Management

Accounting
Level 3

Model Answers
Series 3 2008 (Code 3024)

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Management Accounting Level 3
Series 3 2008

How to use this booklet

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

Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success.

EDI provides Model Answers to help candidates gain a general understanding of the standard
required. The general standard of model answers is one that would achieve a Distinction grade. EDI
accepts that candidates may offer other answers that could be equally valid.

© Education Development International plc 2008

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Page 1 of 11
QUESTION 1

Company Y recently launched a new product (Product A). The variable cost of the product was
estimated, prior to the launch, at £44.00 per unit along with total fixed costs of £336,000 per period.

The initial selling price of Product A was set so as to achieve a net profit margin of 10% based on a
sales volume of 12,000 units per period.

REQUIRED

(a) Calculate the initial selling price of Product A. (4 marks)

Company Y has estimated the sales demand for another of its products, Product B, at three different
selling prices. The company is seeking to determine which of the three prices would generate the
most profit.

The estimates of the selling price/demand relationships are:

Selling price Sales demand
£35.00 per unit 15,000 units
£38.00 per unit 13,000 units
£42.00 per unit 10,000 units

The variable costs of Product B are:

Production £16.40 per unit
Administration and selling £3.60 per unit

Fixed costs of £185,000 would not change over the relevant output range.

REQUIRED

(b) Determine the selling price for Product B that would generate the most profit. (4 marks)

Company Z is considering undertaking a new job that would require the use of 120 units of
Component C7. This component is used regularly on other jobs carried out by Company Z.

Company Z currently has 165 units of Component C7 in stock: the components were purchased for
£62.00 per unit. The current purchase price of the component is £64.00 per unit. The existing stock
of Component C7, if sold, would generate a net revenue of £55.00 per unit.

REQUIRED

(c) State and explain:

(i) The relevant cost per unit of Component C7 that should be used by Company Z in deciding
whether to undertake the new job
(ii) An example of a sunk cost from the information about Component C7 above.
(6 marks)

(d) Discuss briefly the usefulness for decision-making of:

(i) Absorption costing
(ii) Marginal costing.
(6 marks)

(Total 20 marks)

Page 2 of 11
MODEL ANSWER TO QUESTION 1

(a) Product A: initial selling price

£ per unit
Variable costs 44.00
Fixed costs 28.00 (£336,000 ÷ 12,000 units)
Total costs 72.00

÷ 0.9

Selling price = £80.00 per unit

(b) Product B: selling price for most profit

At selling price £35, total contribution = 15,000 units × (£35 - £20) = £225,000
At selling price £38, total contribution = 13,000 units × (£38 - £20) = £234,000
At selling price £42, total contribution = 10,000 units × (£42 - £20) = £220,000

Selling price of £38.00 generates the most profit.

(c) (i) Relevant cost £64 per unit, the current purchase price, because 120 more units of
Component C7 would have to be purchased if the component was used in the new job.

(ii) Sunk cost £62 per unit, the original purchase price of the stock, because a sunk cost is a
cost that has already been incurred.

(d) Usefulness for decision-making

Full absorption costing provides an indication of the long-term profitability of different products
and services and thus may be useful in prompting decisions. It should, however, be realised that
product unit costs are very dependent, in the sharing of fixed costs, both on the level of activity
and on the arbitrary nature of cost apportionment and absorption.

Marginal costing on the other hand, focusing as it does on contribution, can be useful for certain
short-term decisions, especially regarding sales pricing and product mix.

However, all decisions, whether short-term or long-term, should be taken on the basis of the
relevant costs of each situation which will invariably be different from how information is
organised for routine reporting in the management accounts.

Page 3 of 11
QUESTION 2

Company B is made up of three investment centres (ICX, ICY and ICZ). ICX manufactures a single
component (SC) which it sells to ICY and ICZ as well as to other organisations.

The price of SC for transfers between investment centres within Company B is £22.00 per unit. The
price of SC for sales to other organisations is £30.00 per unit.

The following further information is available for Investment Centre ICX for a period:
Transfers Transfers Sales to other
Total to ICY to ICZ organisations
Sales (units) 33,100 5,200 12,600 15,300

£000 £000 £000 £000

Sales revenue 850.6 114.4 277.2 459.0
Cost of sales:
Variable costs 595.8 93.6 226.8 275.4
Fixed costs 229.3 36.0 87.3 106.0
825.1 129.6 314.1 381.4

Net profit/(loss) 25.5 (15.2) (36.9) 77.6

Capital employed 240.0

The fixed costs of Investment Centre ICX are apportioned on the basis of sales units (rounded to the
nearest £ hundred). No saving in fixed costs would be made by ICX unless total sales of Component
SC per period were less than 10,000 units.

