Advanced Management Accounting Sample Questions for Final Exam

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					Sample Questions for AMA Final Exam

Advanced Management Accounting
Sample Questions for Final Exam

Question One

You have been offered employment over the summer break by your uncle, who
operates Flower Power, a large fresh flower delivery service. Flower Power makes
about 400 deliveries per day, often to corporate customers. The company is currently
evaluating the monthly performance of each of its divisions using return on

You are employed at the main depot and over the past few weeks you have noticed
that there appears to be a fair degree of wastage occurring. The business has been
running at a loss, and customer complaints have been increasing. You have suggested
to your uncle that one way of managing this problem would be to design a new
performance measurement system.

To assist you in your task, you have been told that the critical success factors of
Flower Power are product quality, customer responsiveness and a wide product range.
The managers believe that if these factors are focused on, sales revenue and profit will


   (a) For each of the critical success factors, describe two performance measures
       that could be used. Make sure that your measures suit the particular products
       and operations of Flower Power.
                                                                          (6 marks)
   (b) Non- financial performance measures are better suited for monitoring the
       operations of a business and provide a more effective way of improving
       performance, compared with financial measures.

            (i)    Explain why some people believe the above statement.
                                                                             (3 marks)
            (ii)   What are the arguments against claim?
                                                                             (3 marks)

   (c) Explain the positive and negative effects associated with using return on
       investment for evaluating divisional performance.
                                                                       (6 marks)

                                                            (Total marks =18 marks)

Sample Questions for AMA Final Exam

Question Two

Continental Industries is a diversified corporation with separate operating divisions.
Each division’s performance is evaluated on the basis of profit and return on
investment. The Air Comfort Division manufactures and sells air-conditioner units.
The coming year’s budgeted income statement, which follows, is based upon a sales
volume of 15,000 units.

                              AIR COMFORT DIVISION
                              Budgeted Income Statement
                                   (In thousands)

                                                            Total          Per Unit
Sales revenue…………………………………..…..                            $12,000           $800
Manufacturing costs:
   Compressor…………………………………..…                              $ 2,100           $140
   Other direct material……………………………                          1,110             74
   Direct labour……………………………………                                 900             60
   Variable overhead………………………………                             1,350             90
   Fixed overhead…………………………………                                 960             64
        Total manufacturing cost……………………                   $ 6,420           $428
   Gross margin……………………………………                               $5,580           $372
Operating expenses:
   Variable selling…………………………………                            $ 540           $ 36
   Fixed selling……………………………………                                  570           38
   Fixed administrative……………………………                            1,140           76
        Total operating expenses……………………                     $2,250         $150
Net income before taxes……………………………                          $3,330          $222

Air Comfort’s division manager believes sales can be increased if the price of the air-
conditioners is reduced. A market research study by an independent firm indicates
that a 5 percent reduction in the selling price would increase sales volume 16 percent
or 2,400 units. The division has sufficient production capacity to manage this
increased volume with no increase in fixed costs.

The Air Comfort Division uses a compressor in its units, which it purchases from an
outside supplier at a cost of $140 per compressor. The Air Comfort Division manager
has asked the manager of the Compressor Division about selling compressor units to
Air Comfort. The Compressor Division currently manufactures and sells a unit to
outside firms which is similar to the unit used by the Air Comfort Division. The
specifications of the Air Comfort Division compressor are slightly different, which
would reduce the Compressor Division’s direct material cost by $3 per unit. In
addition, the Compressor Division would not incur any variable selling costs in the
units sold to the Air Comfort Division. The manager of the Air Comfort Division
wants all of the compressors it uses to come from one supplier and has offered to pay
$100 for each compressor unit.

  Sample Questions for AMA Final Exam

  The Compressor Division has the capacity to produce 75,000 units. Its budgeted
  income statement for the coming year, which follows, is based on sales volume of
  64,000 units without considering Air Comfort’s proposal.

