2023 - 2024

Advanced
Management
Accounting
(ACCO 1114)
Lecture Session Title and Description Duration
(hours)
1 Introduction AMA & Real Options Analysis (ROA) 3
2 Real Options Analysis (ROA) 2
3 Real Options Analysis (ROA) 3
4 Financial control 1: ROI & RI 2
5 Financial Control 2: ROI & RI 3
6 Financial Control 3: ROI & RI 2
7 Financial Control 4: EVA 3
8 Transfer Pricing 1 2
9 Transfer Pricing 2 3
10 Transfer Pricing 3 2
11 Transfer Pricing 4 3
12 Transfer Pricing 5 2
13 Balanced Scorecard 1 3
14 Balanced Scorecard 2 2
15 Benchmarking 1 3
16 Benchmarking 2 2
17 Environmental MA 3
18 Revision 1: ROA, ROI, RI 3
19 Revision 2: Transfer pricing 3
20 Revision 3: Other topics 3

Page 1 of 100
 LECTURE 1: REAL OPTION

REAL OPTION
TYPE OF REAL OPTION ISSUES OF REAL OPTION

Abandonment option: high salvage

values are attractive but difficult to 1, Identifying an optimal solution to an investment decision is difficult
estimate. probabilities subjective. in practice
useful when wanting to get out of 2, The embedded real options may lead to completely different
loss making business. investment decisions compared to decision based on traditional NPV
analysis.
Expansion option: similar to growth
3, Value of option may change dramatically with different assumptions.
Investment timing option (delay): 4, Probability might change over time.
invest now or later. waiting may help
company avoid less profitable 5, Companies often have little data to assign probabilities
6, All managers need to agree on probability range and its
interpretation.
COMPARE BETWEEN NPV AND REAL OPTION COMPARE BETWEEN NPV AND REAL OPTION

NPV is best when: Real Options Analysis (ROA) is suitable when:

1, Investment is completely independent and it is 1, If there are HIGH LEVELS OF UNCERTAINTY there will
not connected to any other investment and does be opportunities. For example large international
not introduce any additional investment company where investment process is seen as dynamic.
opportunities.
Managers have opportunities to identify ways of
2, Cash flows can be accurately predicted. SIMPLE improving NPV.
INVESTMENT.
3, There will be NO CHANGES TO THE PROJECT over 2, Uncertainty can be seen as valuable. The total value of
its lifetime. Flexibility can be ignored. a project can increase with the value of the real option.

5, RISK IS SEEN AS LOW. Assume a company is 3, If there are HIGH LEVELS OF FLEXIBILITY MANAGERS
working in a fully developed environment. can change the business strategy when there is a change
in the market. Abandonment is an example of an option
to avoid losses. Mangers can adapt strategy over time.

4, RISK STRUCTURE CAN CHANGE OVER TIME. Over the

lifetime of an investment managers may be able to avoid
certain types of risk.

Page 2 of 100
ADVANTAGES OF REAL OPTION
• FLEXIBILITY: Real options analysis allows for flexible decision-making, as it recognizes
that investment opportunities are not fixed and may change over time. This
approach considers the possibility of adjusting or abandoning the investment based
on new information or market conditions.
• INCORPORATION OF UNCERTAINTY: Real options analysis takes into account the
uncertainty surrounding an investment and considers the potential for both upside
and downside scenarios. This helps decision-makers to better understand and
manage risk.
• BETTER DECISION-MAKING: Real options analysis provides a structured framework for
considering multiple scenarios and evaluating potential outcomes. This can lead to
better investment decisions by considering a wider range of possibilities and allowing
for real-time adjustments based on new information.
• IMPROVED FINANCIAL RESULTS: By considering the potential for future changes and
uncertainty, real options analysis can lead to improved financial results compared to
traditional investment analysis methods. This is because it allows for a more accurate
assessment of the value of an investment over time.
• IMPROVED STRATEGIC DECISION-MAKING: Real options analysis provides valuable
insights into the impact of different strategic decisions on the value of an investment.
This can help companies make better strategic decisions, such as when to enter or exit
a market, and how to allocate resources.
DISADVANTAGES OF REAL OPTION
• COMPLEXITY: Real options analysis can be complex, especially when applied to
complex investment opportunities. The calculations involved in real options analysis
require a significant amount of data and specialized knowledge, which can be difficult
for some decision-makers to understand.
• DATA REQUIREMENTS: Real options analysis requires a significant amount of data to
be accurate. This can be difficult to obtain, especially for investments in new or
untested markets. Incomplete or inaccurate data can lead to incorrect results and poor
investment decisions.
• MODEL LIMITATIONS: Real options analysis is based on mathematical models, which
can be subject to limitations. These models are based on assumptions about future
market conditions, which may not be accurate. Additionally, real options analysis is not
suitable for all types of investments, such as those with short investment horizons or
limited information about future conditions.
• COMPUTATIONAL COMPLEXITY: The computational complexity of real options
analysis can be a barrier for some decision-makers. The calculations involved in real
options analysis can be time-consuming and require specialized software, which can
be costly.
• BIAS: Real options analysis is subject to biases, such as overconfidence in one's own
predictions or the influence of personal beliefs and emotions. Decision-makers must
be aware of these biases and work to counteract them in order to make accurate
investment decisions.
• POTENTIAL FOR MISAPPLICATION: Real options analysis can be misapplied, especially
by decision-makers who lack experience or expertise in the field. Improper use of
real options analysis can lead to incorrect investment decisions and poor results.

Page 3 of 100
WHEN NPV SHOULD BE USE RATHER THAN REAL OPTION ANALYSIS
NPV is best used for investment opportunities that have a
• well-defined set of cash flows and a limited number of potential outcomes.
• investments with a defined life span and clear future cash flows, such as a traditional
fixed asset investment.
• NPV provides a straightforward and easily understood method for evaluating the
expected return on an investment.
WHEN REAL OPTION ANALYSIS SHOULD BE USE RATHER THAN NPV
Real options analysis is best used for investment opportunities that
• involve a significant amount of uncertainty or that have multiple potential outcomes.
• This method is particularly useful for investments that allow for flexibility and
adjustments based on changes in market conditions or new information.
• Real options analysis can provide valuable insights into the potential value of
investment opportunities that cannot be easily captured by NPV.

Page 4 of 100
Question 1 (Option to abandon)
A company is considering an investment of £2,200 on a new product. The product will
have a relatively short product life of 2 years. Managers are finding it difficult to
forecast cash flows. If the first year cash flows are not good this will affect cash flows in
year 2. If year one cash flows are good then they are more optimistic with the second
year cash flows.
Managers have the option to abandon the project after one year. If the project is
abandoned after one year the assets can be sold for £1,500
Data
Year 1 Year 1 Year 2 Year 2
Cash flow Probability Cash flow Probability
Scenario 1 £1,200 0.2 £1,000 0.3
£1,500 0.6
£1,800 0.1
Scenario 2 £1,500 0.5 £1,000 0.3
£1,500 0.5
£2,500 0.2
Scenario 3 £2,000 0.3 £1,500 0.2
£2,000 0.5
10% £2,500 0.3
Cost of capital 10%
Investment Year 0 £2,200
Required
(a) What is the NPV with a traditional analysis – assuming there is no possibility of
abandonment?
(b) Now assume there is an option to abandon. What is the value of the
abandonment option for the scenarios above.

Page 5 of 100
Question 2 (Option to abandon)
A new product requires an investment of £600.
Next year, it will require an additional investment of £1,500. The cash flows for years 2
to 6 are:
40% probability of £900 per year
60% probability of £300 per year.
At the end of the first year the managers hope to forecast cash flows with certainty. The
cash flows will either be £900 or £300 per year. Assume the cost of capital is 10%.
Required
(a) Calculate the NPV for this product assuming the decision to accept or reject is
made now. Assume there is no option to abandon.
(b) Calculate the NPV for this product assuming the decision to accept or reject is
made in one year. In one year the company has the option to spend £1,500 to
continue or abandon the product.

Page 6 of 100
Question 4
A new product requires an investment of £600.
Next year, it will require an additional investment of £1,500. The cash flows for years 2
to 6 are:
70% probability of £1,000 per year
30% probability of £350 per year.
At the end of the first year the managers hope to forecast cash flows with certainty. The
cash flows will wither be £1,000 or £350 per year. Assume the cost of capital is 10%.
Required
(a) Calculate the NPV for this product assuming the decision to accept or reject is
made now. Assume there is no option to abandon.
(b) Calculate the NPV for this product assuming the decision to accept or reject is
made in one year. In one year the company has the option to spend £1,600 to
continue or abandon the product.

Page 7 of 100
Question 5: Option to abandon with sensitivity analysis
The management accountant at Kimmeridge Engineering has been asked to report on
the following investment opportunity.
A project will require an immediate investment of £120,000. An additional investment
of £300,000 will be required next year. Assume the cost of capital is 12%.
The initial cash flow forecast cash assumed constant cash flows for years 2-5. The
management accountant discussed the project with other senior managers and identified
the following scenarios.
FORECAST A
Normal scenario (assumes no significant Pessimistic scenario (assumes a
changes in demand) significant downturn in demand)
Probability 50% Probability 50%
Cash flows will be £240,000 per year for Cash flows will be £60,000 per year for
years 2-5 years 2-5
At the end of the first year managers will have a better understanding of the market
conditions and will be able to forecast the cash flows with certainty.
Abandonment
Assume at the end of the first year the company can invest an additional £300,000 or
abandon the project.
Required - Determine the value of the option to abandon.
FORECAST B
Normal scenario (assumes no significant Pessimistic scenario (assumes a
changes in demand) significant downturn in demand)
Probability 50% (No change) Probability 50% (No change)
Cash flows will be £280,000 per year for Cash flows will be £20,000 per year for
years 2-5 years 2-5

Required - Determine the value of the option to abandon.

FORECAST C
Normal scenario (assumes no significant Pessimistic scenario (assumes a
changes in demand) significant downturn in demand)
Probability 80% Probability 20%
Cash flows will be £172,500 per year for Cash flows will be £60,000 per year for
years 2-5 years 2-5
Required - Determine the value of the option to abandon.
Compare the value of the option to abandon in (A), (B) and (C) above and discuss why
the value of the option changes.

Page 8 of 100
Question 6: Option to Delay
Required return = 10%
Investment £7,500,000
Cash flow
Cash flow Probability
£1,240,000 80%
£40,000 20%
Cash flows will begin in one year from today.
Option to delay
Some managers want to consider an option to delay the investment for two years. In
two years the company will have more information on whether the cash flows will be
higher or lower. If the company delays the investment for two years the life of the
project will reduce to 18 years.
PV tables for discount rate = 10%
N = years PV factor Cumulative PV factor
1 0.909
2 0.826 1.736
3 0.751 2.487
4 0.683 3.170
5 0.621 3.791
16 0.218 7.824
17 0.198 8.022
18 0.180 8.201
19 0.164 8.365
20 0.149 8.514
Required:
1, Evaluate whether or not the company should delay the investment.
2, What is the most you would pay for investment if you delayed for two years

Page 9 of 100
Question 7: Option to delay
Required return = 10%
Investment £1,200,000
Cash flow
Cash flow Probability
£300,000 50%
£100,000 50%
Cash flows will begin in one year from today.
Option to delay
Some managers want to consider an option to delay the investment for one year. In
one year the company will have more information on whether the cash flows will be
higher or lower. If the company delays the investment for one year the life of the
project will reduce to 9 years.
PV tables for discount rate = 10%
N = years PV factor Cumulative PV factor
1 0.909
2 0.826 1.736
3 0.751 2.487
4 0.683 3.170
5 0.621 3.791
6 0.564 4.355
7 0.513 4.868
8 0.467 5.335
9 0.424 5.759
10 0.386 6.145
Required:
1, Evaluate whether or not the company should delay the investment for ONE
year.
2, What is the most you would pay for investment if you delayed for one year.
Question 9: Option to abandon
A company is considering an investment of £300 on a new product. The product will
have a relatively short product life of 2 years.
Managers are finding it difficult to forecast cash flows. If the first year cash flows are
not good this will affect cash flows in year 2. If year one cash flows are good then
they are more optimistic with the second year cash flows.
Managers have the option to abandon the project after one year. If the project is
abandoned after one year the assets can be sold for £250
Data

Page 10 of 100
 Year 1 Year 1 Year 2 Year 2
Cash
flow Probability Cash flow Probability
Scenario 1 £200 0.3 £100 0.3
£200 0.5
£300 0.2
Scenario 2 £300 0.4 £200 0.3
£300 0.5
£400 0.2
Scenario 3 £400 0.3 £300 0.3
£400 0.4
Cost of capital 12% £500 0.3
Investment £300
Sell assets end of year 1 £250
Cost of capital 12%
Investment £300
Option sell assets end of
year 1 £250
Required
(a) What is the NPV with a traditional analysis – assuming there is no possibility
of abandonment?
(b) Now assume there is an option to abandon. What is the value of the
abandonment option for the scenarios above.

Page 11 of 100
Exam question 1 (5.2021) Option to delay
Stratford Technology has seen sales fall by 10 per cent in 2020. The management
accountant is concerned that forecasting is becoming more difficult as economic
uncertainty remains high. A new investment opportunity is being considered. Details of
the investment are given below:
The total investment is estimated at £1,800,000.
The life of the investment is estimated at 9 years and the required rate of return = 12%.
Cash flows are estimated as follows:

Scenarios Forecast annual cash flow Probability

Scenario 1 £400,000 0.7
Scenario 2 £80,000 0.3
The managers are unsure about investing immediately or waiting for one or two years.
If the investment is delayed for one year the life of the investment will reduce to eight
years. If the investment is delayed for two years the life of the investment will reduce to
seven years. If the investment is delayed then managers will know for certain which of
the two scenarios applies before the decision to invest is taken.
Present value tables for 12% discount rate.
Year Present value factor Cumulative present value factor
1 0.893 0.893
2 0.797 1.690
3 0.712 2.402
4 0.636 3.037
5 0.567 3.605
6 0.507 4.111
7 0.452 4.564
8 0.404 4.968
9 0.361 5.328
Required
(a) Compare the value of the delay option for:
(i) Delaying the investment for ONE year
(ii) Delaying the investment for TWO years
(15 Marks)
(b) Managers have a choice when deciding which technique to use for an
investment decision. Real options analysis (ROA) and Net Present Value (NPV)
may be popular with some but not all managers. What advice would you give if a
manager asked you to explain the differences between ROA and NPV? (18 ⅓
Marks)
(Total 33⅓ Marks)

Page 12 of 100
Exam question 2 (5.2020) Option to abandon
The management accountant at Green Technology has been asked to comment on a new
product that is being considered. The new product X will require an immediate
investment of £94,000. An additional investment of £900,000 will be required next year.
Assume the cost of capital is 10%.
The initial cash flow forecast assumed constant cash flows for years 2-5. Two scenarios
are presented for discussion.
Forecast 1 cash flows Forecast 2 cash flows
Probability 75% Probability 25%
Cash flows will be £360,000 per year for Cash flows will be £270,000 per year for
years 2-5 years 2-5
In one year managers will have a better understanding of the market conditions and
will be able to forecast the cash flows with more certainty.
Abandonment
Assume at the end of the first year the company can invest an additional £900,000 or
abandon the project.
Required
(a) Determine the value of the option to abandon at the end of year 1. Advise if
this is a good investment for Green Technology. (19 Marks)
(b) You are told that the decision to use Real Options Analysis (ROA) for this
product is unpopular with most managers. Evaluate why managers may not want
to use ROA in this case. (14⅓ Marks)
(Total 33⅓ Marks)

Page 13 of 100
Exam question 3 (5.2019) Option to abandon

The management accountant at Hefei Manufacturing has been given the following
forecast for a new investment.

Year 1 Year 1 Year 2 Year 2

Cash flow Probability Cash flow Probability
Scenario 1 £580,000 0.7 £450,000 0.25
£470,000 0.5
£510,000 0.25
Scenario 2 £540,000 0.3 £525,000 0.5
£555,000 0.3
£600,000 0.2
Additional Information

Discount rate for new investment = 10%

Required investment = £825,000

Option to sell assets at the end of Year 1 for £500,000

For both scenarios Year 2 cash flows are dependent on Year 1 cash flows.

The management accountant is required to advise managers on the suitability of this

investment.

Required

(a) Determine the value of the option to abandon at the end of Year 1. Is the value
of the option significant? (18 Marks)

(b) The management accountant is the only manager with experience of real
options analysis. She is concerned that mangers may reject the real option analysis.

Evaluate why managers may consider the real options approach unhelpful and
therefore reject the analysis. (15⅓ Marks)

(Total 33⅓ Marks)

Page 14 of 100
Exam question 4 (5.2018) Option to abandon

A company has enough capital to invest in Project X OR Project Y. The two projects
are very different and therefore the cash flows of one project will not affect the cash
flows of the other project. Both projects require an immediate investment of £200,000
and an additional investment of £800,000 will be required next year. Assume the cost of
capital is 12%.

Data prepared by the management accountant. The management accountant has taken a
wide range of cash flow forecasts based on the discussions with senior managers. .

Data for Project X

Forecast based on best outcome Forecast based on worst outcome

Probability 50% Probability 50%
Cash flows will be £600,000 per year for Cash flows will be £200,000 per year for
years 2-5 years 2-5
Data for Project Y

Forecast based on best outcome Forecast based on worst outcome

Probability 50% Probability 50%
Cash flows will be £550,000 per year for Cash flows will be £250,000 per year for
years 2-5 years 2-5

Option: In one year the managers can invest the additional £800,000 or abandon the
projects. The decision to abandon one project will have no impact on the other projects.

