Topics: Variable cost, Fixed cost, Total cost Pages: 32 (10982 words) Published: May 10, 2013
Professional Pilot Paper – Options module

Advanced Performance Management

Time allowed Reading and planning: Writing:

15 minutes 3 hours

This paper is divided into two sections: Section A – THIS ONE question is compulsory and MUST be attempted Section B – TWO questions ONLY to be attempted Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Paper P5

Section A: THIS ONE question is compulsory and MUST be attempted


Mackerel Contracting (Mackerel) is a listed defence contractor working mainly for its domestic government in Zedland. You are a consultant brought in to advise Mackerel on a number of issues facing the company. The board need a report from you: • outlining the external factors affecting the profitability of a potential new contract and how these factors can be built in to the choice of the design budget which is ultimately set, • advising on a proposed change to the company’s information systems and • advising on suitable performance measures for Mackerel. Firstly, Mackerel is currently considering tendering for a contract to develop a new armoured personnel vehicle (APV) for the army to protect its soldiers during transport around any future battlefield. The invitation to tender from the government specifies that the APV should take two years to develop and test, and be delivered for a full cost to Mackerel of no more than $70,000 per unit at current prices. Normally, government contracts are approximately priced on a cost plus basis with Mackerel aiming to make a 19% mark-up. At the last briefing meeting, the institutional shareholders of Mackerel expressed worry about the volatility of the company’s earnings (currently a $20.4m operating profit per annum) especially during the economic downturn which is affecting Zedland at present. They are also concerned by cuts in government expenditure resulting from this recession. The Zedland minister for procurement has declared ‘In the current difficult economic conditions, we are preparing a wide ranging review of all defence contracts with a view to deciding on what is desirable within the overall priorities for Zedland and what is possible within our budget.’ The government procurement manager has indicated that the government would be willing to commit to purchase 500 APV’s within the price limit set but with the possibility of increasing this to 750 or 1,000 depending on defence commitments. In the invitation to tender document, the government has stated it will pay $7.5m towards development and then a 19% mark-up on budgeted variable costs. Mackerel’s risk management committee (RMC) is considering how much to spend on design and development. It has three proposals from the engineering team: a basic package at $7.5m (which will satisfy the original contract specifications) and two other improved design packages. The design packages will have different total fixed costs but are structured to give the same variable cost per unit. It is believed that the improved design packages will increase the chances of gaining a larger government order but it has been very difficult to ascertain the relevant probabilities of different order volumes. The RMC need a full appraisal of the situation using all suitable methods. The risk manager has gathered information on the APV contract which is contained in appendix A. She has identified that a major uncertainty in pricing the vehicle is the price of steel, as each APV requires 9.4 tonnes of steel. However, she has been successful in negotiating a fixed price contract for all the steel that might be required at $1,214 per tonne. The risk manager has tried to estimate the effect of choosing different design packages but is unsure...
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