Answers to Textbook Questions
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A2 Accounting for AQA Answers to textbook questions Note: these are the answers to the texbook chapter questions which do not have an asterisk. The answers to the asterisked questions are in the back of the texbook. The page numbers below relate to the answers set out in this document.
A2 Unit 3 Further Aspects of Financial Accounting 1
Sources of finance
1
2
Incomplete records
2
3
Partnership final accounts
8
4
Changes in partnerships
15
5
Published accounts of limited companies
21
6
Cash flow statements
26
7
Accounting standards
30
8
Stock valuation
34
A2 Unit 4 Further aspects of Management Accounting 9
Manufacturing accounts
40
10
Costs and contribution
44
11
Break-even analysis
47
12
Absorption and activity based costing
52
13
Overheads and overhead absorption
57
14
Costing in decision-making
62
15
Standard costing and variance analysis
70
16
Capital investment appraisal
73
17
Further aspects of budgeting
79
18
Decision-making and social accounting
85
1
CHAPTER 1 Sources of finance 1.2
(a) Sajit will need a bank overdraft. Its features are: • borrowing on a current account up to a set limit • interest is only charged when the business borrows • variable interest rate • reviewed every year advantages: • flexibility – the borrowing can be repaid as and when funds are available • economical – interest only charged when the business borrows disadvantages: • interest rates for bank overdrafts can be higher than bank loan rates • repayable on demand • security normally required – danger of loss of property if business fails (b) Rachel will need a bank loan for the equipment for her business. Its features are: • a fixed amount over a fixed period • interest at a fixed or variable rate • a regular repayment schedule advantages: • easy to budget for, as the timing of repayments is known • the possibility of negotiating the timing of repayments (‘holiday’ may be possible) • interest rates may be lower than overdraft rates disadvantages: • a long-term financial commitment which has to be met • security normally required – which could include Rachel’s property (c) Basil will need a commercial mortgage. Its features are: • a long-term loan secured on business premises (ie the hotel) • finance available normally up to 70% of property value (Basil’s deposit of £150,000 will be sufficient) • interest at a fixed or variable rate • a regular repayment schedule advantages: • easy to budget for, as the timing of repayments is known • interest rates may be lower than overdraft rates disadvantages: • a long-term financial commitment which has to be met • the property will be required as security • if the business fails and the bank calls in the loan, Basil will lose his hotel
1.5
Tariq has two distinct financial needs: £80,000 for fixed assets and £70,000 for working capital. There is no ‘right or wrong’ answer to this question. In an exam situation the examiner will be looking for knowledge of the different forms of financing and a reasoned conclusion based on a discussion of the relevant advantages and disadvantages of each form. (a) asset finance The first consideration is likely to be whether the finance can be met from internal sources. The question states that Tariq is already putting in a capital contribution, so further internal financing could be met from a loan from the family – this has the advantage of being cheap and flexible, but the possible downside is the family wanting a say in the way the business is run. The other internal source of finance would be funding from cash generated from profits, but as the business is not yet trading this is not a viable option. The other options are financing from external sources: •
Bank loan – repayable over the long term, repayments can be budgeted for, repayment schedule may be negotiated to include ‘holiday’, interest fixed or variable rate; but . . . security will be required, Tariq may lose his house if the business fails. This is, on balance, probably the favoured option for asset finance.
•
Bank mortgage – not applicable as the office will be rented and not available as security.
•
Business angel – the finance may be available, but the angel will want a stake in the business and a say in how it is run – this may be an advantage or a disadvantage depending on Tariq’s expertise and ambitions for ‘going it alone’. The biggest downside will be the loss of total control, an issue which is often important for the entrepreneur.
1
•
Incorporation of the business as a limited company in order to attract external equity finance from a private equity firm – this is very unlikely in view of the small amount involved. It will also involve a partial loss of control of the business.
(b) working capital finance The requirement could be met from internal sources, but the same considerations in (a) apply, ie Tariq does not have more funds himself; also, involving the family could cause problems and financing from profits is not possible in a business start-up situation. The only other option is an external source of finance – the bank overdraft, which involves borrowing on a current account up to a set limit. The advantages are that it is flexible (the borrowing can be repaid as and when funds are available) and is economical (interest is only charged when the business borrows). The disadvantages are: an overdraft is repayable on demand (this would happen if the bank wanted to cancel the overdraft) and security will be required (the danger of the possible sale of Tariq’s house if the business fails).
CHAPTER 2 Incomplete records 2.2
£77,000
2.5 TALIB ZABBAR CALCULATION OF STOCK LOSS FOR THE YEAR ENDED 30 SEPTEMBER 20-7 £ Opening stock Purchases Cost of stock available for sale Sales 160,000 Less Normal gross profit margin (40%) 64,000 Cost of sales Estimated closing stock Less Actual closing stock Value of stock loss
2.7
•
£ 30,500 89,500 120,000
96,000 24,000 21,500 2,500
Calculating cost of sales, gross profit and sales: £ 890 46,753 47,643 950 46,693 46,693 93,386
Opening stock at 1 January 2004 Purchases Less Closing stock at 31 December 2004 Cost of sales Gross profit at mark-up of 100% ∴ Sales
Tutorial note: mark-up is applied to cost of sales, not to purchases.
•
Using a sales ledger control account:
Dr
Sales Ledger Control Account
2004 1 Jan
£ Balance b/d Sales
2004 31 Dec
96,172 2005 Balance b/d
Balance c/d
93,532 2,640 96,172
2005 1 Jan
£ Bank (missing figure)
2,786 93,386
Cr
2,640
2
•
Calculating the cash loss: £ 93,532 93,322 210
Cash expected to be banked (from control account) Cash actually banked ∴ Cash loss
2.8
(a) Dr
Summarised Cash Account
2003/04 1 Jan
£ Balance b/d Cash sales
Cr
2003/04
229
£ Bank
219,941
165,640
Expenses
49,600
29 May
Amount of cash stolen (missing figure)
31 May
Balance c/d
220,170
2.10
160 220,170
2004/05 1 Jun
4,770
2004/05 Balance b/d
160
(b)
Measures to prevent such a loss occurring in the future; any two from: • Record cash transactions as they occur, eg by using tills that issue receipts. • Collect cash from tills regularly, and place the cash in a safe in the office. • Bank cash regularly, so that there is a low level of cash on the premises at any time. • Pay bills by cheque rather than in cash, so avoiding the need to carry cash when paying creditors. • Divide duties within the business, ensuring that no one person is responsible for all cash handling. • Carry out cash checks at regular intervals, eg to ensure that the cash in tills balances against receipts. • Improve security, eg use of a safe in the office for cash to be banked, keep the office door locked when the office is empty, use of security cameras. • Set authorisation limits for employees who pay bills, to ensure that large amounts cannot be paid out without authority.
(c)
Advice to maintain accurate records of cash transactions; any two from: • Keep a detailed cash book. • Keep a copy of all receipts issued. • Use a numbering system for all receipts and invoices. • Prepare bank reconciliation statements each time a bank statement is received. • Use margin and mark-up to compare expected sales with actual sales figures.
(a) • • • • •
receipts from trade debtors less trade debtors at beginning of year add bad debts written off during year add trade debtors at end of year sales for year
£ 121,000 36,000 550 35,000 120,550
(b)
• • • •
payments to trade creditors less trade creditors at beginning of year add trade creditors at end of year purchases for year
62,500 32,500 30,000 60,000
(c)
• • • •
payments for expenses less accrual at beginning of year add accrual at end of year expenses for year
30,000 500 700 30,200
3
(d)
COLIN SMITH TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 JUNE 20-5 £ £ Sales 120,550 Opening stock 25,000 Purchases 60,000 85,000 Less Closing stock 27,500 Cost of sales 57,500 Gross profit 63,050 Less expenses: Expenses 30,200 Provision for depreciation: fixtures and fittings 5,000 Bad debts written off 550 35,750 Net profit 27,300
(e)
COLIN SMITH BALANCE SHEET AS AT 30 JUNE 20-5
Fixed Assets Fixtures and fittings
£
£
£
Cost
Provision for depreciation
Net book value
50,000
15,000
35,000
Current Assets Stock
27,500
Trade debtors
35,000
Bank
1,210 63,710
Less Current Liabilities Trade creditors
30,000
Accrual: expenses
700 30,700
Net Current Assets
33,010
NET ASSETS
68,010
FINANCED BY Capital Opening capital*
69,500
Add Net profit
27,300 96,800
Less drawings
28,790 68,010
* Opening capital:
£
• assets at 1 July 20-4
102,500
• less liabilities at 1 July 20-4
33,000
• capital at 1 July 20-4
69,500
4
2.11
SANDRINE TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006 £ £ Sales (working 1) 228,295 Opening stock 4,987 Purchases (working 2) 62,794 67,781 Less Closing stock 5,038 Cost of sales 62,743 Gross profit 165,552 Less expenses: Wages (working 3) 56,404 Motor expenses 7,920 General expenses 7,963 Loan interest (working 4) 3,000 Provision for depreciation: equipment (working 5) 1,500 vehicles (working 6) 12,000 Loss on sale of equipment (working 7) 3,800 92,587 Net profit 72,965 WORKINGS £ 163,729 3,746 2,988 65,324 228,295
1
• • • • •
receipts from trade debtors less trade debtors at beginning of year add trade debtors at end of year add cash sales sales for year
2
• • • •
payments to trade creditors (720 + 61,700) less trade creditors at beginning of year add trade creditors at end of year purchases for year
62,420 1,822 2,196 62,794
3
• • •
payments for wages less wages owing at beginning of year wages for year
57,200 796 56,404
4
• • •
payments for loan interest add loan interest paid in advance at beginning of year loan interest for year
5
• •
net book value of equipment at beginning of year less net book value of equipment sold during year
• •
less net book value of equipment at end of year provision for depreciation of equipment for year
• •
net book value of vehicles at beginning of year cost of vehicle purchased during the year
26,000 22,000 48,000
•
provision for depreciation of vehicles for year (£48,000 x 25%)
12,000
• • •
net book value of equipment sold during the year sale proceeds of equipment during the year loss on sale of equipment for year
6
7
5
2,500 500 3,000 20,000 5,000 15,000 13,500 1,500
5,000 1,200 3,800
2.13 (a)
CINDY TOFE Bank Reconciliation Statement as at 31 December 2005 £ (668) (291) (959) 1,084 125
Balance at bank as per bank statement Unpresented cheque Outstanding lodgement Balance at bank as per cash book
Tutorial note: the topic of bank reconciliation statements is covered in AQA AS Accounting; the statement starts with the bank balance, which is overdrawn. (b)
Dr
Bank Account
2005 1 Jan
£ Balance b/d Receipts for year
Cr
2005
1,726
£ Payments for year Drawings (missing figure)
201,784 31 Dec
Balance c/d
17,320 125
203,510
203,510
2006 1 Jan
186,065
2006 Balance b/d
125
(c) Stock at 31 December 2005 – sales at cost price – sales to F Fearless at cost price + sales returns at cost price + purchases – purchases returns Stock valuation at 8 January 2006
£ ? 1,800 780 360 1,036 140 2,986
2,520 ÷ 1.4 858 ÷ 1.1 504 ÷ 1.4
By working up the calculation (adding the minuses and deducting the pluses), the stock valuation at 31 December 2005 is found to be £4,310.
(d)
Dr
Disposals Account
2005
£ Vehicle (book value)
Cr
2005
12,000
£ Vehicle (part exchange value)
(missing figure)
11,500
Profit and loss account (loss on sale) 12,000
500 12,000
6
(e)
CINDY TOFE TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2005 £ £ Sales (working 1) 198,506 Opening stock 2,998 Purchases (working 2) 143,102 146,100 Less Closing stock 4,310 Cost of sales 141,790 Gross profit 56,716 Less expenses: General expenses 1,604 + 5,162 6,766 Wages (working 3) 23,041 Rent (working 4) 4,680 Motor expenses 3,040 Provision for depreciation: equipment 4,000 vehicles (working 5) 17,000 Loss on sale of vehicle 500 59,027 Net loss 2,311
WORKINGS 1
Dr
Cash Account
2005 1 Jan
£ Balance b/d Receipts (missing figure)
Cr
2005
142
£ Expenses
197,833
Bank 31 Dec
Balance c/d
197,975
169
Sales Ledger Control Account
2005
£ Balance b/d Sales (missing figure)
2005
6,546 198,506
31 Dec
Balance c/d
197,833 7,219 205,052
2006
2
Cr £
Receipts
205,052
1 Jan
169
2006 Balance b/d
Dr 1 Jan
186,784 197,975
2006 1 Jan
11,022
2006 Balance b/d
Dr
7,219
Purchases Ledger Control Account
2005 Bank 31 Dec Balance c/d
£
2005
142,911
1 Jan
£ Balance b/d Purchases (missing figure)
5,433
Cr
148,344
5,982 142,362 148,344
2006
2006 1 Jan
Balance b/d
Purchases for year: £142,362 (above) + £740 (cash purchases) = £143,102
7
5,433
3
Dr
Wages Account
2005 Bank 31 Dec Balance c/d
£
2005
23,110
1 Jan
762
Cr £ Balance b/d Profit and loss account
(missing figure) 23,872 2006 1 Jan
Dr
Balance b/d
Rent Account
2005 1 Jan
£ Balance b/d Bank
160
£ Profit and loss account
(missing figure)
4,940
Balance c/d
5,100
420
Vehicles Account
2005
£
Cr
2005
£
Balance b/d
60,000
Disposals
Bank
13,500
Profit and loss account
Part exchange
11,500
(missing figure) Balance c/d
31 Dec 85,000 2006 Balance b/d
12,000 17,000 56,000 85,000
2006 1 Jan
420
2006 Balance b/d
Dr 1 Jan
4,680 5,100
2006
5
762
Cr
2005
31 Dec
1 Jan
23,041 23,872
2006
4
831
56,000
CHAPTER 3 Partnership final accounts
3.3
£10,800
(£32,800 – £1,800 – £10,000 + £600) ÷ 2
3.4
£580 Cr
(£550) + £900 + £10,000 – £14,000 + £4,230
8
3.6 Dr
Partners' Capital Accounts Mike £ 30,000
20-4 31 Dec Balances c/d
Bernie £ 20,000
20-5
Dr
20-4 1 Jan Balances b/d
Bernie £ 20,000
20-5 1 Jan Balances b/d
30,000
20,000
Partners' Current Accounts
20-4 1 Jan Balance b/d 31 Dec Drawings 31 Dec Balances c/d
Mike £ – 21,750 1,510
Bernie £ 420 17,350 830
23,260
18,600
20-5
3.9
Cr Mike £ 30,000
20-4 1 Jan 31 Dec 31 Dec 31 Dec
Cr
Balance b/d Salary Interest on capital Share of profits
20-5 1 Jan Balances b/d
Mike £ 1,560 – 1,500 20,200 23,260
Bernie £ – 7,500 1,000 10,100 18,600
1,510
830
(a) DANIEL AND FREDA, IN PARTNERSHIP STATEMENT OF AFFAIRS AS AT 31 DECEMBER 2005 £
£
Assets Premises
40,000
Vehicle
3,750
Office equipment
6,000
Stock
2,400
Debtors
150
Cash at bank
10,950 63,250
Less Liabilities Creditors
3,250
Capital at 31 December 2005
60,000
Capital at 1 January 2005
50,000
Capital at 31 December 2005 (see above)
60,000
Profit retained for the year
10,000
Add drawings: Daniel
17,000
Freda
23,000 40,000
Profit for the year ended 31 December 2005
50,000
9
(b)
Although there is no legal requirement for Daniel and Freda to keep their financial records using a double-entry system, such a system will: •
provide more accounting information to assist with management decisions
•
enable tax liabilities – income tax and Value Added Tax – to be calculated easily
•
allow better control of the business, eg debtor control
•
allow the partners to see their own financial position with the business better, eg capital accounts and current accounts
•
provide more information to a lender – such as a bank – should the partnership require a bank loan or overdraft
A double-entry system will involve more work than a single-entry system. Thus single-entry is cheaper, easier to maintain, and requires no special training; however, a double-entry system may reduce or eliminate the fees of an external accountant and is a more complete system.
