MANAGERIAL FINANCE TABLES ARE PROVIDED. TIME ALLOWED: ... and care
must be taken regarding the format and literacy of the solutions. The marking ...
MANAGERIAL FINANCE
PROFESSIONAL 1 EXAMINATION - APRIL 2011 NOTES:
Section A – Answer Question 1 and Question 2 and either Part A or Part B of Question 3. Section B – Answer Question 4 and either Part A or Part B of Question 5. (If you provide answers to both Parts A and B in Question 3 and/or Question 5, you must draw a clearly distinguishable line through the answer Part(s) not to be marked. Otherwise, only the first answer(s) to hand for each of these questions will be marked.)
MANAGERIAL FINANCE TABLES ARE PROVIDED
TIME ALLOWED:
3 hours, plus 10 minutes to read the paper.
INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Please read each Question carefully. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page.
You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted.
The Institute of Certified Public Accountants in Ireland,17 Harcourt Street, Dublin 2.
MANAGERIAL FINANCE
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
PROFESSIONAL 1 EXAMINATION – APRIL 2011
Time allowed 3 hours, plus 10 minutes to read the paper.
SECTION A
(Answer Questions 1 and 2 and either Part A or Part B of Question 3.)
1.
BBN PLC owns the Z Hotel, a four star establishment located in Portmarnock Co. Dublin. The owners of the hotel have recently spent €20,000 on market research into the potential for improving the hotel’s image, customer base and profitability. The market research concluded that if the hotel could achieve five star status then the occupancy rate would increase from 60% to 70% for each of the 350 nights that the hotel opens for per year. To achieve five star status the hotel would have to add a leisure complex to its customer offering. The estimated cost of this project is €10,000,000. The average casual spend per room (food and beverage) is currently €50 per occupied room at a contribution margin of 50%. This is expected to increase by €20 per occupied room if five star status is achieved. This is in part due to increased prices which improve the contribution margin to 60%. The Z Hotel has 150 bedrooms which are charged at an average nightly rate of €100. Given the difficult trading conditions this average rate is not expected to change for the next three years, at least. If five star status is achieved the average room rate per night would increase by €50 per night in the first year and settle at an average nightly rate of €200 per room for the next two years. As a result of the hotel upgrade it is expected that the annual local council rates will increase from €60,000 per annum to €100,000 in the first year, increasing by €10,000 per annum thereafter. The pool will cost €10,000 to heat each month. The Z Hotel has agreed that this cost will remain fixed for three years. The business plan for the new leisure facility forecasts a profile of four different users of the facility, namely: • • • •
Hotel guests who avail of the leisure facility at no charge. Casual guests – paying €10 per visit. Family memberships – paying €1,000 per family per year. Single memberships – paying €500 per year.
The above are year one prices. Family memberships will be increased by €100 per year commencing in year three. Single memberships will remain at €500 for the next four years whilst the casual charge will increase by €1 per guest per year commencing in year 2. The indicative charges and trading volumes of each type of customer has been advised by the market research company. A summary of its volume projections read as: Z HOTEL - GUEST PROJECTIONS MEMBERSHIP TYPE Casual Guests (per day) Family Memberships (per annum) Single Memberships (per annum) Hotel Guest Visits (per day)
Year 1 20 30 100 50
Year 2 30 40 150 50
Year 3 40 50 200 50
The leisure facility will incur the following annual salary costs in its first year: • General Manager – €50,000 • Cleaner - €20,000 • Life Guards - €25,000 each. Three lifeguards will be employed to provide the necessary level of service.
