(8 marks evenly spread using ticks)

Comment:
The net present value of GH₵65,200 is positive and the investment can therefore be recommended on financial grounds. However, it should be noted that the positive net present value depends heavily on sales in the first year. In fact, sensitivity analysis shows that a decrease of 5% in the first year sales will result in a zero net present value. (Note: you are not expected to conduct a sensitivity analysis)              (2 marks)

ABS Limited: Budget/actual reconciliation statement

• Can the venue guarantee proper safety and security of participants?
• Is there any competing events in the venue for the days for which the camp meeting is planned?
• Is the church having a contingency plan in the event of poor weather?
• Proximity of venue to participants and how it will encourage attendance.

A sunk cost is a cost that has already been incurred and thus cannot be recovered. A sunk cost differs from future costs that a business may face, such as decisions about inventory purchase costs or product pricing. Sunk costs (past costs) are excluded from future business decisions, because the cost will be the same regardless of the outcome of a decision.
Here are some examples of sunk costs:

• Marketing study: A company spends GH¢50,000 on a marketing study to see if its new product will succeed in the marketplace. The study concludes that the product will not be profitable. At this point, the GH¢50,000 is a sunk cost. The company should not continue with further investments in the product, despite the size of the earlier investment.
• Research and development: A company invests GH¢2,000,000 over several years to develop a left-handed smoke shifter. Once created, the market is indifferent, and buys no units. The GH¢2,000,000 development cost is a sunk cost, and so should not be considered in any decision to continue or terminate the product.
• Training: A company spends GH¢20,000 to train its sales staff in the use of new tablet computers, which they will use to take customer orders. The computers prove to be unreliable, and the sales manager wants to discontinue their use. The training is a sunk cost, and so should not be considered in any decision regarding the computers.
• Hiring bonus: A company pays a new recruit GH¢10,000 to join the organization. If the person proves to be unreliable, the GH¢10,000 payment should be considered a sunk cost when deciding whether the individual’s employment should be terminated.                                                                                                                                       (Any 3 points)

Life cycle costing is the profiling of cost over a products life, including the pre-production stage. Cost reduction may be achieved through the following means:
Target costing
The target cost is a product cost estimate derived by subtracting a desired profit margin from a competitive market price. The target cost may be less than the planned initial product cost, but will be expected to be achieved by the time the product reaches the mature production stage. At the maturity stage. The target cost may be higher than planned, hence management will want to put in place measures to target cost to an acceptable level as a one off measure. For instance, each stage in the supply chain may be reviewed, possibly with the aid of staff questionnaires, to identify areas of likely cost savings.
Value analysis
Value analysis is systematic inter-disciplinary examination of factors affecting the cost of a product or service, in order to devise means of achieving the specified purpose most economically at the required standard of quality and reliability. Value analysis will aim to eliminate non- value added activities– those that do not add value to the product in the eyes of its customers. Example goods returns and order correction, by so doing, cost associated with each stage of the product, would have been contained to an acceptable level.

Identification of a product
Target costing begins by specifying a product an organization wishes to sell. This will involve extensive customer analysis, considering which features customer’s value and which they do not. Ideally only those features valued by customers will be included in the product design.
Determination of the selling price
The price at which the product can be sold at is then considered. This will take in to account the competitor products and the market conditions expected at the time that the product will be launched. Hence a heavy emphasis is placed on external (competitor) analysis before any consideration is made of the internal cost of the product.
Determination of the target cost
From the above price a desired margin is deducted. This can be a gross or a net margin. This leaves the cost target. An organization will need to meet this target if their desired margin is to be met. Costs for the product are then calculated and compared to the cost target mentioned above.
Determination of the cost gap
If it appears that this cost cannot be achieved then the difference (shortfall) is called a cost gap. This gap would have to be closed, by some form of cost reduction, if the desired margin is to be achieved.                                         (Any 3 points)

Review features (Value engineering)
Remove features from the new window phones that add to cost but do not significantly add value to the product when used by the customer. This should reduce cost but not the achievable selling price. This can be referred to as value engineering or value analysis.
Team approach (brainstorming)
Cost reduction works best when a team approach is adopted. Wham limited should bring together members of the marketing, design, assembly and distribution teams to allow discussion of methods to reduce costs. Open discussion and brainstorming are useful approaches here.
Review the whole supplier chain
Each stage in the supply chain should be reviewed, possibly with the aid of staff questionnaires, to identify areas of likely cost savings. Areas which are identified by staff as being likely cost saving areas can then be focused on by the team. For example, the questionnaire might ask ‘are there more than five potential suppliers for this component?’ Clearly a ‘yes’ response to this question will mean that there is the potential for tendering or price competition.
Review component costs
Wham limited should look at the significant costs involved in components. New suppliers could be sought or different materials could be used. Care would be needed not to damage the perceived value of the product. Efficiency improvements should also be possible by reducing waste or idle time that might exist. Avoid, where possible, non-standard parts in the design.
Assembly workers
Productivity gains may be possible by changing working practices or by de-skilling the process. Automation is increasingly common in assembly and manufacturing and Wham limited should investigate what is possible here to reduce the costs. The learning curve may ultimately help to close the cost gap by reducing labour costs per unit. Clearly reducing the percentage of idle time will reduce product costs. Better management, smoother work flow and staff incentives could all help here. Focusing on continuous improvement in production processes may help.
Overheads
Productivity increases would also help here by spreading fixed overheads over a greater number of units. Equally ,Wham limited should consider an activity based costing approach to its overhead allocation, this may reveal more favorable cost allocations for the new window phone product or ideas for reducing costs in the business.                                 (Any 3 points)

Budgeted production overhead expenditure = Normal production volume × Absorption rate per unit
.                                                                     = 16,000 units × GH¢20 = GH¢320,000.
Since expenditure occurs evenly throughout the year, the budgeted production overhead expenditure is GH¢160,000 in each six-month period.

• Identification of “Decision Units”
• Preparation of “Decision Packages”
• Prioritization of decision packages within a decision unit.
• Prioritization of decision packages of various decision units.
• Allocate resources.
• Monitor and evaluate.
  Decision Unit: Each cost center can be a decision unit. Decision units should be a particular activity or a group of activities that can be independent and meaningfully identified and evaluated. Decision units should not overlap. The decision units should be discrete entities for management purposes, e.g. sites or programs.
  Decision Package: A decision package is a document, which identifies a discrete activity, function or operation within a Decision Unit for evaluation and comparison with other activities. Each decision package should be “standalone” containing the following information:
  *Identification data – program/activity for which the package is made.
  *Objective of the decision unit.
  *Objective of the decision package.
  *Feasibility Assessment:
  Is the program required?
  Is the program technically feasible?
  Is the program operationally viable?
  Is the program sound?
  *The benefit-cost analysis:
  Benefit /output (tangible) at existing/threshold/optimum level.
  Tangible costs at the existing/threshold and optimum level.
  Yearly phasing of the proposed expenditure.
  Consequence of non-funding.
  Alternatives considered

Ranking/Prioritization: The following are examples of criteria for ranking a decision package:
Statutory/Legally committed active programs.
Emergent programs arising from national events.
Advancement of knowledge or using innovative methods
Application of knowledge – proven methods for raising output.
Development of Technology based solutions
Welfare/safety issues
Facilitation of policy/decision making

Funding Decisions: Once all the decision packages have been ranked on the basis of pre-determined criteria, the funding decisions for the cost of total decision packages is made. While funding a decision package, it is necessary for management to indicate also the level at which activity/program should be carried out existing, threshold, or optimum level.
Monitoring & Evaluation: Since all the decision packages have to compete for funding, only those, which are most relevant to the organization, are funded. The monitoring and evaluation is done on the basis of the content and particularly the outputs described in the decision packages with fixed accountability.                                                                         (Any 3 points)

Internal Sources:

• Accounting records ; information on the existing costs and their behavior can be obtained.
• Production schedules. This will provide information on the products that are being produced with respect to their technical details.
• Information can also be obtained from the technical department with respect to state of the machinery and capacity utilization.
• Human resource record will make available the labour status, the trend in the labour market and type of skills needed by the company.                                                                                                                                           (Any 2 points)

External Sources:

• Government policy on labour: e.g. Current minimum wage, permissible maximum hours an employee can work.
• Industry information from trade bulletins.
• Prices of similar products or substitutes to be collected from business journals or collected from source through survey.
• Information about the technical features of the new product can be obtained from the internet.
• Ministry of Trade and Industry can provide data on market size of the product.                                                   (Any 3 points)

Market-based transfer prices:
Under this method, transfer prices are based on readily determinable and available market prices. The method is particularly applicable under competitive and efficient market conditions. This is applicable where there is an open market for the intermediate product of the selling division.
Limitations

1. Appropriate Market Price may not Exist:
2. Excess Production Capacity

Marginal cost transfer prices:
Under this method, transfer prices are based on variable costs. This is applicable under short term and in cases of one-off transactions and where the division is purely a cost centre.
Limitations
1. Long-term pricing. The method is completely unacceptable for long-term price setting, since it will result in prices that do not capture a company’s fixed expenses.
2. Ignores market prices. Marginal cost pricing sets prices at their absolute minimum. Any company routinely using this methodology to determine its prices may be giving away an enormous amount of margin that it could have earned if it had instead set prices at or near the market rate.
  3. Customer loss. If a company routinely engages in marginal cost pricing and then attempts to raise its prices, it may find that it was selling to customers who are extremely sensitive to price changes, and who will abandon it at once.

Full cost transfer prices (Absorption costing):
Full costs transfer prices are based on total costs; fixed and variable costs. This method is suitable when dealing with purely cost centres and for costing routine transactions. The method is also used when the entity is operating under the long run.
Limitations
   1. Ignores competition. A company may set a product price based on the full cost plus formula and then be surprised when it finds that competitors are charging substantially different prices.
 2. Ignores price elasticity. The company may be pricing too high or too low in comparison to what buyers are willing to pay. Thus, it either ends up pricing too low and giving away potential profits, or pricing too high and achieving minor revenues.
3. Product cost overruns. Under this method, the engineering department has no incentive to prudently design a product that has the appropriate feature set and design characteristics for its target market (see the target costing method). Instead, the department simply designs what it wants and launches the product.

Cost-plus a mark-up transfer prices:
Cost-plus mark-up based prices are based on costs and a profit element. This method is applicable when dealing with profit centres where in addition to the recovery of costs, divisional profitability is a prime objective.
Limitations
 1. Product cost overruns. Under this method, the engineering department has no incentive to prudently design a product that has the appropriate feature set and design characteristics for its target market (see the target costing method). Instead, the department simply designs what it wants and launches the product.
2. Contract cost overruns. From the perspective of any government entity that hires a supplier under a cost plus pricing arrangement, the supplier has no incentive to curtail its expenditures – on the contrary, it will likely include as many costs as possible in the contract so that it can be reimbursed. Thus, a contractual arrangement should include cost-reduction incentives for the supplier.
3. Ignores replacement costs. The method is based on historical costs, which may have changed. The most immediate replacement cost is more representative of the costs incurred by the entity.

Negotiated Transfer Price:
This is a price that is established as a result of discussions between the buying and selling divisions. Here, selling and buying divisions will only agree to the transfer price only if the profits of their respective divisions increase as a result of the transfer. This method of determining prices has various advantages: First, divisional autonomy is maintained. Second, managers of divisions have better cost versus benefit information. Where idle capacity exists for the selling division.
Limitations
1. Sub-optimal: The agreed transfer price may depend on the negotiating skills and bargaining powers of the managers involved. The final result may not always be optimal
      2. Conflicts: Rather than agreement on transfer prices, negotiations can lead to conflict between divisions and may require top-management mediation.
3. Defeat of Performance evaluation criteria: Transfer prices dependent on Manager’s negotiations skill will defeat the very purpose of performance evaluation.
4. Time and Cost: Negotiations are time consuming for the managers involved, particularly when the number of transactions and interdependencies are large.
(3 marks for Explanation, 3 marks for Limitations)