Subject: MANAGEMENT ACCOUNTING

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  • 20 Marks

Determine the optimal transfer pricing for consulting services between divisions within KayCee Ltd based on varying capacity scenarios.

The Management Information System (MIS) division of KayCee Ltd provides consulting services to its clients as well as to other divisions within the group. Consultants always work in teams of two on every consulting day. Each consulting day is charged to external clients at GH¢750, which represents cost plus a 150% profit markup. The total cost per consulting day has been estimated to be 80% variable and 20% fixed.

The director of the Human Resources (HR) division of KayCee Ltd has requested the services of two teams of consultants from the MIS division on five days per week for a period of 48 weeks, and has suggested that she meets with the director of the MIS division in order to negotiate a transfer price. The director of the MIS division has responded by stating that he is aware of the limitations of using negotiated transfer prices and intends to charge the HR division GH¢750 per consulting day.

The MIS division always uses Internal video-conference equipment on all internal consultations which would reduce the variable costs by GH¢50 per consulting day.

Note: The conference equipment can only be used when providing internal consultations.

Required:

a) Calculate and discuss the transfer prices per consulting day at which the MIS division should provide consulting services to the HR division in order to ensure that the profit of KayCee Ltd is maximized in each of the following situations:

i) Every pair of consultants in the MIS division is 100% utilized during the required 48-week period in providing consulting services to external clients, i.e. there is no spare capacity.
ii) There is one team of consultants who, being free from other commitments, would be available to undertake the provision of services to the HR division during the required 48-week period. All other teams of consultants would be 100% utilized in providing consulting services to external clients.
iii) A major client has offered to pay the MIS division GH¢264,000 for the services of two teams of consultants during the required 48-week period.

(14 marks)

b) Explain THREE (3) limitations of negotiated transfer prices.

(6 marks)

a)
i) The transfer price of GH¢750 proposed by the MIS division is based on cost plus 150% from which it can be deduced that the total cost of a consulting day is (100/250) x GH¢750 = GH¢300. This comprises GH¢240 (80%) variable cost and GH¢60 (20%) fixed cost. In this instance, the transfer price should be set at marginal costs plus opportunity cost. It is assumed in this situation that transferring internally would result in the MIS division having a lost contribution of GH¢750 – GH¢240 = GH¢510 per consulting day. The marginal cost of the transfer of services to the HR division is GH¢190 (GH¢240 external variable costs less GH¢50 saving due to use of internal video-conferencing equipment). Adding the opportunity cost of GH¢510 gives a transfer price of GH¢700 per consulting day. This is equivalent to using the market price as a basis for transfer pricing where the transfer price is set at the external market price (GH¢750) less any costs avoided (GH¢50) by transferring internally.

ii) There is in effect no external market available for one of the required pairs of consultants within the MIS division and therefore opportunity cost will not apply and transfers should be made at the variable cost per consulting day of GH¢190. The other pair of consultants, who would otherwise be 100% utilized in providing consulting services to external clients, should be charged at a rate of GH¢700 per day which represents marginal cost plus opportunity cost.

iii) The lost contribution from the major client amounts to GH¢264,000/(2 x 240) = GH¢550 less variable costs of GH¢240 = GH¢310 per consulting day. Thus, in this instance, the transfer price should be the contribution foregone of GH¢310 plus internal variable costs of GH¢190, making a total of GH¢500 per consulting day.

Alternative

Cost Analysis:
Let X represent the cost
X + 1.5X = 750
2.5X = 750
X = 300

Variable cost = 80% of 300 = GH¢240
Fixed cost = 20% of 300 = GH¢60

i) Where there is no spare capacity, transfer price should be at market price. With the use of internal facilities and savings in variable cost, transfer price should be market price less savings, i.e., GH¢750 – GH¢50 = GH¢700.

ii) Where one team is idle, the fully engaged team will transfer at adjusted market price while the idle team will transfer at adjusted variable cost.
Fully engaged: GH¢750 – GH¢50 = GH¢700
Idle: GH¢240 – GH¢50 = GH¢190
Total = GH¢890

For the two teams:

iii) Where there is an offer from an outside customer, the transfer price should be the opportunity cost.
Offer price = GH¢264,000 / 480 hours = GH¢550, adjusted by savings of GH¢50, giving GH¢500 per consulting day.

