Company -Business Purchase -Financial Statements using IAS 1 -Issue and Redemption of Share Capital -Dividend January 2007 4. (a) Explain the term dividend cover. Dividend cover is the number of times the total annual dividend could have been paid out of the net profit after tax and preference dividends. Dividend cover = Net profit after tax and preference dividends/Ordinary dividend for year The higher the number, the safer the dividend policy (d) Capital gain = (New share price – purchased share price) x No. of shares Lee intends to sell his investment in one company and continue to hold his investment in the other company. He wishes to maximize his long-term investment potential but needs to sell one of the investments to pay for his daughter’s wedding. (e) Evaluate the information above and advice Lee on his best course of action. South China Containers would give the greatest amount of money for the wedding if sold now Best dividend stream for South China Containers - £125 more Best capital growth from South China Containers - £57.50 more Conclusion: Recommend selling Pacific Chemicals and holding on to South China Containers in order to maximize long-term potential. May 2005 4. (b) Give three advantages to a company and its shareholders of making a rights issue. A rights issue to existing shareholders is at a lower cost to the company than a public issue Existing shareholders may be encouraged to invest as the price per share will be less than the current market price If shareholders do not take up their rights, they can be sold to a third party thus, in effect, reducing the value of the shareholder’s investment Although a rights issue will initially dilute market value of the share normally recovers reflecting the markets view of the future prospects of the company. Thus, an investors potential of capital gains will not, normally, be put at risk. 3. (a) Distinguish between capital reserves and revenue reserves, giving two examples of each.
Transcript
Company-Business Purchase-Financial Statements using IAS 1-Issue and Redemption of Share Capital-Dividend
January 2007
4. (a) Explain the term dividend cover. Dividend cover is the number of times the total annual dividend could have been paid out of the net profit after tax and preference dividends.Dividend cover = Net profit after tax and preference dividends/Ordinary dividend for yearThe higher the number, the safer the dividend policy
(d) Capital gain = (New share price – purchased share price) x No. of shares
Lee intends to sell his investment in one company and continue to hold his investment in the other company. He wishes to maximize his long-term investment potential but needs to sell one of the investments to pay for his daughter’s wedding.(e) Evaluate the information above and advice Lee on his best course of action.
South China Containers would give the greatest amount of money for the wedding if sold now Best dividend stream for South China Containers - £125 more Best capital growth from South China Containers - £57.50 more
Conclusion: Recommend selling Pacific Chemicals and holding on to South China Containers in order to maximize long-term potential.
May 2005
4. (b) Give three advantages to a company and its shareholders of making a rights issue. A rights issue to existing shareholders is at a lower cost to the company than a public issue Existing shareholders may be encouraged to invest as the price per share will be less than the
current market price If shareholders do not take up their rights, they can be sold to a third party thus, in effect,
reducing the value of the shareholder’s investment Although a rights issue will initially dilute market value of the share normally recovers
reflecting the markets view of the future prospects of the company. Thus, an investors potential of capital gains will not, normally, be put at risk.
3. (a) Distinguish between capital reserves and revenue reserves, giving two examples of each.
Capital Reserves Revenue ReservesExamples Share Capital, Revaluation,
Capital RedemptionProfit and Loss A/c, General reserve
Formed by E.g. issue of shares, Capital Redemption
From Profit and Loss account
Used for dividends? No Yes
(d) Evaluate the decision of the directors to redeem the preference shares and issue ordinary shares
For Decision Preference shares carry high return at 10%, ordinary return will probably be lower This will leave more funds in the business that can be used to expand/generate more profits ROCE will improve as capital employed is reduced. This will please shareholders and intuitions.
Gearing ratio will improve as fixed interest debt is replaced by equity capital.Against Decision
Possible dilution of ownership of existing shareholders, if any sales in open market Issue costs e.g. lawyers, accountants
Conclusion
7. (c) Evaluate the importance of liquidity to a business.
For importance Firm needs to be liquid in order to pay its own bills to continue trading e.g. wages, suppliers Failure to pay bill e.g. tax could result in closure of firm or extra financial penalties Firm could have profit in books but lack of liquidity could force firm to cease trading
Against importance It is profit that determines the long-term survival of a business. Sources of funds are available
to help firms survive short-term liquidity problems e.g. overdrafts, loans.Conclusion
June 2008
1. (b) Evaluate the importance of the Director’s Report that accompanies the financial statements of a company.
For: Report gives information to shareholders, which they could use to make a decision to invest
more funds in the company, or not. Shareholders may be assured that the company is acting in an ethical manner. Other stakeholders e.g. pressure group may use information in the Report to bring about
change in company. For instance, treatment of disabled. Disclosures may be required under Stock Exchange Regulations which may be appropriate in
the Director’s report; e.g. Legislation pending. Information is given to shareholders which allow them to see in some detail how the company
is performing:E.g. principal activities, review of position of business-post balance sheet events, future developments-names of directors, interest of directors-employee involvement, disabled employees policy-political and charitable donations-creditor payment policy, creditor payment days
Against: Report costs personnel time to prepare and money to print. Directors may use Report to “window dress” accounts, give an unrealistic positive view of the
company as it is in their interest to do so. Readers with no knowledge of accounts may not understand the report.
Conclusion
2. The directors of Karayota Limited were also considering the possibility of raising finance for the business through a bank loan. (c) Evaluate the use of a bank loan or ordinary shares as alternative methods of raising finance.
Case for ordinary shareholders Shareholders do not have to be paid dividends, useful when short of funds No outside parties having any influence on running of the company, e.g. place on Board No interest has to be paid so profits of company is higher No assets offered as security, so no claim on assets by banks, if loan not repaid or company fails
Do not have o be paid back so are a permanent/long term source of finance Bank loans result in higher gearing, which increases risk to company
Case for bank loans Interest is allowable for tax so company may be able to retain more funds than if paying
dividends Bank may bring experience and expertise to company and maybe Board Bank may be flexible regarding payment, length of loan, etc. Issues of shares may dilute the control of existing shareholders Shares take a longer time to issue, e.g. completing forms etc. Shares are costlier to issue, e.g. handling applications
Conclusion: Ordinary shareholders are a more preferable source of income.
7. (c) Evaluate the possible treatment of the goodwill in the accounts of Hotel Maximus Limited after 1 April 2008.
An intangible fixed asset on the balance sheet. Correct treatment of goodwill would be amortize/depreciate/write off over its useful economic life/over a lengthy time period e.g. over 20 years.Case for this treatment
Likely to derive benefits from the expenditure over a number of years, so spread the cost of this expenditure over a number of years i.e. matching concept give a True and Fair view of the accounts
To write off immediately may make profit unrealistically low, and tax charge would be unfairly low.
In line with recommended practice i.e. FRS 10Case against this treatment
If written off over a shorter time period against revenues, the prudence concept is followedConclusion: Writing off over a number of years is required and beneficial as it gives a true and fair view of the accounts
January 2012
3. (e) Explain how the Goodwill paid will be treated in the accounts of Atlantic Foods plc.
Goodwill will appear in the balance sheet of Atlantic Foods plc as an intangible assets, under the heading of Non-Current Assets
Correct treatment of goodwill would be to amortize over its useful economic life. Likely to derive benefits from the expenditure over a number of years, so spread the cost of
this expenditure over a number of years i.e. matching concept gives a True and Fair view of the accounts
To write of immediately may make profit unrealistically low, and tax charge would be unfairly low.
In line with recommended practice i.e. FRS 10.
June 2012
5. (d) Evaluate the treatment of goodwill created in the accounts of Panoramic Cinema Limited following the purchase of Luxury Cinemas Limited.
Correct treatment of goodwill would be to amortize over its useful economic life. Shown as intangible non-current asset.Case For:
Likely to derive benefits from the expenditure over a number of year, so spread the cost of this expenditure over a number of years, i.e. matching concept gives a True and Fair view of the accounts.
To write off immediately may make profit unrealistically low, and tax charge could be unfairly low.
In line with recommended practice i.e. FRS 10/IAS 38.Case Against:
If written off immediately against reserves, the prudence concept is followed.Conclusion
January 2009
1. As part of their business plan, the directors of Standard Bicycles plc intend to reorganize and restructure its workforce in the next financial year, ending 31 December 2009. The reorganizing and restructuring workforce will be treated in the accounts for the year ending 31 December 2009 as an Exceptional Item.(b) Evaluate the usefulness of this treatment to the users of the published accounts of Standard Bicycles plc.
Benefits: This will benefit users of accounts because they can see that the expense of Exceptional Item
will not be expected to be repeated regularly in the future. Although in the normal line of business, the Exception Item should be disclosed because of its
size. This allows reader to predict more accurately future expected performance This may help future potential investors, shareholders, and creditors with decision-making. Should be beneficial if required to be shown by FRS 3. Could be said to give a True and Fair View.
Disadvantages: Adds more figures and details to the accounts so makes them more difficult to understand, Extra cost in spending extra time preparing accounts.
