.

W2

recognizes the NCI by deducting its 20% share of Minor's identifiable net assets at the acquisition
date
.

W3 recognizes the NCI's 20% share in Minor's post

acquisition profits of £20,000

(
£
4,000); the

NCI’s
20% share in Minor’s post acquisition revaluation reserve of £10,000

(
£
2
,000
); and
the NCI's 20%
share in Minor's post

acquisition profits of £20,000

(
£
6
,000
)
.

W4 accounts for the 50% impairment of goodwill

(
£
3,5
00
)
.






Business Accounting


Answers to Practice Questions



34


9
.

Financial statement analysi
s


The following narrative answers are indicative of the main points in the chapter.


1.

Explain the purpose of ratio analysis and describe its limitations as a tool for evaluating the
financial statements of a business.


The purpose of r
atio analysis is
to
evaluat
e

the financial performance and stability of an entity. It helps
internal and external users analyse financial statements by examining ratios that describe the
quantitative relationship between two data items.
R
atio
s can be

used to perform a trend a
nalysis or
they can be compared with
a

predetermined budget
or
previous periods for the same
entity. In
addition, can they can be compared with ratios for
competitors

or
industry benchmarks.



2.

Adams Ltd and Eve Ltd


(a)

M
ain profitability ratios


Adams Ltd

Eve

Ltd

Return on capital employed



Operating profit

x 100

29,500

41,500

Capital employed

281,000

596,000


=
10.50%

=
6.96%

Capital turnover



Revenue

354,900

706,260

Capital employed

281,000

596,000


=
1.26

times

=
1.19

times

Gross profit margin



Gross profit

x 100

71,400

156,200

Revenue

354,900

706,260


=
20.12%

=
22.12%

Operating profit margin



Operating profit

x 100

29,500

41,500

Revenue

354,900

706,260


=
8.31%

=
5.88%


(b)

Interpretation


Adams Ltd has
a

better ret
urn on capital employed because
the company
generated
proportionally higher profits from less capital employed
, wh
ile

Eve Ltd

generated proportionally
lower profits from a larger amount of capital employed
.
The capital turnover ratio helps explain the
reasons:
Adams Ltd
turned over

t
he capital employed
in the company to generate revenue
just
over

1¼ times during the year
, whereas capital employed was used slight less frequently during
the year in

Eve Ltd
. The

superior gross profit margin for Eve Ltd suggests that the company has a
lower cost of sales than Adams Ltd. However, the
superior
operating profit margin
for Adams Ltd
suggests the company is controlling its operating costs better than Eve Ltd.







Business Accounting


Answers to Practice Questions



35


3.

Ted Ba
ker

2005/06

Note

Ted Baker has chosen to refer to the statement of financial position as the balance sheet and
uses the format: Assets


Liabilities = Equity. This explains why the amounts shown for liabilities
are in brackets.

The brief comments in the na
rrative answers below are not exhaustive, but
intended for guidance.


(a) Earnings per share

2005/06

2004/05

Profit for ordinary shareholders

12,919

11,368

Number of ordinary shares

42,237

42,375


= 30.59 pence

= 26.83 pence


This is an

i
nvestment
ratio

that
measure
s
the amount of profi
t earned by one ordinary share.

There was g
ood news

for investors
,

as
EPS
increase
d by

3.8p per share

in 2005/06
.


(b) Return on equity

2005/06

2004/05

Profit for ordinary shareholders

x100

12,919

11,368


Equity

42,172

36,830


= 30.63%

= 30.87%


This is
a

profitability ratio that measures return on shareholders


funds
. U
nlike ROCE, it excludes
long
-
term
debt.

In 2005/06 there was £30.63 operating profit for every £100 capital employed a
little lower than the previous year,
but
nearly 31% represents
a high return compared to
a
no
n
-
risk
y

investment.


(c) Return on capital employed

2005/06

2004/05


Operating profit

x 100

18,334

x100

16,405

x 100

Equity + Non
-
current liabilities

42,922

37,580


= 42.71%

= 43.65%


This
p
rofitability ratio measures the percentage return on total funds (
shareholders’ equity and
long
-
term debt)
.
It reflects

the

stewardship of
management
and the
ir
ability to
generate revenue
and control costs.

ROCE was s
lightly lower in 2005/06
with only £42.71 in operating profit for
every £100 of capital employed compared with £43.65 the previous year. This is di
sappointing as
the amount of
capital
employed
was higher in 2005/06, but
gave proportionately less
operating
profit
.

ROCE is higher than ROE because it is based on profit before interest and tax and
therefore does not takes account of finance costs.


(d)
Operating profit margin

2005/06

2004/05

Operating profit

x 100


18,334

x 100


16,405

x100


Revenue

117,832

105,753


= 15.56%

= 15.51%


This p
rofitability ratio measures the percentage return
on

revenue based on operating profit.

The
results show
a stable performance with approximately £15 of operating profit generated by every
£100 of revenue

in both years
.







Business Accounting


Answers to Practice Questions



36


(e) Acid test ratio

2005/06

2004/05

Current assets

-

Inventory

23,300

18,365


Current liabilities

24,740

21,929


= 0.94:1

= 0.84:1


This is a liquidity ratio that measures the relationship between
the liquid
current assets and
the
short
-
term liabilities.

It excludes inventory as this takes longer to turn into cash.
In 2005/06 there
was
£0.94
in
liquid assets for every £1
of current liabilities, which is
a slight improvement

on the
previous year. It does not matter that the ratio is slightly less than
1:1 because t
he accounts are
prepared on a
pruden
t

bas
is and trade payables will be due at different times in the next perio
d. It
is also
good financial management to obtain
a
longer credit period
from

suppliers than
the
company gives to its

to customers.
This ratio a
ssures users that the business is a going concern.


(f) Inventory holding period

2005/06

2004/05


Invento
ry
x12

for months

23,475

x 12

22,725

x12

Closing inventory

48,979

43,357


= 5.75 months

= 6.29 months


Th
is is
an efficiency ratio that measures average time between purchase and sale of inventory.
There was an improvement in 2005/06
,

as management was more efficient is selling inventory
,
taking
just
under

six months (one fashion season)
. This meant there was little
risk of
extra

storage
costs or
obsole
scence
.


(g) Debt/equity ratio

2005/06

2004/05

Non
-
current liabilities

x100


750

x 100



750

x 100


Equity

42,172

36,830


= 1.78%

= 2.04%


Th
is is
a gearing ratio that describes the financial structure of the business in terms of the
percentage of long
-
term debt to total shareholder’s funds
. The company had
very low gearing in
both years. In 2005/06 it reduced from approximately £2 of long
-
term debt for every £100 of
equity to only £1.78 of long
-
term debt for every £100 of equity. This means there was even less
risk
that the company would be
unable to pay int
erest
due on long
-
term debt
i
n the event of an
eco
n
om
ic downturn
.


