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Institute of Certified Management Accountants of Sri Lanka

Professional II Stage
September 2010 Examination
Examination Date : 25th September 2010 Number of Pages : 07
Examination Time: 9.30 a:m. 12.30 p:m. Number of Questions: 06

Instructions to candidates:
1. Time allowed is three (3) hours.
2. Answer all questions in Section A, any two (2) questions from Section B and any one (1)
question from Section C
3. Answers should be entirely in the English language.

Subject Subject Code

Strategic Management Accounting (SMA / 803)

Section A
Question No: 1 (40 Marks)

The Hospital Instruments Division of MedLife Technology Corporation manufactures a variety of

electric mechanical components. The principal product of the Hospital Instruments Division is a
sophisticated instrument for measuring and graphically displaying a variety of medical phenomena,
such as heart and respiration rates. The culture throughout the division was primarily engineering-
oriented. One result of this culture was that the corporations design engineers generally designed new
products from scratch rather than relying on modification of a current design. While this approach
usually resulted in an elegant design from an engineering standpoint, it often resulted in the use of
new or unique parts that were not already being used in the corporations other products. The strategy
of the Hospital Instruments Divisions management was to position the division as a product
differentiator and price leader, not as the industrys low-cost producer. This means that the division
generally led the medical instruments market with new products that exhibited greater functionally
than competing products and that the products were priced at a premium. The corporations
competitors would then emulate a new product, produce it at a lower cost, and undercut the MedLife
Technology price. However, by then MedLife Technology had moved on to a new product with even
greater functionality. This strategy had been quite successful until the Japanese entered the medical
instruments market in a major way. MedLife Technologys new competitors were able to set product
prices approximately 25% below those of MedLife Technology, while maintaining close to the same
level of functionality. In order to compete, the Hospital Instruments Division had to lower its prices
below its reported product costs. This resulted in significant losses for the division.

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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination
To remedy the situation, the Hospital Instruments Divisions management began an extensive continuous
improvement program. The division changed its production and inventory management system to a JIT
system, ideas of total quality control were aggressively pursued and management attempted to develop an
empowered workforce. All of these efforts paid off dramatically. However, production costs were still
relatively high for the industry, and cycle times were considered too long by management. The general
feeling was that in order to remain competitive in the long run, the division would have to further lower its
production costs and shorten its production cycle times. As management contemplated the high production
costs, one problem that kept coming up was the divisions part number proliferation. As the engineering-
dominated company continued to introduce new products, the number of different parts and components
that had to be stocked in inventory continued to increase. Some members of management felt that the
divisions cost-reduction goals could be achieved, at least partially by solving the problem of part number
proliferation.

As management was pondering the divisions cost reduction goal, the controller was contemplating on the
introduction of a new cost-accounting system. The controller was thinking about introducing Activity
Based Costing (ABC) and Activity Based Management (ABM) in the Hospital Instruments Division.

You are required to:

(a) Explain how the problem of part number proliferation could increase the divisions production costs.
(04 Marks)

(b) Explain how long production cycle times could increase the divisions production costs. (03 Marks)

(c) How could an ABC system be used to help reduce costs by tackling the problem of part number
proliferation?

Hint: Allow yourself to contemplate on an entirely new role for ABC that is quite different from the
conventional objective of more accurate product costs. The following questions may help in
completing this requirement.
(i) What is the divisions strategy in the market place?
(ii) How are prices currently being determined?
(iii) Does management really need more accurate product costs, given its strategy and the reality of
market-driven prices?
(iv) What is the current goal of management?
(v) What causes, at least partly, the high production cost?
(vi) Who is, at least partially responsible for high production costs?
(vii) How could an ABC system help solve the problem and reduce production costs?
(7 3 Marks = 21 Marks)

(d) Following your answer to requirement (c), what cost drivers could be contemplated for use for
solving the problem of part number proliferation? Which cost driver would work best? Explain your
answer. (06 Marks)

(e) How could an ABC system help highlight and solve the problem of production cycle times being too
long? (06 Marks)
(Total 40 Marks)
End of Section A

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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination
Section B
Answer any two (2) questions
Question No. 2 (20 Marks)

The executive directors and the seven divisional managers of PQR Group spent a long weekend at a
country house debating the companys goals. They concluded that PQR had multiple goals, and that
performance of senior managers should be assessed in terms of all of the goals.

