FACULTY OF MANAGEMENT SCIENCES

DEPARTMENT OF ACCOUNTING, ECONOMICS AND FINANCE

QUALIFICATION: BACHELOR OF ACCOUNTING

QUALIFICATION CODE: 07BAC LEVEL: 7

COURSE CODE: GMA711s COURSE NAME: MANAGEMENT ACCOUNTING 310

SESSION: JUNE 2016 PAPER: THEORY AND CALCULATIONS

DURATION: 3 HOURS MARKS: 100

SUPPLEMENTARY EXAMINATION MARKING SCHEME

EXAMINER(S) T. F. Mashoko, L. Wale, L. Odada and A. Makosa

MODERATOR: Z. Stellmacher

INSTRUCTIONS
MARKING SCHEME

PERMISSIBLE MATERIALS

1. Scientific calculators
2.
3.

THIS QUESTION PAPER CONSISTS OF _8_ PAGES (Including this front page)
Question 1 (20 marks)

Target costing process

Target costing involves setting a target cost by subtracting a desired profit margin from a
competitive market price. 

The process starts by determining a product specification using analysis of what customers want.
This will determine the product features that should be incorporated. 

The next stage is to set a selling price taking into account competitors' products and expected
market conditions. The desired profit margin is deducted from the selling price to arrive at the
target cost. 

If the costs are higher than target, there is a cost gap and efforts will be made to close the gap.

( = 1 mark)

(b) Benefits of adopting a target costing approach

External focus

Traditionally the approach is to use an internal focus when developing a new product by calculating
the costs and then adding a margin to decide on the selling price. Target costing makes the business
look at what competitors are offering at a much earlier stage in the development process. 

Customer focus

Customer requirements for quality, cost and time are incorporated into product and process
decisions. The value of product features to the customers must be greater than the cost of providing
them and only those features that are of value to customers are included. 

Cost control

Cost control is emphasised at the design stage so any engineering changes must happen before
production starts. This is much more effective than the traditional method of trying to control costs
too late to make a significant impact. 

Faster time to market

The early external focus enables the business to get the process right first time and avoids the need
to go back and change aspects of the design and/or production process. This then reduces the time
taken to get a product to the market. 

( = 1 mark for each fully explained)

Page 1 of 8
c)

Production overheads

Using high-low method

70 000−620 000 80 000

Variable cost per hour = = = N$20
23 000−19 000 4 000

Fixed costs = N$620 000 – (19 000*N$20) = N$240 000

Annual fixed costs = N$240 000 * 12 = 2 880 000

Absorption rate = N$2 880 000/240 000 = N$12 per hour

Expected cost per unit

N$ per unit Mark

Component 1 (N$4.10 + (2 400/4 000) 4.70 1
Component 2 (25/100 * 0.50*100/98) 0.13 1
Other material 8.10 1
Assembly labour (30/60 * 12.60 * 100/90) 7.00 1
Variable production overhead (30/60*20) 10.00 1
Fixed production overhead (30/60*12) 6.00 1
Total cost 35.93 1
Target cost (N$44*80%) -35.20 1
Cost gap 0.73 1

Question 2

a) Since the Valve Division has idle capacity, it does not have to give up any outside sales in
order to take on the Pump division’s business.  Therefore, applying the transfer pricing
formula, we get:
Transfer price = Variable costs per unit + Lost contribution per unit on outside sales

= N$16 + N$0 = N$16

However, a transfer price of N$16 represents a minimum price to cover the Valve division’s
variable costs.  The actual transfer price would undoubtedly fall somewhere between this
amount and the N$29 price that the Pump Division is currently paying for its valves. Thus,
we have a transfer price range in this case of from N$16 to N$29 per unit, depending on
negotiations between the two divisions.

b) Since the Valve Division is selling all that it can produce on the intermediate market, it would
have to give up some of these outside sales in order to take on the Pump Division’s business.
Applying the transfer pricing formula, we get:

Page 2 of 8
 Transfer price = Variable costs per unit + Lost contribution per unit on outside sales

