PRINCIPLES OF ACCOUNTING

Answers to Homework questions Lecture 14 to 21 TOTAL 47 PAGES

Answer to Homework question- Lecture 14

Question 1

Actual Overhead
Filling Sealing Maintenance Canteen
£ £ £ £
Allocated 74,260 38,115 25,050 24,375
Reallocation:
Canteen 14,265 7,800 1,950 (24,375)
Maintenance 18,900 7,290 (27,000)
Actual Overhead 107,785 54,015 0 0

(a) Predetermined Overhead absorption rates:

Filing Sealing
£ £
Budgeted Overheads 110,040 53,300

/Budgeted direct labour cost 13,100 10,250

Overhead rate 8.40 5.20

Overhead absorbed
8.40 X 12,840 107,688
5.20 X 10,075 53,920

Actual Overhead 107,785 54,015

Under absorbed 97 1,625

(b) Product W2
£
Direct cost 24.00
Overhead:
Filling 2 X8.40 16.80
Sealing 4 X5.20 20.80
61.60
Profit 20% 12.32
Selling price 73.91
Profit for the year
1,500 X 12.32 18,480

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Question 2

Prodn Prodn Service General

Dept 1 Dept 2 Dept Factory Total
Allocated 380 465 265 230 1,340
Allocation of general Factory 92 115 23 (230)
Share of service department
Labour related cost (60%) 76.8 96.0 (172.80)
Machine related cost(40%) 57.6 57.6 (115.20)
Total 606.40 733.60 1,340
Unit of output 120 120
Overhead rate per unit 5.05 6.11

(a) Calculation of total manufacturing cost per unit

£
Direct materials 7.00
Direct labour 5.50
Variable overheads 2.00
Fixed overhead: Department 1 5.05
Fixed overhead: Department 2 6.11
Total Manufacturing cost 25.66

(b) Absorption costing profit statement

£
Sales 114,000 X 36 4,104,000
Cost of Sales 114,000 X 25.66 2,925,240
Add: Under-absorption of overheads
Department 1 (20,000+(4000X5.05) 40,200
Department 2 (4,000 units X6.11) 24,440
Total cost of Sales 2,989,880
Gross Profit 1,114,120
Less: Operating expense
Non manufacturing cost 875,000
Net Profit 239,120

Note that the under-recovery of fixed overheads consists of £20,000 arising from
actual overheads exceeding estimated overheads plus 4,000 times the fixed overhead
rate because actual volume was 4,000 units less than estimated volume.

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QUESTION 3
a.
Total Fabrication Finishing Canteen Maintenance
£ £ £ £ £
Indirect labour 340,000 120,000 140,000 30,000 50,000
Consumables 82,000 24,000 32,000 20,000 6,000
Heating &
Lighting 24,000 8,000 9,600 2,400 4,000
Rent & Rates 36,000 12,000 14,400 3,600 6,000
Depreciation 60,000 30,000 24,000 2,000 4,000
Supervision 48,000 24,000 18,000 3,000 4,000
Power 40,000 18,000 16,000 2,000 4,000
Total 630,000 236,000 254,000 63,000 77,000
Canteen(number
of employees) 33,600 25,200 (63,000) 4,200
Maintenance
(hours) 46,400 34,800 (81,200)
Total 630,000 316,000 314,000

b.
Fabrication labour hours = 12,640

Rate = £316,000 /12,640 = £25 per labour hour

Finishing machine hours = 15,700

Rate = £314,000 /1,570 = £200 per machine hour

c.

Batch cost £
Direct materials 3,000
Direct labour 1,040
Overheads
Fabrication 2,500
Finishing 1,600
Total 8,140
Cost per window 8,140/200 units 40.70
Mark up 16.28
Selling price 56.98

d.
Direct material cost percentage
This method is best used when the price of materials is constant and there is a direct
relationship between the materials and labour costs incurred to manufacture the
product. Consider the following example:

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 Job A Job B Budget
£ £ £
Materials 250 100 15,000
Labour 100 100 92,000

The overheads charges to a job will be distorted. Job A is charged with a greater
proportion of overheads than Job B even thought the labour costs were the same.
In the case of Oriel the production uses a range of materials and this method would be
inappropriate.

Direct wages cost percentage

This method is best used when the wages rates are the same throughout the company
and the same for each job.
In the case of Oriel the production involves differing hourly rates and this method
would be inappropriate.

Prime cost percentage rate

This method combines the faults of the direct materials cost percentage and the direct
labour cost percentage rates.

Labour hours method could have been used in the Finishing department. But on the
basis of the labour hours and machine hours for this department it is obviously
machine-intensive and therefore, machine hours should be used.

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Question 4

(a) Overhead recovery rate

9,000 + 3,000 + 2,000 + 400 = £2.40 per labour hour
6,000

Full cost
Direct material (20 X 2) 40,00
Direct labour (12 X 30,000) 60.00

Overhead (12 u 2.40) 28.80

128.80

(b) Direct cost 100.00

Overhead 14,400 X 5 /2000 36.00
_____
136.00

The choice of overhead recovery rate should be based on the

principal
resource usage of the factory. With more labour hours (a) could be
preferred.

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Answers to homework questions – Lecture 15

Question 1
Cost Volume profit analysis refers to break-even analysis and
the computation of the level of output to achieve target profits.

