MI 2022 PU3 Preliminary Examination Paper 2 Answer

1 2022 H2PAA Prelim Paper 2 Answer Guide Question 1 (a) Fixed Costs: Costs that remain constant over a specific range of activity level. (*the relevant range). For example, rental of factory does not vary with the number of units produced if the business operates at its present capacity. Variable Costs: Costs that vary with changes in activity level. e.g. raw material cost will change in direct proportion with the units produced eg. The cloth used in the manufacture will change in the proportion with the number of uniforms manufactured. (b)Difference in factory cost at 2 different production units = 55 000 – 35 000 = 20 000 Variable Factory cost per unit = 20 000/ 5 000 = $4 Fixed Factory cost = $35 000 – 5000 x $4 = $15 000 Unit CM = $40 – VC (16+4) = $20 The break-even point in units = Fixed Cost = 80000 + 15000 Unit CM $20 = 4 750 units [Total: 6m] (c) Number of units to earn a profit of $50 000 =$ (95 000+50000)/UCM = 7 250 units [Total: 2m] (c) The limitations of using break-even analysis to make decisions: Assumptions of CVP Analysis Limitations A Selling prices and costs remain constant. Selling prices and costs do not remain constant B All cost can be classified into fixed and variable components Many costs are semi -variable and is difficult to separate into its fixed and variable components C Total fixed costs will remain constant. Total fixed costs may not remain constant even at the relevant range D Total variable costs vary in direct proportion to sales volume. Variable costs may not vary directly to volume. E.g. As workers becomes more efficient, wages (a variable cost) may not increase in the same rate as production volume. E Efficiency and productivity remain constant. Efficiency and productivity do not rema in constant. G Volume is the only factor that is affecting costs and sales Besides volume, other factors such as price, efficiency and the economy also affect costs and sales. H Production and sales volume are equal, i.e. all units produced are sold. All production will have ending stock

2 (d) The business should accept the special order. Even though the special selling price of $25 per unit is below its usual selling price of $40 per unit, the special order will give rise to a CM per unit of $5 which will go towards covering the fixed cost of the business and increase its profit and no additional fixed cost/opportunity will be incurred as business is operating below capacity . (Total: 4m) Question 2 a Advantages of budgets Budgets promote forward thinking and the identification of short-term objectives. Budgets play an important communication and coordination role in a business. Budgets provide a basis for a system of control. Budgets provide a useful benchmark for evaluatin g and rewarding employee performance Budgets can motivate managers to better performance Any 2 Disadvantages of budgets Budgets may be unrealistic especially if the budgeting process results in overstated needs or lower targets set. Budgets are subject to uncertainty as it is based on forecasts. Budgets focus management attention on achieving short -term objectives instead of on actions which create value for the business Budgets may protect costs rather than lower costs Any 2 (b) Original Budget Flexible Budget Actual Units 6 000 5 000 5 000 $ $ $ Sales 156 000 130 000 5000x$26 132 500 5000x$26.50 Less costs Raw materials 43 200 36 000 5000x2.4x$3 23 400 5000x2.6x$1.80 Direct labour 63 000 52 500 5000x1.5x$7 81 900 5000x1.5x140%x$7.80 Variable OH 12 000 10 000 5000x$2 11 000 5000x$2x110% Contribution margin 37 800 31 500 16 200 (c) $ 1 Sales price 5000 x $(26-26.5) 2500 favourable 2 Direct materials usage 5000 x (2.6-2.4)kg x $3 3000 unfavourable 3 Direct materials price 5000 x 2.6 x $(1.8-3) 15600 favourable 4 Direct labour efficiency 5000 x 1.5 x 40% x $7 21000 unfavourable 5 Direct labour rate 5000 x 1.5 x 140% x $(7.8-7) 8400 unfavourable 14300 unfavourable

3 (d)Cheaper raw material resulting in favourable material price variance but which caused more wastage resulting in unfavourable material usage variance due to poorer quality. (e) Cheaper raw material resulting in favourable material price variance but due to poorer quality, required more labour hours and hence higher overtime rates or more skilled labour. Question 3 (a) Option 1 Option 2 Option 3 Girona – hrs X $ 300 Ariel Bart New assistant Less: Expenses Fixed Occ & sec costs Direct costs@ 15% of rev Salary A Salary B New Cost Net Profit $ 245 000 102 000 90 000 75 000 75 000 $ 30 000 260 000 195 000 _195000 680 000 (587 000) _ 93 000_ $ 245 000 65 250 - 75 000 ___-___ $ 240 000/ - 195 000 ___-___ 435 000 (385 250) 49 750_ $ 140 000 57 000 90 000 - ___-___ $ 120 000 260 000 - ___-___ 380 000/ (287000) 93 000_ [Total: 12m] (b) Fee Earning Hrs Supervision Hrs Total Hrs Worked Option 1 100 300 + 500 + 500 1400 Option 2 800 500 1300 Option 3 400 300 700 (c) Girona’s Best choice is Option # 3. ▪ Meets Girona’s target profit of $90 000 per year ▪ Better than Option 1 which gives the same profit as Option 3 required fewer number of working hours which meets Girona’s objective of working fewer hours (d) Effect on morale of Ariel as Bart will be retrenched. Cheaper premises on the impact on her reputation. Lower secretarial fees on the quality of service provided to her clients. Need to give up some existing clients as total hours of service will be reduced from 3600h to 1700h. (Any 2 X 1m)

4 Question 4 (a) Contribution margin is the difference between sales and variable cost. In the short run, fixed costs are expected to remain constant within the relevant range. As such only variable costs are expected to change. Relevant costs for decision making are to be incurred in the future and is expected to vary among alternatives. Contribution margin focuses on sales and variable costs, both of which vary with units sold / produced and is likely to vary amongst alternatives, ensuring relevance to the decision to be made. Contribution margin measures the contribution a pr oduct or alternative makes towards covering fixed cost which will improve the overall profitability of the alternative. However, if contribution margin is negative, this implies that the alternative is unable to cover its variable and will make a loss with every unit sold. (b) Should not discontinue ‘Beta’ as the product line provides a contribution of $96 000 to cover the firm’s total fixed costs of $258 000 . Discontinuing Beta will cause profits to fall by $96 000(1m) as Beta’s allocated fixed is unavoidable by its closure and will have to be absorbed by the remaining products ‘Alpha’ and ‘Delta’. (c) Statement of Contribution and Profit Alpha Beta Delta Overall $ $ $ $ Sales 648 000 288 000 900 000 1 836 000 Less: Variable Cost Direct materials 216 000 24 000 240 000 480 000 Direct labour 120 000 60 000 300 000 480 000 Variable overheads 264 000 108 000 168 000 540 000 Contribution margin 48 000/ 96 000/ 192 000 336 000 Less: Fixed costs 258 000 Profit 78 000 (d) Alpha Beta Delta Selling price per unit 360 120 450 Variable cost per unit 300 96 354 CM per unit 60 24 96 DLH used per unit 2h 1h 5h CM per DLH $30 $24 $19.20 Ranking 1st 2nd 3rd Demand 1500 units 6000 unit 3000 unit Optimal production plan 1500 unit 6000 units 1 400 units (16000 – 3000 – 6000)/5 DLH used 3000 DLH 6000 DLH 7000 DLH Computation of profit under the optimal production strategy Sales Dir