3.11
(a) Dr 20-5 31 Mar Balances c/d
Partners' Capital Accounts Sara £ 10,000
Simon £ 6,000
20-5
Dr 20-5 31 Mar Drawings 31 Mar Balance c/d
20-5 1 Apr Balance b/d
Cr
20-4 1 Apr Balances b/d
Sara £ 10,000
Simon £ 6,000
20-5 1 Apr Balances b/d
10,000
6,000
Partners' Current Accounts Sara £ 12,700 1,550
Simon £ 7,400 –
14,250
7,400
–
1,060
20-4 1 Apr 20-5 31 Mar 31 Mar 31 Mar 31 Mar
Balances b/d Salary Interest on capital Share of profits Balance c/d
20-5 1 Apr Balance b/d
10
Cr Sara £ 560
Simon £ 1,050
8,000 1,000 4,690 – 14,250
– 600 4,690 1,060 7,400
1,550
–
3.11
(b)
SARA AND SIMON PENNY, TRADING AS ‘CLASS CATERERS’ TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 MARCH 20-5 £ Sales
£ 44,080
Opening stock
2,850
Purchases
11,300 14,150
Less Closing stock
3,460
Cost of sales
10,690
Gross profit
33,390
Less expenses: Wages
8,020
Rent and rates
4,090
Sundry expenses
1,500
Provision for depreciation: office equipment
800 14,410
Net profit
18,980
Less appropriation of profit: Salary: Sara
8,000
Interest allowed on partners’ capitals: Sara Simon
1,000 600 1,600 9,380
Share of remaining profit: Sara
4,690
Simon
4,690 9,380
BALANCE SHEET AS AT 31 MARCH 20-5 Fixed Assets Equipment
£ Cost 8,000
Current Assets Stock Trade debtors Bank Less Current Liabilities Trade creditors Accrual of expenses
£ Provision for depreciation 800
£ Net book value 7,200
3,460 4,500 8,640 16,600 7,200 110 7,310
Net Current Assets NET ASSETS
9,290 16,490
FINANCED BY Capital Accounts Sara Simon
10,000 6,000 16,000
Current Accounts Sara Simon
1,550 (1,060) 490 16,490
11
3.12
(a) Dr
Partners' Capital Accounts
20-5 30 Jun Balances c/d
A Adams £ 30,000
J Beeson £ 20,000
20-5
Dr
20-4 1 Jul
Balances b/d
20-5 1 Jul
Balances b/d
30,000
20,000
Partners' Current Accounts
20-5 30 Jun Drawings 30 Jun Balances c/d
A Adams £ 16,000 1,209
17,209
J Beeson £ 10,000 1,349
Cr A Adams J Beeson £ £ 780 920
20-4 1 Jul Balances b/d 2005 30 Jun Salary 30 Jun Share of profits
11,349
20-5
(b)
Cr A Adams J Beeson £ £ 30,000 20,000
20-5 1 Jul
Balances b/d
6,000 10,429 17,209
– 10,429 11,349
1,209
1,349
ANNE ADAMS AND JENNY BEESON, TRADING AS ‘A & B ELECTRICS’ TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 JUNE 20-5 £
£
Sales
£ 250,140
Less Sales returns
1,360
Net sales
248,780
Opening stock
26,550
Purchases
175,290
Less Purchases returns
850 174,440 200,990
Less Closing stock
27,750
Cost of sales
173,240
Gross profit
75,540
Add income: Decrease in provision for doubtful debts
13 75,553
Less expenses: Rent and rates
8,170
Wages
29,020
Vehicle expenses
2,470
General expenses
6,210
Bad debts written off
175
Provision for depreciation: vehicle
2,250
fixtures and fittings
400 48,695
Net profit
26,858
Less appropriation of profit: Salary: A Adams
6,000 20,858
Share of remaining profit: A Adams
10,429
J Beeson
10,429 20,858
12
3.12
(b)
continued
BALANCE SHEET AS AT 30 JUNE 20-5 £ Cost 12,000 4,000 16,000
Fixed Assets Vehicle Fixtures and fittings
Current Assets Stock Trade debtors Less provision for doubtful debts
£ Provision for depreciation 5,250 1,200 6,450
27,750 6,850 137 6,713 250 22,009 1,376 58,098
Prepayment of expenses Bank Cash
Less Current Liabilities Trade creditors Accrual of expenses
£ Net book value 6,750 2,800 9,550
14,770 320 15,090
Net Current Assets NET ASSETS
43,008 52,558
FINANCED BY Capital Accounts A Adams J Beeson
30,000 20,000 50,000
Current Accounts A Adams J Beeson
1,209 1,349 2,558 52,558
3.14
(a) Dr 2006 1 Jan
2007 1 Jan
Total Debtors Account* Balance b/d Sales (missing figure)
£ 317 43,915 44,232
Cr
2006 31 Dec
Cash received from debtors Balance c/d
£ 44,049 183 44,232
2007 Balance b/d
183 * also known as sales ledger control account
(b) Dr 2006 Payments to creditors 31 Dec Balance c/d
Total Creditors Account** £ 195,911 5,163 201,074
2007
2006 1 Jan
2007 1 Jan
Balance b/d Purchases (missing figure)
Balance b/d
** also known as purchases ledger control account
13
Cr £ 4,872 196,202 201,074
5,163
3.14
(c)
MARTIN AND NASSER, IN PARTNERSHIP TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006 £ Sales – cash
£ 332,467
– credit
43,915 376,382
Opening stock
14,003
Purchases
196,202 210,205
Less Closing stock
13,471
Cost of sales
196,734
Gross profit
179,648
Add income: Rent received (working 1)
6,000 185,648
Less expenses: Wages (working 2)
63,482
General expenses
56,676
Provision for depreciation: vehicle (working 3)
8,000
machinery (working 4)
10,000
Loss on sale of machinery (working 5)
800 138,958
Net profit
46,690
Workings: 1. Rent received: £7,000 – £500 owing at 1 Jan – £500 paid in advance at 31 Dec = £6,000 2. Wages: £63,156 – £612 accrued at 1 Jan + £938 accrued at 31 Dec = £63,482 3. Vehicle depreciation: £16,000 valuation at 1 Jan – £8,000 valuation at 31 Dec = £8,000 depreciation for year 4. Machinery depreciation: £147,000 valuation at 1 Jan + £12,000 cost of new machine – £4,000* book value of old machine now sold – £145,000 valuation at 31 December = £10,000 depreciation for year * £10,000 cost – £6,000 depreciation
5. Loss on sale of machinery: cost £10,000 – £3,200 part exchange value – £6,000 depreciation = £800 loss on sale
(d)
MARTIN AND NASSER, IN PARTNERSHIP PROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006 £ £ Net profit
46,690
Add interest charged on partners’ drawings: Martin
230
Nasser
100 330 47,020
Less appropriation of profit: Salary: Nasser
3,000
Interest allowed on partners’ capitals: Martin
£100,000 x 6%
6,000
Nasser
£70,000 x 6%
4,200 10,200 33,820
Share of remaining profit: Martin (60%)
20,292
Nasser (40%)
13,528 33,820
14
3.14
(e) Dr
Partners' Current Accounts
Martin 2006 £ 31 Dec Drawings 35,660 31 Dec Interest on drawings 230
Nasser £ 26,480 100
35,890
26,580
6,388
4,548
2007 1 Jan
(f)
2006 1 Jan Balances b/d Salary 31 Dec Interest on capital 31 Dec Share of profit 31 Dec Balances c/d
Cr Martin £ 3,210 – 6,000 20,292 6,388 35,890
Nasser £ 1,304 3,000 4,200 13,528 4,548 26,580
2007 Balances b/d
The benefits of maintaining separate capital and current accounts are: •
the capital amount remains fixed except for capital introduced or withdrawn
•
the current account is a working account dealing with all aspects of the distribution and drawings of profits
•
the distinction between the two accounts shows whether or not partners are maintaining their permanent capital in the business, while the fluctuating current account shows whether or not partners have withdrawn more profit from the business than they are earning
•
the fixed capital account makes interest on capital – where permitted by the partnership agreement – easy to calculate
However, it should be pointed out that separate capital and current accounts require more work and are, therefore, more time-consuming for the book-keeper than using the partners’ capital accounts for all transactions. As to which is used will depend on the size and complexity of the partnership business.
CHAPTER 4 Changes in partnerships
4.1
(a)
(b)
•
Goodwill can be defined as the difference between the value of a business as a whole, and the net value of its separate assets and liabilities.
•
Goodwill is used when changes are made to partnerships, eg the admission of a new partner or retirement of an existing partner.
•
The principle is that the agreed value of goodwill is shared amongst those partners who created the goodwill, and is then charged to new partners as a premium for joining an established business.
•
It is normal practice not to record goodwill on a partnership balance sheet – this follows the concept of prudence.
Using figures of your own choice: •
agree a valuation for goodwill
•
old partners
•
–
debit goodwill account with the amount of goodwill
–
credit partners' capital accounts (in their old profit-sharing ratio) with the amount of goodwill
old partners + new partner –
debit partners' capital accounts (in their new profit-sharing ratio) with the amount of goodwill
–
credit goodwill account with the amount of goodwill
The effect of this is to charge the new partner with a premium for goodwill.
15
4.5
(a) Dr
Revaluation Account
20-4 31 Aug Capital accounts: Reena (4/8) Sam (2/8) Tamara (2/8)
£
20-4 31 Aug
Cr £ 24,000
Fixed assets (£74,000 – £50,000)
12,000 6,000 6,000 24,000
Dr
24,000
Goodwill Account
20-4 31 Aug Capital accounts: Reena (4/8) Sam (2/8) Tamara (2/8)
£
20-4 31 Aug
8,000 4,000 4,000 16,000
Dr
Cr £ Capital accounts: Reena (1/2) Tamara (1/2)
8,000 8,000 16,000
Partners' Capital Accounts Reena
20-4 31 Aug Goodwill w/off
Sam
Tamara
£
£
£
8,000
–
8,000
31 Aug Bank
22,000
31 Aug Balances c/d
45,000
–
32,000
53,000
22,000
40,000
Cr Reena
20-4
Sam
£
£
£
31 Aug Balances b/d
33,000
12,000
30,000
31 Aug Revaluation
12,000
6,000
6,000
31 Aug Goodwill created
1 Sep
Balances b/d
8,000
4,000
4,000
53,000
22,000
40,000
45,000
–
32,000
(b) BALANCE SHEET OF REENA AND TAMARA AS AT 1 SEPTEMBER 20-4 £ Fixed Assets (£50,000 + £24,000)
74,000
Current Assets
10,000
Bank (£25,000 – £22,000)
3,000 87,000
Trade creditors
(10,000) 77,000
Capital Accounts Reena
45,000
Tamara
32,000 77,000
16
Tamara
4.7
(a) Dr
Revaluation Account
2007 28 Feb Fixed assets (£123,000 – £120,000)
£ 3,000
2007 28 Feb
Cr £ Capital accounts: Ibrahim (3/6) Joan (2/6) Kelly (1/6)
1,500 1,000 500 3,000
3,000
Dr
Goodwill Account
2007 28 Feb Capital accounts: Ibrahim (3/6) Joan (2/6) Kelly (1/6)
£ 37,500 25,000 12,500 75,000
Dr 2007 28 Feb Revaluation
Ibrahim
Joan
Kelly
£
£
£
1,500
1,000
500
1,532 45,000
28 Feb Bank 28 Feb Balances c/d
£ Capital accounts: Ibrahim (3/5) Kelly (2/5)
45,000 30,000 75,000
Partners' Capital Accounts
28 Feb Current account 28 Feb Goodwill w/off
2007 28 Feb
Cr
–
Cr Ibrahim
Joan
Kelly
£
£
£
28 Feb Balances b/d
45,000
30,000
35,000
28 Feb Goodwill created
37,500
25,000
12,500
82,500
55,000
47,500
36,000
–
17,000
2007
30,000
52,468 36,000
–
17,000
82,500
55,000
47,500 1 Mar
Balances b/d
(b) Dr 2007 28 Feb Balance c/d
Bank Account £ 72,058
Cr
2007 28 Feb 28 Feb 28 Feb
Balance b/d Joan: loan account Joan: capital account
£ 4,590 15,000 52,468 72,058
1 Mar
Balance b/d
72,058
72,058
17
4.9
(a) JEAN AND DAVID, IN PARTNERSHIP PROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-4 6 months to 30 June Net profit
6 months to 31 December
Total for year
£
£
£
16,350
16,350
32,700
Less appropriation of profit: Salaries: Jean
6,000
6,000
12,000
David
5,000
5,000
10,000
250
250
500
Interest allowed on partners' capitals: Jean David
300
300
600
4,800
4,800
9,600
Jean
(2/3) 3,200
(1/2) 2,400
5,600
David
(1/3) 1,600
(1/2) 2,400
4,000
4,800
4,800
9,600
Share of remaining profit:
(b) Dr
Partners' Current Accounts
20-4 1 Jan
Balance b/d
31 Dec
Drawings
31 Dec
Balance c/d
Jean
David
£
£
20-4
–
1,250
1 Jan
18,600
14,200
31 Dec
Salaries
1,900
–
31 Dec
Interest on capital
31 Dec
Share of profit
31 Dec
Balance c/d
20,500
15,450
–
850
20-5 1 Jan
4.10
Balance b/d
Cr Jean
David
£
£
2,400
–
12,000
10,000
500
600
5,600
4,000
–
850
20,500
15,450
1,900
–
20-5 Balance b/d
1 Jan
Balance b/d
Tutorial notes: • Parts (a) and (b) of this question have been seen already as question 3.9. • As David and Freda do not have a partnership agreement, the Partnership Act 1890 applies, ie they each have an equal share in the activities of the partnership. (c) Dr 2006 30 Jun 30 Jun 30 Jun
Revaluation Account Stock (£3,200 – £2,600) Debtors (£1,985 – £1,410) Capital accounts: Daniel (1/2) Freda (1/2)
£ 600 575 25,000 25,000 51,175
18
2006 30 Jun
Cr Fixed assets (£100,000 – £48,825)
£ 51,175
51,175
Dr
Goodwill Account
2006 30 Jun
£ Capital accounts: Daniel (1/2) Freda (1/2)
Cr
2006 1 Jul
£ Capital accounts: Daniel (1/2) Freda (1/3) Helen (1/6)
30,000 30,000
30,000 20,000 10,000 60,000
60,000
Dr
Partners' Capital Accounts Daniel
2006
Freda
Cr
Helen
Daniel 2006
Freda
Helen
£
£
£
£
£
£
1 Jul
Goodwill w/off
30,000
20,000
10,000
30 Jun Balances b/d
25,000
28,000
–
1 Jul
Balances c/d
50,000
63,000
40,000
30 Jun Revaluation
25,000
25,000
–
30 Jun Goodwill created
30,000
30,000
–
–
–
50,000
80,000
83,000
50,000
50,000
63,000
40,000
1 Jul Bank 80,000
83,000
50,000 1 Jul Balances b/d
(d) DANIEL, FREDA AND HELEN, IN PARTNERSHIP PROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006 6 months to 30 June Net profit
6 months to 31 December
Total for year
£
£
£
45,000
45,000
90,000
250
250
Add interest charged on partners’ drawings: Daniel Freda
80
80
Helen
160
160
45,490
90,490
2,500
2,500
Daniel (£50,000 x 6% x 6 months)
1,500
1,500
Freda (£63,000 x 6% x 6 months)
1,890
1,890
45,000 Less appropriation of profit: Salaries:
Helen (£5,000 x 6 months)
Interest allowed on partners' capitals:
Helen (£40,000 x 6% x 6 months)
1,200
1,200
45,000
38,400
83,400
Daniel
(1/2) 22,500
(1/2) 19,200
41,700
Freda
(1/2) 22,500
(1/3) 12,800
35,300
Helen
–
Share of remaining profit:
45,000
19
(1/6)
6,400
6,400
38,400
83,400
4.10
(e) Dr
Partners' Current Accounts Daniel
Freda
Helen
£
£
£
41,000
35,000
12,000
250
80
160
1,950
2,110
–
2006 31 Dec Drawings 31 Dec Interest on drawings 31 Dec Balances c/d
Cr
2006 31 Dec Salary
37,190
12,160
2007
£
£
£
–
2,500
1,890
1,200
41,700
35,300
6,400
–
–
2,060
43,200
37,190
12,160
1,950
2,110
–
2007
1 Jan Balance b/d
(f)
Helen
–
31 Dec Balance c/d 43,200
Freda
1,500
31 Dec Interest on capital 31 Dec Share of profit
Daniel
–
–
2,060
1 Jan Balances b/d
The benefits of maintaining separate capital and current accounts are: •
the capital amount remains fixed except for capital introduced or withdrawn, and any subsequent capital transactions such as revaluations and adjustments for goodwill
•
the current account is a working account dealing with all aspects of the distribution and drawings of profits
•
the distinction between the two accounts shows whether or not partners are maintaining their permanent capital in the business, while the fluctuating current account shows whether or not partners have withdrawn more profit from the business than they are earning
•
the fixed capital account makes interest on capital – where permitted by the partnership agreement – easy to calculate
However, it should be pointed out that separate capital and current accounts require more work and are, therefore, more time-consuming for the book-keeper than using the partners’ capital accounts for all transactions. The decision to keep separate capital and current accounts is justified in this partnership in view of the complexity of partners’ transactions.
4.14
(a) ALI, BAMBI AND CHARLIE: PROFIT OR LOSS ON DISSOLUTION £ Net book value of assets (excluding bank)
82,020
Less liabilities
23,420
Business sold to Daphne
40,000
Loss on dissolution
18,600
58,600
Capital accounts: Ali (3/6)
9,300
Bambi (2/6)
6,200
Charlie (1/6)
3,100 18,600
20
4.14
(b) Dr
Partners' Capital Accounts
2006
Ali
Bambi
Charlie
£
£
£
9,300
6,200
31 Dec Current account 31 Dec Share of loss 31 Dec Bambi 31 Dec Bank
4,700 720
–
180
31,680
–
9,020
41,700
10,900
12,300
Bambi
Charlie
£
£
£
40,000
10,000
10,000
1,700
–
2,300
2006 31 Dec Balances b/d
3,100
Cr Ali
31 Dec Current accounts 31 Dec Ali
720
31 Dec Charlie
180 41,700
10,900
12,300
Tutorial notes: •
Upon dissolution the capital account of Bambi has a deficit of £900.
•
As Bambi is unable to meet this liability, the rule in Garner v Murray applies, and the amount must be paid by Ali and Charlie in the ratio of their last agreed capital balances, ie Ali £40,000 and Charlie £10,000.
•
Thus Ali will pay £720 and Charlie £180.
•
The amounts paid to Ali and Charlie from the bank are £31,680 + £9,020 = £40,700; this is the £40,000 paid by Daphne plus £700 bank balance from the partnership balance sheet.
CHAPTER 5 Published accounts of limited companies 5.1
5.3
The report and accounts – or corporate report – of a public limited company is available to every shareholder and contains the main elements of financial statements: •
income statement (also known as a ‘statement of comprehensive income’)
•
balance sheet (also known as a ‘statement of financial position’)
•
cash flow statement
•
statement of changes in equity
•
notes to the financial statements, including a statement of the company’s accounting policies
•
directors’ report
•
auditors’ report
•
The directors are responsible for ensuring that the provisions of the Companies Acts 1985 and 2006 which relate to accounting records and statements are followed.
•
In particular the company’s accounting records must:
•
–
show and explain the company’s transactions
–
disclose with reasonable accuracy at any time the financial position of the company
–
enable the directors to ensure that the company’s income statement and balance sheet give a true and fair view of the company’s financial position
A company’s accounting records must contain: –
day-to-day entries of money received and paid, together with details of the transactions
–
a record of the company’s assets and liabilities
–
details of inventories held at the end of the year
•
A company’s financial statements must be prepared in accordance with the Companies Acts and with either UK accounting standards or international accounting standards.
•
The directors must report annually to the shareholders on the way that they have run the company on behalf of the shareholders.
•
Every company director has a responsibility to ensure that the statutory accounts are produced and filed with the Registrar of Companies.
•
The annual accounts must be approved by the company’s board of directors and the copy of the balance sheet filed with the Registrar of Companies must be signed by one of the directors on behalf of the board.
21
5.6
•
The directors must prepare a directors report – this must be approved by the board (and the copy to be filed with the Registrar of Companies signed on behalf of the board by a director, or the company secretary).
•
The statutory accounts must be laid before the company at the annual general meeting (and they must be circulated beforehand to shareholders, debenture holders and any other persons entitled to attend the meeting).
(a)
The published income statement of a limited company does not have to detail every single overhead or expense incurred. However, IAS 1, Presentation of Financial Statements, requires that certain items must be detailed on the face of the income statement, including: •
revenue
•
finance costs
•
tax expense
IAS 1 states that further detail may be needed to give information relevant to an understanding of financial performance. The income statement concludes by showing the profit or loss for the period attributable to equity holders.
(b)
For the income statement, expenses must be analysed either: •
by nature (raw materials, employee costs, depreciation, etc), or
•
by function (cost of sales, distribution expenses, sales and marketing expenses, administrative expenses, etc)
The analysis selected will depend on which provides the more reliable and relevant information – the analysis by nature is often appropriate for manufacturing companies, while the analysis by function is commonly used by trading companies. As Presingold plc is a trading company, the analysis by function would seem to be more appropriate.