Required:

(a) Determine the value of the option to abandon for each project. (14 Marks)

(b) Discuss the differences between the value of the option to abandon for each
project. (5⅓ Marks)

(c) What advice would you give to managers who are unsure about when to use
traditional net present value calculations and when to use real options analysis?
(14 Marks)

(Total 33⅓ Marks)

Page 15 of 100
Exam question 5 (5.2017) Option to delay
Details of investment
A company has prepared two forecasts for a £2 million investment. Managers have
asked for two forecasts so that a range of outcomes can be considered. Managers
cannot agree on the starting date for the investment. The advantage of delaying the
investment by one year will help managers get a more accurate forecast of the annual
cash flows. If the investment is delayed by one year the life of the investment will
reduce to seven years.
Forecast 1
Life of investment = 8 years Required rate of return = 14%
Annual cash flow Probability
Scenario 1 £500,000 0.7
Scenario 2 £100,000 0.3

Forecast 2
Life of investment = 8 years Required rate of return = 12%
Annual cash flow Probability
Scenario 1 £500,000 0.8
Scenario 2 £100,000 0.2

Present value tables 14% discount rate Present value tables 12% discount rate
Present Cumulative Cumulative
Year value factor present value Year Present value present value
s 14% factor s factor 12% factor
1 0.877 1 0.893
2 0.769 1.647 2 0.797 1.690
3 0.675 2.322 3 0.712 2.402
4 0.592 2.914 4 0.636 3.037
5 0.519 3.433 5 0.567 3.605
6 0.456 3.889 6 0.507 4.111
7 0.400 4.288 7 0.452 4.564
8 0.351 4.639 8 0.404 4.968
Required: Compare the two forecasts and determine whether or not the managers
should delay the investment for ONE year. (17 Marks)

Page 16 of 100
Exam question 6 (5.2016) Option to abandon
A company has identified two possible investments but can only invest in ONE.
Both projects require an immediate investment of £300,000 and an additional
investment of £900,000 will be required next year. Assume the cost of capital is 12%.
The main concern for management is the economy. It is difficult to forecast whether
or not the economy will do well over the next 5 years.
Data for Project A
Assume economic growth is good Assume economic growth is weak
Probability 55% Probability 45%
Cash flows will be £750,000 per year Cash flows will be £150,000 per year
for years 2-5 for years 2-5
Data for Project B
Assume economic growth is good Assume economic growth is weak
Probability 55% Probability 45%
Cash flows will be £640,000 per year Cash flows will be £284,444 per year
for years 2-5 for years 2-5
The managers will abandon the project at the end of year 1 if the economic situation
is not good. If the economic situation is not good the additional £900,000 will not be
invested.
The decision to abandon one project will have no impact on the other projects. Also
the two projects are independent.
Required:
A, Determine the value of the option to abandon for each project. (14 Marks)
B, Discuss the differences between the value of the option to abandon for each
project. (5⅓ Marks)
C, What advice would you give to a manager who wants help to understand how real
options analysis can be applied in the public sector. A good answer will includes
examples of how real options can be used in the public sector and also discuss the
main differences between the private and public sectors.(14 Marks)
Total 33⅓ Marks

Page 17 of 100
Exam question 7 (5.2015) Option to delay
A management accountant has been asked to advise a company on the starting date for a
new investment. One senior manager wants the investment to start immediately.
Another senior manager wants to consider delaying the investment for at least one year
or possibly two years. If the investment is delayed the managers will have more
information about whether the forecast annual cash flows will be higher or lower.
Details
Investment £4,500,000. Required rate of return = 10%
Maximum life of investment = 10 years
Forecast cash flow.
Annual cash flow Probability
Optimistic forecast £900,000 0.8
Pessimistic forecast £200,000 0.2
If the investment is delayed by one year the life of the investment will reduce to 9 years.
If the investment is delayed by two years the life of the investment will reduce to 8
years.
Present value tables
Present value Cumulative present
Years factor value factor
1 0.909
2 0.826 1.736
3 0.751 2.487
4 0.683 3.170
5 0.621 3.791
6 0.564 4.355
7 0.513 4.868
8 0.467 5.335
9 0.424 5.759
10 0.386 6.145
Required
(a) Evaluate whether or not the managers should delay the investment for:
(i) One year
(ii) Two years
(16 Marks)
(b) What is the most the company should pay for the investment if it is delayed for
one year?
(5 Marks)
(c) Senior managers have asked you to give more details about your answer to (a)
and (b) above. They particularly want your advice on whether this investment is
suitable for real options analysis. (12⅓ Marks)
Total 33⅓ Marks

Page 18 of 100
Exam question 8 (7.2017) Option to abandon
Two different scenarios have been identified for a new investment.
Year 1 Year 1 Year 2 Year 2
Cash flow Probability Cash flow Probability
Scenario 1 £9,000 0.6 £8,000 0.4
£11,000 0.5
£14,000 0.1
Scenario 2 £11,000 0.4 £10,000 0.4
£14,000 0.4
£16,000 0.2
The company uses a 10% discount rate for this type of investment
The Investment required now is £16,000. This is a significant investment for the
company and it is likely to be the only significant investment this year.
Scenario 1 assumes the year one cash flow will be £9,000 and the year two cash flows
will be in the range of £8,000 to £14,000. The company assumes that for both
scenarios the year two cash flows are dependent on the year one cash flows. Scenario
2 has more optimistic cash flows in years one and two.
The managers also have an option to abandon this investment and sell the equipment
for this investment at the end of year one. The equipment is expected to sell for
£10,000.
Required
a. Determine the value of the option to abandon for this investment. (15 Marks)
b. In your opinion is the value of the option in (a) above likely to influence the
decision to accept or reject the investment?(6 Marks)
c. What advice would you give to managers applying real options analysis for
the first time. In particular discuss when it is best to use traditional net present
value analysis and when it is best to use real options analysis.(12⅓ Marks)

Page 19 of 100
Exam question 9 (7.2018) Option to abandon

The data below is for a new investment opportunity. This investment is for a new
product in a highly competitive market. Managers are not in agreement about whether
or not this is a good investment. Managers have been asked to assign probabilities to the
different scenarios.

Investment cash flows:

Year 1 Year 1 Year 2 Year 2

Cash flow Probability Cash flow Probability
Base Scenario £320,000 0.75 £300,000 0.2
£320,000 0.6
£340,000 0.2
Optimistic Scenario £360,000 0.25 £350,000 0.2
£370,000 0.4
£400,000 0.4
For both scenarios the Year 2 cash flows are therefore dependent on the Year 1 cash
flows.

Investment required is £550,000.

Discount rate for this investment = 10%

The managers also have to consider an offer from a competitor. The competitor is
willing to offer £300,000 for the assets at the end of Year 1.

Required

(a) Determine the value of the option to abandon for this investment and advise
managers whether or not the investment should be approved. (18 marks)

(b) Is the use of probabilities in part (a) above likely to improve decision making?
(5 marks)

(c) Managers also wanted more advice about the different types of real options.
Briefly discuss the different types of real options managers can use, including
examples. (10 ⅓ marks)

(Total 33⅓ marks)

Page 20 of 100
Exam question 10 (7.2021) Option to abandon
Green Engineering is considering a new project. The new project will require an
immediate investment of £75,000. An additional investment of £390,000 will be
required next year. The company assumes a cost of capital of 10%.

The initial cash flow forecast assumed constant cash flows for years 2-5. Two scenarios
are presented for discussion.

Optimistic cash flows Pessimistic cash flows

Probability 75% Probability 25%
Cash flows will be £160,000 per year for Cash flows will be £120,000 per year for
years 2-5 years 2-5
In one year managers will have a better understanding of the market conditions and will
be able to forecast the cash flows with more certainty (i.e. they will know for certain
whether the optimistic cash flows or the pessimistic cash flows will apply).

Abandonment - Assume at the end of the first year the company can either invest an
additional £390,000 or abandon the project.

Required

(a) Determine the value of the option to abandon at the end of year 1. Would you
recommend this investment to managers? (18 Marks)

(b) Prepare a short memo to answer the following questions. Assume the questions
are from a manager in the company who has no experience of using real options.

(i) Do real options calculations have to be so complex to give a more accurate

answer? (5⅓ Marks)

(ii) What are the different types of real options a manager may want to consider?
(10 Marks)

Page 21 of 100
Exam question 11 (1.2022) Option to abandon
The managers at Green Engineering must accept or reject a new project. The project
requires an immediate investment of £240,000. An additional investment of £1,250,000
will be required next year. The company assumes a cost of capital of 10%.

The forecast cash flow assumes constant cash flows for years 2-5. Two scenarios have
been prepared. It is normal to consider two scenarios for each investment.

Optimistic Pessimistic
Cash flows 75% probability cash flows Cash flows 25% probability cash flows
of £512,000 per year for years 2-5 of £380,000 per year for years 2-5
In one year’s time, managers will have a better understanding of the market conditions
and will be able to forecast the cash flows with more certainty (i.e. they will know for
certain whether the optimistic cash flows or the pessimistic cash flows will apply).

Abandonment - Assume that at the end of the first year the company can invest an
additional £1,250,000 or abandon the project.

Required:

a) What is the value of the option to abandon at the end of year 1? Would you
recommend this investment to managers? (18 marks)

b) The management accountant invites managers to ask additional questions

before the decision is made. How would you respond to the following questions?

(i) Are probabilities going to provide a better decision? (5⅓ marks)

(ii) What are the typical types of options a manager may come across when
evaluating a range of investments? (10 marks)

Page 22 of 100
 LECTURE 2: FINANCIAL CONTROL 1

FINANCIAL CONTROL

RESIDUAL INCOME ROI (RETURNED IN INVESTMENT)

WHAT WHAT
Residual income = Controllable profit less a cost of ROI = Controllable profit / investment
Controllable profit = Annual cash flow – Annual
capital charge on the investment controllable by the
depreciation
divisional manager. (*) Investment based on opening balance of net book
ADVANTAGES value
1, Controllable RI is a measure of managerial and ADVANTAGES
divisional performance that is consistent with 1, Easily understood.
responsibility accounting. 2, Useful for measuring divisions which vary in size
3, Comparison with cost of capital.
2, Managers are aware of the need to earn return 4, Encourages managers to minimise working capital
greater than cost of capital. 5, ROI used by external analysts.
3, Consistent with NPV (long term only) 6, ROI can be compared with inflation rates and the
4, Managers can use different interest rates for returns of other companies and sectors.
different types of assets 7, Controllable and non-controllable costs and capital
employed not normally identified.
DISAVANTAGES DISADVANTAGES
1, The problems of identifying controllable profits and 1, If divisional manager disposes of an asset which
investments and calculating the cost of capital cannot earns less than the average ROI
be ignored. 2, Not consistent with NPV.
2, Difficult to apply when company has many 3, Manipulation of assets may occur.
different divisions and divisions buy and sell with 4, It is difficult to identify ROI for individual projects.
each other 5, Managers may hold on to old assets to improve
ROI.
3, There is an element of subjectivity regarding the
6, Depreciation policy needs to be compared when
choice of cost of capital using different cost of capital
making comparisons between divisions.
for different divisions may be difficult to justify.
4, RI is therefore not as popular with managers. RESPONSIBILITY CENTRE

RESPONSIBILITY CENTRE
Objectives of bonus scheme
1, employees to share in the success of the business
RESPONSIBILITY CENTRE 2, change within the organisation.
Cost centres, revenue centres, profit centres, and 3, Desired workplace culture.
4, To improve business performance
investment centres.
5, To focus employees’ efforts on key objectives
CONTROLLABILITY 6, To increase employee motivation by establishing a
A principle that asserts that people should be held clear link between pay and performance
accountable only for the results that they can control. TEAM-BASED BONUS SCHEMES
By measuring targets at the level of specific teams,
Managers should not be held accountable for the impact of employees‘performance is much more
revenues, costs, investments, or other factors outside visible than if the bonus were to be based on
his/her control. corporate-level factors alone.
Page 23 of 100
Question 1:
Greenwich Electronics is based in the UK and is a subsidiary of a large multinational
company. The latest forecast for Greenwich Electronics is summarised below:

Sales forecast for 2013 £57,000,000

Less variable costs £35,000,000
Contribution £22,000,000
Less fixed expenses £20,000,000
Net profit £2,000,000
Divisional capital employed £16,000,000
The forecast above assumes there will be no new products in 2013. .
The company estimates that the required return on investment should be a minimum
of 10% for new and existing investments.
Additional new product
Managers have been asked to consider a new product. They do not have to accept the
new product but if they reject the new product it could be manufactured overseas.
Forecast sales for the new product are 10,000 units per annum.
Additional information:
Selling price is forecast at £150 per unit
Variable costs are 80% of sales.
Additional fixed expenses will be £210,000 per annum.
The new product line will require investment of £800,000.
Annual bonus
The company is considering two different bonus schemes.
(i) The first option is would be to give a bonus to managers who increase the return
on investment each year. If return on investment remains the same or decreases
managers do not receive a bonus.
(ii) The second option is to base a bonus on Residual Income. If managers increase
Residual Income they will receive a bonus. If Residual Income remains the same or
decreases managers do not receive a bonus.
Required
(a) Compare the return on investment and the residual income for the company
before and after the investment in the new product. (12 Marks)
(b) The managers want to set a target residual income of £50,000 for the new
investment. Determine how many units the company must sell to achieve the
target residual income.(7⅓ Marks)
(c) Using the data from (a) above identify which would be the best bonus scheme
for the managers. You should evaluate the advantages and disadvantages of
the two bonus schemes described above. (14 Marks)
(Total 33⅓ Marks)

Page 24 of 100
Question 2:
Managers at Athena share a bonus each year. The total bonus is based on residual
income. Managers have agreed that the total bonus is calculated as 10% of the annual
residual income. There is also a minimum residual income target of £500,000 before a
bonus is paid. If the residual income is below £500,000 managers do not receive a
bonus.
A majority of managers claim to be more familiar with return on investment (ROI).
The minimum bonus is £50,000 (£500,000 X 10%). There is no upper limit for the
bonus.
Budgeted data 2011 (the company has only one product)
Product X
Production capacity (12 months) 80,000 units
Capital employed £2,500,000
Annual fixed costs £1,000,000
Variable cost per unit £20.00
Required rate of return 10%
Required
(a) Based on the data in the budget what is the minimum selling price for
Product X that will give managers a bonus of £50,000. (9 Marks)
(b) Based on the data in the budget what is the required minimum Return on
Investment that will give managers a bonus of £50,000(3 Marks)
(c) In 2010 the ROI was 33% and production was 75,000 units. What bonus
will be paid in 2011 if the same ROI and production is achieved in 2011.
(You are to assume that the bonus is still calculated as 10% of residual
income).(6 Marks)
(d) Athena is one of a number of divisions in a large multinational organisation.
Overall different divisions have different strategies and not all managers
agree with the bonus scheme above. Discuss why strategy is important when
identifying financial objectives for a division. (15 Marks)
(Total 33 Marks)

Page 25 of 100
Question 3:
RI / ROI and minimum price
Data
Current assets £400,000
Long term assets £600,000
Total assets £1,000,000

Capacity (units) per month 200,000

Target ROI 30%
Fixed costs per month £400,000
Variable costs per unit £4
Required rate of return on total
assets 12%
Bonus = 5% of residual income 5%

Required
(a) Calculate the minimum selling price to achieve 30% ROI
(b) Calculate the Residual Income
(c) Calculate the minimum selling price to achieve increase in RI of 10%

Question 4
Athena is one of a number of divisions in a large multinational organisation. Overall
different divisions have different strategies and not all managers agree with the bonus
scheme above. Discuss why strategy is important when identifying financial
objectives for a division.
Students should consider different strategies:
1. Growth strategy (New division with hopes of high sales growth)
2. Sustain strategy (Established successful business)
3. Harvest strategy (Division with no new investments and limited prospects

Page 26 of 100
Exam question 1 (5.2021)
A division produces a single product. The forecast data for product Alpha is given
below:
Original annual forecast from the management accountant Product Alpha
Target Residual Income £2,000,000
Cost of capital for product 10%
Capital employed £15,000,000
Variable cost per unit £50.00
Annual fixed costs £2,000,000
Production (units) based on full capacity 400,000
Details of new bonus scheme
Managers have been asked to comment on a new bonus scheme. Managers have to
reach a minimum residual income target of £2,000,000 before a bonus is paid. If the
residual income total is above £2,000,000 managers will be paid a bonus of 10% of the
residual income. However if the residual income is below £2,000,000, managers do
not receive a bonus. The minimum bonus is £200,000 (£2,000,000 * 10%).
(Note the previous bonus scheme did not have a minimum residual income target).
Required:
(a) Determine the minimum selling price for Product Alpha that will give
managers a total residual income of £2,000,000 and a bonus of £200,000. Assume
the minimum price is when full capacity is achieved. (10 Marks)
(b) The managers prepare a new forecast for Product Alpha
Target Residual Income £2,000,000
Cost of capital for product 10%
Capital employed £13,500,000
Variable cost per unit £45.00
Annual fixed costs £1,800,000
Production (units) based on full capacity 400,000

Based on the new forecast determine the minimum selling price for Product Aplha that
will give managers a total residual income of £2,000,000 and a bonus of £200,000?
Assume the minimum price is when full capacity is achieved. Managers believe a
market price of £60 per unit is likely over the next year. Is there a significant
difference between the original forecast in (a) above and the new forecast in (b)? (7
Marks)
(c) Use the data for the original annual forecast. The company suggests a different way
to calculate a bonus. The company suggests a target minimum return on investment
(ROI) of 22%. Assume the managers are offered a bonus of £200,000 for achieving a
ROI of 22% or higher. Assume the minimum price is when full capacity is achieved.
Determine the minimum selling price that will give managers a bonus of £200,000.
(6 Marks)
(d) Assume the managers can choose between using ROI or RI as a basis for
calculating a bonus. What advice would you give to managers? Your discussion
should include your answers to (a), (b) and (c) above. (10⅓ Marks)
(Total 33⅓ Marks)

Page 27 of 100
Exam question 2 (5.2020)
Details of the new draft budget for Shanghai Engineering.

