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«Paul M. Collier Aston Business School, Aston University Accounting for Managers Accounting for Managers: Interpreting accounting information for ...»

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Victory is operating at almost full capacity, but wishes to improve its profitability further. The accountant has reported that, based on the above figures, Franklin Industries is the least profitable customer and has recommended that prices be increased. If this is not possible, the accountant has suggested that Victory discontinues selling to Franklin and seeks more profitable business from Engineering Partners and Zeta.

Labour is the most significant limitation on capacity. It is highly specialized and is difficult to replace. Consequently, Victory does all it can to keep its workforce even where there are seasonal downturns in business. The company charges £100 per hour for all labour, which is readily transferable between each of the customer products.

You have been asked to comment on the accountant’s recommendations.

–  –  –

Questions for Chapter 11

11.1 Intelco, a professional services firm, has overheads of £500,000. It operates three divisions and an accountant’s estimate of the overhead allocation per division is 50% for Division 1, 30% for Division 2 and 20% for Division 3. The divisions

respectively bill 4,000, 2,000 and 3,000 hours. Calculate the:

ž blanket (organization-wide) overhead recovery rate; and the ž cost centre overhead recovery rate for each division.

11.2 BCF Ltd manufactures a product known as a Grunge. Direct material and labour costs for each Grunge are £300 and £150 respectively. To produce a Grunge requires 20 hours, comprising 10 hours in machining, 7 hours in assembly and 3

hours in finishing. Information for each department is:

–  –  –

Calculate the cost of producing a Grunge using a departmental overhead recovery rate.

11.3 Engineering Products PLC produces Product GH1, which incurs costs of £150 for direct materials and £75 for direct labour. The company has estimated its

production overhead and direct labour hours for a period as:

–  –  –

Product GH1 is produced using 10 hours in Dept A, 12 hours in Dept B and 5 hours in Dept C.

Calculate the total cost of each GH1 using:

ž a plant-wide overhead recovery rate; and ž cost centre overhead recovery rates.

11.4 Haridan Co. uses activity-based costing. The company has two products, A and B. The annual production and sales of Product A are 8,000 units and of product B 6,000 units. There are three activity cost pools, with estimated total cost

and expected activity as follows:

–  –  –

a If set-up costs are driven by the number of production runs, what is the set-up cost per unit traced to product A?

b If materials handling costs are driven by the number of stores orders, what is the materials handling cost per unit traced to product B?

11.6 Elandem PLC produces 20,000 units of Product L and 20,000 units of Product M. Under activity-based costing, £120,000 of costs are purchasing related.

If 240 purchase orders are produced each period, and the number of orders used

by each product is:

Product L Product M No. of orders 80 160

ž Calculate the per-unit activity-based cost of purchasing for Products L and M.

ž Calculate the overhead recovery for purchasing costs if those costs were recovered over the number of units of the product produced.

11.7 Heated Tools Ltd uses activity-based costing. It has identified three cost

pools and their drivers as follows:

–  –  –

Product Hekla uses £100 of direct materials and £75 of direct labour. In addition, each Hekla has been identified as using five purchase orders, eight stores issues and two deliveries.

Calculate the total cost of each Hekla.

11.8 Samuelson uses activity-based costing. The company manufactures two products, X and Y. The annual production and sales of Product X are 3,000 units and of Product Y 2,000 units. There are three activity cost pools, with estimated

total cost and expected activity as follows:

–  –  –

a Calculate the overhead cost per unit of Product X and Y under activitybased costing.

b Samuelson wishes to contrast its overhead allocation with that under the traditional costing method it previously used. Samuelson charged its overheads of £59,000 to products in proportion to machine hours. Each unit of X and Y consumed five machine hours in production. Calculate the overhead cost per unit of Product X and Y under the traditional method of overhead allocation.

11.9 Brixton Industries PLC makes three products: Widgets, Gadgets and Helios.

The following budget information relates to Brixton for next year (Table A1.4).

Overheads allocated and apportioned to production departments (including

service cost centres) were to be recovered in product costs as follows:

Machining department at £1.20 per machine hour.

Assembly department at £0.825 per direct labour hour.

However, you have determined that the overheads could be reanalysed into cost pools as in Table A1.5.

You have also been provided with the following estimates for the period (Table A1.6).

–  –  –

ž Prepare and present a profit calculation showing the profitability of each product using traditional absorption costing.

ž Prepare and present a profit calculation showing the profitability of each product using activity-based costing.

ž Explain the differences between the product profitability using absorption and activity-based costing.

11.10 Klingon Holdings has prepared a marketing study that shows the following

demand and average price for each of its services for the following period:

–  –  –

Fixed expenses have been budgeted as £6,900,000.

Using the above information:

ž Calculate the contribution per unit of volume (and in total) for each service.

Which is the preferred service? Why? What should the business strategy be?

ž Determine the absorption (full) cost per unit for the three services using three different methods of allocating overheads.

ž How do the results of these different methods compare?

ž Assuming a constant mix of the services sold, calculate the breakeven point for the business.

QUESTIONS 399 Questions for Chapter 12

12.1 The Whitton Co. has an opportunity to buy a computer now for £18,000 that will yield annual net cash inflows of £10,000 for the next three years, after which its resale value would be zero. Whitton’s cost of capital is 16%.

ž Calculate the net present value of the cash flows for the computer using spreadsheet formula.

ž What is the IRR?

12.2 SmallCo is considering the following project, whose cost of capital is 12%

per annum:

–  –  –

Depreciation is £70,000 per annum. For each project, calculate the:

ž payback period;

ž accounting rate of return (average);

ž net present value (assuming a cost of capital of 9%); and ž comment on which (if any) project should be accepted.

12.4 Freddie PLC has £5 million to invest this year. Three projects are available, and all are divisible, i.e. part of a project may be accepted and the cash flow returns

will be pro-rata. Details of the projects are:

–  –  –

What is the ranking of the projects that should be accepted?

12.5 Tropic Investments is considering a project involving an initial cash outlay for an asset of £200,000. The asset is depreciated over five years at 20% p.a. (based


on the value of the investment at the beginning of each year). The cash flows from

the project are expected to be:

–  –  –

ž What is the payback period?

ž What is the return on investment (each year and average)?

ž Assuming a cost of capital of 10% and ignoring inflation, what is the net present value of the cash flows? (Use the tables rather than a spreadsheet to answer this question.) ž Should the project be accepted?

Questions for Chapter 13

13.1 Jakobs Ladder has capital employed of £10 million and currently earns an ROI of 15% per annum. It can make an additional investment of £2 million for a five-year life. The average net profit from this investment would be 14% of the original investment. The division’s cost of capital is 12%.

Calculate the residual income before and after the investment.

13.2 China Group has a division with capital employed of £10 million that currently earns an ROI of 15% per annum. It can make an additional investment of £2 million for a five-year life with no scrap value. The average net profit from this investment would be £280,000 per annum after depreciation. The division’s cost of capital is 9%.

Calculate the ROI and residual income for the:

ž original investment;

ž additional investment; and ž total new level of investment.

13.3 Brummy PLC consists of several investment centres. Green Division has a controllable investment of £750,000 and profits are expected to be £150,000 this year. An investment opportunity is offered to Green that will yield a profit of £15,000 from an additional investment of £100,000. Brummy accepts projects if the ROI exceeds the cost of capital, which is 12%.

–  –  –

13.4 Anston Industries is the manufacturing division of a large multinational.

The divisional general manager is about to purchase new equipment for the manufacture of a new product. He can buy either the Compax or the Newpax equipment, each of which has the same capacity and an expected life of four years. Each type of equipment has different capital costs and expected cash flows,

as follows:

–  –  –

The equipment will be installed and paid for at the end of the current year (Year 0) and the cash flows accrue at the end of each year. There is no scrap value for either piece of equipment. In calculating divisional returns, divisional assets are valued at net book value at the beginning of each year.

The multinational expects each division to achieve a minimum return before tax of 16%. Anston is just managing to achieve that target. Anything less than a 16% return would make the divisional general manager ineligible for his profit-sharing bonus.

ž Prepare return on investment (ROI) and residual income (RI) calculations for the Compax and the Newpax for each year.

ž Suggest which equipment is preferred under each method.

ž Compare this with the NPV calculation.

13.5 Magna Products PLC has three divisions, A, B and C. The current investments in and net profits earned by each division are as follows:

–  –  –

Each division has put forward to the parent board a capital expenditure proposal for £50,000. Each division expects to produce net profits of £40,000 from that investment. Magna’s cost of capital is 7% p.a.


Use ROI and RI calculations to:

ž evaluate the current performance of each division; and ž evaluate which proposal the board should approve if finance limits the decision to a single proposal.

Questions for Chapter 14

April Co. receives payment from debtors for credit sales as follows:

14.1 ž 30% in the month of sale.

ž 60% in the month following sale.

ž 8% in the second month following the sale.

ž 2% become bad debts and are never collected.

The following sales are expected:

–  –  –

ž Calculate how much will be received in March.

ž What is the value of debtors at the end of March?

14.2 Creassos Ltd was formed in July 2000 with £20,000 of capital. £7,500 of this

was used to purchase equipment. The owner budgeted for the following:

–  –  –

Wages and other expenses are paid in cash. In addition to the above, depreciation is £2,400 per annum. No inventory is held by the company.

ž Calculate the profit for each the three months from July to September and in total.

ž Calculate the cash balance at the end of each month.

ž Prepare a Balance Sheet at the end of September.

–  –  –

The selling expense recharged from the sales department is £15,000 per month for the first half year, thereafter £12,000. Salaries are £25,000 per month, depreciation is £5,000 per month and rates £8,000 per month. Light, heat and power are expected to cost £3,000 per month for the first half year, falling to £2,000 thereafter.

ž Construct a budget for the year based on the above figures.

ž What can you say about the rate of gross profit?

14.4 Griffin Metals Co. has provided the following data.

Anticipated volumes (assume production equals sales each quarter):

–  –  –

The selling price is expected to be £300 per tonne for the first six months and £310 per tonne thereafter. Variable costs per tonne are predicted as £120 in the first quarter, £125 in the second and third quarters, and £130 in the fourth quarter.

Fixed costs (in £’000 per quarter) are estimated as follows:

–  –  –

Griffin has asked you to produce a profit budget and a cash forecast for the year (in four quarters) using the above data.

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