151 151 *Assume nil as settled between the partners. Alternatively + 7.5 − 7.5 = net nil, settled via Joel; a second alternative is to show a receivable of 7.5 from one partner and 7.5 payable to the other; this method only would afiect the statement of financial position. ** Being the assets and liabilities acquired at the agreed valuations, and the consideration issued in the purchase of Kay and Orla. b If Joel requires a 25% return on its investment then it must make additional profit of 575 0000 × 25% = $143 750. Exam practice questions Multiple-choice questions 1 C 2 D 3 D Structured questions 1 a When a business is purchased by another business then the business which has been bought ceases to exist. The owners of that business will either retire or become workers or directors in the business which bought theirs. However, when business assets are purchased by another business that is simply a commercial transaction. For example, Business A may decide to buy some old plant and machinery from Business B for an agreed amount. Both businesses will continue to operate affier the transaction has been completed. b i Realisation account $000 $000 Property account 100 Trade payables account 20 Vehicle taken over by Ann 4 Vehicles account 20 Purchase consideration: Inventory account 15 Debenture (30 × 0.8) 24 Trade receivables 12 Shares 100 Expense of realisation 1 Profit on realisation: Cash (152 − 100 − 24) 28 Anne* 11 Bridget* 11 Chris* 6 176 176 *The profits on realisation are $28 000 and have been allocated in round thousands in approximately the ratio 2:2:1. ii Capital accounts Ann Bridget Chris Ann Bridget Chris $000 $000 $000 $000 $000 $000 Current a/c 3 Balance b/d 35 30 20 Debenture 24 Current a/c 10 8 Ordinary shares 40 40 20 Loan account 30 Vehicle taken over 4 Bank 18 9 3 Profit on realisation 11 11 6 86 49 26 86 49 26 Bank: 3 − 1 + 28 − (18 + 9 + 3 = 30) = 0 Answers to activities, practice exercises and exam practice questions: Chapter 24 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
152 152 Cambridge International AS and A Level Accounting c If Ann accepts the ofier for her shares and loan from Janty Limited she will receive: $40 000 × 0.75 = $30 000 for her shares and $24 000 × 75% = $18 000 for her loan; a total of $48 000. This will mean that she will need to borrow $150 000 − $48 000 = $102 000 plus $20 000 for working capital; a total of $122 000 in order to buy her new business. Assuming the worst position, she will have to pay interest on the loan of $102 000 × 5% = $5100 a year, plus $20 000 × 7% = $1 400 on the overdraffi, assuming she requires it for a year; a total of $6 500. From her projections the profit she expects to make in the first three years is greater than the interest she will pay. It also seems to be increasing steadily over the three year period. On this basis, provided that she feels comfortable with the move, it makes sense for her to buy the business. She will again be her own boss and, unlike in the previous partnership, all the profit will belong to her. The only negative aspect is the risk of starting the new venture and the accuracy of the profit projections. If she is happy to take the risk and confident in the profit figures, the venture should be taken. She is giving up the interest paid to her on the loan, but Janty Limited is not paying any dividends on the shares, so again it points to the fact that she should start the new venture. The apparent fall in the value of the Janty shares may reflect a real downturn, or it may indicate the relative bargaining power of the two parties. However this position has been reached, Ann must make her calculations based on the current value of the shares. In theory, she could also try and find another buyer willing to pay more than 75c per share. 2 a A merger is when two independent businesses join together to form a new business. The two original businesses are closed and all, or some, of their assets are transferred to the new business, but both underlying trades continue within the new business. When a business is sold to another business, then the business which has been sold ceases to exist. All, or some, of the assets are sold to the new business. Both underlying trades continue within the acquiring business. The owners of the business which has been sold will either retire or become workers or directors (or partners) in the business which bought theirs. b Calculation of opening capital account balances at 1 April 2015 Brian Maye $000 $000 Non-current assets 130 190 Inventory 25 24 Trade receivables 55 39 Cash and cash equivalents [1] 2 1 Trade payables (17) (29) Goodwill at owner's valuation 30 20 Goodwill written ofi (25) (25) Opening balances 200 220 [1] There is no indication from the data that the owners will not transfer their cash and bank balances to the new partnership. Thus they have been included here. Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
153 153 c Brian and Maye Opening statement of financial position at 1 April 2015 $000 Assets Non-current assets 320 Current assets Inventory 49 Trade receivables 94 Cash and cash equivalents 3 146 Total assets 466 Capital and liabilities Capital account: Brian 200 Maye 220 420 Current liabilities Trade payables 46 Total capital and liabilities 466 d Brian and Maye Appropriation account for the year ended 31 March 2016 $000 $000 Profit for the year 27 Less: partners' salaries: Brian 6 Maye 4 10 17 Interest on capital: Brian 10 Maye 11 21 (4) Share of loss: Brian (2) Maye (2) (4) e For the year ended 31 March 2016, Brian's total share of the profit for the year was $14 000 and Maye's share was $13 000. Thus Brian earned more than he would in his own business and Maye earned less than she would in her own business. On this basis Brian was right to form the partnership and Maye was wrong. However, this is based on the profit for the new partnership for one year only. Future profits may well give each partner a greater income than their old businesses. Another way of looking at this leads us to conclude that they combined their businesses on terms that were unfair to Maye. Her old business was twice as profitable as Brian’s, suggesting in broad terms that her goodwill and her profit share could each have been more fairly agreed at double Brian’s. Answers to activities, practice exercises and exam practice questions: Chapter 24 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Cambridge International AS and A level Accounting 25 Consignment and joint venture accounts Activities Activity 1 In Bertie’s ledger: Consignment with Calum account $ $ Goods on consignment 16 000 Sales 25 000 Calum – shipping costs 450 Balance c/d 3 200 Balance c/d 11 750 28 200 28 200 Calum account $ $ Consignment account 25 000 Consignment account – shipping costs 450[1] Balance c/d 24 550 25 000 25 000 Goods sent on consignment account $ $ Income statement 16 000 Consignment with Calum 16 000 Activity 2 a In the books of Nettie: Consignment with Alfonso account $ $ Goods on consignment 15 000 Sales 16 000 Bank – shipping fees (N) 1 800 Consignment loss 600 Landing fees (A) 1 200 Commission 1 600 Balance c/d 3 000 19 600 19 600 Balance b/d 3 000 If Nettie has not yet settled the landing fees: Alfonso account $ $ Consignment account 16 000 Commission 1 600 Consignment account – landing fees 1 200 Bank 10 000 Balance c/d 3 200 16 000 16 000 Balance b/d 3 200 [1] At this point Bertie has not paid a cheque to Calum as reimbursement of the shipping costs. When he does so, the entry will be to credit Bertie's bank account and debit Calum's account. Cambridge International AS and A Level Accounting 154 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
If Nettie has settled the landing fees: Alfonso account $ $ Consignment account 16 000 Commission 1 600 Bank – landing fees 1 200 Consignment account – landing fees 1 200 Bank 10 000 Balance c/d 4 400 17 200 17 200 Balance b/d 4 400 Goods sent on consignment account $ $ Consignment with Alfonso 15 000 b In the books of Alfonso: If Nettie has not yet settled the landing fees: Nettie account $ $ Bank – landing fees 1 200 Customer accounts/SLC 16 000 Bank 10 000 Income statement – commission 1 600 Balance c/d 3 200 16 000 16 000 Balance b/d 3 200 If Nettie has settled the landing fees: Nettie account $ $ Bank – landing fees 1 200 Bank – refund of landing fees 1 200 Bank 10 000 Customer accounts/SLC 16 000 Income statement – commission 1 600 Balance c/d 4 400 17 200 17 200 Balance b/d 4 400 Activity 3 a In the books of Henry: Consignment with Jasmine account $ $ Goods on consignment 12 000 Goods on consignment 1 200 Sales 14 900 Bank – shipping fees (H) 2 800 Landing fees (J) 850 CN for shipping costs (J) 340 Consignment profit 1 870 Balance c/d 1 760 17 860 17 860 Balance b/d 1 760 Answers to activities, practice exercises and exam practice questions: Chapter 25 155 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Jasmine account $ $ Consignment account 14 900 Landing fees 850 Consignment account – credit note for shipping costs 340 Bank 8 300 Balance c/d 5 410 14 900 14 900 Balance b/d 5 410 Goods sent on consignment account $ $ Consignment with Jasmine 1 200 Consignment with Jasmine 12 000 Balance c/d 10 800 12 000 12 000 Balance b/d 10 800 b In the books of Jasmine: Henry account $ $ Bank – landing fees 850 Bank – shipping costs (CN received) 340 Bank 8 300 Customer accounts/SLC 14 900 Balance c/d 5 410 14 900 14 900 Balance b/d 5 410 If Janine has posted the shipping costs from bank payments to the Henry account, the credit note requires her to make no further entry; it is paperwork that confirms that she can remit $340 less than the other transactions would require, but the accounting entry is already made. If Janine had posted the shipping costs from bank payments to her own shipping costs account, the credit note ‘authorises’ her to treat this as, instead, receivable from Henry; it is paperwork that supports a journal by which she transfers $340 from shipping costs (her expense account) to the Henry account, thus ensuring that she remits $340 less than the other transactions would require. The crucial point is that Janine must make only one (debit) entry of $340, so as to reduce her net liability to Henry. Practice exercises 1 a In the books of Marty: Joint venture with Jerry account $ $ Bank – materials 32 600 Bank – sales 120 000 Bank – legal fees 4 100 Bank – from Jerry* 6 350 Share of profit (from part b) 89 650 126 350 126 350 * This is the balancing figure. Alternatively, this could be carried down as an amount due from Jerry. Cambridge International AS and A Level Accounting 156 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Joint venture with Jerry memorandum account $ $ Materials bought by Marty 32 600 Sales by Marty 120 000 Materials bought by Jerry 30 000 Sales by Jerry 126 000 Legal fees 4 100 Share of profit – Marty 89 650 Share of profit – Jerry 89 650 246 000 246 000 c Calculation of amount due from one party to the other: At the end of the venture Jerry owes Marty $6 250, assuming no separate bank account was opened. d At first sight, there appears to be no reason why Marty should not form a partnership with Jerry. The house building venture was successful, with considerable profits made. If they form a partnership then there is perhaps no reason why this may not be the case in future. However, it may be that one or other of the parties saw what was only a ‘one-ofi’ opportunity to build the houses. There seems to be no intention by either to form a partnership in future. We do not know what type of business each runs (if any). Forming a partnership means a long-term commitment by both and one, or perhaps both, may not want this. They may want to concentrate on their own businesses. Should Marty want to go into partnership with Jerry then they must agree on the type of business and how any profits will be shared. Exam practice questions Structured questions 1 a i In the books of Krystal: Consignment with Chen account $ $ Goods on consignment 29 700 Sales* 50 000 Shipping fees (K) 4 900 Balance c/d 3 800 Export charges (K) 3 300 Landing fees (Ch) 4 400 Commission* 5 000 Consignment profit 6 500 53 800 53 800 Balance b/d 3 800 *The balancing figure excluding these items is $45 000 and it must comprise sales less commission, i.e. 90% of the sales figure. Hence sales = $50 000 and commission = $5 