Paper P1 Performance Operations

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March 2011 Exam

General Comments
Performance overall in March 2011 was comparable to the September 2010 diet. While the
pass rate was acceptable, it could have been significantly improved if candidates had worked
through previous examination papers. It was clear from many scripts that this basic part of
exam preparation had not been done. There were very few good scripts with the majority of
candidates achieving a marginal pass. This raises concerns about how candidates will
perform at the Management and Strategic levels of the CIMA syllabus.
The section of the paper that caused most difficulties for candidates was Section B and in
particular questions 2(a) and 2(f). Candidates are reminded that all questions on the P1 paper
are compulsory and that they therefore need to study all areas of the syllabus. Candidates
cannot rely on passing the exam based on their performance in computational questions.
It has become apparent over the last few diets that candidates are learning by rote rather than
understanding what they are calculating and why they are performing the calculation. This
was highlighted in question 2(f) where candidates could explain how to calculate a yield to
maturity on a bond, but could not explain what the yield to maturity represented and why it
may be different from the coupon rate.
Performance in Section C was similar to previous diets. Question 3 was generally well done,
but few candidates were able to achieve a pass mark in question 4. The poor performance in
question 4 could be a result of time pressure however there was no indication that this was
the case. Part (a) of the question was reasonably well done. However some fundamental
mistakes are still being made, thus providing further evidence of lack of practice using past
examination questions. The remainder of the question was not well done with candidates
showing a general lack of knowledge in these areas of the syllabus.

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Section A 20 marks
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION

Question 1.1
A documentary credit is
A

A negotiable instrument, drawn by one party on another, who by signing the document
acknowledges the debt, which may be payable immediately or at some future date.

A document issued by a bank on behalf of a customer authorising a person to draw money to a

specified amount from its branches or correspondents, usually in another country, when the
conditions set out in the document have been met.

A series of promissory notes, guaranteed by a highly rated international bank, and purchased at a
discount to face value by an exporters bank.

A form of export finance where the debt is sold to a factor, at a discount, in return for prompt
cash.
(2 marks)
The correct answer is B

Question 1.2
A company is deciding which of four potential selling prices it should charge for a new product. Market
conditions are uncertain and demand may be good, average or poor. The company has calculated the
contribution that would be earned for each of the possible outcomes and has produced a regret matrix as
follows.
Regret Matrix
Demand level

Selling price
$140

$160

$180

$200

Good

$20,000

$60,000

$0

$10,000

Average

$50,000

$0

$40,000

$20,000

Poor

$0

$30,000

$20,000

$30,000

If the company applies the minimax regret criterion to make decisions, which selling price would be
chosen?
(2 marks)
The correct answer is D
Workings
The maximum regret at a selling price of $140 is $50,000
The maximum regret at a selling price of $160 is $60,000
The maximum regret at a selling price of $180 is $40,000
The maximum regret at a selling price of $200 is $30,000
Therefore if AP wants to minimise the maximum regret it will select a selling price of $200
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The following data are given for sub-questions 1.3 and 1.4 below
A company operates a standard absorption costing system. Details of budgeted and actual
figures for February are given below:

Production (units)
Direct labour hours per unit
Direct labour cost per hour

Budget
29,000
3.0
$10.00

Actual
26,000
2.8
$10.40

Question 1.3
The labour rate variance for the period was:
A

$34,800 A

$34,800 F

$29,120 A

$31,200 A
(2 marks)

The correct answer is C

Workings
The labour rate variance is:
26,000 x 2.8 ($10.00 - $10.40) = $29,120 A

Question 1.4
The labour efficiency variance for the period was:
A

$58,000 F

$60,320 F

$52,000 F

$54,080 F
(2 marks)
The correct answer is C

Workings
The labour efficiency variance is:
(26,000 x (3.0 2.8)) x $10.00 = $52,000 F

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Question 1.5
A company is deciding whether to launch a new product. The initial investment required is $40,000. The
estimated annual cash flows and their associated probabilities are shown in the table below.
Probability
0.20
0.50
0.30