Sales £216,000
Variable costs £140,000
Contribution £76,000
Fixed expenses £71,000
Net profit £5,000
Divisional Capital Employed £48,000
An additional investment is being discussed by managers. The managers have not
agreed on the details for the new investment. The management accountant has been
asked to compare two different forecasts for the new investment.

Pessimistic Forecast Optimistic Forecast

Investment required £8,000 £7,500
Volume (units) 4,000 4,200
Selling price per unit £3.50 £3.70
Variable cost per unit £2.50 £2.30
Additional fixed expenses £2,500 £2,200
Cost of capital 14% 14%
The required rate of return for the new investment is estimated at 14%.

Required

(a) The management accountant has been asked to comment on the different
forecasts for the new investment. Assume that the Return on Investment (ROI)
and the Residual Income (RI) are calculated before and after the new investment
for both forecasts. (17 Marks)

(b) A newly appointed Management Accountant has been asked to explain why
senior managers in divisions are having problems measuring EVA for their
division. Evaluate the problems that you would include in a report. (16⅓ Marks)

(Total 33⅓ Marks)

Page 28 of 100
Exam question 3 (5.2019)
A company has enough funds to invest in one of the following projects. The cash flow
forecast is based on a period of 5 years. The investment will be the same for each
project.

Required investment for each project is £1,800,000. The required rate of return for each
investment is 15%.

Project A Project B Project C

Year 1 £600,000 £300,000 £250,000
Year 2 £520,000 £1,220,000 £300,000
Year 3 £520,000 £650,000 £300,000
Year 4 £500,000 £150,000 £1,000,000
Year 5 £500,000 £150,000 £1,200,000
Additional information

Project A Project B Project C

Net Present Value of -£8,692.7 -£28,910.1 £9,854.6
Project Negative Negative Positive
The management accountant estimates cash flow for each project as income plus
depreciation.

The investment base used for Return on Investment (ROI) and Residual Income (RI)
calculations is net assets valued at the beginning of the year.

Straight line depreciation is applied at the rate of 20%.

Required: Compare the ROI, RI and NPV for the three projects. Explain how the
different measures influence decision making. (16 Marks)

Page 29 of 100
Exam question 4 (5.2018)
Greenwich Electronics is based in the UK and is a subsidiary of a large multinational
company. The latest forecast for Greenwich Electronics is summarised below:
Sales forecast for 2018 £100,000,000
Less variable costs £65,000,000
Contribution £35,000,000
Less fixed expenses £33,000,000
Net profit £2,000,000
Divisional capital employed £20,000,000
The forecast above assumes there will be no new products in 2018. .
The company estimates that the required return on investment should be a minimum of
9% for new and existing investments.
Additional new product
Managers have been asked to consider a new product. They do not have to accept the
new product but if they reject the new product it could be manufactured overseas.
Forecast sales for the new product are 290,000 units per annum.
Selling price is forecast at £20 per unit
Additional information:
Variable costs are 80% of sales.
Additional fixed expenses will be £1,000,000 per annum.
The new product line will require investment of £1,700,000.
Annual bonus
The company is considering two different bonus schemes.
(i) The first option is would be to give a bonus to managers who increase the return on
investment each year. If return on investment remains the same or decreases managers
do not receive a bonus.
(ii) The second option is to base a bonus on Residual Income. If managers increase
Residual Income they will receive a bonus. If Residual Income remains the same or
decreases managers do not receive a bonus.
Required:
(a) Compare the return on investment and the residual income for the company
before and after the investment in the new product. (12 Marks)
(b) The managers want to set a target residual income of £80,000 for the new
investment. Determine how many units the company must sell to achieve the target
residual income. (7⅓ Marks)
(c) Using the data from (a) above identify which would be the best bonus scheme
for the managers. You should evaluate the advantages and disadvantages of the
two bonus schemes described above. (14 Marks)
(Total 33⅓ Marks)

Page 30 of 100
Exam question 5 (7.2017)
Data are available for three investments. Only ONE investment can be approved due
to budget constraints. There are three autonomous divisions asking for funds to
invest.
Senior managers request that the divisional managers calculate the Net Present Value
(NPV), Return on Investment (ROI) and the Residual Income (RI). Senior managers
believe it is better to compare a number of techniques rather than have a clear
preference for one technique.
Details
Division 1 Division 2 Division 3
Investment £1,000,000 £1,000,000 £1,000,000
Length of project (years) 4 4 4

Forecast cash flows

Project Division 1 Division 2 Division 3
Year 1 £100,000 £600,000 £370,000
Year 2 £200,000 £300,000 £370,000
Year 3 £500,000 £250,000 £370,000
Year 4 £800,000 £150,000 £370,000
Net present value
Summary Division 1 Division 2 Division 3
Net present value of project £24,346 -£1,276 £56,342
(Division 2 NPV is negative)
The group cost of capital has been estimated at 15%
Cash flow for each investment is estimated as income plus depreciation. The
management accountant assumed that the investment base used for ROI and RI
calculations is net assets valued at the beginning of the year. Depreciation is
calculated using the straight-line method.
There will be no scrap value in Year 4.
Required
(a)
(i) Compare the ROI, RI and NPV for these divisions (calculate both ROI and RI
for each of the four years) (12 Marks)
(ii) Prepare a summary of the key issues that senior managers should consider
when comparing the three investments. (Your answer should be based on the
calculations in (i) above) (7 Marks)

Page 31 of 100
Exam question 6 (7.2016)
The original budget for Greenwich Electronics is summarised below:
Budget for 2016 £95,000,000
Less variable costs £55,000,000
Contribution £40,000,000
Less fixed expenses £37,000,000
Net profit £3,000,000
Divisional capital employed £20,000,000
The forecast is based on the assumption that there will be no new products in 2016.
Managers are advised that the required return on investment should be a minimum of
10% for new investments.
Revised budget based on a new investment
Managers have been asked to consider a new product.
Data for new product:
Forecast sales for the new product are 20,000 units per annum.
Selling price is forecast at £120 per unit
Variable costs are 70% of sales.
Additional fixed expenses will be £600,000 per annum.
The new product line will require investment of £1,000,000.
Performance Management
Each year managers are expected to improve the return on investment. Return on
investment is calculated for the division and all new investments.
Managers also calculate residual income. Again this is calculated for the division and all
new investments.
Required
A, Compare the return on investment and the residual income for the company before
and after the investment in the new product. (12 Marks)
B, Based on your answer to (a) above explain how the choice of performance measure
could influence whether or not a new investment is accepted. (7⅓ Marks)
C, Textbooks describe a number of different management accounting techniques for
measuring performance. Summarise the main influences on managers when they decide
to adopt or reject a particular technique. (14 Marks)
(Total 33⅓ Marks)

Page 32 of 100
Exam question 7 (7.2018)
You are provided with forecast data for Product X. This is an annual forecast.

Two forecasts have been prepared. Forecast 1 assumes no changes from the previous
year.

Forecast 2 includes cost savings that are being considered by the senior managers.

Forecast 1 Forecast 2
Target ResiduaI Income £1,000,000 £1,000,000
Required rate of return 12% 12%
Capital Employed £10,000,000 £9,000,000
Variable cost per unit £25.00 £22.50
Fixed costs £2,000,000 £1,800,000
Production (units) 400,000 400,000
Details of bonus scheme

Managers have to reach a minimum residual income target of £1,000,000 before a

bonus is paid. If the residual income total is above £1,000,000 managers will be paid a
bonus of 10% of the residual income. If the residual income is below £1,000,000,
managers do not receive a bonus. The minimum bonus is £100,000 (£1,000,000 *
10%).

Required:

(a) For each forecast calculate the minimum selling price for Product X that
will give managers a bonus of £100,000? Assume the minimum price is when full
capacity is achieved. Is there a significant difference between the minimum selling
prices for each forecast? (12 Marks)

(b) Managers of Product X argue that competitors use return on investment (ROI) for
bonus calculations and that ROI should be used for Product X. Managers believe
competitors expect a ROI of 20% for bonus calculations.

If the managers of Product X were offered a bonus for achieving a ROI of 20% or
better would this be acceptable to managers? You are required to compare
Forecast 1 and Forecast 2 in your calculations. (6 Marks)

Page 33 of 100
Exam question 8 (7.2021)
A company has £2,900,000 available to invest. After some early discussions the
company agreed that three departments could apply for the £2,900,000. Only ONE
department can invest the £2,900,000 and only ONE project can be identified for each
department. The weighted average cost of capital for the departments is 15%.

Estimated cash flows for the projects.

Project life 4 years 4 years 5 years

Department A Department B Department C
Year 1 £1,120,000 £500,000 £1,440,000
Year 2 £1,000,000 £500,000 £1,200,000
Year 3 £958,000 £1,640,000 £650,000
Year 4 £945,000 £1,790,000 £400,000
Year 5 £200,000
NPV £264 £14,619 £15,069
Department C has a project life of 5 years. Departments A and B have a project life of 4
years. The company did not specify a project life for the investment.

Additional information. The company employs 220 people and has a turnover of less
than £25 million. The company is a fairly typical small and medium-sized enterprise
(SME). The directors are pleased that the company is doing well compared to other
companies in the sector.

All the departments have been told to calculate cash flow as income plus depreciation.
The investment base for Return on Investment (ROI) and Residual Income (RI)
calculations is net assets at the beginning of the year.

The departments assume the straight-line method of depreciation will be used.

Therefore, they assume a constant rate of depreciation each year. The company always
assumes there is no residual value at the end of the project life.

Required: Compare the ROI, RI and NPV for the three departments. Evaluate
how the different measures may influence decisions. The weighted average cost of
capital for the company has been estimated at 15%. (17 Marks)

Page 34 of 100
Exam question 9 (1.2022)
Ani plc has produced its management accounts for the year ended 31 December 2021:

£
Sales 12,340,000
Variable costs (8,187,000)
Contribution 4,153,000
Fixed expenses (3,080,000)
Net profit 1,073,000
Capital employed 10,000,000
Ani plc wishes to improve its performance and identifies a potential investment:

£
Investment 1,600,000
Increase in sales 2,560,000
Increased in variable costs (1,256,000)
Increase in fixed expenses (1,222,000)
The required rate of return for the company is 8%.

Required

a) Compare the return on investment (ROI) and residual income (RI) of Ani plc
without the investment and the company including the investment. (13 marks)

b) Explain whether Ani plc should make the new investment given your results in
(a). Consider Ani’s performance without the investment, the performance of the
investment on its own, and the performance of Ani plc including the investment. (4
marks)

c) Explain why the measures of profit and capital employed should be controllable
by the division manager and not those figures used for accounting purposes. (4
marks)

d) Discuss the advantages and disadvantages of using ROI as a performance

measure. (12⅓ marks)

Total: 33⅓ marks

Page 35 of 100
 LECTURE 3: FINANCIAL CONTROL 2

FINANCIAL CONTROL
ISSUE OF EVA HOW TO DETERMINE

1, All the adjustments put a lot of EVA (Economic value added) = NOPAT - cost of capital *
pressure on managers. invested capital

2, Problems using book values 1, NOPAT

HOW TO DETERMINE NOPAT
3, Very big assumption that
Operating profit (profit before interest and tax)
company has fair way of allocating
ADD BACK NON-CASH ITEM
shared overheads
1, Depreciation
5, Poor data is a potential 2, other non-cash expense
problem. • bad debt incurred in the year OR change in
allowance for doubful debt,
6, Cost of capital is not easy to
• other non -cash expense incurred during the
identify
period
7, It may be dysfunctional if EVA 3, Interest expense on operating lease (after tax)
used for bonuses.
ADD VALUE ADDED ITEMS:
8, RI, ROI and EVA all have
problem that they can be 2, Research and development cost (recorded as
manipulated.
ADVANTAGES OF EVA expense in period)

9, Also all short-term measures. LESS: DEPRECIATION, AMORITZATION AND TAX

1, Economic depreciation
1, Measures economic profit 2, Amortization of R&D cost (related to R&D cost add
rather than accounting profit and back)
2, Measures wealth creation for 3, Loss of tax due to interest expense
investors. 2, WACC
3, Enable measure divisional • Cost of equity & book value of equity
performance • Cost of debt (after tax) & book value of debt
4, Adjustments allow for a ‘true’ 3, INVESTED CAPITAL = BOOK VALUE OF CAPITAL
comparison by eliminating non- EMPLOYED
cash expenses. Economic value of capital employed = INVESTED
CAPITAL
1, Book value of capital employed
Add: replacement cost (adjustment for accounting and
economic depreciation)
3, Net book value of development cost (after adjusted
amortization)
If development project has completed and started
amortization
4, Opening balance of allowance for bad debt, other
provision
Page 36 of 100
5, Other non - cash expense recorded in previous period
Question 1 (EVA01A)
Company A
Assets (Capital employed) £900

Debt financing 40%

Equity financing 60%

Cost of equity 12%

Cost of debt( pre-tax) 7%

Operating profit £100

Tax rate 30%

Required: Determine EVA?
Question 2 (EVA01B)
Company B
Assets (Capital employed) £900

Debt financing 60%

Equity financing 40%

Cost of equity 12%

Cost of debt( pre-tax) 7%

Operating profit £100

Tax rate 30%

Required: Determine EVA?

Page 37 of 100
Question 3:
Greenwich has an operating profit of £8,400,000, which includes a charge for
£2,000,000 for the full cost of developing and launching a new product that is expected
to generate profits for 4 years.
The company has an after tax weighted average cost of capital of 10%.
The operating book value of the division’s assets is £60 million, and the replacement
cost has been estimated at £75 million.
Taxation is paid at the rate of 20% of the operating profit
Required: Calculate the EVA?
Question 4:
Assume all the data is the same as the previous question. What is the EVA if the new
product is expected to generate profits for 2 years.
Required: Calculate the EVA?
Question 5:
Greenwich made a controllable profit after tax of £100,000 last year.
Annual depreciation was £80,000. The operating net book value of the company’s non-
current assets was £500,000.
Economic depreciation was £75,000.
The net replacement cost of the company’s non-current assets is 20% higher than their
net book value.
The company obtained some assets under operating lease arrangements. It has been
estimated that the net book value of the operating leases is £90,000 and the notional
interest expense of the operating lease payments was £8,000 for the year.
The company is 60% financed by equity and 40% financed by debt. Equity capital has a
cost of 10% per annum and debt has an after tax cost of 6% per annum.
Interest expense in the year was £9,000.
Tax is 30% of net operating profits before tax.
Required: Calculate the EVA?
Question 6:
Operating profits = £21 million
Operating profit was calculated after charging development and launch costs for new
product = £4 million
The new product is expected to generate profits for 4 years.
Taxation is paid at 25% of the operating profit
The risk adjusted WACC = 12%
The company’s non-current asset value is £50 million.
The replacement cost of the non-current assets is £64 million.
The net current asset value is £22 million.
Read question carefully – if tax cash paid is given we would use this figure. No tax
given so we have to calculate tax
Required: Calculate the EVA?

Page 38 of 100
Exam question 1 (7.2017)
You have been asked to prepare a short presentation to senior managers on the potential
limitations of Economic Value Added (EVA). The senior managers have already
identified that EVA is possibly too complex and any adjustments may be manipulated.
Required: Identify and evaluate up to six additional limitations that managers
should consider. (14⅓ Marks)

Exam question 2 (7.2018)

A management accountant been given a statement showing the Economic Value Added
(EVA) for the divisions in the company. The calculations seem to show a wide range of
performances with some divisions doing well and some divisions with a negative EVA.

