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Advanced Leval
Advanced Management Accounting May 2017
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Advanced Management Accounting
Revision Kit

QUESTION 1a

Q Using a decision tree, advise the management of Furahia Ltd. on whether the outdoor concert should be advertised.
A

Solution




1. 35 x 0.6 + -20 x 0.4 = 13
2. 150 x 0.25 + 90 x 0.75 = 105
3. (13 × 0.7 + 105 x 0.3)-15 = 25.6
4.-20 x 0.7 + 90 x 0.3 = 13
5. higher between node 3 and 4

Firelua Ltd should promote the concert because it generates a greater profit of 25.6, in contrast to 13 million when the concert remains unadvertised.

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QUESTION 1b

Q Advise the management of Samoa Ltd. on the maximum amount that should be paid for the information from the market researcher.
A

Solution


Payoff table Sh"000"
Outcomes
Option
 Strong Normal Weak EMV
Product x
Product y
Product z
Probability		 400
800
1,200
0.3		 600
1,200
800
0.2		 1000
1,600
1,000
0.5		 740
1,280
1,020



EMV
x = 400 x 0.3 + 600 x 0.2 + 1,000 x 0.5 = 740
y = 800 x 0.3 + 1,200 x 0.2 + 1,600 x 0.5 = 1,280
z = 1,200 × 0.3 + 800 x 0.2 + 1,000 x 0.5 = 1,020

Value of information = EMV with Information - EMV without Information
VOI = (1,200 x 0.3 + 1200 x 0.2 + 1,600 x 0.5) - 1,280 = 120,000


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QUESTION 2a

Q Evaluate three benefits that might accrue to an organisation that adopts Environmental Management Accounting (EMA).
A

Solution


Adopting Environmental Management Accounting (EMA) can bring various benefits to an organization. EMA is a systematic approach to incorporating environmental considerations into financial and management accounting processes.

Benefits that may accrue to an organization that adopts EMA:


Cost Reduction:

EMA helps in identifying and managing environmental costs more effectively. By tracking resource consumption, waste generation, and emissions, organizations can find opportunities to reduce costs through resource efficiency and waste reduction.


Improved Resource Efficiency:

EMA encourages organizations to use resources more efficiently. By quantifying resource consumption and waste, companies can optimize processes and reduce unnecessary resource use.


Enhanced Compliance:

EMA helps organizations stay in compliance with environmental regulations and permits by tracking and managing the costs associated with compliance. This can reduce the risk of fines and legal issues.


Risk Management:

EMA assists in identifying and managing environmental risks. It enables organizations to assess potential liabilities and take measures to mitigate them.


Improved Environmental Performance:

With EMA, organizations can set environmental targets, track their progress, and make informed decisions to enhance their overall environmental performance.


Sustainability Reporting:

EMA provides the data necessary for accurate and transparent sustainability reporting. This can improve the organization's reputation and stakeholder trust.


Product and Process Innovation:

By assessing the environmental impact of products and processes, EMA can drive innovation. It can lead to the development of more sustainable products and practices, which can be a competitive advantage.


Enhanced Decision-Making:

EMA provides a more comprehensive view of the financial and environmental implications of decisions. This data-driven approach helps in making informed and sustainable choices.


Stakeholder Engagement:

EMA can be a valuable tool for engaging with environmentally conscious stakeholders. It demonstrates the organization's commitment to environmental responsibility.


Resource Allocation:

EMA assists in allocating resources to eco-friendly projects and initiatives, ensuring that funds are used efficiently and in alignment with environmental objectives.


Long-Term Cost Savings:

While there may be initial costs associated with implementing EMA, the long-term benefits, including cost savings and improved sustainability, can lead to significant financial advantages.


Competitive Advantage:

Organizations that adopt EMA may gain a competitive edge by being more environmentally responsible, attracting environmentally conscious customers, and complying with green procurement requirements.


Supply Chain Improvements:

EMA can help evaluate the environmental performance of suppliers, encouraging sustainability within the supply chain.


Transparency and Accountability:

EMA promotes transparency by providing clear visibility into the organization's environmental and financial performance. This fosters accountability to stakeholders and regulators.


Sustainable Growth:

EMA supports the concept of sustainable business growth, which takes into account environmental and social impacts in addition to financial considerations.