000. ii Chen account $ $ Consignment account 50 000 Landing fees 4 400 Commission 5 000 Bank 8 000 Balance c/d 32 600 50 000 50 000 Balance b/d 32 600 Answers to activities, practice exercises and exam practice questions: Chapter 25 157 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b In the books of Chen: Consignment with Krysal account $ $ Bank – landing fees 4 400 Customers a/c 50 000 Bank – to Krystal 8 000 Income statement – commission 5 000 Balance c/d 32 600 50 000 50 000 Balance b/d 32 600 c A consignment arrangement may remain suitable if, for example, the transactions are irregular or are a small part of the activities of either party. Each party may operate a successful business in their own country. Thus, forming a more legal tie between them may mean that they are no longer free to do what they please. It would then be better if the consignment arrangement continued in the future. However, a partnership (or a limited company) arrangement might motivate Chen more, and make it easier for her to expand the Chinese business if both parties are ready to take that path. If Krystal and Chen form a partnership, then given the geographical distance between the two parties, it is essential that a partnership agreement is prepared. This is in order to protect both parties. It is easier now with IT for parties to keep in close contact even over long distances. However, either Krystal or Chen could do something which the other one does not know about, or would not approve of, such as purchasing inventory. This would break the trust between them if the other discovered the actions. It is also worth remembering that the actions of one partner binds the other. Thus if the inventory is bought on credit and not paid for, then the other partner will have to pay. Less melodramatically, potential partners usually have a good understanding of each other’s abilities to contribute to the business and so can agree a fair allocation of responsibilities and rewards (profit shares). It seems to be too early to begin a partnership. It is not recommended that a partnership is formed so near the beginning of a business relationship. A limited company will provide more security for both parties, especially in terms of liabilities for debts. If one is formed then the distribution of shares is crucial as if one member holds more shares than the other then they have control of the business. If equal numbers of shares are held by both then it may lead to stalemate in respect of making future decisions. Whether to choose a partnership or a limited company will depend on whether the higher costs in administrative burdens of a limited company are considered less significant than the benefit of limited liability. This is a judgment that may change over time, as the business develops. 2 a In the books of Alan: Consignment with Zac account $ $ Goods on consignment 100 000 Sales 123 000 Freight charges 7 200 Balance c/d 9 900 Landing dues 3 800 Commission 12 300 Consignment profit 9 600 132 900 132 900 Balance b/d 9 900 Cambridge International AS and A Level Accounting 158 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Zac account $ $ Sales 123 000 Landing dues 3 800 Commission 12 300 Bank 85 000 Balance c/d 21 900 123 000 123 000 Balance b/d 21 900 c Unit cost = 100 000 + (7 200 + 3 800) = 110 000 ÷ 1 000 = $110 each. Number of unsold bicycles at 31 March 2016 = $9 900 ÷ $110 = 90. d The bicycles have been valued in line with IAS 2. This means that they are valued at cost plus any costs incurred in bringing them to a saleable condition. Whilst they only cost $100, that is the value at which they would be valued had they been sold in England. There would be no further costs of bringing them to a saleable condition. However, it is fair to add on the freight charges and landing dues incurred in bringing the bicycles to Botswana as part of their inventory valuation. e Alan is paying Zac a commission of 10%. He may now think this is too much, but he had agreed it with Zac prior to entering into the consignment arrangement. There is no great difierence between the suitability of consignment and joint venture arrangements; each is relatively informal and suitable for occasional transactions or for one-ofi ventures. The key difierence is that joint venturers share the risks and the rewards of their venture and specifically they share in the net profit. If Alan and Zac enter into a joint venture, then they will need to agree profit sharing arrangements. If Zac is risk averse he may want to have a first share in the profit akin to a salary to compensate him for the loss of commission, so that Alan will be no further forward in reducing Zac’s rewards. On the other hand, having a share in the net profit may motivate Zac to greater efiorts, to the net benefit of both parties. As Alan’s success and reward from business in Botswana are entirely attributable to Zac’s efiorts, Alan needs to discuss his concerns and alternative possible future arrangements with Zac, so that they can move forward with an arrangement that ofiers the best mutual advantage. This may enable him to expand his market overseas, perhaps into other countries in Africa, depending on Zac’s trading contacts. 3 a There are basically three ways in which the transactions of a joint venture can be recorded: • One party records all the transactions of the venture. • Each party records their own transactions in respect of the venture. • A separate set of accounting records is kept for the whole of the transaction to the venture. The parties have agreed to use the second method mentioned above. b In the books of Bob: i Joint venture with Sue account $ $ Aug 2 Purchase of cars 50 000 Aug 31 Bank – sales 80 000 Aug 5 Licences and insurance 8 000 Aug 31 Income statement – profit 17 000 Balance due to Sue c/d 5 000 80 000 80 000 Answers to activities, practice exercises and exam practice questions: Chapter 25 159 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
ii Joint venture memorandum account $ $ Purchase of cars 100 000 Sales – Bob 80 000 Licences and insurances (B) 8 000 Sales – Sue 80 000 Licences and insurances (S)* 8 000 Discount 10 000 Share of profit – Bob 17 000 Share of profit – Sue 17 000 160 000 160 000 *it is assumed that Sue asked for a 50% contribution. c Sue should have recorded sales of $100 000, not the $80 000 she has declared. She has obviously tried to mislead Bob and perhaps in a fraudulent way. This means that the overall profit for the venture should have been more and Bob’s share should be $27 000, based on this error only. There is also the aspect of how much Sue actually paid for the licences; it appears that Bob is entitled to another $2 000 back from overpaying for licences and insurances. On this basis Sue should make a full disclosure to Bob of what she actually sold and paid in respect of the venture. A new memorandum joint venture should be prepared, a true profit figure calculated, and Sue must pay Bob anything more she owes him. Bob has every right to ask Sue for all this information. If Sue does not provide it, or he feels that she is still holding something back then he might have to seek help from his solicitor. d A joint venture is a project undertaken by two parties for a specific project. When that project has been completed the joint venture is over and each party can go back to their own business, once any cash difierences between them have been settled. A partnership is where two or more parties join together in business for the foreseeable future. There is no intention to cease working together and they run a single business with a view to that business making a profit and the profit being shared between them annually. e Bob would be advised not to enter into a partnership with Sue. He has discovered that she tried to cheat him previously with the joint venture. The accounts she has produced have been prepared by her brother. This too is suspicious as her brother may not have prepared true accounts. The accounts do show more profit than Bob is making, so there may be a business opportunity for him. If Bob is seriously considering entering into a partnership with Sue, he should instruct his own accountant to review the figures prepared by Sue’s brother to establish the true profit. He should then prepare a partnership agreement setting out every detail of any partnership to ensure Sue does not try to mislead him again. Cambridge International AS and A Level Accounting 160 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
26 Computerised accounting systems Activities Activity 1 a Buying from an IT provider in your town: Advantages: • local so can contact easily if any problems • can build trust and working relationship • may be able to sell a tried and tested package and ofier regular maintenance / updates / upgrades. Disadvantages: • if looking at an accounting package then may not have the necessary expertise in accounting if there are problems • may be restricted in the package they can sell as offen operate as a dealer for a specific product – this means you may not get the type of package required • may also try to sell other packages which you don’t need. b Buying over the internet: Advantages: • may be cheaper than anyone else • the internet provides access to wider market so may be able to find more accounting packages • as with a locally supplied tried and tested package, a widely used package will in efiect have been ‘tested’ by thousands, or perhaps millions, of users, and a responsible supplier will have been making continuous improvements and supplying ‘bug fixes’ since the soffware was first produced. Disadvantages: • probably no backup services ofiered, so may be issues if system breaks down/crashes • may have to buy service contract as part of deal – this can be expensive and if system fails then time may be lost in seeking help • may not ofier regular upgrades. c Getting someone who is computer literate to write a package: Advantages: • local so can ask if in difiiculty • can write a specific package for your business Disadvantages: • may lack expertise in accounting so you may not get what you want • supplier may not be able to produce the soffware quickly • significant risk of errors or bugs in a first release product • with only one user, there is a risk that errors are not detected quickly • neither you nor any potential employee will be familiar how the soffware operates; probably more learning time than with a ‘standard’ commercially available package • probably won’t be able to ofier regular upgrades • may be expensive. Answers to activities, practice exercises and exam practice questions: Chapter 26 161 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 2 This issue depends on what Karly and Viji want from computerising their accounting system. Transferring everything to a computer will save them time and storage space. It should also make the processing of data more accurate and quicker, especially if there is a large volume of postings and their current system is divided into several ledgers. Computerising everything will mean everything can be found in one place. However, there is an issue over who is posting data to the system. If they are leaving it to one person other than themselves then there is a possible fraud issue that the person processing the data can make fraudulent entries. There is also the issue of how computer literate they are. If they are not confident with computers, they may prefer to look at something in a book that has been handwritten. By not computerising everything, it may be difiicult to reconcile everything at the month end. Someone will also have to maintain the manual elements of the system. Overall, if they are going to make the switch to computerising their accounting system then it should ideally be ‘all or nothing’. There is little benefit in only transferring part of their system. True, it will take more time for them to get used to everything and they may feel that information is not as available as before, but the benefits of transferring everything are greater. Activity 3 They should certainly have two categories of sales: • garden furniture • garden equipment. Depending on how much analysis of their sales they require they may expand on this. For example, with garden furniture they may consider garden seats, umbrellas and tables. For equipment, they may