Required: Discuss the problems that a management accountant needs to be aware

of when interpreting EVA calculations (15⅓ Marks)

Page 39 of 100
Exam question 3 (5.2017)
The following data is from the financial statements for the year ending 31 December
2017
£
Revenue 1,600,000
Operating costs 1,450,000
Operating profit 150,000
Interest 50,000
Profit before tax 100,000
Tax @ 30% 30,000
Profit after tax 70,000
Additional information
1, Project X started on 1st January 2017 and incurred costs of £30,000. These costs were
included in the operating costs for 2017. None of these costs had been capitalised in the
financial statements. This project will be completed in 2019.
2, The allowance for doubtful debts was:
Date £
st
1 January 2017 £50,000
st
31 December 2017 £20,000
3, Other non-cash expenses
2016 £10,000
2017 £20,000
4,
Cost of capital
Cost of Equity 10%
Cost of Debt (pre-tax) 6%
Gearing
Equity 70%
Debt 30%
5, Accounting depreciation was £50,000; Economic depreciation has been estimated at
£150,000
6, Capital employed
01/01/2017 £300,000
31/12/2017 £330,000
Required
(a) Calculate the Economic Value Added (EVA). (18 Marks)
(b) Economic Value Added (EVA) is often described as a tool for creating wealth. EVA
is also described as a tool that is suitable for large and small organisations. Evaluate
how a small company can develop strategies that will create wealth in the long term.
(A good answer will include appropriate examples) (15⅓ Marks)
(Total 33⅓ Marks)

Page 40 of 100
 LECTURE 4 TRANSFER PRICING

TRANSFER PRICE

TYPES OF QUESTION ISSUE OF TRANSFER PRICE

TYPE 1: FULL CAPACITY Case 1: Determine sale price to maximum

contribution
Entity produce full capacity in first division and this and both department under capacity => Issue: not
department could sale internal as well as internal achieve full capacity
sale leading to reduce to overall profit of the entity
lost contribution due to lose capacity => Why
Internal department also could purchase from issue raise => both department decision based on
internal and external maximum contribution
Second department choose sale price to
Required: Determine current profit under current maximum contribution
transfer price Sale price second department choose => under
capacity of the entity
Profit under second department purchase external
only
Case 2: Full capacity first division could sale
Profit under situation priority external sale of first outside and sale internal
division and the remained sale internally second department could purchase outside and
internal
TYPE 2: SPARE CAPACITY both division full capacity
=> Issue: Current transfer price policy transfer
Entity produce under full capacity and the first internal first and remained sale external
deparment could sale internal only allow second division decide source of purchase,
the division purchase full outside
The second department could sell different price => this make total profit of the entiy reduce
with difference sale demand because => the first division could not achieve full
capacity
The second department choose sale price to leading to reduce contribution of the first division
maximize profit or contribution amount reduction in contribution of first division
more than reduction in cost of second division
Required: Determine current profit with current Another reason: fixed cost is unchange irrespect
transfer price => need determine which price that level of production.
second department choose sale price The second division purchase from outside, fixed
cost of first division is incurred full.
Determine profit with revised transfer price => need this reduce profit of the entity
=> this need management intervention => to
determine new price that second department
achieve maximum profit of the whole entity
should choose => principle to achieve maximum profit =>
maximum external sale and remained sale internal
=> enable the entity achieve full capacity and
achieve maximum contribution and profit
Page 41 of 100
 TRANSFER PRICE

FEATURE OF GOOD TRANSFER PRICE SYSTEM METHOD OF TRANSFER PRICE

1, Allow division independence to increase motivation

1, MARGINAL COST BASED
Independence => in set selling price to sale internal as well
as external active in production plan Transfer price: margin cost
why increase motivation => ensure rights and Advantages:
responsibiilty of each divisional management • Enable the entity choose sale price to
Responsible for performance of the management's division maximum profit based on economic theory
based on effort MR = MC
2, Allow objective performance measurement of divisions • Easy to apply, transfer price assume equal
Means: enable to evaluate performance of each division variable cost (accountant easy to determine)
separately (such profit of division) Disadvantages:
as well as evaluate performance of division impact on
performance of the whole entity • Could not detemine profit of each
Why need this feature: ensure evaluate performance of division => impact on motivation of
each division separately division
set bonus for each division to improve their performance 2, ACTIVITY BASED COSTING
3, Ensure division's decision are in the best interest of Transfer price = cost (detemine based on ABC) +
both divisions and the company profit
=> example of case 1 or case 2 ADVANTAGES:
Avoide defunctional behaviour => division act for the best 1, Easy to apply and set sale price of each division
interst of its interest however this impact on performance 2, Enable the management of each division clear
of the whole entity undertand its transfer price and components of
transfer price
DUAL PRICING DISADVANTAGE:
1, reduce motivation of the management in sale
external (if division could sale its product both
Advantages => Ensure determine profit of each division =>
internal and external) => price fixed
evaluate performance of each division separately
2, ABC is complex system, need a lot of input
Ensure decision of each division is for the best interset of
data => accounting information system could not
the division as well as the whole entity
provide accurate figure
Disadvantage
1, Total profit of each division MORE than profit of whole
entity MARKET BASED PRICING
=> why => each division set target profit based on full cost
while price transfer to another division not based "selling
price" of selling division
If the entity set bonus for division based on profit of each 1, Market price might not be available =>
division lead to the issue => total bonus for each division especially with work in progress
more than total "benefit" the entity gain Market price could not determine
2, It might reduce motivational of selling division in 2, Transfer price should be lower than market
controlling cost price => if the entity sale internal save marketing
selling price based on cost and profit margin => the and distribution cost, sale staffs expense, credit
management has not motivation to control cost control => if set at market price => make
if cost increase => profit increase also (profit based on cost purchase department might be unhappy
=> cost * mark up) this not impact on purchase division => 3, Enable the entity reduce dysfunctional
purchase division has purchase cost based on margin cost behaviour
=> management of selling and purchase
Page 42 of 100deparment act for their interest, this impact on
interest of the entity
 NEGOTIATE BETWEEN MANAGEMENT CENTRAL ADMINISTRATION

What => transfer price based on result of What => transfer price set by top management
negotiate price between management division Matters should be considered:
Matters should be considered: Ensure reduce dysfunctional behaviour
1, can be time-consuming => agree final transfer
price
2, lose focus on core activity of each division =>
effectiveness of the work reduce
3, Price agreed depend on negotiate skills of each
division
Division with management having good negotiate
skills => better price => better performance (than
"real performance")
4, lead to divisional conflicts => due to negotiate
process => working environmental of the entity

Page 43 of 100
Question 1:
Kwun Tong PLC is a large manufacturing company with divisional performance
assessed on the basis of profitability. Division X of this company produces a single
product with 50% of the output sold externally and 50% transferred within the company
to Division Y which incorporates this product into another product. Both divisions are
currently operating significantly below full capacity.
Division X’s Costs per unit of product are (based on total output of 20,000 units):

HK$
Direct Materials 100
Direct Labour 150
Variable Manufacturing Overhead 150
Fixed Manufacturing Overhead 300
Selling and Distribution Costs* 100
Total Cost 800
* these costs are variable and apply to EXTERNAL sales only
Division X sells the external output at a price of HK $1,000 per unit. Internal transfers
to Division Y are made at a transfer price of HK $900 per unit (reflecting the saving in
selling and distribution costs).
In producing its final product, Division Y incurs further direct costs of HK $400 per unit
and overhead of HK $600 per unit (50% of this figure represents variable overhead and
50% is the fixed overhead per unit at current output level).
Division Y’s management believe the transfer price is too high and claim Division X
could not anyway sell more externally at its current price. Both divisions are concerned
with maximising profits and Division Y argues that a transfer price of HK $600 would
be beneficial to the company and still allow a good contribution margin for Division X.
Estimated demand for the external products is shown below :
Division X
Price $750 $1,000 $1,250
Demand 15,000 10,000 5,000
Division Y
Price $2,000 $2,250 $2,500
Demand 15,000 10,000 5,000
Required
a) Calculate the contribution of both divisions and of the company overall both in
the current situation and using the transfer price proposed by Division Y (14
marks)
b) Briefly explain the nature of the problem being caused by the transfer pricing
system in this situation. (6 marks)

c) Drawing on your knowledge of literature in this area, discuss ways in which

central management may act to reduce such problems arising from transfer
pricing systems. (13 marks)

Page 44 of 100
Question 2:
The processor division of Wan Chai computer company produces computer processors.
It has been the sole supplier to the portable computer division which produces and sells
finished computers. The current processor is sold to the computer division at a transfer
price of HK $350 per unit. This price is based on the current market price for very large
wholesale orders less selling and distribution costs which are not applicable in the case
of internal transfers.
These costs are variable and amount to HK $20 per unit. The processor division also
sells externally at a price of HK $420 per unit with these external sales making up 20%
of the total sales volume of 200,000 processors annually (the full capacity output).
The summarised financial details for the processor division for the last year :
HK $
Sales 72,800,000
Variable Costs
54,800,000
(HK $270 internal, HK $290 external)
Fixed Costs 11,500,000
Gross Profit 6,500,000
Processor Division (Combined internal and external sales)
A separate company has offered to sell similar processors to the computer division at
HK $330 per unit. The director of the division wishes to take up this offer and cease to
purchase internally. The processor division claim that they cannot afford to drop the
transfer price to this level but also claim that they would be able to replace no more than
50% of the lost internal sales with additional external sales. These additional sales
would also be likely to be at the lower price of HK $400 per unit. The performance of
both divisions is measured on the basis of profit generated and neither director is willing
to give way on this issue.
Required
a) Calculate the change in profit for the company overall and for each of the two
divisions arising from a decision by the portable computer division to use the
external supplier. (13 marks)
b) Briefly analyse the situation and consider whether central management should
intervene. (6 marks)
c) Literature in the area of transfer pricing covers a number of different
approachs such as using marginal cost as transfer price or using Activity Based
Costing techniques to split transfer price into two or more elements. Evaluate the
effectiveness of these two different approaches (you do not need to apply your
argument to the question above). (14 marks)
(Total 33 marks)

Page 45 of 100
Question 3:
The engine division of Sai Kung Boatbuilding Company produces boat engines
at the following standard costs.

HK$000’s
Materials 45
Labour 65
Overhead 78
Total Cost per engine 188
The standard labour rate is $250 per hour. Fixed Overhead is absorbed at a rate of $200
per hour. The remaining overhead is variable. The division is operating at full annual
capacity of 52,000 labour hours.
70% of the division’s output is sold to the boatmaking division of the company at a
transfer price of $235,000 per engine giving the engine division a 25% mark-up on total
cost. The remaining output is sold externally at a price of $250,000 per engine (extra
variable costs of $5,000 per engine are incurred for these sales).
The boatmaking division is struggling to meet its profit targets set by central
management. Currently all its engines are supplied by the engine division but it has
been approached by an external supplier offering to supply engines at $205,000 per
engine and is seriously considering changing supplier. In the event of losing its
internal sales, the division feels it could increase external sales to double the current
level but not beyond.
The company’s central management is concerned about the financial implications
of this change and is considering intervention.
Required
(a) Calculate the change in profit for the company overall and for each of
the two divisions arising from a decision by the boat-making division to
purchase all of its engines from the external supplier. (14 Marks)
(b) Calculate the overall financial impact for the company overall of a
decision by the engine division to drop the transfer price to $205,000 but to
supply only its spare capacity after maximising external sales (assume the
boat-making division can buy extra requirements externally at $205,000 per
engine). (3 Marks)
(c) Critically appraise the situation that has arisen in both parts (a) and (b) above
in the context of typical transfer pricing issues and evaluate the need for
central management intervention. (16 Marks)
Total 33 Marks

Page 46 of 100
Exam question 1 (5.2021)
Sevenoaks PLC is a manufacturing company organised on a divisional basis.
Divisional performance is assessed on the basis of profitability. Division A of this
company produces a number of products for internal transfer to various other divisions.
Currently all of the output of one of these products is transferred within the company to
Division B which uses this product to produce another final product which is sold
externally. Both divisions are currently operating below full capacity.
Division A’s Costs per unit of product are (based on current output of 15,000 units):
£
Direct Materials 300
Direct Labour 500
Factory Overheads 900
Total Cost 1,700
40% Mark-Up 680
Transfer Price 2,380
Factory Overheads include a fixed element absorbed at 100% of direct labour cost. The
remaining overhead is variable. Internal transfers to Division B are made at a transfer
price of £2,380 per unit.
In producing its final product, Division B incurs further direct costs of £400 per unit and
overhead of £900 per unit (60% of this figure is the fixed overhead per unit at current
output level and the remainder is variable overhead).
Estimated demand for the final product sold by Division B is shown below:
Price £3,500 £3,750 £4,000
Demand 20,000 15,000 10,000

Central management are concerned that overall profits are lower than expected.
Division B believes that the transfer price should be lowered and suggests a price of
£1,800. However, central management are also considering a dual pricing system
(transfer price split into two elements) to address the issue.
Required
a) Based on the information in the question, calculate the contribution of both
divisions and of the company overall both in the current situation and using the
transfer price proposed by Division B. (18 Marks)
b) Very briefly explain how a dual pricing system (as raised in the final
paragraph) might operate in practice. (i.e. Identify the two elements of the pricing
system). (4 Marks)
c) Critically discuss the advantages and disadvantages of central management
deciding to introduce a dual pricing system. (11 1/3 Marks)
(Total 33 1/3 Marks)

Page 47 of 100
Exam question 2 (5.2020)
The Generator Division of the London Wind Turbines Company produces generators
for wind turbines at the following standard costs.
£000’s
Materials 100
Labour 120
Overhead 310
Total Cost per Generator 530
The standard labour rate is £24 per hour. Fixed Overhead is absorbed at a rate of £35
per labour hour. The remaining overhead is variable. The division is operating at full
annual capacity of 400,000 labour hours. (The capacity and labour hour information
can be used to calculate production volumes).
80% of the division’s output is transferred internally to the Construction Division
of the company at a transfer price of £650,000 per generator giving the
Generator Division a substantial mark-up on total cost. The remaining output is sold
externally at a price of £680,000 per generator (extra variable costs of £15,000 per
generator are incurred for these sales).
The Construction Division is struggling to meet its profit targets. Currently all its
generators are supplied by the Generator Division but it has been approached by an
external supplier offering to supply similar generators at £550,000 per generator and is
considering changing supplier. In the event of losing its internal sales, the Generator
Division feels it could only increase its external sales by a further 50% of its current
level.
Required
(a) Calculate:
(i) The current profit of the Generator Division. (9 Marks)
(ii) The change in profit of the Generator Division if the Construction Division
uses the external supplier. (5 Marks)
(iii) The change in profit for the company overall arising from a decision by the
Construction Division to use the external supplier. (3 Marks)
(17 Marks)
(b) Calculate the financial impact for the company overall of a decision by the
Generator Division to drop the transfer price to £550,000 but to internally supply
only its spare capacity after maximising external sales (assume the Construction
Division can buy all of its extra requirements externally at £550,000 per
generator). (4 Marks)
(c) Identify at least three characteristics (qualities) of a good transfer price with a
very brief explanation of each (2 marks each). Briefly consider whether the two
transfer prices in this question meet these characteristics. (12 ⅓ Marks)
(Total 33 ⅓ Marks)

Page 48 of 100
Exam question 3 (5.2019)
Devonport Ltd is a large manufacturing company with divisional performance assessed
on the basis of profitability. Division A of this company produces a single product with
50% of the output currently sold externally and 50% transferred within the company to
Division B which incorporates this product into another product. Both divisions are
currently operating significantly below full capacity.
Division A’s Costs per unit of product are (based on current total output of 20,000
units):
£
Direct Materials 200
Direct Labour 350
Variable Manufacturing Overhead 400
Fixed Manufacturing Overhead 450
Selling and Distribution Costs * 100
Total Cost 1,500
* - these costs are variable and apply to EXTERNAL sales only
Division A sells the external output at a price of £1,800 per unit. Internal transfers to
Division B are made at a transfer price of £1,700 per unit (reflecting the saving in
selling and distribution costs).
In producing its final product, Division B incurs further direct costs of £500 per unit
and overhead of £800 per unit (40% of this figure represents variable overhead and 60%
is the fixed overhead per unit at current output levels).
Division B’s management believe the transfer price is too high and claim Division A
could not sell more externally at its current price anyway. Both divisions are concerned
with maximising profits and Division B argues that a transfer price of £1,200 would be
beneficial to the company and still allow a good contribution margin for Division A.
Estimated demand for the external product sold by Division B is shown below:
Price £2,800 £3,100 £3,400
Demand (units) 15,000 10,000 5,000
Required
a) Calculate the contribution of both divisions and of the company overall both in
the current situation and using the transfer price proposed by Division B (16
Marks)
b) Would the change in transfer price be likely to affect overall company profits?
Briefly explain the nature of the problem being caused by the transfer pricing
system in this situation. (7 Marks)
c) Identify different ways in which transfer prices may be set and consider how
the price may be set to reduce problems such as seen in this situation. (10 ⅓
Marks)
(Total 33 ⅓ Marks)

Page 49 of 100
Exam question 4 (5.2018)
Sevenoaks PLC is a manufacturing company with divisional performance assessed on
the basis of profitability. Division A of the company produces a single product.
Currently 25% of the output is sold externally and 75% is transferred internally to
Division B which uses this product as part of another product which it sells externally.
Both divisions are currently operating at full capacity.
Division A’s Costs per unit of product are (based on current total output of 25,000
units):
Direct Materials £150
Direct Labour £350
Overhead * £550
Selling Costs** £50
Total Cost £1,100
* - variable overhead is incurred at a rate of 80% of direct labour costs (the remaining
overhead is fixed)
**- these costs are variable and apply to EXTERNAL sales only
Division A sells the external output at a price of £1,400 per unit. Internal transfers to
Division B are made at a transfer price of £1,300 per unit (reflecting the saving in
selling costs and other internal efficiencies).
Division B’s management believe this transfer price is too high and is planning to buy a
very similar product from an external supplier for a cost of £1,150 per unit. Division A
believes that the current transfer price is necessary to allow them to earn a reasonable
profit. Without the internal sales they would be able to double their current external
sales (to 50% of overall capacity) but could not sell more than this. Division B argues
that a transfer price of £1,100 would be beneficial to the company and still allow a good
contribution margin for Division A.
Required
(a) Calculate the following:
i) The current profit (i.e. also show total fixed cost) of Division A. (11 Marks)
ii) The change in profit of Division A if Division B uses the external supplier (i.e.
Division A would increase external sales but make no internal sales). (4 Marks)
iii) The change in profit for both the company overall and for Division B arising
from a decision by Division B to use the external supplier. (3 Marks)

(b) Calculate the change in contribution (from the initial position) for each of the
two divisions if the transfer price were to be changed to £1,100 per unit. Assume
that Division A is permitted to maintain the 50% of capacity level of external sales
and Division B can still buy any shortfall externally at £1,150. (5 Marks)
(c) Critically appraise the situation that has arisen in the context of typical
transfer pricing problems and discuss whether it is advisable for central
management to act to reduce such problems arising from transfer pricing systems.
(10 ⅓ Marks)
(Total 33 ⅓ Marks)

Page 50 of 100
Exam question 5 (5.2017)
Blackheath PLC is a manufacturing company organised on a divisional basis. Divisional
performance is assessed on the basis of profitability. Division X of this company
produces a number of products for internal transfer to various other divisions. Currently
all of the output of one of these products is transferred within the company to Division
Y which uses this product to produce another final product which is sold externally.
Both divisions are currently operating below full capacity.