It is also used to quantify the effects of changing cost and selling price
on the business and for decision
making.

Assumptions of cost volume profit

analysis
1) Cost and revenues pattern are known with certainty.

2) All cost can be classified as being either fixed or

variable.

3) Both cost and revenues are linear over the relevant

range, that is fixed cost, variable cost and selling price is
constant.

4) Volume is the only factor affecting

cost.

Question 2

Proposal i: c Workings
Current Contribution per unit= 8 (20-7-4-1)
Revised unit contribution = 6 8-(10%*20)
Revised break-even point= 83,333 (200,000+300,000)/6

Based on current sales of 50,000 units, sales have to increase by

(83,333-50,000)/50,000 = 67%

Proposal ii : a Workings
Revised unit contribution = 7 8-1
Increased sales=20%*50,000 units= 10,000 units
Additional contribution = £70,000
Additional fixed cost = £50,000
Additional profit £ 20,000

Proposal 2 will contributes additional profit of £20,000 which will reduce current loss to £80,000.

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Hence, proposal 2 is better provided the additional production capacity can
be achieved.

Question 3

(i) c

Variable costs per unit= 300000/1m £0.3

Contribution per unit= 0.5-0.3 = £0.2

BEP in units= 100,000/0.2 = 500,000 Units

(ii) c

Margin of safety in units= 1 mil -500,000 units = 500, 000 units

(iii) c

Additional units = 0.6 X 1 mil = 600,000 units

Revised Variable costs per unit = 1.1 X0.3 = £0.33

Revised Contribution per unit =£0.5 -£0.33 =£0.17

Total fixed cost = £100,000+£50,000 = £150,000

Revised Profit= (0.17 X1,600,00) -150,000= £122,000

Increase profit = £122,000- £100,000 = £22,000

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Question 4
i) d

Break even Point 22,667

3400/300-110-32-8

ii) a

Break even Point 26,154

3400/280-110-32-8

iii) b

CM Per Unit 130

280-110-32-8
X Units 30,000
Total CM 3,900,000
Less: Fixed Cost 3,400,000
Profit 500,000

d) a

Break even Point 60,323

7480/280-156

Revised Profit

iv)
CM Per Unit 124
280-156
X Units 60,000
Total CM 7,440,000
Less: Fixed Cost 7,480,000
Loss 40,000

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Question 5
i) d

Break even units (BEP) = Fixed costs / Contribution per unit

Fixed costs
Direct labour £30,000 (usually variable but fixed in this question)
Machine lease costs 25,000
Other fixed costs 45,000
Total 100,000

Variable cost = Materials £60,000/10,000 = £6

Thus contribution = 18 – 6 = £12

BEP = 100,000/12 = 8,333 units

ii) a

Margin of safety (MOS) = Expected units – BEP = 10,000 – 8,333 = 1,667

units

iii) d

BEP if new machine is leased

Fixed costs
Direct labour £30,000
Machine lease costs 55,000
Other fixed costs 45,000
Total 130,000

Variable cost = Materials £3

Thus contribution = 18 – 3 = £15

BEP = 130,000/15 = 8,667units

iv)

Margin of safety (MOS) = Expected units – BEP = 10,000 – 8,667 = 1,333

units

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Answer to homework questions –lecture 16
Question 1

Incremental costs are those which will change with respect to the
decision being made. These will be relevant to the decision and
included in any computations of outcomes. Costs which will not
change whatever decision is made are not incremental and not
relevant.

(b)Sunk costs are costs which have been incurred prior to the decision
being made. They will not change whatever decision is made. They
are therefore not relevant and will not be included in computations of
outcomes

(c)Opportunity costs are defined as ‘the cost of the next best opportunity
foregone’. These costs may be incurred if certain decisions are made.
They may be relevant and included in computations of appropriate
outcomes.

Question 2
i) b
ii) a
iii) c

As shown below.
Hours to satisfy max demand 185000
(40000 X 1)+(30000 X 1.5)+(50000 X 2)

Available hours 140,000

Short 45,000

A B C
Selling Price 20 30 40
Variable cost 8 20 30
Contribution Margin 12 10 10
Hours per unit 1 1.5 2

CM per hour 12 6.67 5

Ranking 1 2 3

Optimal Mix
Satisfy
Products Demand Hrs per unit Total Hours

A 40000 1 40000
B 30000 1.5 45000
C 27500 2 55000

Total 140000

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 Profit
Products Demand CM Per unit Total CM
A 40000 12 480,000
B 30000 10 300,000
C 27500 10 275,000

Total 1,055,000
Less: Fixed Cost -500,000

Profit 555,000

Question 3
i) d
ii) a
iii) c

As shown below.

A B C
Contribution per unit 30-VC 21 45- VC 34 20- VC 15
= 9 11 5

XZ usage per unit 2 3 1

Contribution per kg of XZ 4.50 3.67 5.00
Ranking 2 3 1

Type No. of units No. of kg of XZ Contribution Total

per kg contribution
C 5,000 5,000 5.00 25,000.00
A 2,000 4,000 4.50 18,000.00
B 333 999 3.67 3,663.00

Total 9,999 46,663

Fixed cost 40000
Net profit 6,663

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Question 4
i) d
ii) c
iii) a

As shown below.

