PDF OPERATIONAL CASE STUDY February 2019 EXAM ANSWERS Variant 2

OPERATIONAL CASE STUDY February 2019 EXAM ANSWERS Variant 2

SECTION 1 DECISION CRITERIA UNDER CONDITIONS OF UNCERTAINTY The three decision criteria used under conditions of uncertainty are known as maximax, maximin and minimax regret. Maximax criterion A decision maker that uses the maximax criterion is an optimist. Using this approach, the option chosen will be the one that offers the maximum monthly return. The maximum return here for each product range are: F$218,400 for the climbing wall, F$174,000 for the playhouse and F$256,800 for the adventure platform. Therefore, under this criterion we will choose the adventure platform as this gives us the highest possible return. Maximin criterion A decision maker that uses the maximin criterion is a pessimist. Using this approach, the range that maximises the minimum return achievable will be selected. The minimum returns for each of the three ranges are: F$40,800 for the climbing wall, F$108,000 for the playhouse and F$32,400 for the adventure platform. Therefore, under this criterion we will choose the playhouse as this is the highest of the three lowest returns. Minimax regret criterion A decision maker that uses the minimax regret criterion is often referred to as a "bad loser". The decision is made by firstly identifying the product range that maximises the return at each of the three market conditions. The differential between the highest return and the other two at each of the market conditions represents the regret of having made a bad choice. If the market demand is low the playhouse has the best return and so the regret of choosing the playhouse is F$0. The climbing wall has a regret of F$67,200 (= F$108,000-F$40,800) and the adventure platform has a regret of F$75,600 (= F$108,000-F$32,400).

CIMA 2019 ? no reproduction without prior consent February 2019 Operational Case Study

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Once we have completed the regret table we then choose the product range that minimises the maximum regret, or to put it another way, we select the best of the worst. So, the maximum regrets for each product range are: F$67,200 for the climbing wall, F$82,800 for the playhouse and F$75,600 for the adventure platform. Therefore, under this criterion we will choose the climbing wall as this has the minimum of the maximum regrets of the three product ranges.

CIMA 2019 ? no reproduction without prior consent February 2019 Operational Case Study

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DEVELOPMENT PROJECT EXPENDITURE

How the criteria in IAS 38: Intangible assets apply to the development project

The project to develop the new product ranges has been underway for approximately two months. Under IAS 38 we can capitalise the costs incurred for a development project from the date that six criteria have been met. These six criteria are as follows:

? The intangible asset must be technically feasible. As the working prototypes were completed on 31 January we can assume that this is the date that this was achieved.

? There must be an intention to complete the intangible asset and use or sell it. As the senior management authorised Grace to start work on the project on 1 January and set a deadline for 28 February, this criterion has been satisfied.

? Resources to complete the development must be available. The finance and staff resources were made available to complete this project on 1 January.

? The intangible asset will generate probable future economic benefit. The market research consultancy firm confirmed that the market was viable on 14 January. In addition, the demand estimates that the consultancy supplied show a positive return even at the markets lowest demand level. Therefore, this criterion was met on 14 January.

? The costs to be capitalised can be reliably measured. The schedule of expenditure identified for the project are proof that this criterion has been met.

? There is an ability to use or sell the intangible asset. As we have developed these product ranges internally with the express intention to sell them in the commercial market, this criterion was met on 1 January.

Therefore, all these criteria had been met on 31 January and this is the date that we should consider that the intangible asset was created.

Treatment in the financial statements for the year ending 31 December 2019

As 31 January is the point at which the intangible asset was created, we can capitalise relevant expenditure incurred from that date until 28 February, which is the date that the project was completed. Relevant expenditure includes any expenditure which is directly attributable to creation of the intangible asset and includes salaries and raw materials and consumables. The advertising costs are specifically excluded under IAS 38 as this expenditure is not incurred to generate the intangible asset.

Although the new cutting machine can be capitalised it is not an intangible asset and therefore will not be covered under IAS 38. Instead this will be part of property, plant and equipment and depreciated in accordance with IAS 16: Property, plant and equipment.

The intangible asset will be shown in the statement of financial position and will be amortised once production begins. Given the project is to develop three new products and only one will be launched on 1 May, then one third of the asset can be amortised from 1 May (the rest will start to be amortised once the other two products are launched). Therefore, in the statement of profit or loss there will be an eight-month charge for the year. The amortisation period should reflect the useful economic life of the asset, which will be the anticipated life of the new product range.

