Reference no: EM13793305
Section 1 Nature of the information presented by accountants
It is important that you have an understanding of the way in which financial statements are prepared. Although it is not expected that you will a detailed knowledge of either the legislation or the accounting standards, it is important that you understand the concepts and conventions of financial accounting.
Question 1
It is important that readers of the Annual Reports of companies are aware of terms that are often used in the Audit Report and Directors' Report.
(a) Explain each of the following:-
- "True and fair view" of the company's financial position and results of the period;
- Historical cost as the basis of valuation of the company's assets in the Balance Sheet;
- The going concern concept.
(b) Discuss the importance of each of these terms to a financial analyst, who has been asked to estimate the value of the company in acting as an advisor to a company that is considering making a bid to acquire a majority holding in the company.
Question 2
(a) Discuss the nature of the accounting information that is provided in a typical Cash Flow Statement that is included in the Annual Report of most companies. You should include a typical Cash Flow Statement in your answer but it is not necessary to show any figures.
(b) Discuss the significance to financial analysts of three of the accounting conventions / concepts when they are using ratio analysis to assess the performance of companies.
There was a question for 25 marks from the final section of the materials - Performance Measurement.
Question 3
In many countries, the prime purpose of financial statements is to provide information to the shareholders. However, after publication, the Annual Report is available to the general public.
(a) What parts of the Annual Report are likely to be of interest to the shareholders? Do you consider that a typical Annual Report provides the information that they are seeking?
(b) What parts of the Annual Report are likely to be used by the other people, who have an interest in the company?
(c) Why do companies publish detailed accounting statements if the information can be used against them?
Section 2 Interpretation of financial statements
The ratio formulae will be provided in the examination as this is NOT a test of your ability to memorise the ratios but to enable you to demonstrate that you are able to interpret the financial information shown in the financial statements. The causes of the changes in the ratios should be discussed.
Question 4
SAM plc manufactures and sells beer and non-alcoholic drinks in many countries. The same technology is used in all the factories and the cost of production is the same in all parts of the world. The expenses in each geographic area are 4.5 % of Sales but the level of advertising and promotional expenses are decided by the management of each geographic area. The financial statements for the year show the following information and ratios have been calculated using the attached ratios.
Africa America Europe TOTAL
Sales - million units 6 000 5 000 2 000 13 000
Sales - £ million 7 200 5 000 2 800 15 000
Ratios
Return on Capital Employed 12.3% 1.6% 18.7% 9.2%
Net Profit Percentage 20% 3% 25% 15%
Gross Profit Percentage 25% 10% 36% 22%
Stock Holding Period (days) 60 40 48 51
Debtor Payment Period (days) 90 73 26 73
Creditor Payment Period (days) 182 182 182 182
Required:-
(a) From this information, compare and contrast the performance of the company in each area of the world. Discuss the strategies in each part of the world in respect of:-
(i) pricing;
(ii) advertising and promotional activities;
(iii) the use of resources which has resulted in differences possible causes of the differences in the Return on Capital Employed.
(b) Calculate the Return on Shareholder's Funds for the whole company If the Interest expense for the year was £500 million and the tax payable was £600 million. The Long-term Debt at the end of the financial year was £8 350 million.
(c) Discuss the financial structure of the company.
Question 5
ABE plc sells only one product. In 2009, there were sales of 10 000 units. During 2010, the unit sales increased to 16 000 units but the profit was lower than expected. The accountant has been asked to prepare a report that can be used to discuss the company's performance and financial position at the next Board meeting. Prior to the meeting, you have received the following information in respect of the years 2004 and 2005.
2009 2010
£000 £000
Sales 2000 2400
Net profit before interest and tax 700 360
Interest expense for the year 100 170
Tax payable 180 57
Net profit after tax 420 133
Ratios (using the attached formulae)
Profitability
Gross Profit Percentage 55% 40%
Net Profit Percentage (after tax) 21% 5.6%
Return on Capital Employed 17.4% 7.8%
Return on Shareholders' Funds 13.0% 3.9%
Liquidity
Current ratio 3.70 4.00
Quick ratio 2.20 1.50
Efficiency ratios
Stock Holding Period (days) 122 127
Debtor Payment Period (days) 44 46
Creditor Payment Period (days) 81 51
Financial Structure
Gearing 20% 27%
Interest Cover 7.0 times 2.1 times
Required:
(a) Prepare a report that identifies possible causes of the changes in the profitability, liquidity and financial position of the company over the period of two years.
(b) Recommend a strategy that could be adopted to improve the performance and financial position of ABE plc. It is generally accepted that the selling price per unit cannot be increased without a major loss of market share. In addition, reductions in the cost of materials and labour are not possible.
Question 6
Parpan plc manufactures and sells a luxury product. Sales and profit have grown over the past two years. However, the latest budget, which has just been prepared, shows that both sales and profits are significantly lower. The details are:-
Year 2007/08 2008/09 Budget 2009/10
Sales - units 6 000 7 500 6 250
£ £ £
Sales 675 000 720 000 625 000
Gross profit 135 000 180 000 112 500
Net profit before interest & tax 54 000 72 000 37 500
Net profit after tax 31 500 48 300 21 350
Ratios (calculated using the attached formulae)
Gross profit percentage 20% 25% 18%
Net Profit percentage 8% 10% 6%
Return on Capital Employed 17% 19% 9%
Return on Shareholders' Funds 11% 15% 6%
Current ratio 3.3 4.3 5.1
Acid test ratio 1.3 1.9 2.5
Inventory - days 60 70 80
Receivables / Debtors - days 30 45 60
Payables / Creditors - days 30 30 30
Leverage / Gearing 8% 15% 18%
Interest cover 24 24 11.5
Required:
(a) Discuss the performance and financial position of the company over the two year years - 2007/08 and 2008/09. (Limit your discussion to just the two years and ignore the budget at this stage.)
(b) The Managing Director has suggested that decreasing the unit selling price by 10 per cent would improve the budgeted results. However, she expects that the decreased selling price will increase the sales units to 7500 units. If 50 percent of the cost of sales is considered to be variable costs and all the other expenses are fixed costs, should this proposal be implemented?
(c) What other actions would you recommend to improve the Return on Capital Employed in the budget period of 2009/10.
Section 3 Determining the cost of a product or service
This is the start of the cost and management accounting section. It is important that you appreciate the nature of costs - direct / indirect and variable / fixed as this is fundamental to an understanding of this and the next part of the course.
Question 7
Warriston plc offers a range of products that are processed in each of two departments. The customers supply their own materials and the following information has been obtained about the cost of producing the three products.
Product Basic Standard Superior
Estimated sales - units 1 000 800 500
Labour required to produce each unit
Department 1 - hours 5 12 20
Department 2 - hours 6 8 10
The average wage paid to the workers is £15 per hour in all departments.
Overhead costs Dept 1 Dept 2 Service 1 Service 2
Direct overhead costs £100 000 £120 000 £80 000 £65 000
Allocated costs £ 39 800 £ 46 100 £40 000 £35 000
Use of Service 1 40% 50% ----- 10%
Use of Service 2 30% 70% ----- -----
Required
(a) If direct labour hours are used to apportion overheads to products, calculate departmental overhead recovery rates that should be used and then calculate the total cost of each of the products manufactured by the company.
(b) There is fierce competition in the industry. The overhead costs are all fixed and as the company has a permanent work force, the labour costs should also be regarded as a fixed cost. Prepare a report providing advice on the company's pricing strategy.
(c) Activity Based Costing (ABC) was developed to deal with the overhead allocation process. Explain ABC and discuss the benefits that would result if Warriston plc were to adopt ABC rather than the use of overhead recovery rates, based on direct labour hours, to apportion overhead costs to the products that they offer to their customers.
Question 8
The Sales Director of MN plc has asked for the accountant to provide details of the "full" cost of the two products that are sold. The cost details are:-
Product M Product N
Expected sales - units 5 000 7 000
Material £15 £12
Labour hours per unit - Dept 1 2 1
Dept 2 1 2
The labour cost is £10 per hour in both departments.
Dept 1 Dept 2 Canteen Repairs TOTAL
Allocated costs £444 800 £99 700 £77 000 £100 000 £721 500
Rent & Power (apportioned on the basis of area) £100 000
Management costs - Apportioned on the basis of numbers £200 000
Further information about the utilisation of the service departments is:-
Area 55% 25% 8% 12%
Numbers 60% 25% 5% 10%
It is expected that 60% of the repair facilities will be used by Dept 1 and 40% will be used by Dept 2. The Canteen costs should be apportioned to the other departments on the basis of the numbers in each department but the Canteen staff should not be included in this part of the calculation.
Required:
(a) If overheads are apportioned to products on the basis of direct labour hours, calculate the cost of each product if only one overhead recovery rate is used.
(b) Calculate the cost of each product if separate departmental recovery rates are used.
(c) If the managers use total cost to set selling prices, discuss the implications of using separate departmental overhead recovery rates rather than a company-wide recovery rate
(d) Explain Activity- based Costing (ABC) and discuss the benefits that could be expected from the adoption of this method of apportioning the company's overheads.
Section 4 Short-term decisions
Contribution is the most important concept that must be used in this part of the course. It is essential that the contribution approach is adopted when making short-term decisions.
Question 9
HAL plc manufactures and sells four products that use the same production facilities. In the plan for 2006, the details of each product were:-
Product J K L M
£ £ £ £
Selling price per unit 83 70 45 30
Variable costs per unit 40 35 25 12
Apportioned fixed costs per unit 25 20 10 10
Profit per unit 18 15 10 8
Estimated sales - units 10 000 15 000 20 000 20 000
Estimated profit - £000 180 225 200 160
When the budget was prepared, the total fixed costs were estimated to be £950 000 and the output was expected to be 190 000 direct labour hours. An overhead recovery rate, based on Direct Labour Hours, is used to apportion the fixed costs to products.
As a result of unforeseen circumstances, the capacity has been reduced to only 145 000 direct labour hours in 2006 but the overhead costs will not be affected by the change in the output level.
Required
(a) What products should be produced and sold to maximise the company's profit and what will be the total profit of the company?
(b) As an alternative to turning away orders, it has been suggested that the selling price of all four products should be increased by 10 per cent. It is expected that this will reduce the demand for each product by 25 per cent. This would reduce the required direct labour below the 145 000 hours that are now available. Would this result in a better outcome than that the one resulting from the strategy proposed in part (a)?
There was another question for 20 marks but it is part of another section of the syllabus.
Question 10
The annual budget of MN0 plc has just been completed and the details are:-
Product P Product Q Product R TOTAL
Sales - units 20 000 40 000 120 000 ---
£000 £000 £000 £000
Sales 2 000 3 200 10 200 15 400
Variable costs 800 2 200 8 400 11 400
Fixed Costs 440 720 2 640 3 800
Total costs and expenses 1 240 2 920 11 040 15 200
Profit / (Loss) 760 280 ( 840) 200
The Directors were alarmed at the forecast of the results and asked for the following alternative courses of action to be assessed:-
(a) What would be the effect of not producing and selling Product R?
(b) An additional amount of £130 000 is available to advertise one of the three products. If it is expected that the additional advertising expenditure would increase the sales of each product by 10%. Should the adverting of any of the products be increased by £130 000?
(c) The decisions in part (a) and (b) are the typical of the decisions that are made when the annual budget of an organisation is being prepared. Describe the process that is most commonly used to produce a organisation's annual budget.
(d) Although many managers consider the production of an annual budget to be a waste of time, most organisations prepare one. Discuss the benefits that arise from the preparation of an annual plan.
Question 11
Bermen plc makes only one product and it is expected that 100 000 units would be manufactured and sold annually at a selling price of £200 per unit. The details of the expected costs per unit are as follows:-
£
Material B 5 kg @ £3 / kg 15-00
Material M 3 kg @ £4/ kg 12-00
Labour 6 hours @ £10 / hour 60-00
Fixed Overheads £8 000 000 / 100 000 units 80-00
Total costs 167-00
The company has a permanent work force and so the Labour costs is regarded as a fixed cost when the managers make decisions.
Required:
(a) What is the company's expected annual profit?
(b) What is the break-even point of the company?
(c) Discuss the assumptions that are made in determining the break-even point and in the light of these assumptions, evaluate the usefulness of break-even analysis to managers.
(d) At the present time, the company is operating at 75% of its production capacity as there is fierce competition in the industry. An enquiry has been received from abroad for 100 000 units. You have been asked to determine the minimum selling price that could be quoted so that the company covers all the costs that are relevant to this order.
Material B is used in many products that are manufactured by the company and there is more than 500 000 kg in stock. It was purchased at £3 but the market price is now £5 per kg.
300 000 kg of Material Q were purchased at £2-50 per kg recently. It was thought that this cheaper material would be a substitute for Material M but it was found to be unsuitable for the purpose. It can be used in this export order. If not used for this order, it could only be sold at a net price of only £1 per kg.
The labour rate and overhead costs will not change if the export order is accepted. However, £15 000 has already been spent on providing samples and visits to the customer abroad.
Question 12
A firm manufactures four products that use the same production facilities. The preliminary 2008/2009 budget has been prepared and the details are as follows:-
Product PB QC RD SF
Sales - units 1000 1200 1500 2000
£000 £000 £000 £000
Sales 300 384 720 480
Variable costs 220 240 330 240
Fixed costs 40 96 270 200
Profit 40 48 120 40
The fixed costs were apportioned to products on the basis of direct labour hours. The overhead recovery rate was £20 per direct labour hour as the total fixed overheads were £606 000 and budget estimated that 30 300 direct labour hours would be worked during the year.
Required:-
(a) After the budget had been prepared, it was found that only 24 300 direct labour hours were available. This meant that the sales would not reach the levels shown in the budget. Which products should be produced and sold to maximise the company's profit as it is not likely that additional skilled labour will be available. It is also not possible to sell more than the budgeted sales units of any of the four products.
(b) It has been suggested that increasing the unit selling prices by 10 per cent, would reduce the units sold by 20 per cent and all these units could be produced within the constraint of the 24 300 direct labour hours. Would this be a more profitable alternative course of action for the firm?
(c) What was the break-even of the firm when the budget was prepared?
(d) Discuss the usefulness to managers of an understanding of Break-even analysis in the light of the assumptions which must be made when determining the break-even point of a firm.
Section 5 Budgets and budgetary control
This is a part of the course that leads into the issue of Control. It is necessary to have a plan to enable managers to assess if the organisation is meeting its objectives. It is a time-consuming process and it is usually resented by the line managers T it does provide opportunities for communication and co-ordination and from an accounting perspective, control.
Question 13
(a) Discuss the costs and benefits of decentralisation in a firm that sells a range of different products countries that are manufactured in factories in several different geographical areas of the world.
(b) What accounting information would be most appropriate to be provided to the managers of:-
(i) discretionary cost centres
(ii) cost centres with output that can be measured
(iii) profit centres
(iv) investment centres
Question 14
In both commercial and public sector organisations, budgeting is an integral part of the management process.
(a) Describe the major functions that are assigned to budgets and the budgeting process and explain how an organisation benefits from the regular preparation of a budget.
(b) Discuss the reasons that budgets "fail" and suggest ways in which the effect on the organisation can be minimised.
Section 6 Measuring performance
It is particularly difficult to measure performance effectively. Issues, such as the diversity of accounting policies used create problems and this section of the course will look at some of the developments that have been introduced to improve performance measurement.
Question 15
Explain and discuss the usefulness of Economic Value Added (EVA) to measure the performance of companies.
Question 16
A manufacturing company, which operates in a highly competitive environment, is reviewing the manner in which its performance is measured. It has been suggested that the senior managers may find the use of the Balanced Scorecard useful.
(a) Describe the Balanced Scorecard and discuss appropriate performance measures that could be shown in each section of the report.
(b) Explain the benefits that could be obtained from adopting Economic Value Added (EVA) as a measure of performance.
Question 17
There are three divisions in a company that manufactures a range of different products. Return on Capital Employed (ROCE) is used to measure the performance of each division. At 30th September 2005, the results of each division were:-
Division 1 Division 2 Division 3 Total
£ million £ million £ million £ million
Profit before interest and tax 36 24 24 84
Interest expense 15
Profit before tax 69
Tax payable 21
Profit after interest and tax 48
Fixed assets - net book value 180 120 100 400
Net current assets 120 120 60 300
There was a Long-term Loan of £260 million at 30th September 2005.
The Balance Sheet also showed the following:-
£ million
Issued Share Capital - 80 million shares of 50 pence each. 40
Reserves 400
440
Required
(a) Calculate the Return on Capital Employed for the whole company and for each division and the Price / Earnings ratio for the company if the share price at 30th September 2005 was 720 pence.
(b) The Return on Capital Employed ratios calculated for each division in (a) was between 3 per cent and 5 per cent lower than the levels expected when the budget had been prepared. Discuss the possible causes and effects of the change in these ratios. For the past five years, the Price / Earnings ratio of the company has usually been about 15.
(c) How could the Return on Capital Employed be improved over the rest of the financial year? It is recognised that it is not possible to either increase selling prices or reduce costs.
(d) Discuss the difficulties that arise if Return on Capital Employed is used to measure divisional performance. Explain another means of measuring the performance of an investment centre, highlighting the benefits of adopting this alternative measure.
Question 18
The senior management of Steinbury plc were keen to evaluate the company's performance and have asked you to prepare a report that will enable them to obtain a better picture of the position in respect of 2007.
The following information was available in the Annual Report:-
Income statement information £ million
Profit before interest and tax (EBIT) 1 000
Interest expense 50
Profit before taxation 950
Tax expense 150
Profit for the financial year 800
Balance Sheet information
Non-current assets 7 800
Current assets less current liabilities 200
8 000
Less: Non-current liabilities / Long-term Debt 3 000
Total Equity 5 000
Additional information
1. The interest rate on the long-term debt is 5 per cent per annum
2. The tax rate is 33 1/3 per cent
3. Equity investors in companies with this risk profile require a return of 12 per cent.
Required:
(a) What is the company's Return on Capital Employed (ROCE) fir 2007?
(b) Discuss the problems that are faced in measuring performance, using Return on Capital Employed.
(c) Calculate the Residual Income of the company for 2007.
(d) Discuss the advantages of using Residual Income (RI) to measure the company's performance.
(e) Explain Economic Value Added (EVA), highlighting the differences between EVA and Residual Income (RI).