MBI 4 2006-2007. Final Examination Course Financial Management, Part Management Accounting

MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007

Financial Management.

Sub-module Management Accounting.

FINAL EXAMINATION.

Time allowed: 3 hours.

February 1st , 2007, 2.00 – 5.00 p.m.

 The examination consists of 15 mainly qualitative questions and 7 open computational problems on 15 pages. The maximum points obtainable are indicated for each problem.  This is a closed-book examination. The use of a scientific/financial calculator and an English/Dutch dictionary is allowed.  Answer the questions in the open space of the examination form. Prepare your answers on scrap paper and present your outcomes in a systematic and clear-cut way. Add core computations. The quality of the presentation is part of the assessment!  You don’t need to answer the problems in the given order: just skim the exam and make the easier first!  Passing on calculators or scrap paper is NOT allowed.  Please don’t detach the pages.

Standard solutions.

The maximum result to obtain from this examination is 70 points.

1 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Problem 1. On qualitative subjects. ( 22.5 points) Below follow 15 statements. You are asked to encircle whether you agree ( CORRECT ) or disagree ( FALSE ) with that statement, based on the materials studied. A correct indication generates ½ point. The answer has to be substantiated by an explanation of 25 words at the most, giving the reasons for that answer. A correct explanation gives one point additionally.

1. Preparing the budgeted income statement for the annual master budget is an issue of management accounting while determining the correct income statement for the annual financial published report is a matter of financial accounting.

Preparing the budget is a part of the internal reporting. The annual published report a part of reporting to external parties.

2.The financial leverage of a company as described by the debt/equity ratio doesn’t only measure the firm’s debt burden, but also influences correct the return on the firm’s equity, given an unchanged interest rate.

The so-called leverage ratio D/E also determines the ROE given the levels of the ROA and average interest rate I paid: ROE = ROA + (ROA – I )* D/E

3. When the Total Asset Turnover ratio of a firm falls, and the Return on Sales Ratio remains the same, the Return on Investment will false increase.

Because ROI = ROS * TAT , ROI will fall when TAT drops.

4. When comparing two companies with equal revenues and costs per unit, but different proportions of flexible versus capacity related costs, correct the firm with the highest level of capacity related costs has the highest break-even volume as well as the most risk.

Higher capacity related costs require more units to be sold in order to break even. However, the contribution margin per unit being higher for the latter firm, its profit variability around the break-even point is larger, and explains so the higher risk level.

5. A firm bases its regular price setting on full costs but decides on accepting or rejecting special orders using relevant costs. This is an correct example of the application of the concept of “different costs for different purposes”.

The additional costs caused by a special order may be higher or lower than the full cost attributed to the initial production. This illustrates the use of different cost concepts for basic production versus incidental orders.

2 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 6. A negative net working capital indicates that the firm could expect problems with its liquidity. correct

When short term debt is larger than the current assets, a higher short-term cash-outflow than cash-in flow from operational activities is obvious.

7. The costs of setting up machines are generally considered to be unit- related costs and the costs of engineering and maintenance will false generally be classified as customer-sustaining costs in a ABC system.

Set-up costs are generally batch-related costs and maintenance costs either batch-related or product-related.

8. Conventional product costing systems are likely to overcost high- volume products and undercost special products. Consequently the correct latter category is probably more attractive for customers and the profits of the company will dwindle.

There is a probability that customers consider the high-volume products too expensive and the special products a bargain. The emphasis of manufacturing shifts to special products that cause more attention and care, and thus higher costs than anticipated, whereas the compensating volume of simple products falls. Profits are expected to fall.

9. When the management of a company considers to replace the existing equipment with modern machinery causing lower levels of annual operating costs, they will consider the original purchase price false and the accumulated depreciation of the old equipment as relevant costs.

The original purchase price nor the accumulated depreciation of the old machine are affected by the decision to replace that machine, and so are irrelevant to that decision.

10. A firm engages in a major change of the lay-out of their production processes. The existing process lay-out will be replaced by a product lay-out. This causes storage time to fall from 6 days to 1 day only and false moving and inspection time from 3 to 2 days. The processing time remains 3 days. The total cycle time will be halved and the PCE ( processing cycle efficiency )-ratio falls as well.

The PCE rises! From 3/(6+3+3) = ¼ to 3/(1+2+3) = ½ .

