronic components that recognise
dampness in wood and concrete structures. These are sold to outside customers
and to Division M. Division M uses the components in the production of damp
metres which it sells to outside customers… [For full question please refer to
the examination paper]
Required:
a. i. Prepare estimated profit statements for one month at current output for
each division based on the transfer price of £800 per component.
ii. Calculate the total profits earned by the two divisions. (5 marks)
Subject guide, Chapter 9, pp.91–94; Horngren et al. 13th edition, Chapter 22,
pp.799–812.
This part uses the basic data from the question to enable the student to
become familiar with the question. Variable costs and revenues must be
correctly identified and the value of goods transferred must be shown as
sales in Division D’s statement and costs in Division M’s statement.
Preliminary calculations of unit contributions are as follows:
Transfer price of £800 Division D Division M

£ £
Selling price 800 1,500
Variable costs (400) (200)
Transfer price 0 (800)
Contribution 400 500
Profit statements Division D Division M Company

£ £
Total contribution (1,600 x £400) (600 x £500)
= £640,000 = £300,000
Less fixed costs 300,000 150,000
340,000 150,000 490,000
6
b. Determine the quantity and price at which Division M should sell the damp
metre:
As part a) above.
Optimal output is obtained where marginal cost equals marginal revenue.
Since the variable costs per unit do not change throughout the range
of demand, the variable cost equals the marginal cost. Obtaining the
marginal revenue can be approached in several ways. The most accurate
way is to use calculus and an extra mark was given for students who
obtained the answer shown by approach 1 or by interpolating in approach
3. Other correct arithmetic approaches used by students are also shown.
Part i) looks at the price from the point of view of Division M which is
the division able to make the decision on price. However, since the price
affects the output of Division D (which is assumed to have exhausted the
outside market, otherwise it would be already selling at full capacity), part
ii) looks at the situation for the company as a whole.
i. to maximise Divisional M’s profit at the existing transfer price.
Approach 1 – Assuming linear relationship between observed points.
The market research data indicates that a price change of £100 generates
a demand change of 150 units. A price demand equation can be thus
identified as:
p = 1,900 – 0.667q
p = price/bag
q = demand per metre
Profit is maximised when marginal revenue = marginal cost. Marginal
revenue is the derivative of the revenue function, thus:
r = price x demand = (1900 – 0.667q)q
r = 1900q – 0.667q2
MR = dr/dq = 1900 – 1.334q, {from y = axn, dy/dx = naxn-1}
Marginal cost = MC = (transfer price + variable cost) =
(£800 + £200) = £1,000 / bag
Thus, 1900 – 1.334q = 1,000, q = 675. If q = 675, by substitution,
p = £1450.
Approach 2 – Maximise Division M’s divisional profit at the existing
transfer price.
The marginal cost faced by Division M per metre is: transfer price £800 +
variable costs £200 = £1000.
7
Marginal revenue calculations
Division M
Price per Sales units Total MR £000
metre revenue
£000
£1,600 450 £720
£1,500 600 £900 £180
£1,400 750 £1,050 £150
£1,300 900 £1,170 £120
£1,200 1,050 £1,260 £90
£1,100 1,200 £1,320 £60
£1,000 1,350 £1,350 £30
The change in price/demand is measured per 150 units and so total

marginal cost is
£1,000 x 150 units = £150,000
The table shows that the optimal output is 750 metres at £1,400 per
metre.
Approach 3 – Contribution optimal output calculations
Unit contribution Units Total sales Total variable Total

costs contribution
£000 £000 £000
£1,600 – 1,000 = 600 450 720 450 270
£1,500 – 1,000 = 600 900 600 300
500
£1,400 – 1,000 = 750 1,050 750 300
400
£1,300 – 1,000 = 300 900 1,170 900 270
£1,200 – 1,000 = 200 1,050 1,260 1,050 210
£1,100 – 1,000 = 100 1,200 1,320 1,200 120
£1,000 – 1,000 = 0 1,350 1,350 1,350 0
The table shows both 600 units and 750 units provide the same total
contribution.
Interpolating between the two gives a price of £1,450 and a
quantity of 675 units.
To maximise Division M’s divisional profit at the existing transfer price:
Approach 1 table shows that the optimal output is 675 metres at
£1,450 per metre.
Approach 2 table shows the optimum output as 750 metres at £1,400
per metre.
Approach 3 table shows that the optimal output is either 600 metres
at £1,500 per metre or 750 metres at £1,400 per metre. Interpolating
gives = 675 metres at £1,450 per metre.
8
ii. to maximise the profit of Super Mechanics plc. (10 marks; total marks for
b.i and b.ii)
To maximise the total company profit requires consideration of
variable costs of both divisions which is:
Per metre Division D £400 + Division M £200 = £600
a demand change of 150 units. A price demand equation can be thus
identified as:
p = 1,900 – 0.667q
p = price/bag
q = demand per metre
r = 1900q – 0.667q2
Marginal cost = MC = (variable cost of D + variable cost of M) =
(£400 + £200) = £600/metre
Thus, 1900 – 1.334 q = 600, q = 975.
If q = 975, by substitution, p = £1250.
Approach 2
Company
Price per Sales units Total revenue MR
metre £000 £000
£1,600 450 £720
£1,500 600 £900 £180
£1,400 750 £1,050 £150
£1,300 900 £1,170 £120
£1,200 1050 £1,260 £90
£1,100 1200 £1,320 £60
£1,000 1350 £1,350 £30
To maximise the total company profit requires consideration of variable

costs of both divisions which is £600 x 150 units = £90,000
Unit Contribution Units Total sales Total variable Total

£000 costs £000 contribution
£000
£1,600 – 600 = 1,000 450 £720 270 450
£1,500 – 600 = 900 600 £900 360 540
£1,400 – 600 = 800 750 £1,050 450 600
£1,300 – 600 = 700 900 £1,170 540 630
£1,200 – 600 = 600 1050 £1,260 630 630
£1,100 – 600 = 500 1200 £1,320 720 600
£1,000 – 600 = 400 1350 £1,350 810 540
9
The table shows both 900 units and 1050 units provide the same total
contribution.
Interpolating between the two gives a price of £1,250 and a
quantity of 975 units.
Most accurate answer = 975 metres at £1,250 per metre.
c. Prepare estimated profit statements for one month for each division and for
the impact on the profits of Super Mechanics plc as a whole, based on your
answers to (b) i. & ii. above. (6 marks)
This part of the question focuses on calculating the impact of decision-
making on price. It is the natural next step in the investigation of changing
the price. It shows that if Division M maximises its own profits, this is
not optimal for the company as a whole. This indicates that the existing
transfer price system does not lead to goal congruent decisions. This
should be discussed in the answer to part d).
Since several prices were offered in part b), marks were awarded for the
use of the same price by the student in part c). Thus several answers are
provided here.
Regarding (b) i.
Division M’s contribution calculations with metre price of
£1,400
Selling price 1,400

Variable costs (200)
Transfer price (800)
Contribution per metre 400
750 units transferred – selling price of metres £1,400
Division D £000 Division M £ Company £000

Total (1,750 x £400) (750 x £400)=
contribution = £700 £300
Less fixed costs 300 150
400 150 550

£1,500
Selling price 1,500

10
Division D £000 Division M £000 Company £000

Total (1600, x £400) (600 x £500)
contribution = £640 = £300
340 150 490

£1,450
Selling price 1,450


Total (1,675 x £400) (675 x £450)
contribution = £670 = £303.75
Less fixed costs 300 150.00
370 153.75 523.75
Regarding (b) ii.

£1,200
Selling price 1,200

1050 units transferred – selling price £1,300

Total (2,050 x £400) (1050 x £200) =
contribution = £820 £210
520 60 580

£1,200
Selling price 1,300

11
Division D £000 Division M £ Company £000

Total (1,900 x £400) (900 x £300
contribution = 760 = £270
460 120 580

£1,250
Selling price 1,250


Total (1975 x £400) (975 x £250)
contribution = £790 = £243.75
Less fixed costs 300 150,00
490 93.75 583.75
d. Provide a considered view of the effectiveness of company’s existing transfer

pricing policy (using market price) and discuss one other alternative basis
that can be used. (4 marks)
Calculations in a) b) and c) show that total company profits increase
most by setting the price for metres at £1,250. However, Division M will
only be prepared to reduce the price to £1,450 as this is most profitable
for them. A reduction to £1,250 provides the most company profit but
reduces Division M’s profit below the amount they were earning at
£1,450. Division D’s profits increase proportionately with both increases
in demand as there is no change in the transfer price. In order to make
extra profit, Division D does not need to take any risks or incur marketing
expenses.
The discussion of one alternative basis requires a comparison of the
basis chosen with the market price based approach currently being used,
in terms of goal congruence, acceptance by the managers and ease of
adoption on a day to day basis.
For example, using opportunity cost as transfer price:
To encourage decisions in the best interest of the company as a whole,
a transfer price should be set at the opportunity cost of the transfer. In
this example, where there is spare capacity, the opportunity cost will be
the variable cost of £400 per component. If this rule is applied, Division
M will be able to identify the group’s opportunity cost (variable cost
in this case) and potential contribution. This is conceptually the best
approach. However, the manager of Division D will be reluctant to accept
this method because Division D will not obtain a contribution on internal
transfers and will not have any incentive to transfer goods to the retail
12
division. In practice it is also difficult to monitor opportunity cost in

