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Performance Pillar P2 - Performance Management 22 May 2013 - Wednesday Afternoon Session Instructions to candidates You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is all parts and/or subquestions). ALL answers must be written in the answer book. Answers written on the question paper will not be submitted for marking. You should show all workings as marks are available for the method you use. ALL QUESTIONS ARE COMPULSORY. Section A comprises 5 questions and is on pages 2 to 5. Section B comprises 2 questions and is on pages 6 to 9. Maths tables and formulae are provided on pages 11 to 14. The list of verbs as published in the syllabus is given for reference on page 15. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered. P2 - Performance Management DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO TURN OVER The Chartered Institute of Management Accountants 2013 SECTION A - 50 MARKS [You are advised to spend no longer than 18 minutes on each question in this section.] ANSWER ALL FIVE QUESTIONS IN THIS SECTION. EACH QUESTION IS WORTH 10 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE. Question One A tree farm supplies shrubs to two customers. Each shrub has a selling price of $60. It costs $25 to grow a shrub and get it to the point of sale. Additional costs incurred by the farm are $100 per order fulfilled and delivery costs of $500 per order delivered. Details of two of the farm's customers (B and C) for the previous period are as follows: Customer B Customer C Shrubs purchased 960 650 Discount allowed 15% 20% Orders fulfilled 8 (each for 120 shrubs) 10 (each for less than 100 shrubs) Deliveries made 8 0 Customers are given a 15% discount on orders for 100 shrubs or more. Customer C is given a 20% discount for collecting the shrubs using its own transport. Required: Evaluate the two customers. (Your answer should include customer profitability statements and appropriate measures.) (Total for Question One = 10 marks) Performance Management 2 May 2013 Question Two A new product has a budgeted total profit of $75,000 from the first 64 units. The time taken to produce the first unit was 225 hours. The labour rate is $40 per hour. A 90% learning curve is expected to apply indefinitely. Note: The learning index for a 90% learning curve is -0.152 Required: Calculate the sensitivity of the budgeted total profit from the first 64 units to independent changes in: (i) (ii) The labour rate The learning rate. (Total for Question Two = 10 marks) Question Three PP is a telecoms provider. It has been operating for five years and has experienced good results; profits have increased by an average of 15% each year. It is accepted within the company that this success has been the result of the continuous stream of new and varied 'cutting edge' products that PP offers. The Research and Development Division has enjoyed the freedom of working with the directive of \"Be creative\". The Director of the Research and Development Division of PP is not happy. At a recent board meeting she said: \"The Research and Development Division is finding it extremely difficult to maintain its current levels of achievement. The Division is suffering from a lack of funds as a result of PP's budgeting system. We receive an uplift of 5% each year from the previous year's budget. This does not provide the necessary funds or freedom to be able to keep the company ahead of the competition. I would like to see incremental budgeting replaced by zero based budgeting in my division\". Required: Discuss the potential disadvantages of implementing zero based budgeting for the allocation of funds to the Research and Development Division from the perspective of the Director of Research and Development. (Total for Question Three = 10 marks) Section A continues on the next page TURN OVER May 2013 3 Performance Management Question Four The owner, Z, of a business has been attending a course on scenario planning and decision making. As a result of that advice the owner has produced, by using cost volume and profit analysis, 12 scenarios for a new product that the business will launch in the near future. There are four possible marketing packages that could be used (A, B, C or D) and there are three possible market conditions (poor, average or good) that could be encountered. The Net Present Value of the cash flows resulting from each of the scenarios is shown in the table below. Marketing package Market conditions A $000 B $000 C $000 D $000 Poor 180 230 220 190 Average 190 200 210 275 Good 550 260 210 500 Unfortunately Z missed the session on how to deal with risk and uncertainty. He has sent the above table to the tutor for the course and has asked for help. The tutor replied \"I will send you some notes. Based on your table you will need the methods in the section on 'Uncertainty'. If you can estimate the probability of each type of market condition occurring you need 'Risk based methods'. However, whichever method you use, your decision will be influenced by your attitude.