Page 1
All salaries will be uplifted for inflation at 5% commencing in year three of the proposal. For the purpose of financing the proposal the company intends to raise debt finance of €10,000,000 at a rate of 10%, which attracts tax relief at 20%. The company already has the following sources of capital:
€5 Ordinary Shares €2 Preference Shares at 8%
€Ms 20.0 7.5
The ordinary shares are presently trading at €6.38 cum div. The most recent dividend declared (but not paid thereon) was €0.88 cent. This represents an average dividend increase of 10% per annum. This increase in dividends is expected to recur into the future. The company’s preference dividends are trading at €2.50 ex dividend. BBN PLC expects all capital investments to achieve a positive Net Present Value after three years. REQUIREMENT: (a)
Calculate the Weighted Average Cost of Capital of BBN PLC before the new capital of €10 million is raised. (4 Marks)
(b)
Calculate the Net Present Value of the proposal to achieve five star status by investing in the leisure centre facilities, when discounted at the after tax cost of the specific finance used for the proposed investment. (Ignoring Corporation Tax Payable/Refundable on proposal) (15 marks)
(c)
Discuss four qualitative factors to be considered when determining whether or not to invest €10 million in the leisure facility. Advise, with justification, whether this investment propsal should proceed. (6 Marks) [Total: 25 Marks]
Page 2
2.
Koln Limited is a company located in Naas Co. Kildare. Koln Limited manufactures and sells a single product, a luxury horse-box. As the racing industry has been experiencing a difficult time raising sponsorship, trainers have become more cost conscious than ever before. In an effort to attract increased custom Koln Limited has decided to alter the manufacturing methods of the horse box and to control the manufacturing costs thereof by implementing a system of standard costing. This will include the production of a reconciliation of budgeted and actual profits for each month of operation. The company has decided to sell each horse box at a reduced price of €4,000 each. The company expects to achieve sales of 2,400 in the financial year (commencing March 2011). Sales are expected to be achieved equally each month. As a business advisor to Koln Limited you have studied the proposed manufacturing process and have determined that the standard cost of the horse-box should be as follows: Material Labour
= =
Steel 15 metres @ €50 per metre 10 Hours @ €30 per hour.
Variable overheads are expected to be incurred at a cost of €8 per labour hour. Likewise, fixed overheads are absorbed at a rate of €25 per labour hour. Horse boxes will be produced on a Just-In-Time basis (to order).You have just printed the following actual financial and operational data from the accounting system for the horse box for the month ended March 2011: Sales (250 boxes sold) = €875,000 Steel (3500 metres purchased and used) = €210,000 Labour (2750 hours) = €110,000 Variable Overheads = €27,500 Fixed Overheads = €75,000 There were no stocks of direct materials (steel) on hand at the start or end of March 2011. It is now early April 2011 and Koln Limited’s Management Team is anxious to receive the standard costing report on March 2011’s sales revenues and manufacturing costs. They have asked for your assistance: REQUIREMENT: (a) Prepare a briefing note for the management of Koln Limited setting out the steps in the operation of a system of standard costing. (6 Marks) (b)
Present an Operating Statement which reconciles the actual and budgeted profit for the horse box for March 2011. (14 Marks) [Total: 20 Marks]
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Answer either Part A or Part B. 3.
Paula McDonald is a forty-five year old Recruitment Consultant and has been out of the workforce for three years as she took a career break following a successful career in recruiting for the construction sector. Paula has recently returned to work as a recruitment consultant in the finance sector. She has been asked to shortlist candidates for the role of Management Accountant in a large manufacturing company. The Human Resources Director of the client company advised her that the company employs a system of Activity Based Costing. Paula has some awareness as to the role of a Financial Accountant but none of that of a Management Accountant. Paula is keen to impress the client by selecting only suitable candidates for interview and has asked you to prepare a briefing for her in relation to the following matters:
REQUIREMENT: Part A) Set out the five main responsibilities of a Management Accountant and four key differences between the role of Management Accountant and Financial Accountant. [Total: 15 Marks]
OR Part B) Explain the concept behind Activity Based Costing, setting out the steps in operating a system of ABC and discuss two of the merits and two of the criticisms of ABC. [Total: 15 Marks]
Page 4
Section B Answer Question 4 and either Part A or Part B of Question 5. 4.
