This paper is not to be removed from the Examination Halls

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1 ~~AC3097 ZB d0 This paper is not to be removed from the Examination Halls UNIVERSITY OF LONDON AC3097 ZB BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences, the Diplomas in Economics and Social Sciences and Access Route Management Accounting Monday, 18 May 2015 : 10:00 to 13:15 Candidates should answer FOUR of the following EIGHT questions: TWO from Section A, ONE from Section B and ONE further question from either section. All questions carry equal marks. Workings should be submitted for all questions requiring calculations. Any necessary assumptions introduced in answering a question are to be stated. 8-column accounting paper is provided at the end of this question paper. If used, it must be detached and fastened securely inside the answer book. A calculator may be used when answering questions on this paper and it must comply in all respects with the specification given with your Admission Notice. The make and type of machine must be clearly stated on the front cover of the answer book. PLEASE TURN OVER UL15/0180 Page 1 of 9

2 SECTION A Answer two questions and no more than one further question from this section. 1. EasyFlight UK, a low cost airline, has spare flight capacity. It is considering which of two alternative routes to develop in the next financial year, both leaving from the English Midlands. Option 1 is to introduce flights to the Spanish Costa del Sol. There would be 300 round trips per annum, aimed at the holiday/tourist market. Each round trip would involve four hours flying time plus a two hour turn-round at the Spanish resort. There would be a flight crew of two pilots and a cabin crew of three flight attendants. They will all be able to make a round trip each day. Option 2 is to introduce flights to Istanbul, Turkey. This would involve 300 round trips per annum, aimed at regular/business customers. Each round trip would involve ten flying hours, plus a two hour turn-round time. The aircraft can make a return flight each day but the crew cannot. Regulations require that they make the outward flight one day and the return flight the next day. Crew requirements are thus double that of the Spanish option, and involve overnight hotel costs. Market research suggests that a price of 80 per return ticket can be charged on the Costa del Sol route and 170 per return ticket on the Istanbul route. Catering costs per round trip will be 5 and 12 per passenger respectively. The aircraft are leased on the basis of a fixed annual charge of 750,000 plus 300 per flying hour. Fuel costs are 500 per flying hour plus 1 per passenger per flying hour. Air Crew costs will be 800 per day and cabin crew cost 500 per day (these are regarded as variable). Hotel costs can be negotiated in Istanbul at 400 per round trip. Landing fees are 500 per round trip in Spain and 1,000 per round trip in Istanbul. EasyFlight recognises that some of the costs can be related to each round trip operated and some fixed costs will relate to each route. Both routes would be expected to cover the fixed element of the lease of one aircraft, specific marketing costs of 150,000 for the Costa del Sol route or 400,000 for the Istanbul route, estimated administration costs for each route of 200,000 per annum and maintenance of the aircraft at 50,000 per annum. In assessing the viability of a new route, EasyFlight assumes that 90% seat occupancy can be achieved. Calculate for each route option: (a) The contribution to round trip flight costs made by each fare-paying passenger. (2 marks) (b) The total specific direct operating costs incurred by each round trip. (5 marks) (d) (e) (f) The break-even point (in terms of numbers of seats occupied and percentage occupancy) to cover only the direct operating costs for each round trip. (5 marks) Assuming 90% seat occupancy, the contribution to EasyFlight central costs per round trip after the direct route costs for each round trip have been covered. (5 marks) Also assuming 90% seat occupancy, the break-even point (in terms of numbers of round trips per annum) to cover the fixed route costs. Which of the two destinations would you recommend and why? Discuss the uncertainties involved in the evaluations and any further issues that should be considered. UL15/0180 Page 2 of 9