                       COMPRESSOR DIVISION
                       Budgeted Income Statement
                            (In thousands)

                                                             Total                  Per Unit
Sales Revenue……………………………………………                               $12,800                   $200
Manufacturing costs:
   Direct material………………………………                               $ 1,536                  $ 24
   Direct labour………………………………..                                 1,024                    16
   Variable overhead…………………………..                               1,280                    20
   Fixed overhead……………………………..                                 1,408                    22
           Total manufacturing costs………                      $ 5,248                  $ 82
Gross Margin…………………………………………...                              $ 7,552                  $118
Operating expenses:
   Variable selling……………………………..                             $   768                  $ 12
   Fixed selling………………………………..                                   512                     8
   Fixed administrative………………………..                               896                    14
           Total operating expenses……….                      $ 2,176                  $ 34
Net income before taxes………………………………..                        $ 5,376                  $ 84


  A.    Should the Air Comfort Division institute the 5 percent price reduction on its
        air-conditioner units even if it cannot acquire the compressors internally for
        $100 each? Support your conclusion with appropriate calculations.
                                                                               (7 marks)

  B.    Independently of your answer to requirement (A), assume the Air Comfort
        Division needs 17,400 units. Should the Compressor Division be willing to
        supply the compressor units for $100 each? Support your conclusions with
        appropriate calculations.
                                                                          (7 marks)

  C.    Independently of your answer to requirement (A), assume Air Comfort needs
        17,400 units. Suppose Continental’s top management has specified a transfer
        price of $100. Would it be in the best interest of Continental Industries for
        the Compressor Division to supply the compressor units at $100 each to the
        Air Comfort Division? Support your conclusions with appropriate
                                                                              (6 marks)

  D.    Is $100 a goal-congruent transfer price? Why?
                                                                               (5 marks)

                                                                       (Total: 25 marks)

        Sample Questions for AMA Final Exam

        Question Three

        Devonport Inc is a large business organized on divisional lines. Two typical divisions
        are Asia-Pacific and Europe. They are engaged in broadly similar activities and,
        therefore, central management compares their results in order to make judgments on
        managerial performance. Both divisions are regarded as investment centres.

        A summary of last year’s financial results of the two divisions is as follows:

                                                                Asia-Pacific                 Europe
                                                              $,000        $,000         $,000     $,000
Capital Employed                                                           2,500                     500
Sales                                                                      1,000                     400
Manufacturing cost:
   Direct                                                      300                        212
   Indirect                                                    220                         48
Selling and distribution cost                                  180           700           40        300
Divisional profit                                                            300                     100
Apportionment of uncontrollable central overhead cost                         50                      20
Net profit                                                                   250                      80

        At the beginning of last year, Asia-Pacific division incurred substantial expenditure
        on automated production lines and new equipment. Europe has quite old plant.
        Approximately 50% of the sales of Europe are internal transfers to other divisions
        within the business. These transfers are based on unadjusted prevailing market price.
        The inter-divisional transfers of Asia-Pacific are minimal.

        Management of the business focuses on return on investment as a major performance
        indicator. The required minimum rate of return is the business’ cost of capital of 10%.


        A.     Compute the following:
               i. Residual income.
               ii. Return on investments based on net profit.
               iii. Return on investment based on divisional profit.
                                                                                         (6 marks)

        B.     Comment on the performance of the two divisions, making reference to any
               matters that give cause for concern when comparing the divisions or in
               divisional performance generally.
                                                                                    (8 marks)

                                                                             (Total: 14 marks)

Sample Questions for AMA Final Exam

Question Four

Lynsar Corporation started as a single plant to produce its major components and then
assembled its main product into electric motors. Lynsar later expanded by developing
outside markets for some components used in motors. Eventually, the company
reorganised into four manufacturing divisions: bearing, casing, switch, and motor.
Each manufacturing division operates as an autonomous unit, and divisional
performance is the basis for year-end bonuses.

Lynsar’s transfer pricing policy permits the manufacturing divisions to sell either
externally or internally. The price for goods transferred between divisions is
negotiated between the buying and selling divisions without any interference from top

Lynsar’s profits for the current year have dropped although sales have increased, and
the decreased profits can be traced almost entirely to the motor division. Jere Feldon,
Lynsar’s chief financial officer, has learned that the current motor division purchased
switches for its motors from an outside supplier during the current year rather than
buying them from the switch division, which is at capacity and has refused to sell to
the motor division. It can sell them to outside customers at a price higher than the
actual full (absorption) manufacturing cost that has always been negotiated in the past
with the motor division. When the motor division refused to meet the price that the
switch division was receiving from its outside buyer, the motor division had to
purchase the switches from an outside supplier at an even higher price.