REQUIRED

(a) Calculate, for Investment Centre ICX, the following ratios for the period:
(i) Net profit margin (%)
(ii) Return on capital employed (%)
(iii) Asset turnover (number of times).
(6 marks)

(b) Calculate the change in profit for Investment Centre ICX, and for Company B, if the transfer price
of Component SC had been £30.00 per unit in the period.
(7 marks)

(c) Calculate the revised net profit/(loss) for Investment Centre ICX in the period if Investment
Centres ICY and ICZ had purchased Component SC entirely from an outside supplier and
Investment Centre ICX had been unable to increase sales to other organisations.
(5 marks)

(d) State the mathematical relationship between the three ratios calculated in part (a). (2 marks)

(Total 20 marks)

Page 4 of 11
MODEL ANSWER TO QUESTION 2

(a) (i) Net profit margin

[(25.5 ÷ 850.6) × 100 = 3.0%

(i) Return on capital employed

[(25.5 ÷ 240.0) × 100 = 10.6%

(ii) Asset turnover

850.6 ÷ 240.0 = 3.54 times

(b) Change in profit for Investment Centre ICX

(5,200 units + 12,600 units) × (£30 - £22) = £142,400 increase in profit

There is no change in the profit of Company B (it is simply a transfer of profit between the
divisions)

(c) Revised profit for Investment Centre ICX

£000 £000
Sales 459.0
Cost of sales:
Variable costs 275.4
Fixed costs 229.3 504.7
Net loss (45.7)

(d) Return on capital employed = Net profit margin × asset turnover

10.6% = 3.0% × 3.54 times

Page 5 of 11
QUESTION 3

Company C currently buys-in various services from an outside organisation. The senior management
of Company C are considering the purchase of equipment to enable the company to provide its own
services in-house instead.

The bought-in services are paid for at each year end. A payment of £60,000 has just been made. If
Company C continues to buy-in the services, the cost would be expected to increase by 10% per
annum in each of the next 4 years due to volume increases and inflation.

The equipment could be purchased and installed immediately at a cost of £125,000: £50,000 payable
on purchase with the balance payable one year after. The equipment would be expected to have a
useful life of 4 years with a residual value of £12,000 at end of Year 4 prices.

Incremental costs (excluding depreciation) of using the equipment to provide the services in-house are
estimated, in the first year and at current prices, to be:
Variable costs £12,000
Fixed costs £18,000

Over the next 4 years, activity of the in-house services would be expected to increase by 5% per
annum and inflation of 4% per annum is expected on all of the above equipment operating costs. It is
to be assumed that all payments would take place at year end.

The cost of capital of Company C, in money terms, is 12% per annum. The following discount factors
apply:
Year Discount factor
(12%)
1 0.893
2 0.797
3 0.712
4 0.636

REQUIRED

In relation to the purchase of equipment by Company C:

(a) Calculate, and present clearly in a table, the relevant cash flows for each year (in money terms)
that should be used to evaluate the investment.
(14 marks)

(b) Calculate:
(i) The net present value
(ii) The discounted payback period.
(6 marks)

(Total 20 marks)

Page 6 of 11
MODEL ANSWER TO QUESTION 3

(a) Cash flows in money terms

Year Bought-in In-house Differential

£000 £000 £000
0 (50.0) (50.0)
1 (66.0) (31.8) + (75.0) (40.8)
2 (72.6) (33.8) 38.8
3 (79.9) (35.9) 44.0
4 (87.8) (38.1) + 12.0 61.7

Workings:

Bought-in:
Year 1 60,000 × 1.1 = 66,000
Year 2 66,000 × 1.1 = 72,600
Year 3 72,600 × 1.1 = 79,860
Year 4 79,860 × 1.1 = 87,846

In-house:
Variable costs:
Year 1 12,000 × 1.04 × 1.05 = 13,104
Year 2 13,104 × 1.04 × 1.05 = 14,310
Year 3 14,310 × 1.04 × 1.05 = 15,626
Year 4 15,626 × 1.04 × 1.05 = 17,064

Fixed costs:
Year 1 18,000 × 1.04 = 18,720
Year 2 18,720 × 1.04 = 19,469
Year 3 19,469 × 1.04 = 20,248
Year 4 20,248 × 1.04 = 21,057

Total costs:
Year 1 13,104 + 18,720 = 31,824
Year 2 14,310 + 19,469 = 33,779
Year 3 15,626 + 20,248 = 35,874
Year 4 17,064 + 21,057 = 38,121

(b) (i) Net present value

Year Net cash flow Discount factor Net present value

£000 12% £000
0 (50.0) 1.000 (50.0)
1 (40.8) 0.893 (36.4)
2 38.8 0.797 30.9
3 44.0 0.712 31.3
4 61.7 0.636 39.2
15.0
The net present value is a positive £15,000.

