Pearson Education Management Accounting for Decision Makers_14 ppt

A fixed cost is one that is the same irrespective of the level of activity or output.. Typicalexamples of costs that are fixed, irrespective of the level of production or provision of a

Students Whether to enrol on a course of study This would probably involve

an assessment of the university’s ability to continue to operate and tofulfil students’ needs

Other universities How best to compete against the university This might involve using and colleges the university’s performance in various aspects as a ‘benchmark’

when evaluating their own performance

Employees Whether to take up or to continue in employment with the

univer-sity Employees might assess this by considering the ability of theuniversity to continue to provide employment and to rewardemployees adequately for their labour

Government/ How efficient the university is in undertaking its various activities.funding authority

Local community Whether to allow/encourage the university to expand its activities To representatives assess this, the university’s ability to continue to provide employ-

ment for the community, to use community resources and to helpfund environmental improvements might be considered

Suppliers Whether to continue to supply the university at all; also whether to

supply on credit This would involve an assessment of the sity’s ability to pay for any goods and services supplied

univer-Lenders Whether to lend money to the university and/or whether to require

repayment of any existing loans To assess this, the university’s ity to meet its obligations to pay interest and to repay the principalwould be considered

abil-Board of governors Whether the performance of the university requires improvement and other managers Here current performance would be compared with plans or some (Faculty deans, other ‘benchmark’ to decide whether action needs to be taken.and so on) Whether there should be a change in the university’s future direc-

tion In making such decisions, management will need to look at the university’s ability to perform and at the opportunities available

to it

In principle, there is no difference between the ways in which the user groups concernedwith a university and those concerned with a private sector business would use accountinginformation

1.1

Chapter 1

Appendix CSolutions to review questions

Most businesses are far too large and complex for managers to be able to see and assesseverything that is going on in their own areas of responsibility merely by personal obser-vation Managers need information on all aspects within their control Managementaccounting reports can provide them with this information, to a greater or lesser extent.These reports can be seen, therefore, as acting as the eyes and ears of the managers, pro-viding insights not necessarily obvious without them.

The following accounting information relating to a new service might be useful to a manager:

l the cost of providing the service and the level of profit that will be required;

l the capital investment that will be necessary to enable the business to provide the vice; and

ser-l the extent to which the provision of the service would be expected to enhance the ness’s wealth

busi-There is no doubt that the onus is on accountants to make their reports as easy to stand as they can possibly be A key aspect of accountants’ work is communicating to non-accountants, and they should never overlook this At the same time, accounting information cannot always be expressed in such a way that someone with absolutely noaccounting knowledge can absorb it successfully The onus is also therefore on managers toacquire a working knowledge of the basis on which accounting reports are prepared andwhat they mean

under-The two attributes are:

1 They must relate to the objective(s) that the decision is intended to work towards In

most businesses this is taken to be wealth enhancement This means that any tion relating to the decision that does not impact on wealth enhancement is irrelevant,where wealth enhancement is the sole objective In practice a business may have morethan one objective

informa-2 They must differ between the options under consideration Where a cost will be the same

irrespective of the outcome of the decision that is to be taken it is irrelevant It is only onthe basis of things that differ from one outcome to another that decisions can be made

A sunk cost is a past and, therefore, an irrelevant cost in the context of any decision aboutthe future Thus, for example, the cost of an item of inventories already bought is a sunkcost It is irrelevant, in any decision involving the use of the inventories, because this costwill be the same irrespective of the decision made

An opportunity cost is the cost of being deprived of the next best option to the one underconsideration For example, where using an hour of a worker’s time on activity A deprivesthe business of the opportunity to use that time in a profitable activity B, the benefit lostfrom activity B is an opportunity cost of pursuing activity A

Cost may be defined as the amount of resources, usually measured in monetary terms,sacrificed to achieve a particular objective

A committed cost is like a past cost in that an irrevocable decision has been made to incurthe cost This might be because the business has entered into a binding contract, for exam-ple to rent some premises for the next two years Thus it is effectively a past cost eventhough the payment (for rent, in our example) has yet to be made Since the business can-not avoid a committed cost, committed costs cannot be relevant costs

2.4 2.3 2.2

2.1

Chapter 2

1.4 1.3 1.2

SOLUTIONS TO REVIEW QUESTIONS 471

A fixed cost is one that is the same irrespective of the level of activity or output Typicalexamples of costs that are fixed, irrespective of the level of production or provision of a ser-vice, include rent of business premises, salaries of supervisory staff and insurance.

