Analysing financial performance

Osborne Books Tutor Zone Analysing financial performance Chapter activities Osborne Books Limited, 2013

2 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 1 Management accounting techniques 1.1 The table below contains the last three months cost per kilogram for product Beta. January February March Actual price was 29.00 Actual price was 31.60 Actual price was 23.90 Seasonal variation was + 1.90 Seasonal variation was Seasonal variation was + 4.60 3.00 The trend in prices is a decrease of per month. 1.2 A company has provided the following information: January February March Total cost 180,000 168,000 299,250 Total quantity purchased 6,000 kg 5,500 kg 9,500 kg The cost index for March based upon January being the base period of 100 is: (a) 105 (b) 166 (c) 158 (d) 106

c h a p t e r a c t i v i t i e s 3 1.3 The cost per unit of a product has increased from 93 in January to 96 in April. The cost per unit was 60 when the index was rebased to 100. (a) The cost index in January was 93 and in April was 96 (b) The cost index in January was 65 and in April was 63 (c) The cost index in January was 155 and in April was 160 (d) The cost index in January was 100 and in April was 103 1.4 Clagstar Limited is considering installing a new boiler system in its factory to provide heating and power. The system will cost 65,000 to purchase and install. The system would result in an annual saving of 8,200 in energy costs due to the improved efficiency. In addition the maintenance costs would be reduced by 7,000 per year. The new system would have a life of 5 years and no residual value. It would be depreciated in the accounts over this period. The company s cost of capital is 10%, and this rate has been used for the discount factors in the table shown below. (a) Complete the following table to calculate the net present value of the system. Year Detail Cash Flow Discount Present Factor Value 0 Purchase and Installation 1.000 1 Net annual savings 0.909 2 0.826 3 0.751 4 0.683 5 0.621 Net Present Value (b) Complete the following sentence by selecting the correct options. The net present value of the scheme is positive / negative, so from a financial point of view the scheme is worthwhile / not worthwhile.

4 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 2 Standard costing direct costs 2.1 A company purchased and used 15,000 kilograms of material at a cost of 97,800. The standard cost per kilogram is 6.35. The standard usage is 14,800 kg for the output that the company achieved. (a) The material price variance is: (a) (b) (c) (d) 2,550 Adverse 2,550 Favourable 2,516 Adverse 2,516 Favourable (b) The material usage variance is: (a) (b) (c) (d) 1,304 Adverse 1,304 Favourable 1,270 Adverse 1,270 Favourable

c h a p t e r a c t i v i t i e s 5 2.2 A company used 25,000 kilograms of material at a cost of 37,500. The material price variance was 500 favourable, and the material usage variance was 1,670 adverse. What is the standard cost per kg of the material? (a) (b) (c) (d) 1.43 per kg 1.52 per kg 1.48 per kg 1.57 per kg 2.3 A company expects to produce 18,000 units of Y using 6,000 labour hours. The actual cost of labour is 88,400. The direct labour rate variance is 1,400 adverse. If the actual output is 17,700 units, and the actual labour time is 5,800 hours, what is the standard labour cost per hour? (a) 15.00 (b) 14.50 (c) 14.75 (d) 15.48

6 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 2.4 Tidy Ltd manufactures office products. The company has several divisions including the Paper Clips Division. You work as an Accounting Technician reporting to the Finance Director. The Radiators Division operates a standard cost system in which: Purchases of materials are recorded at standard cost Direct material and direct labour costs are variable Production overheads are fixed and absorbed on a labour hours basis The budgeted activity and actual results for the month of November 20-3 are as follows: Budget Actual Production units (millions of paper clips) 6,000 5,750 Direct materials steel wire 120 million metres 600,000 116 million metres 577,000 Direct labour 60 hours 1,080 59 hours 1,075 Fixed overheads 220,000 220,000 Total cost 821,080 798,075 Calculate the following variances for November: Variance A/F Direct material price variance Direct material usage variance Direct labour rate variance Direct labour efficiency variance

c h a p t e r a c t i v i t i e s 7 3 Standard costing variable and fixed overheads 3.1 The following information has been calculated for the production of 1 unit of Exe: Each unit will require 0.8 kilograms of material at a cost of 6.50 per kilogram Each unit will require 0.2 hours of labour at a total cost of 2.80 Fixed overheads total 372,400 and the estimated output will be 26,600 units of Exe Fixed overheads are absorbed on a per unit basis Complete the standard cost card below. 1 unit of Exe Quantity Cost per unit Total cost Material Labour Fixed costs Total