(h) Interest cover

2005/06

2004/05

Operating profit

18,334

16,405

Interest payable


109


221


= 168.20 times

= 74.23 times


This g
earing ratio measures the relative safety of
interest payments.

The i
ncrease

in 2005/6

reflects
the
lower gearing and confirms interest payable can still be covered many times

over
.

Therefore, there is very l
ow risk to long
-
term lenders
/creditors

that
the company will not be able to

pay
the
interest

due.



4.

Ted Baker

200
7/08



Investor
s’

perspective

(a) Dividend per share

2007/08

2006/07





Total dividends




x 100 for pence


5,079

x100


4,556

x 100

N
umber of

ordinary shares

42,321

42,915


= 12.00 pence

10.62 pence

This
i
nvestment ratio
is also known as dividend net and
measures the amount of dividend on one
ordinary share.

The results
provide
g
ood news

for
shareholders
,

as the dividend per share has



Business Accounting


Answers to Practice Questions



37


increased by 1.4p per share
. This is partly due to
an increase in total
dividends for 2007/08

and
partly due to
a

reduction in
the
number of shares

that year
.


(b) Dividend yield

2007/08

2006/07

Dividend per share
x100


12
.00

x 100


1
0.62

x 100

Average share price

480
.00

64
1.50


= 2.50%

= 1.65%


This i
nvestment ratio

is also known as
the
yield gross and
it
measures the dividend per share in
relation to the average price of the share.

Shareholders

will be please
d

as the yield rose by 0.
8
5%
in 2007/08 due to
the higher dividend per share. However, the yield would have be
en higher if it
were not for the significantly lower average share price

that year
.


(c) Earnings per share

2007/08

2006/07

Profit for ordinary shareholders

x 100 for pence

15,242

x100

14,416

x 100


N
umber
of ordinary shares

42,321

42,915


= 36.02
pence

33.59 pence


This i
nvestment ratio measures
the
amount of profit earned by one ordinary share.
There is good
news for shareholders as the increased profits in 2007/08 improved EPS by 2.43 pence.
Th
is ratio
is
based on total profits and therefor
e
ref
lects
the
shareholders’
total return
. EPS is higher than
the dividend per share, since
only
part

of the profit is distributed as dividends.


(d) Price/earnings ratio

2007/08

2006/07

Average share price

480.00

641.50

Earnings per share

36.0

33.6


= 13.33

years

= 19.10 years

This investment ratio compares the amount invested in one share with
the earnings per share
and
reflects the stock

market's confidence in how long the current level of EPS will be sustained.

The
results are disappointing for sharehold
ers since the n
umber of years the market believes the
company has good prospects
has dropped

by
nearly 6
years
.

Nevertheless, the P/E ratio is still
more than
13 years, so little cause for concern for existing or potential investors.


(e) Return on equity

2007/08

2006/07

Profit for ordinary shareholders

x100


15,242

x 100

14,416

x 100


Equity

55,712

51,281


= 27.36%

= 28.11%


This i
nvestment ratio measures
the
return on shareholders


funds
.
The results
will be
disappointing for
shareholders

as
the increased equity did not lead to a proportionately higher
total return. In
2007/08
the return was

only
£27.35 for every £100
of
equity

compared with £28.11
the previous year
.
Nevertheless,

a return of 27.36% is very
high

c
ompared to
the

risk
-
free interest
rate of 5.29%

and should be attractive to existing and potential investors
.


(f) Return on capital employed

2007/08

2006/07


Operating profit

x 100

22,142

x100

20,049

x 100

Equity + Non
-
current liabilities

56,555

51,324


= 39.15%

= 39.06%


This is
a

profitability ratio that measures the percentage return on total funds (
shareholders’ equity
and
long
-
term debt)
. It reflects

the
stewardship of
management
and their ability to
generate
revenue and control costs.

ROC
E is stable with approximately £39 in operating profit for every
£100 of capital employed in both years.

The increased amount of
capital
employed in 2007/08 did
not lead to
proportionately
higher

operating
profit
. Nevertheless,

existing and potential

investors
are likely to
consider
a return of
39
% is
favourable

c
ompared to the risk
-
free interest rate of



Business Accounting


Answers to Practice Questions



38


5.29%.

Note that
ROCE is higher than ROE because it is based on profit before interest and tax
and therefore does not

take account of finance costs.


(g) Operating profit margin

2007/08

2006/07

Operating profit

x 100


22,142

x 100


20,049

x 100


Revenue

142,231

125,648


= 15.57%

15.96%


This p
rofitability ratio measures the percentage return
on

revenue based on operating profit.

The

results show a stable performance with approximately £15 of operating profit generated by every
£100 of revenue

in both years
.


(h) Capital turnover

2007/08

2006/07


Revenue
__________

142,231

125,648

Equity + Non
-
current liabilities

56,555

51,324


= 2.51 times

= 2.45 times


This profitability ratio measures the number of times capital employed was used during the year to
achieve the revenue.

The
s
mall
improvement in 2007/08
shows more efficient use of
capital
employed

and this is reflected in the return on capital employed.



5.

Ted Baker

200
7/08



short
-
term lender perspective

(a) Current ratio

2007/08

2006/07

Current assets

57,329

53,397

Current liabilities

25,573

22,289


= 2.24:1

= 2.40:1


This is a liquidity ratio

that measures the relationship between current assets and short
-
term
liabilities.

In 200
7
/0
8

there was
£
2.24

in
current

assets for every £1
of current liabilities, which
means current liabilities are still easily covered by current assets.


(b) Acid test

2007/08

2006/07

Current assets
-

Inventory

28,014

25,572



Current liabilities

25,573

22,289


= 1.10:1

= 1.15:1


This liquidity ratio
is more stringent than the current ratio because it
excludes inventory
,

as this
current asset
cannot be converted
into cash at short notice.

In 200
7
/0
8

there was
£
1.10

in
liquid
assets for every £1
of current liabilities,
which
means current liabilities are just covered by current
assets. However, the
accounts are prepared on a prudent basis and trade payables will b
e due at
different times in the next period.
In addition, i
t is also
good financial management to obtain
a
longer credit period
from

suppliers than
the company gives to its

to customers.
The results for this
ratio
should
a
ssure
lenders and creditors
that t
he

liquidity position is stable and the

business is a
going concern.