5.7
This Question is principally concerned with:
initial reading in order to get an overview of the company’s accounts and an understanding of the industry • horizontal analysis in order to compare certain figures from the financial statements with the figures from the previous accounting period The Question can be developed to look at various aspects of: • the company’s structure and its own industry • the stage of its development • both internal and external influences on the company •
5.9
(a)
Share premium account This occurs where an established company issues shares to the public at a higher amount that the nominal value – the amount above nominal value is the share premium. For example, if shares with a nominal value of £1 are issued at £1.50 each, then 50p per share is credited to share premium account. Revaluation reserve This occurs when a non-current asset – most probably freehold land and buildings – is revalued upwards in the balance sheet. The amount of the revaluation is placed in a revaluation reserve where it increases the value of the shareholders’ investment in the company. For example, if freehold land and buildings had originally cost £250,000 and are now revalued at £450,000, then £200,000 is the amount credited to revaluation reserve.
(b)
Retained earnings are profits that have been retained in the company. They belong to the shareholders, but are represented by assets in the balance sheet and are not a cash balance at the bank available to build a new warehouse for the company.
(c)
Equity is the stake of the ordinary shareholders in the company. It comprises ordinary share capital, plus capital and revenue reserves. Non-current liabilities are those liabilities that are due to be repaid more than twelve months from the date of the balance sheet. Examples include loans and debentures.
22
5.10
This answer may be set out either vertically or horizontally. Non-current Assets
£000
Property, plant and equipment Net book value at start of year
4,217
Additions at cost
930
Disposals during year (£1,634 – £920)
(714)
Depreciation for year (missing figure)
(132)
Net book value at end of year
4,301
Net book
Additions
Disposals
Depreciation
Net book
value at start
at cost
during year
for year
value at end
£000
£000
£000
£000
£000
4,217
930
(714)
(132)
4,301
Non-current Assets
Property, plant and equipment
5.12
This answer may be set out either vertically or horizontally. Non-current Assets
£000
Property, plant and equipment Net book value at start of year
8,074
Additions at cost
1,175
Disposals during year (£2,168 – £970)
(1,198)
Depreciation for year (missing figure)
(404)
Net book value at end of year
7,647
Net book
Additions
Disposals
Depreciation
Net book
value at start
at cost
during year
for year
value at end
£000
£000
£000
£000
£000
8,074
1,175
(1,198)
(404)
7,647
Non-current Assets
Property, plant and equipment
23
5.14
(a)
Shareholders They will almost certainly get a dividend; profits are up which is better for dividends and for ploughing back to yield future dividends; plans for growth will save the company from stagnating.
(b)
Loan stock holders The profits indicate that they will be paid their interest; also the profits mean the company should not fail, so they will be repaid their loans when they are due.
(c)
Employees The profits mean they are put into a better bargaining position for a pay rise. Employees may also be in a company share scheme, so a prosperous company will make their shares worth more. The future growth of the company should mean that their jobs are safe.
5.16 MITHIAN PLC INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-2 £ Revenue
£ 2,640,300
Opening inventories
318,500
Purchases
2,089,600 2,408,100
Less Closing inventories
340,600
Cost of sales
(2,067,500)
Gross profit
572,800
Overheads: Distribution expenses
(216,320)
Administrative expenses (note 1)
(229,080) (445,400)
Profit/(loss) from operations
127,400
Finance costs
(20,000)
Profit/(loss) before tax
107,400
Tax
(30,000)
Profit/(loss) for the year attributable to equity holders
77,400
STATEMENT OF CHANGES IN EQUITY (EXTRACT)
Retained earnings Balance at 1 January 20-2
63,250
Profit for the year
77,400 140,650
Dividends paid
(20,000)
Balance at 31 December 20-2
120,650
24
MITHIAN PLC BALANCE SHEET AS AT 31 DECEMBER 20-2 Non-current Assets
Valuation
Cost
Net
£
Aggregate Depreciation £
£
110,060
48,200
61,860
235,000
55,000
180,000
345,060
103,200
241,860
£
Property, plant and equipment Office equipment Vehicles – Current Assets Inventories
340,600
Trade receivables
415,800
Cash and cash equivalents
20,640 777,040
Total assets
1,018,900
Current Liabilities Trade payables
(428,250)
Tax liabilities
(30,000) (458,250)
Net Current Assets
318,790 *560,650
Non-current Liabilities 10% loan stock
(200,000)
Total liabilities
658,250
Net Assets
360,650
EQUITY Issued Share Capital Ordinary shares of £1 each
200,000
Capital Reserves Share premium account
40,000
Revenue Reserve Retained earnings
120,650
TOTAL EQUITY
360,650
* fixed assets + net current assets Working note 1 Administrative expenses
£ 220,180
Bad debts
8,900 229,080
25
CHAPTER 6 Cash flow statements 6.2
Depreciation is added back to profit from operations because depreciation is a non-cash expense, ie no money is paid out by the business in respect of depreciation charged to the income statement. Thus profit added back to depreciation gives the amount of cash generated by the trading activities of business: this, together with the changes in net current asset items (except for cash/bank) and adjustments for any profits/losses on sales of non-current assets, forms the operating activities section of the cash flow statement.
6.3
Raven Limited: £ Profit from operations
30,000
Depreciation for year
10,000
Increase in inventories
(5,000)
Decrease in trade receivables Increase in trade payables Cash from operations
6.4
4,000 6,000 45,000
Meadow Limited: £ Loss from operations
6.5
6.7
(10,000)
Depreciation for year
8,000
Decrease in inventories
4,000
Increase in trade receivables
(5,000)
Decrease in trade payables
(3,000)
Cash from operations
(6,000)
Points when assessing the cash flow statement of a company include: •
reasonable cash flow from operating activities
•
link changes in net current asset items of inventories, trade receivables and trade payables to changes in profit from operations – is there a strain on the liquidity of the company?
•
link purchase/sale of non-current assets to context of company – expanding or declining?
•
where finance has been raised through increases in loans/shares, look to see how the cash has been used – to finance new non-current assets, or to finance inventories and trade receivables, or other purposes?
•
look at change in cash/bank in relation to profit/loss from operations – is the company generating cash?
(a)
(i)
cash generated from operations amount of cash generated by the trading activities of the company, taking into account non-cash items – such as depreciation – and changes in the net current asset items of inventories, trade receivables and trade payables
(ii)
net cash from operating activities cash generated from operations, less interest paid and taxes paid
(iii)
net cash used in investing activities amount of net cash the company receives from buying and selling non-current assets, from interest received and dividends received
26
(b)
(i)
(ii)
(iii)
6.10
managers •
a cash flow statement highlights information not available from the income statement and balance sheet
•
it shows clearly sources and uses of cash over the year
•
it shows cash available at the year end for future developments
•
it aids decision-making and development of the company
shareholders •
a cash flow statement demonstrates the ability of the company to generate cash from operating activities
•
it shows the liquidity of the business
•
it shows clearly the sources and uses of cash over the year
•
it shows the investment of the company in capital expenditure
•
it shows the amount of dividends paid to shareholders
debenture holders •
a cash flow statement shows the cash available at the year end which demonstrates to debenture holders the security of their loan
•
it shows additional loans raised or repaid, in the financing activities section
•
it shows interest paid to lenders, in the operating activities section
(a) ADAGIO PLC RECONCILIATION OF PROFIT FROM OPERATIONS TO NET CASH FLOW FROM OPERATING ACTIVITIES £000 Profit/(loss) from operations
(2,127)
Adjustments for: Depreciation for year
3,490
Loss on disposal of non-current assets
58
Decrease in inventories
48
Decrease in trade receivables
986
Decrease in trade payables
(1,787)
Cash from operations
668
Interest paid
(–)
Income taxes paid
(278)
Net cash (used in)/from operating activities
390
(b)
ADAGIO PLC DRAFT CASH FLOW STATEMENT FOR THE YEAR ENDED 30 APRIL 2004 £000 Net cash from operating activities
£000 390
Cash flows from investing activities Purchase of non-current assets
(1,795)
Proceeds from sale of non-current assets
818 (977)
Cash flows from financing activities Dividends paid
(299)
Net decrease in cash and cash equivalents
(886)
27
(c)
Using a cash flow statement to judge the financial performance of a company •
The cash flow statement focuses on cash inflows and cash outflows. It concentrates on the liquidity of the business – it is often a lack of cash that causes most businesses to fail.
•
Cash is often described as the ‘life blood’ of a business.
•
The cash flow statement uses the money measurement concept – only items which can be recorded in money terms can be included. This makes it difficult to manipulate, and cash can be seen as an accurate measure of business success or failure. This contrasts with the income statement where judgement has to be made about items such as:
•
6.11
–
recognition of sales/revenue
–
the distinction between capital and revenue expenditure
–
depreciation methods and policies
The cash flow statement shows: –
the cash from operations after interest and tax have been paid
–
the investing activities of the business, eg the purchase of non-current assets
–
the financing activities of the business, eg an increase/decrease in loans/share capital
•
The cash flow statement links profit with changes in cash. Both of these are important: without profit, the company cannot generate cash (unless it sells non-current assets), and without cash it cannot pay bills as they fall due.
•
The cash flow statement is important in judging financial performance because of its emphasis on: –
liquidity and solvency
–
investment in assets
–
financing methods
(a) HALLS-KROSBY PLC RECONCILIATION OF PROFIT FROM OPERATIONS TO NET CASH FLOW FROM OPERATING ACTIVITIES £000 Profit from operations
573
Adjustments for: Depreciation for year
206
Loss on sale of non-current assets (machinery) Increase in inventory
(b)
18 (230)
Increase in trade receivables
(62)
Decrease in trade payables
(46)
Cash from operations
459
Interest paid
(–)
Income taxes paid
(–)
Net cash (used in)/from operating activities
459
Changes made to original reconciliation statement (question asks for an explanation of three of the changes): •
Depreciation is non-cash and is added back to profit from operations in the cash flow statement.
•
Loss on sale of machinery is non-cash and is also added back to profit from operations.
•
Receipts from sale of machinery is shown as a receipt in the investing activities section of the cash flow statement.
•
Dividends paid – both ordinary and preference – are shown as payments in the financing activities section of the cash flow statement.
•
Share premium receipts are included with the proceeds of the ordinary share issue in the financing activities section of the cash flow statement.
28
6.15
(a) KALSI PLC RECONCILIATION OF PROFIT FROM OPERATIONS TO NET CASH FLOW FROM OPERATING ACTIVITIES £000 Profit from operations
237
Adjustments for: Depreciation for year
275
Gain on sale of non-current assets
(2)
Increase in inventories (210–200)
(10)
Increase in trade receivables (390–250)
(140)
Decrease in trade payables (150–160)
(10)
Cash generated from operations
350
Interest paid
(20)
Income taxes paid
(21)
Net cash (used in)/from operating activities
309
(b) KALSI PLC CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 20-5 £000 Net cash (used in)/from operating activities
£000 309
Cash flows from investing activities Purchase of non-current assets
(110)
Proceeds from sale of non-current assets1
7
Net cash (used in)/from investing activities
(103)
Cash flows from financing activities Proceeds from issue of share capital (40–25) Proceeds from long-term borrowings (200-100) Repayment of debentures
15 100 (500)
Dividends paid
(30)
Net cash (used in)/from financing activities
(415)
Net increase/(decrease) in cash and cash equivalents
(209)
Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year
10 (199)
Working note 1
Proceeds from sale of non-current assets
Non-current assets (cost) Gain on sale
Non-current Assets £ 10,000 Accumulated depreciation 2,000 Proceeds (bal fig) 12,000
29
£ 5,000 7,000 12,000
(c)
From the point of view of the company’s shareholders, the following points are highlighted by the cash flow statement of Kalsi plc for the year ended 31 March 20-5: •
an excellent cash flow has been generated from operations, £350,000, which is well above the amounts paid for tax, £21,000, and dividends, £30,000
•
There have been increases in inventories and trade receivables – the increase of £140,000 in the latter seems very large and might indicate that the company is having to offer extended terms to its customers in order to maintain sales; there has been a small decrease in trade payables
•
new non-current assets of £110,000 have been bought – an indication that the company is re-equipping for the future
•
debentures of £500,000 have been repaid – financed mainly from profits and an increased long-term loan of £100,000; the company’s gearing has reduced and it seems that this is a short/medium-term aim of the company
•
the reduction in borrowed funds will reduce the amount of interest to be paid in future years
•
a small share issue has taken place during the year
•
the bank balance – cash and cash equivalents – has fallen during the year from a credit balance of £10,000 to an overdraft of £199,000
Conclusion: The cash flow statement shows that Kalsi plc is a highly profitable company which generates a good cash flow from operations. There has been an expansion of net current assets but shareholders may be concerned to note the increase of £140,000 in trade receivables. The debentures have been repaid – partly from profits which explains the significant fall in cash and cash equivalents. New non-current assets of £110,000 have been purchased. Overall, it seems that the company is reorganising its financing so as to reduce its reliance on borrowed funds, while at the same time seeking to develop in the future. For shareholders, they should hold their existing shares and should consider increasing their holdings as profits and dividends seem likely to increase in the future.
CHAPTER 7 Accounting standards 7.2
Accounting principles are the broad concepts that are applied in the preparation of financial statements. Examples: going concern, accruals, consistency.
Accounting bases are the methods used for applying accounting principles to financial statements, and are intended to reduce subjectivity by identifying the acceptable methods. Example: the use of historic cost or revaluation to value assets. Accounting policies are the specific principles, bases, conventions, rules and practices applied in the preparation and presentation of financial statements. Examples: the use of straight-line or diminishing (reducing) balance method of depreciation for non-current assets.
7.3
(a)
IAS 16, Property, Plant and Equipment, defines depreciation as the systematic allocation of the depreciable amount of an asset over its useful life. (Depreciable amount is the cost or valuation of the asset, less any residual value.)
(b)
•
IAS 16 states that, initially, PPE are to be measured (recorded) at cost in the balance sheet.
•
After acquisition of PPE a company must choose either the cost model or the revaluation model as its accounting policy – which is then applied to an entire class of PPE.
•
Using the cost model, assets are shown in the balance sheet at cost less accumulated depreciation and impairment losses.
•
Using the revaluation model, assets are shown at a revalued amount, being fair value less subsequent depreciation and impairment losses; revaluations are to be made regularly to ensure that the revalued amounts do not differ materially from fair values at the balance sheet date.
•
Depreciation is to be charged on all non-current assets – with the exception of freehold land, which is shown at cost.
•
Depreciation methods include the straight-line and the diminishing (reducing) balance methods.
30
7.6
(a)
•
A company chooses the depreciation method which best reflects the way in which the asset’s economic benefits are consumed.
•
The depreciation method should be reviewed at least annually in order to consider if the method used is still the most appropriate one.
An impairment review is carried out in three steps: STEP 1
The asset’s carrying amount is ascertained
STEP 2
The asset’s recoverable amount is ascertained
STEP 3
If an asset’s carrying amount is greater than its recoverable amount, then the asset is impaired and should be written down to its recoverable amount.
Terms used:
Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation/amortisation and accumulated impairment losses. Recoverable amount is the higher of the asset’s •
fair value, less any costs that would be incurred were it to be sold
•
its value in use.
Fair value, less costs to sell is the amount at which an asset could be sold for, less any selling costs. Value in use is the present value of the future cash flows from an asset’s continued use, including cash from its final sale.
7.7
(b)
When an asset is impaired it should be written down to its recoverable amount in the balance sheet. The amount of the impairment loss is shown as an expense in the income statement.
(c)
The fork lift truck is impaired: its carrying amount is £20,000 but its recoverable amount is £19,000 (the higher of fair value less costs to sell of £18,000, and value in use of £19,000). Accordingly, an impairment loss of £1,000 should be shown as an expense in the income statement.
The overriding principle of inventory valuation is that inventories should be valued at ‘the lower of cost and net realisable value’. Thus two different inventory values are compared: •
cost, which means the purchase price, plus any other costs incurred to bring the product (or service) to its present location and condition
•
net realisable value, which is the estimated selling price less the estimated costs to get the product into a condition necessary to complete the sale
The lower of these two values is taken, and different items or groups of inventory are compared separately.
7.8
Using the lower of cost and net realisable value: £ Vauxhall Corsa Landrover Discovery
2,800 cost 10,000 cost
Nissan Primera
2,600 net realisable value
Ford Focus
6,000 cost
Volkswagen Polo TOTAL
500 net realisable value 21,900
31
7.12
7.14
(a)
Although the selling of the inventory (stock) is an event which happened after the year end, under IAS 10, Events after the Reporting Period, this is an example of an adjusting event. Such events provide evidence of conditions that existed at the end of the reporting period; if the amount involved is material, then the amount shown in the financial statements should be changed. The sale of inventory provides evidence as to the net realisable value of the inventory reported in the financial statements for the year under review. Under IAS 2, Inventories, inventories are to be valued at the lower of cost and net realisable value.
(b)
A dividend declared or proposed on ordinary shares after the balance sheet date is, under IAS 10, an example of a non-adjusting event. Such events are conditions that arose after the reporting period; no adjustment is made to the financial statements – if such events are material, then they are disclosed by way of notes to the accounts. The notes would explain the nature of the event and, if possible, give the likely financial consequences of the event. The proposed ordinary dividend cannot be recorded as a liability at 30 September 20-6 as it was not a present obligation of the company at the financial year end. The details of the proposed dividend will be given in the notes to the financial statements, including the amount of £75,000.
(c)
Under IAS 10, this is an example of a non-adjusting event after the reporting period. Although the employee was working for Gernroder Limited at the financial year end, the legal proceedings do not relate to conditions that existed at the end of the reporting period. Instead, the legal proceedings are conditions that arose after the reporting period and no adjustment is to be made to the financial statements. The amount of £20,000, if material, is to be disclosed by way of a note which explains the nature of the event and the likely financial consequences of the event.
1
IAS 38, Intangible Assets As this is internally generated goodwill, it cannot be recognised as an asset and recorded in the financial statements.
2
IAS 2, Inventories Cost is £100,000; net realisable value is £160,000. Inventories (stocks) are to be valued at ‘the lower of cost and net realisable value’. Therefore this stock should be recognised as an asset at £100,000 and recorded in the financial statements.
3
IAS 16, Property, Plant and Equipment The valuation of £205,000 is acceptable as the overhaul ensures that future economic benefits will flow to the business, and the cost of the overhaul can be measured reliably. The depreciable amount for the machine is now £205,000.
7.15
(a)
IAS 2 states that inventories must be valued at the lower of cost and net realisable value. Cost means the purchase price plus any other costs incurred to bring the product (or service) to its present location and condition. Net realisable value is the estimated selling price less the estimated costs to get the product into a condition necessary to complete the sale. The lower of these two values is taken, and different items or groups of inventory are compared separately.
(b)
1
2
This situation – where a customer, who owes money at the balance sheet date, subsequently goes into liquidation – is covered by IAS 10, Events after the Reporting Period. Adjusting events provide evidence of conditions that existed at the end of the reporting period. If the amount is material, then the amount shown in the financial statements should be changed. In this case, the amount of £30,000 needs to be written off as a bad debt. The book-keeping entries are: DEBIT
Bad debts written off
CREDIT
Trade receivables
£30,000 £30,000
The situation described here is covered by IAS 37, Provisions, Contingent Liabilities and Contingent Assets. A contingent asset is a possible asset arising from past events whose existence will be confirmed only by uncertain future events not wholly within the control of the company. It follows from the above definition that the probable inflow of £25,000 from the legal suit is a contingent asset. IAS 37 states that if a contingent asset is probable, it should be disclosed by way of a note in the financial statements. It cannot be recognised in the financial statements because it would not be prudent to recognise income that may never be realised.
32
7.16
(a)
(b)
1
IAS 38, Intangible Assets
2
IAS 38, Intangible Assets
3
IAS 16, Property, Plant and Equipment
4
IAS 18, Provisions, Contingent Liabilities and Contingent Assets
5
IAS 2, Inventories
Retained earnings and other reserves: £ Balance at start
780,000
Item 1
(40,000) amortisation of intangible asset, £200,000 ÷ 5 years
Item 2
– internally generated goodwill, so cannot be recognised as an asset
Item 3
(50,000) depreciation at 2% on £250,000
Item 4
(480) provision for bad debts, 3% on £16,000
Item 5
(25) cost 10 x £20 = £200; net realisable value 10 x £30 = £300 – £125 repairs = £175; nrv to be used
Corrected balance
689,495
(c)
GROGLIN PLC BALANCE SHEET AT 31 DECEMBER 2008 £ Assets Non-current assets Intangible asset
160,000
Property, plant and equipment
2,450,000
200,000 – 40,000 2,000,000 + 500,000 reval’n – 50,000
2,610,000 Current assets Inventories
119,975
120,000 – 25
Trade receivables
15,520
16,000 – 480
Cash and cash equivalents
28,000 163,495
TOTAL ASSETS
2,773,495
Liabilities Current liabilities Trade payables
(84,000)
NET ASSETS
2,689,495
Shareholders’ equity Called up share capital
1,500,000
Retained earnings and other reserves
1,189,495
TOTAL EQUITY
2,689,495
33
689,495 + 500,000 revaluation
(d)
Although accounting standards are not laws – ie they are non-statutory – any limited company that fails to apply them would cast serious doubts on the reliability of its financial statements. It is one of the duties of directors to ensure that a company’s financial statements are prepared in accordance with the Companies Acts and with accounting standards. At the same time, the auditors’ report must state whether or not the financial statements have been prepared in accordance with company law and accounting standards: if they have not, the auditors’ report will be qualified. The reasons for using international accounting standards are: •
to provide a framework for preparing and presenting financial statements – the ‘rules’ of accounting
•
to ensure that accountants follow the same set of rules
•
to reduce the number of different accounting treatments and so make ‘window dressing’ more difficult
•
to meet with the duty of the directors to ensure that financial statements comply with accounting standards
•
to meet with the auditors’ report requirement to state that the financial statements have been prepared in accordance with accounting standards
The benefits of international accounting standards are: •
to standardise financial statements internationally – thus a company operating in several countries knows that the same accounting rules have been applied to all parts of its business
•
to reduce the variations of accounting treatments used in financial statements – thus making ‘window dressing’ the accounts more difficult
•
to allow users of financial statements to make inter-firm comparisons in the knowledge that all the financial statements have been prepared using the same standards.
CHAPTER 8 Stock valuation 8.3
Date 20-4
Description
FIFO £
AVCO £
21 June
Total issue value*
5,150
5,250
30 June
Total closing stock value†
1,150
1,050
* FIFO:
AVCO:
2,000 units at £2.00 per unit 500 units at £2.30 per unit 2,500
= =
£4,000 £1,150 £5,150
2,000 units at £2.00 per unit 1,000 units at £2.30 per unit 3,000 units at £2.10 per unit
= = =
£4,000 £2,300 £6,300
=
£5,250
500 units at £2.30 per unit
=
£1,150
500 units at £2.10 per unit
=
£1,050
∴ 2,500 units issued at £2.10 per unit
† FIFO:
AVCO:
34
8.4
(a) FIFO
Date 20-4
STORES LEDGER RECORD: Wye
Quantity
Receipts Cost £
Total Cost £
Quantity
Issues Cost £
Total Cost £
1 Aug Balance
10 Aug
2,000
5.25
10,500
Quantity
Balance Cost £
Total Cost £
5,000
5.00
25,000
5,000
5.00
25,000
2,000
5.25
10,500
7,000
18 Aug
3,000
5.50
16,500
35,500
5,000
5.00
25,000
2,000
5.25
10,500
3,000
5.50
16,500
10,000
23 Aug
AVCO
Date 20-4
5.00
25,000
2,000
5.25
10,500
1,000
5.50
5,500
Receipts Cost £
1 Aug
Balance
6 Aug
5,000
4.30
7,500
4.40
Total Cost £
Quantity
Issues Cost £
Total Cost £
21,500
33,000
24 Aug
12,000
(b)
2,000
5.50
11,000
STORES LEDGER RECORD: Zed
Quantity
19 Aug
5,000
52,000
4.20
50,400
Quantity
10,000
£ 4.00
Total Cost £ 40,000
10,000
4.00
40,000
5,000
4.30
21,500
15,000
4.10
61,500
15,000
4.10
61,500
7,500
4.40
33,000
22,500
4.20
94,500
10,500
4.20
44,100
Valuation at 31 August 20-4: £ Wye
10,000
(net realisable value)
Zed
44,100
(cost price)
54,100
35
Balance Cost
8.5
(a) FIFO
Date
20-7
STORES LEDGER RECORD: product Alpha
Receipts
Quantity
Issues
Cost
Total Cost
£
£
Quantity
Balance
Cost
Total Cost
£
£
Quantity
Cost
Total Cost
£
£
Jan
20
3.00
60.00
20
3.00
60.00
Feb
10
3.60
36.00
20
3.00
60.00
10
3.60
36.00
30 Mar
8
3.00
24.00
96.00
12
3.00
36.00
10
3.60
36.00
22 Apr
10
4.00
40.00
72.00
12
3.00
36.00
10
3.60
36.00
10
4.00
40.00
32 May
12
3.00
36.00
4
3.60
14.40
112.00
6
3.60
21.60
10
4.00
40.00
16
61.60
(b)
AVCO Date 20-7
STORES LEDGER RECORD: product Alpha Receipts
Quantity
Issues
Cost
Total Cost
£
£
Quantity
Balance
Cost
Total Cost
£
£
Quantity
Cost
Total Cost
£
£
Jan
20
3.00
60.00
20
3.00
60.00
Feb
10
3.60
36.00
20
3.00
60.00
10
3.60
36.00
30
3.20
96.00
22
3.20
70.40
22
3.20
70.40
10
4.00
40.00
32
3.45
110.40
16
3.45
55.20
Mar Apr
May
8 10
4.00
3.20
25.60
40.00
16
3.45
36
55.20
8.6
(a) FIFO
Date
20-7
STORES LEDGER RECORD: product Jay Receipts
Quantity
Jan
100
Issues
Cost
Total Cost
£
£
4.00
400.00
Feb
Quantity
80
Mar
120
4.21
Balance
Cost
Total Cost
£
£
4.00
320.00
505.20
Quantity
Cost
Total Cost
£
£
100
4.00
400.00
20
4.00
80.00
20
4.00
80.00
120
4.21
505.20
140 Apr
70
3.94
275.80
585.20
20
4.00
80.00
120
4.21
505.20
70
3.94
275.80
210 May
Jun
105
4.30
20
4.00
80.00
120
4.21
505.20
451.50
861.00
70
3.94
275.80
70
3.94
275.80
105
4.30
451.50
175
AVCO
STORES LEDGER RECORD: product Jay
Date 20-7
Jan
Receipts Quantity
100
Issues
Cost
Total Cost
£
£
4.00
400.00
Feb Mar
Apr
Quantity
80 120
70
4.21
3.94
4.30
Cost
Total Cost
£
£
4.00
320.00
275.80
140 105
Balance
505.20
May Jun
727.30
4.10
451.50
37
574.00
Quantity
Cost
Total Cost
£
£
100
4.00
400.00
20
4.00
80.00
20
4.00
80.00
120
4.21
505.20
140
4.18
585.20
140
4.18
585.20
70
3.94
275.80
210
4.10
861.00
70
4.10
287.00
70
4.10
287.00
105
4.30
451.50
175
4.22
738.50
(b) FIFO
LEDGER RECORD: product Kay
Date 20-7
Receipts Quantity
Cost
£
£
Jan
200
10.00
Feb
100
9.55
Issues Total Cost
Quantity
Cost
£
£
Balance Total Cost
Quantity
Cost
£
£
2,000.00
200
10.00
2,000.00
955.00
200
10.00
2,000.00
100
9.55
955.00
300 Mar
Apr
90
10.50
200
10.00
2,000.00
40
9.55
382.00
945.00
2,955.00
60
9.55
573.00
60
9.55
573.00
90
10.50
945.00
150 May
150
10.00
1,500.00
1,518.00
60
9.55
573.00
90
10.50
945.00
150
10.00
1,500.00
300 Jun
60
9.55
573.00
40
10.50
420.00
3,018.00
50
10.50
525.00
150
10.00
1,500.00
200
AVCO
Receipts Quantity
Cost
£
£
Jan
200
10.00
Feb
100
9.55
Issues Total Cost
May
Jun
Quantity
Cost
£
£
Cost
£
£
2,000.00
200
10.00
2,000.00
955.00
200
10.00
2,000.00
100
9.55
955.00
300
9.85
2,955.00
60
9.85
591.00
60
9.85
591.00
90
10.50
945.00
150
10.24
1,536.00
150
10.24
1,536.00
150
10.00
1,500.00
300
10.12
3,036.00
200
10.12
2,024.00
240 90
150
10.50
10.00
Balance Quantity
Mar Apr
2,025.00
STORES LEDGER RECORD: product Kay
Date 20-7
Total Cost
9.85
Total Cost
2,364.00
945.00
1,500.00
100
10.12
38
1,012.00
Total Cost
Valuation at 30 June 20-7: £ Product Jay
727.30 (cost price, using FIFO)
Product Kay
1,950.00 (net realisable value) 2,677.30
8.10
(a)
Tutorial note: This part of the question requires a calculation of the value of closing stock at 30 April 2007. For clarity, the answer below is set out in the form of a stores ledger record; however, it can be answered instead by means of a calculation.
AVCO
STORES LEDGER RECORD: Caravans
Date
Receipts
2007
Quantity
Cost
£
£
Issues Total Cost
Quantity
Cost
£
£
Balance Total Cost
Quantity
Cost
£
£
1
17,700
17,700
3
17,900
53,700
1
17,900
17,900
4
18,275
73,100
2
18,275
36,550
1 Apr Balance
10 Apr
2
18,000
36,000
18 Apr
2
26 Apr
3
18,400
30 Apr
(b)
17,900
35,800
55,200
2
18,275
36,550
Total Cost
•
FIFO will give him a closing stock valuation of £36,800 (2 x £18,400). This higher closing stock under FIFO will give him a higher profit of £250. This could be an advantage if he is thinking of selling the business in the near future; the disadvantage is that he will pay more tax.
•
However, any change in profit will be only temporary as, over the life of his business, total profits will be the same under both methods, and there will be no effect on the cash generated by the business.
•
The FIFO method is logical and relatively easy to calculate; however, for the low number of items that Tom has in stock, AVCO is not difficult to calculate.
•
To meet the accounting concept of consistency, if he changes to FIFO he will need to adjust his financial statements to show comparability.
•
Both FIFO and AVCO are acceptable for tax purposes and under IAS 2.
Conclusion Tom is currently using AVCO which, for the low number of items that he has in stock, is relatively easy to calculate. Although his profits will be higher under FIFO when prices are rising, there will be no effect on the cash generated by the business. All-in-all, there do not appear to be compelling reasons to make the change.
39
8.12
(a)
A stock-take is carried out regularly to check that the quantity of stock held is the same as that recorded in the stock records. This is done by counting the physical stock on hand against the balance shown by the records, and to identify any theft or deterioration. A stock-take is carried out on either a periodic basis or continuously.
(b)
(c)
Stock reconciliation is the process of comparing the stock-take and the stock record. This process is important because: –
an accurate stock figure can then be used to value the stock
–
it will highlight any discrepancies which can then be investigated
Stock number 146: as the discrepancy here is a small shortfall in the physical stock compared with the stock record, ie £2 x 2 units = £4, the likely action to be taken by the company accountant will be to authorise the discrepancy for write-off. Stock number 523: this is a larger discrepancy, ie £200 x 10 units = £2,000 and needs to be investigated to see if it has been caused by: –
an error on the stock record
–
theft of stock
–
damaged stock being disposed of without any record having been made
CHAPTER 9 Manufacturing accounts 9.4
(a)
JACQUI KING PLC MANUFACTURING ACCOUNT FOR THE YEAR ENDED 30 NOVEMBER 2001 £
Opening stock of raw materials Add Purchases of raw materials Less Closing stock of raw materials COST OF RAW MATERIALS USED Direct labour 959,400 x 2/3 Royalties PRIME COST Add Factory overheads: Indirect labour 959,400 x 1/3 Depreciation of factory machinery Overheads
319,800 48,000 548,000 915,800 2,067,100 23,000 2,090,100 24,100 2,066,000
Add Opening stock of work-in-progress Less Closing stock of work-in-progress PRODUCTION COST OF GOODS COMPLETED
(b) 9.6
£ 47,600 498,000 545,600 50,900 494,700 639,600 17,000 1,151,300
Payment/receipts for use of patented/copyrighted process.
(a) (i) 31 December 2007: £4,000, ie £20,000 x 25/125 (ii) 31 December 2008: £4,800, ie £24,000 x 25/125
40
(b)
MALCOLM PLC PROFIT AND LOSS ACCOUNT EXTRACT FOR THE YEAR ENDED 31 DECEMBER 2008 £ 170,000 800 169,200
Factory gross profit Less Increase in provision for unrealised profit 4,000 – 4,800 Adjusted factory gross profit
MALCOLM PLC BALANCE SHEET EXTRACT AS AT 31 DECEMBER 2008 £ Current asset Stock of finished goods Less Provision for unrealised profit Adjusted stock of finished goods
9.7
(a)
24,000 4,800 19,200
DEWRAY PLC SUMMARISED MANUFACTURING ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2002 £000 1,207 915 15 2,137 34 2,171 36 2,135 427 2,562
Prime cost Factory overheads Depreciation of machinery Add Opening stock of work-in-progress Less Closing stock of work-in-progress Factory profit of 20% PRODUCTION COST OF GOODS COMPLETED (transfer price)
(b)
TRADING ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2002 £000 Sales Less Cost of goods sold Opening stock of finished goods Production cost of goods completed
156 2,562 2,718 192
Less Closing stock of finished goods
2,526 934
Gross profit
(c)
£000 3,460
The amount of the adjustment to the provision for unrealised profit to be shown in the profit and loss account is £6,000.
Workings: 192 x 20/120 = 32 156 x 20/120 = 26
(d)
The amount of the adjustment is shown as a deduction from factory profit shown in the profit and loss account.
41
(e)
BALANCE SHEET EXTRACT AS AT 31 DECEMBER 2002 £000 Current Assets Stock – raw materials – work-in-progress – finished goods – less provision for unrealised profit adjusted stock of finished goods
9.8
£000 75 36
192 32 160 271
(a)
CATHY YOW MANUFACTURING ACCOUNT EXTRACT FOR THE YEAR ENDED 31 DECEMBER 2001 £ Opening stock of raw materials 9,000 Add Purchases of raw materials 63,600 72,600 Less Closing stocks of raw materials 9,400 COST OF RAW MATERIALS USED 63,200 Direct labour (146,800 + 3,450) 150,250 Royalties 8,140 PRIME COST 221,590
(b)
The adjustment is £100 Workings: £1,750 – £1,850* * £9,250 x 25/125
(c)
Provision for unrealised profit is made to reduce the closing stock value of finished goods to cost price. This enables the balance sheet valuation to comply with IAS 2, Inventories, and the concept of prudence.
9.10 (a)
CATHERINE DONOVAN MANUFACTURING ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006 £ 9,840 126,430 136,270 10,211
Opening stock of raw materials Add Purchases of raw materials Less Closing stock of raw materials COST OF RAW MATERIALS USED Direct wages Manufacturing royalties
£
126,059 274,700 55,000 329,700 455,759
PRIME COST Add Production (factory) overheads: Factory supervisors’ wages Rates – factory Indirect expenses – factory Factory machinery depreciation
63,150 *4,500 337,171 **40,000
Less increase in work-in-progress PRODUCTION COST Factory profit of 25% PRODUCTION COST OF GOODS COMPLETED (transfer price)
444,821 900,580 580 900,000 225,000 1,125,000
* Rates: £6,400 – £400 prepaid = £6,000, apportioned three-quarters to factory, £4,500, and one-quarter to office, £1,500 ** Factory machinery depreciation: £400,000 x 10%
42
(b)
Closing stock at 31 December 2006: £ £25,600
x
25 100 + 25
=
5,120
Less provision for unrealised profit
4,700
Increase in provision for unrealised profit
420
(c)
£ Gross profit on trading
£ 312,400
Factory profit
225,000
Less increase in provision for unrealised profit
420 224,580
Total gross profit
(d)
9.12
(a)
536,980
Reasons for making a provision for unrealised profit: •
A provision is always required when production is increased with the addition of a factory profit, ie the transfer price to trading account is higher than production cost.
•
As a result of the transfer price, the valuation of finished goods stocks is higher than cost price.
•
Following the prudence concept, the profit element needs to be removed from the valuation of finished goods stocks.
•
IAS 2, Inventories, requires that stock is valued at the lower of cost and net realisable value.
