Performance Management · May 2022

(a) i) Contribution and profit of product/company Product 1 Product 2 Product 3 Company Sales (N) 3,375,000 4,888,000 1,900,000 10,163,000 VC 1,755,000 2,256,000 950,000 4,961,000 Contribution 1,620,000 2,632,000 950,000 5,202,000 Less Fixed Cost: Attributable 275,000 337,000 296,000 908,000 General 553,921 802,242 311,837 1,668,000 Total Fixed Cost 828,921 1,139,242 607,837 2,576,000 Net Profit 791,079 1,492,758 342,163 2,626,000

ii) Budget profit if product 3 is discontinued with no effect on other products sales Product 1 Product 2 Product 3 Company Sales (N) 3,375,000 4,888,000 - 8,263,000 VC 1,755,000 2,256,000 - 4,011,000 Contribution 1,620,000 2,632,000 - 4,252,000 Less Fixed Cost: Attributable 275,000 337,000 - 612,000 General 681,290 986,710 - 1,668,000 Total Fixed Cost 956,290 1,323,710 - 2,280,700 Net Profit 663,710 1,308,290 - 1,972,000

iii) Extra sales to cover advertising cost of N80,000 1 2 3 Company Old contribution 1,620,000 2,632,000 950,000 5,202,000 Additional Contr. 26,567 38,477 14,956 80,000 Total Contribution 1,646,567 2,670,477 964,956 5,282,000 Contribution/unit 7.20 7.00 5.00 New units sold 228,690 381,497 192,991 Old unit sold 225,000 376,000 190,000 Extra units sold 3,690 units 5,497 units 2,991units Selling price (N) 15 13 10 Sale value (N) 55,350 71,461 29,910 156,721 75

(b) i) Computation of minimum selling price using a relevant costing approach Particular Workings Amount Reasons Direct material: Steel Brass Fittings 55 x N40 N2,200 N800 Future cash flow Future cash flow Direct labour: Skilled Semi-skilled 100 x 1,50 x N80 N12,000 - Incremental cash flow No incremental costs Overhead 40 x N7.50 N300 Only power cost is relevant Estimating cost - Sunk cost Administrative overhead - No incremental cost Relevant cost of order N15,300

ii) Factors that need to be considered in making this quotation

- Time period of repeated order, number (frequency of repeat order) and the demand - Cash flow from alternative use of the capacity - Existence of complaints - Price to be quoted by competitors - If there will be need for hiring special equipment - The ability to deliver as at when required to the customer

c. i) Incremental Cost Incremental cost is an additional cost that will occur if a particular decision is taken. Provided this additional cost will result in a cash flow, it is a relevant cost.

ii) Differential Cost It is the amount by which future costs will be different depending on which cause of action is taken. It is thus an amount by which future cost will be higher or lower, if a particular course of action is chosen. It is a relevant cost if it involves additional cash flow.

iii) Committed Cost It is a category of unavoidable costs. It is thus a cost that a company has already committed to or an obligation already made, that it cannot avoid by any means.

iv) Sunk Cost A sunk cost is a cost that has already been committed by an earlier decision. They are not relevant cost in decision making.

v) Opportunity Cost An opportunity cost is a benefit that will be lost by taking one course of action instead of the next most profitable course of action. It is not an actual cost in 76 the real sense of an amount paid out as an expense. It is a comparative cost resulting from making once choice over another.

Examiner’s report The question tests students' understanding of Marginal Cost for Decision Making. Majority of the students attempted the question being a compulsory question. The performance was average. The major pitfall was the inability of students to identify relevant cost and compute extra sales in units to cover additional cost of advertising. Candidates are advised to read ICAN study text when preparing for the future examination of the Institute.

Marking guide Marks Marks a (i) 25 ticks at 1/5 mark 5 (ii) 20 ticks at ¼ mark 5 (iii) 20 ticks at ¼ mark 5 15 b (i) 8 ticks at ½ mark 4 Any 4 correct reasons at ½ mark 2 (ii) Any 4 ticks at 1 mark 4 10 c 5 points at 1 mark 5 Total 20

MEGA LABORATORIES PLC

(a) CASH BUDGET FOR QUARTER ENDING 30TH JUNE 2021 Cash inflow N Collection from customers 2,084,033 Total cash inflow (A) 2,084,033 Cash Outflow Payment to suppliers 398,833 Other expenses 200,000 Labour cost 236,400 Total cash outflow (B) 835,233 Net cashflow (A-B) 1,248,800 Opening Cash balance - Closing cash balance 1,248,800 77

(b) Income statement for Quarter Ending 30 June 2021 N N 2,375,000 Sales Cost of sales: Opening inventory (20,300 x 62) 1,258,600 Production (19,700 x 62) 1,221,400 2,480,000 Closing inventory (15,000 x 62) (930,000) (1,550,000) Gross Profit 825,000 Other expenses 200,000 Depreciation 55,000 (255,000) Net profit 570,000

c. Benefits of Cash Budget

(i) It can help to regulate expenses.