Evaluation: It is beneficial to disclose Exceptional Item
6. (d) KC Jones bought 300 £2 shares in Whistle Stopz plc in the stock market for £2.50 each, one year ago. The shares are not trading on the stock market at £2.03.Evaluate the merger on behalf of KC Jones
Case for takeover KC has received some goodwill, as purchase price is greater than net value of assets sold. Good
will is actually 589,000/5,000,000 = 11.78p per share. Whistle Stopz plc appear to be having problems. Liquidity/working capital is very low. Profits and Loss Reserve Balance is very low. May be
good to sell shares at a decent price before it gets worse. Selling share of £2.10, which is above market value of £2.03 by 7p per share.
Case against takeover KC bought the shares for £2.50 but is only receiving £2.10 per share now. He is making a loss of
£0.40 per share Goodwill paid is low – only about 5% above net asset values. Whistle Stopz plc may improve in the future and the share price could rise about £2.10.
Conclusion
January 2007
7. (d) Evaluate the merger from the point of view of a shareholder in Le Chic Limited, such as Wei Lun.
For: Shareholders in Le Chic receive a profit on realization of £80,000 and goodwill valuation is
£50,000 New company should enjoy benefits of vertical integration as in same line of business New company could enjoy economies of scale, e.g. bulk buying Fragrant Harbor has a healthy balance sheet, with lots of fixed assets and healthy working
capitalAgainst:
Dilution of ownership and voting power We do not know the market price of Le Chic shares We do not know what the market price of Chicarbour shares are likely to be
Evaluation
June 2009
3. (d) Angelina was shareholder in Highway Connections Limited. Evaluate the merger from the point of view of Angelina.
For merger Shareholders in Highway Connections “receive a profit” on realization of £341,000 also
goodwill valuation of £274,000. New company should enjoy benefits of vertical integration as in the same line of business. New company could enjoy economies of scale, for example, bulk buying of machinery OR enjoy managerial economies of scale or marketing economies of scale Larger company could enjoy financial benefits for example easier to get bank loans at a lower
interest rate.Against merger
Dilution of ownership and voting power Wessex Quarries do not appear to be in a healthy financial sate for negative profit and loss
reserve Original Wessex balance sheet appears to have many assets overvalues for example, machinery
overvalued by £100,000 Also liquidity position of Wessex is worrying, as they appear to have worse working capital
ratio/ negative working capital. Wessex may be a drain on the liquid resources of the new company, especially with the large
amount of creditors to pay. We do not know the market price of Highway Connections shares We do not know the market price of Roadworks share are likely to be.
Conclusion
June 2010
3. (d) Sandra as a shareholder in Highland Bank plc. As Sandra’s accountant, evaluate the merger on her behalf.
For merger: New company should enjoy benefits of horizontal integration as in same line of business, which
leads to larger market share, which results in increased profits and dividends. New company could enjoy economies of scale e.g. bulk buying New company should be able to reduce costs e.g. reduce staff or close some branches Highland Bank appears to be in poor financial position e.g. profit and loss reserve is negative
and debtors contained may bad debts. They probably need a stronger company to take them over to improve position or guarantee survival
She gets no dividends at present because Profit & Loss account balance is negative and she may get dividends now
Reduces risk and competitionAgainst Merger:
Shareholders in Highland Bank plc do not benefit from any Goodwill The book value of the company before the merger was £47m, but the value at the time of the
merger was only £28m, a decrease of £19m, (loss in realization). Increased number of shareholders/Dilution of ownership and voting power We do not know what the market price of St. Andrew’s Bank plc shares is likely to be. It is quite
possible it will not settle at £1.25. St. Andrew’s Bank could be purchasing the assets of Highland Bank at a value under the market
priceConclusion
January 2012
3. JD Dalton holds shares in Atlantic Foods pc.(f) Evaluate the take-over on behalf of JD Dalton.
For: Atlantic Foods may improve in the future and the share price could rise above £1.66 This will give Atlantic Foods a foothold/start or greater presence in UK Atlantic Foods may benefit from economies of scale and make more profits Likelihood of dividends in the future Investment may be more secure as business is now enlarged
Against: Goodwill paid is very high – about 60% above net assets value. Atlantic foods may suffer from diseconomies of scale and see profits reduced Atlantic Foods has to pay out a large amount of cash (£9,440,000) which will have a negative
effect on liquidity Issue of more shares will see value of Atlantic Food shares fall and less dividend per share and
reduction in voting power.Conclusion
June 2009
1. (b) A company’s balance sheet is more important than its profit and loss account. Evaluate this statement.
For Balance Sheet: Shows items of value firm possesses and may use for running firm over long term (fixed assets)
i.e. shows strength of firms Shows liquidity position of firm by Net current assets (Current assets – Current liabilities) Shows financial weakness of firm (long term liabilities – debt that must be serviced) Shareholders can see the book value of their investment. Some figures in the Profit and Loss account may be estimates, for example, depreciation and
stock valuesFor Profit and Loss Account:
Shows how well the firm has performed over the last trading period. This is very important as for example; balance sheet may look healthy, but trading at a loss.
Enables firm to see the relationship between sales and production, i.e. Gross Profit and Expenses i.e. Net Profits
Some figures in the Balance Sheets may be estimates, for example, depreciation and stock values
Conclusion
January 2010
1. (b) Evaluate the usefulness of limited companies preparing their final accounts in accordance with the Companies Act 1985.
For: Accounts are prepared in standard format which allows stakeholders to compare the accounts
of one company with another, e.g. for investment potential Having a standard format makes it harder for company to “window dress” or manipulate
accounts. The companies Act must state a good way to prepare the accounts as it was prepared by highly
qualified professionals, e.g.- accountants, lawyers. Readers of accounts e.g. auditors only have to familiarize themselves with the one format.
A standard format allows accounting aids to be developed and used, e.g. software programs A standard format makes it easier for Regulatory authorities to enforce procedures
Against: Preparing the accounts in this format could be time consuming and time means money Staff have to train to learn the format The format still has scope for different interpretation, e.g.-stock value, and depreciation. Original Act is now 25 years old and we live in constantly changing times
Conclusion
3. (d) Evaluate the decisions of the directors of 2009 from the point of view of ordinary shareholders.
Positives: Ordinary dividend received of 5.2p per share, which is quite good. Gearing ratio is 28%, which is healthy and lower than start of the year. Redemption of preference shares will improve the future figure for ROCE as it also reduces
future preference dividends Capital and Reserves have risen, which means book value of firm has risen, which means share
price has risen.Negatives:
Funds are leaving the company to pay preference share dividends and redeem preference shares
Possible that liquidity adversely affected to pay preference shareholdersConclusion
May 2013
1. (b) Evaluate the usefulness of the Auditor’s Report to the users of published accounts of Hong Kong Cameras plc.
January 2008
1. (b) Evaluate the importance of the Auditor’s Report that accompanies the financial statements of a company.
June 2010
1. (b) A director has made the following comment at a Board meeting:“In order to reduce expenditure, we should not have an Auditor’s Report with the final accounts this year, as the Auditor’s Report is not important.” Evaluate this statement.
For importance: Auditors are independent scrutinizers of the accounts, who report that the accounts have been
prepared “correctly” in accordance with company law or Accounting Standards or Stock Exchange regulations. So, it gives a True and Fair view.
Auditors are reporting on how the Directors have used the funds invested by the shareholders Auditors may give tax authorities more confidence that the tax computation is correct. Professional supervising bodies exist to give guidelines to auditors, e.g. Auditing practices
Board. Auditors should be professionally qualified e.g. Chartered Accountants Companies Act could require report
Against importance: Auditors may be not independent, going along with the wishes of clients, in order to keep their
custom. Auditors could be misled by the directors and provide an inaccurate report Auditors do not guarantee that material fraud has not occurred Report may be costly to produce
Conclusion
June 2011
1. (b) Evaluate the importance of sending a copy of the financial statements of a public limited company to shareholders at the end of the financial year.
For usefulness Legally the shareholders must receive a copy/or have copy made available of the accounts and
they can see how the funds they have invested are being used/how the company is performing. Shareholders may be happy (or unhappy) with the performance of the company and may
decide to buy more (sell) shares. Accounts are prepared in the standard format which allows shareholders to compare the
accounts of one company with another, e.g. for investment potential.Against usefulness
Preparing the accounts is time consuming and time means money. Expenses are associated with preparation and sending e.g. printing costs and postage However, shareholders could be sent an abridged (smaller) version of the accounts which may
be cheaper Some figures are estimates, example, Depreciation Some shareholders will not understand the accounts as they have little accounting knowledge They accounts may not be totally reliable e.g. due to ‘window dressing’, fraud etc.
Conclusion
7. (d) Evaluate the position of the original shareholders, after the conversion of the bank loads into ordinary shares.