Cost of making 360,000 cartons £

Direct materials 84,000

Electricity 4,500
Variable overhead 3,000
Direct labour 18,000
Total for 360,000 cartons 109,500

Cost of buying-in the cartons

(360000/1000 X325 +9000) 126,000

Differential cost 16,500

Conclusion:
Cheaper to make the cartons.

Assumptions
- Depreciation is a fixed cost of production
- Fixed production overheads remain unchanged regardless of the
decision made
-Direct Labour is a variable cost

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Question 5

Accept Reject Net cash Flow

Inflow
Scrap Value of material 0 1,000 (1,000)
Net cash Outflow 1,000

Outflow
Material 4,000 0 4,000
Variable Overheads 400 0 400
Net cash Outflow 4,400
Net cash Outflow 5,400

Therefore Minimum Price = $5,400

Reasons & assumptions

a. The original historical cost of the material in inventory is a sunk cost and not
relevant.
The relevant is the opportunity cost of the saving foregone on on the other materials
which now have to be purchased for $4,000. The materials could have been used
elsewhere.

a. The workers would be paid even If the contract is not undertaken. There is thus no
opportunity cost as the department is already working below capacity.

a. The variable overhead is assumed to be an incremental cost. They are included

in the minimum price, as it is assumed they are specifically incurred in conversion
work.

a. Depreciation is not a cash flow and is therefore not relevant. Depreciation Apportions
the original cost of the machine, a cost which was sunk eight ago. There is no
indication of the current resale value of the machine and so it is assumed that
there is no intention of selling it. It is also assumed that there is no opportunity cost
involved in its use for this contract, as it would not be needed elsewhere.

a. The foreman is already being paid. Therefore his salary is not an Incremental cost.
It is assumed that there is no opportunity cost associated with the use of his time
for this contract.

a. It is assumed that general fixed overhead will not increase a result of this contract,
therefore absorbed overhead is not relevant.

a. Scrap revenue foregone will be an opportunity cost, if the product is Converted

rather
than sold as scrap.

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Question 6

Calculation of BE price
Per
Copier
Components Y,Z 53
(75-22)
Component W 34
Direct Labour
1.5 X 0.75X 24 27
1.5 X0.25 X12 4.5

Total Relevant Cost 118.5

X 100 Copiers 100

Total 11850
Add: Travelling time
10 hrs X 24 240
Extra Machine 800

Total Relevant Cost 12890

Explanation of the figures

used
• Component X is a sunk cost which has already been paid for, is
obsolete for future purposes and has no resale value.
• Component W is an additional cost of this special
order.
• The standard cost would have charged for 50 hours but only 10
will actually be incurred. The cost per hour is assumed to be
unchanged.

• Labour costs need to reflect the lower number of hours and the
use of trainees

• The overheads are fixed and so not relevant costs.

• The opportunity cost of using the special machine is the loss of
the resale value.

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(b)Factors to be considered in setting a
price.

• Customer. This price gives a contribution of £2,110 which

represents a 16% margin of safety on the estimated costs.

This reduces the financial risk of accepting the order.

• The cost estimates on a one-off special order do contain an

element of risk.

• With a change in manufacturer would it be a better strategy to

cease

• Will there be enough staff for the job and the introduction of new
copiers? Is it sensible to have trainees working on old types of
copier?
• If this is a large customer would we lose goodwill if we refused
The upgrade? Could this damage future relationships and other
sales possibilities?

15
Question 7

(a) Profit from current sales budget.

£000 Total unit Product Product contribution

contribution fixed costs

P 12,000 x £120 1440 250 1190

Q 10,000 x £90 900 200 700

R 8,000 x £45 360 100 260

2700 550 2,150

Less common fixed costs (1,610)

540

(b) Total production hours required 30,000 units x 2 = 60,000 increase to

18,000 units
Total hours required to 36,000 x 2 = 72,000 hours
R has the lowest contribution so its production would be reduced
This would mean that 72,000 – 64,000/2 = 4000 units of R could not be
produced
Change in profit

£000

Increase in total contribution of P 18,000 x 110 – 1440,000 540

Reduction in contribution from R 4000 x 45 (180)

Additional profit 360

Total profit 540,000 + 360,000 900

(c) i) Dolphy could use the outsourcing company to make unfulfilled

demand of 4000 units.
This would increase profit shown above by 4000 x (£100 – 75) =
£100,000 (i.e. total profit £1,000,000).

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ii) Dolphy could use the company to provide all units of R, and avoid
current separable production fixed costs.

£000 Total unit Product fixed Product

contribution costs contribution

P 18,000 u £110 1980 250 1730

Q 10,000 u £90 900 200 700

R 8,000 u £25 200 30 170

3080 480 2,600

Less common fixed costs (1,610)

990

The alternative of outsourcing all of R is £10,000 less profitable but

gives some spare capacity if needed.

It may be possible to bargain a lower price to be paid by Dolphy if all

quantities are outsourced.

Issues of quality, availability of supply and long-term arrangements

need to be discussed.

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Question 8

Outcome 1 £000
• Contribution lost if Smallville closes:
Sales 500
Direct costs (400)
Factory fixed costs (80)

20

• If Smallville closes Mingus will lose

£20,000 contribution to corporate fixed
costs
• If capital released is invested to return
more than £20,000 (i.e. more than 8%)
the factory should be closed.