(ii) It will clearly show a business has more cash than expected (surplus) or less cost than expected (deficit).

(iii) it is useful in liquidity management and planning.

d. Principal budget factor is the resource or activity which is limited and which forms the base for the preparation of the budgets. Sales are often regarded as a major budget factor to be considered in preparing company budget since all company operation take bearing from what level of revenue that will be expended in the operation. Thus, this factor is known as the principal budget factor or limiting factor. In the majority of organisations, this factor is sales demand or revenue expectation although it can also be shortage of materials or inadequate plant capacity.

Examiner’s report The question examines candidates on Cash Budget. It was attempted by the majority of the candidates. The performance was average. The main pitfall was the inability to compute correct purchase cost of raw materials used. Candidates are encouraged to read the Institute's text when preparing for the examination of the Institute. 78

Marking guide Marks Marks a 8 ticks at 1 mark 8 b 10 ticks at ½ mark 5 c Any 2 points at ½ mark 3 16 d Definition 2 Explanation 2 4 Total 20

a. i. Average Rate of Return (ARR) Average Profit = (2019 Profit before interest/tax + 2020 Profit before interest Tax)/2 Average Capital Employed = (Beginning Capital employed + Closing capital employed)/2 ARR = Average profit before interest and tax Average capital employed Net Profit 2019 2020 Profit N70 million N80million Net capital employed N500 million N545million ARR = (70 + 80)/2 = 75 x 100 (500 + 545)/2 522.52 1 ARR = 14.354%

ii. Computation of Economic Value Added (EVA) Computing 2020 Net operating Profit after tax (NOPAT) N’million Profit after Tax 48.00 Add (1) Finance change (1- 0.25) x 14 10.50 (2) Non cash items 3.00 (3) Deprecation 28.00 (4) Provision for doubtful debts 1,20 (5) Deferred Tax 2.00 (6) Research/Development - 34.20 92.70 less (1) Economic depreciation 50.50 (2) Research/development 1.00 51.50 Adjusted NOPAT 41.20 79 Computation of opening Capital Employed for 2020: N’million 2019 capital employed (N540million – N40million) 500.00 Add: 1 Non-capitalised lease assets - 18.00 2 Non cash item - 3.00 3 Provision for doubtful debt - 1.30 522.30 Computation of Weighted average cost of capital (WACC) = (0.18 x 0.60) + (0.06 x (1-0.25) x 0.4 = 10.80 + 1.80 = 12.60% Computation of EVA Adjusted NOPAT = 41.20 Less capital charge = (0.126 x 522.30) = (65.81) Negative EVA = (24.61)

b. The business is not creating adequate values for the owners Net Present Value (NPV) of Investment Year Cashflow Dcf@ 12.6% PV 0 (3,000,000) 1.000 (3,000,000) 1 850,000 0.8881 754,885 2 850,000 0.7887 670,395 3 850,000 0.7000 595,000 4 850,000 0.6221 528,785 5 850,000 0.5525 469,625 6 500,000 0.5525 276,250 The project is profitable since the NPV is positive Alternative Solution Year Cashflow Dcf@12.6% PV N N 0 (3,000,000) 1.0000 (3,000,000) 1-5 850,000 3.5518 3,019,030 5 500,000 0.5525 276,250 295,280 The project is profitable since the NPV is positive 80

Examiner’s report The question tests students' understanding of Performance Evaluation and Capital Budgeting. Few students attempted the question and the performance was poor. Majority that attempted the questions could not identify the variables to use to arrive at Net Operating Profit After Tax (NOPAT). Candidates are advised to read the study text for future examination of the Institute.