changing business situations, whereas market price is easily obtainable in
this example.
Other methods which could be discussed are:
• Division M could pay Division D a lump sum payment per annum, for
meeting the retail division’s requirements.
• Total contribution of the two divisions could be determined and split
proportionately between the divisions on an agreed basis.
• The Divisions could negotiate the price which will benefit both
divisions.
Question 4
Garden Plastics Ltd is a small company selling a variety of stackable garden
chairs to the trade and retail stores. The company has identified three major cost
pools, ordering, storage and shipping. The following information relates to actual
activities in the year ended 30th April 2010… [For full question please refer to
the examination paper]
Required
a. Calculate the net income and the net income as a percentage of sales made
by Garden Plastics Ltd for the year ended 30th April 2010. (5 marks)
Subject guide, Chapter 7; Horngren et al. (13th edition), Chapter 5, pp.170–78.
Unusually for an ABC question this company has been able to identify the
variable and fixed elements of the cost for each activity. This is a more
realistic approach in terms of providing good information for decision
making. Although in the long run all costs may be variable, in the short-
run some of them are fixed so the allocation of these costs may well result
in over/under absorption but the variable elements can reliably be used
for calculations of contributions.
Net income 2010 £ £

Sales 5,000,000 x £10 50,000,000
Cost of sales 5,000,000 x £7.50 37,500,000
Gross income 12,500,000
Less costs ordering variable 5,000 x £100 500,000
Fixed 720,000 1,220,000
Storage variable 20,000 x £60 1,200,000
Fixed 1,200,000 2,400,000
Shipping variable 16,000 x £70 1,120,000
Fixed 800,000 1,920,000
General fixed costs 2,000,000
Total costs 7,540,000
Net income 4,960,000
Net income/sales 9.9%
13
b. Assuming that general fixed costs are allocated based on numbers of chairs
ordered and using appropriate cost drivers, calculate the contribution, the
Activity Based Cost net income, and the net income as a percentage of sales,
for each of the following two orders: (8 marks)
Sales Order 672 Sales Order 680

Chairs ordered 80,000 1,000
Ordering 3 different orders 40% of 8 different orders

This part requires an ABC analysis to be performed for each of the sales
orders provided. The requirement to calculate contribution means that
the fixed and variable activity charges must be calculated separately.
Providing contribution calculated as sales minus cost of tiles is not correct.
Workings for fixed cost drivers
Fixed cost drivers 2010

Ordering £720,000/5,000 = £144
Storage £1,200,000/20,000 = £60
Shipping £800,000/16,000 = £50
General £2,000,000/5,000,000 = £0.40
Order 672 £ Order 680 £

Chairs ordered 80,000 x £10 800,000 1,000 x £10 10,000
Variable costs
Cost of tiles 80,000 x £7.50 600,000 1,000 x £7.50 7,500
Ordering 3 x £100 300 40% of 8 x £100 320
Storage 4 loads x £60 240 12 loads x £60 720
Shipping 1 shipment 70 2 shipments 140
Total variable costs 600,610 8,680
Contribution 199,390 1,320
Fixed costs
Ordering 3 x £144 432 40% of 8 x £144 460.8
Shipping 1 shipment x £50 50 2 shipments x £50 100
General fixed costs 80,000 x £0.40 32,000 1,000 x £0.40 400
Total fixed cost 32,722 1680.8
Net income 166,668 (360.8)
Net income/sales % 20.8% (3.6%)
Some students may have answered this part of the question

by using the 2011 estimates. The answer for this is shown
below. Equal marks were given for this approach.
14
Workings for fixed cost drivers
Fixed cost drivers 2011

Ordering £720,000/4,000 = £180
Storage £1,500,000/15,000 = £100
Shipping £800,000/16,000 = £50
General £2,000,000/5,000,000 = £0.40
Order 672 £ Order 680 £

Chairs ordered 80,000 x £9.50 760,000 1,000 x £9.50 9,500
Variable costs
Cost of tiles 80,000 x £7.20 576,000 1,000 x £7.20 7,200
Ordering 3 x £100 255 40% of 8 x £100 272
Shipping 1 shipment x £70 70 2 shipments 140
Total variable costs 576,565 8332
contribution 183,435 1168
Fixed costs
Ordering 3 x £180 540 40% of 8 x £144 576
Total fixed cost 32,990 2,036
Net income 150,445 (868)
Net income/sales % 19.8% (9.1%)
c. Compare the two orders and comment on the reasons for differences in
profitability. (3 marks)
As for a) above.
The answer requires demonstration of an understanding of how ABC
information is used to provide information for decision making. The
answer should make reference to the figures provided in part b). For
example:
Order 672 is a large, uncomplicated order. It requires chairs from three
different suppliers but the whole order is all shipped at the same time.
By contrast order 680 is very small and requires chairs of eight different
types, requiring 12 amounts of loading and is shipped either to two places
or on two dates. This makes Order 680 very resource intensive which is
reflected in the higher costs and a loss when attributed fixed costs are
included, although it is making a positive contribution.
Comparing the overall profit margin and the profit margins shown in the
two orders, it would appear that a high proportion of sales orders requires
detailed attention.
15
d. Using the figures provided above create a budget for year ended 30th April
2011. (4 marks)
As for a) above.
Budgeted net income 2011

Sales 5,000,000 x £9.50 47,500,000
Cost of sales 5,000,000 x £7.20 36,000,000
Less costs Ordering variable 4,000 x £85 340,000
Fixed 720,000 1,060,000
Storage variable 15,000 x £60 900,000
Fixed 1,200,000 2,100,000
Shipping variable 16,000 x £70 1,120,000
Fixed 800,000 1,920,000
e. Garden Plastics Ltd wishes to make a fixed charge on small sales orders (of
1,000 chairs or less). If 2,000 small sales orders are expected in the year
ended 30th April 2011, calculate the charge per order which will be needed
to meet Garden Plastics Ltd’s profit target. Using information from (b) above
discuss a different way of setting a charge for complicated orders. (5 marks)
Shortfall in net income/number of small sales orders:
4,960,000 – 4,420,000 = 540,000/2,000 = £270.
The charge could be based on the usage of the facilities, using the ABC
drivers to compute a varying charge based on the requirements of the
customer. This would be fairer and would enable customers to be aware
of the cost of complexity and consider this when making their orders. This
could apply to all orders: alternatively, charging rates could allow for a
certain level of provision with no charge (e.g. over 20,000 chairs) so that
customers who have large simple orders are not driven away.
Section B
Answer one question from this section and not more than one further
are to be attempted with at least two from Section A.)
Question 5
Companies need to forecast in order to make both long-term and short-term
decisions. Discuss the role that management accounting plays in forecasting in
large organisations.
Subject guide, Chapters 1 and 5; Horngren et al. (13th edition), Chapters 6 and
13.
16