= N$16 + N$14¹

= N$30

¹ N$30 selling price – N$16 variable costs = N$14 contribution per unit

Since the Pump Division can purchase valves from an outside supplier at only N$29 per unit,
no transfers will be made between the two divisions. 

c) Applying the transfer pricing formula, we get:

Transfer price = Variable costs per unit + Lost contribution per unit on outside sales

= N$13² + N$14

= N$27

² N$16 variable costs – N$3 variable costs avoided = N$13

In this case, we again have a transfer price range; it is between N$27 (the lower limit) and
N$29 (the Pump Division’s outside price) per unit. 

d) To produce the 20 000 special valves, the Valve division will have to give up sales of 50 000
regular valves to outside customers.  The lost contribution on the 50 000 regular valves
will be as follows:

50 000 valves x N$14 per unit = N$700 000

Spreading this lost contribution over the 20 000 special valves, we get:

N$700 000 lost contribution

20 000 special valves = N$35 per unit

Using this amount in the transfer pricing formula, we get the following transfer price per unit
on the special valves:

Transfer price = variable costs per unit + Lost contribution per unit on outside sales

= N$20 + N$35 = N$55

Page 3 of 8
 Thus, the Valve Division must charge a transfer price of N$55 per unit on the special valves
in order to be as well off as if it just continued to manufacture and sell the regular valves on
the intermediate market.  If the Valve division wishes to increase its profits, it could charge
more than N$55 per valve, but it must charge at least N$55 in order to maintain its present
level of profits. 

( = 1 mark)

Question 3

Maximin: (5 marks)

Here you assume that the worst outcome will occur for the three agreements and then you will
select the maximum out of the worst outcomes.

 The worst outcomes for the three agreements luckily occurs when customer reaction is
deemed to be “weak” i.e. when profit for Agreement A is $38 200; profit for agreement B is
$34 500 and profit for agreement C is $33 100. (2.5 marks)
 The agreement having the highest profit from these outcomes is agreement A with a profit
of $38 200. (2.5 marks)

Maximax: (5 marks)

Here you assume that the best outcome will occur for the three agreements and then you will select
the maximum out of the best outcomes.

 The best outcomes for the three agreements again luckily occurs when customer reaction is
deemed to be “strong” i.e. when profit for Agreement A is $52 600; profit for agreement B is
$44 800 and profit for agreement C is $64 700. (2.5 marks)
 The agreement having the highest profit from these outcomes is agreement C with a profit
of $64 700. (2.5 marks)

Minimax Regret: (10 marks)

Selection under this criterion follows a series of steps:

 Step 1 (5 marks): Construct a regret matrix assuming each of the customer reaction
outcomes materialize. Thus first you assume customer reaction to be “strong” and you
calculate the regret values for each agreement. Then you continue with the “moderate”
customer reaction outcome and so on.

Regret Matrix
Customer reaction Agreement A Agreement B Agreement C
Strong 12 100 19 900 0
Moderate 0 7 500 2 100
Weak 0 3 700 5 100

Page 4 of 8
  Step 2 (2.5 marks) Select the maximum regret for each agreement. This will be $12 100 for
agreement A; $19 900 for agreement B and $5 100 for agreement C. We choose the
maximum regret because we want to know the maximum wrong decision we will make.
 Step 3: (2.5 marks) Select the minimum regret out the maximum regrets identified in step 2
above. This will be $5 100 for agreement C.

Question 4

a) Measuring the sensitivity of NPV to change in input variables (15 marks)

Before we measure sensitivity, we need to calculate NPV with the given information which
will come $1 023 500. This detail of this calculation is left to save space. But some important
figures computed include sales volume equals 650 000; variable cost per unit equals
$3.0769; and cash flow equals, $4 500 000.

Initial investment: (3 marks)

For NPV to come down to zero, the initial investment has to increase by the amount of NPV
which is 1 023 500.  In terms of percentage change, this means initial investment has to
increase by 14.62 % (1 023 500/7 000 000) to bring down NPV to zero. 

Sales Volume: (3 marks)

Before we measure the sensitivity of NPV to sales volume and a couple of other variables
(such as selling price and variable cost per unit), we need to measure NPV’s sensitivity to
cash flow. Thus first we will calculate the amount of cash flow that makes NPV zero.
 NPV = PV of future CFs – Initial Investment (II)
 NPV = CF * F2,8% – II
 NPV + II = CF * F2,8%
 CF = (NPV+ II)/ F2,8%
 CF = (0+ 7 000 000)/1.783
 CF = 3 925 967.  This is the amount of cash flow that makes NPV zero. Thus cash flow has
to decline by 4 500 000-3 925 967 = 574 033 to bring down NPV to zero. This figure is
important as we use it in future calculations. In terms of percentage change, cash flow has to
decline by 12.76% (574 033/4 500 000) to bring down NPV to zero. 

Now we can calculate the sensitivity of NPV to changes in sales volume and a couple of other
variables.

Another computation of cash flow is as follows

 CF = P*Q – VC per unit*Q

 CF = Q(P-VC per unit).
 Q = CF/ (P-VC per unit)
 In this formula insert the cash flow decline figure of 574 033 computed above together with
the price and variable cost figures.
 Q = 574 033/(10-3.0769)
 Q = 82 915. This is the amount of decline in sales volume that brings down NPV to zero.

Page 5 of 8
  In terms of percentage change, sales volume has to decline by 12.76% (82 915/650 000) to
bring down NPV to zero.

Selling price: (3 marks)

From the above cash flow formula, we can derive the formula for the profit margin as follows:

 P-VC per unit = CF/Q

 P-VC per unit = 574 033/650 000 = 0.88.  This means the profit margin has to lower down
by $0.88 to make NPV zero. For the profit margin to lower down either the price has to
decrease by $0.88 or the VC per unit has to increase by $0.88, keeping the other constant.
 Thus price has decrease by 8.8% (0.88/10) to bring down NPV to zero. 

VC per unit: (3 marks)

From the above calculation we see that VC per unit has to increase by $0.88 to bring down NPV to
zero. In terms of percentage change this means, 28.6 %( 0.88/3.0769). 

Cost of capital: (3 marks)

Compute IRR and you will find that IRR will be the discount rate that make NPV zero. Since the
computation of IRR is bulky, we ignore the details and found that IRR is 18.5976%. In terms of
percentage change the cost of capital has to increase by 132% (18.5976-8)/8 to bring down NPV to
zero. 

(Allow for alternative approaches)

b) To which variable NPV is more sensitive? (5 marks)

To answer this, we produce in a form of a table the summary of what we computed earlier.

Summary
Input Variable Percentage Change
Initial investment 14.62%
Sales Volume 12.76%
Selling price 8.8%
VC per unit 28.6%
Cost of capital 132%

From the table it can be seen that NPV is more sensitive to inputs variables that have the lowest
change.  This includes selling price, sales volume and initial investment.  Especially NPV is most
sensitive to decline in selling price with an 8.8% price decline brings down NPV to zero and make
the project not viable. Thus management should closely monitor these variables. 

( = ½ mark)

Page 6 of 8
Question 5

EV

High 0.3 1000 180

E
Medium 0.5 200 60
Market -200 -24
C Low 0.2 216
+ve
0.6
Abandon 50
B

Test
A -100 D
-ve Market -600
0.4
Abandon 50 20
Test 236
Abandon 50 Don’t 50

Recommendation:

It is best to test because expected profit is N$136 000 (236 000 – 100 000)

Marking
1 mark for each branch
1 mark for expected values
1 mark for recommendation
Total = 15 marks

Alternative
Step 1
Calculate EV at point E = (1 000 * 0.3) + (200*0.5) + (-200*0.2) = 360
Step 2
Make a decision at point C, best choice is to market
Step 3
Make a decision at point D, best choice is abandon
Step 4
Now calculate EV at point B – (0.6*360) + (0.4 * 50) = 236
Step 5
Make a decision at point A:
Test = 236 – 100 = 136
Don’t test = 50
Best is to test
END OF EXAMINATION MARKING SCHEME

Page 7 of 8