Marking guide Marks Marks

(a) (i) 8 ticks at ½ mark 4

(ii) 27 ticks at 1/3 mark 9 13 (b) 14 ticks at ½ mark 7 Total 20

a) Large-scale service organisations have a number of features that have been identified as being necessary to derive significant benefits from the introduction of ABC: i) They operate in a highly competitive environment; ii) They incur a large proportion of indirect costs; iii) Products and customers differ significantly in terms of consuming overhead resources; iv) They market many different products and services. v) Their activities are not based on volume such as direct labour hours; vi) Their overhead costs are driven by specific activities

b) The following may create problems for the application of ABC:

i) Facility sustaining costs (such as property rents etc.) represent a significant proportion of total costs and may only be avoidable if the organisation ceases business. It may be impossible to establish appropriate cost drivers; ii) It is often difficult to define products where they are of an intangible nature. Cost objects can therefore be difficult to specify; iii) Many service organisations have not previously had a costing system and much of the information required to set up an ABC system will be non-existent. Therefore introducing ABC is likely to be expensive; iv) The choice of both activities and cost drivers might be inappropriate;

v) The benefits from ABC might not justify the costs. In some cases, it does not provide different information from traditional absorption costing. 81

c) The uses for ABC information for service industries are similar to those for manufacturing organisations: i) It leads to more accurate product costs as a basis for pricing decisions when cost-plus pricing methods are used; ii) It results in more accurate product and customer profitability analysis statements that provide a more appropriate basis for decision-making; iii) ABC attaches costs to activities and identifies the cost drivers that cause the costs. Thus ABC provides a better understanding of what causes costs and highlights ways of performing activities more effectively by reducing cost driver transactions. Costs are managed more effectively in the long term. iv) It enables resources and other related costs to be more accurately attributed to the services which they use. v) It provides understanding into the fastest growing and least visible element of cost-overhead. vi) It encourages continuous improvement and total quality control because control and planning are directed at the process level and it links the corporate strategy to operational decision making. vii) It eliminates waste by providing visibility of non-value added activities.

d) The following aspects would be of most interest to a regulator:

i) The costing method used (e.g. marginal, traditional full cost or ABC). This is of particular importance to verify whether or not reasonable prices are being set and that the organisation is not taking advantage of its monopolistic situation. Costing information is also necessary to ascertain whether joint costs are fairly allocated so that cross-subsidisation from one service to another does not apply; ii) Consistency in costing methods from period to period so that changes in costing methods are not used to distort pricing and profitability analysis; iii) In many situations a regulator may be interested in the ROI of the different services in order to ensure that excessive returns are not being obtained. A regulator will therefore be interested in the methods and depreciation policy used to value assets and how the costs of assets that are common to several services (e.g. corporate headquarters) are allocated. The methods used will influence the ROI of the different services. 82

Examiner’s report The question examines candidates on the application of Activity Based Costing (ABC) in service organisations. Majority of the students attempted the question. The performance was above average. Candidates are encouraged to read ICAN text when preparing for future examinations of the Institute.

Marking guide Marks Marks a Any 5 points at 1mark 5 b Any 5 points at 1mark 5 c Any 5 points at 1mark 5 d Any 5 points at 1mark 5 Total 20

a) When dealing with multi-products, the breakeven point in units is given by: BEP (Units) = FCWC ,where WC = Weighted Contribution per unit and FC = Total fixed costs The WC is calculated using units sold and not sales revenue. The budgeted sales in units are: Units Ratio Product A: ₦8,400,000 ÷ ₦120 = 70,000 1 B: ₦25,200,000 ÷ ₦180 = 140,000 2 210,000 3 This weighted contribution per unit is computed as follows: A B N N Selling price 120 180 Less variable costs 64 76 Contribution per unit 56 104 Weight 1/3 2/3 WC/unit = 563 + 104 × 2 3 = 88 83 Fixed costs: N Production overheads 2,240,000 Selling and adm. overheads 8,320,000 Total fixed costs (FC) 10,560,000 BEP (units) = WC FC= 10,560,000 88 = 120,000 units,made up of: Product A 1/3 × 120,000 = 40,000 units B 2/3 × 120,000 = 80,000 units Alternative Method There are other methods of generating the above results. For example, we can first compute the BEP in naira value as detailed below. 𝐵EP (₦) = WCMR FC The weighted contribution margin ratio (WCMR = weighted contribution margin ratio) (WCMR) must be based on sales revenue as detailed below: Product A 8,400/33,600 = 0.25 B 25,200/33,600 = 0.75 WCMR = ( 120 56 × 0.25) + (104 180 × 0.75) = 0.55 BEP (₦) = ₦10,560,000 0.55 = ₦19,200,000 This made up as follows: Product Weight Sales (₦) Price Qty A 0.25 4,800,000 ₦120 40,000 B 0.75 14,400,000 ₦180 80,000