High
Medium
Low

Year 1
$20,000
$14,000
$9,000

Year 2
$24,000
$16,000
$12,000

Year 3
$18,000
$15,000
$10,000

The companys cost of capital is 10% per annum. You should assume that all cash flows other than
the initial investment occur at the end of the year.
The expected present value of the year 1 cash flows is
A

$12,453

$(27,547)

$15,070

$13,700
(2 marks)
The correct answer is A

Workings
Year 1 cash flows
High
Medium
Low

$20,000
$14,000
$9,000

Probability
0.20
0.50
0.30

Expected value
Year 1
$4,000
$7,000
$2,700
$13,700

$13,700 x 0.909 = $12,453

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Question 1.6
JB has budgeted production for the next budget year of 36,000 units. Each unit of production requires 4
labour hours and the budgeted labour rate is $12 per hour excluding overtime.
Idle time is expected to be 10% of total hours available i.e. including idle time. Due to labour shortages it
is expected that 20% of the hours paid, including idle time, will be paid at an overtime rate of time and a
half.

Required:
Calculate the labour cost budget for the year.
(3 marks)

Workings
Labour hours for production
36,000 units x 4 hours = 144,000 hours
Idle time = 10% of total available hours, therefore total available hours need to be:
144,000 hours / 0.9 = 160,000 hours
Labour cost budget ($)
160,000 hours x 20% = 32,000 hours x ($12 x 1.50) = $576,000
160,000 hours x 80% = 128,000 hours x $12 = $1,536,000
Total labour cost budget = $2,112,000

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Question 1.7
An extract from a companys trial balance at the end of its financial year is given below:

Sales revenue (85% on credit)

Cost of sales
Purchases (90% on credit)
Inventory of finished goods
Trade receivables
Trade payables

$000
2,600
1,800
1,650
220
350
260

Required:
Calculate the following working capital ratios:
(i)
(ii)
(iii)

Inventory days
Trade receivables days
Trade payables days
(3 marks)

Workings

Working capital ratio

Calculation

Days

Inventory days

220/1800 x 365

44.6

Receivables days

350/(0.85 x 2,600) x 365

57.8

Payables days

260/(0.90 x 1,650) x 365

63.9

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Question 1.8
A company is preparing its annual budget and is estimating the number of units of Product A that it will
sell in each quarter of Year 2. Past experience has shown that the trend for sales of the product is
represented by the following relationship:
y = a + bx where
y = number of sales units in the quarter
a = 10,000 units
b = 3,000 units
x = the quarter number where 1 = quarter 1 of Year 1
Actual sales of Product A in Year 1 were affected by seasonal variations and were as follows:
Quarter 1:
Quarter 2:
Quarter 3:
Quarter 4:

14,000 units
18,000 units
18,000 units
20,000 units

Required:
Calculate the expected sales of Product A (in units) for each quarter of Year 2, after adjusting for
seasonal variations using the additive model.
(4 marks)

Workings
Quarter
1

Trend sales
units
13,000

Actual sales
units
14,000

Variation
units
+1,000

16,000

18,000

+2,000

19,000

18,000

-1,000

22,000

20,000

-2,000

Year 2 Quarter 1 = 10,000 + (3,000 x 5) = 25,000 + 1,000 = 26,000 units

Year 2 Quarter 2 = 10,000 + (3,000 x 6) = 28,000 + 2,000 = 30,000 units
Year 2 Quarter 3 = 10,000 + (3,000 x 7) = 31,000 - 1,000 = 30,000 units
Year 2 Quarter 4 = 10,000 + (3,000 x 8) = 34,000 - 2,000 = 32,000 units

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Section B 30 marks
ANSWER ALL SIX SUB-QUESTIONS.
YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE
Question 2(a)
A zero-based budgeting system involves establishing decision packages that are then ranked in order of
their relative importance in meeting the organisations objectives.