consider lawn mowers and garden tools. How many they decide will depend upon how many sales categories their accounting system allows and what benefit they gain by increasing the number of categories. The number of purchases categories must match their sales. So they must have: • puchases of garden furniture • purchases of garden equipment. Activity 4 a Date Customer [1] Customer reference [2] Invoice number [3] Credit note number [4] Amount $ [5] October November December b The immediate benefit they have obtained by doing this is that they now have an aged receivables listing for the customer. It shows them how long the debt has been outstanding. Thus they can now start to chase the customer for overdue payments. This will immediately benefit their cash flow. Activity 5 a Reconciling all the balances which will be transferred to the computer system will ensure that accurate data is transferred. There may be errors in their manual data and it is pointless transferring this to a new system. Ideally they want a ‘clean’ set of data with the new system. [1] The name of the customer would be entered here. [2] This could be the customer reference they currently use with their manual system or the customer reference generated by the computer system when they enter the data. [3] This will be the number on the invoice which they sent to the customer. [4] This will be the credit note number they have used. [5] The amount of the invoice or credit note should be entered here. Cambridge International AS and A Level Accounting 162 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Apart from inventory they should also reconcile: • the petty cash • the bank account • loan accounts • non-current assets at cost and accumulated depreciation. Activity 6 Everything which will be transferred to the computerised accounting system will be the balances on the statement of financial position: • Non-current assets at cost, broken down by category, such as land, buildings, motor vehicles, etc. • Non-current assets’ accumulated depreciation using the same categories as their cost. • Current assets: i trade receivables – these will be transferred by individual customer and the total reconciled back to the total of the trade receivables ii inventory – this can be done either line-by-line or in total iii other receivables to their individual accounts, such as rent or telephone iv cash and cash equivalents. • Owner’s equity – the partners’ capital, current drawings accounts balances. • Non-current liabilities, such as loans. • Current liabilities: i trade payables, again by individual supplier ii other payables to their respective account, such as heat and light or telephone iii any bank overdraffs. Practice exercises 1 This is a summary of the detailed information in the chapter: • select the computerised system which the business will use • set up the chart of accounts for the new system • prepare the final financial statements at the date of the transfer • reconcile any balances at that date (bank, petty cash, etc.) • transfer to the new system the opening balances – these will be the balances from the closing manual statement of financial position • produce a trial balance from the computerised system and match this back to the manual balances • operate a system of parallel running with regular checks between the manual and computerised system • pick a final date on which the computerised system will take over entirely from the manual system. 2 Three advantages of a computerised accounting system: • saves time in processing data • saves storage space, no longer any need for books and ledgers • should be more accurate than a manual system as data is only input once and the computer provides the double entry. Answers to activities, practice exercises and exam practice questions: Chapter 26 163 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Three disadvantages of a computerised accounting system: • initial cost of buying the system • training costs • possible hacking of the data. 3 The integrity of the data which is transferred to the computerised system depends on reconciling and backups. Most computer packages will have a set-up procedure. However, it is critical that the data which is entered at this stage is accurate. Thus, a trial balance must be taken which is efiectively the closing balances on the statement of financial position. All the balances must be verified and, where necessary, reconciled. If incorrect data is entered at this stage the integrity of the new system is already compromised. Where necessary backup schedules of individual items must be prepared. This is particularly the case with trade receivables and payables, where an aged receivables and payables analysis must be prepared showing the individual balances due for customers and due to suppliers. The total of these individual accounts must be reconciled back to the totals appearing in the statement of financial position. Once all the balances have been reconciled they can be entered on to the new system. As previously mentioned, it is likely that any accounting package will have a set-up procedure. All the balances will be entered in a set sequence. It is important that regular backups are taken as the data is input and where possible the input data on the screen is reconciled back to any manual totals, for example the total of the individual customers input with the overall total of trade receivables. Once all the data has been input, a trial balance must be produced. This must be reconciled with the trial balance taken from the manual system. If the two agree then the computer can start to be used for regular work. If not, then any difierences must be found and eliminated before work with the new computerised system can start. 4 a John Rent account Date Details Debit Credit Balance 2016 $ $ $ May 31 Bank 42 000 42 000 Income statement 36 000 6 000 Prepayments 6 000 0 b John Prepayments account Date Details Debit Credit Balance 2016 $ $ $ May 31 Rent 6 000 6 000 c The balance on the prepayments account will be automatically transferred by the system at the year end to the statement of financial position. It will appear under other receivables. At 1 June 2016, if the system does not automatically transfer the balance back to the rental account, John will have to prepare a journal to do this. His journal entry will be: $ $ June 1 Rent account 6 000 Prepayments account 6 000 Cambridge International AS and A Level Accounting 164 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
27 Analysis and communication of accounting information Activities Activity 1 a i Gross margin 2015 gross profit revenue ×100 = × 60308 172308 100 = 35% 2016 = × 60000 187500 100 = 32% ii Profit margin 2015 profit for the year (after interest) revenue ×100 = × 21539 172308 100 = 12.5% 2016 = × 27322 187500 100 = 14.57% iii Non-current asset turnover 2015 net revenue total NBV of non-current assets ×100 = 172308 78322 = 2.2 times 2016 = 187500 93750 = 2 times iv Inventory turnover 2015 cost of sales average inventory = + ÷ 112000 ( ) 12000 16000 2 = 8 times 2016 = + ÷ 127500 ( ) 16000 14000 2 = 8.5 times v Trade receivables turnover 2015 trade receivables credit sales × 365 = × 9914 60 365 % of 172308 = 35 days 2016 = × 12511 60 365 % of 187500 = 40.59 days (or 41 days) vi Trade payables turnover 2015 trade payables credit purchases × 365 = × 13984 116000 365 = 44 days 2016 = × 17192 125500 365 = 50 days vii Current ratio 2015 current assets: current liabilities = 30 765 : 13 984 = 2.2 : 1 2016 = 33 696 : 17 192 = 1.96 : 1 viii Liquid (acid test) ratio 2015 current assets – inventory: current liabilities = 14 765 : 13 984 = 1.06 : 1 2016 = 19 696 : 17 192 = 1.15 : 1 b i Sales have increased by over $15 000, or nearly 9%, but the gross margin has decreased from 35% in 2015 to 32% in 2016, a reduction of 3%. This may be due to: • a reduction in selling prices to increase turnover • an increase in the cost of sales not passed on to customers • sales made at less than the normal mark-up (seasonal sales or disposal of old or damaged inventory) • some inventory valued at less than cost because it is old or has deteriorated • inventory which has been stolen. Whether or not the gross margin is acceptable depends upon the normal margin expected on sales, but information about this is not provided. Answers to activities, practice exercises and exam practice questions: Chapter 27 165 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
ii The profit margin has improved from 12.5% in 2015 to 14.57% in 2016. This is in spite of a reduction of 3% in the gross margin. This has been achieved by tighter control on overhead expenditure, down from $38 769 in 2015 to $32 678 in 2016, a reduction of 15.7% although sales have increased by 8.8%. iii Non-current asset turnover has remained almost steady. Without further information about the nature of the business, it is not possible to comment on this ratio. There has been a considerable increase in the value of non-current assets employed in the business in 2016. The additional assets would have to have been brought in to use early in the year for the full commercial and accounting (depreciation) efiects to have been felt. iv Inventory turnover has increased slightly from 8 times in 2015 to 8.5 times in 2016. The average time that goods remain in inventory is 6.5 weeks which may seem reasonable, but as nothing is known about the type of business, further comment is not possible. v Trade receivables turnover has increased by 6 days, from 35 in 2015 to 41 in 2016. This deterioration may be due to one or more of the following factors: • more lenient terms for debtors, to promote sales • a deliberate policy to attract customers from competitors • general economic conditions • poor credit control. A deterioration in the trade receivables turnover incurs the risk of an increase in irrecoverable debts as old debts usually become irrecoverable. Najim should monitor the situation carefully. vi Trade payables turnover has increased by 6 days, from 44 days in 2015 to 50 days in 2016. While this may help the cash flow at a time when debtors are taking 6 days longer to pay, care must be taken to retain the goodwill of suppliers, otherwise the suppliers may insist on cash basis and this would greatly harm Najim’s cash flow. vii The current ratio has decreased slightly from 2.2 : 1 in 2015 to 1.96 : 1 in 2016. It remains satisfactory by normal standards. viii The liquid (acid test) ratio has remained almost steady at 1.06 : 1 in 2015 and 1.15 : 1 in 2016. As 60% of sales are on credit, the very low ratios on which businesses such as supermarkets work are not appropriate for Najim’s business, and his present ratios may be considered satisfactory. General comments: There are no indications that the business is not a going concern. Its cash position is positive and there are no bank loans or overdraffls that could cause embarrassment in the near future. There is no sign of overtrading as inventory and debtors are not excessive. Overtrading places businesses at great risk. Note: Part b requires more than a simple repetition of the ratios already calculated in part a. It is necessary to compare the ratios and to recognise trends and their significance. Students should avoid irrelevant comments and repetition. Statements which cannot be supported by information provided should be avoided, but possible reasons for an improvement or deterioration in a trend may be suggested. Cambridge International AS and A Level Accounting 166 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 2 a i Gearing: Flora Ltd 600 600 500 + × 100 = 54.54% Fauna Ltd 1000 2800 + 1000 × 1 000 = 26.31% ii Interest cover: Flora Ltd 300 60 = 5 times Fauna Ltd 420 120 = 3.5 times iii Earnings per share: Flora Ltd 240 300 = $0.8 (=80c) per share Fauna Ltd 300 1125 = $0.27 (=27c) per share iv Dividend per share: Flora Ltd 90 300 = $0.3 (=30%) Fauna Ltd 150 1125 = $0.13 (=14%) v Dividend cover: Flora Ltd 240 90 = 2.67 times Fauna Ltd 300 150 = 2 times (twice) vi Price earnings ratio: Flora Ltd $ . $ . 2 70 0 8 = 3.375 Fauna Ltd $ . $ . 3 60 0 27 = 13.33 vii Dividend yield: Flora Ltd $ . $ . 0 3 2 70 × 100 = 11.11% Fauna Ltd $ . $ . 0 13 3 60 × 100 = 3.7% b i Gearing: Flora Limited is highly geared (54.54%) and Fauna Limited is low geared (26.31%). This makes Flora Limited a little more risky from the point of view of shareholders and creditors, but neither company is far from neutral gearing (50%). ii Interest cover: Flora Limited’s interest is covered 5 times by the operating profit, but Fauna Limited’s is only covered 3½ times. Both ratios are satisfactory. Flora Limited’s ordinary shareholders are less at risk of having their dividend curtailed if profits fall than Fauna Limited’s shareholders. iii Earnings per share: Flora Limited’s EPS is much higher at 80 cents than Fauna Limited’s at 27 cents. Arithmetically, this is mainly due to Fauna Limited having raised more money from its shareholders and having a lower gearing than Flora Limited. The implication is that Fauna has had to invest proportionately more capital to achieve a return for its shareholders than Flora. This suggests that Flora Limited is potentially the better company for dividend/capital growth. iv Dividend per share: Flora Limited is paying an ordinary dividend of $0.30 per $1 share, equal to 30 % of the nominal value of the shares. Fauna Limited is paying $0.13 per $2 share, Answers to activities, practice exercises and exam practice questions: Chapter 27 167 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