This question involves an explanation of the processes of forecasting and
the management accounting role in the provision of information for this. A
good structure will assist in providing a good answer. The answer should
identify different management accounting tools which are available for
this purpose and discuss their appropriateness in different situations.
Long-term planning
Include areas considered in long-term strategic forecasting:
• competitive pressures, new products, new markets
• business portfolio – mix of steady products and markets versus risky
products and markets
• innovation.
Management accounting’s role in this:
Management accounting needs to be involved in providing the figures for
all these alternative plans which will include extrapolating from existing
known cost and revenues and working with other professionals who are
estimating new opportunities (sales) and new resource needs.
Discuss techniques which may be used and when they are appropriate,
(e.g. capital budgeting, life cycle budgeting, post implementation project
monitoring).
Short-term planning – annual
Discuss short term forecasting needs, for example:
• annual budget – would lead to discussion of all aspects of why and
how budget is needed, implemented and monitored
• beyond budgeting – could discuss setting targets rather than detailed
budgets.
Even shorter than annual
If students interpret short-term as shorter than one year they may talk
about maximising scarce resources, taking on orders where business is
slack, etc.
There is scope for many interpretations of this question but they must
continually relate back to the question.
Question 6
Describe the four different categories into which the costs and benefits of
activities to improve quality within organisations are often divided. Give
examples of the costs which would appear in each category. Explain how
benefits can be quantified financially and describe how non-financial benefits
can be identified and measured.
Subject guide, p.102; Horngren et al. (13th edition), Chapter 19, pp.693–95.
This is a largely factual question and all parts should be answered to
obtain good marks.
This can either be done by including all aspects, examples, how quantified
and non-financial measures within each category, or providing examples
first and discussing other aspects later.
17
The ideas below can be described in more detail and supported with
examples to earn good marks.
Prevention – purpose, preclude possibility of making products which do
not conform to standards.
Examples:
• design engineering
• product testing labour and equipment
• preventive maintenance, etc.
• quality training
• incoming materials inspection
• supplier evaluation.
Comments
To be most effective, prevention activities should be built into routines
at the same time as manufacturing processes are being designed. Later
introductions can usually be justified financially by improved efficiency
and fewer defective products.
Appraisal – purpose, detecting products that do not conform to
standard.
Examples
• inspection of production
• product testing
• bonus payments for high levels of good output.
Comments
As for prevention: encourages continuous improvement. This may include
analysis of main areas of poor work which can be rectified.
Internal failure – costs arising due to imperfect products which are
identified before shipment.
Examples
• scrap costs
• rework costs
• breakdown repairs.
Comments
Inspection at intervals in the process may be most effective as specific
poor work can be identified and reworked; otherwise it may cause delays
or poor work further along the process.
External failure – cost arising from imperfect products which are sold
to customers.
Examples
• cost of returned goods
• customer support
• warranty repair
• liability claims
• drop in sales through poor reputation.
18
Comments
This is the most important failure because it affects customer attitudes; all
other activities are aimed at minimising this failure.
Quantifying benefits
Information can be used to highlight the costs of poor practice, evaluate
trade-offs between the various categories and explore ways of improving
internal processes. Different quality improvement programmes can be
compared. Comparison over time can highlight problem areas.
Some of the most important costs (e.g. customer satisfaction and
reputation, staff morale) cannot be easily quantified. Non-financial
measures can be used (e.g. customer and staff questionnaire research).
Question 7
a. In relation to responsibility accounting and the budgetary process explain the
meanings of the following terms and the contexts in which they are used:
i. cost centre
ii. revenue centre
iii. profit centre
iv. investment centre. (10 marks)
Subject guide, Chapter 5, pp.55–56 and pp.59–60; Horngren et al. (13th edition),
Chapter 6, pp.223–27 and pp.266–68.
Each of the terms should be described in detail, giving the purposes for
their adoption by an organisation and the context in which each is more
appropriate.
b. Identify and explain six factors which need to be considered when
interpreting variances. (15 marks)
The subject guide gives good information for the answer to this question
(p.59).
The following headings should be amplified to demonstrate
understanding:
• significance – is the variance worth investigating? What rule does
company adopt?
• reliability of standards
• reliability of cost data
• interactions – mutual dependencies
• responsibility
• appropriate use of variance information.
19
Question 8
a. Many of the techniques developed for decision making assume that costs
can be correctly divided into fixed and variable costs. Explain the techniques
which companies can use to calculate the fixed and variable elements of cost
and discuss the difficulties which can arise in obtaining accurate results.
(12 marks)
Subject guide, Chapter 3, p.19; Horngren et al. (13th edition), Chapter 10, pp.362–
98.
Answers may include:
Consideration of Six Steps in quantitative analysis (Horngren
p.339):
• choose dependant variable
• identify independent variable or cost driver
• collect data on the dependant variable and the cost driver
• plot the data
• estimate the cost function
• evaluate the cost driver of the estimated cost function – may need to
perform analysis using several cost drivers to determine which is more
accurate.
Discussion of importance of choice of cost object, relevant
range and time horizon
Types of techniques
Observation techniques
• Industrial engineering method – uses work measurement methods –
thorough and detailed
time consuming, costly.
• Conference method – analysis and estimates of costs and their drivers
from different departments.
encourages interdepartmental co-operation and understanding;
uses opinion rather than systematic estimation;
accuracy of estimates depend on the care and skill of those
providing inputs.
• Account analysis – inspection of behaviour of each type of expense –
for example, indirect labour – may use quantitative analysis as part of
the inspection.
Quantitative techniques
• High low method – choose highest and lowest observations and
interpolate between them.
Easy to understand and perform.
Observations chosen may be outliers.
• Regression analysis – incorporates all observations to determine cost
behaviour.
Much more accurate than high low, incorporates more data.
Slightly more time consuming.
20
General difficulties with all methods

• There may be no past data for statistical purposes and/or no real
correlation observable.
• Cost benefit of achieving greater accuracy.
• Compromise needed if data cannot be split accurately – usually
involves treating variable costs as fixed – with resultant impacts on
reliability of decision and forecasts.
b. Using examples explain the difference between variable costs and direct
costs and explain why it is important that users of cost information know and
understand the difference between the two. (5 marks)
Horngren et al. (13th edition), Chapter 2, pp.53–60.
A dangerous, common assumption is that direct costs are variable and
indirect costs are fixed. A good answer would demonstrate a clear
understanding that the two terms are needed for different purposes in
using cost information.
c. Define the term “Opportunity Cost” and explain why opportunity costs are
rarely captured by a company’s accounting information system. (8 marks)
Subject guide, Chapter 2, p.19; Horngren et al. (13th edition), Chapter 11, p.422.
The reasons why opportunity costs are rarely captured by a company’s
accounting system is not covered in the readings and so requires students
to use their understanding of opportunity cost and their knowledge of
how accounting systems are structured in order to answer the question.
Some suggestions are:
• Opportunity cost changes depending on other factors e.g. depending
on alternative use of resource; opportunity cost varies from 0 to lost
contribution of highest competing alternative.
• May be difficult to measure financially.
• Often does not involve a transaction so cannot be picked up as part of
the data processing mechanism.
21
This paper is not to be removed from the Examination Halls
UNIVERSITY OF LONDON 279 0097 ZB
BSc degrees and Diplomas for Graduates in Economics, Management, Finance and
the Social Sciences, the Diploma in Economics and Access Route for Students in the
External Programme
Management Accounting
Tuesday, 25 May 2010 : 10.00am to 1.15pm
Candidates should answer FOUR of the following EIGHT questions: TWO from Section
A, ONE from Section B and ONE further question from either section. All questions carry
equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.
8-column accounting paper is provided at the end of this question paper. If used, it must be
detached and fastened securely inside the answer book.
A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.
© University of London 2010

PLEASE TURN OVER
UL10/0216
D01 Page 1 of 7
SECTION A
Answer two questions from this section and not more than one further question from tihs section. (You
are reminded that four questions in total are to be attempted with at least one from Section B.)
1. Fine Clays plc extracts and refines china clay. It is organised into two trading divisions: The
Industrial Clays Division handles wholesale business and the Clay Shops Division sells to retailers.
The Industrial Clays Division extracts moulding clay and sells it to external customers and to the
Clay Shops Division. The external wholesale market price is £1,800 per tonne. The transfer price
per tonne has been set at market price, in line with company transfer pricing policy.
The Industrial Clays Division’s production capacity is 2,000 tonnes per month, but current sales are
only 1,000 tonnes per month to external customers and 600 tonnes per month to Clay Shops
Division.
The Clay Shops Division produces 100 bags of refined clay from each tonne of moulding clay,
which it sells at £40 per bag.
Other data relevant to the operation are:
Division Industrial Clays Clay Shops
£ £
Variable costs per tonne (excluding transfer price) 1,000 400
Fixed costs per month 700,000 400,000
The Clay Shops Division wishes to expand sales and has performed market research to determine
the effect of changes in price on demand. The results are as follows:
Price per bag Estimated sales (bags)
£42 50,000
£40 60,000
£38 70,000
£36 80,000
£34 90,000
£32 100,000
£30 110,000
Required:
(a) Prepare estimated profit statements for one month for each division and for Fine Clays plc as
a whole, based on transfer price of £1,800 per tonne at current output. (5 marks)
(b) Determine the quantity and price at which the Clay Shops Division should sell the bags:
i. to maximise Clay Shop’s divisional profit at the existing transfer price.
ii. to maximise Fine Clay plc’s overall profit. (10 marks)
(c) Prepare estimated profit statements for one month for each division and for Fine Clays plc as
a whole, based on your answers to (b) i. and ii. above. (6 marks)
(d) Provide a considered view of the effectiveness of company’s existing transfer pricing policy
(using market price) and discuss one other alternative basis that could be used.
(4 marks)
UL10/0216
D01 Page 2 of 7
2. Crabtree Ltd makes a range of its own products and works on contracts to customer’s specification.
Crabtree Ltd has been approached to accept a contract for the production of 20,000 Kg of product
X at a price of £400 per Kg.
The resources used in the production of 1 Kg of X are:
Resources per Kg of X
Labour – Grade 1 2 hours
Grade 2 6 hours
Material – A 2 units
B 1 litre
Grade 1 labour is highly skilled and although it is currently under-utilised in the firm it is
Crabtree’s policy to continue to pay Grade 1 labour in full. Acceptance of the contract would
reduce the idle time of Grade 1 labour. Idle time payments are treated as production overheads.
Grade 2 is unskilled labour with a high turnover and is considered a variable cost.
The costs to Crabtree Co Ltd of each type of labour are:

Grade 2 £7.50 per hour
The materials required to fulfil the contract would be drawn from materials already in inventory.
Material A is widely used within the firm and the amounts used by this contract will need to be
replaced. Material B was purchased to fulfil an expected order which was not completed; if material
B is not used for this contract it will be sold. For accounting purposes FIFO is used. The various
values and costs for A and B are:
A B
per unit per litre
£ £
Book value 32 120
Replacement cost 40 128
Net realisable value 36 100
Variable production overheads are £12 per productive labour hour using both skilled and unskilled
labour. A single recovery rate for fixed factory overheads is used throughout the firm. The
overhead is recovered per productive labour hour (skilled and unskilled). Estimates of the year’s
activity show budgeted annual fixed production overheads of £2,400,000 and budgeted productive
labour hours of 400,000.
A special machine is required for this contract. The fixed costs of running and depreciating the
machine are included in production overhead. Accepting the contract would not cause these costs to
change but using the machine time would mean that Crabtree Co Ltd would not be able to make
5,000 units of product Y, a product in regular demand, thus decreasing the total expected sales.
(question continues on next page)
UL10/0216
D01 Page 3 of 7
Details of Product Y’s revenues and costs are as shown below.
Per unit
Sales price £280
Labour – grade 2 4 hours
Materials – relevant variable £48
costs
Crabtree Co Ltd uses full absorption job costing in order to derive a profit figure for each contract.
If the contract for X is accepted, it will be treated as a separate job for routine costing purposes.
Required:
(a) Based on financial grounds, advise Crabtree Ltd whether or not to accept the contract.
Support your advice with calculations. (8 marks)
(b) Show how the contract, if accepted, will be reported in the routine job costing system used by
Crabtree Ltd (5 marks)
(c) Explain how each of the two methods (a) and (b) above are used by businesses.
(4 marks)
(d) i. Calculate the difference in profit revealed in your answers to (a) and (b) above.
(1 mark)
ii. Since Crabtree Ltd uses a routine job costing system, accepting the contract would
mean that the difference in profit would have impacts on costs and revenues elsewhere
in the system.
Draw up a schedule to explain which costs and revenues would be affected by accepting
the contract. (The total of your schedule should be the difference in profits which you
have already calculated). (7 marks)
UL10/0216
D01 Page 4 of 7
3. Digital Gadgets, a division of a large group, is developing a new product with a predicted four year
life. To produce this product more building space will be needed. To provide this space, Digital
Gadgets can lease a derelict site for four years, after which time the site must be cleared. Digital
Gadgets plans to hire prefabricated buildings to be used on the site, so that the buildings can be
easily removed after four years. Maximum production capacity available will be 100,000 units per
year.
The estimated costs and revenues are:
Fixed costs (£) Variable costs Sales Volume
Months 1-4 Product Design 700,000
Install rented buildings 500,000
Equipment costs 200,000
Yearly buildings rental 20,000
Months 5-12 Production & admin 200,000 £20 per unit 30,000 units
Marketing & promotion 500,000 £2 per unit
Months 13-24 Production & admin 200,000 £20.50 per unit 80,000 units
Months 25-36 Redesign costs 100,000
Production & admin 200,000 £23 per unit 100,000 units
Months 37-48 Production & admin 200,000 £23 per unit 60,000 units
Dismantling site etc 1,000,000
Digital Gadgets estimates that the price will be £50 per unit from month 5 to month 24. In month 25
there will be a re-launch of the product with new features. At this stage, the price will be increased
to £55 until month 48. The manager wishes to see the total impact on profits of this plan.
Required:
(a) Prepare a lifecycle costing statement for this product (ignore the time value of money).
(7 marks)
(b) The manager is disappointed with the sales forecast for the final year (months 37-48) and
explores possibilities of reducing the price to £52 and increasing marketing and promotion by
£200,000. Demand forecasts indicate:
50% probability that sales units will not increase as the gadget is losing popularity,
40% probability that sales will increase to 80,000 units,
10% probability that sales will increase to 110,000 units.
Provide calculations and comment on whether the manager’s idea should be adopted.
(5 marks)
(c) Show the profits that would be reported each year. Assume that product development costs
and site dismantling costs are expenses in the income statement the year they are incurred; the
cost of installation of buildings and the equipment costs are depreciated using the straight line
method with no residual value. (6 marks)
(d) Explain how your forecasts in (a) to (c) would be used by the divisional manager.
(4 marks)
(e) The group operates a divisional managers’ bonus scheme, based on annual profits. Briefly
discuss the effect this may have on the manager’s decision to adopt this project.
(3 marks)
UL10/0216
D01 Page 5 of 7
4. Decorative Tiles Ltd is a small company distributing wall tiles to the trade and retail stores. The
company has identified three major cost pools, ordering, storage and shipping. The following
information relates to actual activities in the year ended 30th April 2010:
(number of) cost driver variable fixed
Storage Loads moved 20,000 loads £30 per load £600,000
The general fixed costs were £1,000,000. The sales were 5,000,000 tiles at £5 per tile and average
cost of purchase was £3.75 per tile.
For the year ending 30th April 2011, Decorative Tiles Ltd forecasts a 5% reduction in selling price
due to competitive conditions. The company considers that the same number of tiles as in 2010 can
be sold if the price is reduced by 5%. However suppliers of tiles will give only a 4% reduction in
price. Through arrangements with suppliers and reconfiguration of their internal operations
Decorative Tiles Ltd considers that the following can be achieved:
(number of) costs driver variable fixed
Storage Loads moved 15,000 loads £35 per load £600,000
General fixed cost would remain the same as 2010.
The company wishes to achieve at least as much profit in 2011 as in 2010.
Required:
(a) Calculate the net income and the net income as a percentage of sales made by Decorative
Tiles Ltd for the year ended 30th April 2010. (5 marks)
(b) Assuming that general fixed costs are allocated based on numbers of tiles ordered and using
appropriate cost drivers, calculate the contribution, the Activity Based Cost net income, and
the net income as a percentage of sales, for each of the following two orders:
Activity Sales Order 672 Sales Order 680
Tiles ordered 80,000 1,000
ordering 50% of 3 different orders 20% of 8 different orders
(8 marks)
(c) Compare the features of the two orders and comment on the reasons for differences in
profitability. (3 marks)
(d) Using the figures provided above prepare a budget for year ended 30th April 2011.
(4 marks)
(e) The company is considering adding a fixed charge on all sales orders of 1,000 tiles or less. In
2010, this amounted to 2,000 orders. Assuming that the same pattern continues, calculate the
charge per order which would be needed meet the company’s profit target. Using information
from (b) above discuss a different way of setting a charge for complicated orders.
(5 mark)
UL10/0216
D01 Page 6 of 7
SECTION B
Answer one question from this section and not more than one further question from this section. (You
are reminded that four questions in total are to be attempted with at least two from Section A.)
5. Discuss the role of management accounting information in supporting the strategic management
activities of organisations.
6. (a) Draw a diagram to show the separate budgets necessary to produce complete operating
budgets and financial budgets for a manufacturing organisation. You should indicate the
inter-relationships between budgets, where appropriate. (10 marks)
(b) In relation to the use of variance analysis in responsibility accounting, briefly explain the
following:
i. Controllable and uncontrollable variances and how these can be indentified;
ii. Performance measurement using variances;
iii. Organisational learning using variances. (15 marks)
7. (a) i. Meeting customers’ expectations is vital for profitability. Explain the term “customer
response time” and describe, with examples, two reasons why delays in meeting
customer expectations occur. (5 marks)
ii. Describe how customer response time could be improved in a student canteen and how
the costs and benefits could be quantified. (4 marks)
(b) i. Explain the “Theory of Constraints” and define the following:
 Throughput contribution;
 Investments;
 Operating costs. (4 marks)
ii. Describe the process of managing bottlenecks. (6 marks)
iii. Discuss the situations in which it may be more appropriate to use linear programming
approaches as a decision tool rather than “Theory of Constraints”. (6 marks)
8. Describe the following pricing methods, explain the situations when each method is likely to be
used and the problems of each method:
(a) Market based price

(b) Peak-load pricing
(c) Contribution margin pricing
(d) Return on Investment pricing
(e) Cost-plus pricing where there is a learning curve effect.
END OF PAPER
UL10/0216
D01 Page 7 of 7

97 Management accounting – Zone B
Important note
This commentary reflects the examination and assessment arrangements
for this unit in the academic year 2009–10. The format and structure of
the examination may change in future years, and any such changes will
be publicised on the virtual learning environment (VLE).
Specific comments on questions

Candidates should answer FOUR of the following EIGHT questions:
TWO from Section A, ONE from Section B and ONE further question
from either section. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations.
Any necessary assumptions introduced in answering a question are to be
stated.
8-column accounting paper is provided at the end of this question paper. If
used, it must be detached and fastened securely inside the answer book.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.
Section A
Answer two questions from this section and not more than one further
are to be attempted with at least one from Section B.)
Question 1
Fine Clays plc extracts and refines china clay. It is organised into two trading
divisions: The Industrial Clays Division handles wholesale business and the Clay
Shops Division sells to retailers… (For full question please refer to examination
paper)
Reading for this question (all parts)
Subject guide, Chapter 9, pp.91–94; Horngren et al. (13th edition), Chapter 22,
pp.799–812.
Required
a. Prepare estimated profit statements for one month for each division and
for Fine Clays plc as a whole, based on transfer price of £1,800 per tonne at
current output. (5 marks)
This part uses the basic data from the question to enable students to
become familiar with the information. Variable costs and revenues must
be correctly identified and the value of goods transferred must be shown
as sales in Industrial Clays’ statement and costs in Clay Shops’ statement.
1
Preliminary calculations of contribution per tonne are as

follows:
(Clay Shops price per tonne = £40 x 100 bags = £4,000)
Transfer price of £1800 Industrial Clays £ Clay Shops £