\" Required: Note: calculations are NOT required. Explain FOUR methods that could help Z to decide which marketing package to choose. Your answer should include THREE methods to deal with uncertainty, ONE method to deal with risk, and an explanation of the \"attitude\" that would be associated with the decision maker using each of the four methods. (Total for Question Four = 10 marks) Section A continues on the next page TURN OVER Performance Management 4 May 2013 Question Five The modern dynamic business environment has been described as a \"buyer's market\" in which companies must react to the rapidly changing characteristics of the market and the needs of customers. Many managers have criticised traditional forms of budgeting for being too restrictive and for being of little use for performance management and control. Required: Explain how the principles of \"Beyond Budgeting\" promote a cultural framework that is suitable for the modern dynamic business environment. (Total for Question Five = 10 marks) (Total for Section A = 50 marks) End of Section A Section B starts on page 6 TURN OVER May 2013 5 Performance Management SECTION B - 50 MARKS [You are advised to spend no longer than 45 minutes on each question in this section.] ANSWER BOTH QUESTIONS IN THIS SECTION. EACH QUESTION IS WORTH 25 MARKS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE. Question Six A company manufactures three products D, E and F which use the same resources (but in different amounts). In addition to these resources each unit of Product F uses a component which the company currently purchases from an external supplier for $80. The demand for the products in Month 1 and the details per unit of the three products are as shown below: Demand (units) Selling price D E F 2,400 2,200 3,000 $ $ $ 112 136 153 Component 80 Direct materials ($4 per kg) 12 16 12 Skilled labour ($16 per hour) 16 24 8 Unskilled labour ($12 per hour) 18 12 9 Variable overhead ($3 per machine hour) 12 12 9 The fixed costs of the company are $150,000 per month. The company has reverse engineered the component and has realised that it could make the component in-house. The cost of making a component is shown below: $ Direct materials ($4 per kg) 12 Skilled labour ($16 per hour) 16 Unskilled labour ($12 per hour) 3 Variable overhead ($3 per machine hour) 6 There would be no incremental fixed costs incurred as a result of making the component inhouse. In Month 1 the maximum availability of skilled labour is 5,400 hours but all other resources are readily available. The company bases all short term decisions on profit maximisation. Performance Management 6 May 2013 Required: (a) Calculate the optimum production plan for Month 1 and the resulting profit. (Note: The company would either buy the component or make it inhouse; it would not do a mixture of the two options.) (11 marks) For legal reasons it will not be possible to produce Product F in Month 2. Demand for products D and E will be 3,000 units each in Month 2. No inventories can be held. The availability of resources in Month 2 is as follows: Direct materials Skilled labour Unskilled labour Machine hours 16,000 5,400 5,000 19,600 kg hours hours hours Required: (b) (i) Identify the objective function and the constraints to be used in a linear programming model to determine the optimum production plan for Month 2. (4 marks) (ii) The solution to the linear programming model shows that the only binding constraints in Month 2 are those for skilled labour and unskilled labour. Produce, using simultaneous equations, the optimum production plan and resulting profit for Month 2. (You are NOT required to draw or sketch a graph.) (4 marks) (c) It has now been decided that Product F will be redesigned. A team will be formed with representatives from various departments in the company to undertake a Value Analysis exercise on Product F. Required: Describe the stages involved in a Value Analysis exercise. (6 marks) (Total for Question Six = 25 marks) Section B continues on the next page TURN OVER May 2013 7 Performance Management Question Seven S Division and R Division are two divisions in the SR group of companies. S Division manufactures one type of component which it sells to external customers and also to R Division. Details of S Division are as follows: Market price per component $200 Variable cost per component $105 Fixed costs $1,375,000 per period Demand from R Division 20,000 components per period Capacity 35,000 components per period R Division assembles one type of product which it sells to external customers. Each unit of that product requires two of the components