equal to 6.5% of the nominal value of its shares. At first sight, this makes Flora Limited’s shares seem the more attractive, but an investor buying existing shares must pay the market price, so that yield on the amount invested is a more directly useful and relevant ratio. Note: We will use the dividend per share in order to work out the dividend yield in part vii below. v Dividend cover: Flora Limited’s dividend cover is 2.7 times, which is generally considered to be satisfactory. Fauna Limited’s dividend is covered 2 times and may be slightly more at risk if profits decline in the future. vi Price earnings ratio. Flora Limited’s PER is 3.375 and Fauna Limited’s PER is 11.25. The share prices may be influenced by factors not mentioned, and in particular we do not know anything about the future prospects of either company. Fauna Limited’s future trading prospects may be afiected by various favourable factors not mentioned; a low price earnings ratio commonly indicates that investors anticipate significant future growth in profit. vii Dividend yield. Flora Limited’s dividend yield based on the current market price is 11.11% compared with the yield of 3.7% on Fauna Limited’s shares. This makes Flora Limited’s shares more attractive from an income-earning view point. However, it should be considered along with the potential for capital growth and, as has already been stated, Flora Limited’s earnings per share has permitted adequate profits to be retained for capital growth, especially if a conservative dividend policy is continued in future. Conclusion: Every ratio except gearing is favourable to Flora Limited and even the gearing should not give rise to serious concern. Based on the figures presented, an investment in Flora is to be recommended. However, an investment should be based on the future prospects of the entity and the financial consultant should also have regard to the natures of the underlying businesses. Activity 3 a Patience Income statement for the year ended 31 December 2016 $ $ Step 6 Revenue (495 000 × 100/65) 761 538 Cost of sales Step 2 Inventory at 1 Jan 2016 (54 000 × 5/6) 45 000 Step 5 Purchases (balancing figure) 504 000 Step 4 (balancing figure) 549 000 Step 1 Inventory at 31 Dec 2016 (given) 54 000 Step 3 Cost of sales 10 54 000 45000 2 × + 495 000 Step 7 Gross profit (35% of 761 538) 266 538 Step 9 Expenses (balancing figure) 99 000 Step 8 Profit for the year (22% of 761 538) 167 538 Cambridge International AS and A Level Accounting 168 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Patience Statement of financial position at 31 December 2016 $ Assets Step 10 Non-current assets (761 538 / 4) 190 385 Current assets Step 11 Inventory 54 000 Step 12 Trade receivables (761 538 × 34/365) 70 938 Step 15 Cash and cash equivalents (balancing figure) 20 050 Step 14 (balancing figure) 144 988 Step 16 Total assets 335 373 Capital and liabilities Step 21 Capital at 1 Jan 2016 (balancing figure) 249 840 Step 20 Profit for the year 167 538 Step 19 (balancing figure) 417 378 Step 18 Less: drawings (given) 140 000 (from step 17) 277 378 Current liabilities Step 13 Trade payables (504 000 × 42/365) 57 995 Step 17 Total capital and liabilities 335 373 Workings: Step 14: As we know that the current ratio is 2.5:1, having calculated the trade payables at step 13 as $57 995, then the total current assets must be $57 995 × 2.5 = $144 988. b Virtue’s inventory turnover is 12 compared with 10 for Patience. Virtue earns his profit at a faster rate than Patience. His cash flow may be improved by the higher inventory turnover, if he can also collect receivables as quickly as Patience. Virtue’s gross profit margin of 40% is more than Patience’s 35% which indicates that he earns a higher margin on his sales. He may have cheaper sources of supply than Patience, or Patience’s mark-up may be lower than Virtue’s. Without more information about their individual circumstances, further comment is not possible. Virtue’s net profit margin (20%) is 2% lower than Patience’s (22%). This shows that Patience’s overheads are comparatively lower than Virtue’s. Not all overheads are easily controllable, and Virtue may have to pay higher rent, for example, because of the situation or size of his premises. Virtue’s turnover is 5 times his non-current assets but Patience’s turnover is only 4 times. Virtue is using his non-current assets more efiiciently and making them more profitable. Virtue’s trade receivables turnover is 31 days, which is 3 days less than that of Patience (34 days). This indicates that Virtue controls his debtors more efiiciently and his cash flow is improved as a result. Virtue pays his creditors 6 days earlier than Patience pays hers (36 days compared to 42 days). No information is provided regarding the credit terms each receives. If Virtue obtains his goods more cheaply than Patience, as suggested, the period of credit he is allowed may be less than Patience receives. On the other hand, if Virtue is not taking the full period of credit he is allowed, he is not managing his cash flow to the best advantage. Or it may be that he takes more advantage of early settlement discounts, thus improving his profitability; there are advantages and disadvantages to either course of action. Answers to activities, practice exercises and exam practice questions: Chapter 27 169 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Conclusion: With the exception of the net profit margin and the possible exception of his payment of creditors, Virtue appears to be running his business more efiiciently than Patience. Practice exercises 1 a Two advantages of ratio analysis: • allows a business to compare performance with competitors / previous years • helps planning for future. Two disadvantages of ratio analysis: • only shows results – it doesn’t explain why the ratios may have changed from year to year • based on historic data. b Goswami Limited Calculation of ratios Ratio Calculation Answer Industry average i Gross margin $105 000 ÷ 350 000 30% 30% ii Profit margin $45 850 ÷ 350 000 13.1% 18.07% iii Current ratio $88 000 ÷ 47 150 1.87:1 2.21:1 iv Liquid (acid test) ratio $(88 000 − 66 500) ÷ 47 150 0.46:1 1.02:1 v Rate of inventory turnover $245 000 ÷ ([31 500 + 66 500] ÷ 2) 5 times 8 times vi Trade receivables turnover ($21 500 ÷ 350 000) × 365 23 days 25 days vii Trade payables turnover ($21 000 ÷ 280 000) × 365 28 days 30 days c i Profitabilitiy: The gross margin of the company is exactly the same as the industry average. Goswami Limited is performing well in this respect. However, the profit margin of Goswami Limited is lower than the industry average. This is poor and indicates that the company may not be controlling its expenses very well, or may be a consequence of having incurred significant ‘start-up’ costs. ii Liquidity: Both the current ratio and liquid ratio of Goswami Limited are worse than the industry average. This indicates poor control over working capital and thus over liquidity. This is also shown by the inventory turnover which is worse than the industry average. The result of this is probably the reason why the bank is overdrawn. d The directors of Goswami Limited need to take the following actions to improve their results for the business: • Control their running costs as far as they are able to by looking for cost savings in respect of overheads. • Reduce inventory – too much cash is tied up in inventory. The directors need to perhaps sell ofi surplus or slow moving inventory and only purchase more as it is necessary. Cambridge International AS and A Level Accounting 170 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
2 a i Techno Hub Income statement for the year ended 30 April 2016 Step $000 $000 Revenue 5 750 Opening inventory 2 30 Purchases 4 465 Less: closing inventory 1 45 Cost of sales 3 450 Gross profit 6 300 Expenses 8 165 Profit for the year 7 135 ii Techno Hub Statement of financial position at 30 April 2016 Step $ Assets Non-current assets 1 250 Current assets Inventory 4 45 Trade receivables 5 73 Cash and cash equivalents 6 35 3 153 Total assets 7 403 Capital and liabilities Capital 12 362 Profit for the year 11 135 Less: drawings 10 125 9 352 Current liabilities Trade payables 2 51 Total capital and liabilities 8 403 b Ratio Techno Hub Zenapod Inventory turnover 12 times 10 times Gross margin 40% 45% Profit margin 18% 20% Non-current asset turnover 3 times 3½ times Trade receivables turnover 36 days 30 days Trade payables turnover 40 days 28 days Evaluation of performance: Techno Hub has a better inventory turnover than Zenapod which shows good management of inventory. Not too much is held at any one time. The gross margin of Techno Hub is worse than Zenapod, which means that they are either not marking up their goods as much or buying from a more expensive supplier. Answers to activities, practice exercises and exam practice questions: Chapter 27 171 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
The business could improve its margin by increasing the mark-up, or if this would result in a loss of sales, then try to find a cheaper supplier. The profit margin of Techno Hub is worse than Zenapod. This could be partly due to the poorer gross margin. However, it also means that Techno Hub is not controlling its expenses as well as the rest of the industry. This is an area which needs improvement, perhaps by trying to reduce cost through cost savings. Zenapod has better utilisation of its non-current assets than Techno Hub as it generates more revenue per $ of non-current assets. This may be due to Techno Hub having purchased new non-current assets which have yet to generate better sales. The trade receivables turnover is worse than Zenapod. This means that Techno Hub needs to improve its credit control. However, Techno Hub is holding on to its cash for longer by not paying its suppliers as fast as Zenapod. This is acceptable, provided that it does not result in damaging supplier relationships. Techno Hub has a high bank balance. It could perhaps try to negotiate better prices with its suppliers. This will help improve the gross margin. c i Return on capital employed. ii This measures how much profit is earned by every dollar of capital invested in the firm. Capital invested here means not only owner’s capital, but also any non-current liabilities such as long-term loans or debentures. 3 a Oitar plc Calculation of ratios Ratio Calculation Answer i Interest cover $1 000 ÷ 250 4 times ii Dividend cover $750 ÷ 470 1.60 times iii Earnings per share $(750) ÷ 550 $1.36 per share iv Price earnings ratio $30 ÷ $1.36 22 v Dividend yield $(470 ÷ 550) ÷ 30 2.84% vi Gearing ($250 ÷ 12.5%) ÷ (5 500 + 900 + 2 000) 23.81% b Interest cover is important as it indicates how much of the profit for the year can be paid out as dividends. It is a measure of risk: the higher the interest cover the better as more profit is available to pay dividends to the ordinary shareholders. Dividend cover shows how many times the profit for the year covers the dividend paid to the shareholders. A high figure means that the company is retaining profits, perhaps for future expansion and growth, which will help future dividend prospects. Earnings per share measures how much each ordinary share generates in profit for the year. The higher the better as it is likely to increase the market price of the shares. Price earnings ratio measures the confidence that the stock market has in the company. Again, the higher the better. It means that professional investors are confident of the future growth in the company. Alternatively, it could mean that professional investors have been too optimistic and that the share price is overvalued. A potential investor needs to understand the nature of the underlying business to interpret this ratio. Dividend yield measures the return on the share. It can be compared with the return which could be earned by investing the shareholder’s cash in a risk-free investment rather than a share in the company. Again, the higher the better. Gearing measures the capital invested in the company on which a fixed and obligatory return must be paid with the total capital invested in the company, including shareholder’s funds. It is a measure of risk as the more fixed cost capital there is, the more risky the investment and the more profits the company has to earn to pay its fixed costs investors before it can pay dividends to the ordinary shareholders. Cambridge International AS and A Level Accounting 172 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