Selling price 1,800 4,000
Variable costs (1,000) (400)
Transfer price 0 (1,800)
Contribution per tonne 800 1,800
Profit statements Industrial Clays £ Clay Shops £ Company

Total contribution (1,600 x £800) (600 x £1,800)
= £1,280,000 = £1080,000
Less fixed costs 700,000 400,000
580,000 680,000 1,260,000
b. Determine the quantity and price at which the Clay Shops Division should sell
the bags:
ii. to maximise Fine Clay plc’s overall profit. (10 marks)
Optimal output is obtained where marginal cost equals marginal
revenue. Since the variable costs per unit do not change through the
range of demand, the variable cost equals the marginal cost. Obtaining
the marginal revenue can be approached in several ways. The most
accurate way is to use calculus and an extra mark was given for students
who obtained the answer shown by this approach or by interpolating in
approach 3. Other correct arithmetic approaches used by students are also
shown.
Part i)
Part i) looks at the price from the point of view of Clay Shop’s which is
the division able to make the decision on price. However since the price
affects the output of Industrial Clays (which is assumed to have exhausted
the outside market, otherwise it would be already selling at full capacity).
Part ii) looks at the situation for the company as a whole.
The marginal cost faced by Clay Shop per bag is:
Transfer price £18 + variable costs £4 = £22
a demand change of 10,000 units. A price demand equation can be thus
identified as:
p = 52 – 0.2q p = price / bag q = demand (thousand bags).
r = 52q – 0.2q2
Marginal cost = (transfer price + variable cost) = (£18 + £4)
= £22/bag
2
Thus, 52 – 0.4q = 22 q = 75.

That is, 75,000 bags. If q = 75, by substitution, p = £37.
Approach 2 – Marginal revenue calculations
Clay shops Division

Price per bag Sales units Total revenue MR from bags
from bags
£42 50,000 £2,100,000
£40 60,000 £2,400,000 £300,000
£38 70,000 £2,660,000 £260,000
£36 80,000 £2,880,000 £220,000
£34 90,000 £3,060,000 £180,000
£32 100,000 £3,200,000 £140,000
£30 110,000 £3,300,000 £100,000
The change in price/demand is measured in 10,000 units, total marginal

cost is £22 x 10,000 = £220,000. MR = MC at price £36, units 80,000.
Unit Units Total sales Total variable Total

Contribution £000 costs £000 contribution
£000 £000 £000
£42-22 = 20 50,000 2,100 1,100 1,000
£40-22 = 18 60,000 2,400 1,320 1,080
£38-22 = 16 70,000 2,660 1,540 1,120
£36 -22 = 14 80,000 2,880 1,760 1,120
£34-22 = 12 90,000 3,060 1,980 1,080
£32-22 = 10 100,000 3,200 2,200 1,000
£30-22 = 8 110,000 3,300 2,420 880
The table shows both 70,000 units and 80,000 units provide the same
total contribution. Interpolating between the two observations – price
£37, units 75,000.
Any of the above approaches would receive marks.
Part ii)
To maximise the total company profit requires consideration of variable
costs of both divisions which is:
per bag Industrial Clays (£1,000/100) £10 + Clay Shops £4 = £14
Approach 1 – Assuming linear relationship between observed points –
as above.
p = 52 - 0.2q
r = 52q - 0.2q2

MR – 52 - 0.4q
Marginal cost (as above) = (£10 + £4) = £14 / bag
MR =MC, 52 – 0.4q = 14 q = 95
That is 95,000 bags. If q = 95, by substitution p = 33
3
Approach 2 – Marginal revenue calculations
Company
Price per bag Sales units Total revenue MR from bags
from bags
£42 50,000 £2,100,000
£40 60,000 £2,400,000 £300,000
£38 70,000 £2,660,000 £260,000
£36 80,000 £2,880,000 £220,000
£34 90,000 £3,060,000 £180,000
£32 100,000 £3,200,000 £140,000
£30 110,000 £3,300,000 £100,000
Total marginal cost for 10,000 bags is £140,000

The optimal output for the company is 100,000 bags (1,000 tonnes) at
£32 per bag
Contribution Units Total sales Total variable Total contribution

costs
£000 £000 £000
£42-14 = 28 50,000 2,100 700 1,400
£40 -14 =26 60,000 2,400 840 1,560
£38 -14 =24 70,000 2,660 980 1,680
£36-14 = 22 80,000 2,880 1120 1,760
£34-14 = 20 90,000 3060 1260 1,800
£32-14 = 18 100,000 3200 1,400 1,800
£30-14 =16 110,000 3300 1540 1760
The table shows both 90,000 units and 100,000 units provide the same
total contribution.
Interpolating between the two observations – price £33, units 95,000
Maximise the total company profit:
• Approach 1 shows the optimal to be 95,000 bags at £33 per bag.
• Approach 2 shows that the optimal output is 100,000 bags (1,000
tonnes) at £32 per bag
• Approach 3 table shows that the optimal output is either 90,000 bags
at £34 per bag or 100,000 bags at £32 per bag or interpolating 95,000
bags at £33 per bag. Most accurate answer = 95,000 bags at £33
Any of the above approaches would receive marks.
b. Prepare estimated profit statements for one month for each division and
for Fine Clays plc as a whole, based on your answers to (b) i. and ii. above.
(6 marks)
This part of the question focuses on calculating the impact of alternative
prices. It is the natural next step in the investigating the changes in price.
It shows that if Clay Shops maximises its own profits, this is not optimal
for the company as a whole. This indicates that the existing transfer price
system does not lead to goal congruent decision. This should be discussed
in the answer to part d).
4
Since several prices were offered in part b), marks were awarded for the
use of the same price as calculated by the student in part c). Thus several
answers are provided here.
Regarding (b) i.
Clay Shops contribution calculations with shop price of £38
(per tonne £3,800)
Selling price 3,800

Transfer price (1,800)
Contribution per tonne 1,600
700 tonnes transferred – selling price of bags £38
Industrial Clays Clay Shops Company

tonnes £000 tonnes £000 £000
Total sales 1,700 3060 700 2660
Less total variable costs 1700 1540
Total contribution = £1,360 = £1,120
660 720 1,380
Clay shops contribution calculations with shop price of £37
(per tonne £3,700)
Selling price 3,700


Total sales 1,750 3150 750 2775
700 725 1,450
(per tonne £3,600)
Selling price 3,600

5

Total sales 1,800 3240 800 2880
740 720 1,460
Regarding (b) ii.
(per tonne) £3,400
Selling price 3,400

900 tonnes transferred

Total sales 1,900 3,420 900 3,060
Less total variable costs 1,900 1,980
820 680 1,500
(per tonne) £3,300
Selling price 3,300

950 tonnes transferred

Total sales 1,950 3,510 950 3,135
Total contribution £1,560 £1,045
860 645 1,545
(per tonne) £3,200
Selling price 3,200

6
1,000 tonnes transferred

Total sales 2,000 3,600 1000 3,200
900 600 1,500
c. Provide a considered view of the effectiveness of company’s existing transfer
pricing policy (using market price) and discuss one other alternative basis
that could be used. (4 marks)
The most important aspect of this part of the question is recognising that
the calculations in part c) indicate a non goal congruent situation created
by the market based transfer price system assuming that Industrial Clays
division has saturated their own external market.
Calculations in a), b) and c) show that total company profits increase
most by implementing the price reduction for external retail sales to
£33 (£34 or £32). However Clay Shops division will only be prepared to
reduce the price to £37(£38 or £36) as this improves their own profit,
whereas the reduction to £33(£34 or £32) provides the most company
profit but reduces Clay Shops profit equal to or below the amount they
were earning at £40 and below the amount they earn at £37(£38 or £36).
The Industrial Clay Division’s profits increase proportionately with both
increases in demand without the division having to take any risks or incur
marketing expenses.
The discussion of one alternative basis requires a comparison of the basis
chosen with the market based approach currently being used, in terms of
goal congruence, acceptance by the managers and ease of adoption on a
day to day basis.
For example, using opportunity cost as transfer price.
To encourage decisions in the best interest of the company as a whole, a
transfer price should be set at the opportunity cost of the transfer. In this
example, when there is spare capacity, the opportunity cost will be the
variable cost of £1,000 per tonne. If this rule is applied, the retail division
will be able to identify the group’s opportunity cost (variable cost in this
case) and potential contribution. This is conceptually the best approach,
however, the manager of Industrial Clays will be reluctant to accept this
method because Industrial Clays division will not obtain a contribution on
internal transfers and will not have any incentive to transfer goods to the
retail division. In practice it is also difficult to monitor opportunity cost in
changing business situations, whereas market price is easily obtainable in
this example.
Other methods which could be discussed are:
Clay Shops Division pays Industrial Clays Division a lump sum payment
per annum, representing a standing charge for meeting the Clay Shops
Division’s requirements.
Total contribution of the two divisions is determined and split
proportionately between them on an agreed basis.
The Divisions negotiate the price which will benefit both divisions.
7
Question 2
Crabtree Ltd makes a range of its own products and works on contracts to
customer’s specification. Crabtree Ltd has been approached to accept a contract
for the production of 20,000 Kg of product X at a price of £400 per Kg… (For full
question please refer to examination paper)
Subject guide, Chapter 2, pp.18–22 and Chapter 6, pp.65–68; Horngren et al.
(13th edition), Chapter 4, pp.126–31; Chapter 11, pp.413–19 and Chapter 12,
pp.455–60.
Required
a. Based on financial grounds, advise Crabtree Ltd whether or not to accept the
contract. Support your advice with calculations. (8 marks)
This part requires the calculation of the relevant costs to compare with the
price.
Crabtree Co Ltd – Statement to Determine Contract
Desirability
Contract – Product X Relevant values