The following multiple choice question contains 8 sections, each of which is followed by a choice of answers. Only one of the offered solutions is correct. Each question carries 2.5 marks. Give your answer to each section on the answer sheet provided. Office Limited buys heater units from Chinese suppliers and sells them directly to Irish customers. The heaters are quickly shipped to customers, thus requiring minimal storage space or time. The company has experienced significant cash flow problems of late and has decided to review its working capital management in order to identify potential opportunities to reduce cash tied up therein. The company is currently overdrawn to the extent of €270,000 which costs the base rate of interest plus 10%. The current base rate is 1%. The following extracts have been taken from Office Limited’s most recent financial statements: Office Limited Statements of Financial Position as at 31st March 2010 and 2011 2010 €000s
2011 €000s
Non-Current Assets at NBV Property and Plant Other Assets Total Non-Current Assets
600 20 620
1,300 40 1,340
Current Assets Inventories Trade Receivables Cash & Cash Equivalents Total Current Assets
140 80 200 420
320 1,000 0 1,320
1,040
2,660
200 720 920
200 1,000 1,200
0
820
70 50 0 0 120
220 50 270 100 640
1,040
2,660
Total Assets Equity & Liabilities Equity Attributable to Equity Holders Share Capital (@ €2 each) Other Reserves Non-Current Liabilities Long term borrowings Current Liabilities Trade payables Dividend payable Short Term Borrowings Current portion of long term borrowings Total Current Liabilities Total Liabilities
Office Limited Statements of Comprehensive Income - Years Ended 31st March 2010 and 2011 2010 €000s 8,000 6,200 1,800 1,400 400
Revenue Cost Of Sales Gross Profit Less: Expenses Net Profit
2011 €000s 10,000 8,000 2,000 1,670 330
Notes: 1. Each storage heater was sold for €50 during the year ended 31st March 2011. 2. The cost of sales figure represents the cost of purchasing the storage heaters only at €40 per heater. Page 5
3.
4. 5.
Included within the expenses figure for the year ended 31st March 2011 are: • Warehousing Costs = €1,600 • Ordering Costs = €10,000 One half of all sales for the year ended 31st March 2010 were on credit, whilst 60% of all sales for the year ended 31st March 2011 were on credit. Standard credit terms offered by Office Limited for all credit sales is 30 days. All orders are for equal quantities of storage heaters, with each order costing €100 to process.
A factoring agency has approached Office Limited with a proposal which will guarantee that all credit sales will be settled according to terms. Their proposed fee for providing the service is 1% of all credit sales. Office Limited is considering changing to an Economic Order Quantity (EOQ) model to manage inventory costs for the future. The model assumes that no buffer stocks are held and that goods can be instantly replenished once ordered. To enable management to understand the model better they wish to consider the impact the model would have had on costs it if had been applied for the year ended 31st March 2011. Assume a 360 day year. Q1)
Calculate the increase in average debtor days from the year ended 31st March 2010 to 2011: a) 33 days b) 43 days c) 53 days d) 63 days
Q2)
Calculate the working capital cycle for the year ended 31st March 2011: a) 55 days b) 65 days c) 75 days d) 85 days
Q3)
Calculate the cash released if all credit sales were settled in accordance with standard credit terms: a) €500,000 b) €600,000 c) €700,000 d) €800,000
Q4)
Calculate the net financial cost of the factoring proposal: a) Profit of €50,000 b) Loss of €50,000 c) Profit of €5,000 d) Loss of €5,000
Q5)
For the year ended 31st March 2011 calculate the order size: a) 500 units b) 1,000 units c) 2,000 units d) 5,000 units
Q6)
Assuming the EOQ model was applied to the year ended 31st March 2011, calculate the EOQ for the year: a) 500 units b) 1,000 units c) 2,000 units d) 5,000 units
Q7)
Assuming the EOQ model was applied to the year ended 31st March 2011, calculate the annual ordering cost for the year: a) €1,000 b) €4,000 c) €10,000 d) €20,000
Q8)
Assuming the EOQ model was applied to the year ended 31st March 2011, calculate the annual total savings in total inventory related costs (ordering and holding costs) compared to the total actual inventory costs incurred for the year ended 31st March 2011: a) €3,600 b) €4,600 c) €5,600 d) €6,600 [Total: 20 Marks] Page 6
Answer either Part (A) or Part (B) 5. (A)