c The ordinary shareholders would need to see the full set of published accounts produced by the directors of the company. This would include a statement from the chairman which would give an indication of possible future performance. The document would also contain a statement of cash flows, which would allow investors to see how the company generates funds and spends them. Finally, the accounts would contain an audit report. If this is unqualified, it is likely to give the shareholders confidence that their analysis is based on reliable financial information. 4 a i Return on capital employed: Profit before interest Capital employed ×100 (total equity + non-current liabilities) 1000 (7000 + 3000) ×100 = 10% ii Dividends per share: Dividends per share = Ordinary dividends for the year Number of ordinary shares issued In this example we know that the company has already paid an interim dividend of $0.02 per share. We know that the proposed final dividend will be a total of $300 000. This means that each shareholder will receive: $300000 6000000 = $0.05 per share So the total dividend per share for the year is $0.02 + $0.05 = $0.07 per share. iii Dividend cover: Profit attributable to equity holders Ordinary dividends paid The total amount of the interim dividend was $0.02 × 6 000 000 shares = $120 000. So the total dividend paid for the year was $120 000 + $300 000 = $420 000. This means the dividend cover was: 600000 420000 = 1.43 times iv Dividend yield: Dividend paid per share Market price of a share ×100 $0.07 $2.00 × = 100 3 5. % v Earnings per share: Profit attributable to equity holders Number of ordinary shares issued 600 6000 = $ . 0 10 per share vi Price/earnings ratio: Market price per share Earnings per share $2.00 $0.00 = 20 (from the previous question) Notice here that there is no sufiix. The price earnings ratio is usually calculated and expressed only as a figure. Answers to activities, practice exercises and exam practice questions: Chapter 27 173 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Solution: • Gemmaton’s return on capital employed is worse than JAH Limited as it is a lower percentage. • However, Gemmaton’s return on equity is better because it is higher. • Gemmaton’s earnings per share is also better. • Gemmaton’s gearing is better. JAH Limited has a large amount of fixed cost capital which is shown by the higher gearing ratio. Thus, Gemmaton would be a better company to invest in if interest rates increased. Solution: • Gemmaton is providing a better dividend per share by $0.03 ($0.07 − $0.04). • However, JAH has a better dividend cover (2 times compared with 1.43 times). • Gemmaton has a better dividend yield (3.5% compared with 2%). • Gemmaton has a higher price earnings ratio. Overall I would advise Abdul to invest in . . . . . . . . (student answers will vary). Note: It is perfectly acceptable to advise Abdul either way: to invest or not to invest. All that needs to be added is a final comment to justify an overall conclusion. c Benefits of ratio analysis (any two): • It allows managers to make comparisons between difierent years and between difierent businesses in the same trading sector. However, the businesses should ideally be of a similar size. • It helps identify where improvements need to be made for the future. • It allows a trend of performance to be built up over a number of years. Limitations of ratio analysis (any two): • To be useful and reliable, ratios must be reasonably accurate. They should be based on information in accounts and notes to the accounts. Some useful information may not be disclosed in the accounts and some account headings may not indicate the contents clearly. • Information must be timely to be of use. It may not be available until some time affler the end of a company’s financial year. • Ratios do not explain the cause of the changes in the results but may indicate areas of concern; further investigation is usually necessary to discover causes of the concern. • Ratios usually do not recognise seasonal factors in business. Exam practice questions Multiple-choice questions 1 D 2 B 3 C 4 D 5 C 6 D 7 B 8 A Cambridge International AS and A Level Accounting 174 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
28 Costing for materials, labour and overheads Activities Activity 1 Fiford Ltd Inventory of fifolium at 31 October Oct 1 10 15 22 29 Price ($) 5.00 5.20 5.24 5.28 5.32 Quantity (kg) 100 80 50 70 100 Sales 3 (40) 60 12 (60) (15) – 65 14 (50) 15 17 (15) (30) – 20 30 (20) (50) – 31 – 20 100 Value $105.60 $532.00 Total $637.60 Activity 2 A. V. Co. Inventory of digital hammers at 30 June Date Quantity Price per unit Average price Balance $ $ $ Jun 1 Balance b/f 200 5.00 5.000 1 000 4 Purchased 100 5.20 520 Balance 300 5.067 1 520 10 Sold (75) (380) Balance 225 1 140 13 Purchased 100 5.35 535 Balance 325 5.154 1 675 20 Sold (150) (773) Balance 175 902 26 Purchased 80 5.40 432 Balance 255 5.231 1 334 30 Sold (90) (471) Balance 165 5.231 863 Activity 3 a Basic pay for the week = 40 hours × $18 = $720. Note: Basic pay is usually understood to mean the normal pay for normal hours, rather than the amount that would be paid if all hours worked were paid at the basic rate. Answers to activities, practice exercises and exam practice questions: Chapter 28 175 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Overtime = 4 hours × $18 × 1½ = $108. Premium = 108 − (4 hours × $18 = 72) = $36. c For a basic week, Chan is expected to produce 360 units in 40 hours = 9 units per hour. For the week ended 31 March, Chan worked 44 hours so should have produced 44 × 9 = 396 units. He actually made 414 units, so excess production = 414 − 396 = 18 at $5 per unit = $90. d 414 units should have taken 414 ÷ 9 = 46 hours. Chan took 44 hours so saved 46 − 44 = 2 hours at $12 = $24. e Chan’s total gross pay for the week = $(720 + 108 + 90 + 24) = $942. Activity 4 a Expense Basis Total Machining Painting Assembly Packing $000 $000 $000 $000 $000 Indirect labour Actual 125 51 32 28 14 Factory: Rent Floor area 90 45 18 18 9 Heating and lighting Floor area 70 35 14 14 7 Maintenance Floor area 30 15 6 6 3 Insurance Floor area 20 10 4 4 2 Plant and machinery: Depreciation Cost 80 45 20 5 10 Repairs Cost 32 18 8 2 4 Insurance Cost 16 9 4 1 2 Total overhead 463 228 106 78 51 Note: Alternatively ‘maintenance’ could have been allocated in proportion to plant and machinery cost. b Expense Basis Total Machining Painting Assembly Packing $000 $000 $000 $000 $000 Direct materials Allocation 117 80 20 5 12 Direct labour Allocation 323 136 74 68 45 Overhead Apportioned 463 228 106 78 51 Total cost 903 444 200 151 108 Activity 5 Mixing Bakery Packaging Stores Canteen $000 $000 $000 $000 $000 Overheads 165.00 124.00 87.00 80.00 90.00 Reapportion stores 54.55 14.54 3.64 (80.00) 7.27 Reapportion canteen 32.42 43.23 21.62 – (97.27) 251.97 181.77 112.26 – – Cambridge International AS and A Level Accounting 176 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 6 a No. of direct labour hours required: First: 5 000 × 1.3 = 6 500 Second: 7 000 × 0.7 = 4 900 11 400 OAR = $129276 11400 == $11.34 per hour. i OAR per unit: First: $11.34 × 1.3 = $14.742 per unit. ii OAR per unit: Second: $11.34 × 0.7 = $7.938 per unit. b Overhead absorbed: $ Firsts: 5 000 × $14.742 73 710 Seconds: 7 000 × $7.938 55 566 Total overhead 129 276 Activity 7 a Total number of machine hours in a 13 week period = 10 × 7 × 6 × 13 = 5 460. Machine hour OAR = $141960 5460 = $26 b Each unit requires 5460 1200machine hours to make = 4.55 machine hours. Therefore each unit absorbs $26 × 4.55, or $118.30 overhead. (Proof: $118.30 × 1 200 = $141 960.) Activity 8 a OARs Moulding: Direct labour hourly rate $301875 34500 = $8.75 Machining: Machine hourly rate $115200 18000 = $6.40 Paint shop: Direct labour hourly rate $47250 9000 = $5.25 b Overhead absorbed per unit: Sovrin Ginny $ $ Moulding (4 × $8.75) 35.00 (3½ × $8.75) 30.625 Machining (2 × $6.40) 12.80 (2 × $6.40) 12.800 Paint shop (1 × $5.25) 5.25 (1 × $5.25) 5.250 53.05 48.675 c Total overhead recovery: Sovrin Ginny Total $ $ $ Moulding (6 000 × $35.00) 210 000 (3 000 × $30.625) 91 875 301 875 Machining (6 000 × $12.80) 76 800 (3 000 × $12.800) 38 400 115 200 Paint shop (6 000 × $5.25) 31 500 (3 000 × $5.250) 15 750 47 250 318 300 146 025 464 325 Answers to activities, practice exercises and exam practice questions: Chapter 28 177 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
d Total cost per unit: Sovrin Ginny $ $ Direct material 102.00 85.000 Direct labour 190.00 151.000 Overhead 53.05 48.675 345.05 284.675 e Selling prices are therefore: Sovrin $690.10 and Ginny $569.35. Activity 9 Upandown Limited Three months to 31 March Three months to 30 June Three months to 30 September Three months to 31 December $ $ $ $ OAR 124 128 130 131 Overhead recovered 111 600 134 400 143 000 128 380 Actual overhead 128 000 125 000 129 500 132 800 (Under-)/over-recovery (16 400) 9 400 13 500 (4 420) Practice exercises 1 a Overhead expenses in relation to costing are costs which the business incurs when making the product (or service), but which cannot be directly traced to the units of production. b i Overhead allocation refers to overheads which can be identified with specific cost centres, for example packing materials for the packing department or oil for the machine shop. ii Certain overheads cannot be traced directly to a cost centre, for example rent of the whole factory. Such overheads are apportioned (split) between cost centres on a suitable basis, such as floor space for rent. c i Once overheads have been apportioned to cost centres, the next step is to calculate an overhead absorption rate. These rates are then used to calculate the amount of overhead to be attributed or charged to each cost unit in each cost centre. ii Under-absorption of overheads occurs when the actual expenditure on overheads is more than the budgeted amount, and/or production is less than the planned level. iii Over-absorption occurs when the actual expenditure on overheads is less than the budgeted amount, and/or when actual production is more than the planned level. d A company may recover more in overheads than the amount spent in the period when the actual expenditure on overheads is less than the budgeted amount, and/or when actual production is more than the planned level. This can occur because of such things as receipt of a new order from a customer in excess of the orders planned, when invoiced costs were lower than expected or when planned overhead work was not carried out. e Estimated figures are used to calculate an overhead absorption rate because the rate has to be calculated in advance of production. For this reason budgeted costs are used. This allows the managers of the business to work out prices in advance, or if a special order is received then to work out a price to charge the customer. This would be impossible to do afier the event. Cambridge International AS and A Level Accounting 178 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