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QUESTION 2b(i)

Q The expected profit to be earned from the product over its lifetime.
A

Solution


Learning Curve Analysis
y = axb + 1

Where;

a = 52,500
b + 1 = -0.152 + 1 = 0.848

Total number of batches = 256,000 / 1,000 = 256
Remaining batch after end of learning 256 - 64 = 192

Determining total labour cost =Y64 - Y63
= (52,500 x 640.848 ) - (52,500 x 630.848) = 1,785,665 - 1,761,976 = Sh. 23,689

Total labour to make 256 batches
Cost to make 64 batches
Cost to make remaining 192 (192 × 23,689)


Profit statement
Sales = 256,000 × 123
Material cost = 256,000 × 36
Direct labour cost
Variable overhead cost (256,000 × 24)
Fixed cost

 1,785,665
4,548,288
6,333,953


31,488,000
(9,216,000)
(6,333,953)
(6,144,000)
(3,875,000)
5,919,047


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QUESTION 2b(ii)

Q The "learning curve" required to achieve a lifetime product profit of Sh.10 million, assuming that a constant learning rate applies throughout the product's life.
A

Solution


Target profit
Current profit
Incremental profit
Current labour cost
Less: Increment/profit due to leaning
Target labour cost 		10,000,000
(5,919,047)
4,080,953
6,333,953
(4,080,953)
2,253,000


Average labour cost per batch = 2,253,000 / 256 = 8,800 ȳ=axb
8,800 = 52,500 x 256b
256b = 8,800 / 52,500
256b = 0.1676
To get b, introduce log
b log 256 = log 0.1676
b = log 0.1676 / log 256 = 0.3221
b = logr / log 2
-0.3221 = logr / log 2
Logr = log 2 x -0.3221
logr = -0.09696
r = antilog - 0.09696
r = 80%


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QUESTION 3a

Q Explain the term "incremental budgeting", citing one of its major limitations as a budgeting technique.
A

Solution


Incremental budgeting


Incremental budgeting, also known as traditional or historical budgeting, is a budgeting technique where an organization creates its budget by making small, incremental adjustments to the previous year's budget or actual financial results. In other words, the new budget is based on the existing budget or actual performance with minor changes or adjustments. It is a relatively simple and widely used budgeting approach, but it has several limitations:

Lack of Fresh Perspective:

Incremental budgeting tends to perpetuate existing spending patterns and may not encourage a fresh look at the organization's financial needs and priorities. This can lead to inefficiencies and outdated allocations.


Inefficiency:

Since it relies heavily on historical data, incremental budgeting may not identify areas where cost savings or improvements can be made. It can result in wasteful spending on activities that may no longer be relevant or efficient.


Resource Misallocation:

The focus on historical data can lead to resource misallocation. Funds may be directed to areas that have traditionally received high budgets, even if they are no longer the organization's top priorities.


Lack of Alignment with Strategic Goals:

Incremental budgeting does not always align with an organization's current strategic goals and objectives. It may hinder the pursuit of new initiatives and hinder adaptability in a rapidly changing business environment.


Difficulty in Cost Control:

Since incremental budgeting starts with previous budgets or actual expenses, it may not encourage rigorous cost control. This can result in budget overruns as expenses tend to accumulate.


Inertia:

Incremental budgeting may foster a sense of inertia in an organization, making it resistant to change. It can lead to a lack of innovation and a reluctance to adapt to new market conditions or opportunities.


Inaccurate Projections:

Relying solely on historical data may lead to inaccuracies in budget projections, as it may not account for changes in market conditions, inflation, or other external factors.


Lack of Accountability:

Since the budget is based on existing figures, it can make it challenging to hold responsible parties accountable for their performance. This can reduce motivation to improve.


Budget Padding:

Departments or units may engage in budget padding by requesting more funds than they actually need to secure their budgets, leading to inefficient resource use.


Risk of Budget Creep:

Incremental budgeting can lead to budget creep, where costs slowly increase year after year without adequate scrutiny, which can result in financial bloat.


Reduced Flexibility:

The fixed nature of incremental budgeting can limit an organization's ability to react quickly to unforeseen opportunities or threats, as resources are already allocated based on the previous budget.

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QUESTION 3b

Q Discuss the three approaches of evaluating performance.
A

Solution


1. Objective-Based Approach:


The objective-based approach focuses on assessing performance by comparing actual outcomes to predefined objectives and goals. Specific, measurable, achievable, relevant, and time-bound (SMART) objectives are set, and performance is measured based on how well these objectives are achieved. This approach provides a clear and quantifiable standard for evaluating success and determining if goals were met within the defined parameters.

Advantages:

  • Clear and measurable criteria for evaluation.
  • Promotes a goal-oriented and results-driven work environment.
  • Facilitates accountability by linking performance to specific objectives.

Disadvantages:

  • May not capture qualitative or subjective aspects of performance.
  • Potential inflexibility when circumstances change or goals evolve.