Required:
Explain the above statement and the difficulties that a not-for-profit organisation may experience when
trying to rank decision packages.
(5 marks)

Rationale
The question assesses learning outcome B3 (b) apply alternative approaches to budgeting. It examines
the candidates ability to explain the difficulties that a not-for-profit organisation may experience when
ranking decision packages under a zero based budgeting system.

Suggested Approach
Candidates should first explain what is meant by decision packages and how an organisation would
potentially rank these packages. They should then explain why this may cause difficulties in a not-forprofit organisation.

Marking Guide
Explanation of formulation of decision packages
Explanation of ranking process
Explanation of difficulties in ranking process

Marks
5 marks

Up to 2 marks for each explanation

Maximum marks awarded

5 marks

Examiners comments
This question was badly done by the majority of candidates with most scoring only one or two marks.
Many candidates did little more than state that zero based budgets start from scratch and are justified,
while others merely restated the statement in the question. Few explained how the decision packages are
formed or ranked/evaluated. Most candidates thought that charities would not use zero based budgeting
because of lack of knowledge and due to the time and expense involved. Most candidates did mention
that as the organisations were non profit making, a more subjective method of ranking may have to be
used which would be difficult to measure. However candidates explanations were not sufficiently
developed to achieve a good mark for this section.

Common errors
1. Failure to answer the question.
2. Failure to explain the statement as required by the question.
3. Lack of explanation of the points made.

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Question 2(b)
Calculate the maximum amount that should be paid for the information from the market research
company.
(5 marks)

Rationale
The question assesses learning outcome D1(e) calculate the value of information. It examines
candidates ability to calculate the expected values of projects given a range of outcomes and
probabilities and then to calculate the value of perfect information about the projects.

Suggested Approach
Candidates should firstly calculate the expected value of the net present value without perfect information.
They should then select the best outcome for each of the possible competitor reactions and apply the
probabilities to these to calculate the expected value with perfect information. The value of perfect
information can then be calculated as the difference between the expected value with perfect information
and the best of the expected values without perfect information.

Marking Guide
Expected value without perfect information
Expected value with perfect information
Value of perfect information

Marks
1 mark
2 mark
1 mark

Maximum marks awarded

5 marks

Examiners comments
Many candidates scored full marks for this question but others could only earn 1 marks for calculating
the expected value of the products. The weakest candidates calculated the expected values of strong,
normal and weak reactions rather than the expected value of products A, B and C.
Common errors
1. Calculating the expected value of the competitor reaction rather than the expected value of the
products.
2. Comparing the total of the expected values of the products to the total of the three best
outcomes.
3. Lack of understanding of how to calculate the expected value with perfect information.

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Question 2(c)
Explain the decision that the company manager is likely to make, based on the probability distribution
and the current delivery cost of $12.50 per delivery, if the manager is:
(i)
(ii)
(iii)

Risk neutral
Risk averse
Risk seeking
(5 marks)

Rationale
The question assesses learning outcome D1(c) analyse risk and uncertainty by calculating expected
values and standard deviations together with probability tables and histograms. It examines candidates
ability to explain the likely decision that would be made by decision makers with different attitudes to risk
when given a probability distribution of the possible outcomes.

Suggested Approach
Candidates should describe each of the different types of decision maker and then explain how the
different attitudes to risk will affect the decision in this particular scenario. Candidates are expected to
refer to the probability distribution to explain the decision that each type of decision maker would make.

Marking Guide
Explanation of each type of decision maker
Explanation of decision

Maximum marks awarded

Marks
1 mark each
Up to 2 marks
each
Max 2 marks
each for (i), (ii)
and (iii)
5 marks

Examiners comments
This question was reasonably well done with some candidates achieving full marks. The most
disappointing error was that many candidates believed that the decision maker could select a cost and did
not appreciate that the data provided was only the probabilities of incurring those costs. It would help
candidates if they read through their answers to check that what they have written makes sense. Other
candidates chose not to use the table of costs and probabilities at all despite the fact that the question
asked for an explanation of the decision that each manager would take based on the probability
distribution. Candidates who chose to define the three attitudes to risk struggled to explain a risk neutral
decision maker.
Common errors
1.
2.
3.
4.
5.