11. The rework-department of a firm is currently extremely busy: because a supplier delivered components of a quality below the firm’s own standards. The number of rejected units during regular random inspections rose and also the number of defective units, sent back by false distributors and final customers increased significantly. Most of these

3 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 units can however be reworked. The accounting department classifies the cost of the rework-department all as internal failure costs.

The rework costs of the returned items are external failure costs.

12. A company belongs to the three largest competitors in a certain industry. As the products in this market are highly differentiated, the company acts as a price setter. Its short-term price decisions are based correct on opportunity costs. That means, that in a time of full capacity usage, additional orders will only be accepted when the contribution margin per unit of the most constrained resource is positive.

As the contribution margin of sacrificed production, when considering additional orders in a situation of full capacity usage, is part of the opportunity costs and have already been accounted for, any positive difference of the special order price with that cost will enhance the total profit.

13. Target costing implies, that the firm emphasizes short-term cost reduction programs in order to be able to compete at the lowest prices false possible and maintaining its overall profit margins.

The description matches the concept of Kaizen costing; when applying target costing, allowable costs are derived from the subtraction of the desired profit margin from the expected sales revenue.

14. The core element of the Human Relations theory on motivation is the assumption, that employees are mainly motivated by extrinsic false factors, of which monetary rewards is the most important. Much attention will be paid to the implementation of fair bonus systems.

The element in the description applies to the Scientific Management School. Human relations focus on labour environment, future job opportunities and a general well being experience of the employee.

15. The use of variance analysis in management control intends to find clues to the causes of possible differences between budgeted costs and actual outcomes. When lower labour quality is used, it is likely that a correct favourable labour-rate variance will be shown, but simultaneously this could be (over)compensated by unfavourable efficiency variances.

When lower labour quality is used for a certain job, it is probable that this type of labour is paid a lower hourly compensation, but also that the productivity is lower thus creating a higher number of hours spent.

4 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Problem 2. On single and multiple rate allocation. ( 7 points )

The budget of a company for 2006 showed following data:

Service departments Production departments department Engineering Quality Control Machining Assembly Support costs € 240,000 € 110,000 € 680,000 € 400,000 Direct labour costs 0 0 € 1,500,000 € 2,500,000 Direct labour hours 0 0 75,000 200,000 Machine hours 0 0 50,000 25,000

Until 2005 this company used a single plant-wide rate on direct labour hours in order to allocate all the company’s support costs as a rate per direct labour hour. a. Compute the single plant-wide rate per direct labour hour.

Money amounts and hour volumes in 1,000: ( 240 + 110 +680 + 400 ) / ( 75 + 200 ) = 5.20 per DLH (1.5 pts )

In the beginning of 2006 the company received two orders, FX 03 and RR 19. The characteristics of the orders are:

Order FX 03 RR 19 Direct materials € 800 € 450 Direct labour hours machining 60 30 Machine hours machining 40 20 Direct labour hours assembly 60 100 Machine hours assembly 20 10 Remember that the direct labour rate per hour in the machining department is € 20 and in the assembly department € 12.50 b. Determine, using the single plant-wide support cost rate from (a) the manufacturing costs of the orders FX 03 and RR 19.

FX 03 RR 19 Direct material cost 800 450 Direct labour cost machining 60*20=1200 30*20 = 600 Direct labour cost assembly 60*12.50 = 750 100*12.50 = 1250 Allocated overhead 120*5.20 = 624 130*5.20 = 676 Total manufacturing cost 3374 2976 ( 1,5 pts ) However, the cost accountant of the company is not satisfied with the results as he feels that the cost per order using a single rate don’t reflect the real cost burden properly. So he proceeds to change the accounting system in the following manner: - The support costs of the engineering department will be allocated to the production departments according to the machine hours used there. - The support costs of the quality control department will be charged to the production departments according to the direct labour hours used there.

5 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 - All support costs of the machining department will be computed per machine hour used - All support costs of the assembly department will be computed per direct labour hour used. c. Determine the machine-hour support cost rate in the machining department as well as the direct-labour hour support cost rate in the assembly department. Machining Assembly Engineering 2/3 * 240,000 = 160,000 1/3 * 240,000 = 80,000 Quality control 75/225 * 110,000 = 30,000 150/225 * 110,000 = 80,000 Departmental costs 680,000 400,000 total 870,000 560,000

Rate machining: 870,000/50,000 = 17.40 per machine hour Rate assembly 560,000 / 200,000 = 2.80 per direct labour hour

( 2 pts. ) d. Now recompute the manufacturing costs of the orders FX 03 and RR 19 according to the multiple rate system.