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SECTION 2

SALES FORECASTING

How the information has been used to forecast sales demand for our climbing walls

The trend formula has been assumed to apply to our climbing walls because it has been taken from actual sales of similar products. The trend is the long-term direction or underlying movement in values in a set of data. The trend formula, Y = 188 + 12 M is the formula for a straight line and shows an upward demand. We can expect to sell (188+12) 200 climbing walls in the first month following launch and 12 more for every month after this: this is the basis on which the trend for sales of our new climbing wall has been calculated.

Once we had the forecast trend figures for each month's sales for the first year, we adjusted the trend for seasonal variations. Seasonal variations are short?term, predictable variations in the trend. For example, sales of climbing walls may increase during periods when demand for our customers' services is low. These periods would be the most practical time for customers to renew equipment. Our domestic outdoor play equipment is also subject to seasonal variations as we experience higher demand during the summer than we do in the winter.

As the seasonal variation for climbing walls is based on the multiplicative model, this means that the seasonal variation for each month is a proportion of the trend. For example, in January the forecast sales will be 50% below the trend forecast, while in October the seasonal variation will be 50% higher than the trend forecast. We can adjust all the monthly trend figures by the relevant month's seasonal variation and aggregate them to arrive at a demand forecast for the first year's sales.

How the sales forecast has then been used to set the raw material purchase budget

Sales demand is our principal budget factor. This means that sales demand is the element which limits output and therefore our performance and profits in this new sector. Therefore, all our functional budgets flow from the principal budget factor, which is why budget preparation starts with the sales forecast. To calculate our raw material purchase budget, we must follow the budget setting process in a set, logical order.

Once we know how many climbing walls we are forecast to sell each month, we can produce the sales budget. The sales budget will detail the number of climbing walls and the revenue that we expect to achieve from them. Following this we calculate how many climbing walls we need to produce to satisfy the sales budget: this is the production budget. The production budget will differ from the sales budget because, in the early months of production, when sales are below the trend we will be producing climbing walls and placing them in inventory. This inventory will reduce once sales demand increases from October onwards. From the production budget we calculate the material usage, that it the amount of raw materials that we will use in order to satisfy the production budget. We have standard cost cards that detail all the material requirements and we can use these to calculate how much of each of the different categories of raw materials we will need. At this point we can adjust for any fluctuations in raw material inventory levels and any normal loss to ascertain how much raw material we need to purchase.

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THE DECISION-MAKING UNIT (DMU)

A DMU is a term used to describe all the individuals that play a part in their businesses' buying decision-making process. These are:

Users: These are the members of an organisation that will use our climbing walls, in the case of the nurseries and play centres these will be the children and the carers or supervisors of the children. It is important that the sales team understands the needs of the users in order to match the correct product from the range with the organisation.

Influencers: These are the people that can steer the buying decision in a particular direction. For example, the local government will have a Health and Safety Officer and this person could decide that climbing walls are too high a risk for children in the play centre. Although influencers are often formal and internal to the organisation they can also be informal and external. For example, we sent prototypes to specialist children's magazines for review and when the results are published, they may influence the buying decision.

Gatekeepers: These are the people who control the flow of information to others. Even if we produce the best product in Fawland we will not be able to sell it unless we are known by the key roles in the buying decision. A good example of gatekeepers are the receptionists who prevent the members of the sales team from accessing the people in these key buying roles.

Buyers: The buyer is the professional purchasing role. This person will have a criteria for selecting the products and will be responsible for sourcing goods and negotiating the terms. In most cases this is the person that members of our team need to persuade that our products are the most fitting for their organisation's needs.

Decider: This is the person that will make the final decision about placing an order, usually a senior manager. For example, most organisations will operate within budgetary constraints and even if our products are the most suitable for the users, the Finance Director could still veto the deal.

Initiator: The initiator is the person that recognises that there is a need to be satisfied. This role could be as simple as replacing a worn out version of the product. In the case of the climbing walls this is unlikely to be a direct replacement as the climbing walls are novel and innovative. The fact that the Government has warned that children in Fawland are not fit enough may mean that organisations recognise the need for play equipment that means more physical exertion.

It is important to understand that the six roles in a DMU are not mutually exclusive. For example the carers of the children in the play centres or nurseries could also take the role of influencer. If a carer viewed the equipment as too advanced or dangerous for the children, as experts, they could influence the buyer not to buy.

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