Marks Allocation for Part a:

Analysis = 4 marks
i) = 3 marks
ii) = 3 marks
iii) = 4 marks
Total for part a = 14 marks

b) Limitations of negotiated transfer prices:

Suboptimal pricing: The transfer price which is the final outcome of negotiations may not be close to the transfer price that would be optimal for the organization as a whole since it can be dependent on the negotiating skills and bargaining powers of individual managers.
(2 marks)

Potential conflict: They can lead to conflict between divisions, which may necessitate the intervention of top management to mediate. The measure of divisional profitability can be dependent on the negotiating skills of managers who may have unequal bargaining power.
(2 marks)

Time-consuming process: They can be time-consuming for the managers involved, particularly where large numbers of transactions are involved.

(2 marks)

  • 20 Marks

MA – Mar 2023 – L2 – Q1a – Other aspects of performance measurement

Calculate EVA for Vilagio Engineering for 2021 and 2022 and comment on its performance.

Vilagio Engineering (VE) is a listed company manufacturing pumps and valves for use in the irrigation sector. The CEO has tasked you to assess Vilagio’s performance using Economic Value Added. Below is an extract of their financial statements.

Income Statement extract for the year:

Additional information:
i) Capital employed at the end of 2020 amounted to GH¢350 million.
ii) VE had non-capitalised leases valued at GH¢16 million in each of the years 2020 to 2022. Ignore amortisation calculations.
iii) VE’s pre-tax cost of debt was estimated to be 9% in 2021 and 10% in 2022.
iv) VE’s cost of equity was estimated to be 15% in 2021 and 17% in 2022.
v) The target capital structure is 70% equity, 30% debt.
vi) The rate of taxation is 30% in both 2021 and 2022.
vii) Economic depreciation amounted to GH¢64 million in 2021 and GH¢72 million in 2022. These amounts were equal to the depreciation used for tax purposes and depreciation charged in the income statements.
viii) Interest payable amounted to GH¢6 million in 2021 and GH¢8 million in 2022.
ix) Other non-cash expenses amounted to GH¢20 million per year in both 2021 and 2022.

Required:
a) Estimate the Economic Value Added (EVA) for Vilagio Engineering for both 2021 and 2022, and comment on the company’s performance.
b) State THREE (3) advantages and TWO (2) disadvantages of EVA.
c) Explain the relationship between EVA and Net Present Value (NPV).

a) Computation of EVA

WACC = (%e*Ke) + (%d*Kd (1-t))
2022 = (0.7*0.17) + (0.3*0.01(1-0.3)) =14%
2021 = (0.7*0.15) + (0.3*0.09 (1-0.3)) = 12.39%

EVA Calculation:
EVA = NOPAT – (Capital Employed * WACC)

2022 EVA = 113.6 – (416 * 14%) = GH¢55.36
2021 EVA = 95.2 – (366 * 12.39%) = GH¢49.85
Comment:
Management has increased shareholders’ value by 11% between 2021 and 2022.

b) Advantages of EVA:
Aligning decisions with shareholder wealth.
EVA focuses on the long-term NPV of a company.
Emphasizes the cost of capital.
EVA is based on cash flow, less distorted by accounting policies.
Provides an absolute figure for profitability.
Clarifies measures of profitability and shareholder value.
(Any 3 points @ 1 mark each = 3 marks)

Disadvantages of EVA:
EVA calculations are complicated due to adjustments.
Not suitable for inter-firm or inter-divisional comparisons.
Difficult to estimate economic depreciation.
(Any 2 points @ 1 mark each = 2 marks)

c) EVA and NPV Relationship:
There is a direct relationship between EVA and NPV. NPV is equal to the present value of future EVA. Accepting positive NPV projects should result in a positive EVA, making EVA a consistent measure with NPV in capital budgeting.

(3 marks)

  • 9 Marks

MA – Mar 2023 – L2 – Q2a – Standard costing and variance analysis

Prepare a production plan to maximize profit using throughput approach with given labor hours and demand.

The statement below relates to the costs and selling price of a unit of three products produced by a company:

Additional information provided:
Labour rate per hour for all the products is GH¢8
Demand for the year in units: A – 4,000; B – 2,500; C – 3,600
Available labour hours: 65,000
Required:
i) Prepare a production plan that will maximize profit using the throughput approach.
(9 marks)
ii) Calculate the Through Put Accounting Ratio for each product assuming that the conversion
cost is based on the annual demand.
(6 marks)

a)
Allocation of Limited Resources:

B: 2,500 units × 5 hours = 12,500 hours
C: 3,600 units × 11.25 hours = 40,500 hours
A: Remaining hours = 65,000 – (12,500 + 40,500) = 12,000 hours
Units of A to be produced: 12,000 hours ÷ 6.75 hours/unit = 1,778 units
Optimal Production Plan:

Product Units Produced
A 1,778 units(0.5)
B 2,500 units(0.5)
C 3,600 units(0.5)

iii) Total Conversion Cost

Conversion cost per limited resources =
GH¢ 1,037,000/65,000 GH¢ 15.96

  • 5 Marks

MA – Mar 2023 – L2 – Q2b – Standard costing and variance analysis

Explain four considerations management should take into account before investigating adverse material usage variance.

PTC, for the past couple of months, recorded adverse variances in material usage for one of its products. As a result, Management is considering carrying out an investigation on these adverse variances.

Required:
Explain FOUR (4) considerations that Management should take account of before proceeding with the investigation.

1. Materiality:
The amount of the variance should be substantial enough to necessitate the investigation.

2. Controllability:
If the reason for the variance is obvious, for example, the management has taken a decision to give a pay hike of 10%, and then the labor rate variance could be adverse. If the reasons are known, there is no need to investigate the variance.

3. The Type of Standard Used:
If the standard is set at the ideal level of efficiency, the variance could always be adverse.

4. Variance Trend:
If a variance is occurring every month and is of the same or similar amount, then investigations need to be done to find out the root cause.

5. Interdependence Between Variances:
If one variance affects another, then there is no requirement for an investigation. For example, cheap material will make the material price variance favorable and the efficiency variance adverse. Cheap materials could also make the labor efficiency variance adverse.

6. Cost of the Investigation:
If the estimated cost of the investigation is more than the benefit of the investigation, it is pointless to carry out the investigation.

(Any 4 points @ 1.25 marks each = 5 marks)

  • 10 Marks

MA – Mar 2023 – L2 – Q3b – Budgeting

Prepare a budgeted income statement for AJ Ltd based on given projections and assumptions for 2023.

The Income Statement of AJ Ltd for the year ended December 2022 was as follows:

Projections for 2023:

Sales: The current sales represent 15% of market share. Management plans to increase this to 20%. Meanwhile, industry experts are projecting a 12% growth in the sector.
Cost of Sales: Improvement in material quality will reduce cost of sales by 5% from the current level.
Other Expenses:
i) Administrative costs will increase by 20% over the 2022 actual figure.
ii) Selling and distribution costs will increase by 18% over the 2022 actual figure.
iii) Finance costs will remain at the same percentage of sales revenue as in 2022.

Required:
Prepare the budgeted income statement for the year 2023.

Budgeted income statement for the year ending 2023

Workings:
Sales Revenue:
Market size (2022): GH¢120,000 / 15% = GH¢800,000
Projected market size for 2023 (12% growth): GH¢800,000 × 1.12 = GH¢896,000
AJ Ltd’s projected market share: 20% of GH¢896,000 = GH¢179,200

Cost of Sales:
Current cost percentage: 90,000 / 120,000 = 75%
Improvement due to material quality: New cost percentage = 70%
Budgeted cost of sales = 70% of GH¢179,200 = GH¢125,440

Administrative Expenses:
2022 actual: GH¢8,000
Increase: 20% × GH¢8,000 = GH¢1,600
Total for 2023 = GH¢8,000 + GH¢1,600 = GH¢9,600

Selling & Distribution Expenses:
2022 actual: GH¢7,000
Increase: 18% × GH¢7,000 = GH¢1,260
Total for 2023 = GH¢7,000 + GH¢1,260 = GH¢8,260

Finance Expenses:
2022 finance expense percentage of sales: GH¢4,500 / GH¢120,000 = 3.75%
Finance expense for 2023 = 3.75% × GH¢179,200 = GH¢6,720

(10 marks)

  • 15 Marks

MA – Mar 2023 – L2 – Q4a – Discounted cash flow

Determine whether Arkoo Ltd's project is viable using the NPV method.

Question:
Arkoo Ltd (Arkoo) is planning to invest GH¢5 million in its sound engineering studio with a life span of 10 years. Arkoo charges GH¢5.50 for every compact disc (CD) produced with an associated cost of GH¢4.80. The company plans to produce 8,700,000 CDs each year. Arkoo evaluates all investment opportunities against a discount factor of 21%.

Required:
i) Determine whether the project is viable or not using the Net Present Value (NPV) method.
ii) Calculate the percentage by which the following conditioning factors of Arkoo must change
in order for NPV to be zero.

  • Selling price (3 marks)

    • Variable cost (3 marks)

  • Sales Volume (3 marks)
  • Initial investment (3 marks)

Assessing the Project Using NPV:
NPV Calculation:

Total NPV = GH¢19,689,335
Therefore, the NPV is positive, which indicates that the project is viable.

Or

(3 marks)

ii)

  • 5 Marks

MA – Mar 2023 – L2 – Q4b – Budgetary Control

Define budgetary control and its purpose in business operations.

i) Explain budgetary control. (2 marks)

ii) Recommend TWO (2) ways by which budgetary control can help to provide information to ensure operational continuity. (3 marks)

i) Budgetary control provides the framework for ensuring that programs and projects planned are successfully implemented. (2 marks)

ii) Ways by which budgetary control can help to provide information:

  • Activities and programs that will ensure future growth of the organization must be identified to be included in annual plans.
  • Activities that will impact on growth are given funding priority.
  • Unprofitable programmes are dropped.
  • Funds are allocated for research and development.

(Any 3 points @ 1 mark each = 3 marks)

  • 20 Marks

MA – March 2023 – L2 – Q5 – Cost-volume-profit (CVP) analysis

Prepare a profit statement based on demand and propose an optimal production plan considering resource limitations and price adjustments.

The following data relates to the planned activity of three products of Parlour Plc:

Demand (units):
Tintin: 15,000
Panpan: 10,000
Sonson: 12,500
i) Due to the general rise in prices, the company envisages that labour and variable production overhead costs will rise by 20% while material costs increase by 15%. It is the policy of the firm to maintain at all times the current mark-up (to the nearest whole number) on the total variable cost for each of the three products.

ii) The following resources are available to support the production:

Material: 60,000kgs
Labour hours: 65,000 hours
iii) The three products are complements, and the company envisages that 50% of the demand for all products has to be met for any operating year.

iv) The annual fixed cost, which will not be affected by the price adjustment, is estimated at GH¢42,500.

Required:
a) Prepare a profit statement assuming the company has capacity to meet all demand and considering the needed adjustments to reflect the proposed price changes. (8 marks)

b) Based on the resource limitation and proposed adjustment, what should be the optimal production plan? (10 marks)

c) Determine the associated profit from the optimal production plan. (2 marks)

Calculation of price changes:
Material will increase by 15% from GH¢3.5 = (1.15 x GH¢3.5) = GH¢4.025
Hourly rate will increase by 20% from GH¢1.75 = (1.20 x GH¢1.75) = GH¢2.1
Overhead rate will increase by 20% from GH¢0.75 = (1.20 x GH¢0.75) = GH¢0.90
Determination of the new selling price based on the old mark-up
Determination of old mark-up

Determination of new selling price and variable cost sheet

a) Profit Statement assuming there is no shortage in resource

(8 marks)
Determination of the resource in short supply

Thus, while labour hours is in short supply, material is not.
Determination of Contribution per limiting factor

b) Allocation of limited resource

(10 marks)

c) Determination of optimal benefit

(2 marks)

  • 20 Marks

MA – Nov 2019 – L2 – Q1a – Performance analysis

Calculation of key financial ratios for GRAT Authority and evaluation of financial performance from 2017 to 2018.

GRAT Authority operates passenger railway services and is responsible for the maintenance of track signaling equipment, and other facilities such as stations. In recent years it has been criticized for providing poor services to the traveling public in terms of punctuality, safety, and the standard of facilities offered to passengers. Last year, GRAT Authority invested over GH¢20 million in new carriages, station facilities, and track maintenance programs in an attempt to address these criticisms.

Summarized financial results for GRAT Authority for the last two years are given below:

Extracts of Statement of Profit or Loss account for the year ended 31 December

Statement of Financial Position as at 31 December

Required:

a) Calculate the following ratios for GRAT Authority for 2017 and 2018, clearly showing your workings.

i) Return on capital employed (ROCE)
ii) Net profit margin
iii) Asset turnover
iv) Current ratio

b) Evaluate the financial performance of the entity in 2017 and 2018 as revealed by the above ratios.

c) Suggest THREE (3) non-financial indicators that could be useful in measuring the performance of a passenger railway service and explain why your chosen indicators are important.

d) Explain the term short-termism and suggest ways in which a long-term view can be encouraged.
(Total: 20 marks)

a) Financial ratios

(2 marks each for every ratio calculated = 8 marks)

b) Profitability

  • Return on capital employed has fallen from 2017 to 2018, caused by a decrease in operating profit and an increase in capital employed. The fall in operating profit may have been caused by an increase in costs, while the new investment program will have caused an increase in capital employed.
  • Asset turnover has fallen. Sales have only increased by 2.8% between 2017 and 2018, so the new investment program may not yet have had a significant effect on sales.
  • In the short term, the investment program has increased assets and costs but has not yet influenced sales.

    • (4 marks)

  • Liquidity: The current ratio has deteriorated, so the firm’s ability to meet its short-term obligations from its short-term resources has been reduced. The expenditure on the investment program may have decreased the cash balance between 2017 and 2018, causing the deterioration in liquidity.

(2 marks)

c)

d) Short-termism is when there is a bias toward short-term rather than long-term performance.
Steps that could be taken to encourage managers to take a long-term view include:

  • Making short-term targets realistic. If budget targets are unrealistically tough, a manager will be forced to make trade-offs between the short and long term.
  • Providing sufficient management information to allow managers to see what trade-offs they are making.
  • Evaluating managers’ performance in terms of contribution to long-term objectives.
  • Linking managers’ rewards to share price to encourage goal congruence.
  • Setting quality-based targets as well as financial targets.

(Any 2 points for 2 marks)

  • 6 Marks

MA – Nov 2019 – L2 – Q2a – Decision-Making Techniques

Explains how profit maximization leads to shareholder wealth maximization and how constraints, satisficing, and optimizing affect decision-making.

a) Management Accountants are often engaged in decision-making processes that would yield optimal results, given a limited amount of resources available. Such decisions are expected to yield to shareholder wealth maximization through the maximization of profits. Unfortunately, however, constraints sometimes lead to satisficing rather than optimizing decision making.

Required:
i) Explain how profit maximization can lead to shareholder wealth maximization. (4 marks)

ii) Explain how constraints, satisficing, and optimizing affect the management accountant’s decision-making. (6 marks)

i) Profit maximization leading to shareholder wealth maximization:
Shareholder wealth maximization is the corporate objective of satisfying the shareholders of a firm by pursuing decisions that would add to their value and ensure maximum satisfaction.

  • The achievement of this objective is reflected in the payment of regular dividends and ensuring share price appreciation. These indicators are themselves influenced by maximizing the profits of the firm.
  • Profit conditions the size of dividend payment for firms, and the market price of a share is influenced greatly by the earnings per share of that firm.
  • Thus, pursuing profit maximization that ensures adequate generation of operational cash flows would lead to shareholder wealth maximization

    • .

(3 points for 3 marks + 1 mark for explanation = 4 marks)

ii) Constraints, satisficing, and optimizing in decision-making:

  • Constraints: A constraint can be a resource, a company policy, or a management mindset. The concept is applied to the allocation of scarce resources to reduce a company’s costs and improve profitability.

    • (2 marks)

  • Satisficing: Bounded rationality may lead to satisficing. It is the condition where the search for an optimal solution is abandoned upon finding a satisfactory solution. Normally in satisficing, the course of action chosen only leads to the achievement of the minimum basic requirement but does not necessarily give the best options. A management accountant interested only in meeting the basic requirement will not assist the firm in remaining competitive in a changing world.

    • (2 marks)

  • Optimizing: Optimizing means seeking the best option given the constraint faced by the decision-maker. Optimal solution-seeking takes time and effort, but its rewards are enormous. It leads the organization to satisfy its shareholders and achieve competitive advantage. Decision tools like limiting factor analysis and linear programming are useful in making optimal decisions.

    • (2 marks)

(Total for ii = 6 marks)

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