Better position As less interest to pay of £80m, and less capital repayments to make so annual profits will be
higher so more available for dividends Gearing ratio has improved falling from 200% to 12.5% so less risk Net Book Value of business rises so share price in theory may rise
Worse position Ownership diluted to small number of votes More shareholders now to receive dividends so dividends per share may be less Share price will fall as more shares on the open market Interest on loan meant a lower profit so tax bill may now be higher on higher profit.
Conclusion
January 2012
1. (a) Prepare for the Home Gaming plc as at 31 December 2011 EITHER: the appropriation account as required by the Companies Act 1985 the Statement of Changes in Equity in accordance with IAS 1 (Revised)
Statement of Change in Equity
Opening Balance (xxx) DrDividends (xxx) DrComprehensive Income for the year xxx
Balance at Dec 31 2011 xxx
(c) Evaluate whether you think it is beneficial to show Net Current Assets (Liabilities) on the Statement of Financial Position (Balance Sheet) for a company.
For Benefit of showing Net Current Assets (Liabilities) Allows the user to see clearly/easily, which is largest of current assets and current liabilities. This enables the user to judge the net amount of liquid assets. If net current liabilities, then clearly the entity has a liquidity problem and allows them to take
action. Helps potential investors to make a decision whether to invest. Helps suppliers make a decision concerning possible credit to be given.
Against Benefit of showing Net Current Assets (Liabilities) Net Current Assets only shows an amount in a monetary value. This does not show if this
amount is sufficient. The amount required would be affected by the entity’s size and industry. More useful measurements of liquidity are Current Ration and Acid (Quick) Ratio. These could
be calculated using either of the two formats. It may be better to show all the monies put into the entity on the same side of the Statement of
Financial Position/Balance Sheet i.e. Total Equity and Liabilities.Conclusion
June 2012
1. The information given includes revenues and expenses for unused shop premises the Columbo Fireworks plc rents out. Next year, Columbo Fireworks plc intends to sell these premises and record this in the account of Discontinued Activity.
(b) Evaluate the usefulness of recording the shop premises as a Discontinued Activity in the next year’s accounts.
The fireworks activities should be shown as Continued Operations in the accounts next year. All revenues and expenses relating to these should be shown separately.For usefulness
o This will benefit users of accounts because they can see that profits or losses from the Discontinued Operations will not be expected to be realized in the future. This allows reader to predict more accurately future expected performance.
o This may help future potential investors/ shareholders/creditors etc. with the decision-making. For example, buy more shares/ allow credits.
o Should be beneficial if required to be shown by FRS3/IFRS5.Against usefulness
o Adds more figures and details to the accounts so makes them more difficult to understand, especially for those with little accounting knowledge.
o Takes time to add extra detail and therefore this means extra expenseEvaluation
3. (a) Briefly state how the following reserves are 1)created and 2)used.
Created by Used for/Utilized examplesRetained
earningsTrading profits built up over past and present years
Dividends paid to ordinary shareholders
General Reserve
Transfer from retained earnings/profits
Any perhaps unspecified use, issue bonus share, transfer back to retained earnings
Share premium reserve
Issue of ordinary shares above their nominal issue
Write of preliminary expenses on formation of company or share issue, pay premium on redemption of shares or debentures, issue bonus shares
Capital Redemption Reserve
Transfer from revenue reserves when shares are redeemed
Acts as creditors buffer
Revaluation Reserve
Upward revaluation of non-current assets
When asset is sold, transferred to Income Statement/retained earnings
(d) Evaluate the decision to raise further finance by issuing ordinary shares, rejecting the possibility of raising funds by the issue of debentures.
Case for Ordinary Shares Shareholders do not have to be paid dividends, useful when short of funds/making a loss.
Dividends could be variable but interest on debentures must be paid. No “outside” parties having any influence on running of company, e.g. Place on Board. No interest had to be paid, so profits of company higher. No assets offered as security, so no claims on assets by debenture holders, if debenture not
paid, or company fails. Reduces gearing ratio and therefore risk. Debenture results in higher gearing, which increases risk to company. Very important here as if debenture used, gearing goes above 50% at 51.5%.
Case for Debentures Interest is allowable for tax, so company may be able to retain more funds than if paying
dividends. Debenture issuer may bring expertise and experience to Company, maybe Board. No possible dilution of ownership for existing shareholders, which mean earnings per a share,
will fall. May be quicker to issue than ordinary shares. Costs of arranging debenture may be lower e.g. no prospectus to issue.
Conclusion
January 2013
1. At a board meeting at the end of the year, the Marketing Director said, “I am concerned about the liquidity position of the company.(b) Evaluate the statement of the Marketing Director, concerning the liquidity position Channel Oil plc, at 31 December 2012.
For Statement Current ratio is 2,508,600 : 293,250 which is 8.56:1. This is way above ideal ratio of 1.5/2:1 Too much working capital is tied up in stocks of oil Acid ratio is 0.8:1 which is below the ideal ratio of 1:1 A tax bill of £198,000 must be paid in 30 days but there is only £131,000 cash and cash
equivalentsAgainst Statement
A current ratio of above 2:1 is better than below 2:1. If the business can sell stocks quickly, then liquidity problem can be avoided.
The nature of the industry may mean that it is normal for large stocks of oil to be carried. Working capital of £2,215,350 which is a healthy figure Bank balance is positive at £114,000 which can be used to pay debenture and loan interest and
settle trade and other payablesConclusion
3. (b) (i) Could you explain one example for which the funds in the Non-current asset replacement reserve may be used?” To replace worn out airplanes which have a finite life OR to upgrade computer system to ensure the compatibility.
(iv) Can you explain the difference between the amount paid by shareholders to buy each share before 1 January 2012, and the amount to buy each share in September 2012”? The share issue price was higher in September because the market price of the shares was higher then, compared to when the original shares were issued. The share premium reflects the market price.
(v) I am unhappy about the low level of dividend paid. I can see a large figure in the Total Equity column – could we use that to pay dividends?
Share Capital, Share Premium and CRR are capital reserves and cannot be used to pay dividends. Total of 1290 cannot be used for dividends
Retained Earnings, General and Asset Replacement are revenue reserves and can be used to pay dividends. Total of 104 can be used for dividends.
However, Retained earnings have very little left, and General reserve has nothing. It is only the fact that General reserve has been transferred back, that has enabled the present
dividend to be paid. Asset Replacement could be transferred back to retained earnings and used for dividends. However, as more has been transferred into Asset Replacement, it is likely an asset needs
replacing soon.
Another shareholder stated at the meeting. “ I think the company should have issued bonus shares in September instead of a rights issue. This would have been better for Med Isle Travel plc.”
(e) Evaluate this statement on behalf of Med Isle Travel plc.
For Statement Company will not have pay cash dividends, which is beneficial if a liquidity problem Bonus shares make the Statement of Financial Position look like that of a larger company,
which may help to raise the finance etc. Original shareholders would have been kept happy and therefore quiet as they would have
received free shares and these shares are eligible for dividends. Quicker/cheaper to issue bonus shares.
Against Statement
Bonus shares bring in no cash for the company but a rights issue does bring in cash, which is used to run the business/pay bills or expand the business or strengthen the company Statement of Financial Position.
Issue of bonus shares sees share price fall more than the possible fall if a rights issue Bonus shares will result in more shares eligible for dividends so dividend per share likely to
fallConclusion
7. (d) Evaluate the appropriateness of revaluing assets and liabilities before a takeover.
Against revaluations The larger party may be in position of strength and abuse this position to revalue assets to
their own advantage i.e. lower value than true market value. Revaluing assets and liabilities is a pointless waste of time and money because the buyer can
agree to pay whatever goodwill they feel is appropriate Professional valuers may be required and these may charge considerable fees
For revaluations Even if one party is in a position of strength, the other party does not have to agree to a sale if
they do not like the value put on assets It is only fair that assets and liabilities are sold for their correct market value, not some
historical book value that may not reflect market valueConclusion
June 2013
5. “Do not buy the shares in Bengal Life plc at a market price of £2.00. You should buy the shares in Oceanic Assurance at £2.25. They have a higher share price, so they must be a better share.(b) Advice Imran as to the value of this statement.
A higher share price does not mean a “better” share. The nominal or face value of the share needs to be considered. Also the total number of shares in the company.Also important is the movement in the value of the share – is it moving up or down? Very important is the demand and/or future/confidence of the market in the share – if Imran buys now, will he make a profit or a loss on the share? Many factors both inside the company and outside the company can affect the price of a share.
Jahingar also states, “There is only one ratio that is important and worth knowing about, and that is the dividend per share.”(c) Evaluate this statement on behalf of Imran.
For the statement Investors are usually interested only in the return on their investment, which is shown in the
dividend per share, which is used to calculate how much the investor receives Investors are more concerned with what they actually receive, than how easily the company
can afford to pay the dividend, as shown by the dividend cover.Against the statement
Investors also have a capital gain when the share price rises, which is partly shown in the price/earnings ratio.
Dividend yield shows the return for every pound invested, which is more important than dividend per share.
Earnings per share is an important ratio, as it shows how much profit is being generated for each share invested. These profits are then used to pay dividends.