Outcome 2
Direct contribution lost (75% u (500 – 400)) 75
Factory fixed cost 80
Increased corporate contribution 5

• Factory should be closed as it would

increase contribution by 5,000 and release
£200,000 for investment.

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Answers to Homework Questions – Lecture 17

Question 1
Eden Limited

(a) Profit Statements Jan–March(Q1) April–June(Q2)

(i) Marginal costing £000 £000

Sales revenue 2,700 4,050
Opening inventory – 1,650
Production costs:variable 1,155 1,650
Closing inventory -165 -330
990 1,485
Selling and distribution costs
Variable 90 135
Total marginal cost 1,080 1,620
Contribution 1,620 2,430
Fixed costs
Production -100 -100
Selling and distribution -20 -20
Administration -30 -30

Profit 1,470 2,280

(ii) Absorption costing Jan–March(Q1) April–June(Q2)

£000 £000
Sales 2,700.00 4,050.00
Opening inventory – 177.50
Total production costs 1,242.50 1,775.00
Closings inventory(17.75perunit) -177.50 -355.00
1,065.00 1,597.50
Under-absorption of overhead 12.50
Over-absorption of overhead -25.00
1,077.50 1,572.50
Total selling and distribution costs 110.00 155.00
Fixed administration costs 30.00 30.00
Total costs 1,217.50 1,757.50
Profit 1,482.50 2,292.50

(b)The difference in profits of £12,500 for the first quarter is due to the
inclusion in absorption cost of fixed overhead of £1.25 per unit in the
10,000 units in inventory at the end of the quarter. These costs have been
carried forward as part of closing inventory and not expensed. Under marginal
costing all of the fixed production costs are seen as a periodic cost and as

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an expense of the first quarter.

Question 2

The following factors should be considered when deciding whether to

use full (Normal) costing or marginal costing:

1)Full costing involves a greater degree of subjectivity than marginal

costing, and is thus more open to misstatement or manipulation

2) By taking account of all costs involved in production, prices based

on a calculation of full cost should enable the business to earn a profit

3) If prices are steady, marginal costing gives an approximate

replacement cost, tying in with the economist’s concept of short-run
marginal cost. Many would argue that marginal costing is, therefore,
more useful for decision-making purposes in the short term

4) Inventory valuations and, therefore, also the financial position value

of net assets are lower with marginal costing than with full costing

5) Because inventory valuations also affect reported gross profit, when

inventory levels change from year to year, gross profit reported under
marginal costing will be different to that reported under full costing

6) For financial reporting purposes in the UK, companies are required

to use full costing.

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Question 3
a. £000
2007 2008 2009
Sales 64 64 80
Cost of Sales (40) (40) (50)
24 24 30
(under) over (4) 4 (8)
absorption
20 28 22
Fixed selling and 20 20 20
admin
Profit 0 8 2

b. Contribution = £70 per unit

£000
2007 2008 2009
Sales 64 64 80
Variable cost 8 8 10
Contribution 56 56 70
Fixed cost 60 60 60
Profit(loss) (4) (4) 10

c. £000
2007 2008 2009
Absorption profit 0 8 2
Less: Fixed
production -4 -16 -8
overhead in
closing inventory
Add: Fixed
production 0 +4 +16
overhead in
opening
inventory
Marginal costing
profit/loss (4) (4) 10

Fixed overhead absorption rate per unit = £40,000/1,000 units = £40 per unit.

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Question 4
£000
Production Production Service General Total
Depart 1 Dept 2 Dept Factory
Allocated 380.0 465.0 265 230 1,340
Allocation of
general factory 92.0(40%) 115.0(50%) 23(10%) (230)
Share of
service
department
Labour related
cost(60%) 76.8 96.0(10/18) (172.8)
Machine
related cost 57.6 57.6 (115.2)
(40%)
Total 606.4 733.6 0 0
Unit of output 120 120
Overhead rate 5.05 6.11
per unit

(a) Calculation of total manufacturing cost per unit

£
Direct materials 7.00
Direct Labour 5.50
Variable Overhead 2.00
Fixed overhead: Department 1 5.05
Department 2 6.11
Manufacturing cost 25.66

(b) Absorption costing profit Statement

£ £
Sales:114,000 units x £36 4,104,000

Cost of sales 114,000 units x £25.66 2,925,240

Add: Under-absorbed of overhead:
Department 1(£20,000 + (4,000 x £5.05) 40,200
Department 2 ( 4,000 units x £6.11) 24,440
Total cost of sales (2,989,880)
Gross Profit 1,114,120
Less: expenses
Non manufacturing cost (875,000)
Net Profit 239,120_

Note that the under-recovery of fixed overheads consists of £20,000 arising

from actual overheads exceeding estimated overheads plus 4,000 times the

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fixed overhead rate because actual volume was 4,000 units less than estimated
volume.