2 Three ways in which labour can be remunerated are: • hourly rate, usually regarded as a direct cost because it is paid to production workers • piece rate, likewise regarded as a direct cost as it is usually paid to production workers in direct proportion to their output in units • annual salary, regarded as an indirect cost, because this is the normal basis of remuneration for administrative and management staff. 3 Two ways an employee can earn a bonus for work carried out (if her contract includes such an arrangement): • by producing more in the time available than the amount of production set down by management • as a percentage on the amount sold (e.g. commission for a salesperson). 4 a Arthur’s basic pay for the week = 44 hours + 4 hours for Saturday = 48 hours × $20 = $960. Alternatively: 40 × $20 = $800. b Overtime work = 4 hours at time and a half = 6 hours. 4 hours at double time = 8 hours. 6 hours at $20 (= $120) + 8 hours × $20 (= 160) = $280. Of this, 2 of the 6 hours and 4 of the 8 hours are overtime premium = 6 hours × $20 = $120. Alternatively: Overtime = 4 × $30 + 4 × $40 = $280. Premium = 4 × $10 + 4 × $20 = $120. c For a 40 hour week Arthur was expected to produce 480 units = 12 per hour. He worked 48 hours so should have produced 48 × 12 = 576 units. He actually produced 600 units, so he made 600 − 576 = 24 extra units. For this he would be paid 24 × $3 = $72. d The 600 units should have taken 600 ÷ 12 = 50 hours, so he saved 50 − 48 = 2 hours. For this he is paid 2 × $10 = $20. e Arthur’s gross pay for the week was: $960 + 120 + 72 + 20 = $1 172. Alternatively : $800 + 280 = 72 + 20 = $1 172. Exam practice questions Multiple-choice questions 1 C 2 B 3 B 4 D 5 A 6 D 7 D Structured questions 1 a i A cost centre is a location, usually a department within a business, to which costs can be charged. It may also be a person (e.g. a salesperson) or an item of equipment. ii A cost unit is a unit of production, for example a computer or a dress. Answers to activities, practice exercises and exam practice questions: Chapter 28 179 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Overhead cost Total Moulding Sanding Painting Maintenance Canteen $ $ $ $ $ $ Administration 104 000 20 000 25 000 20 000 20 000 19 000 Electricity 70 000 28 000 32 000 3 000 3 800 3 200 Depreciation 50 000 16 200 17 500 4 000 8 000 4 300 Indirect wages 78 565 6 000 11 250 6 375 36 190 18 750 Rent 80 500 21 875 16 625 17 500 14 000 10 500 Total 383 065 92 075 102 375 50 875 81 990 55 750 Reapportionment of canteen costs 13 118 16 396 13 118 13 118 (55 750) Reallocation of maintenance costs 37 152 28 235 29 721 (95 108) Total costs of production cost centres 142 345 147 006 93 714 c Moulding = $142 345 ÷ 8 000 = $17.79 per labour hour. Sanding = $147 006 ÷ 8 650 = $16.99 per machine hour. Painting = $93 714 ÷ 7 500 = $12.50 per direct labour hour. Note: Part c has been answered using the additional information. d Cost Calculation Amount $ Direct material 50.00 Direct labour: Moulding 1 × $8 8.00 Sanding 1.5 × $6 9.00 Painting 2.5 × $10 25.00 92.00 Factory overheads: Moulding 1 × $17.79 17.79 Sanding 2 × $16.99 33.98 Painting 2.5 × $12.50 31.25 Factory cost 175.02 Add: required profit 116.68 Selling price $175.02 ÷ 60% 291.70 (Proof: $116.68 ÷ 291.70 × 100 = 40%, the required margin.) e The directors should not change to a factory-wide overhead absorption rate. The painting cost centre is labour intensive, whilst the other two cost centres are machine intensive. The overhead absorption rate used should reflect most closely what happens in the cost centre. If a factory-wide rate is used then will it be based on direct labour hours or machine hours? Whichever is chosen will not reflect what goes on in all the cost centres. Cambridge International AS and A Level Accounting 180 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
2 a Expense Basis of apportionment Total Machining Assembly Maintenance Power house $000 $000 $000 $000 $000 Indirect materials Given 1 064 298 482 132 152 Indirect labour Given 2 578 706 918 282 672 Rent & taxes Floor area 1 426 465 775 155 31 Supervision Indirect labour 660 176 352 88 44 Plant depreciation Plant value 1 650 975 375 180 120 Total allocated 7 378 2 620 2 902 837 1 019 b Expense Basis of apportionment Total Machining Assembly Maintenance Power house $000 $000 $000 $000 $000 Total allocated 7 378 2 620 2 902 837 1 019 Reallocation of power house Units of power 713 204 102 (1 019) Reallocation of maintenance Maintenance hours 704 235 (939) - Final total for production areas 7 378 4 037 3 341 - c The overhead absorption rates are, therefore: Machining Assembly Overheads allocated $4 037 000 $3 341 000 Hours 11 080 4 800 Absorption rate $364.35 per machine hour $696.04 per direct labour hour d Certain costs can be attributed directly to cost centres, for example indirect labour costs of workers within a particular cost centre. These costs are therefore allocated directly to the cost centre in which they occur. Other costs though cover a number of cost centres, for example rent of a factory. These costs have to be split across cost centres using a pre-determined basis, for example the floor space of each cost centre can be used when splitting rent. This process of splitting overheads on a pre-determined basis is known as apportionment. e Over-absorption of overheads occurs when production passing through a cost centre is charged with more budgeted overhead than the cost centre actually incurs. Answers to activities, practice exercises and exam practice questions: Chapter 28 181 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
f Machining Assembly Actual hours (A) 12 000 4 600 Budgeted absorption rate (B) $364.35 $696.04 Overheads absorbed (A × B) $4 372 200 $3 201 784 Actual overheads $4 100 000 $3 300 000 $272 000 $98 216 over-absorbed under-absorbed g $9 500 × 1.30 = $12 350, ÷ 100 = $123.50 per unit. h As there is spare capacity, the directors should consider making the special order. To do so will increase the utilisation of the factory. It will mean that the fixed costs are spread over a greater number of units produced. This will reduce the overall cost per unit of the product. In order to make a final decision the directors need to identify the variable and fixed costs associated with the order. If the selling price offered results in a positive contribution, then the order should be accepted. If not then it should be rejected. Cambridge International AS and A Level Accounting 182 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
29 Unit, job and batch costing Activities Activity 1 $ Direct materials 398 000 Direct labour 996 000 Overheads 1 687 250 3 081 250 Cost per cost unit of 1 000 packets = $ $ 3081250 425 = 7250 Activity 2 Two actions the directors could take in future to improve profit: • look for a cheaper supplier of materials • look for faster ways of working • look for cheaper stafi • review the make-up of the overheads to see if any costs can be saved. Activity 3 a $ Labour: Geofirey (200 × $100) 20 000 Susan (100 × $60) 6 000 Overhead recovery (300 × $40) 12 000 Amount to charge 38 000 b Geofirey has certain things to consider when deciding whether or not to accept the work for $30 000: • How much work does he currently have? If he accepts the ofier he will cover the two direct cost figures of wages. If it is his only possible work then it must be accepted. • The difierence will also contribute $4 000 towards covering his overheads. If he has no other work this is important. • What exactly is included in the overheads figure? If all of it is fixed, then the $4 000 will help towards covering that. However, if any is variable, then the amount of fixed overheads the $4 000 contributes towards will be reduced. Overall, provided the contribution is positive then Geofirey should accept the work. Activity 4 No. of rolls = 6 000 (1 000 × 6) No. of labour hours = 10 (6 000/[100 × 6]) a $ Raw materials (6 000 × $0.08) 480.00 Labour (10 × $6) 60.00 Setting up machinery 30.00 Labour hour overhead recovery 93.50 663.50 b Cost of one roll: 663.50/6 000 = $0.1 106 Answers to activities, practice exercises and exam practice questions: Chapter 29 183 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Practice exercises 1 a Dept A: $36 000 ÷ 24 000 = $1.50 Dept B: $26 000 ÷ 20 000 = $1.30 Dept C: $24 000 ÷ 8 000 = $3.00 All overheads are per direct labour hour. b Monthly production units: 4 000 $ $ Direct material ($8 × 4 000) 32 000 Direct labour: Dept A (4 000 × [1½ × $8.75]) 52 500 Dept B (4 000 × [1 × $8.75]) 35 000 Dept C (4 000 × [½ × $8.75]) 17 500 105 000 Factory overhead: Dept A (4 000 × 1½ × [$36 000 ÷ 24 000]) 9 000 Dept B (4 000 × 1 × [$26 000 ÷ 20 000]) 5 200 Dept C (4 000 × ½ × [$24 000 ÷ 8 000]) 6 000 20 200 Production cost for one month’s production of Super Burling 157 200 2 a Overhead recovery is the term given to the amount of total overhead for a cost centre which is charged to the total production going through that cost centre in a period. The calculation is based on the overhead absorption rate multiplied by the actual amount worked. For example, suppose the budgeted total overhead for a cost centre is $5 000 and the budgeted overhead rate is $2 per direct labour hour. If 2 400 direct labour hours are worked in a period then the amount of overhead recovered will be 2 400 × $2 = $4 800. b Printing: $127 400 ÷ 3 640 = $35 per direct labour hour. Marketing and promotion: $267 540 ÷ 6 370 = $42 per direct labour hour. c $ $ Direct material: Printing 1 300 Marketing and promotion 1 600 2 900 Direct labour: Printing (120 × $8) 960 Marketing and promotion (300 × $12) 3 600 4 560 Overhead: Printing (120 × [$127 400 ÷ 3 640]) 4 200 Marketing and promotion (300 × [$267 540 ÷ 6 370]) 12 600 16 800 Total cost 24 260 Add: required profit ($24 260 × 40%) 9 704 Price to charge clients 33 964 d If the price of $25 000 is accepted, then it will only just cover the total calculated cost of $24 260. It depends on how much work Successful Promotions Limited has. If they have no other work then it should be accepted as it does at least cover the costs. If they don’t have any work then the company may have to consider making stafi redundant. This could have a negative efiect on their image. They may also have to cancel some deliveries from suppliers, which again may have a negative impact on relationships with their suppliers. Clearly, if they do want to accept the quote and make some profit then they have to look for cost savings. In doing so, the savings can only be made from costs over which the Cambridge International AS and A Level Accounting 184 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
directors have control. This is likely to be the labour cost. They could try to cut down the time taken, without harming the quality of the work. If possible they may try to negotiate a discount for the materials with their suppliers, although this may be difiicult. The other aspect is if they accept the work at the lower price then they may be forced to do this again in the future. If their other customers find out about the deal they too may try to get a lower price. This could have a damaging efiect on future profits. Successful Promotions Limited should try to negotiate a better price, before accepting the work. e Overheads recovered = 3 750 × $35 = 131 250 Less: actual overheads 130 000 Over-absorption 1 250 f The over-absorption may lead to an increase in profits, as the fixed costs are now spread across probably a greater number of units. Note: Strictly speaking costing and overhead absorption are ways only of classifying costs, they do not directly change the overall profit of a company. However, if the overhead recovery rate was slightly higher than necessary, the implication could be that the selling price was also set slightly higher (if it was based on a target mark-up) and therefore this ‘extra’ sales income would have increased profit. 3 a A production cost centre is an area within the factory where production actually takes place. A service cost centre is one which provides a service of some sort to all the production cost centres, for example a canteen or maintenance department. b When calculating an overhead absorption rate it is essential that all the costs of running the factory are included. If the service cost centre costs are not reapportioned to the production cost centres then an element of cost will not be charged to the product. This may result in the selling price being too low to cover all the company’s costs and perhaps not generate any profit at all. c Moulding: $21 840 ÷ 7 280 = $3 per machine hour Lining: $11 375 ÷ 4 550 = $2.50 per direct labour hour Finishing: $4 368 ÷ 1 820 = $2.40 per direct labour hour d Production (units): 2 000 pairs $ $ Direct material: Moulding ($2 × 2 000) 4 000 Lining ($3 × 2 000) 6 000 10 000 Direct labour: Moulding ($7 × [0.25 × 2 000]) 3 500 Lining ($6 × [0.5 × 2 000]) 6 000 Finishing ($6 × [0.25 × 2 000]) 3 000 12 500 Factory overhead: Moulding (0.5 × 2 000 × [$21 840 ÷ 7 280]) 3 000 Lining (0.5 × 2 000 × [$11 375 ÷ 4 550]) 2 500 Finishing (0.25 × 2 000 × [$4 368 ÷ 1 820]) 1 200 6 700 Total cost of 2 000 pairs of children’s boots 29 200 e Cost of one pair of boots: $29 200 ÷ 2 000 = $14.60. Answers to activities, practice exercises and exam practice questions: Chapter 29 185 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