Division X’s Costs per unit of product are (based on current total output of 15,000
units):
£
Direct Materials 200
Direct Labour 400
Factory Overheads 600
Total Cost 1,200
50% Mark-Up 600
Transfer Price 1,800
Factory Overheads include a fixed element absorbed at 60% of direct labour cost. The
remaining overhead is variable. Internal transfers to Division Y are made at a transfer
price of £1,800 per unit.
In producing its final product, Division Y incurs further direct costs of £500 per unit and
overhead of £850 per unit (60% of this figure is the fixed overhead per unit at current
output level and the remainder is variable overhead).

Estimated demand for the final product sold by Division Y is shown below:
Division Y
Price £2,700 £3,000 £3,200
Demand 25,000 20,000 15,000
Central management are concerned that overall profits are lower than expected and
suspect that the transfer pricing system may be causing a problem. Division Y believes
that the transfer price should be lowered and suggests a price of £1,200. However,
central management are also considering a dual pricing system (transfer price split into
two elements) to address the issue.
Required
A, Based on the information in the question, calculate the contribution of both divisions
and of the company overall both in the current situation and using the transfer price
proposed by Division Y.(16 marks)
B, Very briefly explain how a dual pricing system (as raised in the final paragraph)
might operate in practice. (5 marks)
C, Critically discuss the advantages and disadvantages of central management deciding
to introduce a dual pricing system. (12 1/3 marks)
(Total 33 1/3 marks)

Page 51 of 100
Exam question 6 (5.2016)
Tonbridge PLC is a manufacturing company with divisional performance assessed on
the basis of profitability. Division X of the company produces a single product.
Currently 20% of the output is sold externally and 80% is transferred internally to
Division Y which uses this product as part of another product which it sells externally.
Both divisions are currently operating at full capacity.

Division X’s Costs per unit of product are (based on current total output of 20,000
units):

£’s
Direct Materials 100
Direct Labour 300
Overhead * 450
Selling Costs** 100
Total Cost 950
*
- variable overhead is incurred at a rate of 100% of direct labour costs (the remaining
overhead is fixed)
**
- these costs are variable and apply to EXTERNAL sales only
Division X sells the external output at a price of £1,200 per unit. Internal transfers to
Division Y are made at a transfer price of £1,100 per unit (reflecting the saving in
selling costs).
Division Y’s management believe this transfer price is too high and is planning to buy a
very similar product from an external supplier for a cost of £950 per unit. Division X
argues that the current transfer price is necessary to allow them to earn a reasonable
profit. Without the internal sales they would be able to double their current external
sales (to 40% of capacity) but could not sell more than this. Division Y argues that a
transfer price of £900 would be beneficial to the company and still allow a good
contribution margin for Division X.
Required
A, Calculate the change in contribution for the company overall and for each of
the two divisions arising from a decision by the retailing decision to use the
external supplier. (14 Marks)
B, Calculate the change in contribution for each of the two divisions if the transfer
price were to be changed to £900 per unit. Assume that Division X will sell 40% of
capacity as external sales and Division Y can still buy any shortfall externally at
£950. (5 Marks)
C, Critically appraise the situation that has arisen in the context of typical transfer
pricing problems and, drawing on your knowledge of literature in this area,
discuss whether it is advisable for central management to act to reduce such
problems arising from transfer pricing systems. (14⅓ Marks)
(Total 33 ⅓ Marks)

Page 52 of 100
Exam question 7 (5.2015)
Deptford Ltd produces kitchen appliances including freezers. The company operates
with two divisions. The Electronics Division makes the electronic parts and the
Assembly Division puts together and sells the finished products to external customers.
The Electronics Division sells one specific type of cooling unit internally to the
Assembly Division at a transfer price of £161 made up as shown below:
£
Direct Materials 30
Direct Labour 25
Factory Overheads 60
Total Cost 115
Mark-Up 46
Transfer Price 161
Factory Overhead includes both a variable element and a fixed element. The fixed
element is absorbed at a rate of 90% of direct materials cost. There is no external market
for this specific cooling unit.
The Assembly Division incurs further variable costs of £80 per freezer and estimates the
following potential sales at various possible selling prices:
Price Sales Volume
(£) (Units)
550 12,000
500 15,000
450 18,000
400 22,000
350 25,000
Central management at Deptford have noted that budgeted sales units and total company
contribution for the freezer are lower than had been hoped. The Assembly Division
management, however, have confirmed that their proposed budget provides the best
possible contribution to divisional profits. The Assembly Division have also suggested
that a reduction of the transfer price would improve company profits and would still
give the Electronics Division a reasonable contribution. The Electronics Division argues
that the 40% mark-up included in the transfer price is necessary to cover all fixed costs
(including non-factory overheads) and to ensure a reasonable return for the division.
Required
A, Produce a table to show total contribution for both Deptford Ltd overall and for
the Assembly Division at each of the five possible prices. Identify the selling prices
which maximise contribution for the company and for the Assembly Division.(13
1/3 Marks)
B, Establish the likely effect on company profits of reducing the transfer price to
£115.(6 Marks)
C, Explain how the transfer pricing system is causing a problem. Consider how a
dual price system (fixed annual fee plus transfer price) based on Activity Based
Costing might help to overcome this type of situation. (14 Marks)
Total 33 1/3 Marks

Page 53 of 100
Exam question 8 (7.2017)
Asia Aeroplanes Ltd produces small aeroplanes. The company operates with two divisions. The
Engine Division which produces the aeroplane engines and the Bodywork Division which
produces the body of the planes and puts together and sells the finished planes to external
customers. The Engine Division transfers engines internally to the Bodywork Division at a
transfer price of £1,937,500 per set of engines. This transfer price is made up as follows (these
figures are based on the current output of 500 sets of engines):
£000’s
Direct Materials 250
Direct Labour 300
Factory Overheads 700
Total Cost 1,250.00
55% Mark-Up 687.5
Transfer Price 1,937.50
Factory Overheads include both a variable element and an absorbed fixed element. The fixed
element is currently absorbed at a rate of 90% of direct labour cost. The remaining overhead is
variable. There is no external market for this engine.
The Bodywork Division incurs further direct (material and labour) costs of £350,000 per plane
and further overhead costs of £500,000 per plane (20% of this figure represents fixed overheads
at current output levels with the remainder being variable overheads). The Division estimates
the following potential sales at various possible selling prices:
Price(£000’s) Sales Volume (Units)
4,000 500
3,600 700
3,200 900
2,800 1,100
2,400 1,300
The Bodywork Division’s budgeted sales for this plane are lower than central management
expected. The Bodywork Division management, however, have confirmed that their proposed
budget provides the best possible contribution to divisional profits. The division suggests that
the mark-up for the Engine Division could be reduced.
Required
A, Produce a table to show total contribution for both Asia Aeroplanes Ltd overall and for
the Bodywork Division at each of the five possible prices. Identify the prices which
maximise contribution both for the company and for the Bodywork Division.(13 Marks)
B, Recalculate the table showing the effect of reducing the mark-up for the Engine
Division to 35% (and hence reducing the transfer price) as suggested by the Bodywork
Division. State the likely change in overall contribution for the company and state whether
this is the optimum level of contribution. (4 Marks)
C, Briefly explain how the transfer pricing system is causing a problem in this situation.
(5 Marks)
D, Drawing on your knowledge of literature in this area, critically discuss whether it is
advisable for central management to act to reduce such problems arising from transfer
pricing systems. (11⅓ Marks)
(Total 33 ⅓ Marks)

Page 54 of 100
Exam question 9 (7.2018)
Tunbridge Wells PLC is a manufacturing company with divisional performance
assessed on the basis of profitability. Division X of the company produces a single
product. Currently 30% of the output is sold externally and 70% is transferred internally
to Division Y which uses this product as part of another product which it sells
externally. Both divisions are currently operating at full capacity.
Division X’s Costs per unit of product are (based on current total output of 20,000
units):
£
Direct Materials 200
Direct Labour 400
Overhead * 600
Selling Costs ** 100
Total Cost 1,300
* - fixed overhead is absorbed at a rate of 50% of direct labour costs (the remaining
overhead is variable)
** - these costs are variable and apply to EXTERNAL sales only
Division X sells the external output at a price of £1,600 per unit. Internal transfers to
Division Y are made at a transfer price of £1,500 per unit (reflecting the saving in
selling costs and other internal efficiencies).
Division Y’s management believe this transfer price is too high and is planning to buy a
very similar product from an external supplier for a cost of £1,350 per unit. Division X
believes that the current transfer price is necessary to allow them to earn a reasonable
profit. Without the internal sales they would be able to increase their current external
sales to 50% of overall capacity but could not sell more than this. Division Y argues that
a significantly lower transfer price would be beneficial to the company and still allow a
good contribution margin for Division X.
Required
(a) Calculate the following:

i) The current profit (i.e. also show total fixed cost) of Division X. (11 marks)
ii) The change in profit of Division X if Division Y uses the external supplier (i.e.
Division X would increase external sales but make no internal sales). (4 marks)
iii) The change in profit for both the company overall and for Division Y arising
from a decision by Division Y to use the external supplier. (3 marks)
(18 Marks)
(b) Briefly explain the effect that a lower transfer price (as proposed by Division
Y) would be likely to have in this situation. (5 Marks)
(c) Critically appraise the situation that has arisen in the context of typical
transfer pricing problems and discuss whether it is advisable for central
management to act to reduce such problems arising from transfer pricing systems.
(10 ⅓ Marks)
(Total 33 ⅓ Marks)

Page 55 of 100
Exam question 10 (7.2021)
Tonbridge Ltd operates with two divisions. Division X produces products for internal
transfer to other divisions. One of these products is transferred only to Division Y with
the transfer price of £2,400 per unit comprised of the following cost and other items:
£
Direct Materials 200
Direct Labour 500
Factory Overheads 900
Total Cost 1,600
50% Mark-Up 800
Transfer Price 2,400
Overhead includes an absorbed fixed element and a variable element which is incurred
at 25% of direct labour cost. There is no external market for this product.
Division Y incurs further variable costs of £2,100 per product and estimates the
following potential sales at various possible selling prices (note that the price is in
£000’s):
Price Sales Volume
(£000’s) (Units)
13 2,000
12 2,500
11 3,000
10 3,500
9 4,000
Central management at Tonbridge Ltd have noted that budgeted sales for this product
are lower than had been hoped. Division Y management, however, have confirmed that
the proposed budget provides the best possible contribution to divisional profits.
Division Y have also suggested that a reduction of the transfer price to £1,800 would
improve company profits and would still give Division X a reasonable contribution.
Required
a) Produce a table to show total contribution for both Tonbridge Ltd overall and
for Division Y at each of the five possible prices. Identify the prices which
maximise contribution for the company and for Division Y. (14 marks)
b) Recalculate the table showing the effect of changing the transfer price to £1,800
as suggested by Division Y. State the likely change in overall contribution for the
company and state whether this is the optimum level. (5 marks)
c) Explain how the transfer pricing system is causing a problem. Consider how
different transfer pricing systems might help to overcome this type of situation.
(Note that there are two parts to this question – ensure to answer both parts) (14⅓
marks)
(Total 33⅓ marks)

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Exam question 11 (1.2022)
The battery division of Lantau Ltd produces batteries for electric cars at the following
standard costs per battery.
£
Materials 250
Labour 200
Overhead 230
Total cost per battery 680
The standard labour rate is £20 per hour. Fixed overhead is absorbed at a rate of £15
per labour hour. The remaining overhead is variable. The division is operating at its full
annual capacity of 40,000 labour hours.
70% of the division’s output is transferred internally to the car-assembly division of the
company at a transfer price of £800 per battery. The remaining output is sold externally
at a price of £850 per battery (additional variable costs of £30 per battery are incurred
for these sales).
The car-assembly division is struggling to meet its profit targets set by central
management. Currently all its batteries are supplied by the production division, but it
has been approached by an external supplier offering to supply batteries at £700 per
battery and is seriously considering changing supplier. If it were to lose its internal
sales, the battery division feels it could only increase external sales to double the current
level and that these additional sales would be at the lower price of £825 per battery.
The company’s central management is concerned about the financial implications of
this change and is considering intervention.
Required
(a) Calculate the following:
i) The current profit of the battery division. (You will need to use the labour hours
information to calculate total volume first). (10 marks)
ii) The change in profit of the battery division if the car-assembly division uses the
external supplier. (4 marks)
iii) The change in profit for both the company overall and the car-assembly
division arising from a decision by the car-assembly division to use the external
supplier. (3 marks)
17 marks

(b) Calculate the financial impact for the company overall (compared to the
original position with no external purchasing) of a decision by the battery division
to drop the transfer price to £700 but to supply only its spare capacity after
maximising external sales (assume the car-assembly division can buy extra
requirements externally at £700 per engine). (4 Marks)
(c) Briefly explain and analyse the reasons for the problem that has arisen.
Critically analyse how using a system of transfer pricing based on Activity Based
Costing principles might help to avoid this type of problem. Note: there are two
parts to this requirement (c). (12⅓ marks)
Total: 33⅓ marks

Page 57 of 100
 LECTURE 5 BALANCE SCORECARD

BALANCE SCORECARD
WHAT KEY DEFINITION OBJECTIVES

Emphasises the need to A critical success factor is 'An element Objectives of balance scorecards
provide management with of the organisational activity which is 1 Internal and external matters
a set of information which central to its future success. concerning the organisation.
covers all relevant areas Key performance indicators: 2, Related to the key elements of a
of performance in an Measures used to assess whether company's strategy.
objective and unbiased CSFs are being achieved 3, Financial and non-financial
fashion measures are linked together.

CUSTOMER INTERNAL

BASIC QUESTION BASIC QUESTION

What do existing and new customers value from us? What processes must we excel at to
achieve our financial and customer objectives?
PERFORMANCE TARGET
PERFORMANCE TARGET
Gives rise to targets that matter to customers: cost, Aims to improve internal processes and decision-
quality, delivery, inspection, handling, and so on making
EXAMPLE OF GOAL AND KPI EXAMPLE OF GOAL AND KPI
New products: Percentage of sales from new Technology capability: Manufacturing configuration
products vs competition
Responsive supply: On-time delivery(defined by Manufacturing excellence: Cycle time or Unit cost
customer Design productivity: Engineering efficiency
New project introduction: Actual introduction
Preferred supplier: Share of key accounts'
schedule vs plan
INNOVATION & LEARNING FINANCIAL

BASIC QUESTION BASIC QUESTION

Can we continue to improve and create future How do we create value for our shareholders?
value?
PERFORMANCE TARGET PERFORMANCE TARGET
Considers the business's capacity to maintain its Covers traditional measures such as growth,
competitive position through the acquisition of
profitability and shareholder value but set through
new skills and the development of new products
EXAMPLE OF GOAL AND KPI talking to the shareholder or shareholders directly
Technology leadership: Time to develop next EXAMPLE OF GOAL AND KPI
generation of products
Manufacturing learning: Process time to maturity Survive: Cash flow
Product focus: Percentage of products that equal Succeed: Increase market share and ROI OR
80% sales Monthly sales growth and operating income by
Time to market: New product introduction vs division
competition

Page 58 of 100
Question 1:
BSC College
You have been appointed to a college and ask to assist in helping them develop their
corporate strategy over the next 3 years.
You have initially researched the college and ascertained the following information:
The College has year on year declining profits and rising costs. Their surplus of funds as
a percentage of turnover is only 5%. The Board wish this to be increased by 10% per
year over the next 3 years.
There are 110 members of staff but only 26 hold a teaching qualification and 10 a
doctorate.
They teach a wide ranging variety of subjects and the Board are hoping that more
research and teaching will be supplied to industry.
There is no guide to entry but they look to ensure that all students achieve a minimum
of at least 200 entrance points. The Principle feels that this is at least 25% below their
main competitors.
The applicants are split 60% home students and 40 % International students. The
College would like to increase the total number of applicants by 10% and in particular
International students by 20%.
You have also constructed the following table:
Table of Entrants
Leaves
Number of Year 1 Leaves after first
Not registered within first
applicants year
year
1250 150 50 25
The Board of Governors have concerns over the number of students failing to enter
Year 2 of their degree as the national average is 10% higher than the college.
Each year no more than 5% of students achieve a merit or distinction against a market
average of 9%.
Once they leave the college there is no record of what students then do. You find that
other educational establishments obtain information regarding the graduate’s
destinations 6 months after they graduate, with approximately 90% entering work or
further study.
Speaking to the Principle he confirms that generally all the students seem happy. You
find by conducting your own short survey that overall satisfaction is only 65% against a
national average of 86%.
Reviewing the facilities, there is refurbishment work required in the original building,
along with redecoration in other buildings. The estate manager has confirmed that they
are only at 80% of being in an acceptable condition.