(c) Marginal costing profit statement

£
Sales:114,000 units x £36 4,104,000

Variable cost of sales 114,000 units x £14.50 1,653,000

Contribution 2,451,000
Less: Fixed Cost
Fixed Manufacturing cost(1,340+20) 1,360,000
Non manufacturing cost (875,000)
Net Profit 216,000_

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Answers to homework Questions Lecture 18
Question 1

Cash budget for May, June and July 1999

May June July

Bank-start 5,000 28,225 (13,325)

RECEIPTS

Accounts Receivables (see Accounts 223,250 205,000 241,250

Receivables schedule below)

Machine sale 500

TOTAL 228,250 233,725 227,925

PAYMENTS

Accounts Payable (see Accounts 125,400 136,800 135,600

Payableschedule below)

Council rates 5,200

Salaries 58,500 75,000 63,000

Loan Interest 12,400

Office expenses 14,625 18,750 15,750

Drawings 1,500 1,500 1,500

Machine-deposit 1,300

Machine-instalment 1,300 1,300

TOTAL 200,025 247,050 222,350

Bank-end 28,225 (13,325) 5575

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Schedule of collections of sales revenue from Accounts
Receivables
Total Sales May June July

March 200,000

Cash (15%) 30,000

Credit (80% & 5%) 160,000 10,000

April 230,000

Cash (15%) 34,500

Credit (80% & 5%) 184,000 11,500

May 195,000

Cash (15%) 29,250

Credit (80% & 5%) 156,000 9,750

June 250,000

Cash (15%) 37,500

Credit (80% & 5%) 200,000

July 210,000

Cash (15%) 31,500

Credit (80% & 5%)

TOTAL 223,250 205,000 241,250

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Schedule of payment of inventory purchases

Total May June July

Purchases

April (60% of sales) 138,000

cash (60%) 82,800

credit (40%) 55,200

May (60% of sales) 117,000

cash (60%) 70,200

credit (40%) 46,800

June (60% of sales) 150,000

cash (60%) 90,000

credit (40%) 60,000

July (60% of sales) 126,000

cash (60%) 75,600

credit (40%)

TOTAL 125,400 136,800 135,600

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Question 2
Prepare for the months of October, November and December 1999:

(a) A schedule of collections from Accounts Receivables

SALES August Septembe October November Decembe
r r
August 160,000 112,000 32,000 12,800
September 220,000 154,000 44,000 17,600
October 200,000 140,000 40,000 16,000
November 180,000 126,000 36,000
December 162,000 113,400
196,800 183,600 165,400

(b) A schedule of payments to Trade Payable.

PURCHASES October November December
September 132,000 105,600
October 120,000 24,000 96,000
November 108,000 21,600 86,400
December 97,200 19,440
129,600 117,600 105,840

(c) A cash budget

October November December
Cash at start (13,950) (57,250) (427,700)
Sales Revenues 196,800 183,600 165,400
Courier Revenues 20,000 21,000
TOTAL CASH 182,850 146,350 (241,300)

Purchases 129,600 117,600 105,840

Shop rent 66,000
Staff wages 40,000 36,000 32,400
Tax 110,950
Loan 160,000
Drawings 4,500 4,500 4,500
Insurance 22,000
Courier service start 100,000 100,000
Courier service on-going 45,000 45,000
TOTAL EXPENSES 240,100 574,050 309,740

Cash at End (57,250) (427,700) (551,040)

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(d) In the absence of evidence to the contrary, it is assumed that a
business will continue to operate indefinitely into the future. Thus its
assets generally are assumed that they are not held for resale, nor
valued accordingly, but valued on the historical cost principle. If data
suggests that continued existence will be a problem, then the
accounting record has to indicate this fact. This means that financial
reports then are prepared based on expected sales or market values
of assets. Solvency refers to the capacity of a business to met it s
debts as they become due. Liquidity refers to the speed with which a
business’s assets can be turned into cash, without an appreciable
loss of value. The cash budget shows that the firm does not have
enough cash to satisfy its obligations and planned purchases for
December. As a result, it will not be able to conduct its normal
operations and may be forced into liquidation.

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Question 3
Cash Budget for the first 3 months of the 2006/2007 financial year

July 2006 Aug 2006 Sept 2006

£ £ £
Opening cash balance 100,000 230,380 288,580

Cash receipts
Receipts from sales (W1) 510,000 432,000 518,400

Cash payments
Purchases (W2) 216,000 252,000 360,000
Fixed and variable expenses 160,620 118,800 158,400
Cash dividends 0 0 40,000
Advertising 0 0 15,000
Equipment replacements 3,000 3,000 3,000
Tax 0 0 60,000
Repayment of bank loan 0 0 280,000
Interest expense (12%*100k*3/12) 0 0 8,400
379,620 373,800 924,800

Net cash inflow / (outflow) 130,380 58,200 -406,400

Closing cash balance 230,380 288,580 -117,820

June July Aug Sept

May 2006 2006 2006 2006 2006
(W1)
Sales 600,000 800,000 360,000 420,000 600,000
Receipts:
60% of current month 216,000 252,000 360000
30% of previous month 240,000 108,000 126000
9% of the month before previous 54,000 72,000 32400
Total 510,000 432,000 518,400

Aug Sept Oct

(W2) July 2006 2006 2006 2006
Cost of sales 216,000 252,000 360,000 324,000 (0.6*540k)
+ Closing inventory 252,000 360,000 324,000
- Opening inventory 216,000 252,000 360,000
= Purchases 252,000 360,000 324,000