f The directors should not change to a factory-wide overhead absorption rate. The lining and finishing cost centres are labour intensive, whilst moulding is machine intensive. The overhead absorption rate used should reflect what happens in the cost centre. If a factory-wide rate is used then will it be based on direct labour hours or machine hours? Whichever is chosen will not reflect what goes on in all the cost centres. Exam practice questions Multiple-choice questions 1 B 2 A Cambridge International AS and A Level Accounting 186 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
30 Marginal costing Activities Activity 1 a Contribution from 1 unit = $146 250 ÷ 3 000 = $48.75 Contribution from 3 000 units = $(48.75 × 3 000) = $146 250 Profit from 3 000 units = $(146 250 – 82 000) = $64 250 b Contribution from 4 000 units = $(48.75 × 4 000) = $195 000 Profit from 4 000 units = $(195 000 − 82 000) = $113 000 c Contribution from 1 200 units = $(48.75 × 1 200) = $58 500 Loss from 1 200 units = $(82 000 − 58 500) = $23 500 Activity 2 a i Contribution per unit = $(95 − 65) = $30 Break-even point = $ $ 7500 30 = 2 500 units; Break-even revenue = $ . 75000 0 31579 = $237 500 (or 2 500 × $95 = $237 500) ii Margin of safety = 2500 5000 × 100 = 50% b Break even $000 2500 Break-even chart for product Q 0 50 100 150 200 250 300 350 400 450 237.5 475 Total revenue Total costs Fixed costs Activity 3 No. of phones a 10 000 b 15 000 c 20 000 $ $ $ Contribution $(50–41) 90 000 $(48–41) 105 000 $(42–41) 20 000 Fixed overheads 70 000 70 000 70 000 Profit/(loss) 20 000 35 000 (50 000) Activity 4 Marginal cost per 1 000 cans of fruit: $14 250 a Additional contribution from order for 5 000 cans at $16 000 per 1 000 cans: 5 × $(16 000 − 14 250) = $8 750 profit The order should be accepted. b Loss if order for 3 000 cans at $14 100 is accepted: 3 × $(14 100 − 14 250) = $450 loss The order should not be accepted unless it will prevent the company from having to lay ofi valuable skilled stafi because of a temporary slump in trade. Answers to activities, practice exercises and exam practice questions: Chapter 30 187 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
188 188 Cambridge International AS and A Level Accounting Activity 5 Present position (tools produced by Canterbury Planes Limited): $ Selling price per tool 16.00 Direct costs: material 3.00 Labour 2.50 Other expenses 1.00 Marginal cost of production 6.50 Variable selling expenses 2.00 Marginal cost of sales 8.50 Contribution 7.50 Contribution from sale of 15 000 tools = $112 500 Profit on sale of 15 000 tools = $(112 500 − 74 000) = $38 500 Break-even point: $ $ . 74000 750 = 9 867 tools a i North Island Tool Co.: Cost per tool $6. This is $0.50 less than the present cost of production. Efiect on profit: Increase by (15 000 × $0.50) = $7 500 to $46 000. Efiect on break-even point: $ $ 74 000 8 = 9 250 tools. ii South Island Tool Co.: Cost per tool $6.80. This is $0.30 more than the present cost of production. Efiect on profit: Decrease by (15 000 × $0.30) = $4 500 to $34 000. Efiect on break-even point: $ $ . 74000 7 20 = 10 278 tools. b Tools should be purchased from North Island Tool Co. because: • the cost will be $0.50 less than the cost of production • profit will increase by $7 500 to $46 000 • the break-even point will be reduced from 9 867 tools to 9 250 tools. Tools should not be purchased from South Island Tool Co. because: • the cost will be $0.30 more than the cost of production • profit will decrease by $4 500 to $34 000 • the break-even point will increase from 9 867 tools to 10 278. Activity 6 Gimie Gros Petit Per unit $ $ $ Selling price 14 25.00 20 Direct material 5 6.50 8 Direct labour 5 14.00 6 Marginal cost 10 20.50 14 Contribution 4 4.50 6 Contribution per litre of material 1.6 1.38 1.5 Ranking 1 3 2 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
189 189 Answers to activities, practice exercises and exam practice questions: Chapter 30 Castries Limited Revised production budget to maximise profit from available materials Units Litres Contribution $ Gimie (maximum) 1 000 2 500 4 000 Petit (maximum) 800 3 200 4 800 Gros (4 875 / 3.25) 1 500 4 875 6 750 10 575 15 550 Less: fixed expenses 10 000 Profit 5 550 Activity 7 Gimie Gros Petit $ $ $ Contribution 4 4.50 6 Contribution per direct labour hour 8 3.21 10 Ranking 2 3 1 Castries Limited Revised production budget to maximise profit from available direct labour hours Units Labour hours Contribution $ Petit 800 480 4 800.00 Gimie 1 000 500 4 000.00 Gros 1 725 2 415 7 762.50 3 395 16 562.50 Less: fixed expenses 10 000.00 Profit 6 562.50 Activity 8 a Market Limited Per unit Product A Product B Product C $ $ $ Material 20 40 50 Labour 36 60 72 Marginal cost 56 100 122 Selling price 80 130 150 Contribution per unit 24 30 28 Total budgeted contribution 24 000 60 000 112 000 Total contribution 196 000 Less: fixed expenses 115 000 Profit 81 000 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Market Limited Revised production budget Contribution Units Materials Total A 12.0 1 000 2 000 24 000 B 7.5 2 000 8 000 60 000 C 5.6 3 600 18 000 100 800 28 000 184 800 Less: fixed expenses 115 000 Profit 69 800 c Reconciliation of profit per revised budget with profit in original budget: $ $ Profit per original budget 81 000 Budgeted production of C (units) 4 000 Revised budget for C 3 600 Reduction in production 400 Loss of contributions 400 × 28 11 200 Revised profit 69 800 Activity 9 a Fixed costs increase by $12 000 and profit is reduced to $23 000. Break-even = $92000 $5.75* = 16 000 units * Contribution = $(8.75 − 3) b Variable costs increase by $9 000 and profit is reduced to $26 000. Break-even = $ $ . * 80000 5 30 = 15 095 units * Contribution = $(8.75 − 3.45) c Costs and revenue increase by $21 000 and profit is maintained at $35 000. Break-even = $ $ . * 92000 6 35 = 14 489 units. Costs have increased by $21 000; revenue becomes $196 000 ($9.80 per unit). *Unit marginal cost is $3.45; contribution = $(9.80 − 3.45) = $6.35 Activity 10 a Monthly profit using marginal costing Month 1 Month 2 $ $ Revenue 50 000 65 000 Less: variable costs 30 000 39 000 Less: fixed costs 15 000 15 000 Monthly profit 5 000 11 000 Cambridge International AS and A Level Accounting 190 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Monthly profit using full absorption costing Month 1 Month 2 $ $ Revenue 50 000 65 000 Opening inventory – 20 000 Cost of production: Variable costs: 1 500 units x $30 45 000 45 000 Fixed costs 15 000 15 000 60 000 80 000 Less: closing inventory (20 000) (28 000) Cost of sales 40 000 52 000 Monthly profit 10 000 13 000 Notes: 1 Closing inventory is valued at $40 per unit ($60 000 ÷ 1 500 = $40). 2 Closing inventory at the end of month 1 is 500 units (1 500 – 1 000). At the end of month 2 the closing inventory is (500 + 1 500 – 1 300) = 700 units. c Reconciliation of profit using each method Month 1 Month 2 $ $ Profit using marginal costing 5 000 11 000 Add: fixed overheads in closing inventory 5 000 7 000 Less: fixed overheads in opening inventory – (5 000) Profit using full absorption costing 10 000 13 000 Note: The fixed overheads included in the closing inventory is $15 000 ÷ 1 500 = $10 per unit. The total overheads included in the closing inventory at the end of each month, therefore, are: in month 1: 500 units × $10 = $5 000; and in month 2: 700 units × $10 = $7 000. Practice exercises 1 Working: Cost of each order on each machine: X – 123/P X – 382/Q Y – 123/P Y – 382/Q $ $ $ $ Direct material (material cost per unit × number of units) 4 000.00 5 000.00 3 680.00 4 600.00 Direct labour (hourly rate × number of operatives × hours) 200.00 250.00 150.00 200.00 Variable overhead per order 2.40 2.40 2.60 2.60 Total variable cost 4 202.40 5 257.40 3 742.60 4 802.60 Fixed costs per order 200.00 200.00 500.00 500.00 Total cost 4 402.40 5 457.40 4 242.60 5 502.60 Required profit + 25% 1 050.60 1 060.65 Answers to activities, practice exercises and exam practice questions: Chapter 30 191 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
a i 123/P order is more cheaply done on machine Y. ii 382/Q order is more cheaply completed on machine X. b Machine X Machine Y $ $ Selling price (cost plus profit from above) 5 453.00 5 303.25 Variable cost 4 202.40 3 742.60 Contribution = SP – VC 1 250.60 1 560.65 c • Rights issue: Advantage: shares ofiered to existing shareholders, therefore no loss of control. Disadvantage: not all the rights may be taken up by existing shareholders, therefore all the money may not be raised. (They may not have sufiicient spare funds to invest.) • Issue of shares to the public: Advantage: all the money should be received. Disadvantage: will result in reduced extent of control of the company by the present owners / majority shareholders • Issue of debentures: Advantage: all the money should be received. Disadvantage: lenders may require security for the debt from the company and the company has a fixed commitment to repay both the capital and interest. 2 a i 15 000 units: Per unit $ Direct material (4 × $4.10) 16.40 Direct labour ( 1 3 × $12) 4.00 Variable overhead 1.80 Marginal cost 22.20 Selling price 25.00 Contribution 2.80 Profit: $(15 000 × 2.8) − $30 000* = $(42 000 − 30 000) = $12 000. *($1.5 × 20 000 = $30 000) ii 18 000 units: Per unit $ Material 16.40 Labour 4.00 Variable overhead 1.79 Marginal cost 22.19 Selling price 25.00 Contribution 2.81 Profit = (18 000 × $2.81) – $30 000 = $50 600 (rounded) – $30 000 = $20 600. *(16 000 × $1.8 + 2 000 × $1.7) = 18 000 Cambridge International AS and A Level Accounting 192 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Fixed costs are (full production) 20 000 × $1.50 = $30 000. Contribution per unit (up to 16 000 units from i, above) = 2.80. Contribution from 16 000 units = $44 800. This is in excess of break-even, so no need to consider production when semi-variable costs change. Break-even point = fixed costs / contribution per unit – 30 000 / 2.80 = 10 715 units. c 20 000 units sold at $24 per unit: $ $ $ Revenue 480 000 Material (20 000 × $16.40) 328 000 Labour (20 000 × $4) 80 000 Variable overhead 16 000 × $1.80 28 800 4 000 × $1.70 6 800 35 600 443 600 Contribution 36 400 Less: fixed overheads 30 000 Profit 6 400 d A selling price may be lowered with advantage to: • increase demand for the good • undercut the prices of competitors • maintain full production • sell slow-moving inventory • introduce a new product. Possible disadvantages are: • the start of a price war with competitors • fixed overheads may not be covered • the product may be sold below the cost of production if the marginal cost is not known. The price of $24 earns a positive contribution, so could be accepted if there is no other work available and maximum sales are assured. However the calculations show that the company makes more profit at lower volumes of sales if it is able to maintain the selling price at the original level. e The following assumptions are made when break-even charts are prepared (any three): • Fixed costs remain fixed at all levels of activity, but costs are only fixed within certain limits of activity and are more likely to be ‘stepped’ as activity increases. • All costs may be classified as either fixed or variable. But many costs cannot easily be classed