2. Competency-Based Approach:


The competency-based approach evaluates performance based on the skills, knowledge, and behaviors (competencies) that individuals exhibit in their roles. Competencies are specific attributes or qualities essential for effective job performance. This approach assesses how well employees demonstrate these competencies in their work, helping identify areas where they excel and areas for improvement.


Advantages:

  • Holistic evaluation that considers a wide range of skills and qualities.
  • Supports skill development and training by identifying competency gaps.
  • Can be adapted to various job roles and organizational needs.

Disadvantages:

  • Subjectivity in assessment, which can introduce biases.
  • Developing a comprehensive competency framework can be time-consuming and complex.

3. 360-Degree Feedback Approach:


The 360-degree feedback approach gathers input from various sources, including supervisors, peers, subordinates, customers, and self-assessment, to provide a comprehensive evaluation of an individual's performance. This multi-rater feedback method offers a well-rounded assessment by incorporating diverse viewpoints, giving individuals a broader understanding of their strengths and areas for improvement.


Advantages:

  • Provides a comprehensive view of performance from multiple perspectives.
  • Promotes self-awareness by revealing how one is perceived by others.
  • Encourages open communication and feedback within the organization.

Disadvantages:

  • Complex logistics in collecting and analyzing feedback from multiple sources.
  • Concerns about the confidentiality and honesty of feedback providers.

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QUESTION 3c

Q Using a flexible budgeting approach, redraft the operating statement so as to provide a more realistic indication of the variances.
A

Solution


Flexible Budget
Determining flexing base
720,000/640,000 x 100% = 1.125

Flexible Budget Statement


Sales (1,024 × 1.125)
Cost of sales
Material (168 × 1.125)
Labour (240 × 1.125)
Overhead (32 × 1.125)
Fixed labour cost
Selling & distribution cost
Fixed
Variable (144 x 1.125)
Administrative costs
Fixed
Variables (48 × 1.125)
Net profit		 Flexible budget
Sh 000
1,152

189
270
36
100

72
162

184
54
85		 Actual budget
Sh 000
1,071

144
288
36
94

83
153

176
54
43		 Variance
Sh 000
(81)

45
(18)
0
6

(11)
9

8
0
(42)


(ii) Why original budget was of little use to the management

It had minimal utility because there was no value in comparing performance at different activity levels, such as favorable and unfavorable.

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QUESTION 4a

Q Starting with zero stock and a pending order of 105 pieces of pizza, simulate the transactions for 10 days and determine the vendor's profit or loss.
A

Solution


Fresh pizza
Daily Sales
100
101
102
103
104
105
106
107
108
109
110 		Probability
0.01
0.03
0.04
0.07
0.09
0.11
0.15
0.21
0.18
0.09
0.02 		Cummulative Probability
0.01
0.04
0.08
0.15
0.24
0.35
0.50
0.71
0.89
0.98
1.00 		Range
00-00
01-03
04-07
08-14
15-23
24-34
35-49
50-70
71-88
89-97
98-99


One day old pizza
Daily Sales
0
1
2
3 		Probability
0.70
0.20
0.08
0.02 		Cummulative Probability
0.70
0.90
0.98
1.00 		Range
00-69
70-89
90-97
98-99


Simulation table
Day R/no of fresh pizza Fresh stock Demand Quantity sold Closing stock Order initiated Day old stock R/No. old pizza Sale of old pizza Waste
1
2
3
4
5
6
7
8
9
10 		37
73
14
17
24
35
29
37
33
68 		105
110
110
105
105
105
110
110
105
105 		106
108
103
104
105
106
105
106
105
107 		105
108
103
104
105
105
105
106
105
105 		0
0
2
7
1
0
0
5
4
0 		110
110
105
105
105
110
110
105
105
110 		0
2
7
1
0
0
5
4
0
0 		17
28
69
38
50
57
82
44
89
60 		0
0
0
0
0
0
0
0
1
0 		0
0
2
7
1
0
0
5
3
0


Determining profit
Sale of fresh pizza 1,051 × 700
Sale one day old pizza 1 × 200
Total sales
Cost of pizza sold (1,052 x 450)
Cost of spoilt pizza (18 × 450)
Profit
735,700
200
735,900
(473,400)
(8,100)
254,400


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QUESTION 4b

Q Simulate the scenario above to determine the average annual contribution of the product.
A

Solution


Selling price
Price
700
875
900		 Probability
0.20
0.50
0.30 		Cummulative Probability
0.20
0.70
1.00		 Range
00-19
20-69
70-99


Variable cost
Cost
350
550
600		 Probability
0.10
0.50
0.40 		Cummulative Probability
0.10
0.60
1.00		 Range
00-09
10-59
60-99