Page 59 of 100
 New IT labs are required to be built as the college’s main competitors already have
these facilities.
This has impacted negatively on the functionality of the college and you have calculated
that currently the college is only achieving 60% functionality against your competitor’s
average of 85%.
Generally the campus seems dated and dirty, e.g. Rubbish lying around. The Board
inform you that they are in position 101 in the Green League Table from 102 colleges.
They have asked you to review how they can benefit from being involved in this and to
raise their position.
You have been given a table to complete which will form the basis of your
recommendations to the Board of Governors.
Required
Complete the table with at least 10 Key Performance Indicators (KPI’s) which you feel
will assist in developing the college strategy.
Please see the following example as a guide:
Perspective Objectives Measures Current 2017 Initiatives
% / figure Target
Customer Increase Total 100% 110% Increase marketing,
number of number of advertising, PR,
undergraduate students lecture, achievements
students

Page 60 of 100
Question 2
The Greenwich View Hotel has 40 en-suite bedrooms. It is medium-sized hotel and is
privately owned. In recent years total operating revenue has declined and a number of
regular customers have not booked again this year.
Another issue has been an increase in the number of complaints. In contrast, other hotels
in the area are reporting increasing operating revenue.
The manager has worked at the hotel for nearly 40 years and is looking to create a new
post for a management accountant.
The new management accountant has been asked to design a balanced scorecard for the
hotel.
Required:
(a) Identify and evaluate the benefits of implementing a balanced scorecard at the
Greenwich View Hotel. (14 marks)
(b) The management accountant identified the following Key Performance Indicators
(KPIs) for the financial perspective. She then asked the other managers to identify as
many performance measurement ideas as possible in order to cover all possible areas of
evaluation.
Financial Perspective
• Total operating revenue
• Revenue per available room
• Cost versus budget
Comments:
Measures can be weekly / monthly or even daily
Required:
Identify appropriate Key Performance Indicators (KPIs) for the CUSTOMER,
INTERNAL PROCESS, AND INNOVATION AND LEARNING
PERSPECTIVES. Three KPIs for each perspective are required. A good answer
should include a clear discussion of the causal links between the KPIs. (Discuss how
your KPIs would improve the financial KPIs above). (19⅓ marks)

Page 61 of 100
Question 3
The Tyrolean Hotel “Haus Edelweiss” in Austria was – after having been in the
possession of the family for 25 years – taken over in 2010 by the international hotel
conglomerate “Anywhere Hotels plc”.
The new owners send Scarlett Gehenna, their hotel asset manager who manages the
investment on the owners’ behalf and directs the efforts of the property managers.
It is her responsibility to ensure that the owners’ long-term value is enhanced.
Scarlett’s pursuit is guided by the conglomerates vision “To be the hotel of choice of
tourists in the rural areas of Europe”.
Scarlett is taking stock of the whole operation and detects many alarming facts that have
not surfaced during the takeover in addition to the financial results already known.
She realises that “Haus Edelweiss” has lost a lot of guests in the last few years.
On average, occupancy in the peak season plummeted by 22%, whereas occupancy in
the off-peak season decreased by 6% from an already low level.
To make things worse, the family hardly invested in new rooms according to a modern
day standard, banking on the “rural feel” of the place.
A survey of former guests of the hotel revealed that the rooms were more “shabby” and
less “rural”, the prices for rooms in the both peak and off-peak season were considered
too high, and the hotel didn’t offer much entertainment and activities for the guests in
any season.
Also, the hotel staff was referred to as “clumsy”, “rude”, “tardy” and “unreceptive to
my needs”.
A look at staff turnover showed an alarmingly high number of 78% (!).
On average, a member of staff stayed 12.5 months with the hotel.
Keen on getting the hotel back on track, Scarlett wants to introduce a balanced
scorecard in order to achieve these long-term corporate goals of the conglomerate.
Scarlett suggests the following tailor-made balanced scorecard for “Haus Edelweiss”:
Traditional Adapted Performance target Performance measure
categories categories
Financial Financial • Increase operating profit per • Annual operating profit per
room by 10% every year room
• Decrease operating costs by • Operating cost as a % of
5% every year sales
Customer Customer • Increase number of positive • Number of positive
feedbacks by 5% every year. feedbacks
• Decrease number of
complaints received by 10%
every year.
• Increase returning guest rate • Number of complaints
by 7% every year. received
• Increase number of bookings
• Returning customers as a %
of total customers

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 Internal Efficiency • Increase number of bookings • % of room booked through
Business made through reservation reservation channels
Processes channels (phone, agents,
other third parties) by 10%
every year.
• Increase room occupancy • Room occupancy
(peak/off-peak) by 15%.
Learning and Staff • Decrease staff turnover by • Staff turnover
Growth 20% every year.
• Increase average length of
employment by 15% every
year.
• Average length of
employment
The conglomerate’s objectives are clearly stated: increase turnover peak/off-peak,
reduce operating costs, increase number of bookings, increase customer satisfaction,
increase customer retention, increase room occupancy, increase employee satisfaction,
decrease staff turnover. Help Scarlett to make sense of it all!
Required:
a) Assess critically the relevance of the performance targets suggested by Scarlett. Pick
one from each of the categories “Customer”, “Efficiency” and “Staff” (so three
targets altogether), and comment on the suitability of each target provided. You
should clearly explain whether they are suitable or not and why, and in case they are
not, provide an alternative target and justify it. (15 Marks)
b) Scarlett suggests adding the performance measure “Number of training days
delivered” to the “Staff” category. You disagree and propose “Number of staff with
a recognised qualification in hotel & gastronomy services”. Scarlett is not sure;
convince her using a simple cause-and-effect diagram, and justify why your
suggestion is better than Scarlett’s. (6 Marks)
c) “Neither the quality of output nor the bottom line is by itself an adequate measure of
the performance of management and enterprise. Market standing, innovation,
productivity, development of people, quality, financial results – all are crucial to a
company’s performance and indeed to its survival. Performance has to be built into
the enterprise and its management; it has to be measured [...] and it has to be
continuously improved.” (Drucker, P.F. (1998), ‘On the Profession of
Management’, New York Free Press, 1998, p.173)

Critically discuss using Peter Drucker’s statement above why the focus on financial
outcomes alone is a detriment to value creation in the long term, and why
organisations need to adapt their Performance Management Systems to suit their
own individual needs rather than simply using a standard balanced scorecard.
(12 Marks)
(Total 33 Marks)

Page 63 of 100
Question 4
The Tyrolean Hotel “Haus Edelweiss” in Austria was – after having been in the
possession of the family for 25 years – taken over in 2010 by the international hotel
conglomerate “Anywhere Hotels plc”.
The new owners send Scarlett Gehenna, their hotel asset manager who manages the
investment on the owners’ behalf and directs the efforts of the property managers.
It is her responsibility to ensure that the owners’ long-term value is enhanced.
Scarlett’s pursuit is guided by the conglomerates vision “To be the hotel of choice of
tourists in the rural areas of Europe”.
Scarlett is taking stock of the whole operation and detects many alarming facts that have
not surfaced during the takeover in addition to the financial results already known.
She realises that “Haus Edelweiss” has lost a lot of guests in the last few years.
On average, occupancy in the peak season plummeted by 22%, whereas occupancy in
the off-peak season decreased by 6% from an already low level.
To make things worse, the family hardly invested in new rooms according to a modern
day standard, banking on the “rural feel” of the place.
A survey of former guests of the hotel revealed that the rooms were more “shabby” and
less “rural”, the prices for rooms in the both peak and off-peak season were considered
too high, and the hotel didn’t offer much entertainment and activities for the guests in
any season.
Also, the hotel staff was referred to as “clumsy”, “rude”, “tardy” and “unreceptive to
my needs”.
A look at staff turnover showed an alarmingly high number of 78% (!).
On average, a member of staff stayed 12.5 months with the hotel.
Keen on getting the hotel back on track, Scarlett wants to introduce a balanced
scorecard in order to achieve these long-term corporate goals of the conglomerate.
Scarlett suggests the following tailor-made balanced scorecard for “Haus Edelweiss”:
Traditional Adapted Performance target Performance
categories categories measure
Financial Financial • Increase operating profit per room by 10% • Annual
every year operating
profit per room
• Decrease operating costs by 5% every year • Operating cost
as a % of sales
Customer Customer - Increase number of positive feedbacks by • Number of
5% every year. positive
- Decrease number of complaints received feedbacks
by 10% every year. (CUSTOMER)

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 • Increase returning guest rate by 7% every • Number of
year. (CUSTOMER) complaints
received
• Increase number of bookings (CUSTOMER)
• Returning
customers as
a % of total
customers
Internal Efficiency • Increase number of bookings made through • % of room
Business reservation channels (phone, agents, other booked
Processes third parties) by 10% every year through
reservation
channels
• Increase room occupancy (peak/off-peak) by • Room
15%. occupancy
Learning and Staff • Decrease staff turnover by 20% every year. • Staff turnover
Growth
• Increase average length of employment by
15% every year.
• Average length
of employment
The conglomerate’s objectives are clearly stated: increase turnover peak/off-peak,
reduce operating costs, increase number of bookings, increase customer satisfaction,
increase customer retention, increase room occupancy, increase employee satisfaction,
decrease staff turnover. Help Scarlett to make sense of it all!
Required:
d) Assess critically the relevance of the performance targets suggested by Scarlett.
Pick one from each of the categories “Customer”, “Efficiency” and “Staff” (so three
targets altogether), and comment on the suitability of each target provided. You
should clearly explain whether they are suitable or not and why, and in case they
are not, provide an alternative target and justify it. (15 Marks)

Page 65 of 100
Question 5
Farflung Air was founded in January 2010 and is one of a growing number of low-cost
airlines in the United Kingdom.
Farflung’s strategy is to operate as a low-cost, high efficiency airline, and it does this
by:
• Operating mostly in secondary cities to reduce landing costs.
• Using only one type of aircraft in order to reduce maintenance and operational
costs. These planes are leased rather than bought outright.
• Having only one category of seat class.
• Having no pre-allocated seats or in-flight entertainment.
• Focusing on e-commerce with customers both booking tickets and checking in
for flights online.
The airline was given an ‘on time arrival’ ranking of seventh best by the UK’s Civil
Aviation Authority, who rank all 50 of the country’s airlines based on the number of
flights which arrive on time at their destinations. 48 Farfling flights were cancelled in
2015 compared to 35 in 2014. This increase was due to an increase in the staff absentee
rate at Farflung from 3 days per staff member per year to 8 days.
The average ‘ground turnaround time’ for airlines in the UK is 50 minutes, meaning
that, on average, planes are on the ground for cleaning, refuelling, etc for 50 minutes
before departing again. Customer satisfaction surveys have shown that 85% of
customers are happy with the standard of cleanliness on Farflung’s planes.
The number of passengers carried by the airline has grown from 300,000 passengers on
a total of 3,428 flights in 2010 to 920,000 passengers on 7,650 flights in 2015. The
overall growth of the airline has been helped by the limited route licensing policy of the
UK government, which has given Farflung almost monopoly status on some of its
routes. However, the government is now set to change this policy with almost
immediate effect, and it has become more important than ever to monitor performance
effectively.
Required:
(a) Describe each of the four perspectives of the balanced scorecard. (12 marks)
(b) For each perspective of the balanced scorecard, identify two goals together with
corresponding performance measures which could be used by Farflung to measure
the company’s performance. The goals and measures should be specifically
relevant to Farflung. For each set of goals and measures, explain why you have
chosen them. (21marks)

Page 66 of 100
Question 7
Upon reading the following passage, answer the questions below:
Bankers Back in the Classroom
By Andrew Hill
[Link]
Oct 16 2013.
Ask people outside financial services what bankers have been doing for the past few
years and you will probably receive an unprintable response. Ask bankers themselves
and they may reply: training.
In the wake of the financial crisis and a series of scandals and reputational blows, for
instance, all 98,000 employees of Deutsche Bank, about 13,000 senior bankers
at Goldman Sachs, and Barclays’ 140,000 staff have been or are being taken through
programmes aimed at reinforcing codes, values, behaviour and a strong, positive
corporate culture.

Source: [Link]
[Link]#axzz2p9RuJtUF
Required
a) Explain in more detail why in your opinion banks are taking this approach?
(4 Marks)

b) From your knowledge of the Balanced Scorecard approach to performance

measurement highlight the main perspectives within this approach, provide an
explanation of each and clearly highlight which perspective would the above
actions be incorporated within. (14 Marks)

c) List four ways in which the progress of the staff training can be measured
within the bank.
(6 Marks)

d) Describe any problems that you believe the banks may encounter in applying
this approach.
(9⅓ Marks)

(Total 33⅓ Marks)

Page 67 of 100
Exam question 1 (5.2021)
(a)
The owner of a hotel wants to introduce a Balanced Scorecard (BSC). She has seen that
similar hotels have already started to implement the BSC.
The main concern for the hotel is employee turnover. Employee turnover is increasing
and the owner believes this may be affecting the performance of the hotel.
Required: Prepare a short memo to the owner evaluating the potential benefits for
staff of implementing a Balanced Scorecard. (14 Marks)
(b)
Some management accountants believe the BSC may not actually improve financial
performance?
Required: Evaluate the conceptual and practical limitations of the BSC. This a
broad question requiring a range of issues to be raised. (19⅓ Marks)
(Total 33⅓ Marks)

Exam question 2 (5.2020)

A friend owns a medium sized company. She has built the company over a period of 10
years and wants to improve profitability. Recently she has read a little about the
Balanced Scorecard (BSC). All she understands is that the BSC is popular with
businesses.
Required
(a) Your friend wants some advice on the BSC. She believes a diagram would help
with an explanation of each perspective. She also asks for an example of an
appropriate objective for each of the four perspectives and an example of a
measure for each objective. (21 Marks)
(b) Before she adopts the BSC your friend wants a summary of the issues that are
relevant to managers in small and medium-sized enterprises (SMEs). (12 ⅓
Marks)
(Total 33⅓ Marks)

Page 68 of 100
Exam question 3 (5.2017)
According to The Grocer, Tesco boss Dave Lewis has found the old Balanced
Scorecard, internally branded as The Steering Wheel, too complex for staff to handle,
with more than 40 different metrics and is instead launching “The Big Six”, a new set of
principles he believes are more focused for staff.
[Link] 2015
Required:
a). Explain what is a balanced scorecard. (3 Marks)
b). Design a Balanced Scorecard incorporating its constituent parts that could be shown
to ‘staff’ members that would help in explaining what it is. (5 Marks)

c). Describe what is meant by ’40 different metrics’ in the context of the Balanced
scorecard and provide two examples (3⅓ Marks)
d). Tesco has a segment within its balanced score card termed ‘Community’
You have been asked by the Director of a food retailer to apply this perspective to a new
balanced scorecard and have been given the following headings to create a table that can
be given to the directors at the next board meeting.
Provide details of 4 objectives that they may have in this segment and how they would
measure them along with details of an initiative to assist in achieving the objective?
Perspective Objective Measure Initiatives
Community
(12 Marks)
e,
David Lewis states (above) that “The Steering Wheel, is too complex for staff to handle”
Write a memo to the Board of Directors which explains some of the problems
associated with the balanced scorecard approach. (10 Marks)
(Total 33⅓ Marks)

Page 69 of 100
Exam question 6 (5.2016)
(a)
You have been asked to prepare a brief memo to the board of directors detailing the area
of Performance Measurement and therefore you need to explaining what this is and in
particular the following terms:
(i) Balanced Scorecard
(ii) Holistic
(iii)Integrated
(iv) Lag indicators
(v) Lead indicators
(2 Marks each x 5 = 10 Marks)
(b)
Upon reading your memo the director’s state they have heard of the term ‘KPI’ and that
it is in some way linked to the Balanced Scorecard approach.
(i) How would you explain what the term KPI is?
(3 ⅓ Marks)
(ii) To support your explanation, detail what perspectives are within a balanced
scorecard and provide at least 4 examples of KPI’s for each perspective
(5 Marks each x 4 =20 Marks)
(Total 33 ⅓ Marks)

Page 70 of 100
Exam question 7 (5.2015)
(a) Explain what you understand by the terms:
(i) Strategy (2 Marks)
(ii) Acting strategically (5 Marks)
(iii) Strategic Management Accounting (2 Marks)
(9 Marks)

(b) A Balanced Scorecard is one ‘tool’ that management accountants can utilise to
assist a company’s strategy.

Explain what a balanced scorecard is, its general structure (you may use a
diagram to assist you) and how it actually assists a company. A good answer
will give actual real examples where possible.
(18 Marks)

(c) Explain what you understand by the following terms in relation to a Balanced
Scorecard, with an example of each:

(i) Cause and effect relationships

(ii) Lag Indicators
(iii)Lead indicators
(6⅓ Marks)
Total 33⅓ Marks

Page 71 of 100
Exam question 9 (7.2018)
The 10 best places to work in the UK:

2017

Rank Company Rating

1 Expedia 4.3
2 ARM Holdings 4.3
3 HomeServe UK 4.3
4 Mott MacDonald 4.3
5 Hays Plc 4.3
6 Peninsula 4.2
7 Unilever 4.2
8 Salesforce 4.2
9 Screwfix 4.2
10 First Derivatives 4.2
Your company director has handed you the above table and has stated that the new
corporate strategy incorporates the company achieving a top 10 status within the UK’s
‘top places to work’.