Other ratios concerning profitability and liquidity etc. are important, as they show how well the firm is doing.
Conclusion
Investment Appraisal-Weighted average cost of capital-Payback period (Cumulative cash flow)-NPV-ARR-IRR
January 2007
2. (c) Advice Music World plc, giving two reasons, whether to invest in the new project. Project has NPV of 9,573,490 so project is worth investing in. Other factors to be considered: competition, changing tastes, new technology, figures only estimates etc.
(d) Evaluate the capital structure proposed for the new project. Gearing ratio = Debt/Capital employed = 50% Interest payment of £1.1m per year. Although these are allowable for tax Have to ensure ordinary shareholders receive a return of 9%
Conclusion: Gearing is medium
May 2005
3. (b) Using your answer to (a), state with reasons, which machine you would recommend the directors of Kaslan Ltd to purchase. Both machines are acceptable, i.e. both have a positive NPV. Based on NPV, machine Z should be purchased as it has the higher NPV. If the directors are risk averse, Machine Y should be purchased as it has a shorter payback period.
(c) The accounting rate of return method of investment appraisal has one advantage: it is simple to calculate. State three disadvantages.
Different definitions of ARR No generally accepted method of calculating ARR It takes no account of time value of money Cash flow is crucial factor in investment appraisal. The ARR uses profits, which have subjective
elements, and is not appropriate for investment decisions. The timing of cash movement is ignored The incidence of profits over time are ignored; averages can be misleading
June 2008
6. (c) Evaluate the project for the company, using the calculations made, and considering any other relevant factors.
Case for project NPV is positive/large/substantial/profitable at £4.7m Figures are estimates – could be greater profits Company could establish reputation, other lines/events etc. and continue after 4 years
Case against project Figures are only estimates – could be less profits Need to apply other Investment Appraisal techniques, e.g. Payback method Positive cash flow only arrives in year 4, with 2 years of negative cash flow. Non-financial considerations e.g. building work, traffic problems Need to consider alternative use of funds i.e. opportunity cost or example
Conclusion
January 2010
7. (b) Evaluate the project for MetroTransit plc, using the calculations made and considering any other relevant factors.
For Project has a NPV greater than 0 i.e. £356m Figures may not be accurate and NPV may be even greater Other possible investment projects may be made available in the future
Against Figures may not be accurate and NPV may be smaller.
Conclusion
June 2010
6. (b) Evaluate the project for the company, using the calculations made and considering any other relevant factors.
For investment Payback method says invest as within a 4 year payback period Profits will be earned for 1 year and 3 months ARR states invest as to meets % return figure of 8%
Against investment Payback is 3 years plus 9 months which may be considered but reason must be given as to why
it is too long Accuracy of predictions? What happens after 5 years? Net Present Value Calculations? No account taken of falling value of money over time Other possible investment projects available? Objectives/strategy of the company? How can the company finance the investment? Opportunity cost? Are there alternative investment possibilities?
Conclusion
January 2011
2. (b) Evaluate the project for the company, using the calculations made and considering any other relevant factors.
Payback method says invest as project does pay back. However, is the payback period of 4 years 3.89 months acceptable for the company? Is it too long?
Project is profitable for each year NPV method states do not invest as NPV is negative NPV may be a better method to use as it includes falling value of money over time £2m has to be raised which may worsen the gearing ratio How accurate are the predictions for costs, cost of capital and revenues? Chance of renewal of contract after 5 years? Would this be profitable? Other possible investment projects available at present? More or less profitable? Objectives/strategy of company? Is this investment in line with objectives?
Conclusion
June 2011
2. (a) Explain to a potential investor the difference between ordinary shares and preference shares.
Ordinary shares Usually one vote per ordinary share held at AGM/shareholders meetings.Dividend per year is not fixed, but varies according to performance. Last in queue when dividends paid out of profits. Last in queue for payments if a company is wound up.Preference shares Usually no votes to preference shareholders. Dividend per year is usually fixed, despite performance. Before Ordinary shareholders in the queue when dividends paid out of profits. Before Ordinary shareholders in queue for payments if a company is wound up.
(e) Evaluate the opening of new nursing home for Lifecare plc, using the calculations made, and considering any other relevant factors.
Case For Project Figures are estimates, could be greater profits Need to apply other Investment Appraisal techniques e.g. Payback method Positive cash flow in ever year NPV will be positive in Year 5 Could challenge the company policy of positive NPV after 4 years
Case Against Project NPV is negative after 4 years so do not invest in accordance with company policy. Figures are only estimates, could be less profits
Conclusion
Budgeting
January 2007
3. (a) Evaluate the usefulness of budgeting in the management of Lifestyle Gymnasiums Limited.
For: Allows firm to see likely outcome/future situation Allows firm to make changes to plans if budget figures do not look good Examples of above, e.g. reduced planned expenditure or boost planned sales by advertising
campaign Variance analysis can allow firms to take corrective action once business started
Against: Figures are only estimates/guesses Unexpected events or changes may happen in the future Time and cost of accounting staff to prepare budget/variance analysis etc.
Conclusion: Is a useful tool.
May 2013
6. (b) Evaluate whether Venture Vending Limited should draw up a new set of budgets to replace the existing budgets for Months 2 and 3.
For Existing budgets are not likely to be accurate, so there is little point in sticking with them Good budgeting should be flexible, so changes should be made to this ongoing process with
regular reviews taking place. A new business should not draw up a three month budget, as it is likely to be unsure of the
predicted figures, not having any past figures to rely on
A new budget would help planning/changes e.g. reduce the purchases for each month New budgets may have targets staff can reach which will increase motivation
Against Will take time and money to draw up the new budgets Variance analysis could be carried out and actions taken to meet original budgeted figures The new budget will only be estimates anyway, so may not be accurate. The only budget directly affected by a lower sales level is trade receivables so there maybe a
need just to draw up trade receivables This is a new business, and sales may pick up to meet month 2 and 3 figures in the original
budget, making it accurate.Conclusion
January 2008
4. (c) Evaluate whether the expected level of director’s drawings is appropriate for the business during the first four months of trading.
For the level of drawings Closing balance is healthy in months 3 and 4 As long as overdraft agreed for 1+2 months
Against the level of drawings Negative cash flow in month 1+2 means may have to arrange overdraft Could reduce drawings for months 1+2 Figures are only predictions, what if sales are much lower?
Conclusion
June 2008
5. (b) (ii) Discuss what actions the directors of Hercules plc should take in these circumstances.
Reduce material costs for larger output by negotiating better discounts Reduce labor costs e.g. by introducing piecework, bonus, etc. Improve transport efficiency e.g. ensure lorries only travel when full Reduce electric bill e.g. turn off lights when not needed etc. Negotiate better price with customers e.g. reduce the discount given Produce 2000 units as this gives the highest profit level Investigate figures for a lower output level e.g. 1500
(c) Evaluate the use of flexible budgets to managers.
Case for flexible budgets Allow good decision making as “like compared to like” e.g. similar output levels May save time and money by allowing “Management by Exception” i.e. action only if a variance Allows choice of optimum output e.g. 2000 units Meeting the targets leads to motivation of workforce
Case against flexible budgets Labor time which means money in preparation Figures are only estimates so some variances may be misleading/action in appropriate
Conclusion
January 2009
3. (f) Evaluate whether it would be useful for Mrs. Yeungs Cakes Ltd to prepare a cash budget for the first four weeks of trading.
For: Allows firm to see inflows and outflows of cash in the period, and to see whether overall there
is an inflow or outflow of cash for the period This will help the firm with planning and decision-making. E.g. arrange an overdraft or arrange
a loan or chase up debtors, or negotiate with suppliers or adjust prices, prevent overtrading Can compare budget to actual and variance analysis can take place
Against: Takes staff time to draw up budget and this means money. Budget is only an estimate so could be inaccurate and this could lead to inaccurate decision-
making.Conclusion
7. (c) Evaluate the financial success of the route to the new destination by comparing the actual and budget figures.
Better than budget Passenger figures of 130,000 are better than budget figures by 10,000 Sales price per passenger of £55 is better than the budgeted figure of £50. An actual sale of £7,150,000 is better than the budget sales of £6,000,000.
Worse than budget Profit of £550,000 is worse than the budget profit of £600,000 by £50,000 Variable costs of £40 per passenger are higher than the budget figures of £35 Fixed costs of £1,400,000 are higher than the budgeted figure of £1,200,000. Actual total costs of £6,600,000 is worse than budget total costs of £5,400,000 although this is
partly due to passengers Break-even figure for passengers of 93,334 is higher than budget figure of 80,000.
Conclusion
June 2009
4. Production is determined by the maximum production capacity of the factory, NOT by the number of beds ordered by customers.(b) Evaluate the decision to produce a quantity determined by the maximum capacity of the factory instead of producing a quantity determined by customer’s orders.