The goals identified were:

(i) to maintain a high market share;

(ii) to increase productivity, annually;
(iii) to offer an up-to-date product range of high quality and proven reliability;
(iv) to be known as responsible employers;
(v) to acknowledge social responsibilities;
(vi) to generate a reasonable financial return for shareholders;
(vii) to grow and survive independently.

The finance director was asked to prepare a follow-up paper, setting out the implications of the above
goals. He has asked you, to prepare comments on important issues, for his consideration, as required
below:
You are required to set out briefly, with reasons:

(a) Suitable measures of performance for each of the above stated goals, for which you consider this
to be possible. (14 Marks)

(b) An overall comment as to whether any of the stated goals can be considered to be sufficiently
general, to incorporate all the goals of PQR. (06 Marks)
(Total 20 Marks)

Question No. 3 (20 Marks)

L plc and M plc are subsidiaries of the same group of companies. L plc produces a branded product
sold in drums at a price of Rs.4,000/- per drum.
Direct product costs per drum are:

Raw material from M plc: at a transfer price of Rs.1,800/- for 25 litres.

Other products and services from outside the group: at a cost of Rs.600/-.
L plcs fixed costs are Rs.8,000,000/- per month. These costs include process labour whose costs will
not alter until L plcs output reaches twice its present level. A market research study has indicated that
L plcs market could increase by 80% in volume if it were to reduce its price by 20%.
M plc produces a fairly basic product which can be converted into a wide range of end products. It
sells one third of its output to L plc and the remainder to customers outside the group. M plcs
production capacity is 1000 kilolitres per month. However competition is such, it budgets to sell no
more than 750 kilolitres per month for the year ending 31st March 2011. Its variable costs are
Rs.40,000/- per kilolitre and its fixed costs are Rs.12,000,000/- per month.
The current policy of the group is to use market prices, where known, as the transfer price between its
subsidiaries. This is the basis of the transfer price between M plc and L plc.
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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination
You are required to:
(a) Calculate the monthly profit for L plc and M plc if the sales of L plc are;
(i) At their present level, and
(ii) At the higher potential level indicated by the market research, with a cut in price of 20%.
(08 Marks)
(b) (i) To explain why the use of a market price as the transfer price produces difficulties under the
conditions outlined in (a) (ii) above.
(ii) To explain briefly what factors existing and new, you would consider in arriving at a proposal
to overcome these difficulties to go for a new method or alteration of the existing market based
method. (08 Marks)

(c) To recommend, with supporting calculation, what transfer prices you would propose. (04 Marks)
(Total 20 Marks)

Question No. 4 (20 Marks)

Following a strategy of product differentiation, Westwood Company makes a high end kitchen range hood,
KE8. Westwoods data for 2008 and 2009 are given below:

2008 2009
1. UnitsofKE8produceandsold 40,000 42,000
2. Sellingprice Rs.100 Rs.110
3. Directmaterial(squarefeet) 120,000 123,000
4. Directmaterialcostpersquarefoot Rs.10 Rs.11
5. ManufacturingcapacityforKE8 50,000units 50,000units
6. Conversioncost Rs.1,000,000 Rs.1,100,000
7. Conversioncostperunitofcapacity Rs.20 Rs.22
8. Sellingandcustomerservicecapacity 30customers 29customers
9. SellingandCustomerservicecosts Rs.720,000 Rs.725,000
10. Costpercustomerofsellingandcustomer servicecapacity Rs.24,000 Rs.25,000
Westwood produced no defective units and reduced direct material usage per unit of KE8 in 2009.
Conversion costs in each year are tied to manufacturing capacity. Selling and customer service costs are
related to the number of customers that the selling and service functions are designed to support.
Westwood had 23 customers (wholesalers) in 2008 and 25 customers in 2009.

You are required to:

(a) Describe briefly the elements you would include in Westwoods balanced scorecard (BSC).
(08 Marks)
(b) Calculate growth, price-recovery and productivity components that explain the change in operating
income from 2008 to2009. (04 Marks)
(c) Suppose during 2009, the market size for high-end kitchen range hoods grew 3% in terms of number
of units and all increases in market share (that is, increases in the number of units sold greater than
3%) are due to Westwoods product-differentiation strategy, calculate how much of the change in
operating income from 2008 to 2009 is due to the industry-market-size, cost leadership, and product
differentiation. (05 Marks)
(d) How successful has Westwood been in implementing its strategy? Explain your answer. (03 Marks)
(Total 20 Marks)
End of Section B
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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination
Section C
Answer one (1) question only

Question No. 5 (20 Marks)

Summit Equipment specializes in the manufacture of medical equipment, a field that has become
increasingly competitive. Approximately two years ago, Kusal Perera, president of Summit, decided to
revise the bonus plan (based, at the time, entirely on operating income) to encourage division
managers to focus on areas that were important to customers and those that added value without
increasing costs, reduced sales returns and increased on-time deliveries.

Bonus is calculated and awarded semiannually on the following basis: A base bonus is calculated at
2% of operating income; this amount is then adjusted as follows:

a. (i)Reducebyexcessofreworkcostsoverandabove2%ofoperatingincome.
(ii)Noadjustmentifreworkcostsarelessthanorequalto2%ofoperatingincome.

b. (i)IncreasebyRs.500,000/ifmorethan98%ofdeliveriesareontime,andbyRs.200,000/if
96%to98%ofdeliveriesareontime.
(ii)Noadjustmentifontimedeliveriesarebelow96%.

c. IncreasebyRs300,000ifsalesreturnsarelessthanorequalto1.5%ofsales.

d. Decreaseby50%ofexcessofsalesreturnsover1.5%ofsales.

If the calculation of the bonus results in a negative value for a particular period, the manager simply
receives no bonus and the negative amount is not carried forward to the next period.

Result for summits Charter Division and Mesa Division for 2009, the first year under the new bonus
plan, are given below.

In 2008, under the old bonus plan, the Charter Division manager earned a bonus of Rs.2,706,000/-
and Mesa Division manager, a bonus of Rs.2,244,000/-.
CharterDivision MesaDivision
01/01/2009 01/07/2009 01/01/2009 01/07/2009
30/06/2009 31/12/2009 30/06/2009 31/12/2009
Sales(Rs.) 420,000,000 440,000,000 280,500,000 290,000,000
Operatingincome(Rs.) 46,200,000 44,000,000 34,200,000 40,600,000
Ontimedelivery 95.4% 97.3% 98.2% 94.6%
Reworkcosts(Rs.) 1,150,000 1,100,000 600,000 800,000
Salesreturns(Rs.) 8,400,000 7,000,000 4,475,000 4,250,000

You are required to explain:

(a) Why did Kusal Perera need to introduce these new performance measures? (04 Marks)

(b) Calculate the bonus earned by each manager for the six-month period above and for 2009.
(06 Marks)
(c) What effect did the change in the bonus plan have on each managers behavior? Did the new
bonus plan achieve what Kusal Perera desired? What changes, if any, would you introduce to
the new bonus plan? (10 Marks)
(Total 20 Marks)
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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination
Question No. 6 (20 Marks)

Worldwide Cell Phone (WCP) has developed a cell phone that can be used anywhere in the world.
WCP has been receiving complaints about the cell phone. For the past two years, WPC has been test
marketing the phones and gathering nonfinancial information related to actual and perceived aspects of
the cell phones quality. They expect that, given the absence of much competition in this market,
increasing the quality of the cell phone will result in higher sales and thereby higher profits.

Quality related data for 2008 and 2009 include the following:

2008 2009
Cellphonesproducedandshipped 2,000 10,000
Numberofdefectiveunitsshipped 100 400
Numberofcustomercomplaints 150 700
Unitsreworkedbeforeshipping 120 700
Manufacturingleadtime 15days 16days
Averagecustomerresponsetime 30days 28days

You are required to explain:

(a) For each year, 2008 and 2009, calculate:

(i) Percentage of defective units shipped.
(ii) Customer complaints as a percentage of units shipped.
(iii) Percentage of units reworked during production.
(iv) Manufacturing lead time as a percentage of total time from order to delivery. (08 Marks)

(b) Referring to the information computed in requirement (a), explain whether WCPs quality and
timeliness have improved. (08 Marks)

(c) Why would manufacturing lead time have increased while customer response time decreased?
(04 Marks)
(Total 20 Marks)
End of Section C

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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination
Present value table
-n
Present value of 1.00 unit of currency, that is (1 + r) where r = interest rate; n = number of periods until payment
or receipt.

Periods (n) Interest rates (r)

1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Periods (n) Interest rates (r)

11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065
16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

End of Question Paper

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Professional II Stage Strategic Management Accounting (SMA / 803) September 2010 CMA Examination