Required:

(a) Write a memo to the director, incorporating a diagram, explaining what a

balanced scorecard is and how it could assist the company in achieving its goal of
achieving a top 10 position. (18⅓ Marks)

b) Upon receiving your memo the director wishes to know what Key Performance
Indicator’s (KPI’s) you would want to use. Therefore provide the director with 5
relevant KPI’s, ensuring you provide a description for each one, along with how
they would assist the company in their corporate strategy. (15 marks)

(Total 33⅓ Marks)

Page 72 of 100
Exam question 9 (7.2021)
Training sessions for new graduate recruits are organised regularly by senior managers.
You have been asked to lead a session explaining the importance of the Balanced
Scorecard (BSC) in your company.

You are required to a prepare a session plan. The session plan outlines the content of
your session.

Required

Summarise the content of your session plan based on the following headings.

(a) Explain why Key Performance Indicators (KPIs) are identified by the
company. Include examples of different types of KPIs. (12 Marks)

(b) Explain and give examples of the following terminology:

(i) Cause-and-effect relationships

(ii) Lag indicators

(iii) Lead indicators

(9 Marks)

(c) Discuss the main criticisms of the Balanced Scorecard (12⅓ Marks)

(Total 33⅓ Marks)

Page 73 of 100
Exam question 11 (1.2022)
Bukit is an online retailer of books. It started its operations two years ago

Bukit’s customers tend to return to buy books from Bukit rather than its competitors and
spend on average £50 per year. Marketing is done mainly via social media and loyalty
discounts when existing customers introduce friends. Bukit is a cost differentiator
and bulk buys goods at cheap prices to offer customers low prices.

Bukit’s staff are mainly based in its warehouses, its delivery network of drivers and IT
department. Staff costs have increased in the last 12 months because of increasing fuel
costs, staff training as new staff are employed and building IT infrastructure and
security. The costs of offering its free next-day delivery service have increased. There
has been an average of one website crash per week in the last 6 months as demand has
increased from customers.

The founder and CEO of Bukit is Joni Ying. Joni is very involved in the day-to-day
running of the business and wishes to use the balanced scorecard to improve Bukit’s
performance. Bukit’s revenue is not growing as quickly as Joni had hoped at 3% per
year.

a) Describe each of the four perspectives of the balanced scorecard. (8 marks)

b) For each of the four perspectives of the balanced scorecard, identify two
objectives that Joni could set which could be used to measure Bukit’s performance.
The objectives should be specifically relevant to Bukit.

For each objective, identify the measure, target and one initiative that could help
Bukit to achieve its objective. (25⅓ marks)

Total: 33⅓ marks

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Exam question 12 (5.2022)
Klint Ltd is a bicycle manufacturer that was incorporated five years ago. It has been
increasing revenues by approximately 8% per year but profits are growing by only 2%
per year. The owner and manager of Klimt is Bex Klint and she has asked you for some
management accounting advice to help move her business forward. She does not have
much management accounting knowledge in the business at the moment and has relied
on off-the-shelf accounting packages to keep the financial records.

She has heard a little about the balanced scorecard as a management tool and would like
to know some more information about it. Bex is not sure if the balanced scorecard will
be applicable to her business because it is so small.

Required:

a) In the context of the balanced scorecard, explain what is meant by the terms:

• Strategic management accounting

• Integrated tool

• Business objectives

• Key performance indicators

(8 marks)

b) Explain any difficulties that Bex may encounter when implementing a

balanced score card approach in her small business. (12 marks)

c) For each of the four perspectives of the balanced scorecard, identify one
objective and two related measures that Bex could set to measure Klint’s
performance. (13⅓ marks)

Total: 33⅓ marks

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 LECTURE 6: BENCHMARKING

BENCHMARKING

OVERVIEW OF BENMARKING TYPES OF BENMARKING

PURPOSE OF BENMARKING? INTERNAL

1, Evaluate performance of manager for Advantages: 1, data - quick, easy, cheap
performance 2, only method => no external data + difficult to obtain due
to confidential of data
2, Performance gap => Actual performance <
Disadvantages: 1, no attention to external orginzation =>
Benmarking => KPIs (key performance indicators)
lost competitive advantages
3, Determine goal to achieve => KPIs 2, Lack of opportunity for improvement (not realize
4, Encourage management to achieve goals competitor better)
DISADVANTAGES: INDUSTRY
1, Difficult to find approriate information non-competitor + competitor
(confidenlity issue + comparable data = different BEST IN CLASS BENMARKING
charateristic) Disadvantages: 1, Lack of information for comparision
2, Not comparable information (difference in strategy, size,
2, Not method of innovation (idea of copying
nature of product)
others)

BENMARKING IN PUBLIC SECTOR

CUSTOMER BENCHMARKING

1, Some objectives could not be quantifliable

2, Customer benmarking => compare
Set target number of patient per annum, because number of patient
depend on many factors such as environment, weather performance with customer
2, Objectives of public sector set by many stakeholder, it is difficult for expectation => gain long term
the public sector to meet all objectvies of those stakeholders development
for example, with a public hospital, stakeholder includes patient,
government, staffs of the hospital. Each of stakeholder has difference 3, Objectives of customer
objectvies, government want reduce cost of operation of the hospital benmarking => meet customer's
with adquate level of service, staffs want increase income and reduce expectation and requirement
amount of work. This objectives might be conflict and it is difficult for
statisfing all the stakeholders. 4, This method => provide guidance
3, There is no directly link between input (resources used) and output for the company to set long-term
(results) of public sector
mission and stratgey
For example, rate of recover patient might not directly related to quality
of staffs, quality of medical equipment, in fact, it depend on patient 5, The entity might indentify sources
status. A hopsital with good staffs and medical equipment might has
of informatio for benmarking from
higher level of mortality rate because rate of serious patient
in the hospital might be higher than others "experience customers"
4, Information related to performane of public sector difficult to
6, The entity need understand these
obtain and might be manipulated
customer, redesign and implement
In order to set target for public sector organization, sometimes entity
marketing program to increase
need information from similar organization. However, some public
sector organization unit is unique and difficult to find appropriate data
For example, research weapon department of defense Page 76ministry
of 100
Information obtain to assess performane of public sector depend on
quality of information system of public sector organization. This system
is internal and sometime might be manipulate by management.
for example, to assess quality of service of public hospital, level of
Question 1:
Ganymede University (GU) is one of the three largest universities in Teeland, which
has eight universities in total. All of the universities are in the public sector. GU
obtains the vast majority of its revenue through government contracts for academic
research and payments per head for teaching students. The economy of Teeland has
been in recession in the last year and this has caused the government to cut funding
for all the universities in the country.
In order to try to improve efficiency, the chancellor of the university, who leads its
executive board, has asked the head administrator to undertake an exercise to
benchmark GU’s administration departments against the other two large universities
in the country, AU and BU. The government education ministry has supported this
initiative and has required all three universities to cooperate by supplying
information.
The following information has been collected regarding administrative costs for the
most recent academic year:

The key drivers of costs and revenues have been assumed to be research contract
values supported, student numbers and total staff numbers. The head administrator
wants you to complete the benchmarking and make some preliminary comment on
your results.
Required:
(a) Assess the progress of the benchmarking exercise to date, explaining the
actions that have been undertaken and those that are still required. (8 marks)
(b) Evaluate, as far as possible, Ganymede University’s benchmarked position.
(9 marks)

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Question 2:
You are a performance management expert brought in by the Chief Executive Officer
(CEO) of the Department of the Interior for the country of Essland. The department is
a branch of the Essland government which handles security, policing, immigration
and border control. The CEO is a civil servant and he reports to the Minister for the
Interior. The Minister for the Interior is an elected politician selected by the Prime
Minister of Essland, who leads its government.
The newly-elected Minister for the Interior has instructed the CEO to implement his
policy for improving the regional police forces’ performance by copying the method
used for schools. In a recent initiative by the School’s Ministry, a league table for the
hundreds of schools in Essland was created, showing the best and worst in terms of
examination performance only, in order to motivate senior school managers to
improve. The league table was used to create targets for assessing the schools’ and
their managers’ performance. Additionally, parents in Essland have the right to
choose which school their children attend and so often base their selection on league
table performance. Therefore, the Minister has had a policy review body draw up a
method of creating a league table for the police forces.
The CEO has requested your help to clarify his own thinking on this new policy for
the four regional police forces in Essland (Cashire (C), Dashire (D), Eshire (E) and
Fashire (F)). The CEO needs you to assess the use of the league table using the policy
review body’s suggested method and has collected the data and calculation of the
league table given in Appendix 1 to assist you. He also wants to assess whether the
table will help in meeting the Department’s aim and goals for the police. The overall
aim of the Department (and its police forces) is ‘to provide a value-for-money service
to ensure that the community can live in safety with confidence in their physical and
legal security’. The detailed goals of the Department are to:
– Tackle the underlying causes of crime and achieve long-term sustainable solutions
– Bring perpetrators to justice
– Provide protection and support for individuals and communities at risk of harm
– Respond to community needs by being accessible and engaging with their concerns
The CEO warned you, ‘I’m not interested in the performance of the forces. I’m
interested in the method of assessment, so don’t waste time with your ideas on how to
improve actual policing.’
The CEO also wishes to understand the strengths and weaknesses of the use of a
league table, its link to targets and the likely reaction of employees to this system of
performance management, especially as there is a strong union representing the
police. He is worried about the employees’ attitude to the introduction of the system
and its effects on their behaviour and their sense of accountability. He is also
concerned about importing the use of a league table from the schools sector, as it
might not be appropriate here.
Required:
(a) Evaluate the method of calculating and measuring the Force Scores for use in
the league table in achieving the Department of the Interior’s aims and goals. (14
marks)

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(b) Discuss the merits of league tables in performance management and address
the CEO’s concerns over their use in managing the performance of Essland’s
police forces. (11 marks)

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Exam question 1 (5.2020)
Greenwich Airline is in a competitive environment. Senior managers want to focus on
high levels of customer service. To improve customer service the airline agreed to take
part in a benchmarking report. Details from the benchmarking report are given below.
The report, by a London consultancy, included three competitors. Criteria for inclusion
included departure from London Gatwick in economy class with the flight being no
shorter than two hours. A total of 16 flight experiences were measured with all flights
taking place during the busy holiday period for one week in August.

Greenwich Competitor Competitor Competitor

Airline Blue Green Yellow
Check In/Bag Drop 80 100 100 80
In Flight Service - Entertainment 90 100 100 90
Plane cleanliness 90 100 100 90
Food and drinks 90 100 50 60
In flight shopping goods 60 100 100 80
Baggage Pick Up 50 80 80 90
Overall performance score 74% 94% 88% 82%
Required

The management accountant has been asked to write a brief memo on:

(i) The relative performance of Greenwich compared to the other airlines (7

Marks)

(ii) The limitations of the report. (10 Marks)

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Exam question 2 (5.2019)

(a)
A large international airport is concerned that non-aeronautical sales per person have
been falling in recent years. The airport wants to benchmark its performance to identify
areas for improvement. Identify and evaluate the measures an airport should include in a
benchmarking exercise if the target is to increase non-aeronautical sales per person (19
Marks)
(b)
The management accountant at Shanghai Engineering has been asked to write a short
report on the appropriate cost categories that are relevant to measuring the
environmental impact of investment decisions. Identify and evaluate the cost
classifications that could help managers gain a better understanding of the
environmental impact of investment decisions. (14⅓ Marks)

(Tota1 33⅓ Marks)

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Exam question 3 (5.2018)
Last year a company introduced a benchmarking exercise that includes mainly financial
and operational measures. The next step in the opinion of managers is to include a wider
range of measures. One suggestion is to investigate customer-driven benchmarking.
Managers have asked you to write a brief memo that explains and evaluates the
following :
(ii) customer driven benchmarking (8 Marks)
(iii) customer equity. (8⅓ Marks)

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Exam question 4 (5.2017)
A, A management accountant has previous experience of using targets in the private
sector. She has now changed careers and moved to a public sector organization.
Evaluate the problems she may face if she uses targets for performance measurement in
the public sector. A good answer will include a wide discussion on the different issues
faced by managers setting targets in the public sector. (10 Marks)

B, Discuss why a benchmarking exercise in the public sector may not be effective. (8
Marks)

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Exam question 5 (7.2017)
A, A public sector organisation wants advice on the different approaches to
benchmarking. Prepare a summary of the different ways a benchmark can be
established. (A good answer will evaluate the different approaches). (16⅓ Marks)
B, Discuss how an understanding of Activity Based Costing can help companies
improve their understanding of the impact of environmental costs. (17 Marks)
(Total 33⅓ Marks)

Exam question 6 (7.2018)

Explain the following terms:
(i) Industry Benchmarking
(ii) Best-in-class Benchmarking
A good answer will include examples from organisations in the public and private
sectors. (15⅓ Marks)

Exam question 7 (7.2021)

Greenwich Technology is a diversified international company that operates in more than
30 countries.

Senior managers have asked for a report on the different approaches to benchmarking in
the company. The report will help managers understand why there are different
approaches to benchmarking.

Required

Summarise and evaluate the different approaches to benchmarking:

(i) Internal benchmarking. (5 Marks)

(ii) Industry benchmarking. (6 Marks)

(iii) Best-in-class benchmarking (6⅓ Marks)

A good answer should include examples. (Total 17⅓ Marks)

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Exam question 8 (1.2022)
Teal University is a large university based in Winland. Winland has ten universities, all
of which are in the public sector. The Winland government funds universities’ research
and teaching costs.
Teal University wishes to reduce its administrative costs and so plans to undertake a
benchmarking exercise against two large universities in Winland: Scarlet University;
and Yellow University.
Teal University has identified the following measures to benchmark:
• Teaching facilities eg, owned buildings and computers and hired audio-visual
equipment
• Research facilities eg, laboratories, hourly-paid staff
• Student support services
• Staff costs
Required:
a) Identify the factors that affect the four measures Teal University has chosen to
benchmark. Describe how Teal University should determine whether Scarlet and
Yellow Universities are appropriate universities to benchmark against. (12 marks)
b) Describe the ways that benchmarking in the public sector is different to
benchmarking a listed company in Winland. (6 marks)
Teal University has a new strategy for 2022- 2030 to reduce its environmental
impact. As part of this strategy, all environmental costs must be identified to
enable both the financial costs and environmental impact to be reduced.
c) Explain six examples of environmental costs specific to the university that Teal
University should consider. (15⅓ marks)
Total: 33⅓ marks
Exam question 9 (5.2022)
Harry’s Hotels plc (HH) is a chain of hotels situated on the west coast of America. It has
50 hotels that are owned and managed by HH. The main revenue is from overnight stays
by individual or business guests and the spend in the hotel restaurant.

HH would like to benchmark itself against its competitors in the same region because its
revenue has been falling 5% per year over the previous 3 years.

HH has not yet identified whether this reduction in revenue is due to reduced overnight
stays, reduced restaurant bookings, fewer repeat guests, negative guest reviews, or other
factors. The benchmarking exercise is useful to determine identify how HH can
improve.

a) Identify and evaluate four measures that HH should include in a benchmarking

exercise if the target is to increase revenue per guest. (12⅓ marks)

b) What factors should HH consider in terms of the benchmarked hotels and the
measures chosen to ensure the benchmarking process is effective? (5 marks)

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 LECTURE 7: ENVIRONMENT MANAGEMENT ACCOUNTING

ENVIRONMENTAL ACCOUNTING

TYPES OF ENVIRONMENTAL COST BARRIER TO IMPLEMENT ENVIRONMENTAL

ACCOUNTING

Conventional cost: raw material, labor, energy => Financial: resources constraint (significant
wastage through inefficiency (hidden within overhead) investment in equipment for protecting
Administration cost: cost of monitor, reporting and
environmental)
training issue related to environmental (e.g: cost of
testing quality of water, salary for supervisor of cleaning Attitude barrier: resistance to change (lazy
staffs, cost of preparing environmental report, audit cultural, no motivation, fear of change and
environmental report) failure, believe could not change)
Contingent cost: cost related to environmental might
Information barrier: difficult to collect
incurred in the future. (dismantling cost)
Relationship cost: support for environmental protection environmental information
organization, produce environmental information for Institutional barrier: lack of institutional
public pressure, lack of power from driver for change
Reputation cost: cost associated with failure
Management barrier: few incentives provided
environmental issue (lost sale due to boycotts from
customers) to management environmental cost

FACTORS ENCOURAGE IMPLEMENT

ABC ENVIRONMENTAL ACCOUNTING

Activity Driver Coercive factor => regulatory compliance =>

Pollution prevention activity volume of comply with environmental protection law =>
(air, water, noise) wastage,
punishment due to not compliance
noise level
Resource recycling activity volume of Normative factor => protect environmental
(plastic, water, glass) recycle
related to voluntary adoption (staff training,
Activity for efficiency utilization of wastage
resources, recycle industry member of professional body,
wastage
Mimetic factor => respond to proven
Administration activity labour hours
techniques, competition
(implement and maintenance of for
EMS, disclosure information, environmental ENVIRONMENT MANAGEMENT ACCOUNTING
monitor environmental impact) activity
METHODS
R&D activity time for R&D
(R&D product, technology reduce
Input and output
impact on environment)
Social activity centre % distribution Activity based costing => allocated environmental
enable for environmental to activity cost to cost unit => impact of production on
improvement activity environmental on cost of product => allocated
overhead related to environmental
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Question 1:
EMA NPV GARDA plc
Garda plc manufactures resins that are used in the making of glues and paints. The
manufacturing process for the resins adopted by Garda is very energy intensive as high
temperatures are required in the process. Gas emissions in the process have been burnt-
off and the costs incurred treated as part of production overheads. The company’s
managers are becoming more aware of both the environmental impact of their
manufacturing activity and also the consequent likely decline in future sales of the resin
as glue and paint manufacturing customers seek more environmentally neutral inputs to
their own processes. The company’s sales manager has estimated that sales could
decline by over 10% a year for the next five years from a current figure of £20 million
for 2013 due to these environmental pressures.
Indeed largely in response to these concerns, the company’s Research & Development
function has developed a modified production technique which can process the resin at
much lower temperatures and both reduces process waste and converts the waste that
does result into a solid form which will possibly be more easy to dispose of to landfill
sites. This would however require a substantial modernisation of the existing production
process.
The following budgeted figures have been made by the company’s management
accountant with regard to adopting the new production technique.
All figures are £m’s
2014 2015 2016 2017 2018
Energy cost savings 3.4 3.7 4.2 4.6 5.4
Gas emission 2 2.3 2.3 3 3.8
burning costs saved
Costs of landfill [3] [3.5] [3.8] [4.8] [5.3]
sites for solid waste
Spending by R & D function on developing and testing prototype modified production
process to date £2.3 million.
Cost of modernising production process £12.8 million.
Estimated life of modified production process is 5 years.
The company’s cost of capital is currently 14%.
You are required to: Evaluate the possibility of modifying the production process for the
resin and reach a suitable recommendation. What additional considerations would you
suggest are relevant to the decision?

