Operational Level Paper
P1 –Performance Operations Examiner’s Answers SECTION A Answer to Question One 1.1
The correct answer is D.
1.2
(54 + 46 + 32 + 43 – 67) = 108 days The correct answer is C.
1.3
$46,000/$250,000 = 18·4% The correct answer is A.
1.4
The lowest profit in each case is when the weather is bad. If the maximin rule is applied, the highest profit when the weather is bad is $1,000 i.e. 1,000 burgers. The correct answer is A.
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1.5 Minimax Regret Table Weather
No of burgers purchased 1,000
2000
3000
4000
Bad
$0
($1,000)
($2,000)
($4,000)
Average
($4,000)
($1,000)
$0
($1,000)
Good
($9,000)
($6,000)
($3,000)
$0
The maximum regret for 1,000 burgers is $9,000 The maximum regret for 2,000 burgers is $6,000 The maximum regret for 3,000 burgers is $3,000 The maximum regret for 4,000 burgers is $4,000 Therefore if he wants to minimise the maximum regret he will purchase 3,000 burgers. The correct answer is C.
1.6
Payment will be made 50 days early. Number of compounding periods = 365/50 = 7·3
1.00 7.3 1+ r = 0.975 1 + r = 1·203 The cost of offering the discount is 20·3%
1.7 $ 140,000 160,000 160,000 160,000 -
$ 50,000 = 50,000 = 60,000 = 70,000 =
$ 90,000 110,000 100,000 90,000
Joint probability is (0·45 x 0·25) = Joint probability is (0·25 x 0·25) = Joint probability is (0·25 x 0·35) = Joint probability is (0·25 x 0·40) =
0·1125 0·0625 0·0875 0·1000 0·3625
Alternatively: $140,000 – $50,000 = $90,000 Joint probability is (0·45 x 0·25) = At cash inflows of $160,000, net cash flows are all greater than $90,000 therefore probability is
0·1125 0·2500 0·3625
The probability is 36·25%
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1.8
Interest is 80/900 i.e. 8·9% plus capital gain at maturity of $100 therefore discount initially at 10%. Cash flows
Discount rate @ 10%
PV of cash flows $ (900·00) 198·96 737·64 36·60
$ Year 0 Year 1-3 Year 4 NPV
(900) 80 1,080
1·000 2·487 0·683
Discount rate @ 12% 1·000 2·402 0·636
PV of cash flows $ (900·00) 192·16 686·88 -20·96
By interpolation: 10% + (2% (36∙6/(36∙6 + 20∙96)) = 11·27%
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SECTION B Answer to Question Two
(a)
(i) < 1 month $ 145
1- 2 months $ 438
2-3 months $ 0
>3 months $ 118
Balance $ 701
(ii)
Examiner’s note: the question asks for two benefits. Examples of points that would be rewarded are given below.
(a)
(d)
Can be used to help decide what action should be taken about debts that have been outstanding for longer than the specified credit period. Provides information about the efficiency of cash collection. Can provide information to assist in setting and monitoring collection targets for the credit control section. Provides information that can be used in setting a bad debt provision.
(b)
(i)
(b) (c)
EOQ
2x 64,000x150 = 4,000 1.20 Total cost of inventory management is: Cost of ordering inventory + cost of holding inventory DCo ChQ 64,000 × 150 1.2 × 4,000 + = + 2 4,000 2 Q
= $2,400
+
$2,400
= $4,800
(ii)
One week’s usage = 64,000/52 = 1,231 Inventory reorder level = 3 x 1,231 = 3,693 units
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(c)
The traditional approach to determine material requirements is to monitor inventories constantly; whenever they fall to a predetermined level, a preset order is placed to replenish them. This traditional approach (involving re-order levels and economic order quantity calculations) originates in the pre-computer era. A manufacturing resource planning system is a fully integrated computerised planning approach to the management of all the companyâ&#x20AC;&#x2122;s manufacturing resources including inventory, labour and machine capacity. It seeks to ensure that resources are available just before they are needed by the next stage of production or despatch. It also seeks to ensure that resources are delivered only when required so that raw material inventory is kept to a minimum. The technique enables managers to track orders through the manufacturing process and helps the purchasing and production control departments to move the right amount of material or sub-assemblies at the right time to the right place. The current inventory management system relies on the assumption that there is constant demand. An MRP system begins with the setting of a master production schedule specifying both the timing and quantity demanded of each of the finished goods items and then works backwards to determine the resource requirements at each stage of the production process. It aims to generate a planned schedule of materials requirements after taking account of scheduled receipts, projected inventory levels and items already allocated to production. The EOQ model can be used within MRP provided that the major assumption in the EOQ model of constant demand applies.
(d)
Under an activity based budgeting (ABB) system, resource allocation is linked to the strategic plan and is prepared after considering alternative strategies. This approach ensures that new activities that are required to meet the companyâ&#x20AC;&#x2122;s strategic objectives are included in the budget. Under a traditional incremental budgeting system the focus is on existing resources and operations. Adjustments are then made for changes in activity and price which results in past inefficiencies being perpetuated. Under an activity based budgeting system, only resources that are needed to perform activities required to meet the budgeted production and sales volumes are included. Activity based techniques including activity based budgeting focus on the outputs of a process rather than the input to the process. This approach provides a clear framework for understanding the link between costs and the level of activity. It allows the ranking of activities and the determination of how limited resources should be allocated across competing activities. Traditional budgeting systems present costs under functional headings i.e. the emphasis is on the nature of the cost. The weakness of this approach is that it gives little indication of the link between the level of activity and the cost incurred. The approach under a traditional system is to make arbitrary cuts in order to meet overall financial targets. Activity based budgeting allows the identification of value added and non-value added activities and ensures that cuts are made to non-value added activities. ABB is also useful for review of capacity utilisation. If it is known that the resources devoted to a particular activity are greater than those currently required then these resources can be reduced or redeployed.
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(e)
Production cost budget for Quarter 3
Budgeted costs
$
Direct materials Production labour
262,200 219,000
Production overheads
278,000 759,200
Workings: Direct materials Production labour
Variable cost per unit = $12 Variable cost per unit (195,000 – 155,000) / (20,000 – 15,000) = $8 Fixed cost $155,000 – (15,000 x $8) = $35,000
Production overheads
Variable cost per unit (240,000 – 210,000) / (20,000 – 15,000) = $6 Fixed cost $210,000 – (15,000 x $6) = $120,000
Quarter 3 Direct material Production labour Production overheads
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23,000 units x ($12 x 0∙95) = $262,200 23,000 units x $8 = $184,000 + $35,000 = $219,000 23,000 units x $6 = $138,000 + $120,000 + $20,000 = $278,000
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(f)
Decision tree: advertise concert or not
No Increase 40%
5,000 ($35,000)
($9,800)
Increase 60%
7,000 $20,000
$8,400
10,000 $75,000
$16,875
13,000 $135,000
$10,125
Poor 70%
Advertise
No Increase 75% Good 30% Increase 25% Donâ&#x20AC;&#x2122;t Advertise
Poor 70%
Good 30%
$25,600 5,000 ($20,000)
($14,000)
10,000 $90,000
$27,000 $13,000
Therefore the concert should be advertised.
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SECTION C
Answer to Question Three
(a) Reconciliation Statement Budgeted gross profit
$ 432,000
Sales price variance Sales volume profit variance Material price variance ETH 1 Material price variance RXY 2 Material mix variance Material yield variance Fixed overhead expenditure variance Fixed overhead volume variance Actual gross profit
21,300 6,000 2,210 9,580 13,200 18,000 2,000 4,000 457,470
F A A F A F F A
Workings Budgeted sales Budgeted cost of sales Budgeted gross profit
$1,440,000 $1,008,000 $432,000 (or 72,000kg x ($20 - $14))
Sales price variance = ($20·30 - $20·00) x 71,000kg = $21,300 F Sales volume profit variance = (71,000kg – 72,000kg) x ($20 - $14) = $6,000 A Material price variance ETH 1 = ($18·00 - $18·10) x 22,100kg = $2,210 A Material price variance RXY 2 = ($6·00 - $5·80) x 47,900kg = $9,580 F Material mix variance
Raw Material ETH1 Raw Material RXY2
Actual input @ std mix Kg 21,000
Actual input @ act mix kg 22,100
Variance kg
Std Price $
Variance $
1,100 A
18∙00
19,800 A
49,000
47,900
1,100 F
6∙00
6,600 F
70,000
70,000
-
-
13,200 A
Material yield variance Actual total input Standard yield Expected output Actual output Variance Std price per kg Variance
70,000kg 96% 67,200kg 69,000kg 1,800kg F x $10 $18,000 F
Fixed overhead expenditure variance = ($280,000 - $278,000) = $2,000 F Fixed overhead volume variance = (70,000 kg – 69,000kg) x $4 = $4,000 A
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$ 1,441,300 (400,010) (277,820) (278,000) (28,000) 457,470
Actual sales revenue ETH1 RXY2 Fixed o/heads incurred Inventory movement (2,000 units x $14) Actual gross profit
(b) Examinerâ&#x20AC;&#x2122;s note: the question asks for three reasons. Examples of points that would be rewarded are given below. In a JIT environment measuring standard costing variances may encourage dysfunctional behaviour. A JIT production environment relies on producing small batch sizes economically by reducing set up times. Performance measures that benefit from large batch sizes or producing for inventory should therefore be avoided. In an AMT environment the major costs are those related to the production facility rather than production volume related costs such as materials and labour which standard costing is essentially designed to plan and control. Fixed overhead variances donâ&#x20AC;&#x2122;t necessarily reflect under or overspending but may simply reflect differences in production volume. An activity based cost management system may be more appropriate, focusing on the activities that drive the cost. In a total quality environment, standard costing variance measurement places an emphasis on cost control to the detriment of quality. Cost control may be achieved at the expense of quality and competitive advantage. A continuous improvement environment requires a continual effort to do things better rather than achieve an arbitrary standard based on prescribed or assumed conditions. In todayâ&#x20AC;&#x2122;s competitive environment cost is market driven and is subject to considerable downward pressure. Cost management must consist of both cost maintenance and continuous cost improvement. In a JIT/AMT/TQM environment the workforce is usually organised into empowered, multiskilled teams controlling operations autonomously. The feedback they require is real time. Periodic financial reports are neither meaningful nor timely enough to facilitate appropriate control action.
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Answer to Question Four
(a) Restaurant:
Number of customers in Year 1 Contribution per meal Total contribution
= (500 x 360) = 180,000 = $4 = $720,000
Cold food outlet:
Number of meals in Year 1 Contribution per meal Total contribution Reduction in contribution
= (1,200 x 360) = 432,000 = $2·50 = $1,080,000 = $1,080,000 x 40% = $432,000
Cash Flows Restaurant contribution Reduction in contribution from cold food Salaries Additional overheads Net cash flows
Year 1 720,000
Year 2 792,000
Year 3 871,200
Year 4 958,320
(432,000)
(475,200)
(522,720)
(574,992)
(80,000) (70,000)
(80,000) (70,000)
(100,000) (70,000)
(100,000) (70,000)
138,000
166,800
178,480
213,328
Year 1 138,000 (87,500)
Year 2 166,800 (65,625)
Year 3 178,480 (49,219)
Year 4 213,328 (117,656)
50,500 15,150
101,175 30,353
129,261 38,778
95,672 28,702
Taxation Net cash flows Tax Depreciation Taxable profit Taxation @ 30%
Net present value Year 0 Net cash (350,000) flows Tax payment Tax payment Net cash (350,000) flow after tax Discount 1∙000 factor Present (350,000) value
Year 1 138,000 (7,575)
Year 2 166,800
Year 3 178,480
Year 4 243,328
Year 5
(15,177)
(19,389)
(14,351)
( 7,575)
(15,177)
(19,389)
(14,351) (14,351)
130,425
144,048
143,914
209,588
0∙926
0∙857
0∙794
0∙735
0∙681
120,774
123,449
114,268
154,047
(9,773)
Net present value = $152,765
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(b) The NPV is the amount by which the present value of the future cash flows exceeds the initial outlay. The cash flows are discounted at the rate that reflects the alternative use of the funds, normally the company’s cost of capital. Investment decisions should be based on NPV since it is the only appraisal method that will ensure the maximisation of shareholders’ wealth. If the decision is based on NPV then either Project B or C should be undertaken. However NPV does not indicate the range of outcomes that may result. While Project A has a lower expected NPV the standard deviation of Project A is also lower and depending on the company’s attitude to risk they may decide to undertake Project A. The standard deviation is a measure of risk. It compares all the possible outcomes with the expected value (or mean outcome). Project B and C have the same NPV therefore it is possible to directly compare the standard deviations. The standard deviation for Project C is lower than that for Project B which means that the outcomes for Project C have less variability. Since Project A has a lower NPV than Project B and Project C it is necessary to calculate the coefficient of variation. The coefficient of variation for Project A and Project C is 6·67% and 16·67% respectively. Therefore, in terms of achieving the expected net present value, Project A is less risky than Project C. We would need however to see the range of possible outcomes since in this case it is the risk of outcomes below the expected outcome that is important. There is however a trade-off between risk and return. The higher the risk, the higher the potential return. The decision on which project to undertake will depend on the managing director’s attitude to risk. If the Managing Director is risk averse he would choose Project A. If he is risk seeking he would choose Project B as it has the potential for higher returns. The IRR is the rate of return that equates the present value of future cash flows with the initial outlay. It is the discount rate that will result in a net present value of zero. Project C has the lowest IRR, however as stated above investment decisions should be based on NPV. A limitation of Net Present Value is that it does not consider the life of the project. The longer the project the more uncertain the cash flows are likely to be. The payback method of investment appraisal determines how long it takes for the project to payback its initial investment. It therefore to a certain extent copes with an uncertain future by placing more emphasis on early cash flows.
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The Senior Examiner for P1 – Performance Operations offers to future candidates and to tutors using this booklet for study purposes, the following background and guidance on the questions included in this examination paper.
Section A – Question One – Compulsory Question One consists of 8 objective test sub-questions. These are drawn from all sections of the syllabus. They are designed to examine breadth across the syllabus and thus cover many learning outcomes.
Section B – Question Two – Compulsory Question Two has 6 sub-questions. (a)
examines candidates’ ability to prepare an age analysis of outstanding trade receivables and to state the benefits of this process.
(b)
examines candidates’ ability to apply the EOQ formula and to calculate the cost of holding and ordering the suggested level of stock. The ability to calculate the required re-order level based on information regarding a supplier’s delivery times is also examined.
(c)
examines candidates’ ability to identify and explain the benefits of a manufacturing resource planning system in comparison to a traditional stock management system.
(d)
examines candidates’ ability to identify and explain the benefits of activity based budgeting in comparison to a traditional budgeting system.
(e)
examines candidates’ ability to identify the cost behaviour for different cost items and then apply this knowledge to calculate the budgeted costs for a different activity level. The ability to apply the high-low method of cost analysis is examined.
(f)
examines candidates’ ability to use decision trees to evaluate a decision where there is uncertainty regarding expected cash flows.
Section C – Questions Three and Four - Compulsory Question Three examines candidates’ ability to calculate variances including both mix and yield variances and, using these variances, to prepare a statement reconciling the budget profit to the actual profit. The problems with using a standard costing system in an advanced manufacturing environment are also examined. Question Four, in part (a) of the question, examines candidates’ ability to calculate the net present value of a project involving the identification of relevant costs and calculation of the effect of taxation. Part (b) of the question examines candidates’ ability to evaluate three investment project given the projects’ NPV, IRR and standard deviation.
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