(c) Inventory holding period

2007/08

2006/07

Closing inventory

x 12

for months

29,315 x 12

27,825

x 12



Cost of sales

59,560

51,986


= 5.91 months

6.42 months


This is
an
efficiency ratio that measures average time between purchase and sale of inventory.
There was an improvement in 200
7
/0
8,

as management was more efficient is selling inventory
,
taking
just
under

six months (one fashion season)

rather than just over 6 months
. This meant



Business Accounting


Answers to Practice Questions



39


there was little
risk of
extra storage costs or
obsole
scence
.

Lenders and creditors will welcome
this result as it reflects good management of working capital.


(d) Trade receivables collection period

2007/08

2006/07

Trade receivables

x 12

for months


10,217

x 12


8,543

x 12




Revenue

142,231

125,648


= 0.86 months

= 0.82 months


This efficiency ratio measures the average time credit customers took to settle their debts.
The
position is stable with customers taking less than 1 month to pay on average during both years.
This
sugge
sts efficient credit control, but depends on how long the credit period given to
customers is. Th
e short trade receivables collection period will
give
a positive signal to lenders
and creditors as it reflects good management of working capital.


(e) Trade payables payment period

2007/08

2006/07

Trade payables

x 12

for months

13,361

x 12

11,770

x 12


Cost of sales

59,560

51,986


= 2.69 months

=
2.72 months


This efficiency ratio

measures the average time
the company has taken to
pay suppliers

for goods
and services over the year
.

The results show little change
in 2007/08
and suggest
efficient cash
management if
the period agreed with suppliers is two
months.

Taking the maximum
credit period
provided
will be seen by
lenders and creditors
as good financial management.


(g) Debt/equity ratio

2007/08

2006/07

Non
-
current liabilities

x100


843

x 100


43
x
100


Equity

55,712

51,281


= 1.51%

= 0.08%


Th
is is
a gearing ratio that describes the financial structure of the business in terms of the
percentage of long
-
term debt to total shareholder’s funds
. The company had very low gearing in
both
years.

Although

gearing

increased slightly i
n 200
7/08,

the company only had
£1.
51

of long
-
term debt for every £100 of equity
.

This means there was
very little

risk
that the company would
be
unable to pay interest
due on long
-
term debt
i
n the event of an
eco
n
om
ic downturn
.


(h) Interest cover

200
7
/0
8

200
6
/0
7

Operating profit

22,142

20,049

Interest payable


387



67


=
57.21 times

=
299.24

times


This g
earing ratio
assesses

the relative
safety of interest payments

by measuring the number of
times interest payable on long
-
term debt is covered by the available profits. This avoids problems
over different definitions of debt that can be used in the debt/equity ratio.
The
significant reduction
in 2007/08
reflects
the
h
igher
gearing. Nevertheless, there is no cause for concern for lenders and
creditors as

interest payable can still be covered
by operating more than 57 times.


The main
limitations of the
above
analysis
are:




Ideally, the inventory holding period should be

based on average inventory and

purchases

for
the year
. However, average inventory cannot be calculated for 2006/07
because
opening
inventory is not disclosed for that year
. Therefore, closing inventory is used as a proxy so that
both years can be
compared. In addition, cost of sales is substituted for purchases since the
latter is not disclosed for either year.

In both cases, the substitute figures are less precise.



It is difficult to interpret the trade receivables collection period and the trade
payables
payment period without knowing the average credit periods
associated with these ratios.




Business Accounting


Answers to Practice Questions



40




There are no agreed definitions of the terms used, so these ratios should not be compared
with others based on different definitions.



The analysis is based on
comparing two years. It would be more useful if figures were
available to examine the trend over the last five years for example. It would also be useful to
compare these ratios for Ted Baker with
competitors
or

industry benchmarks.



The
a
nalysis is based o
n figures from the f
inancial statements

in which there is

a substantial
degree of classification and aggregation, and the effect of allocating continuous operations to
the period.
A second weakness of the
financial statements
is that they
do not
take accou
nt of
non
-
financial factors such as whether the business has sound plans for the future, a good
reputation, a strong customer base, reliable suppliers, loyal employees, obsolete assets,
strong competitors

or

poor industrial relations
.


Finally, t
he
above
a
nalysis cannot
anticipate the impact of potential changes in the economic
environment
.

The lender
should treat
the analysis as
an indication of where further investigation
might be directed to better understand the present and future financial performance
and position.







Business Accounting


Answers to Practice Questions



41


10
. Ethics, governance and corporate social responsibility


The following narrative answers are indicative of the main points in the chapter.


1.

Explain why professional accountancy bodies issue codes of ethics for their members.


The
Code
of Ethics for Professional Accountants

states that ‘a distinguishing mark of the accounting
profession is its acceptance of the responsibility to act in the public interest. Therefore, a professional
accountant’s responsibility is not exclusively to satisf
y the needs of an individual client or employer’
(IESBA, 2009, para. 100.1).
The main a
dvantages of the IFAC Code of Ethics
for Professional
Accounts
are:





It provides explicit guidance to accountants and aids their understanding of the expectations
place
d upon them in terms of their ethical behaviour.



It lets clients know what they can expect from their professional accountants.



It provides a standard for disciplining professional accountants who adopt poor accounting
practices.



It enhances the reputation

of professional accountants.



It promotes a commitment to best practice within the profession.



Abiding by a code may decrease the legal liability of professional accountants from
inappropriate actions.



It provides users of the accounts with a standard agai
nst which they can compare the ethical
behaviour of their professional accountants and complain about poor accounting practice.



2.

Define the term ‘corporate governance’ and explain its importance to investors.


Cadbury (1992, p. 15) defined corporate governance as ‘the system by which companies are directed
and controlled. Boards of directors are responsible for the governance of their companies. The
shareholders’ role in governance is to appoint the directors an
d the auditors and to satisfy themselves
that an appropriate governance structure is in place. The responsibilities of the board include setting
the company’s strategic aims, providing the leadership to put them into effect, supervising the
management of t
he business and reporting to shareholders on their stewardship. The board’s actions
are subject to laws, regulations and the shareholders in general meeting.’
A succinct explanation by
Law (2012, p. 113)

summarises co
rporate governance
a
s

the manner in wh
ich organizations,
particularly limited companies, are managed and the nature of accountability of the managers to the
owners

.

Corporate governance
i
s importan
t

to investors
because it allow them to
assess the
stewardship
of
management
. This is important

because in large companies there is separation of
ownership and control, and although the company is owned by the shareholders, the latter appoint
directors to manage the business on their behalf.



3.

Obtain information from the FRC’s website and write a su
mmary explaining its role in regulating
corporate governance in the UK.