For Decision Makes full use of factory, i.e. capacity utilization is 100%, no wastage Sales may be more than 55 a week. Able to meet this demand from production or stock In the event of production breakdown, customer’s orders can be met. This will maintain
customer loyalty Beds kept in stock do not deteriorate/perish so money is not lost
Against Decision Stock is building up continually, and this involves a number of costs for example rent,
insurance and ties up working capital Eventually will run out of storage space so must find alternative premises or reduce production It is possible that beds could deteriorate in stock, for example, due to dampness Possible that tastes change and firm left with stock that they cannot sell.
Evaluation
January 2010
2. (c) Evaluate the usefulness to West Anglian Farms of preparing a cash budget for the year.
For usefulness of Cash Budgets The Farm has a very seasonal cash flow, especially from sales. The cash budget will show if the sales will be sufficient to cover all outgoings, and when
shortages may occur. The budget may allow the Farm to see when alternative arrangements, e.g. overdraft may be
required. Also for how long and how much. The budget may show where a cash surplus may be present, so allows the firm time to plan
what to do with the surplus, e.g. invest in shares, currencies etc.Against usefulness of Cash Budgets
The budget takes time and money and expertise to draw up. The figures are only predictions and may be inaccurate or misleading Inaccurate production figures may be caused by weather or volatile market prices
Conclusion
June 2010
2. (c) Evaluate the importance to Lee Ping to draw up a Cash Budget before starting his business.
For: Lee will need to show the potential investors, e.g. family and friends, banks that business will
be successful and is able to give a return/pay back. The cash budget will show if the sales receipts will be sufficient to cover all the outgoings, and
when shortages may occur The budget may allow Lee to see when alternative arrangements, e.g. overdraft may be
required. Also for how long, and how much. The budget may show where a cash surplus may be present, so allows firm time to plan what to
do with the surplus, e.g. invest in shares, currencies, etc. Budget can act as a method of control Budget can give variances which can be analyzed and action taken.
Against: The budget takes time, money and expertise to draw up The figures are only predictions and may be inaccurate or misleading, e.g. inaccurate sales
figures may be caused by change in demand from supermarket. Budgets maybe unrealistic and may demotivate workers not meeting targets.
Conclusion
June 2011
6. (c) Evaluate the company’s policy of producing ovens for expected sales, rather than producing ovens to match actual orders.
For Order: Customers do not have to wait for their orders. Waiting for orders could mean customers go
elsewhere Production may fluctuate if only for actual orders, especially if demand is seasonal If sudden increase in demand, stock is available If delays in production this is not a problem as order can be met promptly
Against policy: Producing for expected orders means some stock may be unsold which is risky Unsold stock may build up and this involves a number of costs, e.g. rent, insurance and ties up
working capitalEvaluation
January 2012
2. (d) Evaluate whether Bazaar Electricals Limited should sell ovens in Department D.
For: Contribution for selling ovens in D is greater by £18,000 than freezers Figures are only predictions, actual figures for sales/contribution could be higher Fewer items need to be sold to make contribution of e.g. 30,000, 400 freezers compared to 150
ovens i.e. 250 less items.Against:
Figures are only predictions. Actual figures for sales/contribution etc. could be lower What does the store know about the quality of the ovens? Has the manager of the store seen
the product/had a demonstration? What does the store know about the reliability of supply, delivery and after sales service of the
ovens? Will this mean not selling one of the other products? What effect will this have? Maybe they
supply one of the other products as well.Conclusion
4. (b) Narayang Doors Limited budgets to pay trade payables (creditors) after three weeks, and allows trade receivables (debtors) to pay after four weeks. Evaluate this method of cash budgeting (credit control).
For: Narayang may have little choice in method as terms may be decided by suppliers who may be
in a strong position, especially as Narayang is a new business Narayang may be able to negotiate better terms in the future, especially if they prove to be a
regular customer and reliable supplier After the first two months, cash flow will be regular, with receipts of £25,632 and payments of
£12,500 for suppliers Discounts could be given for prompt payment.
Against: Firm is waiting longer to collect sales receipts than they are taking to pay suppliers This gives a simple working capital cycle of one week. Negative effect on cash flow in the first two months of business. Selling on credit may result in bad debts
Conclusion
June 2012
4. (c) Evaluate the Internal Rate of Return as a project appraisal method.
For: An accurate return can be calculated Takes account of falling value of money over time Can be compared to target value of business to decide whether to invest in project Can be calculated fairly easily by computer
Against: Calculation of IRR involves use of complicated formula requiring numerical skill Calculation may involve much “trial and error” to arrive at the IRR May need a computer and computing skills to calculate IRR.
Conclusion
January 2013
4. (b) Evaluate the level of drawings that Kim Seng is taking out the business each month.
For: April balance is £1,218 but needs to have monthly rent of £1,199 deducted, leaving a balance of
£19 so Kim cannot draw out anymore May will be the first month of “normal” sales revenue of £6,610, which leaves a balance of
£481. This will be needed for irregular payments, e.g. – truck services, as a precaution and to pay back the loan eventually
Against: £481 per month is not enough to meet irregular payments/bills as a precaution and pay back
the loan. The drawings should be smaller With these drawings, March has a negative balance.
Conclusion
5. (b) Evaluate the project for Metro Clean plc, using the calculations made and considering any other relevant factors.
Against Investment Payback method says do not invest as project not within 3 year payback period May be better investment projects available?
For Investment ARR states invest as meets % return figure of 10% Project if profitable overall having total cash inflow £986,000 It is possible to dispute 3-year payback period, perhaps longer is better. What happens after 5 years? –Renewal of contract? Any other/further business? Customer is in the public sector so little chance of bad debts
Other Relevant Points Accuracy of predictions? Objectives/strategy of company? Both methods ignore time value of money unlike NPV Could use other methods of appraisal
Conclusion
Ratio
May 2005
(b) Explain the importance of price earnings ratio. The ratio indicates the number of years it would take to recover the share price out of the current earnings of the company. This means that if £4 is paid for the shares, then 16 years of current earnings of 25 pence per share are being sought.
January 2008
5. (b) Evaluate the information in the table and calculated in (a) in order to recommend the company in which Demetri should invest.
For Grapefruit Higher dividend yield by 2.36% points Higher dividend paid per share by 1.42 pence per share EPS higher by 0.47 pence per share May argue that market price lower, so can buy more shares More generous to shareholders with dividend cover policy by 0.49 times
For Hallway Safer dividend cover policy by 0.49 times P/E ratio is higher by 3.02 times. Does the market know something good about Hallway, or bad
about grapefruit?Conclusion
June 2009
5. (c) Evaluate the performance of Oriental Tea plc in the year ended 31 March 2009, compared to the year ended 31 March 2008.
2007-8 2008-9 DifferenceNet Profit after Interest and tax worse
£400,000 £129,600 £270,400
Earnings per share worse
16p 4.32p 11.68p
Dividend paid worse
£350,000 £144,000 £206,000
Share price worse £1.85 86.4p 98.6pDividend per share worse
14p 4.8p 9.2p
Price/Earnings Ratio Better
11.56 20 8.44
June 2010
5. (b) Evaluate how Red Arrow plc has performed as a business compared to the industry average for the financial year ended 31 March 2010.
Better than industry average Price/Earnings ratio is better by 3 times – reflecting the generous dividends Dividends per share is better from the shareholder’s point of view by 0.5p per share Dividend yield is better from shareholders point of view by 3.14% Dividend cover could be said to be better for shareholders point of view as a higher percentage
of profits is paid as a dividend by 1.34 times. Worse than industry average
ROCE worse by 1.83% points EPS is worse by 1p per share Dividend cover is less so funds not retained in the business
Conclusion
January 2011
6. (c) Evaluate whether Bharti should sell her shares in Krishnanor Industrials plc.
Case for selling shares Dividend yield is low. She could possibly earn a better return in another company, or maybe
even in a bank deposit account. Price/Earnings ratio is high s a seller would get a good price. Profit of £836 has been made
Case against selling shares Dividend policy looks reasonably generous with about 75% so large amount of this year’s
profit paid as dividend
Price/Earnings ratio is high, which means the market has confidence in the share, so price may continue to rise.
Capital return of 9.59% per year is reasonably good and may continueConclusion
January 2012
5. (b) Evaluate the gearing ratio figure, stating how this figure could be improved. The gearing ratio is too high, being over 50%. It would be better if this ratio were between 30% and 50%. It could be improved by-Issuing more ordinary shares-Redeeming preference shares-Paying off bank loan-Redeeming the debenture-Making more profit and keeping it in reserves.
(d) Evaluate the ratios calculated in (c) above. EPS is low (relating to own figure) Price/earnings ratio is fairly high (relating to own figure) Dividend cover is acceptable (relating to own figure) Dividend yield is acceptable in today’s market/low (relating to own figure)
(e) State two ways in which each of the ratios calculated in (c) above could be improved for the business.
EPS – increasing profits or redeeming ordinary sharesPrice/earnings – raising share price by increasing profits or redeeming ordinary sharesDividend cover – increasing annual profits or paying a lower dividendDividend yield – paying a higher dividend, after making higher profits
Standard Costing/Variances
January 2007
6. (b) Advice management whether to sell 5000 televisions in a stock to DeltaMart at a price of £100 per television, to meet part of the order The marginal cost of producing units is (57+22+12) = £91.Therefore, the 5000 televisions should be sold.
(c) Evaluate the information above, and advice Pharaoh Vision plc whether it should: self-produce, buy or reject the offer. The marginal cost of producing another 10,000 is 91+11 = £102.Therefore, units should not be produced. The offer to supply from the other firm should be accepted.
(d) Explain two other factors that may be considered by Pharaoh Vision plc in the decision-making in (c).
Contract with new customer could lead to future business and this could be at a higher price, with a greater profit margin
Enables product to be sold in home market, at present seems only exported, which should raise profile of company
Contract with supplier may lead to further business in future, perhaps with a keener price or in times of high demand
Selling at the lower price may upset the exporter, who may demand a lower price or find a different supplier.
January 2008
2. (d) Evaluate the decision to pass on the increase in production cost to the customer.
For passing on the increase in production cost Need to maintain profit margin, cannot keep same selling price forever Customers may be quite willing to pay the higher price. New price may still be below that of rival firms
Against passing on the increase in production cost Could absorb rising costs by increasing efficiency Customers could be unhappy and go to a rival supplier New price may make firm’s price higher than rivals.
Conclusion
January 2009
4. (c) The production manager of Coolshades LTD has said, “If you decide to pay a low wage rate, the business does not always benefit.” Evaluate this statement.
For Statement Labor Rate Variance is favorable, so probably less skilled workers than expected employed.
This could result in the adverse Labor Efficiency variance, as they will take more time to complete the job than higher skilled workers.
This also explains the adverse Total Labor Cost Variance Also, the lower skilled workers (favorable labor rate variance) would waste more material. Workers are less motivated so productivity may suffer
Against Statement Labor Rate Variance is favorable which may reduce labor costs.
Conclusion
June 2009
2. (b) Study the budget and actual figures, and the information given for April 2009. Evaluate the most appropriate actions to achieve the £40,000 net profit target required by the directors.
Selling price below budget competitive market? Difficult to raise price (promotions?). Investigate why 0.52 kg of material used per loaf. Wastage? Could reduce this figure. World price of wheat rising. Difficult to reduce purchase price. However, firm could try to find cheaper suppliers or receive discounts for buying in greater
bulk. Labor just had a pay rise. Difficult to now reduce pay rate. Hours used less than budget. Any scope possible for further reduction? Variable overheads difficult to reduce rate, but could reduce usage Fixed overheads unlikely to reduce rent, or managers’ salaries. Lay off staff?
January 2010
4. (b) As Yasmin Faraz’s accountant, evaluate the likely effects of a standard costing system on the production workers.
Positive effects Helps to establish production targets that may be comfortable for the workers to achieve May be basis of possible bonus for production targets met which may see workers taking home
more pay
Anything that benefits the firm will benefit the workers, e.g. for job security, pay, bonuses, competitive pricing of products etc. Meeting production targets will motivate workers.
Negative effects Helps to establish production targets that may be difficult for workers to achieve May be basis of possible bonus for production targets which may see workers missing targets
and taking home less pay Missing production targets will demotivate workers
Conclusion
May 2005
5. (c) Give two possible causes for the (i) labor rate variance, (ii) labor efficiency variance
Rate Overtime Increase in rate of pay Standard of employee
Efficiency Quality of materials Machine breakdown Poor supervision
June 2010
4. (c) Suggest and explain two actions Marcos could take to reduce the total labor cost variance.
Labor rate variance is adverse so Marcos could reduce the rate paid, perhaps, by negotiating with trade unions, or employing low grade workers
This could be difficult for workers to accept as they would be demotivated and output may fall, and strikes etc. could take place
Labor rate variance is adverse, possibly due to workers having to work overtime at a higher rate to complete this job. Marcos need to ensure workers work fast by training or improving better machinery
Labor efficiency variance is adverse so workers must work faster (i.e. increase efficiency) by training, improving motivation or having reliable machinery
Improve quality of materials which may result in less wastage and reworking
(d) Evaluate the effectiveness of management by exception to Marcos.
For: Management by exception sees management only, investigating differences against present
tolerances Saves management time as no need to take any action unless adverse variance. Hence, Marcos
does not need to spend any time worrying about material cost and usage Costs may well be reduced if variances are adverse
Against: It is possible that costs could be reduced e.g. find a cheaper supplier, but Marcos will not spend
this time looking for another supplier as there is no adverse variance Standards set could be poor
Conclusion
January 2011
5. (c) Evaluate whether South East Asia Brick Company should use Chinclay plc or Earthworks Limited as a future supplier of clay.
Case for Chinclay Probably better quality clay as no material usage variance Earthworks had adverse usage variance so poorer quality of clay 0.3 kilos of clay less used per brick Overall cost of using Chinclay is cheaper by £672 Cost of 1 brick per Chinclay is 5.6 p, which is 0.56p cheaper than Earthworks, which is 6.16p.
Case for Earthworks Limited Cost per kilo of clay is cheaper by 0.04p per kilo.
Best to stay with Chinclay
January 2012
6. (a) Explain the stages in establishing a standard costing system.
For product, obtain a product specification giving standard qualities for materials and labor
Standard prices for materials obtained by consulting buyers and suppliers Standard labor rates obtained by consulting human resources depart and/or unions Standard overhead obtained by consulting management finance department Looking at figures for past cost of sales
(d) Evaluate the usefulness of a standard costing system to a Whirlwind Motorcycles Limited.
For usefulness Allows performance to be compared with predetermined standards Variances can be analyzed and action taken to control costs Helps eliminate waste, idle time, inefficiency etc. Allows management by exception, which sees action taken only for large variances
Against usefulness Takes time, expertise and money to prepare Inaccurate standards set may be misleading and unhelpful
Conclusion
June 2012
Benerd Miles, the Chief Executive of Miles of Tiles Limited, has stated, “If there is an adverse variance, this must be bad for the business.(d) Evaluate this statement.
For Statement If this is a cost variance then expenditure had been more than expected. If budget is realistic, this is bad and may be caused by:
-Workers not working as hard as they could-Workers being paid more than a market wage rate-Inefficient machinery-Materials being wasted-Paying more than the market rate for materials
If this is a sales variance, then revenue is less than expected and this could be caused by-Sales volume being less than expected-Sales price being less than expected
Against Statement Budget may be unrealistic and actually the business has performed ell. There may be a positive aspect to adverse variance e.g. Material prices have risen on the world
market, but our buyers are still getting a comparatively good price Adverse variances may be due to production being greater than expected which is good for the
business.ConclusionJanuary 2013
2. (d) Evaluate the decision not to charge the extra production costs to the customer.
Against passing on the increase in production cost Could absorb rising costs by increasing efficiency Customer could be unhappy and not buy and go to a rival supplier New price could make firm’s price higher than rivals Present value of £299 is psychological and an increase will take them through the £300 barrier.
For passing on the increase in production cost Need to maintain profit margin, this (or mark up) could be fixed otherwise business make
losses/goes bankrupt Cannot keep the selling price forever, will have to increase the price some day.
Customers may be quite willing to pay the higher price if they still think they get good value New price may still be below that of rival firms.
Conclusion
June 2013
7. (c) Suggest one reason for each of the following variances and explain the actions Vandeloos Fencing Limited could take on the:
(i) Material usage variance Could be caused by poor quality materials resulting in a lot of wastage. Action to solve the problem could be to change supplier or insist on a certain level of quality. Perhaps insert penalty clauses into supplier’s contracts for quality.OR Wastage caused by poor quality labor. So train labor better or hire better quality labor or raise wage rates to attract better quality labor or improve quality control
(ii) Material price variance Could be caused by suppliers charging a high price. Action could be Purchasing department must negotiate a lower price or change to supplier with a lower price or buy lower quality materials. Or achieve discounts by bulk buying or prompt payment.
Vandeloos Fencing Limited applied management by exception to the figures for April 2013. The cost accountant decided to ignore the labor variance, but to investigate material variances(d) Evaluate the decision of the cost accountant to ignore the labor variance, but to investigate the material variance.
For: Material variance is larger/labor variance is smaller Labor variance is £317.20 adverse, which is £380.32 less than the adverse material variance of
£697 Maybe the policy is to investigate variances over a particular limit e.g. £500 The labor variance is only 3.56%, whereas the materials variance is 15.3% which is much
bigger Management by exception tries to make the management time cost effective, so no time is
wasted investigating small variancesAgainst:
It is possible that all costs, including labor could be reduced so the adverse variance could be investigated.
If you ignore an adverse variance below a certain limit, the cost could “creep up” each year without any action being taken
It is possible that any reduction in costs after investigation is cost effective i.e. could be greater than management time spent investigating
Conclusion
Marginal Costing-BEP/Margin of safety-BEP graph-P/L account (Absorption costing/Marginal costing)
January 2007
5. (d) Evaluate which site would be the better choice for the new factory. Hirandi has a larger profit of £21,200 or £47, 600 to £24600
Hirandi has a lower break even point each month £11,528 to £13,846, by £2,318 Sanvulam has a greater contribution per unit of 0.2 pence
Conclusion: Hirandi is better location
June 2013
2. (b) Advice the management of Chandpur Sounds Limited whether this offer should be accepted.
Marginal costing says the order should be accepted on the grounds that £15is greater than the marginal cost of £12.20 i.e. a positive contribution of £2.80. New customer may result in more orders in the future, perhaps at a higher price. However, in the long run, selling at £15 would result in a Net Loss/not all costs are recovered (loss of £1.40). Absorption costing says do not accept offer. Existing customers would be unhappy to hear this low price on offer/will ask for lower prices.
(c) (ii) Which option would be the best option for Chandpur Sounds Limited, if output were greater or less than 84,000 units for the year starting in 1 April 2013. If output increase, other options may be the best. For example, if output rises by 6667, option (iii) is more expensive than option (i)If output rises by 6086 units, option (ii) is more expensive than option (i). If output is less than 84000, option (iii) remains best.
(d) Evaluate whether Chandpur Sounds Limited should use marginal costing or absorption costing to value inventory.
Case of Marginal Costing Could be said to help decision making in the short term when deciding whether to accept an
offer price or make or buy or discontinue a product/profit center or a limiting factor problem Sees costs allocated to a time period, so it may be argued that profit for that time period if more
accurate. External accounts are drawn up on a basis of a time period. Follows prudence concept, as closing stock and profit figures are lower.
Case for Absorption Costing Sees costs allocated to products. Could be useful for management when fixing prices or
reviewing if a product/project has been profitable in the long term. Recommended by SSAP 9. Gives a realistic figure for profit Follows matching concept as revenues for the product are matched against costs
Other points: If figures in the future are similar, choice of stock valuation will not have very much effect on the profit.Conclusion
4. (c) Evaluate whether it would be advisable to pay direct labor a lower rate per ray, for Sunny Kipwat to achieve a profit of £2000 per month.
Case for lower labor rate Business has profit target and has to take action to achieve these targets May not possible to decrease other costs, especially if fixed e.g. loan repayment, rent etc. May not be possible to increase selling price to increase profit, as will result in reduced sales
Case against lower labor rate Workers will be demotivated and workforce morale will be low It may not e possible for workers to pick extra fruit, to maintain overall wage level Could try to reduce other costs instead e.g. shop around for lower insurance
Conclusion
May 2005
6. (c) (i) Explain the term margin of safety. The excess by which actual sales exceed break-even sales
January 2008
6. (c) Evaluate the figures calculated in (b) to make a decision as t the future of each of the three oil wells.
Al Quarat Jenberouk SudamisFuture Continue Continue Close now
Short Term Long TermPlus Comment Profitable Loss making
Positive Contribution Positive Contribution Negative ContributionRunning out of oil
June 2008
4. (d) Evaluate which type of jacket Ranjeev should produce.
Case for High Quality Jacket Profit is higher by £1100 BEP in units is lower by 14 units Contribution is higher by £20 Profit margin is higher so less risky
Case for Low Quality Jacket Margin of Safety is higher by 36 units Figures are only estimates, e.g. may actually sell fewer high quality jacket. Costs are lowers so less risky
Conclusion
January 2009
4. (b) Advice the management of Himalya Ltd whether this offer should be accepted.
The order could be accepted on the grounds that £30 is greater than the marginal cost of £24. £30 gives a positive contribution of £6 per unit. New customer may result in more orders in the future, perhaps at a higher price. However, in the long run, selling at £30 would result in Net Loss/not all costs are covered. Existing customers would be unhappy to hear of this low price on offer and could go elsewhere,
(c) Evaluate on behalf of the management of Himalya Ltd which method of stock valuation; marginal costing or absorption costing should be used.
Case for marginal costing Could be said to help decision making when deciding whether to accept an offer price or make
or buy or discontinue a product/profit center. Sees costs allocated to a time period, so it may be argued that profit for that time periods is
more accurate. External accounts are drawn up on the basis of a time period. May be argued it is prudent to write off costs in time period incurred.
Case for absorption costing Sees costs allocated to products. Could be useful for management when fixing prices or
reviewing if a product/project is profitable.
Recommended by SSAP 9. Could be said to give a true and fair view.Other points: If figures in the future are similar, choice of stock valuation will not have very much effect on the profit.Conclusion
June 2009
7. (c) Evaluate the figures to make a decision as to the future of each of the three gas fields, using marginal costing.
Nevgrad Ostorov YutangaFuture Do not reopen Marginal costing
says reopenReopen
Present Not profitable Not profitable ProfitablePresent Negative
contributionPositive contribution
Positive contribution
Comment 1 mark 1mark 1 mark
January 2010
5. (e) Evaluate the suggestions of the Managing Director (to reduce costs).
NOT a good suggestion Increase in prices not recommended due to recession and competition, and will probably
reduce sales Rent decrease is difficult, especially if signed a long-term lease or agreement. Manager’s salary reduction will demotivate managers and performance may suffer Director labor’s pay cut will demotivate and could result in industrial action May not be able to reduce other fixed costs, e.g. Business Rates to council, interest on loan etc.
Good suggestion May be possible to negotiate a rent decrease due to recession It is possible to impose a cut in the manager’s salary It is possible to impose a cut in pay to direct labor force It may be possible to reduce some fixed costs e.g. heating, insurance
Conclusion
June 2010
7. (a) (i) Can you explain the difference between semi-variable costs and variable costs, and give three examples of each? Semi-variable costs are expenses that may vary with output, but not directly. OR are costs that have a fixed element and a variable element and could include: telephone, electricity, gas, water. Variable costs are expenses that change directly with output. Examples are direct wages, direct materials, royalties, patents, sales commission, fuel
(ii) Is contribution the same as profit?
Contribution can be found using the formulas:Contribution per unit = Selling price per unit – Variable Costs per unitOR Total contribution = Sales revenue – Variable costs Profit can be found using the following formula:Profit = Sales revenue – total costOR
Profit = Total contribution – Fixed costs To calculate profit, you must take account of fixed costs. Profit is not the same as contribution.
(c) Evaluate the effective of break-even analysis as an aid to business decision-making.
For effectiveness A tool that allows a business to forecast profit/loss at different output levels Helps a business break down coasts into fixed or variable Helps identify margin of safety and angle of incidence
Against effectiveness Cost and revenue figures are only predictions and cannot be assumed as 100% accurate. E.g. in practice, straight lines on graphs are likely to be curves as discounts are given or
received on bulk sales or overtime worked at a higher rate. Theory assumes all output is sold Costs and sales figures are affected by outside influences, e.g. inflation, boom or recession,
seasonal factors, fashions, lifestylesConclusion
January 2011
4. (c) Evaluate the two options for the telephone charge, and recommend which option should be chosen.
Case for keeping Fixed Charge Profit is higher by £3000 Profit is the most important aim of a business/more important than reducing break-even point
especially when break-even point is easily met.Case for changing to Measured method
Measured charge sees break-even point reduced by 30 units which is beneficial to firm especially if trading is tough.
Margin of safely is greater from 1650 (option 1) to 1680 (option 2) by 30.Conclusion
June 2011
4. (c) Evaluate the performance of Goldstar Refrigerators plc during the year ended 31 March 2011 by comparing the performance to the year ended 31 March 2010.
Better than last year Sales units figure is better 6500 than last years figures by 500 Sales price per unit is better £240, than last year by £120 Sales revenue is better by £1.56m than last year’s £1.32m by £240,000
Worse than last year Profit of £40,000 is worse than last year of £88,000 by (£48,000) Variable costs of £160 per unit are high than last year of £132 by £28 Fixed costs of £480,000 are higher than last year by £40,000 Break even figure for units is higher 6000, compared to last year’s 5000 Angle of incidence worse Margin of safety is worse by 500 Total costs have risen from £1,240,000 to £1,520,000
Conclusion
5. (b) Advise management whether or not to sell 10,000 tires in the inventory stock to FitFast Limited at a price of £24 per tyre, to meet part of the order.
The marginal cost of producing the units is (5+13+3) = £21. Therefore, the 10,000 tires should be sold, as there is positive contribution of £3 per tyre.
(c) Using the financial position above, advise which one of the three following possibilities SE Asia Rubber plc should select. Use marginal costing in your answer. The marginal cost of producing another 8000 is (5+21+3) = £29. Therefore, the units should not be produced, as there is a negative contribution of £5 per tire. The offer to supply from other firm (option 2) should be selected as a profit can be made.
(d) Evaluate non-financial factors that may be considered by SE Asia Rubber plc in making the decision in (b) and (c).
Non-Financial Factors to Consider Contract with FitFast could lead to further business in the future and this could be at a higher
price with a greater profit margin. Enables their tire to be sold in a different market which should raise profile of company Contract with supplier may lead to further business in future perhaps with a keener price or in
times of high demand Selling at the lower price may upset the Byby plc who may demand a lower price or find a
different supplier Quality of the products supplied may be better/worse than products produced themselves Workers earn a higher rate if overtime is paid and this increases motivation.
Cast against considering Non-Financial Factors Director’s duty is to the shareholders who want a return on their investment. Loss making firms will go out of business in the long term
Conclusion
7. (a) Is profit the same as margin of safety? Explain your answer. Profit is equal to the total sales revenue less total costs. Margin of safety is equal to the actual sales revenue less sales revenue required to break even.OR actual output sales units less output sales unit to break even. Therefore, the two are not the same.
Varnavas says, “It is easier to control fixed costs than variable costs.”(d) Evaluate this Statement.
Case for easier control of FIXED costs It is possible to decide the length of life of a non-current asset, thus controlling the depreciation
charge per year. It may be possible to negotiate with the landlord to fix a monthly rent charge. It may be possible to negotiate with the bank over the interest rate charged on a bank loan. Fixed costs do not change with output but variable costs do.
Case for easier to control of VARIABLE costs It is possible to fix direct wages, and someone will be willing to work for this rate. It may be possible to negotiate with suppliers for the price of raw materials. Some fixed costs may be impossible to change e.g. loan interest/repayments/business
rates/depreciation/insurance.Conclusion
June 2012
6. (c) Evaluate the figures calculated in (b) to make a decision as to the future of each of the four mines.San Pedro La Rioja Copresol Andacalla
Short Term Open Open/ close Close OpenEither ST or LT Either ST or LT
Long Term Open Close Close CloseLa Rioja and Andacalla must make mention to time period for a mark.Mark if mention made for positive contribution or negative contributionMark if reason given for a supporting decision in ST for La Rioja e.g. in future expect price of copper to rise or expect to reduce costs in future.
January 2013
6.(a) (i) State four other examples of fixed costs face by the stores. Depreciation, Business rates, Loan interest, Insurance
(ii) Define the term semi-variable costs and give two examples. Semi variable costs are costs that may have a fixed element plus a variable element OR For example, there may be a standing charge and an element that varies with usage OR A semi variable costs increases as output increases, but not in direct proportion of outputPossible examples – gas, electricity, telephone, water supply
(c) Evaluate the information and figures calculated in (b) to decide which store should stay open, and which store should close.
Case for Higher End staying open Lower break even point by 10,550 units Lower level of fixed costs by £15,900 if stays open, no need to pay rent on other store. Higher contribution per unit by £5 per unit
Case for Lower End staying open Higher profit by £1,716 Greater margin of safely by 892 units Higher level of sales by 11442 units If other store closes, building could be sold, and maybe this store’s building purchased.
Conclusion: Close Higher end store as lower profits made
Cash Flow Statement
January 2007
1. (d) Evaluate Rapid Distribution plc’s current liquidity position and give two key recommendations to improve future liquidity.
Firm has cleared bank overdraft, and now has money in the bank. However, liquidity position is not good
Current ratio now stands at 125:18, which is 6.94:1 which is way too high. It needs to be reduced.
Acid ratio now stands at 95:18, which is 5.27:1, which is way too high and needs to be reduced. Debtors appear to have got out of control and are way too high. Credit control/chasing up
debtors need to be carried out immediately Dividend policy needs to be reviewed. Ordinary shareholders have been paid a 50% dividend
for 2006 which is way too high Liquidity has been improved by issue of preference shares and taking of bank loan, these now
needs to be serviced, which involves making more profit before interest. Vans have been sold off; to improve liquidity, will the firm need these vans? Will this involve
renting/leasing replacements etc.
May 2005
1. (a) The management of cash flow is more important than profitability to ensure the survival of a business.” Explain this statement.
Cash is required for the day-to-day running of the business, i.e. paying creditors and expenses. Cash is also required to invest in fixed assets if a commitment to external financing is to be avoided or minimized. Profit is an abstract time related measure of performance derived by the application of rules and procedures know as generally accepted accounting principles. A profitable activity may only generate cash in the medium/long term.Other valid pointsE.g. Cash is required to meet long-term commitments such as repayments of loans. In the long run, fixed costs and variable costs must be covered.
January 2009
2. When the Cash Flow Statement if presented to the Board Meeting, the Marketing Director comments, “We should not be worried. Liquidity, not profitability is important for the short term survival of the business.” (same as June 2012)
Not worried If depreciation (a non-cash expense) is not included, Sunset plc makes a profit. The Net Cash figure shows an inflow/increase. (But this has been due to a loan and new share
issue)Worried
Sunset only has no liquidity problem at present because it has increased the bank load and asked shareholders for more refunds
The extra loan now means interest payments of £127,500 to be made a year which will reduce profits.
January 2010
6. (c) Maria Monakolopus, the Marketing Director, has studied the figures and said, “I am concerned about the liquidity of the business.”Evaluate this statement.
Agree with Statement Current ratio is very weak at 0.67:1 Current ratio worsened over the last year from 1:1 which was weak Creditors are rising, is this due to lack of liquidity? Positive bank balance at the start of the year is now an overdraft
Disagree with Statement Debtors are falling so are probably being chased up. Bills such as tax and debenture interest appear to have been paid over the year. Positive Net Cash Flow from Operating Activities of £163,755.
Conclusion
January 2011
3. (b) Evaluate how well the directors of Thames Technical Services Limited have managed the liquidity of the business during the year ended 31 December 2010.
Handled poorly Working capital has decreased from £22,610 to £940 by £23,550 Working capital ratio is worsened from 1.84:1 to 0.98:1
Liquid ratio has decreased from 0.85:1 to 0.36:1 Bank/Cash has decreased by £21,290 Directors paid themselves an enormous interim dividend
Handled well Tax due at the start of the year has been paid Funding via issue of debenture or ordinary shares that covers redemption of preference shares
Conclusion
June 2011
3. (d) Evaluate how well the directors of Arkotari Limited have managed the liquidity of the business during the year ended 31 March 2011.
Handled poorly Working capital has decreased from £12,210 to £2,460 by £9,750. Working capital ratio has worsened from 1.29:1 to 1.05:1 Acid ratio has decreased from 0.26:1 to 0.24:1 Bank + Cash has decreased by £6,385 OR overdraft has increased by £5,900 Creditors have increased by £4,620 A number of vehicles have bee sold off and generated funds. Are these vehicles required for the
business or are they surplus to requirements? Some ordinary shares have been redeemed which must be a drain on liquid resources.
However, this may mean a reduction in future dividends.Handled well
Bank loan has been repaid in full and this should avoid future interest payments that help future liquidity but this may be a problem now.
Dividends paid have been very modest. Ordinary shareholders bases on year-end figure have only received 2% dividend.
Conclusion
May 2013
3. (b) Evaluate the current liquidity position of Larnaca Distributors plc.
Liquidity position good Firm has healthy level of cash and cash equivalents Current ratio now stands at 2.31:1 which is good. Acid ratio now stands at 1.04:1 which is ideal Liquidity has been improved by issue of ordinary share Working capital is £629000 - £272000 = £357000 which is healthy/means current liabilities
can be paidLiquidity position worsening
Net cash outflow of £6000 Inventories are a large figure and rising. Is there a problem with unsold inventories/is it
perishable? Trade receivables rose by 15000. Credit control/chasing up debtors needs to be carried out
immediately as figure is very high Big increase in Trade payables to a very large sum. Is firming paying on time and obtaining
cash discounts etc. Cash and cash equivalents of £71000 are unable to pay. Current Liabilities of £272000 Dividend policy needs to be reviewed. Ordinary shareholders have been paid an interim
dividend for 2013 of £22000 on a profit before tax of £8000, which is very high. Debenture has been redeemed which uses liquid funds but helps future liquidity as no more
interest has to be paid.
Conclusion
June 2012
7. (b) Explain two differences between a statement of cash flow and a cash budget. A statement of cash flow is for the past 12 months and includes mostly exact figures prepared for external users. A cash budget is for future period, and involves figures that are mostly estimates prepared for mainly internal use.
June 2008
3. (d) Evaluate the relative importance of liquidity and profitability to a business (same as above).
Henna Mahmood, a director of Chittagong Stores plc, has stated at a board meeting, “Liquidity is more important than Profitability.”(c) Evaluate this statement.
Profit most important Without profit, business would close down in the long run. If short-term liquidity problem, many sources are available as source of finance. For example –
banks, shareholders, debt factoring E.g. banks, shareholders, debt factoring etc. (need two sources). No/low profits may result in firm unable to attract finance or investors/shareholders. No/low profits may see share price fall, as investors lose confidence
Liquidity most important Liquidity problems results in unable to pay daily bills, e.g. wages, electricity (need two) Unable to pay some bills may result in closure of business, e.g. tax bill Unable to pay some bills may mean business unable to operate, e.g. electricity cut off Can survive short-term losses if previous profits have been built up.