Jere is reviewing Lynsar’s transfer pricing policy because he believes that
suboptimisation has occurred. Although the switch division made the correct decision
to maximise its division profit by not transferring the switches at actual full
manufacturing cost, this was not necessarily in Lynsar’s best interest because of the
price the motor division paid for them. The motor division has always been Lynsar’s
largest division and has tended to dominate the smaller divisions. Jere has learned
that the casing and bearing divisions are also resisting the motor division’s
expectation to use the actual full manufacturing cost as the negotiated price.

Jere has requested that the corporate accounting department study alternative transfer
pricing methods to promote overall goal congruence, motivate divisional management
performance, and optimise overall company performance. Three transfer pricing
methods being considered follow. The one selected will be applied uniformly across
all divisions.

   •   Standard full manufacturing costs plus mark-up.
   •   Market selling price of the products being transferred.
   •   Outlay (out-of-pocket) costs incurred to the point of transfer plus opportunity
       cost to the seller, per unit.

Sample Questions for AMA Final Exam


A.    Discuss the following:
         i.      The positive and negative motivational implication of employing a
                 negotiated transfer price system for the goods exchange between
                                                                         (4 marks)

         ii.     The motivational problems that can result from using actual full
                 (absorption) manufacturing costs as a transfer price.

B.    Discuss the motivational issues that could arise if Lynsar Corporation decides
      to change from its current policy of covering the transfer of goods between
      divisions to a revised transfer pricing policy that would apply uniformly to all
                                                                            (7 marks)

C.    Discuss the likely behaviour of both buying and selling divisional managers
      for each transfer pricing method listed earlier, if it were adopted by Lynsar.
                                                                             (10 marks)

                                                                   (Total: 25 marks)

Sample Questions for AMA Final Exam

Suggested solutions:

Question One

(a)    Critical Success Factor        Measure

Product quality                       No. customer complaints
                                      No. customer returns
                                      Turnover of flowers (hours)
                                      No. orders returned to supplier
                                      Quantity flowers destroyed due to poor quality
Customer responsiveness               Delivery time to customers
                                      Time between order and delivery
                                      Time taken to respond to customer complaints
                                      Response time to customer suggestions

Wide product range                    No. of different types of flowers ordered each
                                      No. new varieties introduced each month
                                      No. of varieties of flowers compared to

(1 mark for each performance measure x 6 – only if it suits the products and
operations of flower Power. Generic lists get 0 marks. Max for 2(a): 6 marks)

(b)    (i)     Reasons in support of non- financial measures:
       -       easier to control at operational level compared to financials
       -       are actionable ( easy to improve directly)
       -       easier to understand, usually relate closely to operations
       -       they drive future financial performance
       -       they highlight the causes of problems

(1/2 mark for each supportive reason – as long as it is logical, max. for 2(b)(i): 3

       (ii)    Arguments against non- financial measures:
       -       not as objective as financials
       -       difficult to choose which ones to measure
       -       may be difficult to see how they relate to achieving profit
       -       we want to maximise profits, and profit should be the focus
       -       costly to develop systems to collect non- financial data

(½ mark for each argument – as long as it is logical, max. for 2(b)(ii): 3 marks)

Sample Questions for AMA Final Exam

(c)    Positive effects of ROI:
       -      motivates managers to maximise profits, while holding asset balances
       -      can be used to compare divisions of different size
       -      easy to understand
       -      widely- accepted in practice

       Negative effects of ROI:
       - creates disincentive to invest in new assets
       - incentive to hold on to old outdated assets
       - incentive to manipulate profits
          reduce R & D, training expenditure
       - causes managers to focus on short- term performance at the expense of the
          long term
       - can cause managers to focus too narrowly on their own division’s
          performance, at the expense of the rest of company
       - can provide misleading signals of performance
       - can cause managers to reject projects which benefit the company, but
          lower divisional ROI.
(1/2 mark (max 2 marks) for each positive effect; ½ mark (max 4 marks) for
          each negative effect. Max. for Part 2(c): 6 marks)

                                               (Total for Question Two: 18 marks)

Sample Questions for AMA Final Exam

Question Two
     A. Yes, Air Division should institute the 5% price reduction on its air conditioner units because
        net profit would increase by $264,000. Supporting calculations follow.
                                                 Before 5%                         After 5%
                                              Price Reduction                   Price Reduction