The answer
should refer to the fact that the FRC is the UK’s independent regulator responsible for
promoting high quality reporting and CG to foster investment, which is does through
the UK Corporate
Governance Code. The FRC
’s
Committee on Corporate Governance leads
work on corporate
governance
. Reference should be made to the
C
ommittee's terms of reference

and
the FRC
’s

role in
influencing EU and global developments
,
promoting
boardroom professionalism and diversity
,

and
encourag
ing

constructive interaction between company boards and institutional shareholder
s

(cf. the
Stewardship Code for Institutional Investors).







Business Accounting


Answers to Practice Questions



42


4.

Obtain a copy of the annual report and accounts
for two

publi
c limited companies and compare
the information they disclose on corporate governance. Write a summary analysing the
differences in the wording used and noting any non
-
compliance with the UK Code of Corporate
Governance.


The

answer shoul
d
cover

the follow
ing

points
:




The l
ength of each

company’s corporate governance
statement

and
how easy it is to find



Whether
each
compan
y has

been
clear about its adherence to the UK Code and

if it has
deviated

from it, whether a
dequate explanations have been given

(the
‘comply or explain’
aspect of the UK Code
)



The usefulness of any additional information provided



An

analysis of
the language used by each company
, noting similarities and differences



Conclusions
on how engaged the company appears to be with corporate gover
nance
principles
.


5.

Select one public limited company and analyse the data provided on corporate governance and
on
corporate social responsibility.

The
answer should refer to the following
:



a)

How satisfied an investor might feel that the CG/CSR information
indicates that the company
is well run and therefore a ‘safe’ investment.

b)

Whether the supplier can take comfort that the CG/CSR sections indicate that as a
stakeholder in the business the company recognises that good supplier relationships are
essential

to

future success.

c)

Appropriate CG/CSR statements should provide the customer with the sense that the
company takes its role in the community seriously and is in business for the longer term.

d)

To some extent this overlaps with the customer view, but would sugg
est the wider context of
how the company is perceived, especially in certain sectors

(eg

pharmaceuticals,
banking

and
the oil industry
)
.








Business Accounting


Answers to Practice Questions



43


Part III Management accounting


1
1.

Importance of cost information


The following narrative answers are indicative
of the main points in the chapter.


1.

Explain the purpose of cost accounting and why it is important for managers to have cost
information.


The purpose of cost accounting is to ascertain the cost of the designated cost centres and cost units
.
Cost is the ex
penditure on goods and services required to carry out the operations of an organization.

A
cost unit
is ‘a unit of production for which the management of an organization wishes to collect the
costs’
and a cost centre
is the area of an organization for whic
h costs are collected for the purpose of
cost ascertainment, planning, decision making and control’ (Law, 2010, p. 11
9 and 11
6)
.

Business is
about money and

in order to run a business successfully, managers need to know the cost of

running
the business

in
order to run it successfully. A

total cost statement shows the total cost of 1 cost

unit

(the p
roduct direct costs
plus a share of the
indirect costs
).
A mark up can be added to establish the
selling price
.



2.

Describe the main classifications of cost.


Revenue expenditure can be classified by:




The nature of the cost, such as those that can be identified for materials, labour and expenses,
and those for materials that can be divided into the different types of raw materials, maintenance
materials, cleani
ng materials, etc.



The function of costs, such as production costs, administration costs, selling and distribution
costs.



Whether they are product costs, which can be identified with the cost unit and are part of the
value of inventory, or period costs, su
ch as selling costs and administrative expenses, which are
deducted as expenses in the current period.



Whether they are direct costs, which can be identified with a specific cost unit, or indirect costs,
which cannot be identified with a specific cost
unit, although they may be traced directly to a
particular cost centre. Indirect costs must be shared by the cost units. Examples of direct costs
are the cost of materials used to make a product; the cost of labour if employees are paid
according to the nu
mber of products made or services provided; the cost of expenses, such as
subcontract work. Examples of indirect costs are expenses such as rent and managers’ salaries.



The behaviour of the cost and whether they are variable costs, which in total change in

proportion
with the level of production activity or fixed costs, which are not changed by fluctuations in
production levels. Direct costs are usually variable and indirect costs are usually fixed. Examples
of direct costs that are fixed are patents, licen
ces and copyright relating to a particular product
and some direct expenses such as the hire of a particular piece of equipment to produce a
specific order.





Business Accounting


Answers to Practice Questions



44


3.

Classify the following costs:


Production
costs

Administration
costs*

Distribution
costs

(a)

Factory rent





(b)

Insurance of office buildings





(c)

Electricity for powering machinery





(d)

Electricity for office lighting and heating





(e)

Tax and insurance of delivery vehicles





(f)

Depreciation of factory machinery





(g)

Depreciation of office
equipment





(h)

Commission paid to sales team





(i)

Salaries paid to accounts office staff





(j)

Factory manager’s salary





(k)

Delivery drivers’ salaries





(l)

Factory security guards’ salaries





(m)

Piecework wages paid to factory operatives





(n)

Salary paid
to managing director’s secretary





(o)

Salaries paid to factory canteen staff





(p)

Fees paid to advertising agency





(q)

Maintenance of machinery





(r)

Accounting software





(s)

Bonuses for factory staff





(t)

Training course for clerical staff.






*Includes

selling costs



4.

Petra Pots

Ltd


(a)

Petra Pots Ltd

Total cost (2,000 units)



£

Direct costs


Direct materials (6,000 + 200)

6,200

Direct labour

10,000

Prime cost

16,200

Production overheads (1,000+2,000+700+1,500+2,500+2,200+800+900)

11,600

Production cost

27,800

Indirect costs


Administration overheads (400 + 800 + 200 + 1,800 + 2,200 + 16,000)

7,000

Distribution overheads (500 + 800)

1,300


8,300

Total cost

36,100



(b)
Interpretation should demonstrate awareness that total cost is

built from a number of key elements
and should explain the terms used.





Business Accounting


Answers to Practice Questions



45


5.

Petra Pots

Ltd
*




Petra Pots Ltd



Total cost (
1

unit)




£

Direct costs


Direct materials

3.10

Direct labour

5.00

Prime cost

8.10

Production overheads

5.80

Production cost

13.90

Indirect costs


Administration overheads

3.50

Distribution overheads

0.65


4.15

Total cost

18.05

Profit

(
Production cost
£13.90 x 50%)

6.95

Selling price

25.00


*The workings are the same as
in

question 4, but divided by 2,000
.








Business Accounting


Answers to Practice Questions



46


1
2.

Costing for product direct costs


The following narrative answers are indicative of the main points in the chapter.


1.

Describe the main stages in controlling direct materials.