that are manufactured by S Division. Details of R Division are as follows: Selling price per unit $800 Variable cost per unit: Two components from S 2 @ transfer price Other variable costs $250 Fixed costs $900,000 per period Demand 10,000 units per period Capacity 10,000 units per period Group Transfer Pricing Policy Transfers must be at opportunity cost. R must buy the components from S. S must satisfy demand from R before making external sales. Performance Management 8 May 2013 Required: (a) Calculate the profit for each division if the external demand per period for the components that are made by S Division is: (i) (ii) (iii) 15,000 components 19,000 components 35,000 components (12 marks) (b) Calculate the financial impact on the Group if R Division ignored the transfer pricing policy and purchased all of the 20,000 components that it needs from an external supplier for $170 each. Your answer must consider the impact at each of the three levels of demand (15,000, 19,000 and 35,000 components) from external customers for the component manufactured by S Division. (6 marks) (c) The Organisation for Economic Co-operation and Development (OECD) produced guidelines with the aim of standardising national approaches to transfer pricing. The guidelines state that where necessary transfer prices should be adjusted using an \"arm's length\" price. Required: Explain: (i) (ii) An \"arm's length\" price The THREE methods that tax authorities can use to determine an \"arm's length\" price (7 marks) (Total for Question Seven = 25 marks) (Total for Section B = 50 marks) End of question paper Maths tables and formulae are on pages 11 to 14 May 2013 9 Performance Management This page is blank Performance Management 10 May 2013 PRESENT VALUE TABLE ( Present value of 1 unit of currency, that is 1+ r periods until payment or receipt. )n where r = interest rate; n = number of Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820 2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673 3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554 4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456 Interest rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312 7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258 8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215 9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149 Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124 12% 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104 13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295 0.261 0.231 0.204 0.181 0.160 0.141 0.125 0.111 0.098 0.087 14% 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 0.123 0.108 0.095 0.083 0.073 Interest rates (r) 15% 16% 0.870 0.862 0.756 0.743 0.658 0.641 0.572 0.552 0.497 0.476 0.432 0.410 0.376 0.354 0.327 0.305 0.284 0.263 0.247 0.227 0.215 0.195 0.187 0.168 0.163 0.145 0.141 0.125 0.123 0.108 0.107 0.093 0.093 0.080 0.081 0.069 0.070 0.060 0.061 0.051 17% 0.855 0.731 0.624 0.534 0.456 0.390 0.333 0.285 0.243 0.208 0.178 0.152 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.043 18% 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 0.071 0.060 0.051 0.043 0.037 19% 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.079 0.062 0.052 0.044 0.037 0.031 20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 0.054 0.045 0.038 0.031 0.026 May 2013 11 Performance Management CUMULATIVE PRESENT VALUE TABLE Cumulative present value of 1 unit of currency per annum, Receivable or Payable at the end of each year for n years Periods (n) 1 2 3 4 5 1 (1+ r ) n r 1% 0.990 1.970 2.941 3.902 4.853 2% 0.980 1.942 2.884 3.808 4.713 3% 0.971 1.913 2.829 3.717 4.580 4% 0.962 1.886 2.775 3.630 4.452 Interest rates (r) 5% 6% 0.952 0.943 1.859 1.833 2.723 2.673 3.546 3.465 4.329 4.212 7% 0.935 1.808 2.624 3.387 4.100 8% 0.926 1.783 2.577 3.312 3.993 9% 0.917 1.759 2.531 3.240 3.890 10% 0.909 1.736 2.487 3.170 3.791 6 7 8 9 10 5.795 6.728 7.652 8.566 9.471 5.601 6.472 7.325 8.162 8.983 5.417 6.230 7.020 7.786 8.530 5.242 6.002 6.733 7.435 8.111 5.076 5.786 6.463 7.108 7.722 4.917 5.582 6.210 6.802 7.360 4.767 5.389 5.971 6.515 7.024 4.623 5.206 5.747 6.247 6.710 4.486 5.033 5.535 5.995 6.418 4.355 4.868 5.335 5.759 6.145 11 12 13 14 15 10.368 11.255 12.134 13.004 13.865 9.787 10.575 11.348 12.106 12.849 9.253 9.954 10.635 11.296 11.938 8.760 9.385 9.986 10.563 11.118 8.306 8.863 9.394 9.899 10.380 7.887 8.384 8.853 9.295 9.712 7.499 7.943 8.358 8.745 9.108 7.139 7.536 7.904 8.244 8.559 6.805 7.161 7.487 7.786 8.061 6.495 6.814 7.103 7.367 7.606 16 17 18 19 20 14.718 15.562 16.398 17.226 18.046 13.578 14.292 14.992 15.679 16.351 12.561 13.166 13.754 14.324 14.878 11.652 12.166 12.659 13.134 13.590 10.838 11.274 11.690 12.085 12.462 10.106 10.477 10.828 11.158 11.470 9.447 9.763 10.059 10.336 10.594 8.851 9.122 9.372 9.604 9.818 8.313 8.544 8.756 8.950 