3 2. Ship Ahoy Ltd is a racing yacht manufacturer with a high reputation for quality. It makes standard yachts and yachts to customer specifications. A valued client, Chris Smith, has just asked Ship Ahoy Ltd to build him a new yacht within the next three weeks to be ready for an event. The work already scheduled for the next three weeks means that, there is sufficient spare capacity to make Chris Smith s yacht in all departments, except yacht building. No other new orders are expected during the next three weeks. The company s method of pricing is to: (a) (b) Add 20% to all material costs and other bought in resources. Calculate the charge out rate for each type of employee as their salary costs + 300% in order to cover a contribution to their departmental overhead and company profits (See table 2 below). All salary costs are fixed in the short-term. General administrative overhead is charged at 2,000 per yacht. This method of pricing has been used to produce Chris Smith s Yacht Estimate below: Table 1: Chris Smith s Yacht Estimate: Design and supervision salaries per hour i. 4,000 Yacht wood material 240 sq. 80 per sq. metre +20% ii. 23,040 Sail Material 200 sq. 100 per sq. metre +20% iii. 24,000 Components cost + 20% iv. 12,000 Yacht building labour per labour hour v. 12,000 Sail making & component fitting labour per hr 12,800 Material handling machine hired % vi. 120 General administration overhead 2,000 per yacht vii 2,000 Price 89,960 The following information has been ascertained relating to the above costs: (i) (ii) (iii) Four of the twenty design and supervision hours have already been used in preliminary design discussions with the client. The yacht wood material is of high quality and there is 300 sq. metres in inventory at present. Due to new environmental issues it now has a scarcity value of 110 per sq. metre. Sail material cost is based on buying it from a subsidiary company of Ship Ahoy Ltd which buys material on a Just in Time basis. The variable cost of the transaction to the subsidiary company is 60 per metre. (iv) Components which cost 2,000 and are used by all boats are already in inventory. Their replacement cost is 2,800. The rest will only be bought if the Yacht is made. (v) Due to demand for standard yachts there is no yacht building labour time available to make Chris Smith s yacht without reducing the production of standard yachts (see details in Table 3 below). (vi) Due to the size of the yacht, a special machine must be hired costing 100 to move the boat to the finishing area. (vii) The general administration overhead is considered to be 90% fixed. UL15/0180 Page 3 of 9

4 Table 2: Salary hourly charge breakdown Department Salary Departmental overhead Fixed variable Design & supervision Yacht building labour Sail making & component fitting labour Table 3: Price Quotation for standard yachts Notes Design and supervision salaries per hour 800 Yacht wood material 160 sq. 40 per sq. metre + 20% 7,680 Sail Material 120 sq. 60 per sq. metre +20% a 8,640 Components cost + 20% 6,000 Yacht building labour per hour 4,800 Sail making & component fitting labour per hour 4,000 General administration overhead 2,000 per yacht 2,000 Price 33,920 (a) The subsidiary variable cost of this material is 40 (a) (b) Calculate the full absorption cost profit on the Chris Smith s contract assuming that a price of 89,960 was charged. (6 marks) Produce an estimate for the above contract based on relevant costs, explaining your reasoning for each item which you include or exclude. (14 marks) Explain how the original estimate and the relevant cost estimate should be used in setting a price for Chris Smith s yacht and recommend a price. (5 marks) UL15/0180 Page 4 of 9

5 3. Elias Intercontinental Hotels (EIH), a major hotel group wishes to have hotels in all major cities. Edgbaston is a city where it has yet to establish a hotel. The Elias Development Director has visited Edgbaston and found a disused office block on a prominent site which can be converted into an attractive 200-room hotel in three years. The office block can be purchased for 15million. Negotiating the sale, obtaining planning consents and detailed design work costing a further 1million will occupy the first year. Installing all major services costing 5million will occupy the second year. Fitting out and furnishing the rooms and public spaces costing 2million will occupy the third year. For financial accounting purposes the value of the site will be assumed to be 3million and that of the building 12 million. The building and the subsequent design work will be depreciated on a straight line basis over 50 years. The major services will be depreciated over 20 years and the furniture and fittings will be depreciated over 10 years. The value of the site will not be depreciated. Asset depreciation will start in the first year of trading. EIH recognise that the Hotel will take time to build up to maximum usage. It expects, once trading starts to achieve 50% room occupancy in Year 1, 60% in Year 2, 70% in Year 3, 80% in Year 4 and 90% thereafter. It is projected that each occupied room will bring in 200 per night (365 days per year), this includes the room charge, meals in the restaurant, drinks in the bar, etc. The variable costs associated with this income will be 50%. Estimates of fixed operating costs (excluding depreciation) in respect of the site will be 2 million per annum. There will be additional income to be earned from hosting conferences, dinners and wedding receptions, etc. But the Development Director is unfamiliar with the local market and prefers to make her initial evaluation of the business without projecting any income from these sources. (a) (b) (d) (e) Calculate the annual depreciation charge and the projected written down value of the assets at the end of ten years of trading. For the four years of preparation and each of the first ten years of trading, calculate the net operating cash flow and the net operating profit. Calculate the approximate payback time of the proposed investment in years and months (from the start of trading). Calculate the accounting rate of return (ARR) of the hotel over its first ten years of trading. Taking the company s cost of capital at 10% per annum, calculate the net present value (NPV) after ten years of trading. To recognise the value of the hotel, you should credit the written down value of the assets calculated in (a) above in year 14 of the cash flow. UL15/0180 Page 5 of 9

6 (f) What is the significance of the figure you have calculated in (e) above? (2 marks) (g) If the figure for NPV is positive, how much more could the company pay for fixtures and fittings and obtain an NPV of zero. (3 marks) Present value of a 1 after n years at 10% Project year UL15/0180 Page 6 of 9

7 4. Playright Ltd makes cricket bats and cricket equipment sets of 6 stumps and 4 bails. The standard costs for these items are shown below: Standard cost Bat Stump set Price Variable costs Wood willow per metre Wood ash per metre 6.60 Handle binding Labour 16 per hour Variable overhead based on labour hours Total variable cost Standard contribution Budgeted fixed overhead per month 200,000 The monthly expected demand is 8,000 bats and 4,000 stumps sets. The following actual activities took place during the month of April: Sales: Total 3,131,200. 9,500 bats were sold at an average price of 304 and 3,800 stump sets were sold. Materials: Willow: 14, per metre. Ash: 6, per metre. Handle binding: 47,100 metres costing 65,940. Labour: 85,400 hours costing a total of 1,359,000. Variable overhead: 261,200: Fixed overhead: 197,000. (a) Calculate the budgeted net income and actual net income for April. (b) Calculate all possible variances for April, including the sales mix variance. (14 marks) You discover the following two factors which have occurred in April: i. On 1 st April, Playright Ltd signed a contract with Sports Ltd who agreed to buy 2,000 bats every month, including April, at a price per bat of 280. The bats for Sports Ltd use cheaper handle binding than the other bats. In April 10,200 metres of this binding was used costing 0.60 per metre. ii. During April the bat pressing machine (the final process) became faulty and production stopped. Before the fault was detected, 20 bats which were complete with respect to all material and labour were spoiled and had to be scrapped. In addition to the time required to make the scrapped bats, twelve productive labour hours were lost whilst the machine was out of action. Identify the variances partially explained by these factors, calculate the value which is explained by the factors and the unexplained part of each variance. (7 marks) UL15/0180 Page 7 of 9

8 SECTION B Answer one question and no more than one further question from this section. 5. In connection with the Annual Budgeting process, explain the following practices and describe their strengths and limitations: (a) Incremental Budgeting (b) Activity Based Budgeting Zero Based Budgeting. (25 marks) 6. A retail chain has two types of outlet: (i) (ii) A health chain with 80 stores. For this chain decisions on merchandise, buying, sales prices, promotions, inventory levels, store layouts, behaviour rules and uniforms are all decided centrally. Some stores are in central shopping malls, others in suburban areas. Some are rented and some have been purchased. Boutiques selling fashion clothes and accessories. In these outlets the manager is responsible for all aspects of buying, setting selling prices, recruitment and the layout of the store. Since all boutiques in this chain use the same name some guidelines on shop appearance and use of the logo are prescribed by head office. For performance appraisal and calculation of bonuses, the company currently uses only Return on Investment (using each store s net income and the asset values from the division s Annual Financial Statements). A new managing director wishes to review this practice and if necessary develop different performance measures for each of the two types of outlet. Discuss the advantages and problems of using Return on Investment for performance measurement and advise the managing director on the issues to be considered when choosing appropriate performance measures for each chain. Recommend, with explanations of their suitability, measures to be used for each chain. (25 marks) 7. (a) Identify and describe the information required to produce the lifecycle costing for a product to be launched in the next financial year and having a life of at least four years. Indicate who would provide the information. (10 marks) (b) Explain how the information would be used during the life of the product. (10 marks) Discuss the ways in which lifecycle costing has similarities to capital budgeting. (5 marks) UL15/0180 Page 8 of 9

9 8. Briefly describe each of the following activities and explain how each provides financial information to help management decision making. Include in your answer some of the practical limitations to be considered when using each technique. (a) Linear Programming, (9 marks) (b) Throughput margin analysis, (8 marks) Process costing. (8 marks) END OF PAPER UL15/0180 Page 9 of 9