In a manufacturing business the
control of materials used in the production process is essential

to

ensure that production is not delayed due to shortages
and that
the business does not tie up capital
by storing excess quantities of inventory. The main stages in material control are:




Th
e stores or production department sends a
purchase requisition

to the purchasing department,
giving details of the quantity and type of materials required.



The buyer in the purchasing department sends a
purchase order

to the supplier.



The supplier sends th
e materials with a
goods received note
, which is checked against the
materials received and the purchase order.



The materials are added to the existing inventory in the stores and the quantity is added to the
inventory level shown on the
bin card
.



When mat
erials are required, the production department sends a
materials requisition

to the
stores and the stores issues the materials and deducts the quantity from the inventory level
shown on the
bin card
. Periodic
stocktaking

ensures that a physical count of al
l inventories is
made to confirm that the actual quantities support the levels shown on the bin cards.


In a well
-
managed business, materials are available in the right place, at the right time and in the right
quantities, and all materials are properly ac
counted for.



2.

Compare and contrast the advantages and disadvantages of the FIFO and CWA methods.


The main a
dvantage of
the
FIFO
cost method is

that it
is acceptable to financial accountants in the UK
and to the HM Revenue and Customs
, which
means that
not only can it be used for
management
accounting purposes
, but also
for financial reporting
and taxation purposes. However, th
is advantage
also
applies to the CWA cost method. The FIFO method
is

the
logical choice if it coincides with the
order in which i
nventory is physically issued to production

(eg
materials
with
a finite life
where
it
makes sense to issue those that have been stored the longest first
)
.
However, the CWA is the logical
choice if
inventory consists of volume and liquid materials where an
averaging method makes sense
because
it may not be possible to differentiate between old and new inventory stored in bulk
containers.


While the FIFO has the benefit of charging
the cost of direct materials against profits in the s
ame
order as costs are in
curred, the CWA offers the advantage of smoothing out the impact of price
changes in the statement of comprehensive income. However,
the
FIFO

method is complex and an
arithmetical burden, even when a spreadsheet is used. While the cost of direct materials
issued to
production is based on historical prices, the
value of inventory at end of period is close to current
prices.

On the other hand, the CWA method
requires the prices of materials issued to production must
be recalculated every time a new consignmen
t is received, this can be relatively simple
to calculate by
entering the quantity and pricing information from the source documents into a spreadsheet or
specialist software package.
The CWA method also offers the advantage that
it
takes account of
quanti
ties purchased and changing prices
, including prices
relating to previous periods.

Nevertheless,
the prices of
materials issued may not match any of the prices actually paid

and the v
alue of closing
inventory
will lag
behind current prices if prices are ri
sing.







Business Accounting


Answers to Practice Questions



47


3.

Janet’s wages are based on piecework and she is paid £5 per piecework hour. Calculate her pay
for a 36
-
hour week in which she produces the following units:


Product

Number

of units

Time allowance

per unit

Total piecework
hours

A

12

0.8 hours


9.6

B

30

0.6 hours

18.0

C

24

0.5 hours

12.0




39.6






Pay (39.6 hours x £5)

£198



4.

Perfect Pans Ltd


(a)


(i)
FIFO



Receipts





Issues



Inventory balance

December

Quantity

Price

Value

Quantity

Price

Value

Quantity

Value



kg

£

£

kg

£

£

kg

£

1







500

1,000.00

2




450

2.00

900.00

50

100.00

7

550

2.10

1,155




600

1,255.00

8




50

2.00

100.00

550

1,155.00

8




450

2.10

945.00

100

210.00

14

600

2.20

1,320




700

1,530.00

15




100

2.10

210.00

600

1,320.00

15




500

2.20

1,100.00

100

220.00

30

500

2.30

1,150




600

1,370.00

31




100

2.20


220.00

500

1,150.00

Total











3,475.00







(ii)
AVCO



Receipts



Issues



Inventory balance

December

Quantity

Price

Value

Quantity

Price

Value

Quantity

Value



kg

£

£

kg

£

£

kg

£

1







500

1,000.00

2




450

2.00

900.00

50

100.00

7

550

2.10

1,155




600

1,255.00

8




500

2.09

1,045.83

100

209.17

14

600

2.20

1,320




700

1,529.17

15




600

2.18

1,310.71

100

218.45

30

500

2.30

1,150




600

1,368.45

31




100

2.28


228.08

500

1,140.38

Total











3,484.62







(b)
Assuming that the business needs to choose between the two methods, recommend which
method management should adopt, giving at least five reasons.


The answer should include a r
ecommendation
. The c
hoice
of method
should be supported with
a
discussion of at least five
advantages
and disadvantage
of the method
chosen contrasted with those
of the method that has been
rejected
.








Business Accounting


Answers to Practice Questions



48


5.

Baked Bean PLC


(a)


(i)
FIFO



Receipts





Issues

Inventory balance

September

Quantity

Price

Value

Quantity

Price

Value

Quantity

Value



tonne

£

£

tonne

£

£

tonne

£

1

1,000

5.00

5,000






1,000

5,000.00

2

1,000

5.50

5,500






2,000

10,500.00

3




750

5.00

3,750.00

1,250

6,750.00

14




250

5.00

1,250.00

1,000

5,500.00






500

5.50

2,750.00

500

2,750.00

15

1,000

6.00

6,000






1,500

8,750.00

16




500

5.50

2,750.00

1,000

6,000.00






250

6.00

1,500.00

750

4,500.00

29

1,000

6.50

6,500






1,750

11,000.00

30




750

6.00

4,500.00

1,000

6,500.00

Total











16,500.00























(ii)
AVCO



Receipts



Issues

Inventory balance

September

Quantity

Price

Value

Quantity

Price

Value

Quantity

Value



tonnes

£

£

tonnes

£

£

tonnes

£

1

1,000

5.00

5,000






1,000

5,000.00

2

1,000

5.50

5,500






2,000

10,500.00

3




750

5.25

3,937.50

1,250

6,562.50

14




750

5.25

3,937.50

500

2,625.00

15

1,000

6.00

6,000






1,500

8,625.00

16




750

5.75

4,312.50

750

4,312.50

29

1,000

6.50

6,500






1,750

10,812.50

30




750

6.18

4,633.93

1,000

6,178.57

Total











16,821.43







(b)
Identify which of the two methods would give the higher profit for the month in this particular case,
giving your reasons.


The basic argument is that the higher the value of closing
inventory
, the higher the profit. Costs
reduce revenue and closing
inventory

reduces the cost of sales for the period. Reference should be
made to the fact that when prices are rising, the value of closing
inventory

under
the
FIFO
method
is
higher than under
the
CW
A

method
. Under
the
FIFO

cost method
, the valuation is closer to current
prices, whereas under
the
CWA
method
price increases are
smoothed

out and the value of closing
inventory

lags behind the current price. Therefore,
the
FIFO
cost method
gives the highe
r profit under
these circumstances







Business Accounting


Answers to Practice Questions



49


13.