8 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 3.2 You have been given the following information: Budgeted overheads are 800,000 Budgeted output is 25,000 units Actual output is 27,000 units Actual overheads are 790,000 The fixed overhead volume variance is favourable / adverse. The fixed overhead expenditure variance is favourable / adverse. 3.3 You have been given the following information: Budgeted overheads are 450,000 Budgeted output is 20,000 units and 5,000 labour hours Actual output is 18,000 units and 4,900 labour hours Actual overheads are 455,000 The fixed overhead efficiency variance is favourable / adverse. The fixed overhead capacity variance is favourable / adverse.

c h a p t e r a c t i v i t i e s 9 3.4 You have been given the following information: Budgeted overheads are 180,000 Budgeted output is 12,000 units and 8,000 labour hours Actual output is 12,420 units and 8,150 labour hours Actual overheads are 184,000 Complete the following table to show the fixed overhead variances. Variance A / F Variance A / F Expenditure Variance Capacity Variance Efficiency Variance Volume Variance Total Fixed Overhead Variances

1 0 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 4 Standard costing further analysis 4.1 Bee Limited uses Standard Costing to manage its costs, and absorbs fixed overheads using direct labour hours as an absorption base. It makes one product. Standard Direct Costs for one unit are: Direct Material 2.5 litres at 5.00 per litre = 12.50 per unit Direct Labour 0.5 hours at 15 per hour = 7.50 per unit Fixed Overheads 0.5 hours at 40 per hour = 20.00 per unit The standard fixed overheads for one month are 100,000. The standard production output for one month is 2,500 standard hours (i.e. 5,000 units of product). During February, actual production was 2,300 standard direct labour hours (i.e. 4,600 units of product). Actual Costs for February were as follows: Direct Material 11,650 litres, costing a total of 58,017 Direct Labour 2,340 hours, costing a total of 35,568 Fixed Overheads actual cost 99,800 Calculate and insert all the variances listed in the following table. Use the table to reconcile the budgeted cost of actual production with the actual cost. Budgeted cost for actual production Variances: Favourable Adverse Direct materials price Direct materials usage Direct labour rate Direct labour efficiency Fixed overhead expenditure Fixed overhead capacity Fixed overhead efficiency Total variances Actual cost of actual production

c h a p t e r a c t i v i t i e s 1 1 4.2 A company uses labour grade L in its production of product Q. Labour grade L has a standard rate of 12 per hour, and a standard labour time of 12 minutes per unit of Q. In June, 8,500 units of Q were made, using 1,800 hours of labour grade L. The labour cost was 24,360. Since the standards were originally set, a pay rise of 4.0% has been agreed and implemented for the employees paid on labour grade L. Complete the following table to show the direct labour rate variance, and its analysis into the part caused by the pay rise and the remainder. Direct Labour Rate Part of variance caused Part of variance caused Variance by pay rise by unknown factors A / F A / F A / F 4.3 From the following statements, select those that are correct. (a) (b) (c) (d) (e) (f) (g) Operational management is concerned with moving actual results as close as possible to results that are achievable in the short term A basic standard is useful mainly as a historical record, and its use is unlikely to result in meaningful variances Ideal standards often result in improved motivation, since the variances recorded will be a mixture of adverse and favourable Strategic management can examine ways of moving what is attainable closer to the ideal over the longer term Attainable standards do not allow for any wastage or inefficiency, and therefore tend to demotivate staff The setting of cost standards is an internal choice for the organisation, and is not governed by accounting legislation Attainable standards can be set as a target that can be achieved under current conditions

1 2 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 5 Measuring quality 5.1 Concentric Limited uses target costing when developing new products. A new product is being considered which has the following cost and revenue information. Sales the demand is expected to average 4,000 units per month at a selling price of 13.00 per unit Materials the product requires 0.2 kg of material R for each unit. Labour each unit requires 10 minutes of labour at 18 per hour. Overheads the product would be manufactured in a separate factory, with total fixed production overheads of 16,000 per month Profit the gross margin required is at least 35% (a) Complete the following table. Maximum production cost per unit Build up of maximum production cost per unit: Materials Labour Overheads Maximum cost per kilo for material R (b) If material R has a normal price of 10.00 per kg, what is the minimum percentage discount that Concentric should negotiate? %

c h a p t e r a c t i v i t i e s 1 3 5.2 Gamma Limited will be replacing some company cars in the next year and needs to decide whether to purchase or lease the vehicles. The discount factors you will need are shown below. Year Discount factor Year Discount factor 0 1.00 3 0.864 1 0.952 4 0.823 2 0.907 (a) Calculate the discounted lifecycle cost of purchasing each car based upon the following: Purchase price of 18,000 Maintenance costs of 600 for each of the next four years, paid annually in arrears A residual value of 3,500 at the end of the four years Year 0 1 2 3 4 Cash flow Discount factor Present value Net present cost (b) Calculate the discounted lifecycle cost of leasing each car for four years based upon the total annual costs of 6,250 paid annually in advance. This figure includes maintenance. There is no residual value if leased. Year 0 1 2 3 4 Lease costs Discount factor Present value Net present cost (c) Based on the calculations it is best to purchase / lease each car, which saves a net present amount of

1 4 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 5.3 Analyse each of the following cost examples into the four main groups of the cost of quality by ticking the appropriate columns. (a) Cost of making design changes (b) Meeting costs of product liability claims (c) Maintenance of quality control equipment (d) Inspection of raw materials received (e) Costs of production delays Prevention Appraisal Internal External Costs Costs Failure Failure Costs Costs (f) Loss of repeat business from customers (g) Losses due to scrapped products

c h a p t e r a c t i v i t i e s 1 5 6 Measuring performance 6.1 A trading company has the following results: Statement of Profit or Loss for the year ended 31 December 20-8 20-7 Sales 151,000 143,000 less cost of sales: Opening Inventory 22,000 21,000 Purchases 135,000 130,000 Closing Inventory 20,000 22,000 137,000 129,000 Gross Profit 14,000 14,000 Depreciation 3,000 3,000 Sundry Expenses 7,000 6,000 10,000 9,000 Operating Profit 4,000 5,000 Interest 1,500 2,000 Net Profit 2,500 3,000 Taxation 1,300 1,000 Net Profit after taxation 1,200 2,000

1 6 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e Statement of Financial Position As at 31/12/20-8 As at 31/12/20-7 Non-current Assets 110,000 113,000 Current Assets: Inventory 20,000 22,000 Trade Receivables 37,000 26,000 Bank 2,000 5,000 59,000 53,000 Current Liabilities: Trade Payables 34,800 23,000 Net Current Assets 24,200 30,000 Total Assets less Current Liabilities 134,200 143,000 Non-current Liabilities: 5% secured loan stock 30,000 40,000 104,200 103,000 Ordinary Share Capital (50p shares) 50,000 50,000 Retained Earnings 54,200 53,000 104,200 103,000 Complete the following table to show the performance indicators listed for each year. Show the solutions to 2 decimal places, with the exception of those measured in days which should be rounded to the nearest day. 20-8 20-7 Gross Profit % Return on Capital Employed % Operating Profit as % Sales Current Ratio Asset Turnover Quick Ratio Trade Receivables Days Trade Payables Days Debt to Equity Ratio %

c h a p t e r a c t i v i t i e s 1 7 6.2 The following performance indicators have been calculated for a trading company, and comments have been made about what each indicator tells us. Match each indicator with the appropriate comment. Performance Indicator 20-8 20-7 Comment Gross Profit % 9.27 9.79 There are more sales for every of resources in the second year Return on Capital 2.98 3.50 The profit margin (after just cost of sales has Employed % been deducted from sales) has reduced in the second year Operating Profit as % 2.65 3.50 The current liabilities have increased in Sales proportion to the current assets in the second year Current Ratio 1.70 2.30 The current assets (after excluding inventory) are lower compared with current liabilities in the second year Asset Turnover 1.13 1.00 Customers are taking longer to pay in the second year Quick Ratio 1.12 1.35 The operating profit as a percentage of the total resources has reduced in the second year Trade Receivables Days 89 66 The value of long term debt compared to the shareholders financial interest has decreased in the second year Trade Payables Days 94 65 The profit before interest as a percentage of revenue is lower in the second year Debt to Equity Ratio % 28.79 38.83 The company is taking longer to pay its suppliers in the second year

1 8 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 6.3 Emme Limited is comparing its results with its major competitor, Cue plc. You have been given the following information about Emme and Cue for the year just ended. Statement of Profit or Loss Emme Cue 000 000 Turnover 20,000 35,000 Cost of production Direct (raw) materials 4,800 5,500 Direct labour 2,700 3,900 Fixed production overheads 1,200 5,000 Total cost of sales 8,700 14,400 Gross profit 11,300 20,600 Selling and distribution costs 1,800 2,500 Administration costs 850 1,500 Advertising costs 1,900 4,500 Net profit 6,750 12,100 Other information Emme Cue Number of units sold Units 4,000,000 5,000,000 Net assets ( 000) 30,000 55,000 Calculate the performance indicators to complete the following table for Emme and Cue: Give answers to two decimal places. Selling price per unit Material cost per unit Labour cost per unit Fixed production overheads per unit Gross profit margin Net profit margin Advertising cost as % of turnover Return on net assets Emme Cue

c h a p t e r a c t i v i t i e s 1 9 7 Measuring performance further aspects 7.1 Indicator Limited makes a single product and uses standard costing. Each unit has a standard labour time of 15 minutes. During November the budget was to produce 80,000 units. In November 81,200 units were manufactured, and this took 20,500 labour hours. Complete the following table by inserting the control ratios calculated as percentages to two decimal places. Efficiency Ratio Activity Ratio (or Production Volume Ratio) Capacity Ratio

2 0 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 7.2 The following table shows matching perspectives and typical ratios based on the balanced scorecard approach. Rearrange the items in the third column, so that they match with the other two columns. Perspective Typical ratios that can What it is concerned with be used Internal Added Value, Satisfying the shareholders, Cost of Quality, Reject Rates Sales returns (due to quality issues) as a % of net sales. primarily by generating profits. Customer Delivery times (or order Improvement of existing products backlogs), Repeat orders from customers, Sales returns as a % of net sales. or services, and development of new products or services. Innovation and Learning R & D Expenditure Technical excellence and quality (or as %), Revenue from new products (or as %). issues. Financial Gross Profit %, Customer satisfaction and loyalty. Operating Profit %, ROCE, Added Value.

c h a p t e r a c t i v i t i e s 2 1 7.3 A hotel chain wishes to use performance indicators to directly measure how well it uses its resources to generate revenue and profit. From the list of indicators shown in the following table, select the three indicators that best meet this requirement, by ticking the column on the right. Performance indicator (a) Asset turnover (b) Gearing ratio (c) Break even point (d) Room occupancy rate (e) Return on net assets (f) Current ratio (g) Debt to equity ratio (h) Contribution to sales ratio Suitable? 7.4 The following operating statement has been prepared for Value Limited, a company that has 320 employees. 000 Sales 650 Materials 130 Bought in services 80 Other variable costs 110 Fixed Costs 160 Operating Profit 170 The value added per employee is

2 2 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 8 Scenario planning 8.1 Cenlow Limited manufactures instant coffee and is considering launching the product in an improved pack that is lighter and cheaper to produce than the current glass jars. Current sales volume is 4.0 million units per annum and is not expected to change. Current fixed production costs are 0.89 million. Current labour cost per unit is 1.15 which is completely variable. Current material cost per unit is 1.75 and is completely variable. Assume inventory levels are kept at zero. Variable material cost of the new product will be 0.15 less per unit than the current product due to the cheaper packaging. Selling price will be reduced marginally from 4.50 to 4.47. Fixed selling and distribution costs will reduce from 700,000 to 630,000. Additional investment in assets will be 2 million which will be depreciated at 200,000 per annum. All other costs will remain the same. (a) Calculate the total annual increase in profit by completing the table below. Units Price/cost Total Reduction in revenue Savings on materials Reduction in selling and distribution costs Additional depreciation Additional annual profit (b) Based on the new product, calculate the performance measures shown in the following table to help understand any additional risk. Return on additional investment (%) Total fixed costs Contribution per unit Break even sales volume in units Margin of safety (%)

c h a p t e r a c t i v i t i e s 2 3 8.2 The table below shows the current situation for a company that buys and sells a single product. Current sales are 5,500 units per month, based on a selling price of 12. Inventory is valued at variable cost and is equal to 2.5 months sales. Customers take 3 months to pay. Payables relate to variable costs and are paid in 2 months. A suggestion has been made to increase the selling price by 5%. It is thought that the benefit of the increased revenue will outweigh a reduced sales volume of 7%. Complete the table based on the proposal, assuming that net current asset periods remain the same. Current Position Proposed Position Monthly Statement of Profit or Loss Sales 66,000 Variable Costs 44,000 Fixed Costs 8,000 Operating Profit 14,000 Net Current Assets Inventory 110,000 Receivables 198,000 Less Payables (88,000) Total Net Current Assets (exc cash) 220,000

2 4 a n a l y s i n g f i n a n c i a l p e r f o r m a n c e t u t o r z o n e 8.3 Phillitt Limited is a company that fills and packs plastic bottles for customers who provide both the contents and the bottles. The main customers are liquid detergent companies. The process is semi mechanised. The bottles are filled automatically by machine, and then the bottle tops are screwed onto the bottles by hand. The bottles are finally packed by hand into cases of 24 bottles. The manager has been investigating the purchase of a fully automated production line that would eliminate the need for the majority of employees by screwing on the bottle tops by machine as well as packing the bottles into cases. The purchase and installation of the equipment would cost 500,000, and would be depreciated at 100,000 per year. The following Statement of Profit or Loss is based on the next year s operation, assuming the current working practices, and production of 4 million filled bottles. 000 Sales 600 less: variable labour cost 350 Contribution 250 less: fixed production costs 110 fixed administration costs 60 Operating profit 80 If the automated line is installed: labour costs will reduce to 150,000 per year, regardless of the production level fixed production costs will increase by 35,000 per year, in addition to the depreciation expense other costs will be unchanged The company s cost of capital is 5%, and discount factors over the five year life of the project are as follows: Year Discount factor 5% Year Discount factor 5% 0 1.00 3 0.864 1 0.952 4 0.823 2 0.907 5 0.784

c h a p t e r a c t i v i t i e s 2 5 The automated line will be paid for immediately and have no value at the end of the five year project. Assume that sales and costs remain at the same level for each of the five years, and occur at the end of each year. (a) Using the following table, calculate the net present value of the mechanisation project. Year Cash Outflow Cash Savings Discount Factor Present Value 0 1 2 3 4 5 Net Present Value (b) Complete the following table to calculate the revised operating profit under the proposal. 000 Sales Labour costs Production costs Additional depreciation Administration costs Operating profit