ABV is a Dutch based distributor of footwear. The company is keen to expand organically in the Irish market commening in 2012, which it considers to have growth potential beyond its traditional markets. The company will have to invest at the outset of the project €400,000 in motor vehicles (for all regions) and €100,000 in equipment for each region. The motor vehicles will be leased at a monthly premium of €10,000 whilst the equipment will be paid for in full five months after purchase. ABV needs to consider carefully the cash flow commitment required to enter the Irish market as its bank will not sanction an overdraft in excess of €400,000. The company plans to lease three distribution centres in Sligo, Wexford and Cork to support the sales to each region. A summary of the business plan projections are as follows: Sales Projections (Pairs of Shoes) Region Q1 Q2 Q3 Q4
Sligo 2,000 12,000 18,000 20,000
Wexford 8,000 12,000 14,000 20,000
Cork 6,000 18,000 24,000 20,000
ABV will charge €30 per pair of shoes to its customers, with each pair of shoes costing ABV €20 per pair for the first year of operation in Ireland. Sales are achieved evenly throughout each month of the year. Customers are expected to pay in the second month following sale and the company expects that 5% of all sales will be lost due to bad debts. Creditors will be paid in full in the month after purchase. Costs 1. The annual rental (which is paid half yearly in arrears) of each depot has been agreed as : • Sligo - €20,000 • Wexford - €26,000 • Cork - €30,000 2. Each region will employ the following sales staff: Sales Staff - Projections – Year 1 – Region Representatives Merchandising Area Manager Tele-Sales Staff
Gross pay per Staff Member €30,000 €25,000 €40,000 €20,000
Sligo Staff 3 2 1 4
Wexford Staff 2 2 1 3
Cork Staff 6 3 1 10
Note: The above figures exclude staff on-cost (employer’s PRSI) of 30% of gross pay. • • •
All wages and salaries are paid in the quarter in which incurred whilst, according to an agreement with the revenue authorities on-costs are paid a quarter in arrears. All wages and salaries will be uplifted by 10% in October 2012. All staff members will share in a bonus paid quarterly in arrears of 3% of total gross sales where the gross sales (before bad debts) in a quarter equal or exceed €1,500,000. On-costs are not payable on such bonuses.
REQUIREMENT: (a) Calculate a cash flow forecast for ABV for each quarter (not monthly) of 2012 and discuss the implications of your findings. (16 marks) (b)
Comment on the importance of cash flow mangement with particular reference to the current economic climate. (4 marks) [Total: 20 Marks]
OR Page 7
(B)
Red United is a football club competing in the Irish Soccer League Division Two. The league is semi-professional. For the season just finished, Red United had a squad of 22 players, three of whom are on full time contracts of €10,000 per season, whilst the remainder of the squad are paid €100 per game that the club plays (irrespective of whether the player makes the starting team). The club’s manager is paid €25,000 per annum plus €400 travel expenses per game (home or away). Wages and expenses are not expected to increase for the forthcoming season. In the season just finished Red United played: • •
30 league games (15 home and 15 away) 6 cup games (3 home and 3 away), as they typically reached the quarter finals.
The club has an ageing stadium located in a Galway suburb. It owns the stadium and is only required to pay a nominal ground rental thereon. The club attracts on average 2,000 supporters per home game, this is broken down into 1,200 adults and 800 children at an average ticket price of €20 and €5 per game respectively. These ticket prices have also been agreed for the forthcoming season. The average spend per supporter (home games only) for the season just ended and expected for next season on casual items (food, programmes etc.) is €10 per game. The Gross Profit Margin on such sales is 50%, all of which accrues to Red United. Red United sells 1,500 jerseys per annum for which it is paid €15 each from the manufacturer. The clubs other source of income is from corporate sponsors, of whom they attract ten per season paying an average of €5,000 each per season. The club has ambitions to reach the first division of the league and is currently considering signing a professional player from Canterbury United, a professional club in the English League. Initial discussions with this player indicate that the following remuneration package would be required to attract that player (for one season only) to the club: • €20,000 signing on fee. • 10% of all gross gate sales. • €1,000 per game played by the club during the season. The club is confident that the signing of the player would have the following impact on the club for the upcoming season: • Increase children in attendance by 400 per home game. • Increase adult attendance by 50%. • Play a further two home and two away cup games as the club would be expected to progress further in the competition. • Attract four new corporate sponsors paying €10,000 each per annum. • Increase jersey sales by 400 per season. REQUIREMENT: (a)
Calculate the club’s profit/loss for the season just finished.