Stating the decision that would be made without explaining why this would be the case.
Selecting a cost that the decision maker would choose.
Not explaining the different attitudes to risk.
Inability to explain the term risk neutral.
Failure to refer to the probability distribution.

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Question 2(d)
(i)

Calculate the annual cost of factoring net of credit control cost savings.
(3 marks)

(ii)

Calculate whether there is a financial benefit from using the factor. You should ignore bad debts.
(2 marks)
(Total for sub-question (d) = 5 marks)

Rationale
The question assesses learning outcome E1(f) analyse the impacts of alternative debtor and creditor
policies. Part (i) of the question examines candidates ability to calculate the annual cost to the company
of debt factoring. Part (ii) of the question examines candidates ability to calculate whether there is a
financial benefit to the company from using the factor.

Suggested Approach
In part (i) candidates should calculate and sum the factoring fee and the annual interest and then deduct
the savings in credit control costs. In part (ii) candidates should calculate the amount the company
requires to borrow and the cost of the borrowing. They should then compare the cost of factoring to the
cost of borrowing and decide whether it is worthwhile for the company to use factoring.

Marking Guide
Part (i)
Factoring fee
Annual interest
Saving in credit control costs
Net cost of factoring

Marks
1 mark
1 mark
mark
mark

Part (ii)
Borrowing requirement
Cost of borrowing
Decision

1 mark
mark
mark

Maximum marks awarded

5 marks

Examiners comments
Very few candidates achieved full marks in this question. Many candidates showed a lack of
understanding of the factoring process by calculating the interest on the total sales revenue of $1,095k.
Candidates were rarely able to gain more than two or three marks with various extraneous items included
in the answer and incorrect calculations of the relevant items.
Common errors
1. Calculating the interest cost based on the total sales revenue rather than on 90% of the outstanding
trade receivables.
2. Deducting $20,000 in both part (i) and part (ii).
3. Failure to recognise that the factor advanced only 90% of the outstanding invoice value.

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Question 2(e)
Explain the advantages AND disadvantages to the company of each of the investments.
Your answer should include relevant calculations.
(5 marks)

Rationale
The question assesses learning outcome E2(b) identify alternatives for investment of short-term cash
surpluses. It examines candidates ability to compare two potential short term investment opportunities and
explain the advantages and disadvantages of each.

Suggested Approach
Candidates should firstly calculate the annual return on the treasury bill and compare this to the return on the
deposit account. They should then explain the advantages and disadvantages that the company would need
to consider before making the investment decision.

Marking Guide
The annual return on the treasury bills is ($5/$995) x 365/91 = 2.02%

Marks
1 mark

1 mark per valid point

4 marks

Maximum marks awarded

5 marks

Examiners comments
Candidates generally scored reasonably well in part (e), often making the expected points regarding risk in
relation to capital and income. Many nevertheless were unable to make a valid interest rate comparison
between the two investments and invariably thought that it would not be possible to recover the capital in the
treasury bills before the end of the 91-day period. This led many to conclude that the 30 day notice account
was the most liquid of the two investments.
Common errors
1. Failure to clearly explain the points made.
2. Inability to correctly calculate the return on the Treasury bills.
3. Failure to recognise that the Treasury bills were negotiable.

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Question 2(f)
Explain why there may be a difference between a bonds coupon rate and its yield to maturity.
(5 marks)

Rationale
The question assesses learning outcome E2(b) identify alternatives for investment of short-term cash
surpluses. It examines candidates ability to explain why the coupon rate on a bond and its yield to
maturity may be different.

Suggested Approach
Candidates should firstly explain what the coupon rate and the yield to maturity on a bond represent and
then explain why there may be a difference between the two rates.