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Question 4

Cash Budget for the four months ended 30 April 2010

Jan Feb Mar Apr
£ £ £ £
Receipts:
Sales 10,800 71,700 120,560 105,880

Payments: 40,000
Purchases 62,000 50,000 36,000
Labour 34,000 34,000 26,000
Capital Expenditure 180,000 – 20,000
Production Expenses 8,500 5,500 4,500 5,500
Administration Expenses 9,200 7,200 7,200 7,200
Selling and Distribution 7,500 8,500 7,000 9,500

39,200 117,200 114,700 8,200

Net cash flow (228,400) (45,500) 5,860 7,680

Balance b/f 0 (228,400) (273,900) (268,040)

Balance c/f 228,400 273,900 268,040 260,360

B) There are three main points to be made in answer to this part of the
question.
• The cash budget identifies shortfalls of cash and enables the company to find
appropriate financing for the project.
• The cash budget enables the company to determine the ongoing working
capital implications of the project.
• The cash budget can be used to avoid over-trading and liquidity crises.

30
Question 5

Week 1 2 3 4 5 6
(£)
(£) (£) (£) (£)
(£)
Receiptfrom 24,000 24,000 28,200 25,800 19,800 5,400
Accounts
Payments:
Receivables
Materials 8,000 12,500 6,000 nil nil nil
Wages 3,200 4,200 2.800 nil nil nil
Variable overheads 4,800 3,200 nil nil nil nil
Fixed overheads 8,300 8,300 6,800 6,80 6,80 6,800
0 0
Total payments 24,300 28,200 15,600 6,800 6,800 6,800

Net cash flow (300) (4,200) 12,600 19,000 13,000 (1,400)

Opening balance 1,000 700 (3,500) 9,100 28,100 41,100

Closing balance 700 3,500) 9,100 28,100 41,100 39,700

31
b. Finance will be required to meet the cash deficit in week 2, but a lowering of the
budgeted material Inventory at the end of week 1 would reduce the amount of cash
to be borrowed at the end of week 2.
1. The surplus cash after the end of week 2 should be
invested on a short-term basis.
2. After week 6, there will be no cash receipts, but cash outflows
will be £6,800 per week. The closing balance of £39,700 at
the end of week 6 will be sufficient to finance outflows for a
further five or six weeks (39,700/£6,800 per week).
3. Assumptions underlying the cash flows budget may be
subject to significant uncertainty.
4. There may be additional costs of plant closure and reopening
due to strike.

32
 Answer to Homework Questions – Lecture 19

Question 1

Price Variance 143 (U) (b)

(0.4 - 0.42)X 7,150

Usage Variance
(6,960 - 7150)X 0.4 76 (U) (b)

Total Material Variance 219 (U) (a)

33
Question 2
Formula
Price Variance = (Budgeted Price - Actual Price) X actual Quantity Purchased/Used

Efficiency variance = (Budgeted Usage - Actual usage) X Budgeted price

Computation

Price variance -220.00 Adverse

(5- 5.2) X 1,100

Efficiency variance 750 Favourable

(5 X 250 -1,100)X 5

Total variance 530 Favourable

Possible Reasons:
1) Price variance- more expensive materials used causing lower
spoilage and hence favourable efficiency variance.

2) Efficiency variance - More experienced workers who are

able to reduce spoilage.

Question 3
Benefits of budgeting
1) Forces planning and improves co-ordination.

2) Improves communication between departments and subordinates.

3) Improves control because highlights problem areas so that corrective

action can be taken.

4) Enhances motivation and employees are clearly directed to targets and

given appropriate feedback.

Limitations:
Dyfunctional behaviour may result if:
1) Budgets may not be taken seriously if they are deemed unrealistic.

2) Responsibility not assign fairly.

3) No timely feedback given to staff.

34
Question 4

A limiting factor is a factor or constraint that

prevents indefinite expansion
or unlimited profits.

Examples:
- labour, material, equipment and factory space may be in short supply.
- firms cannot sell unlimited quantities of output without reducing price

Master budgets are the budgeted profit and loss account, Statement of
Financial Position and the cash budget.
Purposes of budgeting:
- Allow regular examination of organisation’s goals & basic policies
- strengthen cohesiveness of management
- Forces management to plan ahead
- Optimises utilization of resources

Flexible budgeting is the adjustment of original budgets to reflect fluctuations in

activity level.
- Provide a yardstick with which the performance can be compared and
assessed against
- Allow superior to control and monitor the performance of subordinates through
the computation of variances such as material, labour
and overhead variances.