£000 £000
Sales 20,000 Kg x £400 8,000
Labour: grade 1 (not relevant – underutilised) -
grade 2 20,000 x 6 hours x £7.50 (900)
Material A Replacement cost 20,000 x 2 x £40 (1,600)
Material B Opportunity cost 20,000 x 1 x £100 (2,000)
– not selling
Variable production o/head x 20,000 x 8 hrs x £12 (1,920)
Fixed production overhead -
Product Y calculation per unit
total total
Lost sales (280) 5,000 x £280 (1,400)
Cost avoided: Labour 30 5,000 x 4hrs x £7.50 150
Materials 48 £48 x 5,000 240
Variable overheads 48 5,000 x 4hrs x £12 240
Contribution forgone 154 (770)
Total costs (7190)
Net advantage of 810
accepting
b. Show how the contract, if accepted, will be reported in the routine job
costing system used by Crabtree Ltd. (5 marks)
A job costing approach is required using FIFO method for materials,
charging for all labour used at normal rates and charging for overheads in
the manner described in the question.
8
Full absorption cost approach – Contract – Product X
£000 £000
Sales 8,000
Costs
Labour: grade 1 20,000 x 2 hrs x £16 (640)
grade 2 20,000 x 6 hrs x £7.50 (900)
Material A 20,000 x 2 x £32 (1,280)
Material B 20,000 x 1 x £120 (2,400)
Variable Overheads 20,000 x 8 hrs x £12 (1,920)
Fixed overheads 20,000 x 8 hrs x £6* (960) (8,100)
Net Loss on Contract (100)
*Fixed overhead calculation £2,400,000/400,000 = £6
c. Explain how each of the two methods (a) and (b) above are used by
businesses. (4 marks)
The answer to this part of the question requires an explanation of the
principles underlying the two methods. An answer which explained
the rationale behind each amount entered in the statements is not
appropriate. The answer could include the following:
• Calculations in a) indicate the future cash cost/revenue impact of
taking the contract and show that a future positive cash flow would
result. This information is most useful when non-routine situations
occur e.g. spare capacity or constrained capacity. In this case, assuming
that it would not lead to expectations by the customer of a similar price
for subsequent work, this contract should be accepted as the company
will be more profitable by accepting this work, in this situation.
• Calculations in b) use full-absorption costing to trace all resources
used by the product at historical cost and include an average amount
of fixed overhead based on expected costs and activity. It shows that,
under normal circumstances this contract would be unprofitable. If
the company regularly works at expected capacity and overhead and
profit margins are accurately set, this pricing method should generate
expected profits. In using this method companies always need to
compare the cost/price with the competition and lower or raise their
prices in order to maximise profits and stay competitive. Where
situations change from the original assumptions this method is not
sensitive enough to guarantee that optimal decisions will be made.
9
d. i. Calculate the difference in profit revealed in your answers to (a) and (b)
above. (1 mark)
The difference between the two calculations is £810 +100 = £910
ii. Since Crabtree Ltd uses a routine job costing system, accepting the
contract would mean that the difference in profit would have impacts on
costs and revenues elsewhere in the system.
Draw up a schedule to explain which costs and revenues would be
affected by accepting the contract. (The total of your schedule should be
the difference in profits which you have already calculated). (7 marks)
This part of the question proves the validity of the relevant cost
approach by showing how, although the full cost approach shows a loss,
improvements recorded in other areas of the costing system will improve
in ways which are not easily seen at the time of making the decision.
If the contract is accepted the changes in costs will be as follows:
Actual production overheads reduce by the idle time not charged 640
2 hrs x £16 x 20,000kg
Fixed Overhead absorption will increase by 8 hrs x £6* x 20,000 Kg 960
Fixed overhead absorption will decrease by not making Y 4hrs x £6 x 5000 (120)
Material A’s difference between historical and replacement cost will shown
as a lower profit on the jobs which use the replaced material (320)
Material B will not be sold which will save a loss on stockholding 400
Loss of profit from product Y £770 less £120 allocated overhead (650)
Total 910
Question 3
Digital Gadgets, a division of a large group, is developing a new product with
a predicted four year life. To produce this product more building space will be
needed. To provide this space, Digital Gadgets can lease a derelict site for four
years, after which time the site must be cleared. Digital Gadgets plans to hire
prefabricated buildings to be used on the site, so that the buildings can be
easily removed after four years. Maximum production capacity available will be
100,000 units per year… (For full question please refer to examination paper)
Required
a. Prepare a lifecycle costing statement for this product (ignore the time value
of money). (7 marks)
Subject guide, Chapter 10, p.101; Horngren et al. (13th edition), Chapter 12,
pp.469–71.
The purposes of the statement are both to enable decision makers to be
able to see the pattern of inflows and outflows and to focus on critical
issues. The layout of the statement is therefore as important as the
calculations and so marks were split between to both aspects.
10
Months 1–4 5–12 13–24 25–36 37–48 Total

£000 £000 £000 £000 £000 £000
Life cycle revenues 1,500 4,000 5,500 3,300 14,300
Life cycle costs
Product design (700) (700)
Install buildings (500) (500)
Equipment costs (200) (200)
Yearly building rental (20) (20) (20) (20) (80)
4 x £20,000
Production and admin
– fixed (200) (200) (200) (200) (800)
– variable (600) (1,640) (2,300) (1,380) (5920)
Marketing
– fixed (500) (100) (400) (100) (1,100)
– variable (270,000 x £2) (60) (160) (200) (120) (540)
Redesign costs – month 25 (100) (100)
Dismantling site (1,000) (1,000)
Total costs (1,420) (1,360) (2,120) (3,220) (2,820) 10,940
Life cycle cashflow (1,420) 140 1,880 2,280 480 3,360
b. The manager is disappointed with the sales forecast for the final year
(months 37–48) and explores possibilities of reducing the price to £52 and
increasing marketing and promotion by £200,000. Demand forecasts indicate:
• 50% probability that sales units will not increase as the gadget is losing
popularity
• 40% probability that sales will increase to 80,000 units
• 10% probability that sales will increase to 110,000 units.
Provide calculations and comment on whether the manager’s idea should be
adopted. (5 marks)
pp.107–09.
There are several ways to calculate the expected value of this probability
distribution. It should be noted that the maximum capacity is 100,000
units, so the 10% probability has to be reduced from 110,000 to 100,000.
Estimated increased contribution
Increased contribution Probability Weighted increased

contribution
60,000 x -£3 = - £180,000 0.5 -90,000
(20,000 x £27) - (60,000 x £3) = 360,000 0.4 144,000
*(40,000 x £27) – (60,000 x £3) = 900,000 0.1 90,000
Total increased contribution 144,000
*only 100,000 can be made.
11
OR price £55 – Contribution from sales of 60,000 units x (£55-25)

£1,800,000
Price £52 – Probable sales units at 60,000 x 0.5 = 30,000
80,000 x 0.4 = 32,000
100,000 x 0.1 = 10,000
72,000 x (£52-25) £1,944,000
Increased contribution 144,000
If £200,000 needs to be spent on promotion, it is not worth
dropping the price.
c. Show the profits that would be reported each year. Assume that product
development costs and site dismantling costs are expenses in the income
statement the year they are incurred; the cost of installation of buildings and
the equipment costs are depreciated using the straight line method with no
residual value. (6 marks)
The forecast income statements show how the project will affect the
company’s results each year, so these details are also needed when
investigating the viability of a product.
Annual Profit Statement for new product
Year 1 Year 2 Year 3 Year 4 Total

Sales 1,500,000 4,000,000 5,500,000 3,300,000 14,300,000
Less expenses
Fixed costs 1420,000 320,000 720,000 320,000
Variable costs 660,000 1,800,000 2,500,000 1,500,000
Dismantling site 1,000,000
2,080,000 2,120,000 3,220,000 2,820,000 10,240,000
Depreciation* 175,000 175,000 175,000 175,000 700,000
Total expenses 2,255,000 2,295,000 3,395,000 2,995,000 10,940,000
profit (755,000) 1,705,000 2,105,000 305,000 3,360,000
*£700,000/4 = 175,000
d. Explain how your forecasts in (a) to (c) would be used by the divisional
manager. (4 marks)
The approach adopted is lifecycle costing. If only one year at a time were
considered the product would probably not be adopted as it looks very
poor in the first year. The answers in a) and c) enable the division to see
that it is profitable overall and to perform what if analysis to explore
options during the life of the product. The analysis in (b) helps to explore
alternatives highlighted by the life cycle costing approach and could be
used to explore other aspects of the product’s life.
e. The group operates a divisional managers’ bonus scheme, based on annual
profits. Briefly discuss the effect this may have on the manager’s decision to
adopt this project. (3 marks)
The discussion should consider the objective of the bonus acheme and
whether it is designed appropriately to meet its objectives e.g.The bonus
12
scheme was presumably designed to encourage managers to adopt the

most profitable alternatives. However it may deter a manager who is not
expected to stay in this division for the second year, since the first year’s
profit is negative. If the manager and higher management take a long
term view than the project will probably go ahead as the profits are good
for Years 2 and 3. The bonus scheme may encourage the manager to try to
improve performance in all years.
Question 4
Decorative Tiles Ltd is a small company distributing wall tiles to the trade
and retail stores. The company has identified three major cost pools, ordering,
storage and shipping. The following information relates to actual activities in the
year ended 30th April 2010… (For full question please refer to the examination
paper)
Subject guide, Chapter 7; Horngren et al. (13th edition), Chapter 5, pp.170–85.
Required:
a. Calculate the net income and the net income as a percentage of sales made
by Decorative Tiles Ltd for the year ended 30th April 2010. (5 marks)
Unusually for ABC questions this company has been able to identify the
variable and fixed elements of the cost for each activity. This is a more
realistic approach in terms of providing good information for decision
making. Although in the long run all cost may be variable in the short-run
some of them are fixed so the allocation of these costs may well result in
over/under absorption but the variable elements can reliably be used for
calculation of contribution.
Net income 2010
£ £
Sales 5,000,000 x £5 25,000,000
Cost of sales 5,000,000 x £3.75 18,750,000
Gross Income 6,250,000
Less costs –
Ordering: variable 5,000 x £60 300,000
Fixed 360,000 660,000
Storage: variable 20,000 x £30 600,000
Fixed 600,000 1,200,000
Shipping: variable 16,000 x £50 800,000
Fixed 400,000 1,200,000
13
b. Assuming that general fixed costs are allocated based on numbers of tiles
ordered and using appropriate cost drivers, calculate the contribution, the
Activity Based Cost net income, and the net income as a percentage of sales,
for each of the following two orders (8 marks):
Activity Sales Order 672 Sales Order 680

Tiles ordered 80,000 1,000
ordering 50% of 3 different orders 20% of 8 different orders
In order to calculate contribution, the variable costs of each activity
should be included. A separate amount should be included for the fixed
element.
Workings of absorption rates for fixed cost drivers
Fixed Cost drivers 2010

Ordering £360,000/5,000 = £72
Storage £600,000/20,000 = £30
Shipping £400,000/16,000 = £25
General £1,000,000/5,000,000 = £0.20
Order 672 Order 680

£ £
Tiles ordered 80,000 x £5 400,000 1,000 x £5 5,000
Variable costs:
Cost of tiles 80,000 x £3.75 300,000 1,000 x £3.75 3,750
ordering 50% x 3 x £60 90 20% of 8 x £60 96
Fixed costs
ordering 50% x 3 x £72 108 20% of 8 x £72 115.2
storage 4 loads x £30 120 9 loads x £30 270
shipping 1 shipment x £25 25 2 shipments x £25 50
Total fixed cost 16,253 635.2
Net income from order 83,487 148.8
Net income/sales % 20.9% 3.0%
Some students may have interpreted the question to require the use of
2011 estimates instead of 2010 (only one version is needed)
14
The answers would then be:

Workings of absorption rates for fixed cost drivers
Fixed Cost drivers 2010

Ordering £360,000/3,000 = £120
Storage £600,000/15,000 = £40
Shipping £400,000/16,000 = £25
General £1,000,000/5,000,000 = £0.20
Order 672 Order 680

Total Total
Tiles ordered 80,000 x £4.75 380,000 1,000 x £4.75 4,750
Variable costs:
Cost of tiles 80,000 x £3.60 288,000 1,000 x £3.60 3,600
Ordering 50% x 3 x £40 60 20% of 8 x £40 64
Fixed costs
Ordering 50% x 3 x £120 180 20% of 8 x £72 192
Total fixed cost 16,365 802
Net income from order 75,385 (131)
Net income/sales % 19.8% (2.8)%
c. Compare the features of the two orders and comment on the reasons for
differences in profitability. (3 marks)
Order 672 is a large, uncomplicated order. It requires tiles from 3 different
suppliers but the whole order is all shipped at the same time. By contrast
order 680 is very small. It requires tiles of 8 different types, 9 amounts
of loading and shipment to either two places or on two dates. This
makes Order 680 much more resource intensive than Order 672 which
is reflected in the higher costs and very low profit margin of order 680.
Comparing the overall profit margin and those shown in the two orders
it would appear that a high proportion of sales orders require detailed
attention.
15
d. Using the figures provided above prepare a budget for year ended 30th April
2011. (4 marks)
Budgeted net income 2011

Sales 5,000,000 x £4.75 23,750,000
Cost of sales 5,000,000 x £3.60 18,000,000
Less costs 120,000
Ordering: variable 3,000 x £40 120,000
Fixed 360,000 480,000
Storage: variable 15,000 x £35 525,000
Fixed 600,000 1,125,000
Shipping: variable 16,000 x £50 800,000
Fixed 400,000 1,200,000
e. The company is considering adding a fixed charge on all sales orders of 1,000
tiles or less. In 2010, this amounted to 2,000 orders. Assuming that the same
pattern continues, calculate the charge per order which would be needed
meet the company’s profit target. Using information from (b) above discuss a
different way of setting a charge for complicated orders. (5 mark)
Shortfall in net income/number of small sales orders:
2,190,000 - 1,945,000 = 245,000/2,000 = £122.50 per order
Since the basic per tile price is fixed by the market any additional charge
would need to be seen as fair by the customer.
The company could base the charge for all orders on the usage of the
facilities and using the ABC drivers to compute a varying charge based on
the requirements of the customer. It would enable customers to be aware of
the cost of complexity and size and consider this when making their orders.
Charging rates could allow for large orders not to be charged in order not
to drive away customers who have large simple orders.
SECTION B
Answer one question from this section and not more than one further
are to be attempted with at least two from Section A.)
Question 5
Discuss the role of management accounting information in supporting the
strategic management activities of organisations.
Subject guide, pp.9 and 11; Horngren et al. (13th edition), Chapters 13 and 19.
A good answer to this question must be focused on the question which
means it must keep strategic management in mind and discuss the
appropriate management accounting information to support strategic
decision making. Only discussing one or the other is not appropriate.
16
One way to approach this would be to:

Define strategy/strategic management –
• Corporate level
what business are/should we be in?
what are the basic directions for future?
what is the culture and leadership style?
what are the attitudes to strategic change?
• Business level matching internal capabilities with external
opportunities:
i.e. what is our competitive advantage? Who are our competitors?
How can we improve/innovate?
Who are our customers?
What value do we add?
Define and discuss the appropriate management accounting
provision which would assist in the performance of strategy/
strategic management
• Information needs to be sufficiently detailed to be able provide analysis
quickly for different alternatives.
• Cost/benefit aspects of data analysis must be considered.
• Information needed by management may be financial, quantitative e.g.
number qualitative.
• Thus management accountants must work with other professionals to
provide a wide range of information.
Some techniques which have been developed to provide these more
detailed analyses are:
• Analysis of forecasts and results by impact of sales growth, changes in
prices of inputs, changes in productivity, identifying and using spare
capacity and managing bottlenecks (theory of constraints).
• Techniques e.g. target costing, customer profitability profiles.
• Quality measurement and improvement.
• Balanced scorecard.
Reports should be able to compare forecasts with outcomes, including
analysis of unforeseen external influences.
Any of the above techniques should be expanded and more contexts
provided.
Question 6
a. Draw a diagram to show the separate budgets necessary to produce
complete operating budgets and financial budgets for a manufacturing
organisation. You should indicate the inter-relationships between budgets,
where appropriate. (10 marks)
Subject guide, Chapter 5; Horngren et al. (13th edition), Chapter 6, p.213.
The diagram on p.213 of the textbook gives the answer to this part of
the question. Arrows showing the inter-relationships are important in
obtaining full marks but no additional explanation was asked for or
marked.
17
b. In relation to the use of variance analysis in responsibility accounting, briefly