•
In final accounts provision for unrealised profit is dealt with as follows: –
in the profit and loss account, an increase is deducted from the factory profit (and a decrease added) in order to remove the profit element from stock so that profit is not overstated
–
In the balance sheet, the total amount of the provision is deducted from the stock of finished goods in order that the valuation is not overstated and that the balance sheet gives a true and fair view of the business
Finished goods stock at 31 December 2005: £ £31,776
x
20 100 + 20
=
5,296
Finished goods stock at 1 January 2005: £27,804
x
20 100 + 20
=
4,634
Increase in provision for unrealised profit
(b)
662
AMANDEEP PAWAR TRADING ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2005 £ Sales Opening stock of finished goods Production cost of goods completed (transfer price) Less Closing stock of finished goods COST OF SALES Gross profit
£ 1,430,972
27,804 *864,000 891,804 31,776 860,028 570,944
* £720,000 x (100 + 20)%
43
(c)
SUMMARISED PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2005 £ £ Gross profit 570,944 Less Administrative expenses 478,221 Profit from trading 92,723 Factory profit **144,000 Less increase in provision for unrealised profit 662 143,338 Net profit 236,061 ** £720,000 x 20%
9.13
(a) (i) Closing stock at 31 March 2008: £31,906
x
40 100 + 40
(ii)
=
£9,116 provision for unrealised profit
S H MATT BALANCE SHEET EXTRACT AS AT 31 MARCH 2008 £ Current Assets Stock – raw materials – work-in-progress – finished goods less provision for unrealised profit adjusted stock of finished goods
£ 10,980 9,946
31,906 9,116 22,790 43,716
(b)
£ 9,116 8,536 580
Provision for unrealised profit at 31 March 2008 Provision for unrealised profit at 31 March 2007 Increase in provision for unrealised profit
In profit and loss account the increase is deducted from the factory profit in order to remove the profit element from stock so that profit is not overstated. (c)
Any two reasons for transferring goods to the trading account at cost plus a profit: •
Enables the factory to make a notional profit which is added into net profit at a later stage.
•
Gives the unit cost of goods manufactured a more realistic value which can be compared with the cost of buying in completed goods from an outside source.
•
By showing a factory profit, the profit from trading activities can be identified separately.
•
The factory and the warehouse become separate profit centres which show the contribution of each to the overall profitability of the business.
CHAPTER 10 Costs and contribution 10.4
(a)
fixed
(b)
variable
(c)
semi-variable
(d)
fixed
(e)
variable
(f)
fixed
(g)
variable
(h)
variable
44
10.5
The following are example figures; each student’s solution will be different. (a) Fixed costs: Advertising Room hire Speakers
Lunch Course materials
(b)
Variable costs:
£15 £10 £25
(c)
If price charged per delegate is £80, then contribution will be £80 – £25 = £55 per delegate
(d)
less equals less equals
10.7
£200 £150 £350 £700
(a)
(b)
£ 2,400 750 1,650 700 950
course fees £80 x 30 people variable costs £25 x 30 people total contribution fixed costs profit for event
Marginal cost per pair of trainers variable costs: direct materials (per pair) direct labour (per pair) marginal cost (per pair)
15 12 27
Contribution per pair of trainers selling price (per pair) less variable costs (per pair) equals contribution (per pair)
£ 40 27 13
(c)
£
John Walker Limited Marginal costing statement: 25,000 pairs of trainers £ sales (25,000 x £40) less variable costs direct materials (25,000 x £15) direct labour (25,000 x £12)
equals less equals
10.8
375,000 300,000 675,000 325,000 245,000 80,000
total contribution fixed costs (overheads) profit on sales of 25,000 pairs
(a)
Contribution is selling price minus variable cost. Total contribution is used to cover, firstly, fixed costs and then profit.
(b)
(i)
Contribution per unit before the proposed purchase of the machinery:
less equals
£ 1,000,000
£ 44 34 10
selling price (per parachute) variable costs £10 + £16 + £8 contribution (per parachute)
45
(ii)
Contribution after the proposed purchase of the machinery: materials labour £9 per hour x 1.5 hours other variable costs variable costs per parachute
less equals
(c)
selling price per parachute variable costs contribution per parachute
£ 10.00 13.50 8.00 31.50 44.00 31.50 12.50
Profitability before purchase of new machinery: sales £44 x 22,000 parachutes less variable costs £34 x 22,000 parachutes equals total contribution less fixed costs equals profit for the year
£
£ 968,000 748,000 220,000 134,000 86,000
Profitability after purchase of new machinery: sales £44 x 22,000 parachutes less variable costs £31.50 x 22,000 parachutes equals total contribution less fixed costs retraining costs
£
£ 968,000 693,000 275,000
equals
134,000 32,000 166,000 109,000
profit for the year
Tutorial note: The increase in profits of £23,000 (£109,000 – £86,000) can also be calculated by reference to the increase in contribution, as follows: £ increase in contribution £2.50* x 22,000 parachutes 55,000 less retraining costs 32,000 equals increased profits 23,000 * £34.00 – £31.50 = £2.50
Notes:
10.10 (a)
(b)
•
If the new machinery is purchased, profitability in the first year increases from £86,000 to £109,000, an increase of £23,000. As the retraining costs are a ‘one-off’, profits in subsequent years will be £32,000 higher.
•
Depreciation on the new machinery will increase fixed costs, so reducing profit.
•
On the information available, the company should purchase the new machinery.
•
Direct costs can be identified directly with each unit of output.
•
Indirect costs (overheads) cannot be identified directly with specific units of output.
Marginal cost of one compass Variable costs per unit:
£
direct labour (£23,000 ÷ 5,000)
4.60
direct materials (£35,000 ÷ 5,000)
7.00
other direct costs (£9,000* ÷ 5,000)
1.80
marginal cost of one compass
13.40
* £21,000 – £12,000 fixed costs
46
(c)
Marginal costing statement
£
sales £20 x 5,000 compasses
less
£ 100,000
variable costs: direct labour
23,000
direct materials
35,000
other direct costs
9,000 67,000
(d)
equals total contribution
33,000
less
fixed costs
12,000
equals profit for the period
21,000
Advantages of producing a marginal costing statement One from: •
contribution, ie selling price less variable cost, is clearly identified
•
identifying the marginal cost of output enables the managers of a business to focus on the contribution provided by the output
•
the effect on costs of changes in sales turnover can be calculated
•
helps with decision-making in the forms of –
costing a project
–
make or buy
–
acceptance of additional work
–
price setting
–
optimum use of scarce resources
CHAPTER 11 Break-even analysis
11.1
units of
fixed costs
variable costs
total cost
output
sales
profit/(loss)*
revenue
£
£
£
£
£
0
7,500
0
7,500
0
(7,500)
500
7,500
2,500
10,000
5,000
(5,000)
1,000
7,500
5,000
12,500
10,000
(2,500)
1,500
7,500
7,500
15,000
15,000
nil
2,000
7,500
10,000
17,500
20,000
2,500
2,500
7,500
12,500
20,000
25,000
5,000
3,000
7,500
15,000
22,500
30,000
7,500
* brackets indicate a loss
47
11.4
(a) •
contribution sales ratio contribution (£)
=
selling price (£)
£15*
= 0.6 or 60%
£25
* selling price £25 – variable cost £10 •
break-even point in units fixed costs (£)
=
£300,000
contribution per unit (£) •
= 20,000 units
£15
break-even point in sales revenue fixed costs (£)
=
£300,000
CS ratio
= £500,000
0.6
check: 20,000 units x selling price £25 per unit = £500,000 •
margin of safety at output of 30,000 units current output – break-even output
= 30,000 – 20,000 30,000
current output
x 100 1
= 33.3%, or 10,000 units, or £250,000 of sales revenue •
number of units to generate a target profit of £100,000 fixed costs (£) + target profit (£)
= £300,000 + £100,000 = 26,667 units £15
contribution per unit (£)
(b)
(c) •
forecast output (30,000 units)
maximum output (40,000 units)
£
£
sales revenue (at £25 each)
750,000
1,000,000
less
variable costs (at £10 each)
300,000
400,000
equals
contribution (to fixed costs and profit)
450,000
600,000
less
monthly fixed costs
300,000
300,000
equals
forecast profit for month
150,000
300,000
contribution sales ratio £10*
=
0.5 or 50%
£20 * selling price £20 – variable cost £10 •
break-even point in units £300,000
=
30,000 units
£10 •
break-even point in sales revenue £300,000
=
£600,000
0.5 check: 30,000 units x selling price £20 per unit = £600,000 •
margin of safety at maximum output of 40,000 units 40,000 – 30,000 40,000
x
100 = 25%, or 10,000 units, or £200,000 of sales revenue 1
48
•
forecast profit at maximum output of 40,000 units £
less equals less equals
sales revenue (at £20 each)
800,000
variable costs (at £10 each)
400,000
contribution (to fixed costs and profit)
400,000
monthly fixed costs
300,000
forecast profit for month
100,000
EMAIL To:
General Manager
From: A2 Student Date: Today
Proposal to reduce selling price Introduction •
This report considers the suggestion from one of the managers that the selling price for our product should be reduced from £25 per unit to £20.
•
The manager has suggested that the effect of this reduction would be to increase output from the forecast of 30,000 units per month to our maximum output of 40,000 units per month.
Report •
•
As can be seen from the workings at current levels of output of 30,000 units per month: –
contribution sales ratio is 60%
–
break-even point is 20,000 units
–
margin of safety is 33.3%
–
forecast profit is £150,000 per month
If the manager’s suggestion is adopted sales will increase to our maximum output of 40,000 units per month; this will give us: –
contribution sales ratio of 50%
–
break-even point of 30,000 units
–
margin of safety of 25%
–
forecast profit of £100,000 per month
Conclusion •
From the data summarised above it can be seen that the manager’s suggestion would reduce our contribution sales ratio, increase the break-even point, and reduce the margin of safety. All of these are all movements in the wrong direction.
•
The main point to note is that forecast profit will fall by £50,000 per month to £100,000 per month, and the volume of output will need to be higher.
•
Although the firm would be working at maximum output if the suggestion is adopted, this does mean that there is no scope to increase output and sales in the future without major changes to our cost structure. We would not be able to meet requests for additional sales from our existing customers, and this could cause them to seek all of their supplies from our competitors.
•
For these reasons, it is recommended that the manager’s suggestion is not undertaken.
49
11.5
(a) Fixed costs
Variable costs per
£
unit in pence
Wages
20
Raw materials
30
Salespeople’s wages
10
Administration costs
42,000
Business rates
20,400
Total
(b)
(c)
(a)
60p
(i)
Contribution per unit = selling price per unit – variable costs per unit
(ii)
Contribution per unit = £1.00 – £0.60 = £0.40
(iii)
Contribution goes, firstly, towards fixed costs and, when they have been covered, secondly, contributes to profit
(i)
Break-even point (units) =
11.8
£62,400
£62,400 £0.40
=
fixed costs (£) contribution per unit (£)
=
156,000 bookmarks
(ii)
Total revenue = 156,000 bookmarks x £1 = £156,000
(iii)
Sales of 150,000 bookmarks are 6,000 below break-even point. There will be a loss of 6,000 x £0.40 contribution = £2,400
A = margin of safety, between 3,500 and 6,000 carpets, ie 2,500 carpets B = area of loss C = profit at maximum capacity of 6,000 carpets D = sales value and total costs, £25,000, at break-even point
(b)
11.9
Disadvantage of using a break-even graph to identify the break-even point, one from: •
the assumption is made that all output is sold
•
the presumption is made that there is only one product
•
all costs and revenues are expressed in straight lines
•
it is not possible to extrapolate the graph
•
the profit or loss shown by the graph is probably only true for figures close to current output levels
•
external factors are not considered
(a)
Marginal cost is the cost of producing one extra unit of output.
(b)
Marginal cost per unit:
£
materials (3 metres at £5 per metre)
£15.00
labour (15 minutes at £12 per hour)
3.00
variable manufacturing overheads
3.00
marginal cost per unit
(c)
21.00
Marginal cost x 1.2 = £21.00 x 1.2 = £25.20 selling price per unit
50
(d)
Break-even in units: fixed costs (£) contribution per unit (£)
=
£52,500 £25.20 – £21.00
= 12,500 units
Break-even revenue: break-even units x selling price per unit = 12,500 units x £25.20 = £315,000
(e)
Usefulness of break-even analysis in decision-making: •
Break-even is the point at which neither a profit nor a loss is made and tells a business the sales (in both units and revenue) that have to be made to meet costs.
•
It provides: –
the profit or loss at any level of output/sales within the range of the analysis
–
the margin of safety, ie the amount by which sales exceed the break-even point
•
It helps a new business to determine selling prices and can be used to support an application for finance.
•
It can be adapted to take note of changes in costs and selling price.
•
However, break-even analysis: –
assumes that all output is sold
–
presumes that there is only one product
–
all costs and revenues are expressed in straight lines
–
cannot be extrapolated
–
the indicated profit or loss is probably only true for figures close to current output levels
–
does not take into account external factors
Conclusion: break-even analysis is useful for giving guidance to a business about individual products, but it does have a number of limitations.
11.11 (a)
fixed costs (£) contribution* per unit (£)
=
break-even point (in units)
* selling price per unit – variable costs per unit
(b)
(i)
Year ended 30 November 2003: £42,250
=
1,625 portraits
£38 – £12
(ii)
Year ended 30 November 2004: £52,000
=
2,000 portraits
£38 – £12
(c)
(d)
•
Increase in fixed costs: £52,000 – £42,250 = £9,750
•
£9,750 ÷ 1,625 portraits at 2003 break-even = £6 extra per portrait
•
Therefore the price of each portrait will need to increase by £6 to £44
•
The price change to £44 is a 16% increase
•
As a result of the increase the demand for portraits may fall to below break-even point
•
The prices charged by competitors may be below that charged by Tracey
•
Tracey should investigate reducing her variable costs and/or see if the increase in fixed overheads can be reduced in any way.
51
CHAPTER 12 Absorption and activity based costing 12.1
(a) (b)
12.2
•
cost units – units of output to which costs can be charged
•
cost centres – sections of a business to which costs can be charged
Suggestions to include: COST UNIT client hour
COST CENTRE partner in firm tax department administration
parcel delivery company
per parcel per kg per mile/kilometre per kg mile (or kilometre)
vehicle depot head office
•
college of further education
student hour
teaching department learning resources administrative office
•
mixed farm
kg of wheat head of cattle
field cattle shed
•
firm of accountants
•
Suggestions to include: 1.
Sections of a theatre which could be used as cost centres: Productions Bar Confectionery Printing and advertising (or marketing) Box office, stewarding and programme sales Administration Maintenance and cleaning of buildings
2.
Sections of a garage which could be used as cost centres: New car sales Used car sales Repairs and servicing Valeting Management and administration
12.4
•
•
Marginal cost per barbecue
£
Direct materials
30.00
Direct labour
25.00
MARGINAL COST
55.00
Absorption cost per barbecue
£
Direct materials
30.00
Direct labour
25.00
PRIME COST
55.00
Overheads (fixed) 150,000 ÷ 10,000 barbecues
15.00
TOTAL COST
70.00
52
•
COOK-IT LIMITED PROFIT STATEMENT: 10,000 BARBECUES £
£
Sales (10,000 x £90)
12.6
900,000
Direct materials (10,000 x £30)
300,000
Direct labour (10,000 x £25)
250,000
PRIME COST
550,000
Overheads (fixed)
150,000
TOTAL COST
700,000
PROFIT
200,000
(a) ACTIVTOYS LIMITED PROFIT STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-1 MARGINAL COSTING £ £ Sales at £125 each
ABSORPTION COSTING £ £
162,500
162,500
Variable costs Direct materials at £25 each
37,500
37,500
Direct labour at £30 each
45,000
45,000
82,500 Less Closing stock (marginal cost*) 200 frames at £55 each
11,000 71,500
CONTRIBUTION
91,000
Fixed production overheads
82,500
82,500 165,000
Less Closing stock (absorption cost*) 200 frames at £110 each
22,000
Less Cost of goods sold
143,000
PROFIT
8,500
19,500
* Closing stock is calculated on the basis of this year’s costs:
marginal costing, variable costs only, ie £25 + £30 = £55 per frame x 200 frames = £11,000 absorption costing, variable and fixed costs, ie £165,000 ÷ 1,500 frames = £110 per frame x 200 frames = £22,000
(b)
Reasons for different profit figures: •
The difference in the profit figures is caused by the closing stock figures: £11,000 under marginal costing and £22,000 under absorption costing – the same costs have been used, but fixed production overheads have been treated differently.
•
Only fixed production overheads are dealt with differently using the techniques of marginal and absorption costing – both methods charge non-production overheads in full to the profit statement in the year to which they relate.
•
With marginal costing, the full amount of the fixed production overheads has been charged in this year’s profit statement; by contrast, with absorption costing, part of the fixed production overheads (here, £11,000) has been carried forward to next year in the stock valuation.
Comment on the directors’ statement: •
A higher profit does not mean more money in the bank.
•
The two costing methods simply treat fixed production overheads differently and, in a year when there is no closing stock, total profits to date are exactly the same – but they occur differently over the years.
53
12.7
(a) DURNING LIMITED PROFIT STATEMENT FOR THE MONTH ENDED 30 APRIL 20-4 MARGINAL COSTING £ £ Sales 8,000 units at £4 each
ABSORPTION COSTING £ £
32,000
32,000
Variable costs Direct materials at £0.80 each Direct labour at £1.60 each
8,000
8,000
16,000
16,000
24,000 Less Closing stock (marginal cost) 2,000 units at £2.40 each
4,800 19,200
CONTRIBUTION
12,800
Fixed production overheads
10,000
10,000 34,000
Less Closing stock (absorption cost) 2,000 units at £3.40 each
6,800
Less Cost of goods sold
27,200
PROFIT
2,800
4,800
Working notes: Closing stock is calculated on the basis of this year’s costs:
marginal costing, variable costs only, ie £0.80 + £1.60 = £2.40 per unit x 2,000 units = £4,800 absorption costing, variable and fixed costs, ie £34,000 ÷ 10,000 units = £3.40 per unit x 2,000 units = £6,800
(b)
The difference in the profit figures is caused only by the closing stock figures: £4,800 under marginal costing, and £6,800 under absorption costing. With marginal costing, the full amount of the fixed production overheads has been charged in this year’s profit statement; by contrast, under absorption costing, part of the fixed production overheads (here £10,000 x 20%* = £2,000) has been carried forward in the stock valuation. * 2,000 units in stock out of 10,000 units manufactured
12.9
(a)
(i)
Fixed production costs ÷ 12,000 units = £90,000 ÷ 12,000 = £7.50 absorption rate per unit
(ii)
Absorption costing: variable production costs per unit + absorption cost per unit = £70.00 + £7.50 = £77.50 production cost per unit
(b)
Budgeted profit for June
£
sales 10,000 units @ £90
900,000
opening stock 500 units @ £77.50
add
£
38,750
production costs 12,000 units @ £77.50
930,000 968,750
less
closing stock 2,500 units @ £77.50
193,750
cost of sales
775,000
gross profit
125,000
less
non-production costs
50,000
equals
budgeted net profit for June
75,000
54
(c)
12.11 (a)
•
Using absorption costing, budgeted net profit for June is £75,000 which is £15,000 higher than the £60,000 profit using marginal costing.
•
With marginal costing, the full amount of fixed production costs of £930,000 has been charged in this month’s profit statement; by contrast, with absorption costing, part of the fixed production costs (here, £7.50 x 2,000 units = £15,000) has been carried forward to next month in the stock valuation.
•
Profit will always be higher under absorption costing in accounting periods of increasing stock levels.
•
However, a higher profit does not mean more money in the bank and, over the longer term, profit is the same under both methods.
•
Under IAS 2, Inventories, Jayne Bonde plc must use absorption costing for its stock valuation, based on the costs of direct materials, direct labour, direct expenses (if any), and production overheads. Note that nonproduction overheads are charged in full to the profit statement to which they relate.
•
It seems unlikely that there will be any effect on the shareholders as marginal costing cannot be used for stock valuation purposes in published accounts.
Activity based costing is a costing method which charges overheads to output on the basis of activities. The cost per unit of a product can be calculated based on its use of activities. The steps to applying activity based costing are:
(b)
12.13 (a)
1.
The overhead costs which are incurred by the same activity are grouped together in cost pools, eg the costs of purchasing goods to be used in production.
2.
The cost driver – the factor which influences the costs – is then identified, and the rate for each cost is calculated, eg the cost of placing a purchase order for goods to be used in production.
3.
The rate for each cost is charged to production, based on the use of the activity, eg if a product requires two purchase orders to be placed, it will be charged with the cost of two activities.
•
Today’s capital intensive, low-labour industries are very different from older industries which are labour intensive, or where production requires the use of heavy machinery. Traditionally, older industries have charged overheads to output on the basis of direct labour hours, or machine hours. Such methods are not appropriate for modern, complex methods of production.
•
In capital-intensive industries, overheads often form a high proportion of total costs and are complex in nature. They need to be accounted for in a more sophisticated way than would be the case under absorption costing, eg absorbing overhead costs under one basis – such as direct labour hours – does not acknowledge the complex nature of the overheads and production processes.
•
Often modern flexible manufacturing methods require short production runs, with the ability to switch from one product to another at short notice. This is in contrast to older industries where the same product is produced over a long production run. These differing production methods impact on costs such as setting up equipment, which will be much larger per unit of output for small production runs than for large ones. Activity based costing is able to charge the cost of overheads to output on the basis of activities – something which absorption costing would not do.
calculation of weekly overheads for set ups and quality inspections £ set ups:
product Aye
5 x £250
1,250
product Bee
50 x £250
12,500
product Aye
5 x £150
750
product Bee
50 x £150
7,500
£
13,750 quality inspection:
8,250 TOTAL
22,000
At present the weekly overheads are charged on the basis of labour hours: £ product Aye (500 hours)
11,000
product Bee (500 hours)
11,000
TOTAL
22,000
55
(b)
activity based costing: £ product Aye 5 set ups at £250 5 quality inspections £150
£
1,250 750 2,000
product Bee 50 set ups at £250 50 quality inspections £150
12,500 7,500 20,000 22,000
TOTAL
(c)
•
By using activity based costing, there is a more accurate reflection of the cost of the activities of set up and quality inspection.
•
The cost of 50,000 units of product Aye is reduced by £9,000 (ie £11,000 – £2,000), while the cost of 50,000 units of product Bee is increased by £9,000 (ie from £11,000 to £20,000).
•
This may well have implications for the viability of product Bee, and for the selling prices of both products.
12.14 Marginal costing
less
equals less equals
• •
sales variable costs: direct materials direct labour
Product Exe £ £ 200,000 60,000 20,000
Product Wye £ £ 160,000 40,000 20,000
80,000 120,000
contribution fixed production costs profit for the week
Total £
60,000 100,000
220,000 36,000 184,000
With marginal costing, the focus is on the contribution – both by product and in total. Fixed production costs are treated as a period cost – ie cost of time (such as a week, as here) rather than being product related.
Absorption costing Product Exe £
less
equals
sales direct materials direct labour PRIME COST fixed production costs TOTAL COST profit for the week
Product Wye
£ 200,000
60,000 20,000 80,000 *18,000
£
£ 160,000
Total £
40,000 20,000 60,000 *18,000 98,000 102,000
78,000 82,000
184,000
* 2,000 direct labour hours for each product per week, so fixed production costs are £36,000 ÷ 2 = £18,000 per product. • •
With absorption costing, the focus is on profit – both by product and in total. Overhead costs are absorbed by production before profit is calculated.
Activity based costing Fixed production costs: product Exe product Wye
• •
set ups number 2 10
set ups: £24,000 ÷ 12 = £2,000 per set up inspections: £12,000 ÷ 12 = £1,000 per inspection
56
£ 4,000 20,000 24,000
inspections number £ 2 2,000 10 10,000 12,000
Product Exe £ sales less
Product Wye £
£
200,000
Total £
£
160,000
direct materials
60,000
40,000
direct labour
20,000
20,000
PRIME COST
80,000
60,000
fixed production costs set ups
4,000
20,000
inspections
2,000
10,000
TOTAL COST equals
profit for the week
86,000
90,000
114,000
70,000
184,000
• With activity based costing, which is a development of absorption costing, the focus is on identifying the overhead costs for a particular activity. • It gives more accurate costing information and shows that smaller batches (as here with product Wye) cost more to produce.
CHAPTER 13 Overheads and overhead absorption 13.3
(a)
Budgeted total overheads (£) Budgeted lecturer hours Budgeted overhead absorption rate (£)
OVERHEAD ANALYSIS SHEET for January 20-8 Accountancy Department 22,143 1,525 14.52
Management Department 17,251 1,300 13.27
OVERHEAD ANALYSIS SHEET Course: Finance for Managers Accountancy Department 45 14.52 653.40
Management Department 20 13.27 265.40
(b)
Lecturer hours Budgeted overhead absorption rate (£) Overhead absorbed by course (£)
13.5
(a) and (b) cost
basis of apportionment
Rent and rates Buildings insurance Machinery insurance Lighting and heating Depn of machinery Supervisory salaries Maintenance dept salary Factory cleaning
Floor area Floor area Value of machinery Floor area Value of machinery No. of employees
Re-apportionment of maintenance dept
total
machining
finishing
maintenance
£ 5,520 1,320 1,650 3,720 11,000 30,000
£ 2,760 660 1,200 1,860 8,000 18,000
£ 1,840 440 450 1,240 3,000 9,000
£ 920 220 – 620 – 3,000
Allocation Floor area
16,000 4,800 74,010
– 2,400 34,880
– 1,600 17,570
16,000 800 21,560
Value of machinery
– 74,010
15,680 50,560
5,880 23,450
(21,560) –
57
(c)
35 hours x 47 weeks = 1,645 direct labour hours per employee Machining Dept: 6 employees = 9,870 hours = £5.12 per direct labour hour Finishing Dept: 3 employees = 4,935 hours = £4.75 per direct labour hour
(d)
Depending on the method and type of production, the company is most likely to use overhead absorption rates based on: • direct labour hours, or • machine hours The OAR selected may vary from one department to another, depending on whether departments are labour-intensive or machine-intensive. The labour hour rate is a popular method because overheads are absorbed on a time basis. However, the machine hour is particularly appropriate where expensive machinery is used in a department.
13.8
(a)
Direct labour hour: (3 hours x 80 seats) + (3.5 hours x 40 seats) = 380 direct labour hours per month = £2.63 per hour. Machine hour: (1 hour x 80 seats) + (2.5 hours x 40 seats) = 180 machine hours per month = £5.56 per hour. Alternative methods could be based on a percentage of certain costs, eg direct labour.
(b)
Direct labour hour 'Standard'
£36.50 + £7.89
=
£44.39
'De Luxe'
£55.00 + £9.21
=
£64.21
'Standard'
£36.50 + £5.56
=
£42.06
'De Luxe'
£55.00 + £13.89
=
£68.89
Machine hour
Note: some figures have been rounded to the nearest penny
(c)
See text. The machine hour rate charges most to 'de luxe' model. On balance, direct labour hours may be the best method to use because the products are more labour-intensive than machine-intensive.
13.10 total
Overheads Administration Operating theatre
£ 112,195 –
day care ward £ 28,750 1,650
surgical ward £ 42,110 4,125
– 112,195
20,320 50,720
15,240 61,475
total £ 25,000 –
tables £ 12,000 1,500
chairs £ 8,000 1,200
– 25,000
1,380 14,880
920 10,120
operating theatre £ 32,260 3,300 35,560 (35,560) –
administration
stores £ 3,000 (3,000) – – –
maintenance £ 2,000 300 2,300 (2,300) –
£ 9,075 (9,075) – – –
13.11
Overheads Stores Maintenance
58
59
Net book value Floor space Floor space Allocated Allocated
Depreciation of fixed assets
Rent
Other property overheads
Staff costs
Administration overheads
(b)
62,055
21,580
2,600
16,900
3,900
13,000
23,575
6,500
17,075
6,850
450
1,000
–
(13,000)
13,000
18,980
9,975
900
2,000
840
£
Administration
62,055
7,390
1,350
3,000
4,200
£
Servicing
3,860
11,080
1,800
4,000
1,260
£
Used Car Sales
3,860
35,295
4,500
10,000
2,100
£
£ 8,400
New Car Sales
Total
Budgeted fixed overhead absorption rate for the servicing centre: £23,575 ÷ 1,025 hours = £23.00 per direct labour hour
Administration
Basis
(a)
Fixed overheads for four weeks ended 28 April 20-4
13.12
13.13 (a)
Labour hour method Expected number of labour hours, 26,000 units x 3 labour hours per unit = 78,000 hours
total cost centre overheads
=
total labour hours
(b)
£39,000
=
£0.50 per labour hour
78,000 hours
Selling price per unit, using cost-plus pricing £ direct materials
40 metres at £2.50 per metre
direct labour
3 hours at £16 per hour
fixed overheads
3 hours at £0.50 per hour
total cost
plus equals
(c)
100.00 48.00 1.50 149.50
mark-up of 20%
29.90
selling price per unit
179.40
Advantages of using absorption costing to set selling price •
As absorption costing calculates a total cost – variable costs and fixed costs – all overheads are recovered in the selling price.
•
Overhead absorption rates are often based on either machine hours or labour hours – whilst these may not be entirely accurate, they provide a good estimate of overhead costs.
•
The percentage cost-plus mark-up can be varied to suit market conditions but, provided the business sets selling price above total cost, a profit will be made.
Advantages of using marginal costing to set selling price •
As marginal costing focuses on variable costs and contribution it can be a more flexible way of setting selling prices.
•
Variable costs represent the starting point for setting selling prices but Dario Uno must recover the fixed overheads from total sales – even if different prices are charged to different customers – in order to make a profit.
Tutorial note •
In order to set the same selling price under absorption costing and marginal costing, the cost-plus mark-up will be different – it will be lower for absorption costing (being a mark-up on total cost), and higher for marginal costing (being a mark-up on variable cost).
60
61
machine net book value machine hours
Factory machinery depreciation
Machine maintenance
44,860
102,400
57,540
5,040
900
51,600
16,000
8,000
9,600
18,000
£
Assembly
–
(6,300)
300
6,000
–
–
–
6,000
£
Maintenance
Tutorial note: canteen costs are re-apportioned before maintenance because it does not receive any services from the maintenance department.
1,260
–
Maintenance
1,800
41,800
102,400 –
24,000
4,000
4,800
40,000
12,000
14,400
9,000
£
£ 36,000
Machining
Total
Canteen
number of set-ups
number of employees
Factory canteen expenses
Machine set-up costs
Basis
(c)
Fixed overheads for 2006
13.14
–
–
(3,000)
3,000
–
–
–
3,000
£
Canteen
(d)
Machining department The method to be used in this department is labour hour, because the department is more labour-intensive than machineintensive. total machining department overheads
=
total labour hours
£44,860
=
approx £1.12 per labour hour
40,000 hours
Assembly department The method to be used in this department is machine hour, because the department is more machine-intensive than labourintensive. total assembly department overheads total machine hours (e)
=
£57,540
=
approx £0.96 per machine hour
60,000 hours
Cost drivers are activities which cause costs to be incurred. Activity based costing uses cost drivers linked to the way in which the business is conducted in order to charge costs – through cost pools – to activities.
(f)
•
for factory canteen expenses the cost driver will be the number of employees
•
for factory machine maintenance the cost driver will be the number of machine hours
•
for factory machine set-up costs the cost driver will be the number of machine set-ups
CHAPTER 14 Costing in decision-making
14.1
There are a wide range of marginal costing applications in the service businesses mentioned. For example: •
•
•
•
hotel – ‘bargain break’ weekends to make use of rooms occupied by business people during the week – last minute bookings, which are discounted from the normal tariff transport – season tickets – weekend fares – cheaper fares after the morning rush – discounts for categories of people in slack travel months cinema or theatre – standing or cheap tickets released only on the day of the performance – ‘half-price’ ticket booths on day of performance – special cheap ticket deals with transport companies – family tickets holiday companies – discounts for last minute bookings to fill empty places on planes and at hotels – discounts for early bookings, which help with planning the travel companies’ operations – special deals with transport companies – off-peak prices Consider also the benefits and restrictions/problems for both the customer and the supplier. Often only a limited number of products are available at special prices, or there are restrictions on the time that they are available. The major disadvantage for the supplier is that those customers who have paid the full price will be disgruntled when they learn the lower price paid by others.
62
14.2
In-house manufacture Marginal cost of manufacture per pump motor:
£
direct materials
40.00
direct labour
25.00
variable overheads
20.00
marginal cost
85.00
The marginal cost of making 3,500 pump motors per year: 3,500 units at £85
plus
£ = 297,500
contribution which will be lost from ‘olde worlds’ handpumps: 750 units at £250 – £150
=
75,000
= 372,500
Buying in cost from outside supplier 3,500 units at £95
= 332,500
Therefore, by buying in pump motors from an outside supplier, the company has the potential to increase profits by £40,000 (£372,500 – £332,500).
14.5
(a)
Absorption cost per seat (based on sixty seats sold) £ direct materials
£12.50 x 60
direct labour
£10.00 x 60
600.00
£2.50 x 60
150.00
direct expenses fixed overheads
3,500.00
TOTAL COST
5,000.00
The absorption cost per seat is £5,000 ÷ 60 (b)
(c)
750.00
=
Marginal cost per seat direct materials direct labour direct expenses MARGINAL COST (per seat)
£83.33
£ 12.50 10.00 2.50 25.00
Profit or loss if no further tickets sold revenue 60 seats at £100 each less total cost (see above) PROFIT
£ 6,000.00 5,000.00 1,000.00
63
(d) MERCIA AIRWAYS profit statement for flight MA 005 60 seats sold £
60 seats + 30 sold to travel firm £
60 seats + 40 sold to newspaper £
6,000
6,000
6,000
30 seats at £45 each
–
1,350
–
40 units at £35 each
–
–
1,400
6,000
7,350
7,400
Direct materials (£12.50 per passenger)
750
1,125
1,250
Direct labour (£10 per passenger)
600
900
1,000
Sales revenue for flight: 60 seats at £100 each
Less costs:
Direct expenses (£2.50 per passenger)
150
225
250
Fixed overheads
3,500
3,500
3,500
PROFIT
1,000
1,600
1,400
Flight MA 005 to Rome •
•
Two proposals for the 40 unsold seats on next week’s flight: –
to sell approximately 30 seats at £45 each to the travel firm
–
to sell all 40 seats to the local newspaper at £35 each
The profit statement shows –
if no further seats are sold the profit will be £1,000
–
if sold to the travel firm, the contribution (selling price – marginal cost) is 30 seats x (£45 – £25) = £600, which gives a profit figure of £1,600
–
if sold to the newspaper, the contribution is 40 seats x (£35 – £25) = £400, which gives a profit figure of £1,400
Conclusion
14.6
(a)
•
The offer from the travel firm should be taken up, while the newspaper offer should not be considered on this occasion.
•
With contributions of £20 per seat from the travel firm and £10 from the newspaper, provided that the flight firm can sell more than 20 seats, the contribution will be greater than that from the newspaper.
Absorption cost
£
direct materials (per pair)
20.00
direct labour (per pair)
18.00
fixed overheads
16.00
(£200,000 ÷ 12,500 pairs)
ABSORPTION COST (per pair)
54.00
Marginal cost
£
direct materials (per pair)
20.00
direct labour (per pair)
18.00
MARGINAL COST (per pair)
38.00
Profit or loss at existing production of 12,500 pairs of boots, see below.
64
(b) THE LAST COMPANY LTD profit statements Existing production 12,500 pairs of boots £
Existing production + 2,500 pairs @ £45 each £
Existing production + 5,000 pairs @ £37 each £
12,500 pairs at £60 each
750,000
750,000
750,000
2,500 pairs at £45 each
–
112,500
–
5,000 pairs at £37 each
–
–
185,000
750,000
862,500
935,000
250,000
300,000
350,000
Sales revenue (per week):
Less production costs: Direct materials (£20 per pair) Direct labour (£18 per pair)
225,000
270,000
315,000
Fixed overheads
200,000
200,000
200,000
75,000
92,500
70,000
PROFIT
Offer from Zambesi Limited •
•
Two contracts offered by Zambesi Limited for the ‘Snowdon’ range: –
either 2,500 pairs at £45 per pair
–
or 5,000 pairs at £37 per pair
The profit statement for planned sales, together with the two offers shows: –
if either offer is not taken up, profits next year are expected to be £75,000
–
if 2,500 pairs sold to Zambesi at £45 per pair, the contribution (selling price – marginal cost) is 2,500 x (£45 – £38) = £17,500; thus profits increase by £17,500 to £92,500
–
if 5,000 pairs sold to Zambesi at £37 per pair, the contribution is 5,000 (£37 – £38) = (£5,000); this price of £37 is below our marginal cost of £38; thus profits fall by £5,000 to £70,000
Conclusion •
The offer of 2,500 pairs at £45 per pair should be taken up, while the offer of 5,000 pairs at £37 should be rejected. This follows the principle that, once the fixed overheads have been recovered from normal sales, provided that additional units can be sold at a price above marginal cost, then profits will increase.
14.10 (a)
Product
‘People’ £
Selling price per unit
60
‘Animals’ £
27.50
‘Birds’ £
17.50
Less: Unit variable costs Direct materials
5
3
2
Direct labour
15
5
3.33
Variable overheads
10
4.50
2.96
Contribution per unit
30
65
15
9.21
(b)
Break-even point for the ‘People’ range is: fixed costs (£) contribution per unit (£)
= £45,400 £30
= 1,514 units
(c)
Product
(d)
‘People’
‘Animals’
‘Birds’
Contribution per unit
£30
£15
£9.21
Labour hours per unit
1.5
0.5
0.333
Contribution per labour hour
£20
£30
£27.66
•
Labour hours are the scarce resource here, with 2,800 hours available.