                                      Per                  Total         Per           Total                Difference
                                      Unit            (in thousands)     Unit         (in thousands)      (in thousands)
      Sales revenue                    $800              $12,000         $760            $13,224.0          $1,224.0
      Variable costs
             Compressor               $ 140               $2,100        $ 140             $2,436.0            $336.0
             Other direct materials      74                1,110           74              1,287.6             177.6
             Direct labour               60                  900           60              1,044.0             144.0
             Variable overhead           90                1,350           90              1,566.0             216.0
             Variable selling            36                  540           36                626.4              86.4
             Total variable costs      $400               $6,000         $400             $6,960.0            $960.0
      Contribution margin              $400               $6,000         $360             $6,264.0            $264.0

Summarised presentation:
      Contribution margin of sales increase ($360 × 2,400)                                        $864,000 (4marks)
             Loss in contribution margin on original volume arising from
             decrease in selling price ($40 × 15,000)                                              600,000 (3 marks)
             Increase in net profit before taxes                                                  $264,000

                                                                                   (Total: 7 marks)

B.    No, the Compressor Division should not sell all 17,400 units to Air Division for $100. If the
      Compressor Division does sell all 17,400 units to Air Division, Compressor Division will only
      be able to sell 57,600 units to outside customers instead of 64,000 units due to the capacity
      restrictions. This would decrease Compressor Division’s net profit before taxes by $71,000.
      Compressor Division would be willing to accept any orders from Air Comfort above the 64,000
      unit level at $100 per unit because there would be a positive contribution margin of $43.
      Supporting calculations follow.
                                                                                Outside             WindAir
                                                                                  Sales               Sales
      Selling price                                                                $200             $100.00
      Variable costs
              Raw materials                                                        $ 24              $21.00
              Direct labour                                                          16               16.00
              Variable overhead                                                      20               20.00
              Variable selling expenses                                              12                   –
              Total variable costs                                                 $ 72              $57.00
      Contribution margin                                                         $ 128 (2 marks)    $43.00 (2 mks)
      Capacity calculation in units:
      Total capacity                                                                                 75,000
      Sales to WindAir                                                                               17,400
      Balance                                                                                        57,600
      Projected sales to outsiders                                                                   64,000
      Lost sales to outsiders                                                                        6,400 (1 mk)

Sample Questions for AMA Final Exam


     Contribution from sales to WindAir ($43.00 × 17,400)                                       $748,200 (1 mark)
     Loss in contribution from loss of sales to outsiders ($128 × 6,400)                          819,200 (1mark)
     Decrease in net profit before taxes                                                         $ 71,000

                                                                                  (Total: 7 marks)
C.   Yes, it would be in the best interests of National Industries for the Compressor Division to sell
     the units to the Air Division at $100 each. The net advantage to National Industries is $625,000
     as shown in the following analysis. The net advantage is the result of the cost savings from
     purchasing the compressor unit internally and the contribution margin lost from the 6,400 units
     that the compressor division otherwise would sell to outside customers.

                       Cost savings by using compressor unit from Compressor Division:
            Outside purchase price                                                         $ 140.00 (1 mark)
            Compressor Division’s variable cost to produce (see requirement 2)                 57.00 (1 mark)
            Savings per unit                                                                 $ 83.00
            Number of units                                                                    17,400
            Total cost savings                                                             $1,444,200 (2 marks)

     Compressor Division’s loss in contribution from loss of sales to outsiders
     (See requirement 2): $128 × 6,400                                                      819,200 (2 marks)
     Increase in net profit before taxes for National Industries                           $625,000

                                                                                  (Total: 6 marks)
D.   As the answers to requirements (2) and (3) show, $100 is not a goal-congruent transfer price (1
     mark). Although a transfer is in the best interests of National Industries as a whole (2 marks), a
     transfer of $100 will not be perceived by the Compressor Division’s Management as in that
     division’s best interests (2 marks).

                                                                                  (Total: 5 marks)

Sample Questions for AMA Final Exam

Question Three

A.    i.     Residual Income.

             Asia-Pacific = 300,000 - (2,500,000 x 0.1) = 50,000

             Europe = 100,000 - (500,000 x 0.1) = 50,000

      ii     ROI based on net profit

             AP = 250,000 ÷ 2,500,000 = 10%
             Europe = 80,000 ÷ 500,000 = 16%

      iii.   ROI based on divisional profit

             AP = 300,000 ÷ 2,500,000 = 12%

             Europe = 100,000 ÷ 500,000 = 20%

                                                                    (Total: 6 marks)

B.    The ROIs indicate that Europe is the better performing division (1 mark).
      However, we are told in the question that Europe has older plant (1/2 mark)
      than Asia-Pacific, which has recently modernised its production lines (1/2
      mark). This difference in the age of the plant is likely to mean that the ROI of
      Europe is higher due, at least in part, to the fact that the plant has been
      substantially written down (1 mark). Some common base is required for
      comparison basis (eg unadjusted historical cost) (1/2 mark).

