AC3097 Management accounting: Notes on the end-of-chapter questions

AC3097 Management accounting:

Notes on the end-of-chapter questions

Note: the below are not sample answers to the questions, and do not
always give guidance or comments on every part of each question. These
are notes for your information only.
They are designed to help you to check that you have understood the
concepts being examined and what is required by the questions.
You should always formulate your own full and clear answers to
examination questions, paying attention to what the question asks you to
do and using your own examples.

Chapter 1
1. My Drugs plc and Their Drugs plc
A good way to address this question is to apply the value chain
framework and indicate what costs and performance variables are
relevant to each part of the value chain in each firm. A diagrammatic
answer is suggested. An example of such an answer is below.
This table indicates the main management accounting variables that
should be measured in the two firms, according to the value chain
framework. This framework refers to management accounting; those
variables that are not management accounting are highlighted in italics.

Research and Design of Production Marketing Distribution Customer

development products, service
services and
processes
My Cost of scientists Costs of Costs of Costs of direct Costs of Costs of
Drugs (basic research) scientists production of marketing transportation customer
plc (application drugs (i.e. targeted to clients support for
to specific to specific according advice on
drugs) clients) to their use of drugs
specification
Cost of running Costs of Revenues and
laboratories packaging volumes of
orders from
new clients
Number of new Volume of
patents production
Their Cost of exploring Costs of Costs of Costs of Costs of Costs of
Drugs the market marketing packaging marketing outsourced display
plc department to the wider delivery material
for packaging public
Number of new Speed of Revenue Costs of
drugs added production trends per customer
to the firm’s drug support for
portfolio payments

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AC3097 Management accounting

2. What makes management accounting strategic?

Management accounting information can be used to support decisions that
have strategic implications.
For this reason, management accounting information needs to be produced
with knowledge of the strategic direction intended by the decision,
including the aim and the timing of its use.
For example, a decision to launch a new product or service line is of a
strategic nature. The cost analysis that supports this decision does not need
to be meticulously precise, but it must be as comprehensive as possible and
should be readily available when the decision makers need to use it.
The analysis will need to have a broader focus than just the sales and
direct costs of the product and may look at: additional capital expenditure
required to extend production, launch costs, relationships along the supply
chain and contracts that need to be drawn up for that purpose. Additional
sales personnel may need to be recruited.
To answer this question, you can use an example of any business (whether
production or service based) where you can show an understanding of the
interrelationships between different parts of the business when a change in
strategic direction is required.

Chapter 2
1. Using traditional methods of cost allocation
a. In situations where indirect costs account for a small proportion of all
costs, the arbitrary allocation of costs caused by the traditional methods
is less significant, hence they can be more safely used.
When the aim of the cost analysis is to compare the overall efficiency of
different organisations, the traditional methods can provide meaningful
results.
Some companies have routine processes and a small number of different
products (but high volume) and are mostly priced competitively using
market price. These companies are likely to use a contribution approach
and make decisions based on changes in contribution. They allocate
fixed costs which relate to a specific product line to that line, but not
to individual products. This provides better information for decision
making, planning and control.
b. The production of white paper lends itself to the use of process costing,
so that the cost of materials, labour and overheads are allocated through
the process rather than on a product-by-product basis.
The production of ordinary posters lends itself to the use of batch
costing, whereby all costs that refer to each batch are clustered together
and allocated to the products of that batch.
The production of very large posters lends itself to the use of job costing,
because it is possible to identify the materials and labour that have been
employed for a specific poster.
2. Consulting Ltd
a. One-stage traditional method
i. The only direct costs are production team salaries, because there is
no indication as to how to trace the other costs to each production.
The average cost of direct labour in production per hour is:
$1,200,000 / 3,780 hours in the year = $317.46

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 AC3097 Management accounting: Notes on the end-of-chapter questions

Indirect costs are:

Customer relations team: salaries $400,000

other costs $150,000
Production team: other costs $100,000
Visual creation department: salaries $500,000
other costs $150,000
Audio optimisation department: salaries $600,000
other costs $150,000
Administration: salaries $200,000
other costs $20,000
Total $2,270,000
In other words, this is all costs except the direct labour in
production.
Overhead absorption rate is $2,270,000 / 3,780 hours =
$600.53
ii. Hence the full costs per production can be calculated, as
shown in the table.

Radio Television Press

production production production
Direct costs $38,095 $76,190 $1,905
($317.46 × ($317.46 × ($317.46 ×
1,200/10) 2,400/10) 180/30)
Indirect costs
per unit of
production $72,064 $144,127 $3,603
($600.53 × 100) ($600.53 × 240) ($600.53 × 6)
Full cost $110,159 $220,317 $5,508
Average
selling price $120,000 $210,000 $7,000
b. Two-stage traditional method
i. Direct costs are as above.
Indirect costs will be allocated to their respective departments
first and then to individual productions.
So, the cost of the visual creation department ($650,000) is
allocated to television productions and press productions in
the ratio of 1,000/1,600 and 600/1,600 respectively.
The cost of the audio optimisation department ($750,000) is
allocated to radio productions and television productions in
the ratio of 1,200/2,000 and 800/2,000 respectively.
Other indirect costs are:
$400,000 + $150,000 + $100,000 + $200,000 + $20,000 =
$870,000
(In other words, all costs except the direct labour in production
and the visual creation and audio optimisation departments).
Overhead absorption rate is $870,000/3,780 hours = $230.16

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AC3097 Management accounting

ii. Full cost per production – two-stage method

Radio Television Press production

production production
Visual creation
0 $406,250 $243,750
department costs
Audio optimisation
$450,000 $300,000 0
department costs
Other indirect costs per
$276,192* $552,384* $41,428*
type of production
*Indirect cost calculation ($230.16 × 1,200) ($230.16 × 2,400) ($230.16 × 180)
Total indirect costs per
$726,192 $1,258,634 $285,178
type of production
*Per unit of production $72,619 $125,863 $9,505
Direct costs (as above) $38,095* $76,190* $1,905*
Full cost per unit of
$110,714 $202,053 $11,411
production
*Indirect cost per unit
($726,192 / 10) ($1,258,634 / 10) ($285,178 / 30)
calculation
Average selling price $120,000 $210,000 $7,000
c. These results demonstrate that decisions on prices and analysis
of profitability based on the traditional methods must be used
with care and with an understanding of the basis used. Radio
productions appeared to be profitable with both methods, but
television productions and press productions respectively appeared
to go from unprofitable to profitable and from profitable to
unprofitable.
3. Mr Wilcox
a.
Last year’s consumables × 100 £3,000 × 100
Standard charge for consumables = = = 12.5%
Last year’s paper £24,000

Last year’s fixed costs × 100 £96,000 × 100

Standard charge for fixed overhead = = = 80%
Last year’s wages £120,000

Total amount billed to customers £

Wages billed (120,000 x 85%) 102,000
Fixed costs (80% x wages billed) 81,600
Paper 22,000
Consumables (12.5% paper billed) 2,750
Total costs billed 208,350
10% expected profit 20,835
Total sales 229,185

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 AC3097 Management accounting: Notes on the end-of-chapter questions

b.

Income statement £ £
Sales as above 229,185
Less: Expenses (actual costs)
Paper 22,000
Consumables 2,250
Wages 120,000

Fixed overheads 96,000

Total costs 240,250
Net loss (11,065)
c. Difference between expected profit and actual loss

Expected profit 20,835

Actual loss 11,065
31,900
The wages and fixed costs that were paid were the same as the
previous year but the work was only 85 per cent of total capacity
so not all costs were covered by being included in the invoicing.
The total amounts not invoiced are as follows.
Costs not covered £
Wages (15% x 120,000) 18,000
Overhead charged based on wages (80%) 14,400
32,400
Consumables saved £2,750 – £2,250 (500)
31,900
Mr Wilcox needs to stay competitive so it may be difficult to
change prices if this formula is used by his competitors. However,
he could check whether his competitors’ prices are higher.
Sales were down due to there being less work and because the
absorption of fixed overhead was based on the direct labour hours.
The idle labour hours meant that the overhead was not recovered.
Regular, monthly profit reports would help Mr Wilcox to see the
decline, reduce the staff costs and take action to attract more
business.

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Chapter 3
1. Smooth Running Ltd
Parts (a)–(c) are answered in the tables below.

Equivalent unit workings Quantity Material Conversion

WIP brought forward 600 600 240
Completion of opening WIP 0 360
Started in production 13,375
Total to be accounted for 13,975
Units accounted for Units Units
a) Total transferred – balance 11,575 11,575 11,575
Closing WIP 2400 2,400 1,680
b) Equivalent units 13,975 13,975 13,255

Costs £ £
Opening WIP 68,160 51,600
Cost for period 1,433,500 1,050,180
Total 1,501,660 1,101,780
Cost per equivalent unit
Weighted average 1,501,660 / 13,975 1,101,780 / 13,255
£190.575 =£107.453 =£83.122
FIFO
Completion of opening stock 0 360
Started and completed in month (11575 – 600) 10,975 10,975
Closing WIP 2,400 1,680
Total 13,375 13,015
Cost per equivalent unit 1,433,500 / 13,375 1,050,180 / 13,015
FIFO £187.867 = £107.177 = £80.690

c) Process account Units £ Units £

Weighted average
WIP B/F 600 119,760 Transferred to finished 11,575 2,205,905
goods
Materials 13,375 1,433,500 WIP C/F* 2,400 397,532
Conversion 1,050,180
Total 13,975 2,603,440 13,975 2,603,437
*2,400 x 107.453 257,887
1,680 x 83.122 139,645
397,532
FIFO
WIP B/F 600 119,760 Finished goods previous 600 148,808
inventory ^
Materials 13,375 1,433,500 This month 10,975 2,061,840
Conversion 1,050,180 WIP C/F* 2,400 392,784
13,975 2,603,440 13,975 2,603,432

^ Calculation of finished goods

opening inventory
WIP B/F 119,760
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 AC3097 Management accounting: Notes on the end-of-chapter questions

Labour and o’head to finished goods 29,048

600 x 0.6 x £80.69
Total 148,808
Calculation of WIP C/F
2,400 x 107.177 257,225
Differences due to rounding 1,680 x 80.69 135,559
392,784
d. The information would be used to monitor output quantities and unit
costs and if necessary to investigate changes. The cost figures may be
used as long-run average cost in connection with pricing decisions.
The FIFO method assumes that the WIP is completed first and
allocates the costs accordingly. The weighted average smooths out the
costs. There would be major differences in the two methods if prices
were changing significantly between the two periods.
e.

Job costing Arises where there is a customised, one-off commission (for example,
in industries such as printing, shipping, construction, film, hospitals,
accountancy). Requires tracing specific resources required for the product;
may involve research, negotiation and estimation of costs to be included.
Total cost of complete job calculated, usually including allocations for fixed
costs and usually a profit mark-up.
Batch costing Used for batches of products which are standardised within the batch,
such as clothing, motor cars and components. The products are designed
by the company and may be made for stock or customer order. May use
variable or full absorption methods of tracing costs to products. Unit cost
is calculated by dividing total cost by number produced in batch.
Process Suitable for continuous flow production (e.g. oil, paper, sugar, plastic)
costing where there is a standardised product which may go through a series of
processes. Usually absorption costing is used, i.e. a fair share of overhead
is included in the cost. Unit costs are calculated as in parts (a) and (b) of
this question.

Chapter 4
1. Alpha plc
a. Traditional approach
The overhead could be recovered based on consulting hours for
web- and telephone-based advice, as follows:
Overhead recovery rate £300,000 / (800 × 1 hour) + (1590 × 2
hours) = £75.38
Client profitability

Client A Client B Client C Totals

Web based sessions @ 1hr x £100 60,000 20,000
Telephone sessions @ 2hrs x £100 18,000 300,000
Direct costs 78,000 20,000 300,000 398,000
Overhead costs 58,796 15,076 226,140 300,012*
Total cost 136,796 35,076 526,140 698,012
Revenues 156,000 40,000 600,000 796,000
Margin 19,204 4,924 73,860 97,988*
*Differences due to rounding
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AC3097 Management accounting

b. ABC approach
Cost driver for processing orders:
Cost driver for marketing:
Cost driver for invoicing:
£150,000 / (300 x 0.5) + (60 x 1) = £714
per hour of order
£90,000 / 3 = £30,000 per client
£60,000 / 300 + 60 = £167 per invoice

Client profitability

Client A Client B Client C Totals

Direct costs (as above) 78,000 20,000 300,000 398,000
Cost of web orders (web orders x 0.5 x £714) 35,700 71,400 - 107,100
Cost of phone orders (phone orders x 1 x £714) 32,130 - 10,710 42,840
Cost of marketing 30,000 30,000 30,000 90,000
Cost of invoicing (total orders x £167) 24,215 33,400 2,505 60,120
Total overhead costs 122,045 134,800 43,215 300,060*
Total cost 200,045 154,800 343,215 698,060
Revenues 156,000 40,000 600,000 796,000
Margin -44,045 -114,800 256,785 97,940*
*Differences due to rounding
Note: ABC provides information about the cost of each activity,
enabling the decision maker to evaluate which products (or other
cost objects) require each activity and to what extent. The decision
maker is, therefore, supported in making long-term considerations
with regard to each product’s profitability. This will also imply
considerations on the allocation of resources to activities.
Traditional methods provide fewer insights into which activities have
been involved in production, so the information is less meaningful in
support of the decision maker’s evaluations.

Chapter 5
1. HumanityHelp

a.
i. Direct costs
• Volunteer insurances
• Travel costs to and from missions
ii. Overhead costs that can be allocated using ABC
• Responding to enquiries and arranging interviews
• Carrying out interviews
• Post-mission support
• Rescue operations (but this could be considered a direct
cost, too)
iii. Overhead costs that cannot be allocated for lack of information
• Maintenance of the webpage
• Conferences and events
• Flyers
b. and c. Cost drivers to be used and calculation of cost driver rate:
• Responding to enquiries: allocation based on number of
enquiries multiplied by average time of each enquiry.
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 AC3097 Management accounting: Notes on the end-of-chapter questions

£96,000 / (600 × 0.25) + (3,200 × 0.5) + (1,000 × 0.3) =

£46.83 per hour.
• Carrying out interviews: allocation based on number of
interviewees multiplied by average time of each interview; and
post-mission support: allocation based on number of missions
multiplied by average time of each post-mission support.
£240,000 / (100 × 0.75) + (240 × 0.5) + (60 × 1) + (75 ×
10) + (360 × 12) + (120 × 8) = £38.186 per hour.
• Rescue operations: allocation based on number of rescue
missions. £192,000 / 95 = £2,021 per rescue.
Overhead cost per mission
Allocated Responding Carrying out Post-mission Rescue Total Cost per
costs to enquiries interviews support operations mission
day (£)*
CZM £7,024 £2,863 £28,639 £50,525 £89,051 119
PCM £74,927 £4,583 £164,965 £20,210 £264,685 49
CWM £14,049 £2,291 £36,659 £121,265 £174,264 145

*Total cost/number of missions × average length of mission.

d. PCM missions seem to be the most efficient. Given a fixed amount
of resources, focusing more on PCM would enable HH to have
greater humanitarian impact. Given that rescue operations are
costly and non-strategic, enhancing the selection/interviewing
activity, particularly for volunteers going to CZM and CWM, would
reduce this cost.
Other actions could be to reduce the incidence of the post-
mission support, by choosing destinations and volunteers more
carefully and making their missions longer. Both of these aspects
significantly affect the average cost of a mission day.
2. ABC versus traditional methods
Traditional budgeting provides little information about the uses
made by the different fixed overhead resources, so when determining
the budgeted costs for a future period there is a tendency to use an
incremental approach and adjust the previous period’s expenditure
by expected future changes such as inflation. The attachment of fixed
costs to products for standard costing purposes usually charges one
amount to each product based on a driver such as direct labour time or
direct machine time.
Activity-based costing provides drivers for each aspect of the fixed
overhead and may also be able to identify variable overheads which
had previously been assumed to be fixed. This information is coupled
with better tracing of time used by each activity, and therefore cost,
to each product. So, each product’s standard cost will be charged
with different costs relating to their use of different resources such as
set-up time, materials handling, machine time in different production
areas, sales commissions, and so on. Rather than creating one overall
charge, the information leads to more accurate estimation of the total
expected cost in line with output estimates and also provides more
accurate standard product costs.
When used for variance analysis and investigations of differences
between budgeted and actual performance, the additional information
can pinpoint more accurately which resources have been used efficiently.

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AC3097 Management accounting

Chapter 6
1. Direct labour
Unless direct labour employees are paid by the hour or for piece work
(in other words, paid for a certain amount of work done) their cost to
the firm cannot change in proportion to the volume of production, so
this cost would appear to be fixed.
However, under the condition of full capacity of direct labour, if the
firm chooses to increase the volume of production of one product,
the volume of production of another product must be curbed. To this
extent, the cost of direct labour allocated to a department can be
considered proportional to the department’s volume of production.
For example, a company has two departments: A and B. The direct
labour employees are interchangeable (i.e. they can work in both
departments according to where they are needed). If the volume
of production in department A decreases by 10 per cent, the direct
labour consumption will also decrease by 10 per cent. The full capacity
assumption implies that employees will use their freed up time to
work for department B. From the departments’ point of view the cost
increases in proportion to the volume of production (i.e. it is a variable
cost).
Another example is where the direct labour is not interchangeable –
for example, where direct labour employees of department A can only
work for department A, and the same is true for department B. If the
volume of production is reduced by 10 per cent, the employees’ freed
up time will become idle, which means that direct labour will be a
capacity cost, which is to say that it is a fixed cost.
2. Direct and indirect costs
Direct costs measure the use of resources that are consumed directly
in the production of goods or services. The test is: for each specific
product or service, what resources are ‘embedded’ in the goods or
services and as such are consumed in proportion to the volume of
production? Such resources can be materials, direct labour, direct
machine time, or, to use the example of a hospital: drugs prescribed,
surgeons’ time, nurses’ time. These can be ‘variable’ costs such as
raw material or prescription drugs. They can also be fixed if direct
employees are paid a salary whether there is work for them or not, or
variable (as mentioned above) if hourly rates or piece work methods
are used. The hospital case would depend on whether the surgeon is a
member of staff (fixed) or paid as a visiting consultant (variable).
Indirect costs measure the use of resources that enable the
production of goods or services. These resources may be required in
quantities that are proportional to the volume of production, such as
the electricity that powers a machine that produces goods in fixed
quantities per unit of time. In this case the electricity used and the
number of goods produced are constantly in proportion. However,
the electricity that powers a machine that can produce one or more
goods at the same time will be considered a fixed cost, because its
consumption is not proportional to the volume of production. There
may also be variable costs which are treated as indirect because they
are too insignificant to be traced to products, like glue and small nails.
They will be variable but the costs will be captured under indirect
costs.

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 AC3097 Management accounting: Notes on the end-of-chapter questions

Note: These sorts of costs are a reason why, in order to plan and make
decisions, the elements of mixed costs must be determined using
statistical methods, which we covered in Chapter 6 of the subject
guide.

Chapter 7
1. Freddy and Flora
a. Based on the information given, the most appropriate unit would
be packages consisting of: initial contact plus two hours of
consulting and a set of illustrative material.
b. Given the suggestion above,

€
Freddy and Flora’s salaries 150,000
Full-time employee salary 90,000
Annual costs 24,000
Total 264,000
Selling price of one package = €900
Variable cost of one package:
Tax consultant 2 hours €130 × 2 = 260
Illustrative material 50
Total 310
Contribution margin per package = € 590
Break-even point = 264,000/310 = 448 packages.
Both employees’ salaries are a fixed cost because their capacity
would not be used completely, given that the practice’s maximum
number of packages is 400 per year, whereas they could in theory
work on 450 packages per year.
c. In the new situation the fixed costs would increase by €90,000 to
€354,000.
Selling price of one package = €900
Variable cost of one package = €50
Contribution margin per package = €850
Break-even point = €354,000 / 850 = 417 packages.
d. In both cases Freddy and Flora cannot break even. However,
appointing a new full-time employee lowers the loss and shows a
lower break-even point. You are faced with the challenge of the
dissonance between increasing fixed costs but at the same time
lowering the risk. A good answer would address this dilemma.
You should also bear in mind that Freddy’s and Flora’s salaries are
not the result of a negotiation, but simply of their own allocation,
so there is still the option to revise that allocation in light of the
alternative opportunities that are available to them. Alternatively
they could increase their capacity to work by working harder to
obtain clients or by taking on some of the consultancy themselves
and reducing the variable costs.

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2. Immaculate Production Ltd

a. This is a batch situation, so the Y value will be the cumulative
average time per batch for four batches of 20 units.
b= log 0.8 / log 2.0 = –0.322
X=4
Y = 200 (4-0.322) = 128 (rounded) hours per batch.
b. 4 batches × 128 = 512 hours
c. The incremental time for the fifth batch equals the total time for
five batches minus the total time for four batches:
Y = 200 (5-0.322) = 119 (rounded) hours per batch
Total time for five batches = 119 × 5 = 595 hours
Incremental time = 595 – 512 = 83 hours
d. The variable costs and expected contribution of the batches are:

First four batches Fifth batch

Material 80 x £50 £4,000 20 x £50 £1,000
Labour   512 x £16 £8,192 83 x £16 £1,328
Total variable cost £12,192 £2,328
Expected contribution £12,192 £2,328
Acceptable price 24,384 £4,656
The table above shows that the total of £40,000 to be paid by
the customer for all four batches is acceptable because the total
acceptable price shown above is £24,384. The price for the fifth
batch would also be higher than the acceptable price by (5,500 –
4,656) £844.
However, the customer’s method of negotiating is concerning as
it appears that she may wish to lower prices more as later orders
continue. This will not be acceptable to Immaculate Production
Ltd in the long term, particularly as the learning curve effect will
shortly achieve a steady state and so labour saving will not occur.
It may be better at this point to agree terms for future work, before
agreeing to continue with batch 5.

Chapter 8
1. Lost opportunities and make-or-buy
a. The effect of a missed opportunity on profit is equivalent to an
additional cost. For example, a company misses the opportunity to
produce and sell a service that would increase its profit by $100.
This has the same effect on profit as an inefficiency which results
in increased costs of $100.
b.
• Depreciation is irrelevant in this case, because the decision to
produce in-house or to buy the product from a supplier will
not affect the effect of the depreciation of that machine. If, as
in the example, the machine becomes unusable, its remaining
depreciation is accounted for all in one go upon scrapping it.

• Electricity is relevant, because the decision to purchase will

imply lower electricity consumption by the company.

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 AC3097 Management accounting: Notes on the end-of-chapter questions

2. Raleigh Ltd
a. Total future cost for three years

Keep Upgrade Replace

£000 £000 £000
Outlay cost 0 2,000 4,200
Disposal value (800)
Manufacturing variable cost of 6000 units x 3 years 5,400 3,240 1440
Total future cost for 3 years 5,400 5,240 4,840
Replacing the equipment is the most profitable option over the
three years.
b. The upgrade option is £400,000 more expensive over three
years than the replacement option (£5,240,000 – £4,840,000
= £400,000) so the cost of the upgrade equipment should be
reduced by at least £400,000.
c. Income statement for each alternative at the end of the third year
of original machine:

Keep Upgrade Replace

£000 £000 £000
Sales 4,800 4,800 4,800
Less variable manufacturing cost (1,800) (1,080) (480)
Annual depreciation existing machine (5 years) (800) (800)
Annual depreciation on upgrade/new machine (3 years) (667) (1,400)
Loss on sale* (1,600)
Net income 2,200 2,253 1,320

*Written-down value
Cost 4,000,000
Less two years’ depn –1,600,000
Written down value 2,400,000
Less disposal value after 2 years –800,000
Loss on sale 1,600,000
This shows that despite the long-term savings available from
replacing the machine, in the short-term the net income of that
option is reduced by the loss on sale, so if the manager is focusing
on the short-term results, the upgrade will be implemented.

Chapter 9
1. Interior design business
a. Demand and use of Lillian’s and Johanna’s days is shown in this table:

Demand Lillian’sTotal Johanna’s Total Johanna’s

per year days Lillian’s days days needed
days
Per type Per type
needed
Type 1 20 1 20 3 60
Type 2 20 8 160 6 120
Type 3 10 25 250 5 50
Total 430 230

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Lillian’s time is constrained but Johanna has exactly the right amount
of work to fill her time. So, in order to find the most profitable
portfolio the types that provide the most contribution per hour of
Lillian’s time will be prioritised.

Lillian’s Johanna’s Contribution Contribution Ranking

days days margin per margin per
project scarce factor

Type 1 1 3 £2,000 £2,000 2nd

Type 2 8 6 £20,000 £2,500 1st
Type 3 25 5 £40,000 £1,600 3rd
The ranking shows that Type 2 work provides the most contribution
per Lillian’s hour and so all of this work should be done (20 projects).
The next greatest contribution is Type 1 work, followed by type 3.
Using Lillian’s time most profitably would result in the following
portfolio:

Optical mix Lilian’s hours Margin

needed
Type 1 20 20 £40,000
Type 2 20 160 £400,000
Type 3 2 50 £80,000
Total margin 230 £520,000
This would earn a margin of £520,000.
b. Using Abigail provides enough time to meet all demand, as shown here:

Lillian or Johanna Contribution Possible mix Margin

Abigail margin per
project
1 1 3 £2,000 20 £40,000
2 8 6 £20,000 20 £400,000
3 25 5 £40,000 10 £400,000
Total £840,000
Abigail (£150,000)
New total £690,000
Total margin increases by £320,000 at a cost of £150,000: a net
increase of £170,000. It is worth hiring Abigail.
c. The table shows that both Lillian’s and Johanna’s time is constrained:

Demand Lillian’s Total Johanna’s Total

per year days Lillian’s days Johanna’s
days days needed
Per type Per type
needed
Type 2 20 7 140 7 140
Type 3 10 16 160 14 140
Total 300 280
Linear programme equations
Maximise C = 20,000T2 + 40,000T3
Lillian constraint 7T2 + 16T3 < 260
Johanna constraint 7T2 + 14T3 < 230
14
 AC3097 Management accounting: Notes on the end-of-chapter questions

Because there are only two constraints, this can be solved

algebraically:
Deduct equation 2 from 1
2T3 = 30
T3 = 15
Substituting in Equation 1 7T2 + 240 = 260
T = 2.86
This would yield a margin of T3 £40,000 × 15 = 600,000
T2 £20,000 × 2.8 = 56,000
Total 656,000
(Assuming that it is possible to perform a partial job.)
This is higher than option (a) and would work if Abigail is not
available. But Lillian would have to decide how important Types 1
and 2 work are for her reputation and her ability to continue to obtain
Type 3 work.
2. Auditing and consulting
a. The law has been introduced to avoid a conflict of interest in
accounting firms. Consulting services are designed to meet
the needs of company management, whereas audit services,
although paid for by the company, represent the shareholders’
interest: they need to know that management has been acting
in their best interest and that the accounts show a true and fair
view of the financial position of the company. If auditors also
worked alongside management in their consulting role and the
audit then revealed areas where management had not behaved
correctly, auditors would be vulnerable to management trying to
persuade the auditors not to report the facts to the shareholders
as they should. This is particularly true if there is a threat of the
accounting firm losing all the work from that client.
b. The issues which must be considered are:
i. The income generated by the consulting fees, both now and in
the future, compared to the possible audit fees.
ii. Even if it is recommended by a firm’s directors, the
appointment of the audit firm must be voted for by
shareholders. There is therefore a risk of loss of appointment.
iii. The probable expansion of the company which will enable
more fees to be earned (of either nature).
iv. Ability to recruit new audit staff or retrain consulting staff to
develop audit skills.
v. Other audit clients whose business may be expanding, thus
requiring more audit work.
c. The consulting department would argue that they have wide
knowledge of the client’s processes and needs. This enables
them to meet new client consulting needs quickly and cheaply,
thus earning good margins, while undercutting their competitor
consulting firms who do not already have this knowledge.
The audit department would argue that audit work is almost
guaranteed from year to year, whereas consulting work is only
required when clients need to review new ways of working, etc.

15
AC3097 Management accounting

d. Firstly, the accounting firm would have to be decide how this new
tier of management would work. Would the account managers be
drawn from the pool of existing audit and consulting managers or
would they be new appointments? Whichever method is adopted
it would cause initial jealousies from those who previously worked
with clients and there may be resistance from clients to liaising
with different personnel.
A client-based structure is not likely to be tenable in this scenario,
since audit work and consulting work require different skills in
terms negotiating with clients, deployment of staff, etc. So the firm
would incur additional work and costs for no specific benefits.
Note that this answer makes certain assumptions about the
working of the accounting firm. Different assumptions, if well-
argued and clearly explained, would be equally acceptable.

Chapter 10
1. Consultants Ltd
a. The 5,200 consulting hours worked last year were made up of
eight consultants working 500 hours = 4,000 hours, and 1,200
hours of external consultants. The expected demand for year 1 is
5,100 hours. Consultants Ltd has enough expected demand in year
1 to justify the appointment of two new full-time consultants.
b. The current gross margin is 32.8 per cent. As the cost of the
software is specifically related to the new project, it is reasonable
to assume that Consultants Ltd consider this direct cost as part of
the calculation to reach its margin.
Calculation of price of new project:

Consultants’ time: 500 hours x $400 $200,000

Cost of software $50,000
Margin of 32.8 per cent means marking up by 49 per cent $122,500
Price $372,500
c. No other costs would arise from accepting the contract, given that
idle capacity would be employed. Hence:

Consultants’ time: 500 hours x $0 $0

Cost of software $50,000
Margin of 32.8 per cent means marking up by 49 per cent $24,500
Price $74,500
d. The client would reject the request of £372,500 and Consultants
Ltd would miss the opportunity to earn $100,000 (this is $350,000
– $250,000). Since the client is prepared to pay $350,000, this
price should be charged and will earn a contribution of $275,500
($350,000 – $74,500).
2. Target costing
Target costing aims to determine, through market research, the
price and features which are valued by customers and to design new
products specifically for that market. A required profit per product is
calculated and deducted from the price determined from the research.
This gives the target cost which must be met by the design of the
product.

16
 AC3097 Management accounting: Notes on the end-of-chapter questions

Reverse engineering requires competitors’ products to be obtained,

taken apart and examined to find out if there are any ideas which
can be used and any ways in which the new product can be made
in a cleverer or cheaper way.
Value analysis is an examination of the factors affecting the
cost of a product or service in order to find new, more effective
ways of achieving the required purpose at the target cost, while
retaining the level of quality and reliability expected. It involves an
interdisciplinary approach.
Process improvements involve examining the machining and other
processes involved in the production of the new product to ensure
that they are as cost-effective and efficient as possible.
3. Grand Designs plc
a.

Greenwood Wholesalers Local Authority Total

£000 £000 £000 £000
Sales 350 550 600 11,500
Variable costs 105 165 180 450
Sales discounts 52.5 27.5 12 92
Sales commission 29.75 52.25 58.8 140.8
Sales promotion 3 15 18 36
Distribution* 11.25 14.25 15 40.5
Total traceable costs 201.5 274 283.8 759.3
Customer profitability 148.5 276 316.2 740.7
Profit/sales % 42.4% 50.2% 52.7% 49.4
*Workings: variable distribution costs 600,000 – 200,000 / 6 =
1,500 per 100,000 over 200,000.
b. Greenwood has the lowest profit percentage. It is a valuable
customer, providing 23 per cent of total sales. It would be very
detrimental to lose their custom, but Grand Designs is giving large
sales discounts to keep this business. Local authorities are the most
profitable in profit and percentage terms and efforts should be
made to retain them.
c. Ideally, ABC analysis would be done to provide the allocations of
shared costs. Without this information it would give misleading
information to allocate them at all.

Chapter 11
1. Net present value
Project B will have a higher NPV than project A as long as the discount
rate (whatever it may be) is the same for both projects. This is because
discounting affects the cash flows that are further in the future more
than the cash flows that are nearer in the future. Projects A and B have
the same total cash flows but the cash flows of A are more skewed
towards the future than those of project B.

17
AC3097 Management accounting

2. Cost-plus and lifecycle costing

a. The limitations of cost-plus pricing are twofold:
i. The price ignores the market demand, therefore the price does
not necessarily hit the demand curve at the optimum level of
supply that maximises the suppliers’ revenues.
ii. The price includes any inefficiency that the firm may have in the
production of that product or service, and no pressure is put on
those responsible for the production to reduce such costs.
The adoption of homogeneous cost-plus pricing in sectors
where the costs are similar among most players results in
similar prices, which may be perceived as resulting from
an implicit agreement among competitors. This practice is
normally discouraged by regulatory authorities, because it
negatively affects consumers.
b. In life-cycle costing the cost of a product comprises not just
its cost of production but also its cost of disposal and plant
decommissioning. Considering the cost of disposal and plant
decommissioning means that costs that would otherwise be
suffered by the environment (business, social and ecological) are
instead factored into the company’s costs. Therefore, these costs
measure the company’s impact on the external environment and
help to tackle its effects.
3. Ultimate Business Software Ltd
Product life cycle income statement for each software package
a.

(IM) (DL) (QM)

Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Year 1 Year 2 Year 3
Total Total Total
2017 2018 2019 2018 2019 2020 2019 2020 2021
Estimated
2,500 10,000 6,000 18,500 2,000 3,000 2,000 7,000  4,000 3,500 1,500 9,000 
demand (units)
Selling price (£) £1,800 £1,600 1,400   £3,000 £3,000 £2,500   £2,500 £2,200 £2,000  
(£000) (£000) (£000) (£000) (£000) (£000) (£000) (£000) (£000) (£000) (£000) (£000)
Total sales 4,500 16,000 8,400 28,900 6,000 9,000 5,500 20,500 10,000 7,700 3,000 20,700
Costs              
Research &
6,500 12 0 6,512 5,100 100 5,200 2,400 910 0 3,310
product design
Production 750 2,800 2,000 5,550 900 1,200 800 2,900 1,500 1,400 700 3,600
Marketing 1,400 2,600 3,000 7,000 1,200 800 1,000 3,000 2,400 1,700 800 4,900
Distribution 150 600 400 1,150 240 360 100 700 600 360 200 1,160
Customer call
500 1,250 1,600 3,350 450 850 900 2,200 2,200 3,080 1,000 6,280
out & support
Total product
9,300 7,262 7,000 23,562 7,890 3,310 2,800 14,000 9,100 7,450 2,700 19,250
costs
Product net 1,000 2,700
–4,800 8,738 5,338 –1,890 5,690 6,500 900 250 300 1,450
income
Net income % 18.5% 31.7% 6.5%

18
 AC3097 Management accounting: Notes on the end-of-chapter questions

b. Impact of the new packages on company’s income for years

2017–21

2017 2018 2019 2020 2021

Product IM –4,800 8,738 1,000
Product DL –1,890 5,690 2,700
Product QM 900 250 300
Total annual
increase in net
income –4,800 6,848 7,590 2,950 300
c. The information shows that profits are low in the first year of each
product’s life due to research and product development costs and
lower sales. The sales peak in the second year and then decline.
Both IM and DL show similar total returns.
Since these are forecasts there is an opportunity to see whether
actions could be taken to make the products even more profitable.
Product IM has a lower profit percentage than DL, but the best
sales growth. This may be due to good research and product
design, and an increase in marketing in the second year as well as
a slight drop in price.
Product DL appears to be a complicated or highly valued product
as the price is so high. Customer support costs are expected to be
low due to the excellence of the product. Marketing is also low,
which may be correlated with low sales growth. An excellent profit
percentage was obtained.
QM has much lower spending on research and product design
compared to the other products, but this appears to lead to much
higher customer call out costs and, despite the drop in price, lower
expected sales in the second year. More is spent on research and
product design in year 2, but this does not remedy the expected
need to support customers and the total profit is much worse than
the other products.
The production cost per unit went down between the two years for
IM and DL indicating learning curve effects/economies of scale.
QM’s production cost is planned to increase per unit. It is £375
per unit in year 1, £400 per unit in year 2 and £467 in year 3.
This should be investigated. Overall QM, though generating good
sales, has poor net income due to very high customer call out and
support.
Since this product is not due to be launched until 2019 there is
time to spend more on design to make a more robust product.
The impact of the new packages on the company’s income for
years 2017–21 is helpful for planning purposes. It shows the
importance of having three new products each year. This means
that a new (or revised) product must be launched every year.

19
AC3097 Management accounting

Chapter 12
1. The logic of the budgeting process
In order that the budget of sales can be drawn, conclusive decisions
must have been taken on the quality of the products or services that
the firm is planning to sell, the segments it will target and the time
of delivery. This information is necessary for planning the usage of
materials, direct labour, machines and all other resources in terms of
their quality, quantity and timing.
The ultimate manifestation of a firm’s strategy is in its output of
products or services, their quality, quantity, time and place of delivery.
Hence, the fact that the budget reflects the firm’s strategy supports
the logic of starting from the sales budget. Managers must strike
a balance between what is ideal and what is possible; starting the
budgeting process from any other budget than sales would indicate
that the firms’s priority is on what it can do as opposed to what it is
appropriate to do in order to succeed in the market.
2. Greaves Ltd
a. i)

Greaves Ltd – Cash budget January February March Outstanding March

Receipts £ £ £ £
Sales (cash) 17,400 19,140 20,097 0
- credit 1st month 99,400 109,620 120,582 126,611
- credit 2nd month   42,600 46,980 (51,678 + 54,262)
Fixed asset proceeds 2,000    
Total receipts 118,800 171,360 187,659
Payments      
Capital expenditure   103,000 50,000
Corporation tax     31,000
Materials 1st month 34,800 38,280 40,194
2nd month 20,000 34,800 38,280 40,194
Wages 26,000 23,000 20,000
Admin o/head 8,100 8,100 8,100
Advertising 20,000 10,000 30,000
Selling o/head 9,400 6,050 10,850
O/draft interest 1% previous month
    384 (79,708 x 1% = 797
balance
Total payments 118,300 223,230 228,808
Difference 500 –51,870 –41,149
Opening balance 13,000 13,500 –38,370
Closing balance 13,500 –38,370 –79,519

Workings
Sales – using probabilities
Probability Sales January February March
£ £ £ £
20% 140,000 28,000    
70% 180,000 126,000    
10% 200,000 20,000    
20 174,000 191,400 200,970
 AC3097 Management accounting: Notes on the end-of-chapter questions

Calculation of receipt of sales

Opening receivables January February March
Sales   174,000 191,400 200,970
Less cash 10%   17,400 19,140 20,097
Credit 142,000 156,600 172,260 180,873
70% 99,400 109,620 120,582 126,611
30% 42,600 46,980 51,678 54,262
Calculation of material and when paid        
Direct materials 40% sales   69,600 76,560 80,388
Opening payables      
50% of material cost - 1st month 20,000 34,800 38,280 40,194
2nd month 34,800 38,280 40,194
ii) and iii)

Income statement: three months

January February March Total
£ £ £ £
Sales revenue 174,000 191,400 200,970 566,370
Less material costs 69,600 76,560 80,388 226,548
Gross income 104,400 114,840 120,582 339,822
Less expenses:        
Wages 20,000 23,000 26,000 69,000
Admin 13,100 14,900 16,100 44,100
Advertising 20,000 10,000 30,000 60,000
Selling 9,400 6,050 10,850 26,300
Profit on sale –1,000     –1,000
Overdraft interest   384 797 1,181
Total expenses 61,500 54,334 83,747 199,581
Net income 42,900 60,506 36,835 140,241
iv)

Statement of financial position at

£ £
31 March 
Non-current assets (130 + 153 – 19.8 – 1) 262,200
Current assets
Inventory 76,000
Receivables 232,551
Total current assets 308,551
Total assets 570,751
Equity and liabilities
Shareholders’ funds opening balance 310,000
Add: Profit 140,241
450,241
Current liabilities
Trade payables and accrued interest 40,991
Bank overdraft 79,519
Total current liabilities 120,510
Total equity and liabilities 570,751
21
AC3097 Management accounting

b. The budget is a planning document. The above figures show that

the budgeted net income is positive, although March’s net income
is impacted by lower growth and high advertising costs. The
figures could suggest that using higher advertising during January
or February might help March’s sales to improve.
The cash budget shows a large overdraft. This can be seen to be
largely due to the purchase of capital expenditure. Since the company
is still at the planning stage it can consider how to fund this cash
deficit. Overdraft interest is usually one of the most expensive forms
of borrowing and can be withdrawn at any time by the bank, so is not
usually considered appropriate for financing long-term assets.
Long-term funding could be raised by loans or share capital to
finance the capital expenditure. Alternatively it may be possible
to defer some expenses to later months. If adjustments cannot be
made an overdraft facility must be negotiated with the bank.

Chapter 13
1. Westward Ltd
a. Standard cost budget and actual performance

£ 1 unit Budget Flexed budget Actual Actual

8000 8,600 calculations
Sales £160.00 1,280,000 1,376,000 8,600 x 163 1,401,800
Material 007 6kg x 12.25 73.5 588,000 632,100 50,960 x 12.45 634,452
XL 90 3kg x 3.20 9.6 76,800 82,560 25,600 x 3.19 81,664
Labour 4 hrs x 8.40 33.6 268,800 288,960 35,690 x 8.6 306,934
Variable overhead lab 4 x £1 4.00 32,000 34,400 38,425
Variable overhead mach 3 x £2 6.00 48,000 51,600 51,080
Set up costs* 0.50 4,000 4,300* 3,860
Fixed overhead 4 x £1.75 7.00 56,000 60,200 56,860
Total cost 134.2 1,073,600 1,154,120 1,173,275
Profit 25.8 206,400 221,880 228,525
b.

Favourable Unfavourable
£ £
Sales volume variance 25.80 x 600 15,480
Sales price 1,376,000 – 1,401,800 25,800
Material 007 price (50,960 x 12.25) – 634,452 10,192
XL 90 price (25,600 x 3.20) – 81,664 256
Material 007 quantity (51,600 – 50,960) x 12.25 7,840
XL 90 quantity (25,800 – 25,600) x 3.20 640
Labour rate 35,690 x (8.4 – 8.6) 7,138
Labour efficiency (34,400 – 35,690) x 8.4 10,836
Variable overhead labour spending (35,690 x 1 ) – 38,425 2,735
Variable overhead labour efficiency (34,400 – 35,690) x 1 1,290
Variable o/head machine spending (25,740 x £2) – 51,080 400
Variable o/head machine efficiency (25,800 – 25,740) x 2 120
Set up cost spending* (500 x 7) – 3,860 360
Set up cost efficiency* 4,300 – (500 x 7) 800
22
 AC3097 Management accounting: Notes on the end-of-chapter questions

(Or set up cost efficiency* 4,500 – (500 x 7) 1,000

set up costs – capacity*) 4,300 – 4,500 200)
Fixed overhead spending maintenance 24,000 – 23,260 740
Fixed overhead spending general 32,000 – 33,600 1,600
Fixed overhead capacity 35,690 – 32,000 x 1.75 6,457.5
Fixed overhead efficiency 34,400 – 35,690 x 1.75 2,257.5
Total variances 58,533.5 36,408.5
Net favourable variances 22,125
* You could enter either 4,500 in flexed budget (9 x 500) because
the standard number of batches for 8,600 units is 9 batches, or
4,300, which is 8,600 x £0.05. Either answer would receive marks.
c. There is good performance on sales volume and price, which
explains most of the improved profit, perhaps due to the absence
of a competitor. 007 price variance is high and unfavourable due
to a small price increase on a material representing most of the
product cost. Other material variances were positive, indicating
careful usage.
Labour rate and efficiency were unfavourable – this needs to
be investigated. Could additional production have a bearing on
it? The adverse labour efficiency also affected overhead costs
recovered on a labour basis.
Machine costs were lower than expected. Set up expenditure was
higher, but the lower number of batches showed savings overall.
The company worked harder than expected resulting in higher
overhead recovery: a good sign.

Chapter 14
1. Purpose and information provided by variances
a. Material mix and yield variances
Some processes require the input of various different material
resources, the proportions of which can be adjusted but still
produce the correct final product. Changes in the mix can lead to
cheaper production overall. Changes will often be made if input
prices have altered. However, the change in the mix can result in
greater or lesser amounts of the final product being produced. This
is the yield variance. The mix and yield variances added together
will agree with the material usage variance.
The information provided enables decision makers to understand
the impact of changes in inputs on both the amount of the yield
and whether or not there are financial savings. Since the variances
are calculated based on standard material prices, it is also
important to calculate the material price variances as this is an
important part of making the decision to change the mix.
b. Sales mix and quantity variances
When budgeting for sales in companies with several products, it is
usual to detail the expected sales quantity of each product. This is
both to help the planning process and to determine budgeted net
income, as products will have different contribution margins.
In any one month the actual quantity of each product sold is likely
to be different from the budgeted quantity. The total quantity may
also be more or less than budgeted.
23
AC3097 Management accounting

Since the proportions of each type of product relative to the total

sales are likely to have changed, the impact of the changed mix
must be measured. The sales mix contribution variance plus the
sales quantity contribution variance will give the total for the sales
volume variance.
The information provided gives a good idea of which products are
selling better than expected and which are lagging. This might
inform marketing strategy, particularly if high margin products are
falling behind in sales performance.
c. Planning and operational variances
The budget each year will be based on the environment at the
time and any known changes. As time goes on the environment
will change in unexpected ways. Good managers will be expected
to consider this in their decision making. Planning variances
compare the current situation with the budgeted one and calculate
variances which show how much of the total variance is due to
the changed environment. The operational variance is the amount
which reflects the actual decision taken, given the changed
environment. The two variances together will equal the original
sales contribution variance based on the existing budget.
The purpose of this is to encourage managers to keep referring to
the current business situation and to make good decisions in the
light of new opportunities.
2. Alfa plc
a) and b)

Budget Flex Actual Total Chantal Steffan Mariel

budget variance
Number of clients 10 11 11
Revenues €1,200,000 €1,320,000 €1,000,000 –320,000 (A) –320,000 (A)
Cost of full-time €150,000 €150,000 €160,000
employees
(including heads)
Content €150,000 €150,000 €160,000 –10,000 (A) –10,000 (A)
Story €170,000 €170,000 €175,000 –5,000 (A) –5,000 (A)
Media €190,000 €190,000 €190,000 0 0
Cost of freelance
consultants
Content €30,000 €33,000 €40,000 7,000 (A) 7,000 (A)
Story €20,000 €22,000 €10,000 12,000 (F) 12,000 (F)
Media €5,000 €5,500 €10,000 4,500 (A) 4,500 (A)
Other team costs
Content €15,000 €15,000 €15,000 0 0
Story €15,000 €15,000 €25,000 –10,000 (A) –10,000 (A)
Media €20,000 €20,000 €25,000 –5,000 (A) –5,000 (A)
Administrative costs €30,000 €30,000 €40,000 –10,000 (A) –10,000 (A)
Profit €555,000 €669,500 €310,000 –359,500 (A)
Sales volume 114,500 (F) 114,500 (F)
contribution
variance
Total variance –245,000 (A) –22,000 (A) –203,500 (A) –19,500
24
 AC3097 Management accounting: Notes on the end-of-chapter questions

c) Evaluation of responsibilities
• Chantal is responsible for hiring, dismissing and paying all full-
time members of all teams.
This seems unfair because full-time employees may be entitled
to overtime as and when Steffan and Mariel decide, so why
should Chantal be responsible for these costs?
• Mariel is responsible for overhead administrative activities.
This seems acceptable as long as the administrative activities
do not depend on the team directors’ decisions. However, if the
directors can influence the administrative costs it is difficult to
justify this allocation of responsibility.
• Steffan is responsible for finding clients and negotiating selling
prices.
This seems acceptable, as long as Steffan is actually the only
person determining who the clients will be. It is, however,
likely that the clients depend on the product, hence the other
directors should be jointly responsible for their share.
• Each team director is responsible for hiring freelance
consultants.
This seems fair because the freelance consultants are a variable
cost that is determined by the directors.
• Each team head is also responsible for all other costs incurred
by his or her respective team. For a similar reason to hiring
freelance consultants, this allocation seems reasonable.
It would be advisable for Alfa plc to review the allocation of
the cost of administration (and possibly the costs of finding
clients and negotiating selling prices) with the intention of
charging each director for the costs their activities give rise to.
Note: If your answer is merely descriptive, perhaps just
repeating the information provided in the scenario, then you
should think of improving it with critical evaluation (in other
words, give comments and criticise).
d)
Planning

(Original consultants’ cost – market rate)

Content (33,000 – 37,950) = –4,950(a)
Story (22,000 – 25,300) = –3,300(a)
Media (5,500 – 6,325) = –825(a)
Total –9,075(a)
Operational

(Price variance – planning variance)

Content (–7,000 – –4950) = –2,050(a)
Story (+12,000 – –3,300) = +15,300(f)
Media (–4,500 – –825) = –3,675(a)
Total +7,575(f)

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AC3097 Management accounting

This shows that €9,075 was explained by the market rise in pay.
If we regard the operational variances as the measure of each
manager’s responsibility:
Chantal is now responsible for –€2,050
Steffan has managed to keep costs down by +€15,300
Mariel is now responsible for –€3,375.

Chapter 15
1. Net income and EVA
EVA measures the excess profit that a firm or part of a firm makes after
having covered all its costs, including the cost of risk borne by the
investment. In other words, the two concepts of a firm’s profit and its
EVA are similar in that they both measure the added value of a firm’s
operations. However, profit only refers to the costs that are recognised
in the profit and loss. EVA, instead, considers further costs: the implicit
or ‘economic’ cost of taking the risk.
2. Snackandgo

All figures in £000 Finchley Morden

a) ROI before oven project (196 / 890 ) x 100 = 22% (264 / 1740) x 100 = 15 %
b) ROI of oven project – first year asset cost  180
                                               Less depn                36
                                Written-down value               144
Net income 140 – 80 – 36 = 24

Project ROI first year = (24/144) x 100 = 16.7%

Store ROI if ovens installed £000 £000
Net income without oven 196 264
Oven net income 24 24
Total net income 220 288
ROI 220 / 890 + 144 = 21.3 288 / 1,740 + 144 = 15.3
RI with existing position
Investment 890 1,740
Profit 196.0 264.0
Less capital charge 124.6 243.6
Residual income 71.4 20.4
Store RI if ovens are installed
Investment 1,034 1,884
Net income 220 288
Less capital charge 144.8 263.8
Residual income 75.2 24.2
The residual income of each division increases by £3,800.
c. The ROI shows that Finchley is performing better than Morden but
this is largely because the fixed assets are (on average) eight years old,
which reduces their value in the balance sheet. They were also bought
when the price index was lower. In order to continue to improve ROI,

26
 AC3097 Management accounting: Notes on the end-of-chapter questions

managers are discouraged from replacing assets. Finchley would also

be reluctant to take on the new expansion even though its ROI is
higher than the company cost of capital because their ROI would fall
slightly. Morden, however, would have a slightly improved ROI. This
method therefore does not lead to goal congruence as the company
as a whole would benefit from both stores adopting the pizza oven
business.
As the above calculations show, the residual income approach would
rectify this, as the project would improve the residual income of each
store. Residual income has the limitation of not providing a percentage
figure, which some managers prefer. Both measures suffer from the
problems of asset values and provide a single measure related to
complex activities.
d.

Current value ROI

All figures in £000 Finchley Morden
Fixed asset values 600 x 200 / 160 = 750 1,450 x 200 / 180 = 1,611
Net current assets 290 290
Total 1,040 1,901
Current value net income
Historical cost net income 196
Less additional current cost depn (300 x 200 / 160) – 300 = 75 207 x 200 / 180 – 207 = 23
Current cost net income 121 241
Current value net income 121 / 1040 x 100 = 11.6% 241 / 1,901 x 100 = 12.7%
The current value approach shows the Finchley store making lower
ROI than the Morden store. Since all non-current assets are now
at the same value, the comparison is slightly fairer by coping with
changes in price level on asset values and having fairer annual charges
for depreciation. It does not, however, iron out the difference in the
number of years of depreciation.
It reveals that neither store is meeting the required return. The
Finchley store’s profit is reduced more than the Morden store by
current cost depreciation charges. The method therefore makes
comparisons between divisions fairer but is still not ideal.

Chapter 16
1. Transfer pricing and tax avoidance
An opportunistic choice of transfer prices may result in allocation of
profits among subsidiaries of the same multinational group in a way
that ‘transfers’ taxable income from subsidiaries registered in high-
tax regions to subsidiaries registered in low-tax regions. For example,
a subsidiary in a low-tax region may invoice its fellow subsidiaries
for services such as consultancy, use of licences, etc. In so doing, the
fellow those will produce lower taxable income, which is beneficial to
the group as a whole. This inappropriate (and often illegal) policy can
be detected by observing that the price level for these services cannot
be explained by any of the methods accepted in management and cost
accounting or OECD regulations.

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AC3097 Management accounting

2. Microelectronics
a.
Circuit Board Mobile Phones
Division Assembly
Division
$000 $000
Contribution of two divisions without super phone
Outside sales (70,000 units) 1,400 1,200
Transfer sales (30,000 units) 600
Total sales 2,000 1,200
Variable costs 1,300 450
Transfer price 600
Total variable costs 1,300 1,050
Contribution 700 150
Contribution of super phone
Transfer sales 800
Outside sales 1,920
Variable costs 520 1,200
Transfer price 800
Contribution 280 –80
b. The new phone project makes an overall profit of $200,000 but the
high transfer price means that the Mobile Phones Assembly Division
makes a loss of $80,000 and the Circuit Board Division makes a profit
of $280,000. It appears that there is no alternative market for the
30,000 original circuit boards transferred or the 40,000 extra circuit
boards. The original transfer price was market price. Since the Mobile
Phones Assembly Division will not continue with the super phone at
this market price. Theoretically, the correct price for the transfer is
outlay cost plus opportunity cost, which in this case is $13. However,
in order for the Circuit Board Division to be motivated to produce the
additional boards, the managers need to negotiate a price above $13,
the variable cost. Whether this will apply to all circuit boards will have
to be discussed. It is also worth considering whether the price of the
super phone is too low.

Chapter 17
1. Gregory Ltd
a.
Cost of quality – existing motors 2016 2017 2018
£ £ £
Lost contribution due to insufficient machine time
2,160,000
used for rejected units 60,000 x (120–84) = £36
Lost contribution due to use of machine for
1,440,000
reworking 20,000 x 2 x £36
Rework direct material and labour 60,000 x £8 480,000
Cost of modification per year 2,100,000 1,800,000
Saving in inspection cost (60,000) (60,000)
Staff retraining 2017 80,000 0
Total cost of quality 4,080,000 2,120,000 1,740,000
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 AC3097 Management accounting: Notes on the end-of-chapter questions

The table above shows that in 2017 there would be a saving in

quality costs of $1,960,000 and that from 2018 onwards it is well
worth implementing the new design with savings of $2,540,000.
b. The most important qualitative aspects are the improvement
in customer confidence and staff morale. There could be staff
redundancies due to reduction in the inspection costs. It may be
possible to deploy these workers in the work required due to the
modification.
c. At present the machine hours are just sufficient to meet the
demand of 700,000 motors if 100 per cent good units are
produced. To produce anything else would require some of these
motors to be discontinued.
The demand from Williams of 20,000 units at a rate of 1.6 per
hour would use 20,000 / 1.6 = 12,500 hours and contribute
20,000 × £40 = £800,000.
The lost contribution would be 12,500 × 2 =25,000 motors x £36
contribution = £900,000.
This is not profitable financially. The contribution would need be
negotiated to more than (40 × 9 / 8) = £45 per unit to make it
worthwhile.
Also, if this were done Gregory Ltd would lose goodwill from
existing customers.
Since Gregory Ltd is operating at full capacity to meet demand it
might be worth exploring its customers’ plans for expansion and
possibly considering expansion of its production capacity.

Chapter 18
1. Globe Oil plc
a. Globe Oil has met its main target. It has exceeded its profit target
from price recovery by £10M and increased profit from growth.
This indicates that there has been a move to increased sales to
high-income customers.
b. Since Globe Oil’s main strategy is focused on good customer
service at the service stations, employee satisfaction is important.
The focus of the other perspectives on quality, reliability,
availability and implementation of more advanced controls all
require skilled, motivated employees. This means that employee
satisfaction and training are very important throughout the
organisation.
c. Globe Oil attracted more high-income customers, as shown by
the changes from price recovery. It has also grown its sales but
it is not clear whether this is in the ‘price shoppers’ category as
well as the high-income category. The market share is not only an
indicator of whether Globe Oil has grown but how they have kept
up with market growth, which they have not. In order to find out
what has happened, Globe Oil needs to know whether they have
matched or exceeded growth in the high-income customer market.
It is difficult to know whether the measures should be changed to
growth of share in the high-income market since this may motivate
staff to focus only on those customers, which could lead to the loss
of a greater proportion of price shoppers. It would be better to give
targets for the different types of customer.

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d. In the customer perspective, a measure of customer satisfaction

would help focus staff at the petrol stations on the importance of
this factor. It might also be useful to have an index of sales other
than petrol as part of the scorecard and bonus scheme.

Chapter 19
1. Management accounting and control versus strategic management
accounting and control
Strategic management takes a wide approach to monitoring and
controlling activities and opportunities for change by ensuring that
they focus on the strategic goals identified by the company.
Strategic management control ensures not only that the
accounting measures are meeting the strategic goals but that the
lead measures (learning and growth, internal business process
efficiency and customer retention and growth activities) are also
monitored to ensure that they are in line with future strategy.
Strategic management accounting for decision making will give
senior managers an overview of the far-reaching effects of their
decisions, whereas non-strategic management accounting supports
the decision makers by providing very specific and financially-
orientated measures.
Strategic management accounting is able to feed into broader
cost–benefit analyses with measures and indicators that can help
senior managers to evaluate decisions in their multiple aspects.
Note: The wording of the answer to this question may vary
considerably, but the main concept that should emerge is that strategic
management accounting provides indicators and supports the
multifaceted evaluation of decisions. Examples could also be given to
support your explanation.

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