(9 marks)
(b)
Calculate the net financial impact on the clubs finances for the forthcoming season if the new player is signed. (7 marks)
(c)
State, with reasons, whether the club should sign the new player.
(4 marks) [Total: 20 Marks]
END OF PAPER
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SUGGESTED SOLUTIONS
MANAGERIAL FINANCE
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
PROFESSIONAL 1 EXAMINATION – APRIL 2011
SOLUTION 1 (a) WACC Note MV Ordinary Shares (ex div) 1 22,000,000 Preference Shares 2 9,375,000 Weighted Average Cost of Capital 31,375,000
% Cost 27.60% 6.40%
Cost of Equity (Gordon's Growth Model) [.88*(1+.1)/(6.38 -.88)] +.1 =
27.60%
Note 2)Cost of Preference Shares Interest Payable/Ex Div. Market value = 16/250 * 100 =
6.40%
Weighting 22,000/31,375 9,375/31,375
% Weight 70% 30% 100.00%
Weighted 19.35% 1.91% 21.27%
Year 2 40,000 75,000 115,500 -145,000 4,200,000 756,000 -50,000 -120,000
Year 3 55,000 100,000 168,000 -152,250 4,200,000 756,000 -70,000 -120,000
4,946,750 0.7938 3,926,730
(b)
CASHFLOW Income Family Memberships Income - Single Memberships Income - Casual Guests Wage Costs Accommodation Charges Increase Casual Earnings Increase Rates Increase Heating Initial Cost NET ANNUAL CASHFLOW Discount Factor at 8% PRESENT VALUE NET PRESENT VALUE
Note 1) Z HOTEL - WAGE COSTS STAFF MEMBER Manager Cleaner Life Guarding Total Wage Costs
Z HOTEL - INVESTMENT APPRAISAL NOTE Year 0 Year 1 30,000 50,000 70,000 1 -145,000 2 2,362,500 3 756,000 -40,000 -120,000 -10,000,000 -10,000,000 1 -10,000,000 8,469,772.7
2,963,500 0.9259 2,743,905
4,871,500 0.8573 4,176,337
Year 1 50,000 20,000 75,000 145,000
Year 2 50,000 20,000 75,000 145,000
Year 3 52,500 21,000 78,750 152,250
Page 9
Note 2) Z HOTEL - ACCOMODATION INCOME Cash flow Accommodation Nights Occupancy Rate Rate Per Room Per Night Rooms Available Current Income Accommodation Nights Occupancy Rate Rate Per Room Per Night Rooms Available Projected Income INCOME INCREASE
Year 1 350 0.6 100 150 3,150,000 350 0.7 150 150 5,512,500 2,362,500
Year 2 350 0.6 100 150 3,150,000 350 0.7 200 150 7,350,000 4,200,000
Year 3 350 0.6 100 150 3,150,000 350 0.7 200 150 7,350,000 4,200,000
Note 3) Z HOTEL - CASUAL INCOME PROFIT Cash flow Accommodation Nights Occupancy Rate Spend per room Contribution Margin Rooms Available Current Contribution Accommodation Nights Occupancy Rate Spend per room Contribution Margin Rooms Available Projected Contribution INCOME INCREASE
Year 1 350 0.6 50 0.5 150 787,500 350 0.7 70 0.6 150 1,543,500 756,000
Year 2 350 0.6 50 0.5 150 787,500 350 0.7 70 0.6 150 1,543,500 756,000
Year 3 350 0.6 50 0.5 150 787,500 350 0.7 70 0.6 150 1,543,500 756,000
(c)
Other Factors to Consider: • • • • •
How reliable is the market research Economic outlook Competition type and levels around the Portmarnock area Ability to raise funds Ability to attract staff
Page 10
SOLUTION 2 (a)
Steps in Standard Costing 1. determine unit production costs (standard cost card) and finished goods and raw materials stockholding policy 2. agree unit sales price estimate unit sales volumes 3. 4. project profits for future period (typically monthly) 5. record actual sales and costs 6. report and reconcile actual and budgeted profit for each control period 7. take appropriate corrective actions
(b)
Details Budgeted Profit Variances Sales Price Sales Volume Direct Materials Price Direct Materials Usage
Koln Ltd, Operating Statement - Month Ended March 2011 Variances Note Favourable Adverse N1
Direct Labour Rate Direct Labour Efficiency Variable Overhead Exp Expenditure Variable Overhead Effcy Fixed Overhead Expenditure Fixed Overhead Volume Sub Totals Net Variance Actual Profit
N2 N3 N4 N5 N6 N7 N8 N9 N10 N11
Total 524,000
−125,000 131,000 −35,000 12,500 -27,500 −7,500 -5,500 –2,000 −25,000 12,000 156,000
−2,275,000 -71,500 452,500