Costing for indirect costs


The following narrative answers are indicative of the main points in the chapter.


1.

Describe the main stages for calculating the total cost per unit under an absorption costing
system.

Absorption costing is the cost accounting system in which the overheads of an organization are
charged to the production by means of the process of absorption. Costs are first allocated or
apportioned to the cost centres, where they are absorbed into the c
ost unit using absorption rates

(Law, 2012, p. 2)
.

There are three main stages as follows:




Collect indirect costs in
cost centres
on the basis of

allocation or apportionment




Determine an overhead absorption rate (OAR) for each production cost centre (eg
cost per
direct labour hour)



Charge indirect costs to products using the OAR and a measure of the product’s consumption
of the cost centre’s cost (eg

number of direct labour hours)



Calculate the cost per unit
.


2.

Explain what it means to allocate, apportion

and absorb indirect costs.

In some cases, indirect costs that
have been classified by nature can be
w
holly identified with one
particular cost centre

(eg wages and depreciation on machinery relating to a particular production
department that has been designated as a cost centre)
.

These
overheads

can
simply
be allocated to
that cost centre (eg the whole amount of the annual allowance for
depreciation on

machinery
in
that
department is
allocated to that cost centre). However,
indirect costs

that

are associated with more
than
one cost centre
must be
apportioned over
th
e

cost centres benefiting from them

(eg
factory rent
could be
apportioned over the
production cost centres on the basis of the proportion of space each
department occupies in the factory
)
.


An overhead absorption rate

is
calculated in advance of an accounting period
and used to charge
the
indirect costs
to the production
for
th
at

period

(Law,
2010
).

The choice of absorption rate depends on
the basis of apportionment and the resources used.
The main rates used are:




The cost unit overhead absorption rate



The direct labour hour overhead absorption rate



The machine hour overhead absorption r
ate.



3.

Discuss the advantages and disadvantages of using an absorption costing system for calculati
ng
the total cost of a product.

The advantages of absorption costing are

that it provides a means of sharing
the total overheads of
a
business in the manufac
turing sector
over the various production cost centres

and
the overheads for a
particular production cost centre over the various products passing through it.

It
allows p
roduction
overheads

to be
allocated or apportioned to the cost centres on a fair basis

and absorbed into the
cost unit using an appropriate using an
overhead absorption rate.
Non
-
production overheads are
absorbed into the cost unit by adding a percentage based on the proportion of non
-
production
overheads to the total production cost
.


However,
there are a number of disadvantages. Not only is this cost accounting system is unsuitable
for businesses in the service sector, but a major
limitation of absorption costing is that it is based on
arbitrary decisions about the basis for apportioni
ng and absorbing the overheads
.
Normally
predetermined overhead absorption rates are used because the actual figures are not available until



Business Accounting


Answers to Practice Questions



50


the end of the period
, but if

the predetermined overhead that has been absorbed is higher than the
actual overhead,

it will result in
overabsorption
, which
reduces expenses in the
statement of
comprehensive
income
. On the other hand, if
the predetermined overhead that has been absorbed is
lower than the actual overhead,
it will result in
underabsorption
, which
increase
s expenses in the
statement of comprehensive income.

In addition
,

general overheads are spread across the product
range with little regard for how the costs are actually generated. Therefore, there is always some
concern that the total cost of each product

is not being calculated in the most precise manner. If the
business is miscalculating the cost of its products and basing its selling prices on this inaccurate
information, it could have a dramatic impact on financial performance. For example, if the
inac
curacies result in selling prices that are too high, the business could lose market share to
competitors; if they result in selling prices that are too low, the business will not achieve its planned
profit.


A further criticism of a
bsorption costing
is tha
t assigns
indirect costs in proportion to the number of
units produced (volume), but many resources used in support activities are not related to volume

(eg

machine set
-
up, where the cost varies with the complexity of the production process and the diversi
ty
of the product range
). This means
too large a proportion of the cost of support activities is assigned to
high volume products that cause little diversity, and too small a proportion is assigned to low volume
products t
hat use more support activities.




4.

Toy Craft Ltd


(
a)

Toy Craft Ltd

Production overhead analysis

Overhead

Total

Basis of

Machine

Assembly

Maintenance




apportionment

department

department

department



£


£

£

£

Indirect materials

24,500

Allocated

12,000

10,000

2,500

Indirect labour

54,500

Allocated

14,000

18,000

22,500

Rent and rates

26,000

Area

13,000

10,400

2,600

Electricity

4,000

Area

2,000

1,600

400

Depreciation on machinery

36,000

Value of machinery

24,000

8,000

4,000

Supervisors' salaries

42,000

No. of employees

9,800

29,400

2,800

Subtotal

187,000


74,800

77,400

34,800

Apportioned service costs

-

Value of machinery

26,100

8,700

(
34,800
)


Total

187,000


100,900

86,100

-



(
b)

Machine
department OAR


Cost centre overheads

=
£100,900

= £2.37 per machine hour

No. of
machine hours 42,500






(
c)

Assembly

department OAR


Cost centre overheads

=
£86,100

= £5.74 per direct labour hour

Direct labour hours


15,000











Business Accounting


Answers to Practice Questions



51


5.

West Wales Windsurfers Ltd


(a)


West Wales Windsurfers Ltd

Production overhead
analysis


Basis of

Body

Finishing

Canteen

Total


apportionment
*

workshop

workshop





£

£

£

£

Production overheads

Allocated

680,000

390,000

160,000

1,230,000

Apportioned service costs

No. of employees

100,000

60,000



Total


780,000

450,000




*Students
should give a rationale for the basis of

apportionment used
.



(
b)

Overhead absorption rates



Body workshop: Total machine hours (30


2,000) + (80


2,500) = 260,000





Cost centre overheads

=
£780,000

= £3.00 per unit


No. of machine hours


260,000








Finishing workshop: Total direct labour hours (40


2,000) + (40


2,500) = 180,000








Cost centre overheads

=
£450,000

= £2.50 per unit


No. of direct labour hours


180,00
0




(
c)

Predicted production cost per unit



Fun Wave

Hot Racer


£

£

Direct costs



Materials

80

50

Labour




Body workshop

150

180


Finishing workshop

80

80

Indirect costs




Body workshop

90

240


Finishing workshop

100

100

Production cost

500

650












Business Accounting


Answers to Practice Questions



52


1
4.
Activity
-
based costing


The following narrative answers are indicative of the main points in the chapter.


