Performance Management · November 2024

a) Kayode Limited Budgeted contribution last month Budgeted Selling price/kg = ₦368 - ₦18 = ₦350 Budgeted VC/kg = ₦19,000/95kg = ₦200 Budgeted contribution/kg ₦150 Budgeted sales quantity = 19,000kg/0.95* = 20,000kg Total budgeted contribution = 20,000 kg × ₦150 = ₦3,000,000 (* Actual sales were 95% of budget) Actual contribution last month ₦000 Actual sales = 19,000 kg × ₦368 = 6,992 Total variable cost = 4,105 Actual contribution 2,887 Materials Price Variance (MPV) Std price Actual Price Actual Qty Variance (₦000) A ₦160 ₦165 9,800 49 (A) B ₦180 ₦175 6,800 34 (F) C ₦280 ₦295 4,400 66 (A) Total MPV 81 (A) Material Mix Variance (MMV) Actual Qty in Std Mix (5:3:2) Actual Qty in actual mix Std Price/Kg ₦ Variance

(a) (b) (c) (a-b) × (c) Kg Kg ₦ ₦000 A 10,500 9,800 160 112 (F) B 6,300 6,800 180 90 (A) C 4,200 4,400 280 56 (A) Total 21,000 21,000 34 (A) Material Yield Variance (MYV) Std material cost per kg of output = ₦19,000/95 kg = ₦200 Actual Yield = 19,000kg of output Std Yield = 21,000 kg × 95/100 = 19,950kg of output MYV = (Actual Yield – Std Yield) × Std RM Cost/kg of output = (19,000 – 19,950) × ₦200 = ₦190,000 (A) 76 OR: Alternative Calculation of MYV Standard quantity in standard mix: A 19,000 × 50/95 = 10,000 kg B 19,000 × 30/95 = 6,000 kg C 19,000 × 20/95 = 4,000 kg 20,000 kg Std Q Ty In Std mix Actual Qty in Std mix Yield Variance

(a) (b) (c) (d) = (a-b) × (c) Kg Kg ₦ ₦190,000 (A) A 10,000 10,500 160 80 (A) B 6,000 6,300 180 54 (A) C 4,000 4,200 280 56 (A) Total 20,000 21,000 190 (A) Sales Price Variance (SPV) Actual Price – Budgeted Price x Actual Qty = (₦368 – 350)(19,000) = ₦342,000 (F) Market Size Variance (MZV) MZV = Budgeted contribution per unit = %)25( ⎛ │⎝000,19 %30- 000,20 %25⎞ │⎠Market Share Variance (MSV) MSV = Budgeted market share % × Actual Budgeted industry sales − industry sales in units in units × X (₦150) = 625,000 (A) Actual 𝐴𝑐𝑡𝑢𝑎𝑙 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 Budgeted Industry sales × ð‘šð‘Žð‘Ÿð‘˜ð‘’ð‘¡ − 𝑚𝑎𝑟𝑘𝑒𝑡 × contribution in units 𝑠ℎ𝑎𝑟𝑒 % 𝑠ℎ𝑎𝑟𝑒% per unit In units = 000,19 %30× %)25%30( - X ₦150 = 475,000 (F) 77 Std Price per kg Reconciliation of contribution ₦’000 ₦’000 Budgeted Contribution 3,000 Material Price Variance 81(A) Material Mix Variance 34(A) Material Yield Variance 190(A) Material Usage Variance 224 (A) Sales Price Variance 342 (F) Market Size Variance 625 (A) Market Share Variance 475 (F) Sales Volume Variance 150 (A) Actual Contribution 2,887