9.129 7.824 8.022 8.201 8.365 8.514 Periods (n) 1 2 3 4 5 11% 0.901 1.713 2.444 3.102 3.696 12% 0.893 1.690 2.402 3.037 3.605 13% 0.885 1.668 2.361 2.974 3.517 14% 0.877 1.647 2.322 2.914 3.433 Interest rates (r) 15% 16% 0.870 0.862 1.626 1.605 2.283 2.246 2.855 2.798 3.352 3.274 17% 0.855 1.585 2.210 2.743 3.199 18% 0.847 1.566 2.174 2.690 3.127 19% 0.840 1.547 2.140 2.639 3.058 20% 0.833 1.528 2.106 2.589 2.991 6 7 8 9 10 4.231 4.712 5.146 5.537 5.889 4.111 4.564 4.968 5.328 5.650 3.998 4.423 4.799 5.132 5.426 3.889 4.288 4.639 4.946 5.216 3.784 4.160 4.487 4.772 5.019 3.685 4.039 4.344 4.607 4.833 3.589 3.922 4.207 4.451 4.659 3.498 3.812 4.078 4.303 4.494 3.410 3.706 3.954 4.163 4.339 3.326 3.605 3.837 4.031 4.192 11 12 13 14 15 6.207 6.492 6.750 6.982 7.191 5.938 6.194 6.424 6.628 6.811 5.687 5.918 6.122 6.302 6.462 5.453 5.660 5.842 6.002 6.142 5.234 5.421 5.583 5.724 5.847 5.029 5.197 5.342 5.468 5.575 4.836 4.988 5.118 5.229 5.324 4.656 4.793 4.910 5.008 5.092 4.486 4.611 4.715 4.802 4.876 4.327 4.439 4.533 4.611 4.675 16 17 18 19 20 7.379 7.549 7.702 7.839 7.963 6.974 7.120 7.250 7.366 7.469 6.604 6.729 6.840 6.938 7.025 6.265 6.373 6.467 6.550 6.623 5.954 6.047 6.128 6.198 6.259 5.668 5.749 5.818 5.877 5.929 5.405 5.475 5.534 5.584 5.628 5.162 5.222 5.273 5.316 5.353 4.938 4.990 5.033 5.070 5.101 4.730 4.775 4.812 4.843 4.870 Performance Management 12 May 2013 FORMULAE PROBABILITY A B = A or B. A B = A and B (overlap). P(B | A) = probability of B, given A. Rules of Addition If A and B are mutually exclusive: If A and B are not mutually exclusive: P(A B) = P(A) + P(B) P(A B) = P(A) + P(B) - P(A B) Rules of Multiplication If A and B are independent: If A and B are not independent: P(A B) = P(A) * P(B) P(A B) = P(A) * P(B | A) E(X) = (probability * payoff) DESCRIPTIVE STATISTICS Arithmetic Mean x = x n x= fx f (frequency distribution) Standard Deviation SD = ( x x ) 2 n SD = fx 2 x 2 (frequency distribution) f INDEX NUMBERS Price relative = 100 * P1/P0 Price: Quantity: Quantity relative = 100 * Q1/Q0 P w 1 Po w x 100 Q w 1 Qo x 100 w TIME SERIES Additive Model Series = Trend + Seasonal + Random Multiplicative Model Series = Trend * Seasonal * Random May 2013 13 Performance Management FINANCIAL MATHEMATICS Compound Interest (Values and Sums) Future Value S, of a sum of X, invested for n periods, compounded at r% interest n S = X[1 + r] Annuity Present value of an annuity of 1 per annum receivable or payable for n years, commencing in one year, discounted at r% per annum: PV = 1 1 1 r [1 + r ] n Perpetuity Present value of 1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum: PV = 1 r LEARNING CURVE b Yx = aX where: Yx = the cumulative average time per unit to produce X units; a = the time required to produce the first unit of output; X = the cumulative number of units; b = the index of learning. The exponent b is defined as the log of the learning curve improvement rate divided by log 2. INVENTORY MANAGEMENT Economic Order Quantity 2C o D EOQ = Ch where: Co Ch D = = = cost of placing an order cost of holding one unit in inventory for one year annual demand Performance Management 14 May 2013 LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE Level 1 - KNOWLEDGE What you are expected to know. Level 2 - COMPREHENSION What you are expected to understand. VERBS USED DEFINITION List State Define Make a list of Express, fully or clearly, the details/facts of Give the exact meaning of Describe Distinguish Explain Communicate the key features Highlight the differences between Make clear or intelligible/State the meaning or purpose of Recognise, establish or select after consideration Use an example to describe or explain something Identify Illustrate Level 3 - APPLICATION How you are expected to apply your knowledge. Apply Calculate Demonstrate Prepare Reconcile Solve Tabulate Level 4 - ANALYSIS How are you expected to analyse the detail of what you have learned. Level 5 - EVALUATION How are you expected to use your learning to evaluate, make decisions or recommendations. May 2013 Analyse Categorise Compare and contrast Put to practical use Ascertain or reckon mathematically Prove with certainty or to exhibit by practical means Make or get ready for use Make or prove consistent/compatible Find an answer to Arrange in a table Construct Discuss Interpret Prioritise Produce Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between Build up or compile Examine in detail by argument Translate into intelligible or familiar terms Place in order of priority or sequence for action Create or bring into existence Advise Evaluate Recommend Counsel, inform or notify Appraise or assess the value of Advise on a course of action 15 Performance Management Performance Pillar Management Level Paper P2 - Performance Management May 2013 Wednesday Afternoon Session Performance Management 16 May 2013