b) We first determine the revised weighted contribution margin ratio (WCMR) A B Direct materials* ₦28.80 ₦28.80 Direct labour 17.60 26.40 Variable overheads 16.00 16.00 Total variable costs per unit 62.40 71.20 Selling price 120.00 160.00 Contribution per unit 57.60 88.80 CMR 0.48 0.555 84 WCMR = (0.2 × 0.48) + (0.8 × 0.555)= 0.54 * The direct material cost per unit is computed as follows: Product A ₦2,240,000 70,000 × 90% = ₦28.80 B ₦5,040,000 140,000 × 80% = ₦28.80 The revised fixed costs = N10,560,000 + 456,000 = ₦11,016,000 Profit after tax, as a percentage of revenue = 12% × (1 – 0.40) = 20% Let ₦x = the required revenue. Profit after tax = 20% of x = N0.20x Using: Sales (₦) = Total fixed cost+ Profit WCMR ,or x = 11,016,000+0.20x 0.54 0.54 x = 11,016,000 + 0.20x 0.34x = 11,016,000 x = N32,400,000 Product A = 20% of ₦32,400,000 = ₦6,480,000 B = 80% of ₦32,400,000 = ₦25,920,000

c) Total sales ₦33,600,000 Ratio of revenue 20% 80% Value N6,720,000 N26,880,000 Selling price N120 N160 Quantity 56,000 168,000 Ratio based on units 0.25 0.75 Contribution per unit N57.60 N88.80 WC/Unit = (₦57.60 × 0.25) + (₦88.80 × 0.75) = ₦81 BEP (units) = FCWC = ₦11,016,000 ₦81 = 136,000 units Product A: 0.25 × 136,000 = 34,000 units B: 0.75 × 136,000 = 102,000 units Total = 136,000 units 85 Alternative Method BEP (₦) = ₦11,016,000 0.54 = ₦20,400,000 Product A Product B Ratio – Value weighted 20% 80% Value ₦4,080,000 ₦16,320,000 Selling price ₦120 ₦160 Quantity 34,000 102,000

Examiner’s report The question tests the candidates’ understanding of Cost-Volume-Profit-Analysis. Majority attempted the questions and the performance was below average. The major pitfall was the inability to compute combined contribution margin. Students are advised to read the Institute's text when preparing for the Institute's examination in future.

Marking guide Marks Marks a 18 ticks at 1/3 mark 6 b 20 ticks at 1/4 mark 5 c 8 ticks at 1/2 mark 4 Total 15

Flexible Budget for 3 months Particulars 80,000 100,000 120,000 140,000 160,000 ’000 ’000 ’000 ’000 ’000 Variable Costs: Direct materials 3,200 4,000 4,800 5,600 6,400 Indirect materials 320 400 480 560 640 Direct labour 2,000 2,500 3,000 3,500 4,000 Power 240 300 360 420 480 Repairs 400 500 600 700 800 Total (A) 6,160 7,700 9,240 10,780 12,320 86 Fixed Costs: Indirect material 160 160 160 160 160 Power 480 480 480 480 480 Repairs 400 400 400 400 400 Supervision 800 800 1,440 1,400 1,440 Rent, rates & Insurance 360 360 360 360 360 Total fixed costs (B) 2,200 2,200 2,840 2,840 2,840 Production Cost (A+B) 8,360 9,900 12,080 13,620 15,160 Working Particulars 80,000 100,000 120,000 140,000 160,000 Cost analysis N’000 N’000 N’000 N’000 N’000 Direct material 3,200 4,000 4,800 5,600 6,400 Variable cost Indirect material 480 800 Semi-variable cost Direct Labour 2,000 2,500 3,000 3,500 4,000 Variable cost Power 720 960 Semi-variable cost Repairs 800 1,200 Semi-variable cost Supervision 800 800 1,440 1,440 1,440 Step cost Rent/insurance/ rates 360 360 360 360 360 Fixed cost Using High – Low method analysis of semi-variable costs: Indirect Material Variable cost Per unit = 800,000 – 480,000 = 320,000 160,000 – 80,000 80,000 = N4 per unit Fixed Cost = (800,000 – 640,000) = N160,000 Power variable cost per unit = N960,000 – N720,000 = 240,000 = N3 80,000 80,000 Fixed cost = 960,000 – (3 x 160,000) = N480,000 Supervision (variable cost) = 1,440,000 – 800,000 = 640,000 = N8 80,000 80,000 Fixed cost = 1,440,000 – 8 (160,000) 1,440,000 – 1.280,000 = N160,000 Repair Variable cost = 1,200,000 – 800,000 = 400,000 = N5 80,000 80,000 Fixed cost = N1,200,000 – 5 x (160,000) = N400,000 87

