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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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14.5 Mega Stores is a chain of 125 retail outlets selling clothing under the strong Mega brand. Its sales have increased from £185 million to £586 million over the last five years. The company’s gross profit is currently 83% of sales, giving it a little more than 20% mark-up on the cost of goods and retail store running costs.

Corporate overhead is £19 million and the operating profit is £81 million.


Mega Stores’ finance director has produced a budget, which has been approved by the board of directors, to increase sales by 35% next year and to improve operating profit margin to 15% of sales. Corporate overheads will be contained at £22 million.

The strategy determined by the marketing director is to continue expanding its sales by winning market share from competitors and by increasing the volume of sales to existing customers. It aims to increase its direct mailing of catalogues to customers and its television advertising. The company also intends to open new stores to extend its geographic coverage.

Mega Stores also plans to improve its cost effectiveness by continuing its investments in major regional warehouses and distribution facilities servicing its national network of stores, together with upgrading its information systems to reduce inventory and delivery lead times to its retail network.

You have been asked to produce a report for the senior management team identifying the financial information that is required to support the business strategy. You are also asked to identify any non-financial issues arising from the strategy.

Questions for Chapter 15

15.1 Conrad Corporation has a budget to produce 2,000 units at a variable cost of £3 per unit, but actual production is 1,800 units with an actual cost of £3.20 per unit.

Calculate the variance based on a flexible budget and determine whether it is favourable or adverse.

Calculate the material price variance for Cracker Barrel based on the 15.2

following information:

–  –  –

a Prepare a traditional budget versus actual report using the above figures.

b Prepare a flexible budget for Gargantua.

c Calculate all sales and cost price and efficiency variances.

d Reconcile the original budget and actual profit figures using the variance analysis.

Appendix 2 Solutions to Questions Solutions for Chapter 6 6.1 Kazam Services’ accounting records are shown in Table A2.1.

–  –  –

630,000 150,000 60,000 450,000 200,000 70,000 40,000 −40,000

–  –  –

230,000 6.2 See Table A2.2.

6.3 Answer e: Although the operating profit has increased (from £137,000 to £139,000), the operating margin has decreased (from 11.6% to 11.1%) as a result of a reduction in the gross margin (from 39% to 37%) and higher expenses (from £323,000 to £324,000), despite sales growth (of 6.4%). See Table A2.3.

6.4 See Table A2.4.

6.5 a Prepayment The annual payment is 24 × £400 = £9,600 (this is £800/mth). The prepayment at 31 March is 9/12 (Apr–Dec) @ £800 = £7,200.

–  –  –

Profit is reduced by £2,400 (expense: 3 mths @ £800).

Asset in the Balance Sheet is increased by £7,200 (prepayment is an asset: 9 mths @ £800).

Cash flow is reduced by £9,600 (payment 31 December).

NB: The effect of the prepayment of £7,200 is to carry forward the expense to the next financial year.

b Accrual The simple solution is to divide £6,000 by 12 months and charge £500/mth to profit.

However, this ignores seasonal fluctuations and cash flow differences from quarter to quarter.

The quarterly bills have been paid during the year, but the last quarterly bill was in November. Therefore the business is missing one month’s expense (i.e. December). To

determine the amount we need to calculate the seasonal charges:

£6,000 × 70% = £4,200 for September–February/6 = £700/mth.

£6,000 × 30% = £1,800 for March–August/6 = £300/mth.

Accrue for one month (December) = £700.

Profit reduced by £700 (expense).

Balance Sheet reduced by £700 (accrual is a creditor).

Cash flow has no impact (no money yet paid).

–  –  –

c Depreciation Depreciation is 20% of £12,000 = £2,400 p.a. or £200/mth. As depreciation is charged from the next month, it needs to be provided for the period July–March. For that period, depreciation is £200 × 9 = £1,800.

Profit reduced by £1,800 (depreciation expense).

Balance sheet increased by £12,000 (new asset) and reduced by £1,800 (depreciation), leaving a net value of £10,200.

