ii Budgeted selling price: Straight Flared $ $ Cost per unit 33.37 36.42 Mark up +50% 16.69 18.21 50.06 54.63 d By changing from absorption costing, using machine hours as the basis of absorbing overheads to ABC, Straight dresses become slightly more expensive and Flared dresses slightly less expensive to make. At present, the Straight style is the lower seller of the two in terms of unit sales. If ABC is used and their price is increased then the number of sales may decrease. By the same token, if Flared dresses are reduced in price then their sales may increase. Liz needs to identify by how much the unit sales may change for each style if she changes the selling price as a result of ABC. It is also worth stating that the difference in cost (and therefore in budgeted selling price) between each method is very little. Both methods of costing are approximations, but the purpose of ABC is to try and give a more complete picture of how costs are incurred and thus enable management to try to identify potential cost savings, either by reducing costs or by reducing the numbers of activities (the cost drivers) that occur, for example by better planning. For example, can either or both production processes be rearranged to reduce the number of times machines need to be set up? It is recommended, therefore, that whilst she takes into account the findings of ABC, she should not change her selling price as a result of it. ABC is more complicated to calculate and there is no guarantee that the allocation of overheads made by it make it any more accurate. Answers to activities, practice exercises and exam practice questions: Chapter 31 201 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
32 Budgeting and budgetary control Activities Activity 1 Martha and Florence Limited Sales budget for six months ending 30 June January February March April May June Unit sold 1 000 1 200 1300 1 500 1 700 1 800 Price per unit $20 $20 $20 $22 $22 $22 Revenue $20 000 $24 000 $26 000 $33 000 $37 400 $39 600 Activity 2 Martha and Florence Limited Production budget for six months ending 30 June December January February March April May June Production (following month’s sales in units) 1 000 1 200 1 300 1 500 1 700 1 800 2 000 Add 10% 100 120 130 150 170 180 200 Monthly production 1 100 1 320 1 430 1 650 1 870 1 980 2 200 Activity 3 a J Limited Direct labour budget Jan Feb March Production (units) 2 200 2 400 2 600 Direct labour (hours) 4 400 4 800 5 200 Direct labour cost ($) 44 000 48 000 52 000 b Direct labour to be included in cash budget: J Limited Direct labour budget Dec Jan Feb March $ $ $ $ Direct labour cost in month 40 000 44 000 48 000 52 000 Paid in month (80%) 35 200 38 400 41 600 From previous month (20%) 8 000 8 800 9 600 To include in cash budget 43 200 47 200 51 200 202 Cambridge International AS and A Level Accounting Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 4 Martha and Florence Limited Purchases budget for the period December to June November* December January February March April May June Units of production 1 100 1 320 1 430 1 650 1 870 1 980 2 200 2 100 Material required (litres) 2 750 3 300 3 575 4 125 4 675 4 950 5 500 5 250 Price per litre $4.10 $4.10 $4.10 $4.10 $4.25 $4.25 $4.25 $4.25 Purchases $11 275 $13 530 $14 658 $16 913 $19 869 $21 038 $23 375 $22 313 *November has been included as part of the answer in order to show the build-up for the December purchases. Activity 5 Martha and Florence Limited Expenditure budget for six months ending 30 June January February March April May June $ $ $ $ $ $ Purchases 13 530 14 658 16 913 19 869 21 038 23 375 Wages 4 000 4 000 4 000 4 000 4 000 4 000 Bonus – – 160 240 520 696 Electricity – 2 400 – – 1 800 – Other expenses 6 000 6 000 6 000 6 600 6 600 6 600 Interest on loan – – 500 – – 500 Dividend – – – 4 000 – – Purchase of machine – – – – 15 000 – 23 530 27 058 27 573 34 709 48 958 35 171 Activity 6 a Workings: November December January February March April May June $ $ $ $ $ $ $ $ Revenue 18 000 17 600 20 000 24 000 26 000 33 000 37 400 39 600 Cash sales 9 000 8 800 10 000 12 000 13 000 16 500 18 700 19 800 Credit sales 9 000 8 800 10 000 12 000 13 000 16 500 18 700 19 800 Affer one month 7 200 7 040 8 000 9 600 10 400 13 200 14 960 Discount 180 176 200 240 260 330 374 Cash affer one month 7 020 6 864 7 800 9 360 10 140 12 870 14 586 Affer two months 1 800 1 760 2 000 2 400 2 600 3 300 203 Answers to activities, practice exercises and exam practice questions: Chapter 32 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Martha and Florence Limited Trade receivables budget January February March April May June $ $ $ $ $ $ Opening balance (1 800 + 8 800) 10 600 11 760 14 000 15 400 19 100 22 000 Credit sales for month 10 000 12 000 13 000 16 500 18 700 19 800 20 600 23 760 27 000 31 900 37 800 41 800 Less: cash received 1 month 6 864 7 800 9 360 10 140 12 870 14 586 Discount 176 200 240 260 330 374 2 months 1 800 1 760 2 000 2 400 2 600 3 300 Closing balance 11 760 14 000 15 400 19 100 22 000 23 540 b Workings: November December January February March April May June Purchases 11 275 13 530 14 658 16 913 19 869 21 038 23 375 22 313 Payment 13 530 14 658 16 913 19 869 21 038 23 