Marking Guide
1 mark per valid point

Marks
5 marks

Maximum marks awarded

5 marks

Examiners comments
This question was answered very poorly. Candidates did not understand the difference between the
coupon rate and the yield to maturity, but assumed that it was to do with discount factors, NPVs and
IRRs. Many consequently tried to provide calculations which were not requested in the question.
Candidates would have done better if they had started by defining the coupon rate and the yield to
maturity.
Common errors
1. Failure to explain the coupon rate and the yield to maturity.
2. Making irrelevant calculations.
3. General lack of knowledge of the topic area.

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Section C 50 marks
ANSWER BOTH THE TWO QUESTIONS

Question 3

(a)

Calculate the annual profit per machine for each of the three sizes of machine, using
the current basis for charging the costs of support activities to machines.
(4 marks)

(b)

Calculate the annual profit per machine for each of the three sizes of machine using
activity-based costing.
(14 marks)

(c)

Explain the potential benefits to the company of using an activity-based costing

system.
(7 marks)
(Total for Question Three = 25 marks)

Rationale
Part (a) of the question assesses learning outcome A1(a) compare and contrast marginal (or variable),
throughput and absorption accounting methods in respect of profit reporting and stock valuation. It
examines candidates ability to calculate the cost of a service using a traditional method of overhead
absorption. Part (b) assesses learning outcome A1(c) discuss activity-based costing as compared with
traditional marginal and absorption costing methods, including its relative advantages and disadvantages
as a system of cost accounting. It requires candidates to be able to apply activity-based costing to the
calculation of service costs. Part (c) assesses learning outcome A1(c) discuss activity-based costing as
compared with traditional marginal and absorption costing methods, including its relative advantages and
disadvantages as a system of cost accounting. It examines candidates ability to explain the potential
benefits of activity-based information for management decision making.

Suggested Approach
In part (a) candidates should identify the direct costs for each procedure and then calculate the overhead
absorption rate. This rate can then be applied to each procedure and the profit calculated. In part (b)
candidates need to calculate a cost driver rate for each of the activities and then apply this cost driver rate
to calculate the overhead cost for each activity per procedure. The profit per procedure can then be
recalculated using the activity-based overhead costs per procedure. In part (c) candidates need to clearly
explain the potential benefits to the company of using activity-based costing in the areas of planning,
decision making and control.

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Marking Guide
(a)
Copy charge per machine
Direct costs
Overhead costs
Profit per machine
(b)
Cost driver rates
Application of cost driver rates
Profit per machine
(c)
1 mark per valid point
Maximum marks awarded

Marks
mark
1 mark
2 marks
mark

5 marks
7 marks
1 marks

7 marks
25 marks

Examiners comments
This question was generally very well done although some calculations caused difficulty, in particular the
customer account handling costs in part (b). Candidates lost marks and time because they did not read
the question properly. In part (a) some candidates apportioned the overhead by activity which wasted a
lot of valuable time and gained no marks. Some candidates failed to show workings in part (b) which
potentially lost them marks. Too many candidates are still not laying out workings in a clear, structured
way, potentially resulting in the loss of marks. Part (c) was reasonably well answered by most candidates
although many tended to focus on one particular area rather than considering planning, control and
decision making.

Common errors
1. Failure to include either the overhead cost or parts and labour costs in part (a).
2. Allocating overhead costs based on number of machines or number of copies rather than based
on sales revenue in part (a).
3. Incorrect calculation or incorrect application of cost driver rates.
4. Confusion between total $000 and $ per single machine.
5. Lack of reference to the calculations in part (a) and (b) in the answer to part (c).