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Question 2:
Question based on 2016 exam
PTTP plc [‘Power to the People’] is an electricity-generating company producing and
selling power to large industrial users currently on 2 -year fixed price contracts. The
company’s pre-dominant goal is to make suitable returns on capital for its
shareholders.
The company currently operates 2 large coal-fired power stations located in
Yorkshire. Whilst both these stations have up to 10 years remaining generating life,
issues over the security of coal supplies [currently entirely imported from Russia] and
growing awareness of government and public concerns around carbon, sulphur and
dust emissions from coal combustion mean that the company’s directors are
considering decommissioning both their coal stations.
The directors are examining two possible alternatives :
1. Replacement by 3 gas-fired stations.
2. Replacement by 1 nuclear-fired power station.
Investment outlay, operating cost and carbon dioxide emissions statistics for the two
types of station are given below, together with comparable figures for coal-fired
stations where relevant.

Type of Maximum Operating Capital Total CO2

station generating investment emissions per
Cost of
power per cost per station
electricity
station station [million tonnes
generation
[MWs / hr] [£million] per year]
[£ / MW ]
Gas 300 45 900 3
Nuclear 1 200 15 6 000 1
Coal 400 35 N/A 10
Notes:
1. Maximum generating power is the output of a station measured in megawatts
(MW) at 100% operating capacity. The electricity produced by a station is
measured in megawatt hours (MWh). It is assumed that the same load factor
applies across all the different types of station, i.e. they are working at the
same percentage of capacity throughout the year.
2. Operating cost of electricity is the cost before the cost of financing the capital
invested in a station.
3. The CO2 (carbon dioxide) emissions are estimated based on industry standard
figures for these types of power stations. Capital costs and CO2 emission
figures are current best estimates.

Page 88 of 100
 4. The retail price of electricity per MWhour is not expected to increase in real
terms in the foreseeable future from its current level.
5. A nuclear station takes about five years to build (assuming no regulatory
difficulties or problems over the design choice). It has a life of 40 years and
costs about £2 000 million at current prices to decommission although this
estimate is uncertain as each site is unique in the decommissioning difficulties
which it presents. A gas station can come into operation within 2 years as
planning consents and building regulations are less stringent. Gas stations have
a similar useful life of around 40 years but end-of-life decommissioning costs
are significantly lower at estimated £100 million per station
6. Electricity demand is expected to rise by around 10% over the next 5 years in
UK.

The UK government has stated that there is a national goal to reduce carbon dioxide
emissions by 20% in the next five years. There is a government bill currently before
Parliament to raise a carbon tax on CO2 emissions in order to encourage reductions.
The rate of the tax is expected to be in the order of £5 per tonne of CO2 emitted. The
government is also concerned that there are other pollutants emitted by power stations –
most notably SO2 [sulphur dioxide] from coal fired stations - but has decided to focus
efforts on CO2 initially, as it is regarded as a key cause of climate change.

PTTP’s directors wish to demonstrate their company’s commitment to reducing carbon

dioxide emissions. They also are hopeful of the possibility of providing electricity to
the domestic consumer market at some time in the near future..
PTTP currently has a cost of capital rate of 12%.
Note : Cumulative Present Value factor £1 at 12% for 40 years is 8.2438
Present value of £1 at 12% at end 40 years is 0.0107
Required:
[i] Identify the key factors upon which you think the decision of PTTP to replace
its existing coal – fired stations with either gas or nuclear power generation will
depend. You should identify the risk factors in the decision choice. [12 marks]
[ii] By means of an appropriate evaluation approach, recommend to the
management of PTTP whether they should invest in gas or nuclear power
generation. Any calculations attempted should be to nearest £100 million. [6
marks]
[18 marks]

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Exam question 1 (5.2021)
A management accountant has been asked to write a report on what appears to be the
slow implementation of Environmental Management Accounting practices in the
organization. The report by the management accountant had the following main
headings.
Financial barriers
Attitudinal barriers
Informational barriers
Institutional barriers
Management barriers
Evaluate the barriers identified by the management accountant. (15 Marks)
(b)
Human rights and environmental, social and governance (ESG) issues can be
included in benchmarks to compare the performance of companies. Evaluate how
human rights and ESG issues may impact on a company.
This is a broad question. You are not required to describe in detail the different types
of measures that may be included in human rights and ESG benchmarks. (18⅓
Marks)
(Total 33⅓ Marks)

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Exam question 2 (5.2020)
Identify and evaluate the different motivations for firms to adopt Environmental
Management System (EMS) practices. A good answer will cover:
Relational Motivations (7 Marks)
Innovational Motivations (7 Marks)
Operational Motivations (2⅓ Marks)
(16⅓ Marks)

Exam question 3 (5.2019)

All senior managers have been sent a draft Economic Value Added (EVA) statement.
The management accountant has been asked to prepare a short summary of the
adjustments included in the EVA statement.
You are required to prepare a short summary of the following adjustments.
Your comments should be helpful for managers who do not have a background in
accounting and have little or no experience of EVA.
(i) Depreciation adjustment. (3 Marks)
(ii) Expenditure on research and development. (3 Marks)
(iii) Non-cash expenses (3 Marks)
(iv) Provisions for doubtful debts (3 Marks)
(v) Finance charge (5⅓ Marks)
(17⅓ Marks)

Exam question 4 (5.2018)

Implementing Environmental Management Accounting (EMA) techniques is a
challenge for management accountants. Identify and evaluate the potential barriers that
a management accountant should consider before implementing EMA. A good answer
should focus on the following:
• Financial barriers
• Attitudinal barriers
• Informational barriers
• Institutional barriers
• Management barriers
(17 Marks)

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Exam question 5 (5.2017)
The senior managers in a company are not sure how to categorise environmental costs
for project appraisal purposes. Prepare a summary of the main categories for costs that
would be helpful for completing a net present value evaluation. A good answer will
include examples of costs for each. (15⅓ Marks)

Exam question 6 (5.2016)

Your company director has heard of the term Environmental Management Accounting
(EMA), but is unsure what this term means and how it applies to the company.
Required
(a) Write a memo to him explaining:
(i) What is EMA? (8⅓
Marks)
(ii) How could it be applied to the company?
(7 Marks)
Upon reading your memo he has now requested you present to the board some EMA
techniques that identify and allocate environmental costs.
Required
(b) Prepare notes describing the following EMA techniques:
(i) Activity based costing/management (8 Marks)
(ii) Life cycle costing (6 Marks)
(iii) Full cost accounting (4 Marks)
(Total 18 Marks)
(Total 33 ⅓ Marks)

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Exam question 7 (5.2015)
Question TWO
(a) Discuss the potential benefits to business decision making from the application of
effective environmental management accounting techniques.(17 Marks)
(b) J.C. Blunt plc (JCB) is a large manufacturer and installer of designer bespoke
kitchen and bedroom furniture. The directors have recently been reviewing JCB's
corporate objectives, and have added a new strategic objective entitled ‘Building a more
environmentally friendly business for the future’. The directors have recognised that the
company needs to reduce its environmental footprint. Consequently, JCB has adopted a
goal that, by 2020, it would have reduced its environmental impact by 60% (compared
to year 2010).
JCB has a large number of employees working as installation teams and also employs
sales and design people as well as craftsmen in its factories. Currently data (2013) show
that for a typical customer order there are three pre-order sales/design home visits and
two post installation visits to correct quality issues in addition to installation which
takes on average three days.
JCB runs a large fleet of commercial vehicles for its installation teams along with a
company car scheme for its sales / design employees. Tom Sutcliffe, manager in charge
of JCB's travel budget is reviewing data on carbon dioxide emissions to assess JCB’s
recent performance in this area in the light of the new strategic environmental objective.
At the beginning of 2014, JCB invested in new technology which is aimed to improve
the measuring and design process, reducing pre-installation visits and improving
product quality and installation times. This will also permit sales / designers to work
more from home and to increase the use of teleconferencing facilities by employees.
Data on JCB plc: Carbon Dioxide emissions
Measured in millions of Kgs 2010 Actual 2014 Actual 2020 (forecast)
Commercial fleet vans - diesel 110 78 64
Commercial fleet vans - petrol 20 15 7
Company car - diesel 15 13 9
Company car - petrol 25 24 20
Total 170 130 100
Required:
(a) Evaluate the data given on carbon dioxide emissions using suitable indicators.
Identify trends from within the data and comment on whether the company’s
behaviour is consistent with meeting its targets. (8 Marks)
(b) Suggest further data that the company could collect in order to improve its analysis
and also actions that the company might take to ensure it meets its reduction targets. (8
1/3 Marks)

Exam question 8 (7.2018)

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(a) A company’s senior managers have asked you for a report on environmental
management accounting (EMA). You are required to write a brief report in which you:
(i) Explain the term “environmental management accounting” (6 Marks)
(ii) and discuss how a better understanding of EMA can help the company. (12
Marks)

Exam question 9 (7.2021)

An internal survey at Greenwich Engineering shows that managers want to get more
information about environmental management accounting (EMA). Managers are not
familiar with the terminology used and need to understand why EMA is becoming more
important.

The management accountant has been asked to prepare a summary of the following:

(i) Explain the term environmental management accounting (6 Marks)

(i) Explain why EMA is becoming increasingly important in organisations. (10

Marks)

Exam question 10 (5.2022)

HH’s management accountant is keen to identify and understand the environmental
costs of running the hotels. The management accountant has decided to use activity-
based costing (ABC) to understanding the environmental costs of washing the hotel’s
towels and bed linen.

Towels are washed on a daily basis and bed linen is washed at the end of each guest’s
stay. The environmental costs identified are the water used, the amount of washing
detergent used, and the frequency of purchasing replacement cotton towels and linen.
Cotton plants require huge volumes of water to grow and be processed.

c) Identify the cost drivers for ABC for the environmental costs of washing towels
and bed linen. Explain how identifying each cost driver can help HH to reduce its
environmental costs. (8 marks)

d) Explain the financial and non-financial advantages to HH of using ABC for this
purpose. (8 marks)

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Contents
LECTURE 1: REAL OPTION ...................................................................................................... 2
Question 1 (Option to abandon) ............................................................................................ 5
Question 2 (Option to abandon) ............................................................................................ 6
Question 4 ............................................................................................................................. 7
Question 5: Option to abandon with sensitivity analysis ...................................................... 8
Question 6: Option to Delay.................................................................................................. 9
Question 7: Option to delay ................................................................................................ 10
Question 9: Option to abandon............................................................................................ 10
Exam question 1 (5.2021) Option to delay.......................................................................... 12
Exam question 2 (5.2020) Option to abandon ..................................................................... 13
Exam question 3 (5.2019) Option to abandon ..................................................................... 14
Exam question 4 (5.2018) Option to abandon ..................................................................... 15
Exam question 5 (5.2017) Option to delay......................................................................... 16
Exam question 6 (5.2016) Option to abandon ..................................................................... 17
Exam question 7 (5.2015) Option to delay.......................................................................... 18
Exam question 8 (7.2017) Option to abandon ..................................................................... 19
Exam question 9 (7.2018) Option to abandon ..................................................................... 20
Exam question 10 (7.2021) Option to abandon ................................................................... 21
Exam question 11 (1.2022) Option to abandon ................................................................... 22
LECTURE 2: FINANCIAL CONTROL 1 ................................................................................. 23
Question 1: .......................................................................................................................... 23
Objectives of bonus scheme ............................................................................................... 23
Question 2: .......................................................................................................................... 25
Question 3: .......................................................................................................................... 26
Question 4 ........................................................................................................................... 26
Exam question 1 (5.2021) ................................................................................................... 27
Exam question 2 (5.2020) ................................................................................................... 28
Exam question 3 (5.2019) ................................................................................................... 29
Exam question 4 (5.2018) ................................................................................................... 30

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 Exam question 5 (7.2017) ................................................................................................... 31
Exam question 6 (7.2016) ................................................................................................... 32
Exam question 7 (7.2018) ................................................................................................... 33
Exam question 8 (7.2021) ................................................................................................... 34
Exam question 9 (1.2022) ................................................................................................... 35
LECTURE 3: FINANCIAL CONTROL 2 ................................................................................. 36
Question 1 (EVA01A) ......................................................................................................... 37
Question 2 (EVA01B) ......................................................................................................... 37
Question 3: .......................................................................................................................... 38
Question 4: .......................................................................................................................... 38
Question 5: .......................................................................................................................... 38
Question 6: .......................................................................................................................... 38
Exam question 1 (7.2017) ................................................................................................... 39
Exam question 2 (7.2018) ................................................................................................... 39
Exam question 3 (5.2017) ................................................................................................... 40
LECTURE 4 TRANSFER PRICING ......................................................................................... 41
Question 1: .......................................................................................................................... 44
Question 2: .......................................................................................................................... 45
Question 3: .......................................................................................................................... 46
Exam question 1 (5.2021) ................................................................................................... 47
Exam question 2 (5.2020) ................................................................................................... 48
Exam question 3 (5.2019) ................................................................................................... 49
Exam question 4 (5.2018) ................................................................................................... 50
Exam question 5 (5.2017) ................................................................................................... 51
Exam question 6 (5.2016) ................................................................................................... 52
Exam question 7 (5.2015) ................................................................................................... 53
Exam question 8 (7.2017) ................................................................................................... 54
Exam question 9 (7.2018) ................................................................................................... 55
Exam question 10 (7.2021) ................................................................................................. 56
Exam question 11 (1.2022) ................................................................................................. 57
LECTURE 5 BALANCE SCORECARD ................................................................................... 58
Question 1: .......................................................................................................................... 58

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 Question 2 ........................................................................................................................... 61
Question 3 ........................................................................................................................... 62
Question 4 ........................................................................................................................... 64
Question 5 ........................................................................................................................... 66
Question 7 ........................................................................................................................... 67
Exam question 1 (5.2021) ................................................................................................... 68
Exam question 2 (5.2020) ................................................................................................... 68
Exam question 3 (5.2017) ................................................................................................... 69
Exam question 6 (5.2016) ................................................................................................... 70
Exam question 7 (5.2015) ................................................................................................... 71
Exam question 9 (7.2018) ................................................................................................... 72
Exam question 9 (7.2021) ................................................................................................... 73
Exam question 11 (1.2022) ................................................................................................. 74
Exam question 12 (5.2022) ................................................................................................. 75
LECTURE 6: BENCHMARKING ............................................................................................. 76
Internal........................................................................................................................................ 76
Best in class benmarking ........................................................................................................... 76
Purpose of benmarking? ............................................................................................................. 76
Question 1: .......................................................................................................................... 77
Question 2: .......................................................................................................................... 78
Exam question 1 (5.2020) ................................................................................................... 80
Exam question 3 (5.2018) ................................................................................................... 82
Exam question 4 (5.2017) ................................................................................................... 83
Exam question 5 (7.2017) ................................................................................................... 84
Exam question 6 (7.2018) ................................................................................................... 84
Exam question 7 (7.2021) ................................................................................................... 84
Exam question 8 (1.2022) ................................................................................................... 85
Exam question 9 (5.2022) ................................................................................................... 85
LECTURE 7: ENVIRONMENT MANAGEMENT ACCOUNTING ....................................... 86
Question 1: .......................................................................................................................... 86
Question 2: .......................................................................................................................... 88
Exam question 1 (5.2021) ................................................................................................... 90

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Exam question 2 (5.2020) ................................................................................................... 91
Exam question 3 (5.2019) ................................................................................................... 91
Exam question 4 (5.2018) ................................................................................................... 91
Exam question 5 (5.2017) ................................................................................................... 92
Exam question 6 (5.2016) ................................................................................................... 92
Exam question 7 (5.2015) ................................................................................................... 93
Exam question 8 (7.2018) ................................................................................................... 93
Exam question 9 (7.2021) ................................................................................................... 94
Exam question 10 (5.2022) ................................................................................................. 94

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