•
To maximise profits, the company should maximise the contribution from each labour hour.
•
The preferred order is ‘Animals’ (at £30 contribution per labour hour), ‘Birds’ (at £27.66), and ‘People’ (at £20).
•
Optimum production plan:
less
Total hours available per month
2,800
‘Animals’, 2,000 units x 0.5 hours per unit
1,000 1,800
less
‘Birds’, 2,700 units x 0.333 hours per unit
900
equals
hours remaining to produce units of ‘People’
900
Therefore production of ‘People’ at 1.5 hours per unit will be 600 units per month. This production plan does not allow for full production of the ‘People’ range.
14.12 (a)
(i)
sales revenue – variable costs = contribution
(ii)
sales revenue – variable costs = contribution per unit number of units £
(b)
(i)
Ink pen £8.00 – £6.20 = £1.80 contribution x 4,200 units
=
7,560
Novelty ruler £2.50 – £0.60 = £1.90 contribution x 8,400 units
=
15,960
Total contribution (ii)
23,520
Ink pens £1.80 contribution x 3,000 units
=
5,400
Novelty rulers £1.90 contribution x 6,000 units
=
11,400
Bought in: ink pens £8.00 – (£3.10 + £4.00) = £0.90 contribution x 1,200 units
=
1,080
novelty rulers £2.50 – (£0.40 + £1.10) = £1.00 contribution x 2,400 units
=
2,400
Total contribution
(c)
20,280
•
The bought-in goods give a positive contribution of £0.90 for the pen and £1.00 for the ruler; these amounts will contribute to fixed costs and profit.
•
By buying-in goods Drew Armstrong is able to satisfy the demand from customers who will not seek out an alternative supplier.
•
Drew must be sure of the quality of the bought-in goods, the timing of deliveries, and the reliability of the supplier.
66
(d)
14.13 (a)
(b)
See also chapter 18: •
The current staff may be resistant to retraining on the new machine.
•
The staff will be demotivated until they know who is to be made redundant and who is to be retrained; some staff may seek work elsewhere.
•
The staff to be retrained may seek a pay rise on account of their increased skills.
•
Once retrained, staff will have transferable skills useful to other employers who may seek to recruit them.
•
Staff may see increased production as a positive sign that their jobs are safe. They may be concerned about the effect of the loan interest and repayments for the machine on the financial viability of the business.
•
Fixed costs remain fixed over a range of output levels and vary with time rather than activity levels, eg rent, insurance.
•
Semi-variable costs include both a fixed and a variable element, eg utility bills such as telephone, fuel.
•
Variable costs vary directly with output, eg direct materials, royalties, direct labour.
Sales revenue – variable costs = contribution. £
(c)
less
selling price £40 per unit x 12,000 units
480,000
variable costs £12 per unit x 12,000 units
144,000
variable overheads £1.50 per unit x 12,000 units
equals
(d)
total contribution for year to 31 May 2007
fixed costs (£) contribution per unit (£)
=
£256,500 – £18,000 variable costs £318,000 ÷ 12,000 units
£238,500 £26.50
=
9,000 units to break-even
(e)
18,000 318,000
Profit statements for each new order for the year ended 31 May 2008 Order JJH 6,000 units £ Sales JJH £180,000/6,000 = £30 per unit; JHB £256,000/8,000 = £32 per unit
180,000
256,000
Variable costs £14 x 6,000 (JJH) or 8,000 (JHB) units
(84,000)
(112,000)
Variable overheads £1.50 x 6,000 (JJH) or 8,000 (JHB) units
(9,000)
(12,000)
Delivery charges JJH 2% of £180,000; JHB 2.5% of £256,000
(3,600)
(6,400)
Machinery modification
(19,000)
–
Staff retraining
(8,000)
–
Overseas agent
(14,000)
(14,000)
Temporary staff
–
(28,000)
42,400
83,600
PROFIT FROM EACH NEW ORDER
(f)
Order JHB 8,000 units £
Note that the factory is currently operating at 60 per cent of capacity: current production is 12,000 units, so maximum capacity is 20,000 units, ie an increase of 8,000 units.
Order JJH •
Although profit on this order is lower than for JHB, future orders “are almost guaranteed”.
•
In the year to 31 May 2008, one-off costs of machinery modification and staff retraining are £27,000. Provided no further such costs are incurred, the profit of subsequent years will be £42,400 + £27,000 = £69,400 from this order.
•
Staff retraining will motivate the staff but will also give them transferable skills useful to other employers who may seek to recruit them.
•
Staff may seek a pay rise once they have been retrained.
•
Staff may see increased production as a positive sign that their jobs are safe.
67
•
With a selling price of £30 per unit, this order gives a positive contribution, £30 – £15.50 (£14 + £1.50) = £14.50 to delivery charges and fixed costs.
•
It utilises spare capacity, but leaves 2,000 further units of spare capacity.
•
Although the selling price is £30 instead of the normal selling price of £40, the company is already past the break-even point with its normal sales.
Order JHB •
This is a ‘one-off’ order which utilises the full capacity of the factory, and so prevents future growth of the business for the year to 31 May 2008.
•
With a selling price of £32 per unit, this order gives a positive contribution, £32 – £15.50 (£14 + £1.50) = £16.50 to delivery charges and fixed costs.
•
Profit is higher than for JJH but is likely to be for one year only.
•
Temporary staff will need to be employed, helping the local economy, in the short-term.
•
For this order, the product will need to be modified – management needs to ensure that the modifications are within the capabilities of the staff.
Conclusion The order from JJH is to be preferred provided that there is the likelihood of future orders. This will safeguard the jobs of current employees and may enable the company to expand in the future. Although profit will be lower than JHB in the first year, this will be more than made up by the second year order.
14.14 (a)
less
PRODUCT
Caz
Jaz
Selling price per unit
£42
£45
Unit variable costs per unit Caz, materials £18, direct labour £16
£34
Jaz, materials £12, direct labour £24
equals
£36
Contribution per unit Direct labour hours per unit
£8
£9
2 hours
3 hours
£4
£3
Contribution per direct labour hour
(b)
•
Labour hours are the scarce resource, with 42,000 hours available.
•
To maximise profits, the company should maximise the contribution from each labour hour.
•
The preferred order is Caz (at £4 contribution per labour hour) and Jaz (at £3).
•
Optimum production plan: Total hours available per year
42,000
less
Caz, 12,000 units x 2 hours per unit
24,000
equals
hours remaining to produce units of Jaz
18,000
Therefore production of Jaz at 3 hours per unit will be 6,000 units. In summary:
Production plan Caz
12,000 units
Jaz
6,000 units
68
(c)
The shortfall in Jaz is 2,000 units (8,000 – 6,000): £ Selling price per unit
less
45.00
Buying-in price per unit £38 + *£5.70 delivery charge
equals
Contribution per unit
43.70 1.30
* £38 x 15% This contribution will increase profit by £2,600 (£1.30 x 2,000 units) and will be worthwhile –
to maintain market share
–
to retain customers
provided that –
quality can be assured
–
delivery dates can be relied upon
14.16 (a)
PRODUCT Selling price per unit
less
JHB1
JJH2
£50
£50
Unit variable costs per unit JHB1, labour £32, materials £8
£40
JJH2, labour £16, materials £16
equals
Contribution per unit Direct labour hours per unit Contribution per labour hour
£32 £10
£18
4 hours
2 hours
£2.50
£9
2
1
Ranking
•
Labour hours are the scarce resource, with 80,000 hours available.
•
Optimum production plan: Total hours available per year
80,000
less
JJH2, 20,000 units x 2 hours per unit
40,000
equals
hours remaining to produce units of JHB1
40,000
Therefore production of JHB1 at 4 hours per unit will be 10,000 units. (b)
Shortfall in JHB1 is 5,000 units (15,000 – 10,000): £ Selling price per unit
50
less
Buying-in price per unit
45
equals
Contribution per unit
5
This contribution will increase profit by £25,000 (£5 x 5,000 units) and will be worthwhile –
to maintain market share
–
to retain customers
provided that –
quality can be assured
–
delivery dates can be relied upon
69
(c)
Contribution: JHB1 JJH2
£ 10,000 units @ £10 per unit
100,000
5,000 units @ £5 per unit
25,000
20,000 units @ £18 per unit
360,000 485,000
less
Fixed costs
equals
Profit
420,000 65,000
CHAPTER 15 Standard costing and variance analysis
15.1
(a)
Standard costing sets a pre-determined/budgeted cost for materials, labour and overheads in advance of production. Many businesses establish a standard or budgeted cost for their output in advance of production. Standard costs can then be compared with actual costs and variances calculated.
(b)
The main advantages of standard costing are that it can be used: •
to help with decision-making – for example, with price setting
•
to assist in planning – for example, to plan the quantity and cost of resources needed for production
•
as a means of controlling costs – standard costs are compared with actual costs and variances calculated so that action can be taken by the responsible manager or department when appropriate
15.4
Material A
Material B
£ p
£ p
Material C £ p
Material D £ p
material price variance
120.00 FAV
200.00 ADV
500.00 FAV
250.00 ADV
material usage variance
100.00 ADV
400.00 FAV
1,000.00 FAV
100.00 FAV
20.00 FAV
200.00 FAV
1,500.00 FAV
150.00 ADV
materials variance
15.5
Product 1
labour rate variance labour efficiency variance labour variance
15.6
(a)
Product 2
Product 3
£ p
£ p
7.00 ADV
4.00 ADV
15.00 FAV
15.00 ADV
10.00 FAV
9.00 ADV
72.00 ADV
48.00 ADV
3.00 FAV
13.00 ADV
57.00 ADV
63.00 ADV
Material price variance 800 kg x (75p – 80p)
=
£40 ADVERSE
75p per kg x (900 kg – 800 kg)
=
£75 FAVOURABLE
TOTAL MATERIALS VARIANCE
=
£35 FAVOURABLE
Material usage variance
Labour rate variance 140 hours x (£10 – £11)
=
£140 ADVERSE
£10 per hour x (150 hours – 140 hours)
=
£100 FAVOURABLE
TOTAL LABOUR VARIANCE
=
Labour efficiency variance
£40 ADVERSE
70
£ p
Product 4 £ p
(b)
15.8
(a)
•
the managers responsible for each section of the business will be asked to explain the reason for any significant variances of their section
•
the buying department should explain the 5p per kilo adverse variance in the cost of materials – perhaps better quality materials have been purchased, or there has been a price increase, or there has been an adverse exchange rate fluctuation
•
the production department should explain the favourable variance in materials usage – perhaps better quality materials have been used with less wastage, or the workforce is better trained in using the materials
•
the human resources department will need to explain the £1.00 per hour higher labour rate – perhaps there has been a pay rise; alternatively, overtime rates may have had to be paid, which the production department will be asked to explain
•
the production department should be asked to explain the favourable variance in labour efficiency – perhaps more use has been made of machines, or the workforce is better trained, or better quality materials have been used
•
it may be that variances are linked, eg more expensive materials have less wastage; skilled employees (on higher pay rates) work more efficiently
•
corrective action may need to be taken in some areas despite the overall favourable variance in total cost
(i)
Material price variance: actual quantity x (standard price – actual price) 60,000 metres x (£8.00 – *£9.75)
=
£105,000 ADVERSE
* £585,000 ÷ 60,000 metres
Material usage variance: standard price x (standard quantity – actual quantity) £8.00 x (*66,000 metres – 60,000 metres)
=
£48,000 FAVOURABLE
=
£0 NO VARIANCE
* 12,000 units produced x 5.5 metres per unit
(ii)
Labour rate variance: actual labour hours x (standard rate – actual rate) 60,000 hours x (£6 – *£6) * £360,000 ÷ 60,000 hours
Labour efficiency variance: standard rate x (standard hours – actual hours) £6 per hour x (*52,000 hours – 60,000 hours)
=
£48,000 ADVERSE
* 12,000 units produced x 4 hours 20 minutes (note 20 minutes = 1/3rd of an hour) = 48,000 hours + 4,000 hours = 52,000 hours
(b)
JAYNE BONDE PLC VARIABLE PRODUCTION COSTS RECONCILIATION STATEMENT FOR MAY £
£
ADV
FAV
£
Materials: 5.5 metres x £8 per metre x 12,000 units produced
528,000
Labour: 4 hours 20 minutes x £6 per hour x 12,000 units produced
312,000
Budgeted variable production costs
840,000
Material price variance
105,000
Material usage variance
48,000
Labour efficiency variance
48,000 153,000
Actual variable production costs
48,000
105,000 945,000
Remember: because we are dealing with costs, adverse variances are added and favourable variances are deducted.
71
(c)
15.10 (a)
•
As the material price variance is adverse this could indicate that the material is of better quality which has led to a favourable material usage variance because there is less wastage.
•
However, the labour efficiency variance is adverse which may have been caused by the workforce spending longer and taking more care with the product; alternatively a lower grade of labour may have been used which does not have sufficient skills.
Material price variance: actual quantity x (standard price – actual price) 80,000 kg x (£18 – *£15)
=
£240,000 FAVOURABLE
* £1,200,000 ÷ 80,000 kg
Material usage variance: standard price x (standard quantity – actual quantity) £18 x (*76,200 kg – 80,000 kg)
=
£68,400 ADVERSE
=
£30,000 FAVOURABLE
=
£58,080 ADVERSE
* 15,240 units produced x 5 kg per unit
(b)
Labour rate variance: actual labour hours x (standard rate – actual rate) 15,000 hours x (£12 – *£10) * £150,000 ÷ 15,000 hours
Labour efficiency variance: standard rate x (standard hours – actual hours) £12 per hour x (*10,160 hours – 15,000 hours)
* 15,240 units produced x 40 minutes (2/3rd of an hour) per unit
(c)
A J DAN PLC: COSTS RECONCILIATION STATEMENT FOR APRIL 2008 £
£
ADV
FAV
Materials: 5 kg x £18 per kg x 15,240 units
£
1,371,600
Labour: 40 minutes x £12 per hour x 15,240 units
121,920
Budgeted total cost
1,493,520
Material price variance
240,000
Material usage variance
68,400
Labour rate variance
30,000
Labour efficiency variance
58,080 126,480
Actual total cost
270,000
(143,520) *1,350,000
* Materials £1,200,000 + labour £150,000
Remember: because we are dealing with costs, adverse variances are added and favourable variances are deducted.
(d)
The costs reconciliation statement is used to: –
link the budgeted total cost with the actual total cost
–
identify whether the actual total cost of output is greater or less than the standard cost of the output
–
show the effect of variances on the total budgeted costs
–
list the amounts of the variances – and whether they are adverse or favourable – and bring them to the attention of management so that they can take appropriate action
72
15.13 (a)
Sales price variance: actual quantity x (standard price – actual price) 18,000 units x (£5 – *£6)
=
£18,000 FAVOURABLE
=
£10,000 ADVERSE
* £108,000 ÷ 18,000 units
(b)
Sales volume variance: standard price x (standard quantity – actual quantity) £5 x (20,000 – 18,000)
(c)
ZELAH LTD SALES RECONCILIATION STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20-9 £ Forecast sales (20,000 units at £5 per unit)
(d)
100,000
add
Sales volume variance
less
Sales price variance
(10,000)
Actual sales (18,000 units at £6 per unit)
108,000
18,000
Sales price variance: –
higher selling price than expected
–
less competition, or
–
smaller discounts offered to customers
Sales volume variance: –
fewer sold than expected
–
either higher price has been charged than competitors
–
or competitors are seeking to gain market share by reducing their selling prices
CHAPTER 16 Capital investment appraisal
16.4
(a)
payback period
PROJECT ESS Year
Cash Flow
PROJECT TEE Cash Flow
£
Cumulative Cash Flow £
£
Cumulative Cash Flow £
0
(100,000)
(100,000)
(115,000)
(115,000)
1
40,000
(60,000)
50,000
(65,000)
2
60,000
–
35,000
(30,000)
3
20,000
20,000
30,000
–
4
20,000
40,000
30,000
30,000
5
*15,000
55,000
*37,500
67,500
* includes scrap value
73
net present value
PROJECT ESS Year
PROJECT TEE
Discount Factor
Cash Flow £
Discounted Cash Flow £
Cash Flow £
Discounted Cash Flow £
0
1.000
(100,000)
(100,000)
(115,000)
(115,000)
1
0.909
40,000
36,360
50,000
45,450
2
0.826
60,000
49.560
35,000
28,910
3
0.751
20,000
15,020
30,000
22,530
4
0.683
20,000
13,660
30,000
20,490
5
0.621
15,000
9,310
37,500
23,290
Net Present Value
23,910
25,670
(b) REPORT To:
Managing Director
From:
A2 Accounting Student
Date:
Today
Capital investment projects: Ess and Tee This report carries out an appraisal of these two projects, based on the information provided. Two techniques are used: • payback • net present value The first of these, payback, sees how long it takes for the initial outlay of the project to be repaid by the net cash flow coming in. For Project Ess, the payback period is two years; for Project Tee, it is three years. Using this technique, Project Ess is more favourable. Payback is an easy technique both to calculate and understand. However, it does have the disadvantage of ignoring all cash flows after the payback period. With these two projects, Tee has strong cash inflows in years 4 and 5, after the payback period (however, these could be a disadvantage if the project is likely to go out-ofdate soon). The net present value technique relies on discounting relevant cash flows at an appropriate rate of return, which is 10 per cent for these projects. Net present value is a more sophisticated technique than payback in that it uses all cash flows and takes the timing of cash flows into account. However, the meaning of NPV is not always clear, and the rate of return required on the projects may vary over their life. Project Tee has a higher net present value (but also a higher initial cost) at £25,670, when compared with Ess at £23,910. The fact that both figures are positive means that either project will be worthwhile. However, Project Ess is to be preferred because: –
it has the faster payback
–
the initial capital outlay is smaller
–
it has strong cash flows in the early years, which are likely to be more accurate than the amounts for later years
74
16.5
(a)
THE CHESTER CARPET COMPANY Working paper for the financial appraisal of a new machine for the production department DISCOUNTED CASH FLOW
Year
Cash Flow
Discount Factor at 10%
Discounted Cash Flow
£
£
0
(65,000)
1.000
(65,000)
1
17,000
0.909
15,453
2
25,000
0.826
20,650
3
31,000
0.751
23,281
4
*28,000
0.683
19,124
Net Present Value
13,508
* £24,000 + £4,000 scrap value
PAYBACK PERIOD
Year
Cash Flow
Cumulative Cash Flow
£
£
0
(65,000)
(65,000)
1
17,000
(48,000)
2
25,000
(23,000)
3
31,000
8,000
4
28,000
36,000
£23,000* required
* £31,000 – £8,000
Payback period = 2 years + (£23,000/£31,000) = 2 years and 8.9 months/2 years and 38.6 weeks/2 years and 270.8 days
(b)
REPORT To:
General Manager
From:
A2 Accounting Student
Date:
Today
Purchase of a new machine for the production department This report carries out an appraisal of the above project. The proposal to purchase the new machine is acceptable from a financial viewpoint because it returns a positive net present value of £13,508 at a discount rate of 10%. This calculation assumes that all cash flows occur at the end of each year. The payback period is during year 3. Assuming even cash flows during the year, the payback period is 2 years and 8.9 months/2 years and 38.6 weeks/2 years and 270.8 days. This is acceptable since it is shorter than the company requirement of three years, although there is not a great deal of room for error in the cash flow calculations.