Supporting Notes Note 1) Budgeted Profit Budgeted Unit Sales * Standard Profit per Unit 200 * 2620 = 524000 Note 2)
Sales Price Variance (Actual Unit Price – Budgeted Unit Price) *Actual Units Sold (3500 − 4000) *250 = −125000 Adverse
Note 3)
Sales Volume Variance (Actual Units Sold – Budgeted Unit Sales) *Standard Profit per Unit (250 − 200) * 2620 = 131000 Favourable
Note 4)
Direct Materials Price Variance (Standard Unit Cost – Actual Unit Cost) * Actual Units Purchased (50−60) * 3500 = −35000 Adverse
Note 5)
Direct Materials Usage Variance (Standard Unit Usage (for the actual level of production) – Actual Units Used)* Standard Cost per Unit. (3750 − 3500)* 50 = 12500 Favourable
Note 6)
Direct Labour Rate Variance (Standard Hourly Rate – Actual Rate per Hour) *Actual Hours Worked (30 − 40) * 2750 = -27500 Adverse
Note 7)
Direct Labour Efficiency Variance (Standard Hours (for the actual level of production) – Actual Hours Worked) *Standard Rate per Hour (2500 − 2750)* 30 = −7500 Adverse
Page 11
Note 8)
Variable Overhead Expenditure Variance (Standard Hourly Cost – Actual Cost per Hour) * Actual Hours Worked (8 − 10) * 2750 = -5500 Adverse
Note 9)
Variable Overhead Efficiency Variance (Standard Hours (for the actual level of production) – Actual Hours Worked) * Standard Cost per Hour (2500 − 2750) * 8 = −2000 Adverse
Note 10)
Fixed Overhead Expenditure Variance (Budgeted Fixed Overhead – Actual Fixed Overhead) (50000 − 75000) = −25000 Adverse
Note 11)
Fixed Overhead Volume Variance (Actual Units Produced – Budgeted Unit Production) * Fixed Overhead Absorbed per unit (250 − 200) * 250 = 12500 Favourable
Page 12
SOLUTION 3 (A) Briefing Note To: Paula Mc Donald From: Mr. X Management Accounting Advisor Subject: Role of the Management Accountant Date: 10th May 2011 Purpose The purpose of this briefing note is to explain the typical role a management account¬ant and how this role would differ from that of the financial accountant. Role of the Management Accountant Planning In the planning process of budgeting the management accountant provides infor¬mation on past costs and revenues which help inform the budget setting process. Information manager The management accountant will gather data from both internal and external sources, process, analyse and interpret this information. Control The management accountant supplies performance reports comparing actual and budgeted performance, highlighting deviation from plan. Motivation Budgets prepared by the management accountant serve to motivate managers and budget holders. Decision Making The management accountant provides information and relevant analysis to enable informed and appropriate decisions to be made. Cost accumulation A key responsibility of the management accountant will be determining the cost of a unit/product/service. This information will be necessary for many rea¬sons, particularly for the purposes of informing pricing decisions. Differences between the Management Accountant's and the Financial Accountant's Role • There is no legal requirement to prepare management accounts. There is a statutory requirement to prepare and file financial accounts. • Management accounts are prepared almost exclusively for management purposes. Financial accounts normally have a wider external user base, e.g. bankers, tax authorities etc. • There is no fixed format to management accounts. In essence, management can dictate the style and content thereof. The formats of financial accounts are prescribed by accounting conventions and standards, e.g. IASs. • Financial accounts are typically prepared once a year. Management accounts are normally prepared monthly. • Financial accounts normally present a historic picture of past performance. Management accounting information is often more prospective an example being information provided for decision making purposes.