375 Martha and Florence Limited Trade payables budget January February March April May June $ $ $ $ $ $ Opening balance 13 530 14 658 16 913 19 869 21 038 23 375 Purchases 14 658 16 913 19 869 21 038 23 375 22 313 28 188 31 571 36 782 40 907 44 413 45 688 Less: payments 13 530 14 658 16 913 19 869 21 038 23 375 Closing balance 14 658 16 913 19 869 21 038 23 375 22 313 Activity 7 a Greenfields Limited Cash budget for the four months ending 30 April 2017 January February March April $ $ $ $ Receipts Cash sales 25 000 28 000 30 000 33 000 Trade receivables 42 500 37 500 42 000 45 000 67 500 65 500 72 000 78 000 Payments Trade payables 22 500 25 000 20 000 30 000 Selling and distribution 6 250 7 000 7 500 8 250 Administration 20 000 20 000 20 000 20 000 Purchase of plant – – 60 000 – Dividend – – – 6 500 48 750 52 000 107 500 64 750 Net receipts/(payments) 18 750 13 500 (35 500) 13 250 Balance b/f 20 750 39 500 53 000 17 500 Balance c/f 39 500 53 000 17 500 30 750 204 Cambridge International AS and A Level Accounting Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Greenfields Limited Budgeted income statement for the four months ending 30 April 2017 $ $ Revenue 290 000 Cost of sales Opening inventory 30 000 Purchases 112 500 142 500 Closing inventory 22 500 120 000 Gross profit 170 000 Selling and distribution expenses (W2) 32 500 Administration expenses (W3) 83 500 116 000 Profit from operations 54 000 Interest on debentures (W4) 1 000 Profit for the year 53 000 Ordinary dividend 6 500 Transfer to general reserve 25 000 31 500 Retained earnings for the year 21 500 Workings: 1 Depreciation: Premises 4/12 × 3% × $50 000 = 500 P&M 4/12 × 20% × $97 500 = 6 500 Total $7 000 (Working 1 is needed for workings 2 and 3.) 2 Selling and distribution 10% × $290 000 + 50% × $7 000 3 Administration 4 × $20 000 + 50% × $7 000 4 Debenture interest 4/12 × 12% × $25 000 Note: Although this is not the correct layout for published accounts, as there is no request for a statement of changes in equity, it is perfectly acceptable for management accounts. c Greenfields Limited Budgeted statement of financial position at 30 April 2017 Cost Accumulated depreciation Net book value Non-current assets $ $ $ Freehold premises 50 000 10 500 39 500 Plant and machinery 97 500 29 000 68 500 147 500 39 500 108 000 Current assets Inventory 22 500 Trade receivables 49 500 Cash and cash equivalents 30 750 102 750 Total assets 210 750 (cont.) Answers to activities, practice exercises and exam practice questions: Chapter 32 205 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Cost Accumulated depreciation Net book value $ $ $ Equity and liabilities Capital and reserves Ordinary shares of $1 65 000 General reserve 55 000 Retained earnings 27 250 147 250 Non-current liability 12% debentures 2019/2020 25 000 Current liabilities Trade payables 37 500 Other payables Debenture interest accrued 1 000 38 500 Total equity and liabilities 210 750 Practice exercises 1 a Banner Limited Cash budget for four months January to April Details January February March April $ $ $ $ Income From sales: one month affer sale 180 000 205 000 212 000 230 000 From sales: two months affer sale 400 000 360 000 410 000 424 000 Sale of old machine 4 000 Total receipts 580 000 565 000 622 000 658 000 Expenditure Purchases of material paid in month 28 600 29 700 33 000 32 000 Materials paid two months affer purchase 81 000 79 500 85 800 89 100 Wages paid in month 20 000 22 000 24 000 26 000 Wages paid in following month 10 000 10 000 11 000 12 000 Overheads paid in month 180 000 195 000 206 000 210 000 Overheads paid in following month 190 000 180 000 195 000 206 000 Purchase of new machine 45 000 Total expenditure 509 600 516 200 599 800 575 100 Surplus/(deficit) of income over expenditure 70 400 48 800 22 200 82 900 Opening bank balance (63 000) 7 400 56 200 78 400 Closing bank balance 7 400 56 200 78 400 161 300 206 Cambridge International AS and A Level Accounting Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b Accruals appearing in the statement of financial position at 30 April: $ $ Direct material March ($132 × ¾) 99 April ($128 × ¾) 96 195 Wages: April ($39 × ⅓) 13 Overheads: April ($420 × ½) 210 New machine 45 Accruals (Other payables) 463 2 a i Roh Limited Production budget in units For month of July 2017 For month of August 2017 Units Units Sales 800 1 000 Less: opening inventory (880) (1 100) Add: closing inventory 1 100 990 Production 1 020 890 Note: The July budget is needed later in the question. ii Roh Limited Purchases budget For the month of July 2017 For the month of August 2017 Production in units 1 020 890 Kgs of material required (units × 3) 3 060 2 670 Cost of purchases (kgs × $4) $12 240 $10 680 Note: The July budget is needed later in the question. iii Roh Limited Cash budget for the month of August 2017 $ Income From sales (July units × $60) 48 000 Expenditure Purchases of (July) material 12 240 Wages (monthly production × 2 hours × $8) 14 240 Variable overheads (monthly production × 2 hours × $14) 24 920 Fixed overheads (monthly production × 2 hours × $3.50) 6 230 Total expenditure 57 630 Surplus/(deficit) of income over expenditure (9 630) Opening bank balance (per question) 16 000 Closing bank balance 6 370 Answers to activities, practice exercises and exam practice questions: Chapter 32 207 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
b A principal budget factor is something which limits the activities of the organisation. It is also known as a limiting factor. It may be sales level or quantity of raw materials, cash or space. It is important that this is identified as it indicates which budget should be prepared first. Usually it is the sales budget which is the principal budget factor. c Budgets are an essential part of managing a business. They force managers to think about what will happen in the next year, or even years, as far as the business is concerned. The planning aspect is one of the two principal benefits of preparing a budget. The second aspect is control. By collecting the actual data, it can then be compared with the planned (budget) data and corrective actions taken as necessary. The directors are correct that it takes time to prepare a budget, but that time is well spent as it gives the business direction and focus, by co-ordinating all the business activities. Therefore the accountant should continue to prepare the budgets for Roh Limited. 3 a Alan Cash budget for three months ending 30 June 2017 Details April May June Income from customers from two months ago 2 400 2 200 Income from customers from previous month 9 600 8 800 11 200 Total income from customers 9 600 11 200 13 400 Expenditure Payments to suppliers 10 000 8 000 9 000 Monthly overheads 4 000 4 000 4 000 Monthly drawings 2 000 2 000 2 000 New delivery vehicle 4 000 Total expenditure 16 000 14 000 19 000 Surplus/(deficit) of income over expenditure (6 400) (2 800) (5 600) Opening bank balance (2 000) (8 400) (11 200) Closing bank balance (8 400) (11 200) (16 800) b Alan Budgeted income statement for three months ending 30 June 2017 $ $ Revenue ($11 000 + $14 000 + $15 000) 40 000 Opening inventory 4 000 Add: purchases ($8 000 + $9 000 + $9 500) 26 500 30 500 Less: closing inventory (5 000) 25 500 Gross profit 14 500 Expenditure Monthly overheads ($4 000 × 3) 12 000 Loan interest ( $15 000 × 10% × 3 12 ) 375 Depreciation (36 000 × 10% for 3 months) 900 13 275 Profit for the period 1 225 Cambridge International AS and A Level Accounting 208 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
c Two advantages of preparing budgets: • It aids business planning and control. • It is motivational as it gives managers a target to work towards. Two disadvantages of preparing budgets (any two): • It takes time to prepare them. • Managers may try to build some ‘slack’ into their budget in order to achieve them. • Managers may aim to ‘achieve budget’ rather than do their best. d In every month Alan’s cash income is exceeded by his cash expenditure. The closing bank balance is increasingly overdrawn; the bank may threaten to close the business. • Alan has just about broken even for the three-month period. As he is making very little profit, Alan’s drawings are not only a drain on cash flow, but are in excess of his entitlement. • He should consider reducing his drawings. • He is paying his suppliers more quickly than his customers are paying him. This is not a good situation, as it worsens cash flow. • He should try to reverse this so that his customers pay him before he pays his suppliers. • He might also consider delaying the purchase of the new vehicle or perhaps leasing one rather than buying it. • Perhaps he could also reduce his purchases to reduce his inventory. • He should urgently assess whether he can take suflicient actions in total to ensure that the business can achieve sustained profits and positive cash flows in the future: • If he cannot do so, he will have to consider closing the business. • If he thinks he can do so, he should consider raising additional finance. Exam practice questions Multiple-choice questions 1 C 2 B 3 B 4 A Answers to activities, practice exercises and exam practice questions: Chapter 32 209 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
33 Standard costing Activities Activity 1 Jumal Budgeted profit statement for next six months $ $ Revenue: Bicycles (4 000 × $600) 2 400 000 Tricycles (2 500 × $250) 625 000 3 025 000 Cost of sales: Direct material Bicycles (10 × $45 × 4 000) 1 800 000 Tricycles (4 × $45 × 2 500) 450 000 Direct labour Bicycles (2 × $10 × 4 000) 80 000 Tricycles (1 × $10 × 2 500) 25 000 2 355 000 Gross profit 670 000 Fixed overheads 42 000 Profit for the period 628 000 Activity 2 Breakfast Limited Flexed budget for the production of 110 000 packets of cereal $ Variable expenses Direct materials 22 000 Direct labour 16 500 Production expenses 6 600 45 100 Fixed expenses Production expenses 13 000 Administration 29 000 87 100 Activity 3 a Selling and distribution costs for 8000 pairs of sunglasses: $4 000 + (8 000 × $3) = $28 000. b Flexed budget cost statement for 8 000 pairs of sunglasses: $ Direct materials 16 000 Direct labour 24 000 Production overheads 22 000 Selling and distribution 28 000 Administration 12 000 Total cost 102 000 Cambridge International AS and A Level Accounting 210 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 4 No. of locks 9 000 $ Direct materials 22 500 Direct labour 54 000 Production overhead 34 000 Selling and distribution 30 000 Administration 80 000 220 500 Activity 5 Underpart Limited Flexed budget statement Flexed budget Actual Variances No. of units 6300 6300 $ $ $ Revenue 157 500 163 800 6 300 Direct materials 21 420 20 890 530 Direct labour 42 525 44 065 (1 540) Variable overheads 3 150 3 250 (100) Fixed overhead 62 000 62 000 – Total cost 129 095 130 205 (1 110) Profit 28 405 33 595 5 190 Activity 6 a Sales volume variance = (9 500 − 10 000) × $15 = $7 500 adverse. b Sales price variance = $(15.50 − 15) × 9 500 = $4 750 favourable. Activity 7 a Direct materials usage variance = (9 500 − 9 700) × $6 = $1200 adverse. b Direct materials price variance = $6 − [$57 715 ÷ 9 700] × 9 700 = $485 favourable. c Total direct material variance = ($6 × 9 500) − $57 715 = $715 adverse. This is equal to the net of the price and usage variances $(1 200 − 485) = $715 adverse. Activity 8 a Direct labour efiiciency variance = (9 500 − 9 450) × $4 = $200 favourable. b Direct labour rate variance = $(4 − 3.98) × 9 450 = $189 favourable. c Total direct labour variance = (9 500 × $4) − (9 450 × $3.98) = $389 favourable. This is equal to the sum of the two favourable variances for rate and efiiciency $(200 + 189) = 389 favourable. Activity 9 The standard total direct labour cost for the production of 12 000 packets of Pickup: = $10 × 12 000 = $120 000. Actual hours taken 12 000 × 1.25 = 15 000. The direct labour efiiciency variance = (12 000 − 15 000) $10 = $30 000 (A). Answers to activities, practice exercises and exam practice questions: Chapter 33 211 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
The direct labour rate variance = $(10 − 8.50) 15 000 = $22 500 (F). Check: Actual labour cost of production of 12 000 packets of Pickup: = 1.25 hours × $8.50 × 12 000 = $127 500. Total labour variance = $7 500 (A) = $(30 000 (A) – $22 500 (F)) (as above). Activity 10 a Fixed overhead expenditure variance = $(20 000 − 19 800) = $200 favourable. Before calculating the remaining overhead variances it is first necessary to work out the budgeted fixed overhead absorption rate: Budgeted fixed overhead absorption rate = $20 000 ÷ 10 000 = $2 per direct labour hour. b Fixed overhead volume variance: 9500 units should have taken 9 500 hours. 10 000 units should have taken 10 000 hours. Volume variance = (10 000 − 9 500) × $2= $1 000 adverse (because less hours were worked than planned). c Fixed overhead capacity variance: Budgeted direct labour hours = 10 000. Actual direct labour hours = 9 450. Capacity variance = (10 000 − 9 450) × $2 = $1 100 adverse. d Fixed overhead efiiciency variance: 9500 units should have taken 9500 hours. They actually took 9 450 hours. Efiiciency variance = (9 500 − 9 450) × $ 2 = $100 favourable. Proof: the fixed overhead volume variance = $1 000 adverse. This is equal to capacity variance $1 100 adverse + efiiciency variance $100 favourable. e Statement reconciling total fixed overhead variance with the expenditure and volume variances: $ Fixed overhead expenditure variance 200 (F) Fixed overhead capacity variance 1 100 (A) Fixed overhead efiiciency variance 100 (F) Total fixed overhead variance 800 (A) Activity 11 Before preparing the statement it is first necessary to calculate the budgeted cost per unit for Polonius Limited, using the results of previous activities: $ Direct material 6 Direct labour 4 Fixed overhead 2 Budgeted cost per unit 12 Cambridge International AS and A Level Accounting 212 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Polonius Limited Statement to reconcile the standard cost of production with the actual cost of production Favourable variances Adverse variances Total $ $ $ Standard cost of production (9500 × $12) 114 000 Direct material price variance 485 Direct material usage variance (1200) Direct labour rate variance 189 Direct labour efiiciency variance 200 Fixed overhead expenditure variance 200 Fixed overhead volume variance* (1000) 1074 (2200) (1 126) Actual cost of production** 115 126 *The total overhead volume variance has been included. The overhead capacity and efiiciency variances could have been used with the same net result, but not all three variances. **Actual cost: $ Direct materials 57 715 Direct labour 37 611 Fixed overheads 19 800 115 126 Activity 12 Calculation of profit: Budget Actual $ $ Revenue 142 500 147 250 Less: costs (114 000) (115 126) Profit 28 500 32 124 Polonius Limited Statement reconciling actual and flexed budget profits $ Flexed budget profit 28 500 Sales price variance 4 750 33 250 Less: total cost variances (1 126) Actual profit 32 124 Note: Notice only the sales price variance is included in this reconciliation. The volume variance is ignored. Answers to activities, practice exercises and exam practice questions: Chapter 33 213 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 13 Cantab Limited Calculation of actual profit made in a three-month period $ $ Profit per master budget 98 970 Add: favourable variances Sales volume 6 210 Materials price 9 635 Labour efiiciency 10 500 125 315 Less: adverse variances Quantity 17 009 Sales price 3 730 Materials usage 6 280 Labour rate 7 840 Overhead expenditure 5 760 40 619 Actual profit 84 696 Activity 14 a Workings: Direct material: Standard cost per kg $7 200 300 × 4 = $6 per kg. Standard usage for 400 units = 4 × 400 kg = 1 600 kgs. Actual material per unit: $9 000 $6.25 × 400 = 3.6 kgs. Actual usage 400 × 3.6 kg = 1 440 kgs. Direct labour: standard hours per unit $6 600 $11 × 300 = 2 hours. Standard hours for 400 units = 800. Actual hours for 400 units = 400 × 2.25 = 900. Actual cost per hour $10 890 400 × 2.25 = $12.10. i Direct material usage variance: (1 600 − 1 440) × $6 = $960 (F). ii Direct material price variance: $(6.00 − 6.25) × 1 440 = $360 (A). iii Direct labour efiiciency variance: (800 − 900) × $11 = $1 100 (A). iv Direct labour rate variance: $(11.00 − 12.10) × 900 = $990 (A). b The favourable material usage variance may be due to a better quality of material being used resulting in less wastage during production. This view may be supported by the adverse price variance which suggests that a better quality of material was more expensive than standard. Both of the labour variances are adverse. The higher hourly rate of pay has not resulted in a favourable efiiciency variance, even though the workers may have been working with a better quality of material. The adverse efiiciency variance does not suggest that the higher rate of pay was due to the employment of a more skilled work force. It is possible that a pay increase given to the workers was below their expectation and they are poorly motivated as a result. The reason for the adverse variances can only be discovered by further investigation. Cambridge International AS and A Level Accounting 214 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Practice exercises 1 a If a business does not prepare a flexed budget then it is not comparing like with like. It is very rare that the actual and budgeted figures are the same. In order to make a meaningful comparison between the two sets of data then the budget must be flexed to what the figures would have been for the actual output and sales. b Workings: Actual direct material cost $(80 000 − 6 200) = $73 800. Actual cost per kg = $73 800 ÷ 18 000 = $4.10 per kg. Actual direct labour cost = $(300 000 + 18 400) = $318 400. Actual direct labour hours = $318 400 ÷ $9.95 = 32 000 hours. Budgeted overhead absorption rate = $77 550 ÷ (11 000 × 3) = $2.35 per direct labour hour. i Material price variance = $(4.00 − 4.10) × 18 000 = $1 800 adverse. ii Material usage variance = (20 000 − 18 000) × $4 = $8 000 favourable. iii Labour rate variance = $(10.00 − 9.95) × 32 000 = $1 600 favourable. iv Labour efiiciency variance = (30 000 − 32 000) × $10 = $20 000 adverse. v Fixed overhead expenditure variance = $(77 550 − 74 000) = $3 550 favourable. vi Fixed overhead volume variance = [(11 000 × 3) − 32 000] × $2.35 = 2350 adverse. c i Possible causes for the material price variance is change to a more expensive supplier or supplier increased price more than budgeted. Possible causes for the labour efiiciency variance are poor management control over workers, perhaps more were recruited than was budgeted, or perhaps the material which was bought, if from a new supplier, was of a lower quality meaning more scrap and workers having to work longer to complete the output. Also possible was that the workforce was less skilled than planned (for example due to high stafi turnover). ii In order to improve the adverse labour variance, tighter control over labour is required. An alternative is to ofier labour a bonus to complete the work more quickly. However, the cost of any bonus must be less than the efiiciency variance and output quality must be monitored to ensure workers are not rushing to complete the work at the expense of reduced quality. Training may help. 2 a When the actual results for a period are compared with the flexed budget results, there is usually a difierence between the two sets of figures. This difierence is known as a variance. Management needs to analyse variance to identify the cause of the difierence between the two sets of figures. Once the causes have been identified then corrective action can be taken as necessary. b i Total material variance: Flexed budget fuel cost = (130 000 × $1.20) ÷ (6 500 × 5 900) = $141 600. Total material variance = $141 600 − 175 000 = $33 400 adverse. ii Total labour variance: Budget labour cost = $82 875 ÷ 9 750 = $8.50 per direct labour hour. Flexed budget direct labour hours = 9 750 ÷ 6 500 × 5900 = 8850. Total labour variance = (8 850 × $8.50) − (9 000 × $8.65) = $2 625 adverse. iii Fixed overhead expenditure variance = $62 400 − 58 000 = $4 400 favourable. iv Fixed overhead absorption rate = $62 400 / 7 800 units = $8 / unit. Hence: Fixed overhead capacity variance = (7 800 − 7 200) × $8 =$4 800 adverse. v Fixed overhead efiiciency variance: Flexed budget operating hours = (7 800 ÷ 6 500) × 5 900 = 7 080. Variance = (7 080 − 7 200) × 8 = 960 adverse. Answers to activities, practice exercises and exam practice questions: Chapter 33 215 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
c Calculation of flexed budgeted cost of sailings: $ Fuel 141 600 Direct labour (8850 × $8.50) 75 225 Fixed overheads (7080 × $8) 56 640 Total flexed budgeted cost 273 465 Seaview Ferries Limited Statement to reconcile the actual cost of sailings with the standard cost of sailings Favourable variances Adverse variances Total $ $ $ Standard cost of actual sailings 273 465 Total fuel variance (33 400) Total direct labour variance (2 625) Fixed overhead expenditure variance 4 400 Fixed overhead capacity variance (4 800) Fixed overhead efiiciency variance (960) 4 400 (41 785) (37 385) Actual cost of actual sailings* 310 850 *Actual cost: $ Fuel 175 000 Direct labour 77 850 Fixed overheads 58 000 310 850 d The directors should include sales variances in their analysis. By doing so it will enable them to find out more information on performance which, at present, they don’t seem to have. By setting and analysing sales variances, the directors could assess the impact on profitability of changing passenger numbers and changing fares, respectively. In order to analyse the profitability of each route, they would also need to prepare cost budgets for each of the three journeys (‘products’). 3 a Calculation of budgeted selling price per unit: $ Direct material (2 kg × $5 per kg) 10 Direct labour (3 hours × $10 per hour) 30 Total variable cost 40 Add: Mark-up (40 × 50%) 20 Budgeted selling price per unit 60 b Statement to show the actual contribution for the month of June: $ $ Revenue (5200 × $58) 301 600 Direct material (10 920 × $4.80) 52 416 Direct labour (16 640 × $10.50) 174 720 227 136 Actual contribution 74 464 Cambridge International AS and A Level Accounting 216 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
c i Sales price variance = $(58 − 60) × 5 200 = $10 400 (A) ii Direct material price variance = $(5.00 − 4.80) × 10 920 = $2 184 (F) iii Direct material usage variance = [(5 200 × 2) − 10 920 × $5] = $2 600 (A) iv Direct labour rate variance = $(10.00 − 10.50) × 16 640 = $8 320 (A) v Direct labour efiiciency variance = [(5 200 × 3) − 16 640 × $10] = $10 400 (A) d Statement reconciling the flexed budget contribution with the actual contribution for the month of June: A F Total $ $ $ Flexed budget contribution Revenue (5200 × $60) 312 000 Direct material ([5200 × 2) × 5 (52 000) Direct labour ([5200 × 3) × $10) (156 000) Budgeted contribution 104 000 Sales price variance 10 400 Direct material price variance 2184 Direct material usage variance 2 600 Direct labour rate variance 8 320 Direct labour efiiciency variance 10 400 (31 720) 2184 (29 536) Actual contribution 74 464 e Perhaps as a result of market competition or his own decision to drop the selling price, the result has been to sell more units than budgeted. However, this has cost him over $10 000 in lost revenue. Bertie does need to pay attention to his direct costs. His only favourable variance is material price, which means he may have found a cheaper supplier. However, this has impacted negatively on the usage of material, which showed a negative variance. Both labour variances were adverse. The rate variance may have been a result of workers working overtime to produce the extra sales units. This in turn could have made them tired and, as a result, less efiicient. Overall the negative variances have had a serious impact on the contribution earned. This in turn will have a negative impact on his overall profit for the month. Exam practice questions Multiple-choice questions 1 A 2 B 3 A 4 C 5 C 6 C Answers to activities, practice exercises and exam practice questions: Chapter 33 217 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
34 Investment appraisal Activities Activity 1 Ignore the machine that was acquired some years earlier as it is a sunk cost. Average profit = $150 000 ÷ 6 = $25 000. Average investment =$( ) 120 000 2 + 25 000 = $85 000. ARR = 25 000 85 000 × 100 = 29.4%. Activity 2 a Calculation of payback periods: First Last $ $ Year 0 (90 000) (90 000) 1 30 000 40 000 2 36 000 40 000 3 24 000 10 000 Payback 2 + 20 40 years 2 + 10 40 years 2 + ( 24 40 × 12) years 2 years 7.2 months 2 years 8 months 2 years 3 months b Last should be chosen because it has the shorter payback period and its pattern of cash flows will benefit the liquidity of Martinez Limited. Activity 3 Nomen Limited Machine A Machine B Machine C Year Discounting factor at 12% Cash flows NPV Cash flows NPV Cash flows NPV $ $ $ $ $ $ 0 1.000 (135 000) (135 000) (135 000) (135 000) (135 000) (135 000) 1 0.893 50 000 44 650 38 000 33 934 26 000 23 218 2 0.797 50 000 39 850 38 000 30 286 26 000 20 722 3 0.712 38 000 27 056 38 000 27 056 38 000 27 056 4 0.636 26 000 16 536 38 000 24 168 50 000 31 800 5 0.567 26 000 14 742 38 000 21 546 50 000 28 350 Net present values 7 834 1 990 (3 854) Nomen Limited should choose machine A as it has the highest NPV. Machine C should not be considered because it has a negative NPV. Cambridge International AS and A Level Accounting 218 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Activity 4 Machine A Machine B Year Discounting factor at 20% Cash flows NPV Cash flows NPV $ $ $ $ 0 1.000 (135 000) (135 000) (135 000) (135 000) 1 0.833 50 000 41 650 38 000 31 654 2 0.694 50 000 34 700 38 000 26 372 3 0.579 38 000 22 002 38 000 22 002 4 0.482 26 000 12 532 38 000 18 316 5 0.402 26 000 10 452 38 000 15 276 Net present values (13 664) (21 380) IRR for machine A: 12% + ( 8% × 7834 7834 13664 + ) = 14.9% IRR for machine B: 12% + ( 8% × 1990 1990+ 21380) = 12.7%. Activity 5 Workings: 1A 1B Annual depreciation cash outflows $140000 $20000 5 $24000 − = $180000 $30000 5 $30000 − = Costs 1A 1B $ $ Year 1 $(70 000 − 24 000) 46 000 $(84 000 − 30 000) 54 000 2 $(84 000 − 24 000) 60 000 $(98 000 − 30 000) 68 000 3 $(91 000 − 24 000) 67 000 $(105 000 − 30 000) 75 000 4 $(98 000 − 24 000) 74 000 $(112 000 − 30 000) 82 000 5 $(95 000 − 24 000) 71 000 $(100 000 − 30 000) 70 000 Net receipts 1A 1B $ $ Year 1 $(98 000 − 46 000) 52 000 $(101 000 − 54 000) 47 000 2 $(112 000 − 60 000) 52 000 $(118 000 − 68 000) 50 000 3 $(126 000 − 67 000) 59 000 $(126 000 − 75 000) 51 000 4 $(126 000 − 74 000) 52 000 $(140 000 − 82 000) 58 000 5 $(100 000 − 71 000) 29 000 $(110 000 − 70 000) 40 000 Average profit 1A 1B $ $ Year 1 $(98 000 − 70 000) 28 000 $(101 000 − 84 000) 17 000 2 $(112 000 − 84 000) 28 000 $(118 000 − 98 000) 20 000 3 $(126 000 − 91 000) 35 000 $(126 000 − 105 000) 21 000 4 $(126 000 − 98 000) 28 000 $(140 000 − 112 000) 28 000 5 $(100 000 − 95 000) 5 000 $(110 000 − 100 000) 10 000 $124 000 ÷ 5 24 800 $96 000 ÷ 5 19 200 Answers to activities, practice exercises and exam practice questions: Chapter 34 219 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
a i 1A 1B ARP = = 24 800 70 000 ×100 35.%4 19 200 90 000 × = 100 21.%3 ii Payback period: 1A 1B $ $ Year 0 (140 000) (180 000) 1 52 000 47 000 2 52 000 50 000 3 36 000 Year 3 51 000 4 32 000 Year 3 months Year months 36 000 59 000 12 8 4 32000 58000 × = × = 12 7 Payback = 2 years 8 months 3 years 7 months iii Net present values at 10%: 1A 1B Year Factor Net (payment)/ receipt NPV Net (payment)/ receipt NPV $ $ $ $ 0 1.000 (140 000) (140 000) (180 000) (180 000) 1 0.909 52 000 47 268 47 000 42 723 2 0.826 52 000 42 952 50 000 41 300 3 0.751 59 000 44 309 51 000 38 301 4 0.683 52 000 35 516 58 000 39 614 5 0.621 29 000 18 009 40 000 28 840 Net present values 48 054 6 778 iv IRR (40%): 1A 1B Year Factor Net (payment)/ receipt NPV Net (payment)/ receipt NPV $ $ $ $ 0 1.000 (140 000) (140 000) (180 000) (180 000) 1 0.714 52 000 37 128 47 000 33 558 2 0.510 52 000 26 520 50 000 25 500 3 0.364 59 000 21 476 51 000 18 564 4 0.260 52 000 13 520 58 000 15 080 5 0.186 29 000 5 394 40 000 7 440 Net present values (35 962) (79 858) Cambridge International AS and A Level Accounting 220 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
IRR: 1A: 10% + 30% × 48 054 = 27.2% 48 054 + 35 962 1B: 10% + 30% × 6 778 = 12.3% 778 + 79 858 b Flags Limited should purchase 1A because: • it has a higher accounting rate of return: 35.4% (1B: 21.3%) • it has the shorter payback period: 2 years 8 months, lower risk (1B: 3 years 7 months) • it has higher net present value: $48 054 (1B: $6 778) • it has higher internal rate of return: 27.2% (1B: $12.3%). Activity 6 Net present value: − $150 000 + $(50 000 × 3.169) = $8450. The net present value will become negative if: 1 the cost of the machine rises by $8450, i.e. an increase of 5.6%, or 2 the annual savings in operational costs fall below $47 333, i.e. they fall short by 5.3%. Activity 7 A Co Limited should invest in the order C, A and B. By dividing the net present value by the capital cost C yields a net present value of 20%. Similarly, A yields 17.5% and C 12%. Thus C, A, B will be the most advantageous for the company. Practice exercises 1 a Payback refers to how long it takes to pay back (in cash terms) the original investment. It is expressed as a period of time, usually years and months. Accounting rate of return measures the profit which an investment makes. The return (average profit) is expressed as a percentage of the average investment. b Calculation of the net present value of each machine: Machine 1 (Red) Year Cash income Cash expenditure Net cash flow Discount factor 10% Discounted cash flow $ $ $ $ 0 (100 000) (100 000) 1.00 (100 000) 1 70 000 (25 000) 45 000 0.909 40 905 2 80 000 (35 000) 45 000 0.826 37 170 3 90 000 (40 000) 50 000 0.751 37 550 4 90 000 (45 000) 45 000 0.683 30 735 Net present value 46 360 Machine 2 (Green) Year Cash income Cash expenditure Net cash flow Discount factor 10% Discounted cash flow $ $ $ $ 0 (130 000) (130 000) 1.00 (130 000) 1 72 000 (27 500) 44 500 0.909 40 451 2 84 000 (37 500) 46 500 0.826 38 409 3 90 000 (42 500) 47 500 0.751 35 673 4 100 000 (47 500) 52 500 0.683 35 858 Net present value 20 391 Answers to activities, practice exercises and exam practice questions: Chapter 34 221 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
c The directors should choose Red for two reasons: 1 The net present value is higher than Green. 2 It generates a return of 46.36% on the capital invested. Green only generates a return of $20 391 ÷ $130 000 × 100 = 15.69%. Thus it fails on two criteria. d Calculation of the internal rate of return of Red: Year Cash income Cash expenditure Net cash flow Discount factor 20% Discounted cash flow $ $ $ $ 0 (100 000) (100 000) 1.00 (100 000) 1 70 000 (25 000) 45 000 0.833 37 485 2 80 000 (35 000) 45 000 0.694 31 230 3 90 000 (40 000) 50 000 0.579 28 950 4 90 000 (45 000) 45 000 0.482 21 690 Net present value 19 355 At a 20% discount factor, the net present value is still positive. This means the internal rate of return is greater than 20%. The calculation is: 10% + [(20% − 10%) × {46 360 / (46 360 − 19 355)} = 27% As this return (27%) is greater than the 25% benchmark, it is acceptable. 2 a Two advantages of the payback method over the net present value method (any two): • The payback method considers cash returns. The method is also easy to calculate and is understood by non-accountants. • It tells you when funds are recouped and available for other investments. • On the other hand, net present value requires the identification of the cost of capital which is not always easy, and is also subjective to a degree. It is also more complicated to calculate than payback. b Workings: Year Cash cost Annual cash income (a) Annual cash expenses (b) Net cash flow (a − b) $ $ $ $ 0 (100 000) (100 000) 1 10 000 × $20 = 200 000 (10 000 × $15) + $15 000 = (165 000) 35 000 2 11 000 × $21 = 231 000 (11 000 × $16) + $16 000= (192 000) 39 000 3 12 000 × $22 = 264 000 (12 000 × $17) + $17 000 = (221 000) 43 000 4 13 000 × $23 = 299 000 (13 000 × $18) + $18 000 = (252 000) 47 000 i Step 1 To work this out, add up the net cash flows for each year, starting with year 1. At the end of year 1 the net cash flow is $35 000. At the end of year 2 the total net cash flow is $35 000 + $39 000 = $74 000. At the end of year 3 the total net cash flow is $74 000 + $43 000 = $117 000. This means that by the end of year 3, the company will have received back more cash than the equipment cost. However, students are required to work out exactly when the cash cost will be covered. The data indicates that it is some time in year 3. Cambridge International AS and A Level Accounting 222 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
Step 2 Deduct the total cash flow at the end of year 2 from the capital cost of the project: $100 000 − $74 000 = $26 000. This is how much more is required for the cost to be covered. Step 3 Divide the amount required by the full receipts in year 3 and multiply the answer by 12. This shows how many months it takes to reach the figure required. $ $ 26 000 43 000 × 12 = 7.3 months Step 4 Add the answer to the two years. This gives 2 years 7.3 months. Ofien it can be rounded to 2 years and 8 months. Always go up to the higher month. The payback period is 2 years 8 months. ii The sum of the cash flows before they were discounted is: $35 000 + $39 000+ $43 000 + $47 000 = $164 000. If the machine is scrapped at the end of the project it will have been depreciated in full over the four year period. This means that the profit made by this project would have been: $164 000− $100 000 = $64 000. The calculation for the accounting rate of return is: Average profit × 100 Average investment In this case it is: 64 000 100 000 4 2 ÷ × 100 = 32% The accounting rate of return is 32%. c Comparison of data: Machine 1 Alternative Capital cost $100 000 $150 000 Payback 2 years 7 months 3 years NPV (Working) $22 846 $15 000 ARR 30.5% 25% Working: Year Net cash flow (a) Discount factor at 12% (b) Net present value (NPV) (a) × (b) $ $ 0 (100 000) 1.0 (100 000) 1 35 000 0.893 31 255 2 39 000 0.797 31 083 3 43 000 0.712 30 616 4 47 000 0.636 29 892 NPV 22 846 Answers to activities, practice exercises and exam practice questions: Chapter 34 223 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737
In terms of financial data, the machine we are considering is better than the alternative in all respects considered: payback, NPV and ARR. It also has a lower capital outlay. A company usually bases its decision on the results from the payback and net present value calculations. Therefore, the machine we are considering should be chosen. In terms of non-financial factors, the directors should consider the impact on the workforce of both machines. It may be that one of the machines will lead to (more) redundancies of staff, which will have a negative effect on the image of the company. It may also be that one machine is more environmentally friendly in terms of pollution and/ or waste that the other. However, on purely financial grounds the machine costing $100 000 should be chosen. Exam practice questions Multiple-choice questions 1 C 2 A 3 D 4 B Structured question 1 a Accounting rate of return (ARR): $(80 000 − [46 000 + 30 000]) = $4 000 average annual profit $120 000 ÷ 2 = $60 000 average investment ARR = $(4 000 ÷ 60 000) × 100 = 6.67% b Net present value: As all the yearly cash flows are the same, then the discount factors for each year can be added together. = 0.909 + 0.826 + 0.751 + 0.683 = 3.169 $34 000 × 3.169 = $107 746 NPV at 10% = $(−120 000 + 107 746) = − $12 254 c Internal rate of return (IRR): At 15% the total of the discount factors = 2.856 $34 000 × 2.856 = $97 104 NPV at 15% = $(−120 000 + 97 104) = − $22 896 Both NPVs are negative. Therefore the IRR will be calculated as: IRR = + × − − − − = − = 10 5 12 254 12 254 ( ) ( 22 896) 10 5.76 4.24% Cambridge International AS and A Level Accounting 224 Downloaded by Nuraisyah Dahiyah Binti Hashim ([email protected]) lOMoARcPSD|20729737