1.

Discuss the reasons why accountants have developed ABC as an alternative to the traditional
method of
absorption costing for charging overheads to products or services.


Once of the main criticisms of
absorption costing

is that
this cost

accounting
system is based on
arbitrary decisions about the basis for apportionment and absorption of overheads. In addition,
general overheads are spread across the product range with little regard for how the costs are
actually generated. Therefore, there is always

some concern that the total cost of each product is not
being calculated in the most precise
way
. If
a

business is miscalculating the cost of its products and
basing its selling prices on this inaccurate information, it could have a dramatic impact on fin
ancial
performance. For example, if the inaccuracies result in selling prices that are too high, the business
could lose market share to
its
competitors; if they result in selling prices that are too low, the business
will not achieve its planned profit.


Absorption costing was developed at a time when the majority of firms w
ere in the manufacturing
sector
and

tended to carry high levels of inventory
. Therefore,
the valuation of inventory was very
important
.
In
addition,
direct labour was a major element in

the cost of a product
and

overheads were
relatively small, so inaccuracies in apportioning indirect costs to cost units did not have a significant
effect on the total cost, which is calculated to determine the selling pric
e or to value closing inventory.
Today,
advanced manufacturing technology (eg computer
-
controlled processes and robotics) has
decreased direct labour costs and increased overheads (eg power, maintenance

and

depreciation

on
machinery and equipment
)
.
Moreover,
just
-
in time techniques mean l
ittle

or
no
inventory

is held
.


Activity
-
based costing

(ABC)
was proposed by Johnson and Kaplan (1987), who questioned the
relevance of traditional management accounting practices to modern business.
The increased
importance of financial accounting as one
of the main branches of accounting and the fact that
the
majority of firms are now in the service sector

means that traditional
management accounting
techniques based on the needs of manufacturers are
irr
elevant to
many
businesses
today. A
BC

is ‘a
system of costing… that recognizes that cost are incurred by each activity that takes place within an
organization and that products (or customers) should bear costs according to the activities they use.
Cost drivers are identified, together with th
e appropriate activity cost pools, which are used to charge
cost to products’

(Law, 2010, p. 15).

The main assumption is that products (goods or services)
consume activities and activities consume resources.
This
o
vercomes the problem of finding a
meaningf
ul relationship between non
-
production overheads and the production activity
.



2.

Describe the four main stages in implementing a system of activity
-
based costing, defining all
terms used.


Activity
-
based costing (ABC) is a system of costing

that recognize
s that costs are incurred by each
activity that takes place within an organization and that products (or customers) should bear costs
according to the activities they use. Cost drivers are identified, together with the appropriate activity
cost pools, whic
h are used to charge cost to products

An activity cost pool is a collection of indirect
costs grouped according to the activity involved

(Law, 2010, p. 15).
The implementation of an activity
-
based costing system involves four main steps:




Identify the mai
n activities in the organization and classify them into activity centres if there
are a large number of different activities. An activity centre is an identifiable unit of the
organization that performs an operation that uses resources. For most organizati
ons the first
activity will be the purchase of materials. This will involve several sub
-
activities, such as
drawing up material specifications, selecting suppliers, placing the order, receiving and
inspecting the materials that have been delivered.




Business Accounting


Answers to Practice Questions



53




Identif
y the
cost drivers
associated with each activity centre.
A cost driver is ‘any factor such
as number of units, number of transactions, or duration of transactions that drives the costs
arising from a particular activity. When such factors can be clearly id
entified and measured,
they will be used as a basis for allocating costs to cost objects’ (
Law, 2010, p. 117).
For
example,
a cost driver for
the purchase of materials would be the number of orders placed
; for
customer support
,
it might be the number of
calls answered; for a quality control activity, it
might be the number of hours of inspection conducted
.

Some

activities have multiple cost
drivers
.



Calculate the
cost driver rate
, which is

the cost per unit of activity. For example, in purchasing
it would

be the cost per order placed.



Assign costs to the products by multiplying the cost driver rate by the volume of the cost
driver units consumed by the product. With purchasing, the cost driver rate will be calculated
on the b
asis of orders placed. For exam
ple, if
Product A requires 15 orders to be placed in
January, the cost of purchasing activity for Product A will be 15 times the cost driver rate.


3.

Write a short report discussing the types of business where ABC might be appropriate and the
advantages and
d
isadvantages of implementing this type of cost accounting system.


A
ctivity
-
based costing

is best suited
to

businesses that operate in highly competitive markets and
which
have many different products that require complex production processes. In such
firms

the
arbitrary process of absorption costing does not generate sufficiently specific information to aid
managers in planning, controlling and decision making.


The main advantages of
activity
-
based costing

are:




It provides more comprehensive detail
about product costs.



It generates data that is more specific and reliable than traditional costing.



Because it does not distinguish between production overheads and general overheads, it
overcomes the problem of finding a meaningful relationship between th
ese non
-
production
overheads and the production activity.



It provides better information about the costs of activities, thus allowing managers to make
more informed decisions.



It improves cost control by identifying the costs incurred by specific activitie
s.


The main disadvantages are:




It can be costly and difficult to implement.



Trained and experienced staff are required to operate the system.



Substantial IT costs may be required.



Managers may not find the information useful.



It uses predetermined rates
and therefore underabsorption or overabsorption of overheads
will still occur as they do under absorption costing.


Managers should be aware that the different basis for assigning costs to products is likely to result in
a different total cost per unit. Th
is can have important consequences for decision making and strategy
in the company. More accurate cost information could lead to some products being eliminated and
changes in the market price of other products. Installing the system will require teamwork b
etween
accounting, production, marketing and other functions in the company.

Therefore, m
anagement
should conduct a cost/benefit analysis before implementing activity
-
based costing and, unless the
expected benefits are greater than the costs, the firm shou
ld not move from absorption costing.









Business Accounting


Answers to Practice Questions



54


4.

Continental Communications Ltd



Rate

Standard

Advanced

Total


£

£

£

£

Direct costs





Direct labour


200,000

100,000

300,000

Direct materials


50,000

20,000

70,000

Indirect costs





Production

3,000

120,000

30,000

150,000

Quality

2,000

16,000

24,000

40,000

Delivery

200

16,000

4,000

20,000

Total cost


402,000

178,000

580,000






Number of units produced


100,000

50,000


Cost per unit


4.02

3.56




5.

Parfums de Paris AG


(a)


Sweet Pea

Allure






Direct costs



Direct materials

35,000

12,000

Direct labour

25,000

16,000

Indirect overhead costs



Purchasing

1,800

720

Quality control

4,000

3,000

Material handling

4,000

2,000

Production cost

69,800

33,720




Litres produced

20,000

4,000

Cost per litre

€3.49

€8.43





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Business Accounting


Answers to Practice Questions



55


1
5
.