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(B) Briefing Note To: Paula Mc Donald From: Mr. X Management Accounting Advisor Subject: Activity Based Costing Date: 10th May 2011 Purpose The purpose of this briefing note is to explain the term ABC, explain the steps in operating a system of ABC and discus its merits and associated criticisms. Activity-Based Costing (ABC) ABC has been developed as an alternative to traditional absorption costing. The Chartered Institute of Management Accountants (CIMA) defines ABC as: "An approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities and activities to cost objects based on consumption estimates. The latter use cost drivers to attach activity costs to outputs." In essence, ABC identifies the factors which cause the cost of the various overhead activities carried out by an organisation. Thereafter, the overheads of each separate overhead activity are charged to units based on each unit's proportionate consumption of the activity. Steps in Activity-Based Costing Step 1 Identify the various overhead activities carried out in the organisation Step 2 Record the costs of each overhead activity, known as cost pools. Step 3 Identify the factor which is primarily responsible for driving the cost of each overhead activity, known as the prime cost driver. Examples of prime drivers would include: Overhead Activity Production Set Ups Materials Handling Transport Ordering
Prime Driver Set Ups Material Movements Deliveries Requisitions
Step 4 Determine driver rates for each overhead cost activity. Step 5 Charge the overheads of each activity to units based on each unit's proportion¬ate consumption of the prime driver of each overhead activity. Merits of ABC • It recognises the increasing complexity of business and the fact that many overhead costs are transaction based rather than volume based. • It determines more accurately unit costs, thus leading to a more informed approach to product pricing. • It leads to a more realistic assessment of product profitability. • It may assist in cost reduction as it provides accurate costing of overhead activities, enabling comparison with industry benchmarks and the consideration of outsourcing options. Criticisms of ABC • The cost of obtaining information regarding cost pools and cost drivers may be significant. • Some arbitrary apportionment will still be necessary between cost activities in relation to items, such as factory rent. • Often there will be more than one driver of an overhead activity's cost. • It is often referred to as a variation of basic absorption costing.
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SOLUTION 4 Q1 Office Limited Increase in Debtors Days Indicator Debtors Days y/e 31/3/10 Debtors Days y/e 31/3/11 Increase in Debtors Days Q2 Office Limited Operating Cash Cycle Ended 31st March 2011 Indicator Stock Days Debtor Days Creditor Days Operating Cash Cycle Q3 Office Limited Cash Released if debtors pay per terms Ended 31st March 2011 Indicator Cash released if debtors pay per terms
Formulae Closing Debtors/Credit Sales * 360 Closing Debtors/Credit Sales * 360
Days 7 60 53
Formulae Closing Stock/Cost of Sales * 360 Closing Debtors/Credit Sales * 360 Closing Creditors/Cost of Sales * 360
Days 15 60 -10 65
Formulae 30 days * €60,000,000
€ 500,000
Formulae 30 days * €6,000,000 * 11% 1% of €6,000,000
€ 55,000 -60,000 -5,000
Q5 Office Limited Number of Annual Orders Ended 31st March 2011 Indicator Number of Orders Order Size
Formulae €10,000/€100 = 100 orders 200000 units / 100 orders
Units 2,000
Q6 Office Limited EOQ Ended 31st March 2011 Indicator EOQ
Formulae SQ ROOT (2*100*200,000/1.6)
Units 5000
Q4 Office Limited Evaluation of Factoring Proposal Ended 31st March 2011 Indicator Cash flow released at 11% financing Cost of Factoring Service Change
Q7 & Q8 Office Limited EOQ Savings Ended 31st March 2011 Indicator Order Costs Holding Costs Total EOQ Related Costs Current Inventory Costs Net Savings
Formulae 200,000/5,000 = 40 orders * €100 per order 500/2 * €16 €10,000 + €1,600
Page 15
€ 4,000 4,000 8,000 11,600 -3,600
SOLUTION 5 (A) A BV Projected Cash Budget - Year Ended 31st December 2012 Details Receipts From Debtors (Note 1) Payments Creditor Payments (Note 2) Wage Payments (Note 3) On Costs (Note 3) Commission payable (Note 1) Rental Payments Lease of motor vehicles Purchase of Equipment Net in Month Cash Movement Opening Cash Balance Closing Cash Balance
Quarter 1 304,000
Quarter 2 950,000
Quarter 3 1,463,000
Quarter 4 1672,000
-213,333 -241,250 0
-666,667 -241,250 -72,375
-1,026,667 -241,250 -72,375
-1,173,333 -265,375 -72,375 -50,400
-38,000 -30,000
-30,000
-218,583 0 -218,583
-30,000 -100,000 -160,292 -218,583 -378,875
54,708 -378,875 -324,167
80,517 -324,167 -243,650
Note 1 - Sales Receipts & Commission Payable Details SALES IN QUARTER BAD DEBTS NET SALES RECEIPTS RECEIVED FROM CURRENT QUARTER RECEIVED FROM PREVIOUS QUARTER TOTAL RECEIPTS COMMISSION PAYABLE
Quarter 1 480,000 -24,000 456,000 304,000 0 304,000 0
Quarter 2 1260,000 -63,000 1,197,000 798,000 152,000 950,000 0
Quarter 3 1,680,000 -84000 1,596,000 1,064,000 399000 1,463,000 0
Quarter 4 1,800,000 -90,000 1,710,000 1,140,000 532,000 1,672,000 50,400
Note 2 - Creditor Payments Details PURCHASES IN QUARTER PAID FROM CURRENT QUARTER RECEIVED FROM PREVIOUS QUARTER
Quarter 1 320,000 213,333 0
Quarter 2 840,000 560,000 106,667
Quarter 3 1,120,000 746,667 280,000
Quarter 4 1,200,000 800,000 373,333
213333
666667
1,026,667
1,173,333
Quarter 1 82,500 43,750 30,000 85,000 24,1250
Quarter 2 82,500 43,750 30,000 85,000 241,250 72,375
Quarter 3 82,500 43,750 30,000 85,000 241,250 72,375
Quarter 4 90,750 48,125 33,000 93,500 265,375 72,375
TOTAL PAYMENTS Note 3 - Wages Payments Details Representatives Merchandising Managers Tele Sales Total Wages & Salaries On Cost Payments
-38,000 -30,000
Page 16
SOLUTION 5 (B) Last Season - Profit/Loss Ticket Sales Adult (1200 * 20 * 18) Ticket Sales Children (800 * 5 * 18) Casual Profits (2000*10*18%*50%) Corporate sponsors (10*5000) Jersey Royalty (1500*15) Wages - Full Time Players (3 * 10000) Wages - Part Time Players (19*36* 100) Manager Travel Expenses SEASON PROFIT
Incremental Financial Impact Ticket Sales Adult (1800 * 20 * 20) Ticket Sales Children (1200 * 5 * 18) Current Income Incremental Income Expected Casual Profits (3000*10*20*50%) Current Casual Profits Incremental Casual Profits Increased Corporate Sponsors Increased Jersey Royalty (400*15) Signing on Fee % of Gross Ticket Sales Game Fee (40 * 1000) Incremental Wages (19*100*4) Incremental Travel Expenses NET INCREMENTAL IMPACT
€ 432,000 72,000
€ 720,000 120,000 -504,000
€ 504,000 180,000 50,000 22,500 -30,000 -68,400 -25,000 -14,400 618,700
€
336,000 300,000 -120,000 120,000 40,000 6,000 -40,000 -84,000 -40,000
Page 17
-144,000 -7,600 -1,600 348,800