b) The strategy seems to have centred around trying to achieve an increased share of a declining market. The evidence for this is that market share increased significantly (from budgeted 25% to actual 30%). This helped somewhat to offset the fact that the total market shrank very significantly in by 20.83% (from 80,000 units budgeted to 63,333 units actual). How was this achieved? It seems likely that the quality of the product was deliberately improved. All of the variances in relation to raw materials are unfavourable. KL may have purchased more expensive versions of the raw materials (MPV ₦81,000 (A)), combined them in ways which made use of the more expensive types B and C (MMV ₦34,000 (A)), and been more stringent in the removal of wastage in production (MYV ₦190,000 (A)). Was this financially successful? In short, yes. The combined cost of the 3 raw materials referred to above is ₦305,000. But the benefits (in terms of an increased market share and a higher selling price) were ₦342,000 (F) + ₦475,000 (F) = ₦817,000 (F). So it could be said that there was a net gain from the strategy of (₦817,000 – ₦305,000 = ₦512,000). Why then was the actual total contribution for the month below budget? Only because of the market size variance (₦625,000 (A)) which was uncontrollable by the company. If the company had not adopted the strategy that it did, then the decrease in contribution experienced would have been far worse than it actually was. 78

Examiner’s report This is a compulsory question that tests candidates’ knowledge of how to handle advanced variance analysis and reconciliation of budgeted contribution with actual contribution. The question also tests with the analysis of Product life cycle as it relates to variance accounting. Being a compulsory question, it was attempted by most candidates. The candidates recorded average performance. The pitfall is that most candidates failed to compute material mix and material yield variances. Candidates are encouraged to study the Institute’s Study Text when preparing for future examination.

Marking guide Marks Marks Marks 1a. Budgeted Contribution Actual Contribution Reconciliation of Budgeted and Actual Contribution 22 b. Evaluation of the Product life cycle in variance analysis. 8 30

SECTION B

a.i. Labour hourly rate = N13,328,000 5,400,000 = N2.468 per labour hour a.ii Overhead attributable to each of the Product AlphamBetam Blanket rate N2.468 N2.468 Labour Hours 20 25 Overhead cost per unit N49.36 N61.70 79 b.i. Computation of cost driver absorption rate S/n Activity Cost Allocated (N) Cost driver rate (N)

1. Set up cost 2,928,000 No. of set up 72,120 40.599 2. Special handling cost Cost Driver 6,000,000 0.40

3. Customer invoicing costs 2,400,000 No. of special parts 1,160,000 No. of invoices 2900 400

4. Material handling cost 2,520,000 No. of batches 2412 1044.77

5. Other overheads 4,300,000 Labour hours 5,400,000 0.80 6. 13,328,000 Computation of total activity Product No. of setup No of spare parts Labour hours Alpham 120 1,200,000 500 12 2,400,000 Betam 72000 4,800,000 2400 2400 3,000,000 Total 72120 6,000,000 2900 2412 5,400,000 b.ii. Determination of total and unit overhead allocation to the Product: S/n Particulars Alpham Betam N N 1. Set up cost 120 x N40.599 7200 x N40.599 No. of No. of invoice Batches 4,872.00 2,923,128.00

2. Special Part handling costs: 1,200,000 x N0.40 4,800,000 x N0.40 480,000.00 1,920,000.00

3. Customer invoicing costs: 500 x N400 2400 x N400 . 200,000.00 960,000.00

4. Material handling costs: 12 x N1044.77 2400 x N1044.77 12,537.00 2,507,463.00

5. Other overhead: 2,400,000 x N0.80 3,000,000 x N0.80 1,920,000.00 2,400,000.00 Total Overhead 2,617,409.00 10,710,591.00 Units Produced 120,000.00 120,000.00 80 Total Activity(N) Unit overhead cost 21.81 89.255.00

c. Selling Price for each Product using Traditional Method Cost Particulars Alpham(N) Betam(N) Material cost 400.00 500.00 Labour cost 100.00 125.00 Overhead cost 49.36 61.70 Total costs 549.36 686.70 Profit 137.34 171.68 Selling Prices 686.70 858.38 d. Selling Prices for each product using ABC Method Cost Particulars Alpham(N) Betam (N) Material cost 400.00 500.00 Labour cost 100.00 125.00 Overhead cost 21.81 89.26 Total costs 521.81 714.26 Profit 130.45 178.57 Selling Prices 652.26 892.83

Examiner’s report This question tests candidates understanding of using ABC approach for overhead estimation. The candidates recorded an average performance. The pitfall noticed was the candidates’ failure to determine the cost driver rate of the activities. Candidates are advised to study the Institute’s Study Text when preparing for future examination.