FX 03 RR 19 Direct material cost 800 450 Direct labour cost machining 60*20=1200 30*20 = 600 Direct labour cost assembly 60*12.50 = 750 100*12.50 = 1250 Overhead machining 40*17.40 = 696 20*17.40 = 348 Overhead assembly 60*2.80 = 168 100*2.80 = 280 Total manufacturing costs 3614 2928

( 2 pts )

6 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Problem 3. On multi-product break-even analysis. ( 6 points ).

Company B manufactures and sells two products, TT and SS, of which the following data are available for the year 2007:

products TT SS Direct material costs € 200 € 300 Direct labour costs € 400 € 150 Other flexible unit costs € 100 € 50 Sales price per unit € 900 € 600

TT and SS will be sold in a proportion of 1 unit TT against 2 units SS. The total capacity- related costs of company B for the year 2007 is estimated to be € 800,000. a. Determine the break-even sales volume in units ( SS and TT added together ) of this company for the year 2007.

Contribution margin per package: 1 * (900 – 700) + 2 * (600-500) = 400 Break-even volume in packages: 800,000 / 400 = 2,000 Break-even volume in units: 2,000 * 3 = 6,000 ( there are more ways to solve this question! ) ( 3 pts.) b. Determine the net income of this company when the expected sales of 2007 are 7,500 units of TT and SS together. number of packages sold: 7,500 / 3 = 2,500 net income: 2,500 * 400 – 800,000 = 200,000 ( 2 pts. ) c. Draw below a break-even graph showing the total revenue and the total costs for 2007.

0 6,000 7,500 units sold

( 1 pt. ) Indicate on the x-axis the number of units sold, as well as the break-even volume.

7 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Problem 4. On the allocation of service departmental costs. ( 6 points )

The following table shows the budgeted monthly activity levels of two service departments, energy and maintenance, and two production departments, milling and mixing, of a company C for the year 2007.

From/to Energy Maintenance Milling Mixing Energy: Units of power 50 100 500 350 Maintenance: Maintenance hours 100 200 400 800 Labour hours 0 0 2,000 1,000 Machine hours 0 0 1,200 1,200

The monthly ( overhead ) support costs of the various departments are:

Department Amount in € Energy 40,000 Maintenance 30,000 Milling 50,000 Mixing 75,000 a. Determine the total support costs of each of the production departments, using the Direct Method for allocating the service departmental costs.

From/to Milling Mixing Energy 50/85*40,000 = 23,529 35/85*40,000 = 16,471 Maintenance 4/12*30,000 = 10,000 8/12*30,000 = 20,000 Departmental 50,000 75,000 total 83,529 111,471

( 2 pts. ) b Determine the total support costs of each of the production departments, using the Sequential Method for allocating the service departmental costs, firstly allocating the costs of the energy department.

From/to Maintenance Milling Mixing Energy 10/95*40,000=4,210 50/95*40,000=21,053 35/95*40,000=14,737 Maintenance - 34,210 40/120*34,210=11,403 80/120*34,210=22,807 Departmenta 50,000 75,000 l Total 82,456 112,544

( 2 pts. ) c. Give the service cost-allocation formulae to be used when the Reciprocal Method is applied.

K (energy) = 40,000 + 50/1000* K(energy) + 100/1500*K(maintenance) K(maintenance) = 30,000 + 100/1000*K(energy) + 200/1500*K(maintenance)

8 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 ( 2 pts. ) Problem 5. On ABC and ABM. ( 8 points ).

Company D is engaged in designing, assembling and installing kitchens. For that purpose components and apparel is bought from independent suppliers. On behalf of customers, corporate or private, the Sales and Design Department will prepare a kitchen plan and discuss that with the customer. Moreover this department is responsible for the quality control. Once an order is received, materials are bought and the Installation Department will plan for the application and assembly of the standard parts to the specifications of the order and take care for the transportation and installation.

The budgeted support costs – all being capacity-related – of the support departments are for 2007:

Sales and Design ( S&D ) € 840,000 Transport and Installation ( T&I ) € 1,020,000 Total support costs € 1,860,000

The only flexible cost categories are the direct materials ( according to the kitchen plan ) and the direct labour hours involved in assembly and installation.