Cash flow reduced by £12,000 (payment for new system).

NB: The Balance Sheet value of the asset will be reduced by £2,400 p.a. until the asset is written down to a nil value, or sold or disposed of.

–  –  –

ROI and ROCE have both reduced. There has been a very small sales growth (less than 2%, i.e. less than the rate of inflation) but expenses have increased by 4.6%. Consequently, operating profit has fallen, as has profit as a percentage of sales. The fall in profits and the increase in shareholders’ funds and capital employed have resulted in the decline in ROI and ROCE.

Gearing has also fallen as a result of a large reduction in long-term debt. Asset turnover has improved marginally.

Although two years is too short a period to draw any meaningful trends, we can say that Drayton needs to increase its sales and/or contain its expenses.

7.2Conclusions include:

ž Profit has declined on each of the measures.

ž Liquidity: Working capital has deteriorated and debtors are taking longer to pay their accounts.

ž Gearing: Long-term debt has increased in proportion to shareholders’ funds and there is less profit to pay a higher amount of interest.

ž Assets are being used less efficiently to generate sales.

Overall, Jupiter’s performance on all four criteria has been worse in the current year.

SOLUTIONS TO QUESTIONS 413 Solutions for Chapter 8 8.1 See Table A2.5.

–  –  –

The standard cost per unit is £9.00 at the budgeted level of activity.

The actual cost per unit is £9.14 – this is the actual average production cost per unit.

The marginal cost per unit is £7.00 – this is the variable cost per unit.

–  –  –

The average cost reduces by £5 from £17 to £12. This is because the fixed costs of £100,000 are spread over 20,000 documents (£5 per document) rather than 10,000 documents (£10 per document).

The marginal cost is £7, i.e. the variable cost. It does not change per unit irrespective of volume within the relevant range.

The costs per unit at each activity level are:

10,000 20,000

–  –  –

The Eastern division should not be closed. It currently contributes £95,000 towards corporate costs. If the division were closed, the corporate costs would remain unchanged and the current loss of £60,000 would increase to £155,000.

–  –  –

8.7 Profit = selling price per unit × number of units − (VC/unit × no. units + fixed costs) therefore, £40,000 = SP × 20,000 − ((£8 × 20,000) + £100k)

–  –  –


Profit = price × no. of units − (fixed costs + variable costs × no. of units) 0 = 10,000P − (450,000 + 35 × 10,000) 0 = 10,000P − (450,000 + 350,000) 0 = 10,000P − 800,000 800,000 = 10,000P P = 800,000/10,000 = 80 Proof 10,000 × (80 − 35) = 10,000 × 45 = 450,000 − 450,000 = 0 8.9 Contribution per unit is 75 − 30 = 45 Fixed costs are 1,000 × 12 = 12,000

–  –  –

8.12 See Table A2.6.

The maximum contribution is at a selling price of £28. Note that this is not necessarily the highest sales revenue. The highest contribution will also be the highest profit because the same amount of fixed costs are deducted from each level of activity (within the relevant range).

–  –  –

Solutions for Chapter 9 9.1 Variable costs are £2 per unit (£10,000/5,000), for December 10,000 @ £2 = £20,000.

Fixed costs do not change with activity, for December £30,000.

As total costs are £75,000, semi-variable costs for December are £25,000 (£75,000 − £20,000 − £30,000).

–  –  –

The increase in hours sold of 8,000 has generated a higher cost of £160,000. This cost must be a variable cost as, by definition, fixed costs do not vary with the volume of activity.

Therefore variable costs are £160,000/8,000 or £20 per hour.

At the 15,000 level of activity, 15,000 @ £20 = £300,000. Therefore fixed costs are £45,000 (£345,000 − £300,000).

At the 7,000 level of activity, 7,000 @ £20 = £140,000. Therefore fixed costs are £45,000 (£185,000 − £140,000).

However, this only applies in the relevant range, as outside the relevant range the cost structure of fixed and variable costs may alter.

–  –  –

9.5 Production will be 8,000 units special order plus 12,000 units regular sales to give a maximum production capacity of 20,000 units.

Variable costs are £49 per unit (£588,000/12,000 units).

Fixed costs are £345,000 (£245, 000 + £100,000).

–  –  –

9.6 As the material is in regular use and has to be replaced, it is irrelevant that some is already in stock as the relevant cost – the future, incremental cash flow (in this case the replacement cost) – is 150 kg @ £12.50, a total of £1,875. The scrap value is not relevant.

–  –  –

Variable cost = £100,000/200,000 = £0.50 1,200,000 @.50 = £600,000. Therefore fixed costs are £250,000 (£850,000 − £600,000)


10.3 Direct materials and variable costs are relevant costs as they are only incurred if manufacture takes place. Direct labour is avoidable, i.e. it will only be incurred if Cardinal makes the part. As 60% of the fixed costs will continue regardless of the decision, only 40% of the fixed cost is relevant for the decision. Therefore, relevant costs of in-house


–  –  –

10.6 The comparison of costs under each alternative is shown in Table A2.10.

Direct labour and fixed overheads are irrelevant in making a choice between alternatives.

Direct materials and variable overheads will not be incurred if the components are purchased, and are therefore relevant costs.

Relevant costs are therefore as in Table A2.11.

If employees were on a temporary contract, labour cost would be avoidable and therefore the comparison of costs would be as in Table A2.12.

Fixed overheads are irrelevant in making a choice between alternatives. Direct labour, materials and variable overheads will not be incurred if the components are purchased, and are therefore relevant costs.

Relevant costs are therefore as in Table A2.13.

Costs based on stock valuation are not relevant, as we are concerned with future costs only.

–  –  –

10.7 An alternative format for these figures is as in Table A2.14.

This format shows the contribution, which based on the contribution after deducting material is in fact highest for Franklin. However, calculating the contribution per labour hour (by dividing the contribution by the number of hours, i.e. labour cost divided by £100 per hour) verifies the lower contribution by Franklin per unit of the limiting factor, i.e.

labour capacity. This is reflected in the rate of gross profit being the lowest of the three main customers.

The issues that arise from these figures are:

1 Labour is in effect a fixed cost given the circumstances of the business and its allocation to different products is questionable, other than in terms of determining the most profitable utilization of the limited capacity.

2 Can the high labour cost for Franklin be reduced by mechanization given that Franklin contributes almost 17% of total sales (£1,000,000/£6,000,000) with the highest contribution margin of 75%?

3 While Engineering Partners and Zeta are the most profitable customers in the accountant’s report, the revised format shows the highest contribution per labour hour from the ‘other’ customer segment. Zeta, which on the accountant’s figures appears more profitable than Engineering Partners, is using the revised format, less profitable per labour hour.

4 Do the corporate overheads, presently allocated arbitrarily in proportion to sales volume (30% of sales), accurately reflect the different cost structure of each segment of the business in terms of space utilization (rent), capital investment in production processes (depreciation), non-production salaries, selling and administration expenses? An activity-based approach may lead to more meaningful allocation of costs and a different decision as to the profitability of different business segments.

–  –  –

11.5 (a) Set-up costs £66,000 Production runs 12 + 5 + 8 = 25 Cost per set-up £66,000/25 = £2,640 Product A has 12 runs @ £2,640 = £31,680 And 4,000 units are produced Cost per set-up per unit is £31,680/4,000 = £7.92 (b) Materials handling costs £45,000 Stores orders 12 + 6 + 4 = 22 Cost per store order £45,000/22 = £2,045 Product B has 6 stores orders @ £2,045 = £12,270 And 3,000 units are produced Cost per stores order per unit is £12,270/3,000 = £4.09

–  –  –

If £120,000 of costs were recovered over the number of units produced (20,000 + 20,000 = 40,000), the purchasing cost per unit would be £3 (£120,000/40,000 units) for both L and M.

–  –  –

See Table A2.16.

Total profit £388,750.

Activity-based costing See Tables A2.17 and A2.18.

Total £389,000.

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