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 rewar