b. i. Budget report from July to Sept 2021 at 100,000 units showing variances: S/N Particulars Variable Fixed Total Actual Cost Cost Cost Cost Variance N’000 N’000 N’000 N’000 N’000 1. Direct material 4,000 - 4,000 4,150 150 A 2. Indirect material 400 160 560 580 20 A 3. Direct labour 2,500 - 2,500 2,700 200 A 4. Power 300 480 780 760 20 F 5. Repairs 500 400 900 885 15 F 6. Supervision - 800 800 850 50 A 7. Rent, Insurance/Rates - 360 360 320 40 F Where A = Adverse variance and F = favourable variance iii.Further investigations on the variances and measures/actions needed to be taken by director. S/N Variance Variance amount Investigations and measures to be taken on the variances 1 Direct material cost variance N150,000A There exists a N150,000 adverse variance which could be as a result of price and usage of materials. High actual direct material price, wastage, poor quality of materials, and loss in production. Management is expected to conduct price and market survey, ensure high quality low priced materials are procured and used, handling of materials to reduce wastage to be improved. 2 Indirect material cost variance N20,000 A There is N20,000 adverse variance for indirect material which could be as a result of price and usage of such materials, wastage, poor quality of such materials Management is expected to conduct price and market survey, ensure high quality low priced materials are procured and used, handling of such materials to reduce wastage. 3 Direct Labour cost variance N200,000 A An adverse variance of N200,000 was observed. This could arise from direct labour rate and efficiency variances. The variance could be attributable to high labour rates, inefficient operations and excessive overtime. 88 Management can control same through appropriate labour pricing, effective job evaluation and manpower planning. 4 Power overhead cost variance N20,000F There is a favourable variance of N20,000 which could be due to decrease in power rates. There is a need for investigation to ensure appropriate and realistic figure is used for budgeting purposes in future. 5 Repairs expenses cost variance N15,000F A favourable variance of N15,000 was noticed. It may mean that maintenance programme of equipment was not only adhered to but surpassed. A favourable variance of N15,000 means that there is a need for investigation to ensure appropriate figure (realistic figures) are used for budgeting purposes in future. 6 Supervision cost variance N50,000A There is an adverse variance of N50,000 which could be due to increase in cost of supervision. There is need for investigation to ensure appropriate figure is used for budgeting purposes in future. 7 Rent, insurance and Rates cost Variances N40,000F purposes in future. There is a favourable variance of N40,000 which could be due to decrease in rates. There is a need for investigation to ensure appropriate figure is used for budgeting.

Examiner’s report The question examines candidates on Flexible Budget. Majority of the students attempted the question. The performance is above average. Candidates are advised to study the Institute's text for future Institute's examination.

Marking guide Marks Marks a 63 ticks at 1/7 mark 9 b (i) Any 6 ticks at 1/2 mark 3

(ii) Any 6 ticks at ½ mark 3 6 Total 15

a. i) Production Budget Kay Lay Unit needed for sales 23,000 10,000 Units needed to increase closing stock 275 185 Total good units needed 23,275 10,185 Normal loss: 2/98 x 23,275 475 3/97 x 10,185 315 23,750 10,500

ii) Raw Material Purchase Budget 23,750 10,500 Usage of Material Tee 2kg 3kg Material Tee needed for production, net of wastage 47,500 31,500 Normal wastage: 5/95 x 47,500 = 2,500 10/90 x31,500 3,500 Material purchase (gross) 50,000 35,000 Total raw material to be purchased is 85,000 kgs of material Tee at a price of N30 per kg gives a total purchasing budget of N2,550,000 for the period.

b. Economic Order Quantity (EOQ) EOQ = 2 DK H,𝐰here D = annual demand in units = 85,000 units K = cost per order = N30 H= holding cost per unit per unit = N30 x 17% = N5.10 EOQ = √ 2 x 85,000 N5.10 x N30 = 1,000 units

Examiner’s report The question tests candidates' understanding on preparation of Operational Budget. The major pitfall was the inability to adjust for wastages. The performance was below average. Candidates are encouraged to read the study text of the Institute for future examination.

Marking guide Marks Marks a (i) 10 ticks at ½ mark 5 (ii) 10 ticks at ½ mark 5 10 b 5 ticks at 1 mark 5 Total 15 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA