ed ed | Notes Paper FI Financial Operations p44 Paper P2 Performance Management 4: SELLING PRICES AND COSTS OF PRODUCTS A, B, C&D Salngpree (Eoeran % 50 3076 idates make thesame old mistakes when answering questions on limiting {actors andespecially those concerning make- vversus-buy decisions. It's time ta stop therot (@ £50" Rou) Leaelmerter forthe P2peper very time Imarkthe Performance Man agement paper, I constantly find the same errors on certain topic in each sit- ting, so see many students failing to achieve the markthattheirefforts deserve Asa result, have waitten an article on liza iting factors that I hope will help you to avotd the same mistakes in your P2 exam. First, let's work through a simple question where ‘the iaiting factorhas tobe determined. Acompany manufactures four products: A,B, Cand. Their sell- ingpricesand.coste te shown in table. All products use the same direct material and the same grade of labour, In the year ahead the available supply of ‘material willbe restricted to 38,000kg and working time to 21,000 hours. We are required to determine ‘the product mixthat would maximise the company's profit in the coming year. Afitstglance at the scenario suggests that there could be two scarce resources: dizect material and directlabour, Our first action should be to establish, ‘whether there is no limiting factor, one limiting factor or two limiting factors by using table 2. rom. BLACK YELLOW MAGRNTA CYAN ‘avaiable (rours) z 1 70 7 z 2 Scan ses UR) 2 5000 this we can see that direct material is obviously the single limiting factor. ‘Acommon ervorat the start would be to assume ‘that both the supply of material and working hours are limiting fectors, nd to produce figures accord- ingly. This practiceisboth technically incorrect and extremely time-consuming. Once the limiting factorhas been determined, the ‘exercise can follow its usual course. First, we esta lish the unit contribution per product; then we I DETERMINING THELIMITING FACTOR. 910MA1104133 pgs 04.01.2012 10:23 study Notes |o| cel em de [a Study notes Study notes a] Paper P2 Performance Management calculate the contribution per unit of limiting factor, ranking each product accordingly see table 3). Then we allocate what resource is available ina production plan (see table 4). Thiswillleave ashort- fallof2,500 ~ 1,440 = 1,050 units of product . Common errors a thi point include ranking the products on their contributions perunit made, which is fandamentally wrong and devalues the rest ofthe answer. Some candidates forget, ordon'trealise that only the variable costs should be subtracted fromthe selling price to arrive at the conteibution. Again, this isabasicerrorand produces an incorrectranking. In real situations this would have disastrous eonse- quences fora company, inthatit wouldn’tmaximise its profit fit were to rank the products wrongly. ‘Make-versus-buy decisions In the worked example we have assumed that the company would not be ableto meet the fll budgeted. demand forall four products. But ifthe company had. received definite orders for all the demand figures quoted, it would need to decide which products to make and which to purchase. It must meet the demand ~ otherwise, t would incu penalty charges andlose the goodwill ofits customers, Let's consider 4: CALCULATING EACH PRODUCT'S CONTRIBUTION, PER UNIT OF LIMITING FACTOR ‘5: MANUFACTURING DATA GIVEN FOR PRODUCTS X, ¥ &7, Tena Selingpr Costta purchase (per unt) simple exampleto develop this point. Working time js the limiting factor in this caze -only 32,000 direct. labourhoure ate available ~ and we have been given the data shown in table 5 above, ‘An analysis of the table shows that ifwe bought a unit of itwould release two hours of labour touse, Dbuteach ofthese would cat the company £6. I we ‘bought product X it would also release two hous of direct labour per unit, but the cost would be only ‘£4 per hou of direct Isbour. Similarly, we can see that ¥ would be cheaperthan Xo buy. So the prior- ity for making the components in-house willbe first, followed by Xand then ¥. The company willachieve aJowerlevelofcontribution by buying the product rather than making them, but itis reducing the {impact on its profits by taking this approach. ‘The final postions shown in table 6 and the final contribution relating to satisfying the total demand for products X, Y and is shown in table 7 common error on such questions isto rank the products incorrectly. The rule here is to minimise the extra variable cost of subcontracting per ualtof scarce resource saved, Inthiscase, it means minimis- ing the cost per direct labour hour saved. ‘Combining the two techniques Inthe past fev years the P2 paper hasincluded ques- tions that combine alimiting-factor situation with a ‘make-versus-buy decision. Let's considera simple question thatis not complicated by the requirement toidentify which cost item i the limiting factor but does feature the needtofulia one-off contract, Beta ‘Manufacturing is a company that produces three products ~ R, Sand T~ using different quantities of the same resources. Information about the three products shown in table 8. Beta buys ina special component XX from a sup- plier called Gamma that it uses in making product ‘Tat £35 per unit, [cis considering manufacturing this component in-house and has established that thetatal costper unit of doing so would be as follows: direct material at 3kg per unit (£12) + direct labour (£8) + variable overhead (£6) ~ £26. The material ‘used to produce component XXisthe same material A that's used in making products R, $ and. The ‘quantity of output for component 3x will relate dlizectlytothat of product. Beta has also established ‘that itcan obtain only 57,000kg of direct material A per week forthe foresceable future. CALCULATING WHETHER BETA SHOULD CONTINUETO PURCHASE COMPONENT XX OR PRODUCEIT IN-HOUSE 1 «x perunt_perur Selngpres umngm cone) 72 ees rect materaia @) za 20 TEE 0 7 5 = 12 32 2a as (qummanminueea) 6 5 @ per iqotmateraiA(@) 533480375 a z 3 7 10:PRODUCTIONPLAN Avaliable dvect materia Ag) 57,000 Sao sg 2. Prepare a statement to show the optimum weekly ‘output based on your decision for requirement L 3. Explain any non-financial factors that Beta should consider before it decides whether or not to make component XX itself ‘An analysis of table 9 shows that ifthe company ‘manufactures component XX internally it will eon sume 3kg of direct material Aperunitandeach unit (of XX will generate £3 per kg ofthis limiting factor. ‘This figure is lower than those earned by any of Beta’ three existing products. Therefore, since com: ponent XX has the lowest rank, the company should J continue tobuy inXXsothat the resources available Gs canbe used tomanufacture products, Sand, The resulting production plan (see table 10) indicates that Beta's optimum weekly output would be 4,200 Ents of 7, 1800 units of R and 2.520 units ofS. 3__ Wenow need to calculate the purchase price of. Ta component XX at which Beta would manufacture @ it internally as opposed to buying it. This type of 3 _ situation has featured in several recent P2 papers ‘The decision conceming the purchase of component As ; pee Selling price (6) cc EI SPRODUCTIONPLAN 1. Calculate whether the company should continue esas oe . par Sea Sea Lee aean ey Contribution (£) 18 2 iS Jabour (hours) 32,000 ‘itshould manufacture this internally. S: MANUFACTURING DATA GIVENFOR PRODUCTS R, 8 4: PRODUCTION PLAN aoe eT . 7eTOTAL CONTRIBUTION a - - 7255 xXwouldchangeifthe contribution earned from mp BLACK YELLOW MAGRNTA CYAN 910MA1104134.pgs 04.01.2012 10:24 ‘Study Noteso| cel em dd [a suey | Paper P2 Performance Management manufacturing it equalled that of the lowest contributing product ofthe otherthree. Inthis case itsproductS, which has a contribution of £4.60 per kg of direct material A. This is £1.80 higher than that from component XX. Because each unit of XX requires kg of direct material A. the buying price ‘would have to be 3x £1.80 ~ £5.40 per unit higher ‘than it is at present. It would then have the same contribution per unit of limiting factor, and rake Ing. as product. So the purchase price of XX at ‘which Beta’s decision could change is £35 + £5.40 = £40.40 per unit. sucha situation did actually arise and raw mate- rials were still in short supply, this would obviously ‘open the door to another set of questions relating to the manufacture and supply of product. ll discuse ‘these points in the last part of the answer. ‘Common errors here include failing to reslise that component XX is comparable with products R Sand Tin arriving atadevision and, again, ranking product on its contribution rather than on its eon- ‘tribution per unit of limiting factor. “The most elevant non-financial fctore associated ‘with this scenario are a follows ‘*Does Beta's workforce possess the requisite skills to produce component XX? Some candidates forget,ordon't realise, that only the variable costs should be subtracted from the selling rice toarrive at the contribution ‘© Would Beta be able tomanufacture component XX tothe same standard as that achieved by Gamma Je, would quality be compromised? ‘© Does Beta have sufficient resources to manufac- ture component XX? Is special machinery needed, {or example? If Beta manufactures component XX internally, ‘more of product § would have to be sacrificed. low ‘might thie affect the sales of products Rand T? ‘eHow would Gamma reactto losingits businese with Delta? Could it jeopardise the relationship? ‘Atypical error at this point would be tocite non- ‘nancial factors that do not relate tothe seenasio. hope that this article has clarified any misun- dlerstandings associated with questions on limiting factors and make-versus-buy decisions. My advice toP2 candidates would be to: ‘Review the past papers and practise answering {questions relating to this topic. ‘¢ When attempting these questions, you should make every effortto lay out your answers clearly and also apply proper exam technique by completing them inthe time allowed. (Visit CIMA's website and read the post-exam guide relating to the past few sittings. This will ive details ‘ofall common mistakes to avoid. Paper F1 Financial Operations ‘Questions asking youto produce statements of ‘cash lowshave become. staple of Flexams,50you ‘would be well advised to learn and practise methodical approach to meeting this requirement ByRobecea Hare Subject matter expert forpaper Fat BPP Learning Media| tatements of cash flows were examined as section-C questions in the November 2010, May 2011 and August 2011 FL papers, so they are clearly here to stay. Finding a logical way to tackle these is ‘essential, therefore, #0 in this article T ‘will work through question 4(a) of the May 2011 paperto demonstrate my recommended approach BLACK YELLOW MAGRNTA CYAN (the question is available to download free via your "My CIMA" account on wsiw.cimaglobal.com). ‘Step one: analyse the requirement and additional information “The frst thing to dois read the requirement, This may sound obvious, but tis surprising how many candidates calculate the wrong things asing the ‘wrong dates. In this question the requirement is to “prepare a statement of cash flows, using the indirect method, for OP for the year ended 31 ‘March 2011" ‘Neat, skim-read the additional information pro- vided inthe question that is, anythingotherthan the financial statements. As you do this, puta mark rhext to items in the financial statements that are affected by these extra detalls. For example, the additional information provided in (ii)~"Plant > 91CMA1104135 pgs 06.01.2012 12:07 study notes |