The management accountant of company D recognizes three types of kitchens to be sold. The standard kitchens are generally sold to a contractor engaged in mass house construction. The customized kitchens are adapted from a limited number of basic types to the buyer’s ideas within a certain budget, and the private “dream”-kitchens are sold on a complete buyer’s specification. In the table below follow the characteristics of each of those types.

Kitchen type Standard Customized Dream Expected numbers sold in 2007 6,500 3,000 500 Number of designs developed 130 150 500 Hours spent per design 50 30 20 Batches transported and installed 275 500 500 Direct labour hours per kitchen 16 24 48

The cost per direct labour hour is estimated at € 40, including social costs and fringe benefits.

Until last year all support costs have been allocated by a single plant-wide rate per direct labour hour. a. Determine the plant-wide support cost rate per direct labour hour.

Determine total DLH: 6500*16 + 3000*24 + 500*48 = 200,000

Support cost rate per DLH: 1,860,000 / 200,000 = 9.30 ( 2 pts )

( total rate per DLH: 40 + 9.30 = 49.30 )

9 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007

b. Determine the costs per kitchen of each type – excluding materials costs – according to the method of a single support cost rate.

S: 16 * 49.30 = 788.80 C: 24 * 49.30 = 1183.20 D: 48 * 49.30 =2366.40

( 2 pts. )

The company’s accountant however is convinced, that the cost driver for sales and design costs are the design hours and the cost driver for transportation and installation should be the batch. Direct labour costs used for installation remains unit-driven. c. Determine the ABC rates for S&D and for T&I.

determine number of design hours: 130*50 + 150*30 + 500*20 = 21000

Rate per design hour: 840,000 / 21,000 = 40 per design hour

Determine number of batches: 275 + 500 + 500 = 1275

Rate per batch: 1,020,000 / 1,275 = 800 per batch

( 2 pts. ) d. Determine, using the ABC-rates computed above, the costs per type of kitchen, excluding material costs.

Kitchen type S C D Design hours per 6500/6500 = 1 4500/3000 = 1.5 10000/500 = 20 unit Batches per unit 275/6500 = 0.0423 500/3000 = 0.1666 500/500 = 1

Cost per kitchen: Design costs 1 * 40 = 40 1.5 * 40 = 60 20*40 = 800 Batch costs 0.0423* 800 = 33.85 0.1666*800 = 133.33 1*800 = 800 Direct labour costs 16*40 = 640 24*40 = 960 48*40 = 1920 Cost per kitchen 713.85 1153.33 3.520

( 2 pts )

10 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007

Problem 6. On decision calculus. ( 8 points ).

Company E specializes in mobile telephone assembly from electronic components and body- parts, provided by the customer. In 2007 90,000 labour hours will be available and the company expects to work at full capacity. One direct labour hour costs € 50. The total capacity-related costs of staff, housing, machinery and equipment are estimated to be in 2007 € 1,350,000.

To construct the electronic device requires 0.4 labour hour. To assemble this device and the hull components takes another 0.2 labour hour. Both categories of work can be performed by the people currently employed and can be done separately.

For the regular market, this company is a price taker. Contracts to construct the electronics device can currently be obtained for € 32 per unit and for a final assembly the price is € 15 per unit.

Because of long-term contracts a minimum production of each of the categories of work has to be fulfilled. However, there is a maximum production level per category as well, caused by potential undesirable reactions of competitors in this market:

Category Minimum Maximum Electronic device 75,000 150,000 Hull assembly 50,000 400,000 Expressed in units sold. a. What is the most profitable category of work, device construction or hull assembly, and why?

Type of work Device construction Hull assembly Revenue per dlh 32’0.4 = 80 15/0.2 = 75 Direct labour cost per dlh 50 50 Contribution margin per dlh 30 25

Prefer: device construction ( 2 points ) computation per hour required. b. Assuming that – within the limits mentioned above – as many orders of either type can be obtained, but that the work force can NOT be increased nor the productivity improved, what will the most profitable product mix in 2007 be? Compute that profit. product mix: hours needed minimum hull assembly 50,000 * 0.2 = 10,000 maximize device construction 150,000 * 0.4 = 60,000 remainder 90,000 – 70,000 = 20,000 for hull assembly : 20,000 / 0.2 = 100,000 units. Maximum profit mix: 150,000 hull assembly and 150,000 device construction, requiring 30,000 resp. 60,000 hours. ( 2 pts. )

11 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Profit: ( 30,000 * 25 + 60,000 * 30 ) – 1,350,000 = 1,200,000 ( 1 pt.) For special orders, this company can act as a price-setter. A customer makes inquiries about the price of a rush order to produce additionally 25,000 electronic devices. But the company has no spare capacity nor can the job be done in overtime. This order can be executed beyond the scope of the maximum production constraint mentioned above. c. What is the minimum price to be asked for this order?