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Question 4

(a)
(i)

Advise the management of the company which project should be undertaken based
on a financial appraisal of the projects.
You should use net present value (NPV) to appraise the projects.
(13 marks)

(ii)

Explain TWO other major factors that should be considered before a final decision is
made.
(4 marks)

(b)

Calculate the sensitivity of the choice between Project 1 and Project 2 to a change in
passenger numbers for Project 2.
(4 marks)

(c)

Prioritise the projects and determine how much funding should be allocated to each
project.
(4 marks)
(Total for Question Four = 25 marks)

Rationale
Part (a)(i) of the question assesses learning outcomes C1(b) apply the principles of relevant cash flow
analysis to long run projects that continue for several years and C2(a) evaluate project proposals using
the techniques of investment appraisal. It examines candidates ability to identify relevant costs and
calculate the net present value of two projects and then to advise the management of the company which
project should be undertaken. Part (a)(ii) of the question assesses learning outcome C1(g) prepare
decision support information for management, integrating financial and non-financial considerations. It
examines candidates ability to explain two major factors that management would need to consider before
making a final decision on the choice of project. Part (b) of the question assesses learning outcome C1(f)
apply sensitivity analysis to cash flow parameters to identify those to which net present value is
particularly sensitive. It examines candidates ability to calculate the sensitivity of the decision to a change
in one variable. Part (c) of the question assesses learning outcome C2(c) prioritise projects that are
mutually exclusive, involve unequal lives and/or are subject to capital rationing. It requires candidates to
allocate available funds to projects based on their profitability index.

Suggested Approach
In part (a)(i) candidates should identify the relevant cash flows for each year of the project and discount
these at the rate of 8% to calculate the net present value (NPV) of the project. They should then select
the project for investment based on the highest NPV. In part a(ii) candidates should explain relevant nonfinancial factors that should be considered before making a final decision. In part (b) candidates should
calculate the present value of the contribution from passengers in Project 2 and use this to calculate the
sensitivity of the decision to changes in this value. Candidates should recognise that the decision would
change when the NPV of project 2 falls below the NPV of project 1. In part (c) candidates should calculate
the profitability index for each project and rank the projects on the basis of this index. The funding should
then be allocated based on this ranking.

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Marking Guide
Part a(i)
Project 1
Incremental contribution
Incremental costs
Initial investment
Present value of cash flows
Net present value of cash flows

Marks

1 marks
mark
mark
1 mark
mark

Project 2
Year 1 contribution
Additional fixed costs excluding depreciation
Initial investment
Working capital
Years 2-5 contribution
Present value of cash flows
Net present value of cash flows

2 marks
1 mark
1 mark
1 mark
1 mark
1 mark
1 mark

Investment decision

1 mark

Part a(ii)
Up to 2 marks per factor

4 marks

Part (b)
Present value of contribution from passengers
Calculation of sensitivity of investment decision

2 marks
2 marks

Part (c)
Calculation of profitability index
Ranking of projects
Allocation of funding

2 marks
1 mark
1 mark

Examiners comments
Part a(i) of question 4 was reasonably well done although candidates are still making fundamental errors
such as including depreciation and sunk costs in the cash flows. The quality of answers to part a(ii) was
fairly mixed, with some candidates failing to expand on the points made while others gave very good,
thoughtful answers about the environment, competitors and the publics attitude to the new services.
Part (b) was badly answered although candidates invariably knew the general formula required. The
difference in NPV between Project 2 and Project 1 was very rarely calculated as the numerator.
Candidates frequently simply used passenger numbers as the denominator, rather than the contribution. .
In part (c), there were relatively few correct answers. Most candidates ranked on absolute NPV values,
although it was not always made clear that absolute NPV had been used as the basis for the ranking. The
better candidates who knew that the profitability index needed to be used earned all four marks but
unfortunately these candidates were in the minority.
Common errors
1.
2.
3.
4.
5.
6.
7.

Failure to calculate the incremental contribution for Project 1.

Including the sunk costs in Project 1.
Including the depreciation in Project 1.
Failure to multiply the contribution in Project 2 by 365 days.
Failure to show the release of working capital as a cash flow in Year 5.
Failure to adjust the fixed cost for depreciation in Project 2.
Inability to apply sensitivity analysis to the scenario.

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8.
9.

Use of passenger numbers rather than contribution in part (b)

Failure to use the profitability index to rank projects in part (c).

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