35
Question 5

Operating statement - April 2007 Fav Unfav £

Budgeted profit (500x36) 18,000
Sales variances: Volume (i) 1,440 -
Price (ii) - 3,240 1,800
16,200
Cost variances
Materials: Price (iii) 1,100 -
Efficiency (iv) - 400

Labour: Price (v) - 400

Efficiency (vi) - 160

Variable overhead: Price (vii) 400 -

Efficiency (viii) - 100

Fixed overhead: Spending (ix) - 2,000

Volume (x) 960 -
2,460 3,060 600
Actual profit 15,600

36
 Flexible
(i) (540-500)*36 budget
@540
(ii) 540*(126-(64800/540)) units
Price Eff
Actual var AQ*SP var SQ*SP
Materials 20,900 (iii) (1,100) 22,000 (iv) 400 21,600
Labour 9,200 (v) 400 8,800 (vi) 160 8,640

Var OH 5,100 (vii) (400) 5,500 (viii) 100 5,400

Fixed OH 14,000 (ix) 2,000 12,000 (x) (960) 12,960

(b)

Question 6

Labour rate variance 513 Adverse

Labour efficiency variance 275 Adverse
Power
cut idle time variance 550 Adverse
Workings
Labour rate
(AQ x AP) – (AQ x SP)
(1,710 x 5.80) – (1,710 x 5.50)
9,918 – 9,405 = 513
Labour efficiency (based on hours worked and paid)
(AQ x SP) – (SQ x SP)
(1,610 x 5.50) – (1,560 x 5.50)
8,855 – 8,580 = 275
Power cut (hours paid not worked) 100 x 5.50 = 550
N.B. If idle time is not computed the labour efficiency variance is £825 Adverse

37
Question 7

a. Operating statement for 4 weeks to 31 May 2009.

Favourable Adverse £000

Budgeted profit 200

Sales price variance (500)

Sales margin variance 50 _____ ____

50 (500) (450)

Standard profit (250)

Cost variances

Materials : price (48)

: efficiency 20

Labour : price (125)

: efficiency (250)

Var OH : price 67.5

: efficiency (62.5)

Fixed OH : spend (50)

: volume 150 _____
237.5 (535.5) (298)

Actual loss (548)

38
 Answers to Homework Questions – Lecture 20 & 21

Question 1
a)
Depreciation (100000-20000)/5 year = 16,000

Payback Period

Project P
Year Cash Flow Cumulative
Cash Flow
0 (100,000) (100,000)
1 50,000 (50,000)
2 40,000 (10,000)
3 30,000 +20,000
4 20,000
Payback period = 2 1/3 = 2.33 years

Project Q
Year Cash Flow Cumulative
Cash Flow
0 (100,000) (100,000)
1 20,000 (80,000)
2 20,000 (60,000)
3 28,000 (32,000)
4 32,000 0
Payback period 4 years

b)
Disadvantages : –
-Ignores Time Value of Money.

–Ignores Cash Flows after Payback Therefore Bias Against Long Term
Projects –

Question 2

Contribution per year (520-400)*220 26,400

Fixed cost -44,000
Yearly subsidy 40,000
Annual net profit 22,400

Year 0 Year 1 Year 2

Closing NBV 200,000 160,000 120,000
Ave NBV 180,000 140,000

AROR 22,400 22,400

180,000 140,000
= 12.4% 16.0%

39
Question 3

2009 2009 2010 2011 2012 2013 2014

000 Start
Sales 0 800 800 800 640 400
Equipment (480) 80
Inventory` (60) 60
W Capital (40) 40
Overheads (16) (16) (19.2) (19.2) (19.2)
Materials (480) (480) (480) (384) (240)
Variable
Cost (80) (80) (80) (64) (40)
Cash Flow (580) 576) 224 220.8 332.8 520.8 400
D Factor 1 0.893 0.797 0.712 0.636 0.567 0.507
Present
Value (580) (514.4) 178.5 157.2 211.7 295.3 202.8

NPV = (48,900)

A negative NPV project should be rejected.

40
Question 4

Accounting Rate of Return is the ratio of the average annual profit to the
investment amount for a project.

Advantages:
1) Relatively simple to use as data readily available.

Disadvantages:
1) Does not account for time value of money.

2) Uses subjective accounting profit instead of objective cash flows.

3) Ignores the absolute size of the investment outlay.

4) It is not an absolute measure, difficult to say if ARR of 30% is good or bad.

Question 5

Project A Cash Flow Cumulative

Cash
Flow
Year
0 -75,000 -75,000
1 30,000 -45,000
2 20,000 -25,000
3 15,000 -10,000
4 10,000 0
5 10,000 10,000

Payback Period 4 years

Payback Period
140000/45000 3.11 Years

iii) Net Present Value

Project A
Present
Year Cash Flows PVIF @6% Value
0 -75,000 1.000 -75,000
1 30,000 0.943 28,290
2 20,000 0.890 17,800
3 15,000 0.840 12,600
4 10,000 0.792 7,920
5 10,000 0.747 7,470

Total -920

41
Project B
Present Value of inflows
45000 X PVIFA 6% 5
years 189,540.00

-
Less: Initial Investment 140,000.00

Net Present value 49,540.00

Project A Cash Flow Cumulative

Cash
Flow
Year
0 -75,000 -75,000
1 30,000 -45,000
2 20,000 -25,000
3 15,000 -10,000
4 10,000 0
5 10,000 10,000

Payback Period 4 years

Payback Period
140000/45000 3.11 Years

iii) Net Present Value

Project A
Present
Year Cash Flows PVIF @6% Value
0 -75,000 1.000 -75,000
1 30,000 0.943 28,290
2 20,000 0.890 17,800
3 15,000 0.840 12,600
4 10,000 0.792 7,920
5 10,000 0.747 7,470

Total -920

42
Project B
Present Value of inflows
45000 X PVIFA 6% 5
years 189,540.00

-
Less: Initial Investment 140,000.00

Net Present value 49,540.00

b. Notes

Payback Method

1) Refers to the number of years it takes to recover initial investment. The shorter
the payback, the better.

2) Disadvantage is that it does not account for the time value of money and
ignores cash flows after payback period.

Net Present Value

1) Refers to the absolute increase in shareholder's wealth and is the most conceptually
sound technique.

2) Accounts for the time value of money.

IRR
1) Refers to the minimum return for the project to be acceptable.

2) Gives the same accept/reject decision as the NPV for individual project.

3) Accounts for the time value of money.

4) Conceptually, IRR is problematic as there potential for multiple IRRs.

Recommendation:
Company should use the NPV method as is the most conceptually
sound technique.

The Payback could be used as an initial screening device.

43
 Question 6
The payback period of investment appraisal focus on the payback
period.
The payback period refers to the number of years it takes to recover
the initial investment. Objective is to select the project with the shortest
payback period.

For example if a project requires an initial investment of $100,000

and produces cash inflows of $20,000 per year for the next 8 years,
its payback period is 5 years.($100,000/$20,000)

Advantages of payback
1) Simple to use

2) Uses objective cash flow instead of subjective accounting profit.

Disadvantages:
1) Ignores the time value of money.

2) Ignores the cash flow after the payback period.

QUESTION 7

a) NPV YEARS
Description 0 1 2
Initial Investment -900,000
Building Cost -1,000,000 -600,000
Apartment sales 1,800,000
300000 X 6
300000X3 900,000
Net Cash Flow -900,000 800,000 300,000
X PVF @12% 1 0.893 0.797

Present Value -900,000 714,400 239,100

NPV 53,500

b) To get the % increase in Auction

price, simply use the following
formula
= NPV / Auction Price

I) Auction Price 953,000

= 53500/953,000 = 5.61%
increase
Therefore auction price
= 1.0561 X 953,000 = 1,006,500

ii) % reduction in sales price

= NPV/ Present value of sales price

44
Present value of sales Price =
(1,800,000X
.893)+(900000X0.797)
=2324700

% reduction = 53500/2324700
= 2.3% X300,0000 =6,900

sales price can fall by 2.3%

Hence each unit can be reduced by 6,900 for a price of

300,000 - 6,900= 293,100

iii) Cost of capital with zero NPV = IRR

Discount rate of 12% = + 53,500

Try discount rate of 17%

a) NPV YEARS
Description 0 1 2
Initial Investment -900,000
Building Cost -1,000,000 -600,000
Apartment sales 1,800,000
300000 X 6
300000X3 900,000
Net Cash Flow -900,000 800,000 300,000
X PVF @12% 1 0.855 0.731

Present Value -900,000 684,000 219,300

NPV 3,300

5% Reduction = 50200 reduction in NPV

for further 3,300 reduction, increase discount rate by 3,300/50200X5%
0.32
Hence rate = 17% =0.32% = 17.32%

c) Risk of the project is of the project eventually becoming

a negative NPV project when it was first thought to be a
positive NPV project.

Hence the major risk factor is the fall in the price of the
house as it will only take a 2.3% (small) decrease to cause
NPV to be negative.

Because the auction price is paid at the beginning, it can be

factored in to the company's bid.

45
Question 8
(a) Payback period A B C

(years) 2 2 3

(b) Accounting rate of return

Average profit 5,000 2,500 5,000
Average investment 30,000 25,000 30,000

ARR 16.67% 10% 16.67%

Workings – Alpha
Average profit = (cash flows – depreciable amount) ÷ 4
= (60,000 – 40,000) ÷ 4
= 5,000

Average investment = Initial investment + residual value

2
= 50,000 + 10,000 = 30,000
2
(c) On the basis of ARR projects A and C are preferred. However, as A has a shorter
payback period this is the preferred option.

46
5
Question 9
(a) Discounted cash flow computations

Start End £000

2009 2009 2010 2011 2012 2013

Sales receipts 1,300 2,000 2,200 2,200 2,200

Disposal costs 80 80 80 80 160

Cost of materials (1,200) (1,400) (1,400) (1,400) (1,450) –

Equipment (1,650) 50

Labour costs (95) (115) (125) (115) (115)

Overheads (20%) _____ (30) (65) (60) (60) (60)

Net cash flow (2,850) (145) 500 695 655 2,235

Discount rate 0 .893 .797 .712 .636 .567

Present value (2,850) (129) 399 495 417 1,267

Net present value = (401)

(Ignore commissioning report cost)

Advice to the board

If the loss is measured in opportunity cost NPV terms then the project
can go ahead as it is within the agreed £500K.

(b) When making any decision about the future, managers have to rely on their
expectations of future events. As no one can perfectly predict the future, investment
decisions are affected by uncertainty (whatever method of investment appraisal is used).
Long-term decisions are affected more than short-term decisions, as it is easier to make
accurate predictions over a shorter time period.
Uncertainty can affect the amount or timing of future cash flows, as well as deciding which
discount rate is appropriate (when using DCF techniques). However, managers can assess
how sensitive their decisions are to errors in their estimates and forecasts. This is called
sensitivity analysis.
In respect of the recycling project, considerations might be:
• the amount by which sales reductions give an NPV less than £(500)K
• the amount by which labour costs might increase to give an NPV less than £(500)K.

THE END

47