75
16.6
(a)
The net cash flows are: £ year 0
(110,000)
year 1
20,000
year 2
60,000
year 3
80,000
year 4
80,000
year 5
85,000
payback period
Year
Cash Flow £
Cumulative Cash Flow £
0
(110,000)
(110,000)
1
20,000
(90,000)
2
60,000
(30,000)
3
80,000
50,000
4
80,000
135,000
5
85,000
220,000
∴ £30,000 required
The development costs are recovered in the first half of year 3: £20,000 + £60,000 + (£30,000/£80,000). Thus the payback period is 2 years and 4.5 months/2 years and 19.5 weeks/2 years and 136.9 days. Note that these assume even cash flows during the year.
net present value
Year
Cash Flow
Discount Factor
£
Discounted Cash Flow £
0
(110,000)
x
1.000
(110,000)
1
20,000
x
0.909
18,180
2
60,000
x
0.826
49,560
3
80,000
x
0.751
60,080
4
80,000
x
0.683
54,640
5
85,000
x
0.621
52,785
Net Present Value
76
125,245
(b)
REPORT To:
Managing Director
From:
A2 Accounting Student
Date:
Today
Development of new product: ‘Zelahcold’ This report carries out an appraisal of the project, based on the information provided. It would be relevant to know: 1.
whether there are any additional cash flows beyond year 5
2.
whether the introduction of ‘Zelahcold’ will affect sales of our existing products
The net present value technique relies on discounting relevant cash flows at an appropriate rate of return – 10 per cent for this project. The proposal to develop the new product is acceptable from a financial viewpoint because it returns a positive net present value of £125,245 at a discount rate of 10 per cent. This calculation assumes that all cash flows occur at the end of each year. The payback period is 2 years and 4.5 months/19.5weeks/136.9 days. These calculations assume even cash flows during the year. Both project appraisal methods show that the project meets with the company’s criteria of: •
a positive net present value at a discount rate of 10 per cent, and
•
a maximum payback period of three years
These show that, from a financial viewpoint, the project should be carried out.
16.7
(a)
Net cash inflow per month: £
less
14,000 units at £90 each
1,260,000
total costs
1,130,000
cash inflow per month
130,000
∴ cash inflow per year £130,000 x 12
1,560,000
Payback period: cost of machinery cash flow per year
= £2,400,000 x 365 days = £1,560,000
561.54 days = 1 year, 196.5 days Tutorial note: the examiner will also accept the answer given in weeks, 1 year and 28 weeks, and months, 1 year and 6 months.
(b)
Any two limitations of payback: •
all cash flows after the payback period are ignored
•
within the payback period the timing of receipts and payments is not considered
•
the effects of inflation are ignored
•
the time value of money is ignored
•
the life of the asset is not considered
77
16.9
(a) Net present value of new machine
Year
Cash Flow
Discount Factor
Discounted Cash Flow
£
£
0
(350,000)
x
1.000
=
(350,000)
1
144,000
x
0.877
=
126,288
2
144,000
x
0.769
=
110,736
3
144,000
x
0.675
=
97,200
4
144,000
x
0.592
=
85,248
=
69,472
Net Present Value
current production (units) per year x 120% x 6,000 units per year
(b)
profit per unit
= cash flow per year
x 120% x £20 profit (£80 – £60)
= £144,000 per year
On the basis of net present value, the new machine should be purchased.
Advantages: –
There is a positive net present value over the four years for which information is given.
–
There is a further six years when, subject to economic conditions, cash flow should continue to be generated.
–
Payback is 2 years and 157 days, leaving a further 7.5 (approx) years to generate cash flow.
Disadvantages:
16.12 (a)
–
Can purchase of the new machine be justified when the old machine has four years’ economic life remaining?
–
Will the quality of the output from the new machine be as good as/better than from the old machine?
–
Will Roberta be able to sell the increased output of 1,200 units per year? If not, and output/sales continue at 6,000 units per year, cash flow will be £120,000 per year. This gives a payback of 2 years and 335 days, and a negative net present value of £440 at the end of year 4.
–
Will the market continue for the product over the next ten years?
–
The new machine will need financing – is this available?
–
Will there be any proceeds from the sale of the old machine?
–
The cost of capital is high at 14% – is lower cost finance available?
–
Borrowing will increase the gearing of the business and may make it less attractive to investors.
–
The estimates of cash flows may be inaccurate.
–
Staff may need to be retrained.
Year
Machine A
Machine B
£
£
0
(30,000)
(80,000)
1
*18,000
†30,000
2
*18,000
†30,000
3
–
†30,000
6,000
10,000
Expected total net cash flow * 12,000 cakes x (£3.00 – £1.50)
= £18,000
† 15,000 cakes x (£3.00 – £1.00) = £30,000
78
(b)
Net present value Year
(c)
Cash Flow
Discount Factor
Discounted Cash Flow
Machine A
Machine B
Machine A
Machine B
£
£
£
£
0
(30,000)
(80,000)
x
1.000
=
(30,000)
(80,000)
1
18,000
30,000
x
0.909
=
16,362
27,270
2
18,000
30,000
x
0.826
=
14,868
24,780
3
–
30,000
x
0.751
=
–
22,530
Net Present Value
=
1,230
(5,420)
On the basis of net present value, Machine A should be purchased and Machine B should be rejected because of its negative net present value.
Reason: Machine A has a positive net present value and the initial cost is much less than Machine B. However, –
the net present value is not large and the estimates of revenues and costs may be inaccurate.
–
if the cost of capital increases, the positive net present value could disappear.
–
will there be any proceeds from the sale of the old machine?
–
if Beard Bakeries Ltd needs to borrow to finance the machine, the company’s gearing will increase and may make the company less attractive to investors.
CHAPTER 17 Further aspects of budgeting 17.1
(a)
Benefits of budgetary control • planning – using a formal framework of budgets to predict future activities and potential problems • co-ordination – individual budgets are integrated into the master budget • control – comparison of actual results against the budget • communication – between the owner and staff to achieve the objectives of the business • motivation – of staff to ensure that budgets are met • evaluation of performance – to see where improvements can be made • decision-making – about production, sales and costs
(b)
Any three budgets • sales budget • production budget • purchases budget • debtor budget • creditor budget • cash budget The most likely three budgets for a small business such as AggieSurf would be cash, sales and production
(c)
Relevant factors when implementing budgetary control • costs and benefits – benefits must exceed the cost of budgetary control • accuracy – of information used • demotivation – of staff may occur if they have not been involved in planning the budget and/or where budgets are set at too high a level • disfunctional management – ensure that the budgets co-ordinate • set too easy – ensure that budgets are set at realistic levels to enable the business to use its resources to best advantage • may restrict activities – budgets may be inflexible so that staff are unable to take advantage of opportunities
79
17.3
(a) purchases budget April
June
August and
October and
December
February
and May
and July
September
November
and January
and March
£000
£000
£000
£000
£000
£000
40.0
35.0
30.0
20.0
10.0
10.0
Sales
(b)
Margin
10.0
8.75
7.5
5.0
2.5
2.5
Purchases
30.0
26.25
22.5
15.0
7.5
7.5
(i)
Debtor collection period Formula:
Debtors Credit sales
x 365 days (or 52 weeks or 12 months)
Year ended 31 March 2003: £12,000 £150,000
x 365 days
= 29.2 days
Year ended 31 March 2004: £14,000 £145,000*
x 365 days = 35.2 days
* (£20,000 x 3 months) + (£15,000 x 4 months) + (£5,000 x 5 months)
(ii)
Creditor payment period Formula:
Creditors Credit purchases
x 365 days (or 52 weeks or 12 months)
Year ended 31 March 2003: £11,000 £110,000
x 365 days = 36.5 days
Year ended 31 March 2004: £10,000 £108,750*
x 365 days
= 33.6 days
* see purchases budget
(c)
Debtor collection period: •
debtor days have increased by six days
•
this means that customers are taking longer to pay
Creditor payment period: •
creditor days have reduced by almost three days
•
this means that suppliers are being paid earlier
Recommendation: •
encourage debtors to pay quicker
•
delay payments to creditors
80
17.4
(a) ROBERT ADAMS Production budget for periods 1 – 3 Period 1
Period 2
Period 3
units
units
units
Sales
13,600
12,400
12,000
Opening stock
(3,400)
(3,100)
(3,000)
3,100
3,000
2,700
13,300
12,300
11,700
Closing stock Production
Tutorial note: the closing stock for each period is one-quarter of the next period’s expected sales.
(b)
Budgeted closing stock at end of period 3
2,700 units
Actual closing stock at end of period 3
2,500 units
Stock lost during periods 1 – 3
(c)
(d)
200 units
Any two limitations of budgetary control: •
costs and benefits – the benefit must exceed the cost of budgetary control
•
accuracy – some information used in the budget may be inaccurate and may distort the budget
•
demotivation – of staff who have not been involved in planning the budget, or who are set too high a level to achieve
•
dysfunctional management – where different sections of the business are not co-ordinated there may be departmental rivalry
•
set too easy – where budgets are set at too low a level they will not enable the business to use its resources to best advantage
•
may restrict activities
Debtor collection period
=
Debtors
x 365 days (or 52 weeks or 12 months)
Credit sales Total sales for periods 1–3 at £1 per football
£38,000
14% of sales is ∴ Debtor collection period
£5,320 =
£5,320
x 365 days
= 51.1 days
£38,000
(e)
•
A longer period of credit can be offered to customers.
•
The amount of cash discount for prompt payment can be reduced so that customers have less incentive to pay quickly.
•
Both of the above will delay receipt of payment by customers.
•
As a result, the bank balance will be reduced or an overdraft will be increased.
81
17.6
(a) SU LING LTD Labour budget for months 1 – 3 Month 1
Month 2
Month 3
2,100
2,400
3,000
Labour hours at 6 hours per unit
12,600
14,400
18,000
Labour hours available
15,000
15,000
15,000
2,400
600
(3,000)
Production in units
Surplus/(shortfall) of labour hours
(b)
•
Total cost without using part-time labour: (12,600 hours + 14,400 hours + 15,000 hours) x £8 per hour = 42,000 hours x £8
•
= £336,000
Total cost with the use of part-time labour: £336,000 + 3,000 part-time hours at £14 per hour = £336,000 + £42,000
= £378,000
∴ percentage increase in total cost: £378,000
x 100
= 112.5%
= 12.5% increase
£336,000 (c)
17.7
•
The surplus of labour hours in months 1 and 2 could be used to manufacture stock in advance of month 3.
•
This additional stock would need to be stored until month 3.
•
The costs of manufacturing the stock earlier will have to be paid.
•
The management of Su Ling Ltd need to consider whether it is cheaper to manufacture earlier, with its attendant costs, or whether to pay the higher rate for part-time labour in month 3.
•
The main limitation of using the labour budget in this way is that much depends on the accuracy of future sales forecasts, as this will affect the production budget. If the sales forecasts are over-stated, goods will be manufactured needlessly and may remain unsold, thus incurring extra storage costs, or have to be scrapped if the goods have a limited life (eg perishable goods).
(a) debtor budget Jan
Feb
Mar
Apr
May
Jun
Total
£
£
£
£
£
£
£
Opening debtors
65,500
60,550
61,050
65,600
69,500
73,200
65,500
Credit sales
38,300
39,500
42,400
45,000
47,400
44,700
257,300
(42,400)
(38,100)
(37,400)
(40,600)
(43,200)
(45,800)
(247,500)
Discount allowed
(350)
(400)
(450)
(500)
(500)
(400)
(2,600)
Bad debts written off
(500)
(500)
–
–
–
–
(1,000)
60,550
61,050
65,600
69,500
73,200
71,700
71,700
Receipts
Closing debtors
(b) creditor budget Jan
Feb
Mar
Apr
May
Jun
Total
£
£
£
£
£
£
£
Opening creditors
42,400
39,130
40,730
41,410
42,830
40,870
42,400
Credit purchases
19,500
22,300
22,500
24,000
22,600
23,400
134,300
(22,600)
(20,500)
(21,600)
(22,300)
(24,300)
(23,200)
(134,500)
(170)
(200)
(220)
(280)
(260)
(270)
(1,400)
39,130
40,730
41,410
42,830
40,870
40,800
40,800
Payments Discount received Closing creditors
82
17.10 (a)
(b)
Difference between cash and profit: •
cash is the actual amount of money held in the bank or as physical cash (eg in a cash till)
•
profit is a calculated figure which shows the surplus of income over expenditure for the period; it takes note of adjustments for accruals and prepayments and non-cash items such as depreciation and provision for doubtful debts; it does not include capital expenditure (ie the purchase of fixed assets), or owner’s drawings/dividends
Possible reasons for a bank overdraft when profits are being made: •
capital expenditure – the purchase of fixed assets reduces cash, but profit is affected only by the amount of depreciation on the asset
•
increase in debtors – with more goods sold, profits will increase but, until debtors pay, there is no benefit to the bank balance
•
decrease in creditors – if creditors have been paid earlier there will be no effect on profit, but a bank overdraft will increase
•
increase in stock – with more stock purchased there will be an increase in profit as it is sold, but paying for the stock will increase the bank overdraft
•
prepayment of expenses made at the year end – no effect on profit as the prepayment is an expense for next year, but the bank overdraft will increase
•
repayment of a loan – no effect on profits (although loan interest may be reduced), but the bank overdraft will increase
•
drawings/dividends – no effect on profit, but the bank overdraft will increase
(c) SALES BUDGET
Parts (units) Revenue (£)
March
April
May
June
July
200
200
260
260
260
£4,800
£4,800
£6,240
£6,760
£6,760
(d) PRODUCTION BUDGET IN PARTS (UNITS) March
April
May
June
July
Sales
200
200
260
260
260
Opening stock
(20)
(20)
(26)
(39)
(39)
20
26
39
39
39
200
206
273
260
260
Closing stock Production
(e)
Other budgets:
• purchases budget
•
(f)
Tutorial note: see also Chapter 18 • No pay rise – workforce will be demotivated – may understand that it is needed for job security – some may seek alternative employment • An increase in the working day – workforce will become tired at the end of the day – workforce will be demotivated and stressed – quality of output may suffer – health and safety issues, particularly when working with machinery – some may seek alternative employment • A reduction in overtime rates – workforce will not work overtime – output is likely to be reduced, leading to reduced sales and profit – job security may be at risk if overtime not worked
83
debtor budget
• creditor budget
17.13 (a)
production budget (units/surfboards) March
April
May
June
July
16
16
28
40
40
Opening stock
–
(24)
(48)
(60)
(44)
Closing stock
24
48
60
44
28
Production
40
40
40
24
24
March £
April £
May £
June £
July £
Sales
2,560
2,560
4,480
7,600
7,600
Variable costs
3,400
3,400
3,400
2,040
2,040
Brother’s wages
800
800
800
–
–
Fixed overheads
500
500
500
500
500
4,700
4,700
4,700
2,540
2,540
(2,140)
(2,140)
(220)
5,060
5,060
3,200
1,000
(1,140)
(1,360)
1,000
(60)
–
–
(2,700)
(5,060)
1,000
(1,140)
(1,360)
1,000
1,000
Sales
(b)
cash budget
Net cash flow Add opening balance Less drawings Closing balance
Tutorial notes: •
The selling price of each board increases to £190 from 1 June
•
Net cash flow is receipts from sales less payments for expenses
•
Drawings have been shown in the bank summary, but could be included amongst the payments
•
Other layouts of the cash budget are acceptable in the examination
17.14 (a)
Potter and Son Ltd Forecast trading and profit and loss account for the year ending 31 March 2004 £ Sales (312,500 units at £13.60 each)
£ 4,250,000
Opening stock (20,000 units)
200,000
Purchases (317,500 units at £9.00 each)
2,857,500 3,057,500
Less Closing stock (25,000 units)
225,000
Cost of sales
2,832,500
Gross profit
1,417,500
Less expenses: Overheads (£1,080,000 x 106.25%)
1,147,500
Net profit
270,000
Tutorial notes: •
Units of closing stock are 8% of sales: at 31.03.2004 312,500 units x 8% = 25,000 units.
•
Closing stock at 31.03.2003 had cost £10 per unit (£200,000 ÷ 20,000 units), so purchases for the year ended 31.03.2004 will be £10 x 90% = £9 per unit.
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(b)
•
The forecast profit – both gross and net – can be calculated and compared with the actual profit of the previous year.
•
The forecast profit shows the effect of changes in the selling price, volume of units sold, the buying price, and in overhead expenses. Here the forecast profit is reduced by £190,000 from the actual profit of the previous year.
•
Management can take action by reviewing their selling and buying prices, and overhead expenses.
•
Corrective action can be taken in advance if the forecast operating statements show a loss.
•
The actual gross and net profits for the year can be compared with the forecast profits, and any differences can be investigated.
CHAPTER 18 Decision-making and social accounting
18.2
(a)
Increase in total contribution resulting from the change in paint supplier Original contribution = (£190 – £140) x 12,000 sheds = £600,000 New paint = (£190 – £118*) x 12,000 sheds = £864,000 * £140 – £22 saving Increase in total contribution = £264,000
(b)
Points raised in the discussion might include: •
an increased contribution which, once fixed costs have been paid off, becomes profit
•
the increase in contribution could be used to reduce the selling price to stimulate sales
•
increased funds generated could be used to invest in the business
•
the break-even point will be reduced
•
the margin of safety will be increased
The possible downsides are:
18.4
•
the need to investigate the fact that the paint is only ‘rumoured’ to be harmful to wildlife – this has to be substantiated
•
possible bad publicity from environmental activists and loss of customers if product is then seen to be environmentally unfriendly
•
extra costs incurred in dealing with potentially harmful paint (safety procedures)
The suggested answer from the textbook is shown below. The question, however, requires the students to explain this term in their own words. ‘Social accounting’ is the term used to describe the way in which businesses are accountable and responsible to society as a whole. Social accounting requires that businesses should not be driven just by the profit motive but should also consider the wider implications of their decisions. The issues which involve social accounting can be internal, eg the demands of the workforce, or they can be external. External factors can be economic (providing local employment), ethical (not selling high nicotine cigarettes to developing countries), political (not selling goods to oppressive governments), legal (employment law) or environmental (using renewable resources or not polluting the atmosphere).
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