Needed: 25,000 * 0.4 = 10,000 hours. Sacrifice hull assembly – the least profitable job. Opportunity cost of hours involved: 10,000*25 = 250,000 lost contribution margin Labour cost to be accounted for: 10,000*50 = 500,000 Costs to be recovered by special order 750,000

Minimum price to be required: 750,000/25,000 = 30 per unit.

( 1.5 pts. )

Company E could eventually outsource the hull assembly activity at a price of € 12 per unit. d. Is this price leading to outsourcing or not? Why should they or not?

Revenue per unit hull assembly: 15 purchase price when outsourcing: 12 Contribution margin per unit 3

The firm works at full capacity with the original optimal mix. Still there are sales opportunities of 400,000 maximum sales – 150,000 own production = 250,000 units. When outsourcing this number, the firm increases its profit with 250,000*3= 750,000

( 1.5 pts )

12 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Problem 7. On budgeting and budget control. ( 7 points )

Starting the year 2006, company F based its Master Budget on the following expectations:

Sales: 2,000,000 units of mass product Ebolite. Sales price: € 10 per unit. Direct materials consumption per unit of Ebolite: 2 kg. costing € 1 per kg. Direct labour: 0.3 hour costing € 15 per hour. Total capacity-related costs for 2006: € 3,000,000 a. Make the master budget by completing following table:

Item Amount Revenues 20,000,000 Direct materials costs 4,000,000 Direct labour costs 9,000,000 Capacity-related costs 3,000,000 EBIT 4,000,000

( 1 pt. ) At the end of 2006 however, the accounting department of this company concluded that only 1,800,000 units of product were manufactured and sold. b. Determine the flexible budget by completing the following table:

( 2 pts.)

The following actual results of 2006 were collected:

Sales in units: 1,800,000 Average sales price € 11 Materials usage: 3,700,000 kg. Average purchase price of direct materials: € 0.90 per kg. Actual labour hours worked: 525,000 hours Average costs per direct labour hour: € 16

13 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Actual capacity-related costs of 2006: € 3,110,000 c. Determine the actual EBIT by completing following table:

( 1 pt. ) d. Determine the planning variance of 2006.

3,300,000 – 4,000,000 = - 700,000 ( Unf. ) ( 1.5 pts.) e. Determine the flexible budget variance of 2006.

4,960,000 – 3,300,000 = 1,660,000 ( Fav. ) ( 1.5 pts. )

14 MBI – 4 2006-2007. Final examination course financial management, part management accounting. 02-01-2007 Problem 8. On financial control. ( 5.5 points )

At the beginning of the year 2005 company G started a project with an investment of € 1,000,000 and a lifetime of 2 years. This investment would be depreciated straight-line to a residual value of 0. In each of the years 2005 and 2006 the EBITDA ( earnings before interest, taxes and depreciation ) has been according to expectations € 650,000. As the company enjoyed a full tax relief, the tax rate was 0. a. Determine the Return on Investment in each of the years 2005 and 2006.

2005 2006 Ebitda 650,000 650,000 depreciation 500,000 500,000 Ebit 150,000 150,000 Investment per 01-01 1,000,000 500,000 ROI 150/1000000 = 15 % 150/500000 = 30 %

( 2 pts. )

The required rate of return ( in this case the firm’s cost of capital ) is 10 % per year. b. Determine the EVA ( Economic Value Added ) in each of the years 2005 and 2006.

2005: 150,000 – 0.1 * 1,000,000 = 50,000 2006: 150,000 – 0.1 * 500,000 = 100,000

( 2 pts. ) c. The EBITDA can be considered the project’s annual cash flow. Could you establish a relationship between EVA and the original Net Present Value that has been computed on acceptance of this project? Use as Present Value Factors 0.9091 for 2005 and 0.8264 for 2006 if necessary.

PV of EVA: 50*0.9091 + 100 * 0.8264 = 128.1 rounded NPV 650 * 0.9091 + 650 * 0.8264 – 1,000 = 128.1 rounded PV of EVA = NPV !

( 1.5 pts ) end of examination