A variable cost is one that varies with the level of activity or output Examples includeraw materials and labour, where labour is rewarded in proportion to the level of output.Note particularly that it is relative to the level of activity that costs are fixed or variable.Fixed costs will be affected by inflation and they will be greater for a longer period than for

a shorter one

For a particular product or service, knowing which costs are fixed and which are variableenables managers to predict the total cost for any particular level of activity It also enablesthem to concentrate only on the variable costs in circumstances where a decision will notalter the fixed costs

The BEP is the break-even point, that is, the level of activity, measured either in physicalunits or in value of sales revenue, at which the sales revenue exactly covers all of the costs,both fixed and variable

Break-even point is calculated as

Fixed costs/(sales revenue per unit − variable costs per unit)which may alternatively be expressed as

Fixed costs/Contribution per unitThus break-even will occur when the contributions for the period are sufficient to cover thefixed costs for the period

Break-even point tends to be useful as a comparison with planned level of activity in anattempt to assess the riskiness of the activity

Operating gearing refers to the extent of fixed cost relative to variable cost in the total cost

of some activity Where the fixed cost forms a relatively high proportion of the total, we saythat the activity has high operating gearing

Typically, high operating gearing is present in environments where there is a relativelyhigh level of mechanisation (that is, capital-intensive environments) This is because suchenvironments tend simultaneously to involve relatively high fixed costs of depreciation,maintenance, and so on and relatively low variable costs

High operating gearing tends to mean that the effects of increases or decreases in thelevel of activity have an accentuated effect on operating profit For example, a 20% decrease

in output of a particular service will lead to a greater than 20% decrease in operating profit,assuming no cost or price changes

In the face of a restricting scarce resource, profit will be maximised by using the scarceresource on output where the contribution per unit of the scarce resource is maximised.This means that the contribution per unit of the scarce resource (for example, hour ofscarce labour, or unit of scarce raw material) for each competing product or service needs to

be identified It is then a question of allocating the scarce resource to the product or servicethat provides the highest contribution per unit of the particular scarce resource

The logic of this approach is that the scarce resource is allocated to the activity that uses

it most effectively, in terms of contribution and, therefore, profit

3.4 3.3 3.2

3.1

Chapter 3

472

In process costing, the total production cost for a period is divided by the number of pleted units of output for the period to deduce the full cost per unit Where there is work

com-in progress at the begcom-inncom-ing and/or the end of the period complications arise

The problem is that some of the completed output incurred cost in the preceding period.Similarly, some of the cost incurred in the current period leads to completed production inthe subsequent period Account needs to be taken of these facts, if reliable full cost infor-mation is to be obtained

The only reason for distinguishing between direct and indirect costs is to help to deduce the full cost of a unit of output in a job-costing environment In an environment where all units of output are identical, or can reasonably be regarded as being so, a process-costing approach will be taken This avoids the need for identifying direct and indirect costsseparately

Direct cost forms that part of the total cost of pursuing some activity that can, vocally, be associated with that particular activity Examples of direct cost items in the typical job-costing environment include direct labour and direct materials

unequi-Indirect cost is the remainder of the cost of pursuing some activity

In practice, knowledge of the direct costs tends to provide the basis used to charge heads to jobs

over-The distinction between direct and indirect cost is irrelevant for any other purpose

Directness and indirectness is dictated by the nature of that which is being costed, asmuch as the nature of the cost

The notion of direct and indirect cost is concerned only with the extent to which lar elements of cost can unequivocally be related to, and measured in respect of, a particularcost unit, usually a product or service The distinction between direct and indirect costs ismade exclusively for the purpose of deducing the full cost of some cost unit, in an envir-onment where each cost unit is not identical, or close enough to being identical for it to betreated as such Thus, it is typically in the context of job costing, or some variant of it, thatthe distinction between direct and indirect cost is usefully made

particu-The notion of variable and fixed cost is concerned entirely with how costs behave in theface of changes in the volume of output The benefit of being able to distinguish betweenfixed and variable cost is that predictions can be made of what total cost will be at particu-lar levels of volume and/or what reduction or addition to cost will occur if the volume ofoutput is reduced or increased

Thus the notion of direct and indirect cost, on the one hand, and that of variable andfixed cost, on the other, are not linked to one another, and, in most contexts, some ele-ments of direct cost are variable, while some are fixed Similarly, indirect cost might be fixed

or variable

The full cost includes all of the cost of pursuing the cost objective, including a ‘fair’ share

of the overheads Generally the full cost represents an average cost of the various elements,rather than a cost that arises because the business finds itself in a particular situation

The fact that the full cost reflects all aspects of cost should mean that, were the business to sell its output at a price exactly equal to the full cost (manufacturing and non-manufacturing cost), the sales revenues for the period would exactly cover all of the costand the business would break even, that is make neither profit nor loss

