MANAGEMENT ACCOUNTING REVISION CLASS

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1 MANAGEMENT ACCOUNTING REVISION CLASS Section 1. (DAY3) STANDARD COSTING Definition of standard costing Types of standard costing Importance of standard costing Variance analysis Control ratio in standard costing Planning and operational variances

2 Q1: Starry Gold manufacture one product called Chocolate and operate a standard costing system. Analysis of variance is made monthly, the standard score card for Chocolate is as follows: Direct material 0.5 N4 per kg Direct wage 2 N2 per hour Variable overhead 2 k per hour Fixed overhead 2 N4 per hour Budgeted output for the month of January 2013, was 5000 units of chocolate. Actual results for the period are as follows: (i). Production for the month were 4,850 units of Chocolate (ii). Material consumed in production 2,300 kg at a total costs of N9,800. (iii). Labour hours paid for amounted to 8,500 hours at a cost of N16,800

3 Other details for the month are: a). Actual operating hours 8,000. b). variable overhead N3,000. c). Fixed overhead N42,800 you are require to calculate: (i). MPV (ii) MUV (iii) LRV (iv) LEV (V) ITV (Vi) VOexpdV (Vii) VOeffy V (Viii) FOexpdV

4 Solution 1-MPV=(Stdp-Ap)AQ =(N4-N4.26)2,300Kg =N600 Adverse Note: N9,800/2300kg =N MUV=(SQ-AQ)Std price =(2,425-2,300)N4 = N500 Favourable Note: SQ=0.5Kg x 4,850 units =2,425kg 3-LRV=(StdR-AR)AH =(N2-N1.98)8,500Hrs =N200 Favourable Note:AR=N16,800/8,500Hrs=N L EFFY V=(SH-AH used)stdr =(9,700-8,000)N2 =N3,400 Favourable 5-ITV=(AH used-ah Paid for)stdr

5 =(8,000-8,500)N2 =N1,000 Adverse. Note:SH=2hrs x 4,850 units=9,700hrs 6-VOexpd V=(SVOAR-AVOAR)AH =(N0.50-N0.35)8,500Hrs = N1,250 Favourable Note:AVOAR=N3,000/8500HRS=N VO EFFY V=(SH-AH)SVOAR =(9,700-8,500)N0.5 =N600 Favourable 8- FO Expd V= BFO-AFO =(N8x5000units)-N42,800 =N2,800Adverse

6 Section2 CAPITAL BUDGETING Meaning of capital budgeting Capital budgeting techniques: i. Traditional/non discounting CF technique - PBP -ARR ii. Modern/discounting CF technique -NPV -IRR Concepts of relevant cash flows in investment appraisal: i. Sunk cost, ii. Ignore depreciation, iii. Incremental CF, iv. Opportunity cost, v. Working capital. Capital rationing Taxation and inflation in capital budgeting Sensitivity analysis/deterministic simulation Risk and uncertainty in capital budgeting Replacement decision: The following steps should be taken: i. Determine the replacement option

7 ii. For each replacement option estimate the cash flow over the replacement cycle. iii. Calculate the present value after each replacement cycle iv. Calculate the equivalent annual cost= PV of cost over 1 replacement cycle cumulative DF for the number of years in the cycle v. The optimal replacement cycle is the cycle with the least annual equivalent cost or the highest annual equivalent revenue.

8 Review questions: 1. Success Ltd is considering the selection of one of the pair of mutual exclusive investment project. Both would involve with a life of five years. Project A will generate annual cash flow (receipt less payment) of N200,000. The machinery would cost N556,000 and have a scrap value of N 56,000. Project B will generate annual cash flow of N 500,000 and the machinery would cost N 1,616,000 with a scrap value of N 301,000. Success Ltd uses a straight line method for providing depreciation. Its cost of capital is 15% per annum. Assumed that annual cash flows arose on the anniversary of the initial outlay and there would be no price changes over the project life. The acceptance of

9 one of the project will not alter the required amount of working capital. You are required to: (a) Calculate for each project: (i) The PBP to one decimal place (ii) The ARR (Ratio over project life of average accounting profit to average book value of investment) (iii) The net present value (iv) The IRR to nearest. (b) State which project should be selected for acceptance and give reasons for your choice of criterion to guide the decision. Ignore taxation.

10 Solution: i. project A B PBP=initial outlay N556,000 N1,616,000 Constant cash in inflow N200,000 N500,000 = 2.8yrs 3.2yrs ii.arr=avg profit after deprn100,000 N237,000x100 Avg investment N 306,000 N958,500 =33% =25% iii&v. project:a yr CF df15% PV Df30% PV N N N 1 Outlay (556,000) 1 (556,O00) 1 (556,000) 1-5 Inflow 200, , ,000 5 SV 56, , ,120 NPV 142,000 (52,880) IRR= LR + NPVP (HR LR) =26% NPV p + NPV n Project B. yr CF df15% PV Df30% PV N N N 1 Outlay ( ) 1 (1616,O00) 1 ( ) 1-5 Inflow 500, , ,000

11 5 SV 301, , ,270 NPV209,500 (314,730) IRR= LR + NPVP (HR LR) =21% NPV p + NPV n DECISION?

12 2. SPAL Ltd is considering investment in a computer-controlled machine which can be replaced by an identical one when it gets to the end of its economic life. The machine has a maximum life of four years but, as its productivity declines with age, it could be replaced after either one, two, three or four years. The financial details of the machine are as given below: Cost 6,000,000 Running cost N Year1 450, , , ,000 Scrap value after: Yr1 4,500, ,900, ,000, ,100,000

13 The board of directors of SPAL Ltd are concerned with deciding on its replacement policy. As the financial manager of the company, you are required to advise the board on the optimal replacement policy of the machine assuming that the company s cost of capital is 10%.

14 Section3 LEARNING CURVE THEORY Meaning of learning curve Conditions under which learning curve operate Application of learning curve Methods of solving learning curve Note: Y=ax b Where: Y= Cumulative Average time / hour per unit A= Average time spent in producing the first batch, or the total hour spent in producing the first unit. X =No of units made so far, or a define cumulative output No of unit in the first batch b = Log of learning curve percentage Log 2

15 QUESTION Success, has asked Hardwork to prepare a bid on supplying 1600 units of a new product, production will be in batches of 100 units. Hardwork has estimated that the labour cost for the first batch of 100 units will average N50 a unit. Hardwork also expects that an 80% learning curve will apply to the cumulative labour cost on this contract. Required: 1. Prepare an estimate of labour cost of fulfilling this contract. 2. Estimate the incremental labour cost of extending the production run to produce an additional 1600 units. 3. Estimate the incremental cost of extending the production run from 1600 to 2000 units.

Chapter 6 Making Capital Investment Decisions

Chapter 6 Making Capital Investment Decisions Making Capital Investment Decisions Solutions to Even-Numbered Problems and Cases 6.2 Manitoba Railroad Limited (MRL) (a) Discount Rate 7% Cash Cash Net Cash Cumulative Year Outflows Inflows Flows Cash