Marking guide Marks Marks Marks 2a.i. Direct Labour hourly rate 1

ii. Unit overhead rate 2 3 bi. Cost driver rate 9 ii. Unit overhead rate using ABC approach 3 12 c. Computation of unit selling price 5 20 81

a. Calculate the Sales Price, Sales volume Profit, Sales mix profit and Sales quantity profit variances

(i) Sales price variance = AS - SS = AQS (ASP - SSP) For F = (220 - 200 ) 9,500 = N190,000 (F) For R = (260 - 250 ) 13,500 = N135,000 (F) For E = (320 - 300) 8,500 = N170,000 (F) Total sales price variance = N495,000 (F)

(ii) Sales volume variance: = (AQS in Standard Proportion - BQ) SSP F = (9,843.75 - 10,000) 200 = 31,250A R = (12,796.875 – 13,000) 250 = N50,781.25 (A) E = (8,859.375 - 9,000) 300 = N42,187.50 (A) Total N124,218.75 (A)

(iii) Sales mix variance: = (AQS - AQS in Standard Proportion) SSP Product Standard Proportion Actual Quantity Sales in Std Proportion F 10,000 = 0.3125 9,843.750 R 13,000 = 0.40625 12,796.875 E 9,000 = 0.28125 8,859.375 Total 32,000 31,500.000 F = (9,500 - 9,843.75) 200 = N68,750 (A) R = (13,500 - 12,796.875) 250 = N175,781.25 (F) E = (8,500 - 8,859.375) 300 = N107,812.50 (A) Product Sales mix variance Sales volume variance Sales Quantity variance F 68,750.00 (A) 31,250.00 (A) 100,000.00 (A) R 175,781.25 (F) 50,781.25 (A) 125,000.00 (F) E 107,812.50 (A) 42,187.50 (A) 150,000.00 (A) Total 781.25 (A) 124,218.75 (A) 125,000.00 (A) Standard Profit per unit Product F R E Direct Material 75 90 114 Direct labour 12 15 18 Variable overhead 6 7.50 9.0 Total variable cost 93 112.5 141 Fixed cost 6 12 16 Profit 101 125.5 143 Standard selling price 200 250 300 82

b. Monthly Budgeted Profit Budgeted Sales N F = 10,000 x 200 = 2,000,000 R = 13,000 x 250 = 3,250,000 E = 9,000 x 300 = 2,700,000 7,950,000 Budgeted/Standard Costs Variable Cost Material Unit Cost Labour Volt Total variable cost N F 75 12 6 = 93 x 10,000 = 930,000 R 90 15 7.5 = 112.5 x 13,000 = 1,462,500 E 114 18 9 = 141 x 9,000 = 1,269,200 3,661,500 4,288,500 Fixed Cost (4320000/12) 360,000 Budgeted Profit 3,928,500

c. Significance of Sales Mix Variance The sales mix is a calculation of the mix or proportion of each product or services sold in relation to the total sales volume and profitability. Sales mix variance is significant because:

(i) It affects profitability; (ii) It can be used in performance evaluation; and (iii) It is used for decision-making.

Examiner’s report The question tests candidates’ understanding of advanced variance analysis - Sales Price variance, Sales mix variances, Sales volume variances and sales quantity prices. It also tests candidates’ ability to determine budgeted contribution as well as the explanation of the implication of sales mix in variance accounting. The attempt on this question by candidates was very moderate. The candidates recorded average performance. The Pitfalls noticed were: The candidates’ inability to compute the standard mix /proportions on actual sales; and Deduction of annual fixed overhead when what was required is monthly fixed overhead. Candidates are advised to use the Institute’s Study Text intensively when preparing for future examination. 83

Marking guide Marks Marks Marks 3a.i. Sales price variance 2 ii. Sales volume variance 2 iii. Sales mix variance 3 iv. Sales quantity variance 3 10 b. Determination of monthly budgeted profit 6 c. Significance of sales mix variances in variance 4 20

Suggested Solutions on Relevant Costing principles:

(a) Revised Cost Estimate N Direct material Deluxe 30,000 Unique 80,000 Skilled 51,750 Direct labour Unskilled - Variable o/h 38,500 Printing press 300,000 Fixed production costs - Estimating costs - Public relation cost 10,000 510,250 Reasons for Resource valuation 1 Direct material – duluxe Current stock value of N50,000 is irrelevant as it is a sunk cost. As there is no other use for this material replacement is irrelevant. The scrap value of N30,000 is an opportunity cost and relevant. 2 Direct material – unique As paint unique is not in stock the purchase price is relevant. The entire N80,000 is chargeable though only 70% of the material will be used, as there is no foreseeable use of the remainder. 3 Direct labour – skilled As this is in short supply all labour costs are relevant. 150 hours @ N150 per hour = N22,500 150 hours @ N195 per hour = N29,250 N51,750 84 4 Direct labour - unskilled The weekend work results in 75 hours’ time off in lieu, this with the 120 (150 – 30) other hours worked totals 125 hours which is less than the 300 hours of idle time which are already being paid for, thus there is no incremental cost.

5. Variable overhead This is a future cost which will be incurred if the work is undertaken and therefore is relevant.

6. Painting Equipment The depreciation is a sunk cost and should be ignored. However, the use of the painting machine has an opportunity cost. If this work is undertaken, the machine is not available for hire. The opportunity cost is the contribution which would be earned from hiring: (300 hours x N1,000) = N300,000

7. Fixed production cost: As these costs are unaffected by the decision, they should be ignored.

8. Estimating Department cost – these costs are past and sunk

9. Public Relation costs – relevant

(b) Other non-monetary factors that should be taken into consideration are:

• Is there sufficient capacity to undertake the project?

• Is the customer credit worthy?

• Has the company the necessary skills and quality to execute the contract?

• Is the contract likely to lead to future contracts?

• Is these other lucrative contract for the company in future?

• Will project publicity translate to positive contribution to the company?

• Does the company have required expertise?

Examiner’s report This is a popular question which tests computation of revised cost estimate using relevant costing approach. The attempt by candidates was more than average. Performance on this questing remains average. The pitfall noticed was the inability of candidates to decipher relevant cost items that should be computed and added to the cost estimate. Candidates are advised to study the Institute’s Study Text when preparing for future examination. 85

Marking guide Marks Marks Marks 4 a. Preparation of revised cost estimate 15

b. Identify 4 non-monetary factors in accepting the Art Gallery contract 5 20

(a) The analyst has adopted the principles of economic value added (EVA). EVA is an estimate of a firm’s economic profit, or the value created in excess of the required return of the company. The idea is that value is created when the return on the firm’s economic capital employed exceeds the cost of that capital. This amount can be determined by making adjustments to GAAP accounting as presented by the analyst. Adjustments are made to the reported financial accounting profit and also to the statement of financial position, as follows:

i) Some of the revenue expenditure, such as research and development and advertising, provide future benefits over several years but financial accounting requirements often require such expenditure to be written off in the year in which they are incurred. This understates the value added during a particular period;

ii) The profits computed to meet financial accounting requirements do not take into account the cost of equity finance provided by the shareholders. The only cost of capital that is taken into account is interest on borrowed funds (i.e. the cost of debt finance). Profits should reflect the cost of both debt and equity finance; and

iii) A better measure of the managers’ ability to create value is to adjust the traditional financial statements for those expenses that are likely to provide benefits in future periods. The economic value added measure attempts to meet this requirement.