ABC is a means of dealing with charging overheads to units of output to derive full costs in

a multi-product (job or batch costing) environment

The traditional approach tends to accept that once identifiable direct costs, normallylabour and materials, have been taken out, all of the other costs (overheads) must be treated

as common costs and applied to jobs using the same formula, typically on the basis of directlabour hours

ABC takes a much more enquiring approach to overheads It follows the philosophy thatoverheads do not occur for no reason, but they must be driven by activities For example,

a particular type of product may take up a disproportionately large part of supervisors’ time If that product were not made, in the long run, supervision costs could be cut (fewersupervisors would be needed) Whereas the traditional approach would just accept thatsupervisory salaries are an overhead, which needs to be apportioned along with other over-heads, ABC would seek to charge that part of the supervisors’ salaries which is driven by theparticular type of product, to that product

One criticism is on the issue of the cost/benefit balance It is claimed that the work sary to analyse activities and identify the cost drivers tends to be more expensive than isjustified by the increased quality of the full costs that emerge

neces-Linked to this is the belief of many that full cost information is of rather dubious valuefor most purposes, irrespective of how the full costs are deduced Many argue that full costinformation is flawed by the fact that it takes no account of opportunity costs

ABC enthusiasts would probably argue that deducing better quality full costs is not theonly benefit which is available, if the overhead cost drivers can be identified Knowing whatdrives costs can enable management to exercise more control over them This benefit needs

to be taken into account when assessing the cost/benefit of using ABC

Generally, a rise in the price of a commodity causes a fall in demand A commodity is said

to have a relatively elastic demand where demand reacts relatively dramatically (stretchesmore) in the face of a particular price alteration Elastic demand tends to be associated withcommodities that are not essential, perhaps because there is a ready substitute

It can be very helpful for those involved with pricing decisions to have some feel for theelasticity of demand of the commodity that will be the subject of a decision The sensitiv-ity of the demand to the decision is obviously much greater (and the pricing decision morecrucial) with commodities whose demand is elastic than with commodities whose demand

is relatively inelastic

A business will make the most profit from one of its products or services at the point wheremarginal sales revenue equals marginal cost of production, or in other words, the pointwhere the increase in total sales revenue that will result from selling one more unit equalsthe increase in total costs which will result from selling that unit

A budget can be defined as a financial plan for a future period of time Thus it sets out theintentions which management has for the period concerned Achieving the budget plansshould help to achieve the long-term plans of the business Achievement of the long-termplans should mean that the business is successfully working towards its objectives

A budget differs from a forecast in that a forecast is a statement of what is expected tohappen without the intervention of management, perhaps because they cannot intervene(as with a weather forecast) A plan is an intention to achieve

Normally management would take account of reliable forecasts when making its plans

6.1

Chapter 6 5.4

5.3 5.2

5.1

Chapter 5

474

1 Budgets tend to promote forward thinking and the possible identification of short-term

problems Managers must plan and the budgeting process tends to force them to do so

In doing so they are likely to encounter potential problems If the potential problems can

be identified early enough, solutions might be easily found

2 Budgets can be used to help co-ordination between various sections of the business It

is important that the plans of one area of the business fit in with those of other areas;

a lack of co-ordination could have disastrous consequences Having formal statements

of plans for each aspect of the business enables a check to be made that plans are complementary

3 Budgets can motivate managers to better performance It is believed that people are

motivated by having a target to aim for Provided that the inherent goals are achievable,budgets can provide an effective motivational device

4 Budgets can provide a basis for a system of control Having a plan against which actual

performance can be measured provides a potentially useful tool of control

5 Budgets can provide a system of authorisation Many managers have ‘spending’ budgets

such as research and development, staff training, and so on For these people, the size oftheir budget defines their authority to spend

Control can be defined as ‘compelling things to occur as planned’ This implies that trol can only be achieved if a plan exists Budgets are financial plans This means that, ifactual performance can be compared with the budget (plan) for each aspect of the business,divergences from plan can be spotted Steps can then be taken to bring matters back undercontrol where they are going out of control

con-A budget committee is a group of senior staff that is responsible for the budget tion process within an organisation The existence of the committee places the budgetresponsibility clearly with an identifiable group of people This group can focus on the tasksinvolved

prepara-Feedforward controls try to anticipate what is likely to happen in the future and then assist

in making the actual outcome match the desired outcome They contrast with feedbackcontrols, which simply compare actual to planned outcomes after the event Feedforwardcontrols are therefore more pro-active

A variance is the effect on budgeted profit of the particular cost or revenue item being sidered It represents the difference between the budgeted profit and the actual profit assum-ing everything, except the item under consideration, had gone according to budget Fromthis it must be the case that

con-Budgeted profit + favourable variances − unfavourable variances = actual profit