(ii) Discounted payback period

3 years + 39.2 – 15.0

39.2

= 3.6 years

Page 7 of 11
QUESTION 4

REQUIRED

(a) Describe the steps taken when using the high/low method to forecast a semi-variable cost. NB A
numerical example is not required.
(8 marks)

Company D manufactures and sells a single product. The selling price and unit costs of the product
are:
£ per unit
Selling price 7.40
Production costs:
Variable 3.60
Fixed 2.10
Non-production costs:
Variable 0.50
Fixed 0.80

The fixed costs per unit listed above are based on sales and production quantities of 6,400 units per
period.

REQUIRED

(b) Calculate the:

(i) Net profit per period (£)
(ii) Contribution/sales ratio (%)
(iii) Break-even sales revenue per period (to the nearest £ hundred)
(iv) Margin of safety (%).
(10 marks)

(c) State whether the break-even point (in sales units) would increase or decrease if the selling price
was raised with no change in the cost structure. Explain why.
(2 marks)

(Total 20 marks)

Page 8 of 11
MODEL ANSWER TO QUESTION 4

(a) High/low method

Steps:
1. Collect data on total costs for a range of activity levels
2. Calculate the difference between the highest and lowest activity and divide this into the difference
in the associated costs (adjusted for inflation where necessary) so as to establish an estimated
variable cost per unit
3. The difference between the total costs on the one hand (at either the highest or lowest activity)
and the variable cost per unit multiplied by the associated activity on the other will be the
estimated total fixed costs
4. Calculate forecast costs by multiplying the forecast activity by the variable cost per unit and then
adding the total fixed costs (adjusted for inflation where necessary).

(b) (i) Net profit per period

Unit contribution = £7.40 - (£3.60 + £0.50)

= £3.30 per unit

Total fixed costs = 6,400 units × (£2.10 + £0.80)

= £18,560

Net profit = (6,400 units × £3.30) - £18,560

= £2,560

(ii) Contribution/sales ratio

(£3.30 ÷ £7.40) × 100

= 44.6%

(iii) Break-even sales revenue

£18,560 ÷ 0.446

= £41,600

(iv) Margin of safety

{[(6,400 units × £7.40) – £41,600] ÷ (6,400 units × £7.40} × 100%

= [(£47,360 – £41,600) ÷ £47,360]

= 12.2%

(c) The break-even point in sales units would decrease because the unit contribution would increase.

Page 9 of 11
QUESTION 5

A wholesale business has the following budgeted balance sheets for the year ahead:
Start of year End of year
£000 £000
Fixed assets (at cost) 525 566
Cumulative depreciation 190 201
335 365

Stock 20 26
Debtors 69 71
Bank 2 ---
91 97

Trade creditors 12 10
Expense creditors 5 4
Bank overdraft --- 4
17 18

Net assets 409 444

Capital at start 409 409

Net profit for period 35
444

The following additional budgeted information is available relating to the year ahead:

(i) Profit margins:

Gross profit 39.0%
Net profit 5.0%

(ii) Fixed asset disposal:

Fixed assets (at cost £96,000: cumulative depreciation £78,000) are budgeted to be
disposed of at their net book value.

REQUIRED

Prepare in as much detail as possible, using the above budgeted information for the year ahead:

(a) A profit budget. (8 marks)

(b) A reconciliation of the budgeted profit with the budgeted change in the bank balance. (12 marks)

(Total 20 marks)

Page 10 of 11
MODEL ANSWER TO QUESTION 5

(a) Profit budget

£000 £000
Sales 700 (35 ÷ 0.05)

Cost of sales 427 (700 × 0.61)

Gross profit 273 (700 × 0.39)

Expenses:
Depreciation 89 [201 – (190 – 78)]
Other 149 238 (700 × 0.34)

Net profit 35 (700 × 0.05)

(b) Reconciliation of profit with change in bank balance

£000 £000
Net profit 35
Add back depreciation 89
124

Changes in working capital:

Increase in stock (6)
Increase in debtors (2)
Decrease in creditors (trade & expense) (3)
(11)

Sale of fixed assets 18

Purchase of fixed assets (137) [566 – (525 – 96)]
(119)

Reduction in bank balance (6) [2 – (4)]

Page 11 of 11