explain the following:
i. Controllable and uncontrollable variances and how these can be
indentified;
ii. Performance measurement using variances;
iii. Organisational learning using variances. (15 marks)
Subject guide, Chapter 5, pp.55–57 and Chapter 9, p.90; Horngren et al. (13th
edition), Chapter 6, pp.224–25 and Chapter 7, pp.264–68.
i. A comprehensive answer requires recognition of two aspects of
controllability, a) controllability by the manager of the responsibility
centre and b) controllability with reference to external factors e.g.
inflation. Discussion and examples need to explain both aspects to
receive high marks.
For example:
Variance shows difference between predicted and actual activities,
preferably in as much detail as possible.
Controllable costs and revenues are those within a budget holder’s
ability to influence e.g. material usage, labour efficiency.
Some costs may not be controllable by the budget holder but are
the responsibility of other decision makers within the company e.g.
wage changes agreed by unions.
Other costs and revenues may be uncontrollable by the company
e.g. input cost increases. Some budgeted cost and revenues can be
met by adopting alternative strategies e.g. change supplier, develop
a new market, others may not be able to be changed at all e.g.
due to general inflation, commodity scarcity. Some uncontrollable
costs may be savings e.g. price reduction and these too should be
identified separately.
ii. Use of variances to appraise managerial performance can focus on
effectiveness and efficiency.
Causes of variances must be determined and inter-relationships
between variances understood e.g. lower material price and higher
production wastage may be noticed. Care should be taken to follow
through observed variances as dependant variances may appear in
different appraisal periods and so links may not be noticed.
All variances should be taken into account for use in performance
measurement (possibly with other BSC measures) in order to avoid
the tendency to focus on one important variance which may change
managers’ behaviour to keeping that variance on target to the
detriment of other aspects within their control.
iii. The prime purpose of variances is to inform managers of where costs
and revenues differed from expected, so that the reasons for the
variances can be explored. This improves both forecasting and control
of costs and revenues in the future and hopefully leads to continuous
improvement. Companies which encourage a “blame game” approach
will engender a defensive, backward looking attitude in managers,
whereas those encouraging and rewarding learning from experiences
will tend to be more forward looking and innovative.
18
Question 7
a. i. Meeting customers’ expectations is vital for profitability. Explain the term
“customer response time” and describe, with examples, two reasons why
delays in meeting customer expectations occur. (5 marks)
Subject guide, pp.56–60 and p.104; Horngren et al. (13th edition), pp.701–03.
Customer response time is the amount of time between a customer placing
an order and delivery to the customer.
Two reasons for delay (Horngren et al., p.703) are:
• uncertainty over when a customer will order products or services.
• bottlenecks due to limited capacity.
Examples of these or other valid reasons were required to obtain good
marks.
A high proportion of students suggested that customer response time was
the amount of time it took the customer to respond. This meant that their
examples in part i) and answer to part ii) tended to be incorrect.
ii. Describe how customer response time could be improved in a student
canteen and how the costs and benefits could be quantified. (4 marks)
As for part i) above.
In the canteen example there is little uncertainty over when the customer
will require the products, in fact that is part of the problem, so the
answers must address the bottlenecks by first obtaining good information
on the problem and then trying to resolve it. Good examples were needed
and a discussion on how cost and benefits would be measured, for
example:
• Monitor busy times, monitor types of transaction e.g. how many items
bought, what types, drinks, cold food, hot food.
• Monitor customer waiting time expectations, how long before to go
elsewhere, etc.
• Possible solutions – more vending machines, more staff at busy times,
hot food paid for at a separate cash desk, etc.
• Measuring cost and benefits – cost extra resources, benefit increased
contribution at busy times, customer satisfaction survey.
b. i. Explain the “Theory of Constraints” and define the following:
• Throughput contribution;
• Investments;
• Operating costs. (4 marks)
Subject guide, p.104; Horngren et al. (13th edition), Chapter 19, p.707.
Correct definitions as shown in subject guide or textbook are
acceptable. For example:
• Throughput contribution – revenues – direct material cost of goods
sold – Investments – sum of direct materials cost in direct materials,
19
work in progress and finished goods inventories, R&D costs and costs
of equipment and buildings.
• Operating costs – all costs other than direct material incurred to earn
throughput contribution, includes salaries and wages, rent, utilities,
depreciation, etc.
ii. Describe the process of managing bottlenecks. (6 marks)
Subject guide, p.104; Horngren et al. (13th edition), Chapter 19, pp.707–09.
This question can be answered by expanding on the points below. It is well
discussed in the textbook:
• recognise that bottleneck resource determines throughput contribution
of the plant as a whole
• search and find bottleneck resource, evidenced by large quantities of
work in progress waiting to be worked on
• keep bottleneck working and subordinate all non-bottleneck resources
to bottleneck resource
• take actions to increase bottleneck efficiency and capacity by
calculating throughput capacity and identifying any relevant/irrelevant
costs
• improve the quality of parts and products manufactured at the
bottleneck operation.
iii. Discuss the situations in which it may be more appropriate to use linear
programming approaches as a decision tool rather than “Theory of
Constraints”. (6 marks)
Subject guide, Chapter 4, pp.46–49 and Chapter 10, p.104; Horngren et al. (13th
edition), Chapter 11, pp.236–438 and Chapter 19, pp.706–09.
This part requires a discussion of the important features of the two
methodsand the contexts in which each is more appropriate e.g.
Linear programming is most relevant where there are several limited
resources and shared by several products. The approach assumes that it is
possible to identify, all variable costs (not only materials), revenues and
resource use for all products involved. The method can respond quickly
to changes in prices and variable costs. It tends to be used in highly
structured environments e.g. mix of products to be made from crude oil.
It is also more relevant where it is difficult to make for inventory. The
technique requires good information relating to all the costs, revenues
and constraints. As a powerful mathematical model it can also calculate
shadow prices for all the limited resources.
The throughput contribution approach is used in situations where a more
pragmatic solution is required and many factors are difficult to identify
with accuracy. It therefore focuses on the areas which are easy to identify,
product prices, material prices and one bottleneck. It is more appropriate
where a company makes a large number of diverse products for which the
estimates of demand are difficult and different products use the resources
in different ways. In today’s environment it is not an unreasonable
assumption that direct materials are the only easily measurable variable
cost.
20
Question 8
Describe the following pricing methods, explain the situations when each
method is likely to be used and the problems of each method:
a. Market based price
b. Peak-load pricing
c. Contribution margin pricing
d. Return on Investment pricing
e. Cost-plus pricing where there is a learning curve effect.
pp.456–74.
The pricing methods are well discussed in the textbook
(Horngren et al.). It is important to answer the question, which was
not about transfer pricing but about how companies set prices to charge to
their customers. Important points not mentioned or clearly understood by
many candidates were:
b. Peak load pricing is a deliberate mechanism to try to encourage
users to use off peak when the capacity is otherwise underused. It is
therefore not a problem if people change from using on peak to off
peak.
c. The Contribution margin pricing method is needed if there is not
already a price which can be taken from the market, so contribution is
not, in this case sales price – variable cost. It is a mark up on variable
cost. This does not necessarily lead to fixed costs not being covered
as businesses who use this method adopt a higher mark up than they
would use for full absorption costing mark up.
d. In order to answer this part well a description of how the return, once
calculated, is to be applied to each product in order to set prices which
will ensure that the profit target is met. The problem is less difficult
if the business makes many units of one homogenous product but is
difficult if the company makes many products of different types with
different levels of demand.
e. The effect of the learning curve is that labour costs will fall. However
the company can decide the extent to which it passes these benefits on
in lower prices, depending on the market for their new product.
21

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UNIVERSITY OF LONDON 279 0097 ZA

Tuesday, 25 May 2010 : 10.00am to 1.15pm

© University of London 2010

1. Reichelstein, quoted in Horngren C. Datar S. and Foster C. (“Cost Accounting a Managerial

Initial capital investment £5,000,000.

Cash receipts Cash

The costs to Custom Boats Ltd of each type of labour are:

Grade 1 £16 per hour

Wood - Per Glass - per

(question continues on next page)

Examiners’ commentaries 2010

Specific comments on questions

Net present value calculations at 12% cost of capital

Net cash Discount Net present

Residual income calculation

Assets at Net cash Capital Residual Residual income.

Reading for this question

Custom Boats Ltd – Statement to Determine Contract Desirability

Contract – 1628 Relevant Values

If the contract is accepted, the changes will appear as follows:

Transfer price of £800 Division D Division M

Profit statements Division D Division M Company

Marginal revenue calculations

The change in price/demand is measured per 150 units and so total

Unit contribution Units Total sales Total variable Total

To maximise the total company profit requires consideration of variable

Unit Contribution Units Total sales Total variable Total

Selling price 1,400

750 units transferred – selling price of metres £1,400

Division D £000 Division M £ Company £000

Division M’s contribution calculations with metre price of

Selling price 1,500

600 units transferred – selling price of metres £1,400

Division D £000 Division M £000 Company £000

Division M’s contribution calculations with metre price of

Selling price 1,450

675 units transferred – selling price of metres £1,450

Division D £000 Division M £000 Company £000

Regarding (b) ii.

Selling price 1,200

1050 units transferred – selling price £1,300

Division D £000 Division M £000 Company £000

Division M’s contribution calculations with metre price of

Selling price 1,300

900 units transferred – selling price £1,300

Division D £000 Division M £ Company £000

Division M’s contribution calculations with metre price of

Selling price 1,250

975 units transferred – selling price £1,250

Division D £000 Division M £000 Company £000

d. Provide a considered view of the effectiveness of company’s existing transfer

division. In practice it is also difficult to monitor opportunity cost in

Net income 2010 £ £

Sales Order 672 Sales Order 680

Reading for this question

Fixed cost drivers 2010

Order 672 £ Order 680 £