MI 2020 Prelim Paper 2 Ans

1 Answer to P2 Prelim 2020 1(a) Only really useful for making short term decisions as it ignores fixed cost. Not all costs can easily be classified as either fixed or variable 1(b) Working: Jen Kit Mat Total production and sales units 6 000 7 000 8 000 Unit costs: Selling price Raw materials @ $10 per kilo Direct labour $ 72 30 6 $ 90 40 8 $ 136 60 10 Total fixed costs $750 000 Contribution 36 42 66 Raw materials per unit (kg) 3 4 6 Contribution per kilo 36/3= 12 42/4= 10.5 66/6=11 Rank 1* 3* 2* Option 1 Units Kilos $ Jen 6 000 x 3 = 18 000 6 000 x $36 = 216 000 Mat 8 000 x 6 = 48 000 (8 000 x $66 = 528 000 Kit 2 000 x 4 = 8 000 2 000 x $42 = 84 000 74 000 CM 828 000 Fixed costs (750 000) * Profit 78 000 Option 2 Units Kilos Jen 5 000 x 3 = 15 000 Kit 5 000 x 4 = 20 000 Mat 5 000 x 6 = 30 000 65 000 Material remaining 9 000 74 000

2 The product which has the highest contribution margin per limiting factor is Jen. Therefore the remaining materials should be used first to make Jen. 5000 units have already been ,made and the maximum required is 6 000. Therefore a further 1 000 units of Jen should be made. This will use 3 000 kilos of material The final balance of materials (6 000 kilos) will then be used to make 1 000 unit of Mat the product yielding the next highest contribution margin per kilo of material. Total profit under this option is: Units Kilos $ Jen 6 000 x 3 = 18 000 6 000 x $36 = 216 000 Kit 5 000 x 4 = 20 000 5 000 x $42 = 210 000 Mat 6 000 x 6 = 36 000 2m 6 000 x $66 = 396 000 74 000 CM 822 000 Fixed costs (750 000) * Profit 72 000 1 (c) Explanation: The two profit figures show only a small difference between them , with the option to meet the 5 000 sales requirement giving the lower profit . If this option is chosen, then all customers will be happy and Samuel should keep them for the future. However, Samuel needs to determine whether or not the shortage of materials will be permanent. If it is, then he will need to talk to his customers about their future requirement. He will also need to consider an alternative source of material. Decision: In light of this, if the problem is a short-term one, then the second option should be selected, as all customers will be happy.

3 2 (a) Computation of total budgeted overhead cost Base Machining Assembly Maintenance Canteen $ $ $ $ Indirect expenses 120 100 80 050 40 000 15 000 Reallocation of canteen costs No, of employees 3 000 9 000 3 000 (15 000) 43 000 - Reallocation of Maintenance costs No. of Maintenance Requisitions 34 400 8 600 (43 000) 157 500 97 650 - (b) Department Budgeted Overhead Cost Activity Level Selected Budgeted Absorption Rate Machining $157 500 45 000 machine hours $3.50 per machine hour ( 157 500/45 000) Assembly $97 650 15 500 direct labour hours $6.30 per direct labour hour (97 650/15 500) ( c )Computation of over / (under) absorbed overheads Department Machining Assembly $ $ Overheads absorbed 155 050 102 060 ($3.5 X 44300 MH) ($6.3 X 16200 DLH) Actual overheads 150 000 105 000 Over/(under) absorbed overheads 5 050 (2 940)

4 (d) Possible reasons: (any 1 reason + 1m) ▪ Unexpected changes in factory overhead items. Some examples are changes in insurance rates, indirect labour and indirect material. Budgeted overheads for Machining is $157 500 while actual is $150 000 which resulted in over absorbed OH for Machining while budgeted OH for Assembly was $97650 but actual is $105 000 leading to an under absorbed OH. ▪ Changes in activity levels. The actual number of units produced (compared to the estimated or budget) is either too high or too low. Budgeted activity level for Machining is 45 000 machine hours but actual is only 44300h which led to an under absorb ed overhead. But the impact is offset by the impact of higher budgeted overhead costs. Budgeted activity level for Assembly is 15 500DLH while actual is 16200DLH which should result in an over absorbed OH. Again impact of this is offset by the larger decrease in OH costs as compared to the budgeted. (see above) (e) Effect of under/over applied manufacturing on financial statements Current Assets Inventory (unsold) Cost of sales (when sold) Shareholders’ equity Net profit (when sold) Under applied Understated Understated Overstated Over applied Overstated Overstated Understated

5 3 (a) Allows for future planning Identifies areas where corrective action has to be taken For full answer, please refer to 2020 A level P2 3 (b) Lex Sales Budget January Units February Units March Units Opening inventory 50 40 60 Purchases 450 490 460 Closing inventory (40) (60) (30) Sales 460 (1OF) 470 (1OF) 490 (1OF) Sales Value ($) 460x$15=$6900 470x$15=$7050 490x$15=$7350 3 (c) Lex Cash Budget January $ February $ March $ From customers 8 000 6 900 7 050 Payments: To suppliers 3 000 4 500 4 900 Monthly expenses 2 000 2 000 2 000 Director’s dividends 5 000 5 000 5 000 10 000 11 500 11 900 Opening balance (5 000) (7 000) (11 600) Surplus/(Deficit) (2 000) (4 600) (4 850) Closing balance (7 000) (11 600) (16 450)

6 3 (d) Lex’s business Budgeted Income Statement for 3 months ended March 2020 $ Sales revenue 21 300 Less: Cost of sales (14 200) Gross profit 7 100 Less: Expenses ( 6 000) Net profit 1 100 Workings: $ $ Sales revenue (1 420 x $15) 21 300 Opening inventory 500 Purchases (1 400 x $10) 14 000 14 500 Closing inventory (30 x $10) 300 14 200 Gross profit 7 100 Monthly expenses ($2000 x3) 6 000 Net profit 1 100 3(e)(i) Lex’s business is making a profit but her dividend payouts are greater than the profit the Business is making. Dividend is the distribution of profit which is an outflow of cash and does not impact net profit. 3(e)(ii) There are several actions Lex could take to reduce her bank overdraft. 1. The most obvious thing is for Lex to reduce her monthly dividend payouts. However, this may not be possible if shareholders’ demand that level of dividends. 2. She could increase the selling price of her product. However, this may depend On her competitors and their pricing policy. . Lex could also look for a cheaper supplier. However, this may not be possible in the short term and issues of quality and regularity of supply will need to be considered. 3. Lex could also reduce the monthly expenses of the business . However this may be fixed and impossible to change in the short term. 4. Finally, Lex could take up a long term loan but she must be prepared to face an increase in interests payments each month, and at the end of the maturity period have sufficient funds to repay back the loan.

7 Q4. Net present value is the sum of the discounted net cash flows arising a) Explain the term ‘capital investment’. Support your answer using an example. [3] Capital investment refers to expenditure on long-term/non-current assets that are expected to benefit the business over several years and would require equity or loan financing. Example – purchase of the equipment to replace the old one. b) Explain what is meant by the term ‘weighted average cost of capital’. [3] Average rate of return the company will pay to those who have provided finance eg shareholders and