      We are told that ROI is used as a basis for evaluating performance. We can see
      that, whichever measure of ROI is used, the two divisions meet the minimum
      returns required (1/2 mark). If ROI is being used to assess managerial
      performance, then the divisional profit rather than net profit figure should be
      used in the calculation (1 mark). This is because the net profit figure is
      calculated after non-controllable central overheads have been deducted (2

      The business should consider the use of RI as another measure of divisional
      performance. This measure reveals the same level of performance for the
      current year from each division (1 mark).

                                                                    (Total: 8 marks)

Sample Questions for AMA Final Exam

Question Four

A.       i. The positive and negative motivational implications arising from employing
         a negotiated transfer price system for goods exchanged between divisions
         include the following:

         • Both the buying and selling divisions have participated in the negotiations
            and are likely to believe they have agreed on the best deal possible. (1
         • Negotiating and determining transfer prices will enhance the
            autonomy/independence of the divisions. (1 mark)

         • The result of a negotiated transfer price between divisions may not be
            optimal for the firm as a whole and therefore will not be goal congruent. (1
         • The negotiating process may cause harsh feelings and conflicts between
            divisions. (1 mark)

           ii. The motivational problems which can arise from using actual full
         (absorption) manufacturing costs as a transfer price include the following.

         •   Full-cost transfer pricing is not suitable for a decentralized structure where
             the autonomous divisions are measured on profitability as the selling unit
             is unable to realize a profit. (2 marks)
         • This method can lead to decisions that are not goal congruent if the buying
             unit decides to buy outside at a price less than the full-cost of the selling
             unit. If the selling unit is not operating at full capacity, it should reduce
             the transfer price to the market price if this would allow the recovery of
             variable costs plus a portion of the fixed costs. This price reduction would
             optimize overall company performance. (2 marks)
B.       The motivational problems that could arise if Lynsar Corporation decides to
         change its transfer pricing policy to one that would apply uniformly to all
         divisions include the following:

     •   A change in policy may be interpreted by the divisional managers as an
         attempt to decrease their freedom to make decisions and reduce their
         autonomy. This perception could lead to reduced motivation. (2 marks)
     •   If managers lose control of transfer prices and thus, some control over
         profitability, they will be unwilling to accept the change to uniform prices. (2
     •   Selling divisions will be motivated to sell outside if the transfer price is lower
         than market as this behavior is likely to increase profitability and bonuses. (3

Sample Questions for AMA Final Exam

C. The likely behavior of both buying and selling divisional managers, for each of the
   following transfer pricing methods being considered by Lynsar Corporation,
   include the following:

       a. Standard full manufacturing costs plus a markup.

   •     The selling divisions will be motivated to control costs because any costs over
         standard cannot be passed on to the buying division and will reduce the profit
         of the selling division. (2 marks)
   •     The buying divisions may be pleased with this transfer price. However, if the
         market price is lower and the buying divisions are forced to take the transfer
         price, the managers of the buying divisions will be unhappy. (2 marks)
       b. Market selling price of the product being transferred.

   •   Creates a fair and equal chance for the buying and selling divisions to make
       the most profit they can and should promote cost control, motivate divisional
       management, and optimize overall company performance. Since both parties
       are aware of the market price, there will be no distrust between the parties, and
       both should be willing to enter into the transaction. (2 marks)
    c. Outlay (out-of-pocket) costs incurred to the point of transfer plus opportunity
   cost per unit.

   •     This method is the same as market price when there is an established market
         price and the seller is at full capacity. At any level below full capacity, the
         transfer price is the outlay cost only (as there is no opportunity cost) which
         would approximate the variable costs of the good being transferred. (2 marks)

   •     Both buyers and sellers should be willing to transfer under this method
         because the price is the best either party should be able to realize for the
         product under the circumstances. This method should promote overall goal
         congruence between managers and the firm, motivate managers, and optimize
         overall company profits. (2 marks)
                                                                  (Total: 25 marks)