The purpose of analysing variances is to identify whether, and if so where, things are notgoing according to plan If this can be done, it may be possible to find out the cause ofthings going out of control If this can be discovered, it may then be possible to put thingsright for the future

Where the budgeted and actual volumes of output do not coincide it is impossible to makevalid comparison of ‘allowed’ and actual costs and revenues Flexing the original budget toreflect the actual output level enables a more informative comparison to be made

Flexing certainly does not mean that output volume differences do not matter Flexingwill show (as the difference between flexed and original budget profits) the effect on profit

of output volume differences

7.3

7.2

7.1

Chapter 7 6.4

6.3 6.2

SOLUTIONS TO REVIEW QUESTIONS 475

Deciding whether variances should be investigated involves the use of judgement Oftenmanagement will set a threshold of significance, for example 5 per cent of the budgetedfigure for each variance relating to revenue or cost items All variances above this thresholdwould then be investigated Even where variances are below the threshold, any sign of a sys-temic variance, shown, for example, by an increasing cumulative total for the factor, should

be investigated

Knowledge of the cause of a particular variance may well put management in a position

to take actions that will be beneficial to the business in the future Investigating variances,however, is likely to be relatively expensive in staff time A judgement needs to be made onwhether the value or benefit of knowing the cause of the variance will be justified by thecost of this knowledge As with most investigations of this type, it is difficult to judge thevalue of the knowledge until after the variance has been investigated

NPV is usually considered the best method of assessing investment opportunities because ittakes account of:

l The timing of the cash flows By discounting the various cash flows associated with each

pro-ject according to when it is expected to arise, it recognises the fact that cash flows do notall occur simultaneously Associated with this is the fact that, by discounting using theopportunity cost of finance (that is, the return which the next best alternative oppor-tunity would generate), it is possible to identify the net benefit after financing costs havebeen met (as the NPV )

l The whole of the relevant cash flows NPV includes all of the relevant cash flows

irrespec-tive of when they are expected to occur It treats them differently according to their date

of occurrence, but they are all taken account of in the NPV and they all have, or canhave, an influence on the decision

l The objectives of the business NPV is the only method of appraisal where the output of the

analysis has a direct bearing on the wealth of the business (Positive NPVs enhancewealth; negative ones reduce it) Since most private sector businesses seek to increasetheir value and wealth, NPV clearly is the best approach to use, at least out of the methods we have considered so far

NPV provides clear decision rules concerning acceptance/rejection of projects and theranking of projects It is fairly simple to use, particularly with the availability of moderncomputer software that takes away the need for routine calculations to be done manually

The payback method, in its original form, does not take account of the time value ofmoney However, it would be possible to modify the payback method to accommodate thisrequirement Cash flows arising from a project could be discounted, using the cost offinance as the appropriate discount rate, in the same way as with the NPV and IRR methods.The discounted payback approach is used by some businesses and represents an improve-ment on the original approach described in the chapter However, it still retains the otherflaws of the original payback approach that were discussed: for example, it ignores relevantdata after the payback period Thus, even in its modified form, the PP method cannot beregarded as superior to NPV

The IRR method does appear to be preferred to the NPV method among many practisingmanagers The main reasons for this seem to be as follows:

l A preference for a percentage return ratio rather than an absolute figure as a means ofexpressing the outcome of a project This preference for a ratio may reflect the fact that

8.3 8.2

other financial goals of the business are often set in terms of ratios (for example, return

mis-Cash flows are preferred to profit flows because cash is the ultimate measure of economicwealth Cash is used to acquire resources and for distribution to shareholders When cash isinvested in an investment project an opportunity cost is incurred, as the cash cannot beused in other investment projects Similarly, when positive cash flows are generated by theproject it can be used to reinvest in other investment projects

Profit, on the other hand, is relevant to reporting the productive effort for a period This measure of effort may have only a tenuous relationship to cash flows for a period Theconventions of accounting may lead to the recognition of gains and losses in one periodand the relevant cash inflows and outflows occurring in another period

The objective of strategic management accounting (SMA) is to provide information to agers that will help them to run the business in a way that will work towards achievement

man-of the business’s strategic objectives Traditional management accounting is not necessarily

so much different, but lacks the clear focus on achievement of strategic objectives

Given its focus, SMA necessarily needs to be more outward looking and more customeroriented than the traditional approach It also needs to focus on beating the competition.Finally, it must monitor the business’s strategies and be concerned with bringing these to asuccessful conclusion

Possible reasons for Customer A being preferred to Customer B include:

l A may place fewer orders than B, so saving the business’s order handling costs

l A may have the service provided in larger quantities than B This might lead to savings

in travel costs or similar, if the service is provided on the customers’ premises

l A may require fewer visits by sales representatives than B

l A may be a quicker payer than B, assuming that sales are on credit

There may well be other possibilities

Shareholder value analysis is based on the principle that there are just a few key valuedrivers that generate shareholder value, for example, investment in working capital If man-agers are focused on maximising performance with each of these so-called value drivers, themaximum increase in shareholder wealth will be generated This can be used to relate theobjectives of individual managers throughout the business to the primary objective for the business as a whole This should lead to managers working directly towards shareholdervalue enhancement It is claimed that more traditional approaches to management targetsetting tend not always to lead to the desired outcome for the business as a whole

The four main areas in the balanced scorecard are:

1 Financial Here targets for measures such as return on capital employed will be stated.

2 Customer Here the market/customers that the business will aim for is established, as will

be targets for such things as measures of customer satisfaction and rate of growth in tomer numbers

cus-9.4 9.3 9.2

9.1

Chapter 9 8.4

SOLUTIONS TO REVIEW QUESTIONS 477

3 Internal business process Here the processes that are vital to the business will be

estab-lished This might include levels of innovation, types of operation and after-sales service

4 Learning and growth In this area issues relating to growing the business and development

of staff are identified and targets set

Reporting non-financial measures may pose a number of problems These include:

l resistance to the introduction of new measures (and, by implication, new ways of beingassessed);

l scepticism of proposed measures (the latest ‘flavour of the month’);

l the cost of reporting new measures;

l data integrity (the lack of common measurement bases and objectivity associated withmany non-financial measures);

l the difficulty of measuring the benefits (for example, establishing the link between a particular non-financial measure and the achievement of business objectives)

Four possible measures may include:

l Sales per employee

l Output per employee

l Total output during the period

l Sales to assets employed

Other measures may have been suggested which are equally valid

Three non-financial measures might include:

l Turnover of staff during period

l New clients obtained during period

l Level of client satisfaction during period

We saw in the chapter that negotiated prices can create problems for both the efficient use

of resources and divisional autonomy They can also tie up central management in tional matters and deflect them from their more strategic role This method is best usedwhen there is an external market for the services or goods of both buying and selling divi-sions and when divisional managers are free to reject offers made by other divisions.Market-based prices are, generally speaking, more appropriate as they reflect the oppor-tunity cost of the goods However, where the division is operating below capacity, a variable-cost-based approach is more appropriate

arbitra-Although the credit manager is responsible for ensuring that receivables pay on time, Tariq may be right in denying blame Various factors may be responsible for the situationdescribed which are beyond the control of the credit manager These include:

l a downturn in the economy leading to financial difficulties among trade receivables;

l decisions by other managers within the business to liberalise credit policy in order tostimulate sales;

l an increase in competition among suppliers offering credit, which is being exploited bycustomers;

11.1

Chapter 11

10.4 10.3 10.2

10.1

Chapter 10

478

l disputes with customers over the quality of goods or services supplied;

l problems in the delivery of goods leading to delays

You may have thought of others

The level of inventories held will be affected in the following ways

(a) An increase in production bottlenecks is likely to result in an increase in raw materialsand work in progress being processed within the plant Therefore, levels of inventoriesshould rise

(b) A rise in interest rates will make holding inventories more expensive if they are financed

by debt This may, in turn, lead to a decision to reduce inventory levels

(c) The decision to reduce the range of products should result in fewer inventories beingheld It would no longer be necessary to hold certain items in order to meet customerdemand

(d) Switching to a local supplier may reduce the lead time between ordering an item andreceiving it This should, in turn, reduce the need to carry such high levels of the par-ticular item

(e) A deterioration in the quality of bought-in items may result in the purchase of higherquantities of inventories in order to take account of the defective element in invent-ories acquired and, perhaps, an increase in the inspection time for items received Thiswould lead to a rise in inventory levels

Inventories are held:

l to meet customer demand,

l to avoid the problems of running out of inventories, and

l to take advantage of profitable opportunities (for example, buying a product that isexpected to rise steeply in price in the future)

The first reason may be described as transactionary, the second precautionary and the thirdspeculative They are, in essence, the same reasons why a business holds cash

(a) The costs of holding too little cash are:

l failure to meet obligations when they fall due which can damage the reputation ofthe business and may, in the extreme, lead to the business being wound up;

l having to borrow and thereby incur interest charges;

l an inability to take advantage of profitable opportunities

(b) The costs of holding too much cash are:

l failure to use the funds available for more profitable purposes;

l loss of value during a period of inflation

11.4 11.3 11.2

SOLUTIONS TO REVIEW QUESTIONS 479

Appendix D Solutions to selected exercises

Strategic management involves five steps:

1 Establish mission and objectives The mission statement is usually a brief statement of the

overall aims of the business The objectives are rather more specific than the mission andneed to be both quantifiable and consistent with the mission or aims

2 Undertake a position analysis Here the business is seeking to establish how it is placed

rela-tive to its environment (competitors, markets, technology, the economy, political mate and so on), given the business’s mission and objectives This is often approachedwithin the framework of an analysis of the business’s strengths, weaknesses, opportuni-ties and threats (a SWOT analysis) Strengths and weaknesses are internal factors that areattributes of the business itself, whereas opportunities and threats are factors expected to

cli-be present in the environment in which the business operates The SWOT framework isnot the only possible approach to undertaking a position analysis, but it seems to be avery popular one

3 Identify and assess the strategic options This involves attempting to identify possible

courses of action that will enable the business to reach its objectives in the light of theposition analysis undertaken in Step 2

4 Select strategic options and formulate plans Here the business will select what seems to be

the best of the courses of action or strategies (identified in Step 3) and will formulate astrategic plan in the form of long- and short-term budgets

5 Perform, review and control Here the business pursues the plans derived in Step 4, using

the traditional approach to compare actual performance against budgets, seeking to control where actual performance appears not to be matching plans

SWOT analysis of Jones Dairy Ltd Strengths

l A portfolio of identifiable customers who show some loyalty to the business

l Good cash flow profile Though credit will be given, a week is the normal credit period

l An apparently sound distribution system

l A monopoly of doorstep delivery in the area

l Barriers to entry There are probably relatively high fixed costs, which implies a ‘criticalmass’ of volume is necessary

l Good employees and ease of recruitment

l Differentiated product; clearly different from what is supplied by the supermarket in that

it is delivered to the door

l Apparently good marketing, since the decline in business is less than the national average

l Good knowledge of the local market

1.2 1.1

Chapter 1

l Tendency for people to shop infrequently means that doorstep delivery may be the onlypractical means of having fresh milk.

Weaknesses

l Ageing managers

l Success might be dependent on the present management continuing to manage

l Narrow product range

l High price necessary to generate acceptable level of profit

l Available substitute – that is, non-delivered milk

l High operating gearing (probably) means that profit suffers disproportionately with adownturn in demand (This point will be considered in Chapter 3.)

l Single supplier

Opportunities

l Possibility of extending the product range to include other dairy and non-dairy products

to existing customers

l Possible geographical expansion to cover other local towns and villages

l Possibly move to act as a wholesaler to local stores at differentiated prices It is probablethat the bottlers would supply Jones more cheaply than they would supply individualsmall stores

l Using plant for some other purpose, such as leasing cold store facilities

Threats

l Apparently strong trend against doorstep delivery driven by price differential

l Trend away from dairy products for health/cultural reasons

l The probability that Jones is entirely dependent on the only local bottler More graphically remote bottlers may not be prepared to supply at an acceptable price

geo-l Increasing strength of supermarket buying power

Lombard Ltd

Relevant costs of undertaking the contract are:

£

Equipment costs 200,000Component X (20,000 × 4 × £5)

Any of these components used will need to be replaced 400,000Component Y (20,000 × 3 × £8)

All of the required units will come from inventories and this will be an effective cost of the net realisable value 480,000Additional costs (20,000 × £8) 160,000

1,240,000Revenue from the contract (20,000 × £80) 1,600,000

Thus, from a purely financial point of view the project is acceptable ( Note that there is norelevant labour cost since the staff concerned will be paid irrespective of whether the con-tract is undertaken.)

2.1

Chapter 2

SOLUTIONS TO SELECTED EXERCISES 481

The local authority

(a) Net benefit of accepting the touring company proposal

Since there is a net deficit, on financial grounds, the touring company’s proposal should

(£16,400 × 50% × 20) £164,000Touring company ticket sales:

Total revenue for each performance for a full house:

(b) Other possible factors to consider include:

l The reliability of the estimations, including the assumption that the level of occupancywill not alter programme and refreshment sales revenue

l A desire to offer theatregoers the opportunity to see another group of players

l Dangers of loss of morale of staff not employed, or employed to do other than theirusual work

2.2

482

Andrews and Co Ltd

Minimum contract price

£ Materials Steel core: 10,000 × £2.10 21,000

Plastic: 10,000 × 0.10 × £0.10 100

Unskilled: 10,000 ×5/60× £7.50 6,250Minimum tender price 27,350

The local education authority

(a) One-off financial net benefits of closing:

D only A and B A and C

Capacity reduction 800 700 800

Property developer (A) – 14.0 14.0Shopping complex (B) – 8.0 –Property developer (D) 9.0 – –