as fixed or variable. • Variable costs vary directly with the output in units. But variable costs may decrease with the level of activity because quantity discounts are received on purchases of materials, or labour costs increase because overtime has to be paid to workers to achieve the level of activity. • Revenue will increase proportionately to the volume of sales. But it may be necessary to discount prices to achieve the desired volume of sales. • All the resources required for production will be available. But there may be limiting factors afiecting materials, labour or demand for the product. Answers to activities, practice exercises and exam practice questions: Chapter 30 193 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Exam practice questions Multiple-choice questions 1 C 2 D 3 D 4 D Structured questions 1 a i A variable cost is one which can be attributed directly to the unit of production. It increases in direct proportion to changes in the level of activity. ii A fixed cost is one which does not change as production increases or decreases within a certain range. iii A semi-variable cost is one which contains both a fixed and variable element. b Calculation of break-even point in units and value: Calculation Per unit $ Revenue $80 000 ÷ 4 000 20 Direct material $32 000 ÷ 4 000 8 Direct labour $12 000 ÷ 4 000 3 Semi-variable cost (W1) 2 Total variable cost 13 Contribution 7 Break-even point calculation Total fixed costs $(10 000 + 6 000) ÷ 7 = 2 286 units Break-even point = 2 286 × $20 = $45 720 W1: Units Value $ 6 000 18 000 4 000 14 000 Change 2 000 4 000 Variable element = $4 000 ÷ 2 000 = $2 Fixed element = $18 000 – (6 000 × $2) = $6 000 c Margin of safety = 6 000 units – 2 286 units = 3 714 d To make a profit of $40 000: Total required = fixed costs $16 000 + required profit $40 000 = $56 000 ÷ 7 = 8 000 units e Although the company has spare capacity and is able to produce the extra units, should it do so? By producing them it may avoid having to make stafi redundant or cut down on deliveries from suppliers, both of which may have a negative efiect on the image of the company. If it does increase production then it may not be able to sell the extra, or sell it at the full price. If it fails to sell the extra then it will have surplus inventory which may deteriorate and have to be scrapped at a cost to the company, both of the original production and scrapping. If it has to reduce the selling price to get rid of the extra then Cambridge International AS and A Level Accounting 194 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
existing customers who are paying full price may find out. They will also ask for a lower price or may even change suppliers. However, if management can work through these possible difiiculties then it may be possible to produce and sell the extra production. In essence, the management needs to be confident that it can obtain a positive contribution from the additional sales without there being any negative efiect on future selling prices. f (Assuming the current budgeted output is 6 000 units.) Option 1: Additional fixed costs = $9 800 Additional contribution = 1 200 units × $7 = $8 400 Cost to company = $(9 800 – 8 400) = $1 400 Option 2: Contribution on 8 750 units = 8 750 × $(7-2) = $43 750 Contribution on 6 000 units = 6 000 × $7 = $42 000 On the basis of these calculations the company should choose option 2. Doing so will increase the total contribution and, assuming that there is no increase in fixed costs, then it will also increase the overall profit. With option 1, the cost of advertising is greater than the extra contribution earned and should not be considered. 2 a A limiting factor is something which stops a company making its budgeted production. It may be a shortage of material or labour, space or cash. Once it has been identified then any budget should be constructed taking the limiting factor into account. b Exe Wye Zed Material per unit (kg) 2 3 4 Total budgeted output 5 000 4 000 2 000 Total kg per product 10 000 12 000 8 000 = 30 000 kg c Exe Wye Zed Total Budgeted sales (units) 5 000 4 000 2 000 Contribution per unit ($) 13 12 14 Total contribution ($) 65 000 48 000 28 000 141 000 Budgeted fixed costs ($) 82 000 Budgeted profit ($) 59 000 d Exe Wye Zed Contribution per kg ($) 6.50 4.00 3.50 Order of production 1 2 3 i If 2 000 of each unit is made: Total Exe Wye Zed Kgs 18 000 4 000 6 000 8 000 Available 6 000 6 000 - - 24 000 10 000 6 000 8 000 Contribution per kg ($) 6.50 4.00 3.50 Total contribution ($) 117 000 65 000 24 000 28 000 Fixed costs ($) 82 000 Profit ($) 35 000 Answers to activities, practice exercises and exam practice questions: Chapter 30 195 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
ii Make as much as possible in most profitable order if no minimum production requirement of any product is put in place: Total Exe Wye Zed Output 5 000 4 000 500 Total kgs 24 000 10 000 12 000 2 000 Contribution per kg ($) 6.50 4.00 3.50 Total contribution ($) 120 000 65 000 48 000 7 000 Fixed costs ($) 82 000 Profit ($) 38 000 e There is very little difierence in budgeted total profit between the two options (because Wye and Zed make similar levels of contribution). Purely on financial grounds option ii should be chosen as it makes the most profit. However, this will result in only 500 units of Zed being made. Option i means that all of Zed and Exe will be made, but less Wye. This may afiect the decision when taking into account customer requirements. If by choosing option i they make customers for Wye unhappy, then option ii should be chosen. If by choosing option ii they make customers of Zed unhappy then option i should be chosen. Cambridge International AS and A Level Accounting 196 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
31 Activity-based costing (ABC) Activities Activity 1 a Budgeted overhead absorption rate using direct labour hours: Total storage costs Total direct labour hours $ $ 60000 25000 = 2 4. 0 b Amount of storage costs charged to each product using direct labour hours: Children’s Adult’s Direct labour hours 10 000 15 000 Storage costs charged $24 000 $36 000 c Storage costs charged when using activity based costing: Total storage costs Total rolls of cloth $ $ . 60000 5000 = 12 00 Amount charged to each product: Children’s Adult’s Rolls of cloth 1 000 4 000 Storage costs charged $12 000 $48 000 Activity 2 a Total overheads $216 000 ÷ total direct labour hours (12 000 + 24 000) = $6 per direct labour hour. b Tables Chairs $ $ Selling price per unit 200 80 Less: Direct material and labour 80 30 Factory overhead* 24 12 Profit per unit 96 78 * Factory overhead per unit = 4 × $6 for tables and 2 × $6 for chairs. Activity 3 a Activity Tables Chairs Total Cost Absorption rate for cost driver $ $ Machine maintenance 3 500 5 500 9 000 108 000 12 Materials handling 500 700 1 200 72 000 60 Packing 700 1 100 1 800 36 000 20 216 000 Answers to activities, practice exercises and exam practice questions: Chapter 31 197 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Allocation of total costs: Activity Tables Chairs Total $ $ $ Machine maintenance 42 000 66 000 108 000 Materials handling 30 000 42 000 72 000 Packing 14 000 22 000 36 000 Total cost 86 000 130 000 216 000 Cost per unit (to two decimal places) (units from Activity 2) $86 000 / 3 000 units = $28.66 $130 000 / 12 000 units = $10.83 Activity 4 a Tables b Chairs $ $ Selling price per unit 200.00 80.00 Less: Direct materials and labour 80.00 30.00 Factory overhead using ABC $86 000 ÷ 3 000 28.66 $130 000 ÷ 12 000 10.83 Profit per unit using ABC 91.34 39.17 Practice exercises 1 a Total overheads $110 000 ÷ total direct labour hours (14 000 + 13 500) = $4.00 per direct labour hour. b Pin Qua $ $ Selling price per unit 500.00 300.00 Less: Direct material and labour 200.00 80.00 Factory overhead* 20.00 6.00 Profit per unit 280.00 214.00 * Factory overhead per unit = 5 × $4.00 for Pin and 1.5 × $4.00 for Qua. c Two advantages of ABC: • links overheads with their cause • identifies areas where cost savings can be made. Two disadvantages of ABC: • time consuming to identify costs drivers and not every cost has a cost driver • expensive to set up and collect data as ofien requires specialist staff. Cambridge International AS and A Level Accounting 198 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
d Allocation of overheads allocated to each product using ABC: Activity Pin Qua Total Cost Absorption rate for cost driver $ $ Machine set up costs 300 100 400 20 000 50.00 Machine maintenance 8 000 2 000 10 000 40 000 4.00 Forklifi truck costs 350 150 500 50 000 100.00 110 000 Allocation of total costs: Activity Pin Qua Total $ $ $ Machine set up costs 15 000 5 000 20 000 Machine maintenance 32 000 8 000 40 000 Forklifi truck costs 35 000 15 000 50 000 82 000 28 000 110 000 Per unit: Pin ($82 000 ÷ 2 800) 29.29 Qua ($28 000 ÷ 9 000) 3.11 e Profit per product using ABC: Pin Qua $ $ Selling price per unit 500.00 300.00 Less: Direct materials and labour 200.00 80.00 Factory overhead using ABC 29.29 3.11 Cost per unit 229.29 83.11 Profit per unit using ABC 270.71 216.89 f Pin Qua $ $ Profit using absorption costing 280.00 214.00 Profit using ABC 270.71 216.89 Difference (9.29) 2.89 This is also the difference in overheads per unit under the two methods. g There is very little difference between the two profit per unit figures. On this basis, therefore, there seems little point in Khalid changing his method of costing. By the same token, the data may give Khalid some ideas as to which areas to concentrate on in order to reduce his total costs for that particular activity. Using ABC, Khalid can ask price and operational questions: Can I reduce the cost of machine set-up? Can I rearrange production to reduce the frequency of machine set-ups? He can ask himself similar questions about maintenance costs and time spent, and on fork lifi costs and numbers of movements. Answers to activities, practice exercises and exam practice questions: Chapter 31 199 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
In this respect, the analysis by ABC can have some benefit. However, Khalid is recommended not to change from his present method unless he considers that these advantages will outweigh the extra time and cost of setting up the system and collecting the data. 2 a Straight Flared Per unit $ $ Direct material 13.00 15.00 Direct labour 3.00 3.00 Production overheads* 15.00 20.00 Total cost per unit 31.00 38.00 Add: profit 15.50 19.00 Budgeted selling price 46.50 57.00 * Factory overheads: Absorption rate = $360 000 ÷ 12 000 = $30 per hour. Machine hours per unit: Straight = 4 000 ÷ 8 000 = 0.5. 0.5 hours × $30 = $15. Flared = 8 000 ÷ 12 000 = 0.67. 0.67 hours × $30 = $20. b Absorption costing charges overheads to products on some predetermined basis, ofien reflecting the method of production. In this case, they are charged on the basis of machine hours, presumably because the manufacturing process is machine intensive. ABC charges overheads to products on the basis of cost drivers, that is, to key activities that form part of the production process. This identifies how much of a particular cost the production of the product generates. To do this means all the activities involved in producing a product have to be identified. The different activities are placed in cost pools. So there may be cost pools for machine set up costs and machine maintenance costs. It is then necessary to determine how much of each activity the production of a product takes. The theory is that if no production of a product takes place then none of that cost will be incurred. In other words, the production of a product is responsible for the cost being incurred, or the amount of the cost is driven (cost driver) by the level of production of a particular product. c i Allocation of total costs: Activity Straight Flared Total $ $ $ Machine stet up costs 40 000 56 000 96 000 Machine maintenance 73 333 126 667 200 000 Inspection 25 600 38 400 64 000 Total 138 933 221 067 360 000 Per unit: Straight ($138 933 ÷ 8 000) $17.37 Flared ($221 067 ÷ 12 000) $18.42 Budgeted cost per unit: Straight Flared $ $ Direct material 13.00 15.00 Direct labour 3.00 3.00 Overheads 17.37 18.42 33.37 36.42 Cambridge International AS and A Level Accounting 200 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737