Sales volume
Sales volume
20,000
30,000
40,000		 Probability
0.20
0.40
0.40 		Cummulative Probability
0.20
0.60
1.00		 Range
00-19
20-59
60-99


Simulation table
Trial Selling price Variable cost Contribution margin Sales volume Total CM

1
2
3
4
5
6
7
8		 Rn
80
63
36
16
28
57
49
95		 Amount
900
875
875
700
875
875
875
900		 Rn
60
21
05
73
31
39
77
82		 Cost
600
550
350
600
550
550
600
600
300
325
525
100
325
325
275
300 		Rn
43
40
69
86
61
96
26
72		 volume
30,000
30,000
40,000
40,000
40,000
40,000
30,000
40,000
9,000,000
9,750,000
21,000,000
4,000,000
13,000,000
13,000,000
8,250,000
12,000,000
90,000,000


Average contribution = 90,000,000 / 8 = 11,250,000

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QUESTION 5a

Q Summarise four factors that should be taken into consideration in establishing the length of a proposed budget period.
A

Solution


  1. Nature of the Business: The type of business or industry can influence the budget period. Some industries, like retail, may benefit from shorter periods due to rapidly changing trends, while others, like infrastructure projects, may require longer-term budgets.
  2. Business Goals and Objectives: The organization's short-term and long-term goals should align with the budget period. Short-term objectives may warrant shorter budget cycles, while long-term goals require longer planning horizons.
  3. Market Conditions: Consider the stability and predictability of the market. In volatile markets, shorter budget periods allow for more flexibility to adapt to changing conditions, while stable markets may support longer-term planning.
  4. Budgeting Complexity: The complexity of the budgeting process, including the number of budget line items and the depth of analysis, can influence the budget period. More complex budgets may benefit from longer planning cycles.
  5. Funding and Financing: The availability of funding sources and financing arrangements can impact the budget period. Projects with long financing cycles may necessitate extended budget periods.
  6. Economic and Inflationary Factors: Economic conditions, inflation rates, and currency stability can affect budgeting. In high-inflation environments, shorter budget periods may help control costs.
  7. Regulatory and Reporting Requirements: Compliance with regulatory and reporting obligations can dictate the budget period's length. Some regulations require specific reporting at particular intervals.
  8. Technology and Industry Trends: Advances in technology and industry trends should be factored in. Rapid technological changes may require shorter budget cycles to remain competitive.
  9. Historical Data and Forecast Accuracy: Consider the historical accuracy of forecasts. If past forecasts have been reliable, it may justify a longer budget period.
  10. Risk Tolerance: Assess the organization's risk tolerance. Shorter budget periods provide more frequent opportunities to assess and adjust for risk, while longer periods require longer-term risk mitigation strategies.
  11. Operational Cycles: Understand the operational cycles within the business. Budget periods should align with these cycles to ensure that resources are available when needed.
  12. Resource Availability: Consider the availability of key resources, such as skilled personnel, equipment, and materials. Ensure that the budget period accommodates the availability and allocation of these resources.
  13. Strategic Planning: The organization's strategic planning cycle should inform the budget period. Ensure that the budget aligns with the timing of strategic decisions.
  14. Stakeholder Expectations: Consider the expectations of stakeholders, including investors, lenders, and board members. Some stakeholders may prefer more frequent budget updates.
  15. Flexibility and Adaptability: Evaluate the need for flexibility and adaptability in the budgeting process. Shorter budget periods allow for quicker adjustments, while longer periods may provide stability.

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QUESTION 5b(i)

Q The current effect of the transfer pricing system on the company's profits
A

Solution


Variable cost = 44 - 12 = 32


Selling price
Variable cost
Contribution margin
Demand (units)
Total contribution 		60
(32)
28
15,000
420,000 		90
(32)
58
10,000
58,000 		120
(32)
88
5,000
440,000

The optimal selling price is Sh. 90 and optimal output of 10,000 units

Variable cost = 240 - 36 = 204

Profit with transfer of sh. 87 for division B
Selling price
Variable cost
Contribution margin
Demand (units)
Total contribution 		240
(204)
36
7,200
259,200 		270
(204)
66
5,000
330,000 		300
(204)
96
2,800
268,800


Optimal selling price will be Sh 270 and optimal output of 5000 units

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QUESTION 5b(ii)

Q The effect on profit of adopting the above proposal from the manager of division B
A

Solution


Profit with transfer price of Sh. 36
Variable cost = 69 + 9 + 36 + 3 + 36 = 153

Selling price
Variable cost
Contribution margin
Demand (units)
Total contribution 		240
(153)
87
7,200
626,400 		270
(153)
117
5,000
585,000 		300
(153)
147
2,800
411,600


Optimal output is 7,200 at a selling price of sh 240

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