Marginal costing


The following narrative answers are indicative of the main points in the chapter.


1.

Describe the purposes of marginal costing and the importance of
contribution.


The purpose of marginal costing is to meets the need for detailed information about costs in a
business where production levels fluctuate. It requires revenue expenditure to be classified into
variable costs or fixed costs according to the behaviour of the

cost when the level of production or
sales activity changes.
A variable cost is ‘an item of expenditure that, in total, varies directly with the
level of activity achieved’ and a fixed cost is ‘an item of expenditure that remains unchanged, in total,
irre
spective of changes in the levels of production or sales (Law, 2010, pp. 430 and 194)
.

The variable
costs per unit are usually regarded as the direct costs plus any variable overheads and are assumed
to be constant in the short term. Therefore, a character
istic of a variable cost is that it is incurred at a
constant rate per unit; for example, the cost of direct materials will tend to double if output doubles.
Semi
-
variable costs contain both variable and fixed elements and must be analysed so that the
vari
able elements can be added to the other variable costs and the fixed elements can be added to
other fixed costs.


In marginal costing, only the variable costs are charged to the units. The difference between sales
revenue
and the variable costs is not the
profit, since no allowance has been made for the fixed costs
incurred; it is the contribution towards fixed costs.

Contribution is

the additional profit that will be
earned by an organization when the breakeven point production has been exceeded. The unit

contribution is the difference between the selling price of a product and its marginal cost of production.
This is based on the assumption that the marginal cost and t
he sales value will be constant (
Law
,

2010, p. 110)
. Co
ntribution can be calculated for
one unit or for any chosen level of sales. The total
contribution is the contribution per unit multiplied by the number of units produced.
Contribution is
important because o
nce

the total contribution exceeds

the total fixed costs the business
start
s

makin
g
a profit.



2.

Explain the impact of limiting factors and how you would allow for them. Use a worked example to
illustrate your answer.


A limiting factor is a constraint that
restricts a

business from achieving higher levels of profitability

(eg
a shortage

of materials or labour
,
a restriction on the sales demand at a particular price or
a limit in
the production capacity of machinery).
If the business has more than one product that uses the limited
resource, it
could mean that the
business
can

only make a
limited number of product
s and
m
anagement
needs to decide
which
products to
make to obtain the maximum profit
.
T
he general rule
is to maximize production of the product with the highest
contribution per unit of limiting factor.


The example should show how

the contribution per unit of limiting factor has been calculated and how
selection will maximise overall profitability.



3.

Funfair Engineering Ltd


The report should include the following points
:


(a)

The total cost per unit increases because some costs are
fixed
. T
herefore
,

the same total amount
of cost has to be shared over fewer units.


(b)

Marginal costing focuses on the contribution to fixed costs. In periods of recession, most decision
-
making is concerned with achieving the best con
tribution. Although in th
e long
-
term it is essential
that fixed costs are recovered, marginal costing can give a new perspective on the problems
confronted by the businesses.




Business Accounting


Answers to Practice Questions



56



4.

Edwards & Co Ltd


(a)

Marginal cost statement

1

unit


£

Revenue

10.00

Variable costs


Direct
materials

(
1.00
)

Direct labour

(
5.00
)


(6.00)

Contribution

4.00


(b)

Marginal cost statement

1
2,000
unit
s


£

Revenue

120,000

Variable costs


Direct materials

(
1
2,0
00
)

Direct labour

(60,00
0
)


(72,000)

Contribution

4
8,000

Fixed costs

(32,000)

Profit for the period

16,000



(c)
The breakeven point

is the level of
production, sales volume, percentage of capacity, or sales
revenue at which an organization makes n
either a profit nor a loss

(Law, 2010, p 65). At this point,
total revenue equals
total costs (or total contribution equals total fixed costs).


(
d) Breakeven analysis


(i) B
EP

in units





Fixed costs

32,000

= 8,000 units


Contribution per unit

4





(ii) B
EP

in sales

revenue





B
EP

in units


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Business Accounting


Answers to Practice Questions



57


5.

Audiomax Ltd


(
a)

Audiomax Ltd

Marginal cost statement

(1 unit)


Premier


Deluxe


Superior



£


£


£


Selling price

100


150


240


Variable costs







Direct materials


(
30
)



(
40
)



(
50
)


Direct labour


(
30
)



(
50
)


(
120
)


Direct expenses


(
10
)



(
25
)



(
24
)



(70)


115)


(194)


Contribution

30


35


46








(b) Contribution per £1 direct materials







Contribution

Direct materials

30

30

= £1.00

35

40

= £0.88

46


50

= £0.92

Ranking


1
st


3
rd


2
nd


Therefore, i
f direct materials are a limiting factor, maximise production of Premier, followed by Superior;
reduce production of Deluxe.










(c) Contribution per £1 direct labour







Contribution

Direct labour

30

30

= £1.00

35

50

= £0.70

46


120

= £0.38

Ranking


1
st


2
nd


3
rd


Therefore, if

direct labour is a limiting factor, maximise production of Premier, followed by Deluxe;
reduce production of Superior.










d) Other considerations (
indicative
)




The a
nalysis does not take into
account that more than one of the two limiting factors identified
may arise.



Management may have overlooked other limiting factors (eg constraints on production capacity,
constraints on sales capacity, obsolescence of its products through development of ne
w
technology).



All the revenue and expenditure used in budgets is based on estimates and their utility depends
on how realistic they are.



Budgeted figures are only useful if there is frequent monitoring against actual figures and action
taken to remedy any

adverse variances.



Budgeted figures may be difficult to predict for a new business or an existing business in a volatile
market.







Business Accounting


Answers to Practice Questions



58


1
6.

Budgetary
planning and
control


The following narrative answers are indicative of the main points in the chapter.


1.

Describe the main stages in budgetary control and the specific purposes of a system of budgetary
control.

Budgetary control

is the process by which financial control is exercised within an organization.
Budgets for income and expenditure for each function
of the organization are prepared in advance of
an accounting period and are then compared with actual performance to establish any variances.
Individual function managers are made responsible for the controllable costs within their budgets, and
are expecte
d to take remedial action if the adverse variances are regarded as excessive

(
Law
,

2010,
p. 67)
. The main stages in budgetary control are:




Consult with managers to make assumptions and predictions about m
arkets and business
environment



Set financial objec
tives in the form of detailed budgets for income and expenditure for each
function of the business



Once the budget period begins, continuously compare actual performance against the budget