Management

Accounting
Level 3

Model Answers
Series 2 2008 (Code 3024)
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Management Accounting Level 3
Series 2 2008

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Model Answers have been developed by Education Development International plc (EDI) to offer
additional information and guidance to Centres, teachers and candidates as they prepare for LCCI
International Qualifications. The contents of this booklet are divided into 3 elements:

(1) Questions – reproduced from the printed examination paper

(2) Model Answers – summary of the main points that the Chief Examiner expected to
see in the answers to each question in the examination paper,
plus a fully worked example or sample answer (where applicable)

(3) Helpful Hints – where appropriate, additional guidance relating to individual

questions or to examination technique

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Management Accounting Level 3
Series 2 2008
QUESTION 1

A company is considering investment in two projects, PR1 and PR2.

Project PR1 requires investment of £260,000 in Year 0 which is expected to be followed by constant
annual net cash inflows in each of Years 1 to 6. No residual value is expected at the end of the project
life. The net present value of Project PR1 has been calculated as £23,660 (positive) with the cash
flows discounted at the company's cost of capital of 12% per annum.

Project PR2 requires investment of £410,000 in Year 0, with estimated net cash inflows over 5 years
as follows:

Year £000
1 80
2 105
3 130
4 130
5 75

In addition, the investment is expected to have a residual value of £25,000 in Year 5.

Discount factors
Year Annual discount rate %
9 12 15
1 0.917 0.893 0.870
2 0.842 0.797 0.756
3 0.772 0.712 0.658
4 0.708 0.636 0.572
5 0.650 0.567 0.497
6 0.596 0.506 0.432

REQUIRED

(a) Calculate the annual net cash inflow expected on Project PR1. (3 marks)

(b) Calculate, for Project PR2, the:

(i) payback period (3 marks)

(ii) net present value (discounted at the cost of capital) (3 marks)

(iii) internal rate of return (5 marks)

(c) Explain and illustrate how a weighted average cost of capital can be calculated. (6 marks)

(Total 20 marks)

3024/2/08/MA Page 1 of 10
MODEL ANSWER TO QUESTION 1

(a) Project PR1 – annual net cash inflows:

Present value of cash inflows = £283,660 (260,000 investment + £23,660 NPV)

÷ 4.111 (annuity factor at 12% over 6 years)

= Net cash inflows of £69,000 per annum

(b) (i) Project PR2 - payback period:

Year Cash flow Cumulative cash flow

£000 £000
0 (410) (410)
1 80 (330)
2 105 (225)
3 130 (95)
4 130 35

Payback period = 3 + 95/130 years

= 3.7 years

(ii) Project PR2 – net present value (NPV) + workings for IRR calculation:

Year Cash flow Disc factor NPV Disc factor NPV

£000 12% £000 9% £000
0 (410) 1.000 (410) 1.000 (410)
1 80 0.893 71.4 0.917 73.4
2 105 0.797 83.7 0.842 88.4
3 130 0.712 92.6 0.772 100.4
4 130 0.636 82.7 0.708 92.0
5 100 0.567 56.7 0.650 65.0
(22.9) 9.2

Net present value = £22.9k negative

(iii) Project PR2 – internal rate of return (IRR):

Approx IRR = 9% + {[12 – 9%] × [9.2 ÷ (9.2 + 22.9)]}

= 9.9%

(c) The long term capital employed by a business is likely to be a mix of equity capital and debt
capital. Each has its own risks and associated rewards. The overall cost of capital to a business
will depend upon the cost of each element of long term capital and their relative proportions in the
capital mix.

Illustration:
A company has equity capital which represents 70% of total long term capital, requiring a return
of 15% per annum, and 30% debt capital at a cost of 10% per annum. The overall cost of capital
will be:

Equity 15% × 0.7 = 10.5%

+ Debt 10% × 0.3 = 3.0%
13.5%

3024/2/08/MA Page 2 of 10
QUESTION 2

A wholesale business has the following budgeted balance sheets for the year ahead:

Beginning of year End of year

£000 £000
Fixed assets (at cost) 400 465
Cumulative depreciation 170 220
Fixed assets (net book value) 230 245

Stock 36 42
Debtors 67 74
Bank --- 9
103 125

Trade creditors 17 21
Expense creditors 6 8
Bank overdraft 11 ---
34 29

Net assets 299 341

Capital at beginning 299 299

Net profit for period 42
Capital at end 341

The profit to sales ratios for the year are budgeted to be:

Gross profit 30.0%

Net profit 7.0%

No fixed assets are budgeted to be disposed of during the year. The cost of capital is 10% per
annum.

REQUIRED

(a) Prepare a summary cash budget for the year (workings for each item must be clearly shown)
(15 marks)

(b) Calculate each of the following budgeted ratios for the year:

(i) return on average capital employed (%) (2 marks)

(ii) residual income (£) (3 marks)

(Total 20 marks)

3024/2/08/MA Page 3 of 10
MODEL ANSWER TO QUESTION 2

(a) Summary cash budget:

£000
Receipts
from sales 593 [(42 ÷ 0.07) – (74 – 67)]

Payments
to trade creditors 422 [(sales × 0.7) – (21 – 17) + (42 – 36)]
for expenses 86 [(sales × 0.23) – (8 – 6) – 50 depreciation]
for fixed assets 65 (465 – 400)
573

Net cash inflow 20

Bank overdraft at
beginning of year 11

Bank balance at
end of year 9

(b) Budgeted ratios:

(i) return on capital employed:

(net profit 42 ÷ average capital employed 320) × 100

= 13.1% return on capital employed

(ii) residual income:

[net profit 42 – (capital charge 320 × 0.1)

= £10k residual income

3024/2/08/MA Page 4 of 10
QUESTION 3

REQUIRED

(a) Explain each of the following terms used in business decision-making:

(i) avoidable cost (2 marks)

(ii) opportunity cost (3 marks)
(iii) sunk cost (2 marks)

A company manufactures and sells three products with the following selling prices and costs:

Product X Product Y Product Z

£ per unit £ per unit £ per unit

Selling price 12.00 10.00 8.00

Variable costs 7.30 6.50 5.00
Fixed costs 3.50 3.00 2.50

Availability of direct labour will be limited to 5,000 hours in the next period. Other resources will be
available as required. Output per direct labour hour is as follows:

Product X 10 units
Product Y 12 units
Product Z 15 units

Demand for the three products in the next period is expected to be:

Product X 15,000 units

Product Y 24,000 units
Product Z 30,000 units

REQUIRED

(b) For the next period:

(i) demonstrate that direct labour will be the limiting factor (3 marks)

(ii) prepare a statement showing the sales units, and the resulting profit contribution,
of each product that would maximise profit. (10 marks)

(Total 20 marks)

3024/2/08/MA Page 5 of 10
MODEL ANSWER TO QUESTION 3

(a) (i) Avoidable cost:

A cost that can be avoided if one or other of the decision-making alternatives is not
pursued.

(ii) Opportunity cost:

The benefit foregone by not pursuing the next best alternative.

(iii) Sunk cost:

A cost already incurred and thus irrelevant as such for decision-making.

(b) (i) Labour hours required to satisfy sales demand:

Product X 1,500 hours (15,000 units ÷ 10 units per hour)

Product Y 2,000 hours (24,000 units ÷ 12 units per hour)
Product Z 2,000 hours (30,000 units ÷ 15 units per hour)
5,500 hours

Demand exceeds supply by 500 hours so direct labour is the limiting factor.

(ii) Statement of sales units and profit contribution:

Product Labour hours allocation Product units Contribution £000

X 1,500 15,000 (x 4.7) 70.5
Z 2,000 30,000 (x 3.0) 90
3,500
Y 1,500 (x 12) 18,000 (x 3.5) 63
5,000 223.5

Workings:

Product X Product Y Product Z

Selling price (£ per unit) 12.00 10.00 8.00
Variable costs (£ per unit) 7.30 65.50 5.00
Contribution (£ per unit) 4.70 3.50 3.00
Contribution (£ per labour hour) 47 42 45
Production priority 1 3 2

3024/2/08/MA Page 6 of 10
QUESTION 4

REQUIRED

(a) Briefly, describe and appraise how ideal and attainable standards may be used as the basis for a
standard costing system.
(6 marks)

A company has a single product with standard selling price and standard production costs of £75 and
£50 per unit respectively. In the period just ended, 2,400 units of the product were sold, 100 units less
than budgeted, for a total revenue of £182,400.

REQUIRED

(b) Calculate the following variances for the period just ended:

(i) sales volume profit (2 marks)

(ii) selling price (2 marks)

In the same period, the cost variances reported by the company included:

£
Direct material price 415 Favourable
Direct material usage 1,320 Adverse
Direct labour rate 296 Favourable
Direct labour efficiency 480 Adverse
Fixed production overhead volume 1,820 Adverse

A single raw material is used in the manufacture of the product. The standard purchase price of the
material is £12.00 per kg. 2,400 units of the product were manufactured in the period during which
3,950 kgs of the raw material were purchased and used. The standard direct labour rate is £6.00 per
hour with standard efficiency of 1.2 hours per unit of product. The fixed production overhead
absorption rate is £14 per unit of output.

REQUIRED

(c) Calculate, for the period just ended, the:

(i) actual total cost of the material purchased and used (3 marks)

(ii) actual total direct labour cost of production (4 marks)

(iii) budgeted production units (3 marks)

(Total 20 marks)

3024/2/08/MA Page 7 of 10
MODEL ANSWER TO QUESTION 4

(a) Ideal standards are performance standards that can only be achieved under perfect operating
conditions, i.e. maximum efficiency making no allowance for losses, waste, etc. Such standards
are very unlikely to be achieved and may as a consequence be de-motivational.

Attainable standards are performance standards that assume efficient levels of operation but
make some allowance for losses, waste, etc where appropriate. Such standards are commonly
adopted as they can be seen to be achievable with effort and thus may provide motivation to
improve performance.

(b) (i) Sales volume profit variance:

100 units × (£75 – 50/unit) = £2,500 Adverse

(ii) Selling price variance:

£182,400 – (2,400 units × £75/unit) = £2,400 Favourable

(c) (i) Actual total cost of the material purchased:

Standard cost of material purchased £47,400 (3,950 kgs × £12/kg)

- Favourable material price variance £415
Actual cost of material purchased £46,985

(ii) Actual total direct labour cost of production:

Standard labour cost of production £17,280 (2,400 units × 1.2 hrs/unit × £6.00/hr)
+ Adverse labour efficiency variance £480
- Favourable labour rate variance £296
Actual labour cost of production £17,464

(iii) Budgeted production (units):

Actual production 2,400 units

+ Adverse fixed production
overhead volume variance 130 units (£1,820 ÷ £14/unit)
Budgeted production 2,530 units

3024/2/08/MA Page 8 of 10
QUESTION 5

A company manufactures two products (P1 and P2). Three raw materials (M1, M2 and M3) are used
in the manufacture of the two products, as follows:

Raw material
M1 M2 M3
kg/unit of product litres/unit of product kg/unit of product
Product P1 1.4 0.2 ---
Product P2 --- 0.4 0.6

Standard costs are as follows:

Product P1 £19.40 per unit

Product P2 £22.90 per unit
Material M1 £3.60 per kg
Material M2 £9.40 per litre
Material M3 £8.00 per kg

The sales budget for the following three months is:

Month 1 Month 2 Month 3

Product P1 (units) 1,200 2,700 3,300
Product P2 (units) 2,000 2,100 1,800

Finished stock of each of the products at the beginning of each month is 25% of that month's expected
sales.

Stocks of raw material at the beginning of Month 1 are expected to be:

Material M1 460 kgs

Material M2 500 litres
Material M3 300 kgs

The stock of Material M1 is not expected to change but the stocks of Material M2 and Material M3 are
considered to be too high and a reduction of 10% is to be budgeted for each material in each month.

REQUIRED

(a) Prepare the following budgets for each of Months 1 and 2:

(i) production budget for each product (units only) (4 marks)

(ii) usage budget for each material (quantities only) (6 marks)

(iii) purchases budget for each material (quantities only) (6 marks)

(b) List the stock valuations on the budgeted balance sheet at the end of Month 2. (4 marks)

(Total 20 marks)

3024/2/08/MA Page 9 of 10
MODEL ANSWER TO QUESTION 5

(a) (i) Production budget:

Month 1 Month 2
Product P1 Product P2 Product P1 Product P2
(units) (units) (units) (units)
Sales 1,200 2,000 2,700 2,100
+ closing stock 675 525 825 450
- opening stock (300) (500) (675) (525)
Production 1,575 2,025 2,850 2,025

Working:

e.g. Product P1 closing stock, Month 2 = Month 3 sales 3,300 × 0.25 = 825 units

(ii) Material usage budget:

Month 1 Month 2
Mat M1 Mat M2 Mat M3 Mat M1 Mat M2 Mat M3
kgs litres kgs kgs litres kgs
Product P1 2,205 315 ----- 3,990 570 -----
Product P2 ----- 810 1,215 ----- 810 1,215
Material usage 2,205 1,125 1,215 3,990 1,380 1,215

Working:

e.g. Material M2 usage, Month 2 = Product P1 production, Month 2 2,850 units × 0.2
+ Product P2 production, Month 2 2,025 units × 0.4 = 1,380 litres

(iii) Material purchases budget:

Month 1 Month 2
Mat M1 Mat M2 Mat M3 Mat M1 Mat M2 Mat M3
kgs litres kgs kgs litres kgs
Material Usage 2,205 1,125 1,215 3,990 1,380 1,215
+ closing stock 460 450 270 460 405 243
- opening stock (460) (500) (300) (460) (450) (270)
Material Purchases 2,205 1,075 1,185 3,990 1,335 1,188

Working:

e.g. Material M3 closing stock, Month 1 = opening stock, Month 1 300 kgs × 0.9 = 270 kgs

(b) Stock valuations (end of month 2):

Finished goods:
Product P1 825 units x £19.40/unit £16,005
Product P2 450 units x £22.90/unit £10,305 £26,310
Raw materials:
Material M1 460 kgs x £3.60/kg £1,656
Material M2 405 litres x £9.40/litre £3,807
Material M3 243 kgs x £8.00/kg £1,944 £7,407
£33,717

3024/2/08/MA Page 10 of 10 © Education Development International plc 2008