Recurrent financial net benefits of closing:

D only A and B A and C

Administrators 0.2 0.4 0.4

Ranking based on total of recurrent benefits 3 2 1

On the basis of the financial figures alone, closure of either A and B or A and C looksbest It is not possible to add the one-off and the recurring costs directly, but the largeone-off cost saving associated with closing schools A and B makes this option lookattractive (In Chapter 8 we shall see that it is possible to add one-off and recurring costs

in a way that should lead to sensible conclusions.)( b) The costs of acquiring and improving the schools in the past are past costs or sunk costsand, therefore, irrelevant The costs of employing the chief education officer is a futurecost, but irrelevant because it is not dependent on outcomes, it is a common cost

(c) There are many other factors, some of a non-quantifiable nature These include:

l Accuracy of projections of capacity requirements

l Locality of existing schools relative to where potential pupils live

l Political acceptability of selling schools to property developers

l Importance of purely financial issues in making the final decision

l The quality of the replacement sporting facilities compared with those at school D

l Political acceptability of staff redundancies

l Possible savings/costs of employing fewer teachers, which might be relevant if nomies of scale are available by having fewer schools

eco-l Staff morale

2.6 2.3

SOLUTIONS TO SELECTED EXERCISES 483

Rob Otics Ltd

(a) The minimum price for the proposed contract would be:

£

MaterialsComponent X (2 × 8 × £180) 2,880

If the 16 units of this component are used on the proposed contract, the business will need to buy an additional

16 units at the new price

The history of the components held in inventories is irrelevant because it applies irrespective of the decision made on this contract Since the alternative to using the units on this contract is to scrap them, the relevant cost is zero

Component Z [(75 + 32) × £20] − (75 × £25) 265The relevant cost here is how much extra the business will

pay the supplier as a result of undertaking the contract

Other miscellaneous items 250Labour

Assembly (25 + 24 + 23 + 22 + 21 + 20 + 19 + 18) × £48 8,256The assembly labour cost is irrelevant because it will be

incurred irrespective of which work the members of staff do

The relevant cost is based on the sales revenue per hour lost if the other orders are lost less the material cost per hour saved; that is £60 − £12 = £48

Inspection (8 × 6 × £12 × 150%) 864

Thus the minimum price is £12,515

(b) Other factors include:

l Competitive state of the market

l The fact that the above figure is unique to the particular circumstances at the time– for example, having component Y available but having no use for it Any sub-sequent order might have to take account of an outlay cost

l Breaking even (that is, just covering the costs) on a contract will not fulfil the ness’s objective

busi-l Charging a low price may cause marketing problems Other customers may resent thelow price for this contract The current enquirer may expect a similar price in future

Motormusic Ltd

(a) Break-even point = fixed costs/contribution per unit

= (80,000 + 60,000)/[60 − (20 + 14 + 12 + 3)] = 12,727 radios

These would have a sales value of £763,620 (that is, 12,727 × £60)

(b) The margin of safety is 7,273 radios (that is, 20,000 − 12,727) This margin would have

a sales value of £436,380 (that is, 7,273 × £60)

Products A, B and C

(a) Total time required on cutting machines is:

(2,500 × 1.0) + (3,400 × 1.0) + (5,100 × 0.5) = 8,450 hoursTotal time available on cutting machines is 5,000 hours Therefore, this is a limiting factor

Total time required on assembling machines is:

(2,500 × 0.5) + (3,400 × 1.0) + (5,100 × 0.5) = 7,200 hoursTotal time available on assembling machines is 8,000 hours Therefore, this is not a limiting factor

(per unit) (per unit) (per unit)

Selling price 25 30 18Variable materials (12) (13) (10)Variable production costs (7 ) (4 ) (3 )

Time on cutting machines 1.0 hour 1.0 hour 0.5 hourContribution per hour on cutting machines £6 £13 £10Order of priority 3rd 1st 2nd

sub-Similarly it would be worth paying up to £6 per unit for product A – that is, £6 ×2,500 = £15,000 in total

Darmor Ltd

(a) Contribution per hour of skilled labour of product X is

= £14Given the scarcity of skilled labour, if the management is to be indifferent between theproducts, the contribution per skilled labour hour must be the same Thus for product

Y the selling price must be

[£(14 × (9/12)) + 9 + 4 + 25 + 7] = £55.50(that is, the contribution plus the variable costs), and for product Z the selling pricemust be

[£(14 × (3/12)) + 3 + 10 + 14 + 7] = £37.50(b) The business could pay up to £26 an hour (£12 + £14) for additional hours of skilledlabour This is the potential contribution per hour, before taking account of the labourrate of £12 an hour

£(30 − 6 − 2 − 12 − 3)(6/12)

3.6 3.5

SOLUTIONS TO SELECTED EXERCISES 485

Intermediate Products Ltd

(a)

Total costs per unit (£) (65) (41) (36) (46)

Variable cost per unit (£) (45) (33) (28) (34)Buying/selling price per unit (£) 70 45 40 55Contribution per unit (£) 25 12 12 21Hours on special machine 0.5 0.4 0.5 0.3Contribution per hour (£) 50 30 24 70Order of preference 2nd 3rd 4th 1st

Optimum use of hours on special machine Balance of hours

Therefore, make all of the demand for Ds, As and Bs plus 400 (of 4,000) Cs

(b) The contribution per hour from Cs is £24, and so this is the maximum amount per hourthat it would be worth paying to rent the machine, for a maximum of 1,800 hours (that

is, 3,600 × 0.5, the time necessary to make the remaining demand for Cs)

(c) Other possible actions to overcome the shortage of machine time include the following:

l Alter the design of the products to avoid the use of the special machine

l Increase the selling price of the product so that the demand will fall, making theavailable machine time sufficient but making production more profitable

Gandhi Ltd

(a) Given that the spare capacity could not be used by other services, the standard serviceshould continue to be offered This is because it renders a positive contribution.(b) The standard service renders a contribution per unit of £15 (that is, £80 − £65), or £30during the time it would take to render one unit of the nova service The nova servicewould provide a contribution of only £25 (that is, £75 − £50)

The nova service should, therefore, not replace the standard service

(c) Under the original plans, the following contributions would be rendered by the basicand standard services:

£

Basic 11,000 × (£50 − £25) = 275,000Standard 6,000 × (£80 − £65) = 90,000

Promptprint Ltd

(a) The plan (budget) may be summarised as:

£

Sales revenue 196,000Direct materials (38,000)Direct labour (32,000)Total indirect cost (77,000) (2,400 + 3,000 + 27,600 + 36,000 + 8,000)Profit 49,000

The job may be priced on the basis that both indirect cost and profit should be tioned to it on the basis of direct labour cost, as follows:

appor-£

Direct materials 4,000Direct labour 3,600Overheads 8,663 (£77,000 × 3,600/32,000)Profit 5,513 (£49,000 × 3,600/32,000)

21,776

This answer assumes that variable overheads vary in proportion to direct labour cost

Various other bases of charging overheads and profit loading the job could have beenadopted For example, materials cost could have been included (with direct labour) asthe basis for profit loading, or even apportioning overheads

(b) This part of the question is, in effect, asking for comments on the validity of ‘full plus’ pricing This approach can be useful as an indicator of the effective long-run cost

cost-of doing the job On the other hand, it fails to take account cost-of relevant opportunitycosts as well as the state of the market and other external factors For example, it ignoresthe price that a competitor printing business may quote

(c) Revised estimates of direct material cost for the job:

£

Paper grade 1 1,500 (£1,200 × 125%) (this item of inventories needs to be replaced)Paper grade 2 0 (it has no opportunity cost value)

Card 510 (£640 − £130: using the card on another job would save

£640, but cost £130 to achieve that saving)Inks and so on 300 (this item of inventories needs to be replaced)

APPENDIX D SOLUTIONS TO SELECTED EXERCISES

6,800) 6,800) 6,800) 6,800)

Dep’n and Book value 25,000 12,500 6,250 2,500 3,750insurance (150/300) (75/300) (30/300) (45/300)

132,380 49,160 29,220 21,600 32,400Canteen Number of

employees – 10,800 8,400 (21,600) 2,400

(18/36) (14/36) (4/36)

132,380 59,960 37,620 – 34,800Machine Specified % – 24,360 10,440 – (34,800)maintenance (70%) (30%)

section

132,380 84,320 48,060 – –

Note that the canteen overheads were reapportioned to the other cost centres firstbecause the canteen renders a service to the machine maintenance section but does notreceive a service from it

Calculation of the overhead absorption (recovery) rates can now proceed:

(i) Total budgeted machine hours are:

Hours

Product X (4,200 × 6) 25,200Product Y (6,900 × 3) 20,700Product Z (1,700 × 4) 6,800

52,700

Overhead absorption rate for the machine shop is:

= £1.60/machine hour(ii) Total budgeted direct labour cost for the fitting section is:

£

Product X (4,200 × £12) 50,400Product Y (6,900 × £3) 20,700Product Z (1,700 × £21) 35,700

106,800

Overhead absorption rate for the fitting section is:

× 100% = 45% or £0.45 per £ of direct labour cost

£48,060

£106,800

£84,32052,700