(b) The following comments relate to the treatment of specific adjustments: Research and development The expenditure of ₦2.1 million is added back because it represents an investment that will yield future benefits. Therefore, it should be capitalised and allocated to the future periods based on the benefits received in the particular period. The expenditure of ₦17.4 million is added back based on the assumption that the company is continuing to benefit from such expenditures that have previously been written off as depreciation based on the value that has been eroded during the period. 86 Advertising Advertising expenditure adds value by supporting future sales arising from increasing customer awareness and brand loyalty. Based on the same justification as research and development expenditure, advertising should be capitalised for the EVA calculation and added back to profits. The ₦10.5m added back in the statement of financial position reflects the costs incurred in building up future income. Some of this cost should be depreciated based on the value of future benefits eroded during the period. Interest and borrowings The aim is to ascertain whether value is being added for the shareholders in the sense of whether the funds invested in the business generate a return in excess of the opportunity cost of capital. To do this, a profit figure is calculated that initially does not include any charges for the cost of capital. Interest on borrowings is therefore added back to avoid the situation where the cost of capital on debt finance is included in the traditional profit calculation whereas the cost of equity capital is not. To ascertain the total source of funds invested in the business borrowings are added back to the capital base in the balance sheet. The required return (i.e. the opportunity cost of capital) of ₦17.5m on the resulting capital base is calculated and compared with the adjusted profit of ₦16.1m generated from the funds. This comparison captures the cost of both debt and equity and indicates that value added is a negative figure. Goodwill Goodwill refers to price paid for the business in excess of the current cost of net assets. Goodwill payments should therefore add value to the company. Hence the amount written off is added back to profits since it represents part of the intangible assets value of the business. The cumulative write off of ₦40.7m is added back in order to provide a more realistic value of the capital base from which a return should be generated. This is because it represents an element of the value of the business. The value of goodwill should be regularly reviewed and the amount eroded written off against profits.

Examiner’s report The question tests candidates’ understanding of economic value added (EVA) principle. The question was averagely attempted by candidates as it was not a popular question. The candidates recorded low performance. The pitfall noticed was candidates’ lack of understanding of the principles of EVA approach to performance measurement. Candidates are advised to study the Institute’s Study Text when preparing for future examination. 87

Marking guide Marks Marks Marks 5 a. Explanation of the Economic value Added principle (EVA) 5 b. Comment on the treatment of specific adjustments like R&D, Advertising, Interest, Borrowings and Goodwill 10 15

(i) Growth Stage Compared to the introduction stage likely changes are as follows: Unit selling prices These are likely to be reducing for a number of reasons:

• The product will become less unique as competitors use reverse engineering to introduce their versions of the product;

• PT may wish to discourage competitors from entering the market by lowering the price and hereby lowering the unit profitability; and

• The price needs to be lowered so that the product becomes attractive to customers in different market segments thus increasing demand to achieve growth in sales volume. Unit production costs These are likely to reduce for a number of reasons:

• Direct materials are being bought in larger quantities and therefore PT may be able to negotiate better prices from its suppliers thus causing unit material costs to reduce;

• Direct labour costs may be reducing if the product is labour intensive due to the effects of the learning and experience curves; and

• Fixed production costs are being shared by a greater number of units. 90

(ii) Maturity Stage Compared to the growth stage the likely changes are as follows: Unit selling prices These are unlikely to be reducing any longer as the product has become established in the market place. This is a time for consolidation and while there may be occasional offers to tempt customers to buy the product the selling price is likely to be fairly constant during this period. Unit production cost Direct material costs are likely to be fairly constant in this stage. They may even increase as the quantities required diminish compared to those required in the growth stage, with the consequential loss of negotiating power. Direct labour costs are unlikely to be reducing any longer as the effect of the learning and experience curves has ended. Indeed the workers may have started working on the next product so that their attention towards this product has diminished with the result that direct labour costs may increase. Overhead costs are likely to be similar to those of the end of the growth stage as optimum batch sizes have been established and are more likely to be used in this maturity stage of the product life cycle where demand is more easily predicted.

Examiner’s report The question tests candidates’ understanding of likely changes that will occur in unit selling price and unit cost of production in product life cycle situation especially during growth and maturity stages. Many candidates attempted the question, but performance was poor. The pitfalls noticed were: Candidates’ failure to read the questions to decipher the requirements; and Candidates’ failure to limit their discussion to the growth and maturity stages made them miss the points. Candidates are advised to pay special attention to the requirements of questions before attempting them. They should also use the Institute’s Study Text when preparing for future examination.

Marking guide Marks Marks Marks 7.i. Explain the changes in unit selling prices and unit production costs on growth stage of a product life cycle. 9 ii. Explain the changes in unit selling prices and unit production costs on maturity stage of a product life cycle. 6 15 91 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA