Question 1: The management of ‘Caring For you’ is concerned about the provision of the financial information for internal use, as there has been a number of unforeseen budget overspends recently and certain decisions have has a financial impact exactly opposite to that which was expected The current system appears to be ‘providing information’ for external users as required by the statutes and other regulations.
Identify at least three weaknesses of the current approach to internal provision of information, (15 marks)
b) Suggest possible actions to improve situation (10 marks) Question 2: Laxo Tent Ltd. is preparing a quotation for manufacturing and supplying 32 tents. These are assembled from prefabricated parts bought specifically and fitted. The work will be highly intensive, estimated costs and other relevant data is as follows: Prefabricated parts per tent Direct labour hours (at RM 15 per hour) Direct labour related costs Sundry expenses RM 1,600.00 60 Hours for the first tent 25% of labour cost RM 500.00 per tent
Requirements: i) Determine the average hours per tent (correct to two decimal points) and the total hours required for the cumulative output of 32 tents. (10 marks) ii) iii) Calculate the total cost to Laxo Tent Ltd. Of producing the 32 tents, and (5marks)
What will be the price of per tent if Laxo want mark up at 25% and what will be the gross profit at that price? (10 marks)
Question 3 Explain what you understand by the following terms used in Management Accounting, with appropriate examples to illustrate: i) Absorption Costing (5 marks) ii) iii) iv) Marginal Costing (5 marks) Activity Based Costing, and (5 marks) Job Costing (5 marks)
Question 4 a) Jackson Printers publishes school textbooks. The press has fixed expenses of RM600,000 each month plus variable expenses of RM 500 for every 100 books printed. Each book is sold for RM15.00. Required: (i) Calculate the number of books Jackson must sell each month to break even. (2 marks) (ii) Calculate the required sales in units and RM Jackson needs a month in order to earn RM50, 000 monthly net profits. (3 marks) The manager is considering an expansion that will increase fixed expenses by 50% and variable expenses by 20%. Calculate the new breakeven point in units and in Ringgit Malaysia. (5 marks)
b) Elaborate on any two of the following terms, using suitable examples to illustrate i) Pay-back period (5 marks) ii) iii) iv) Accounting Rate of Return (5 marks) Net Present Value, and (5 marks) Internal Rate of Return (5 marks)
ANSWERS: Answers to Question 1: a) The current system used by the Management of ‘Caring For You’ is based on an annual report which includes a balance sheet and a profit and loss account for the year, it also offers a picture of the financial status of the organization. This information is known as financial accounting information. Where as, the internal provisions of information is known as Management Accounting. Management Accounting measures and reports financial and non-financial information that helps managers make decisions to fulfill the goals of an organization.
Three Weaknesses of the current approach to internal provision of information: i. Time Focus - The current approach is a net effect of transactions
recorded in financial accounting based on historical nature. These records do not help for future planning and other managerial decisions. It does not provide day-to-day cost information for making effective plans for coming year and the period after that. The internal provisions of information are focused on making future decisions and have forecasting value to those within the company, for example: sales budget and cash-flow forecast. ii. Concentrates on the business as whole rather than analyzing the
component part of the business: The current approach does not indicate profit or loss of each department, job process or contract. Loss or less profit disclosed by the profit and loss account is a signal of bad performance of the
business unit as a whole, but the exact cause of such performance is not identified. The internal provisions of information can focus on specific areas of a business’ activities. For example, it can provide insights into performance of product, business unit, a department or a division. Thus, providing an indepth understanding of a business unit or an activity. iii. Frequency of reporting: The current approach generates a report based
on business as a whole with either monthly, quarterly, half-yearly or annually. The internal provisions of information can be produced on a regular basis that best suit the needs of the management.
b) Possible actions to improve the situation will be for the management of ‘Caring For You’ to adopt management accounting, they will be able to track, record, and report financial information of management review. This will help the management team to lower their operational expenses. The management can utilize management accounting information to review the cost of economic resources and other business operations. This information allows them to better understand how much money it costs to run the business. They can also use management accounting to conduct an analysis on the quality of economic resources used to produce goods or services. For example, if overall product quality would not suffer by using a cheaper raw material, the management team can make this change to reduce production costs. This will lead to improvement of cash flow. Budgets are a major part of management accounting. The management team may use budgets so they have a financial
road map for future business expenditures. Many budgets are based on a company’s historical financial information. Management accountants can comb through this information and create a master budget for the entire company. The management team may also use several smaller budgets for divisions or departments. These individual budgets usually roll up into the company’s overall master budget. The main purpose of budgets is to save the company money through careful analysis of necessary and unnecessary cash expenditures, thus improving the current situation of the company.
Answers to Question 2: i. Average hours per tent = Total hours for all tents / 32 tents 1,920hrs / 32 tents = 60hrs Total hours required for the cumulative output of the 32 tents; 60hrs for the first tent, therefore, 60hrs X 32 tents = 1,920hrs ii. Total cost to produce 32 tents; Cost per tent: RM 1,600.00 + RM 900.00 + RM 500.00 = RM 3,000.00, therefore to produce 32 will be: RM 3,000.00 X 32 tents = RM 96,000.00 Cost per tent is RM 3,000.00, therefore if Laxo is to markup 25%; Selling price = RM 3,000.00 + 25% = RM 3,750.00 Gross profit = Selling price – Total cost per tent = RM 3,750.00 – RM 3,000.00 = RM 750.00
Answers to Question 3: i. Absorbtion Costing: A method of costing a product in which all fixed and variable costs are apportioned to cost centers where they are accounted for using absorption rates. This method ensures that all incurred costs are recovered from the selling price of a good or service. Absorption costing is also known as “full absorption costing”.
Example of Absorption costing: A factory that is producing a single end product that sells for RM 50,000 each. The direct costs in connection with manufacturing each unit of the product may have been RM 10,000 for materials and RM 20,000 for direct labor. If the hours of direct labor relating to each unit of the product are 100 hours, and the capacity of labor for the factory in one year is 100,000 hours, the fraction of 100 divided by 100,000 could be used to allocate general overhead expenses to each product. So if we consider that general overhead expenses in one year are calculated to be RM10 million, then the overheads allocated to each product is one-thousandth of this figure which amounts to RM 10,000. The total cost allocated to each unit produced, using full absorption costing, is therefore the direct costs of RM 30,000 plus overhead costs of RM10, 000, giving a total cost of RM 40,000 per product. As each product sells for RM 50,000, the absorption costing system calculates a profit of RM 10,000 on each unit sold.
Marginal Costing Marginal cost is the cost management technique for the analysis of cost and revenue information and for the guidance of management. Marginal Costing is an accounting system where only variable cost or direct cost will be charged to the cost units. This costing technique is also known as direct costing .Fixed costs are never charged to production. They are written off to the profit and loss account. Example of Marginal Costing: A factory may be operating at the highest capacity it can with all workers working normal full time hours, so increasing production by one more unit would mean paying overtime, so the marginal cost would be higher than the current variable cost per unit. Conversely, an input may become cheaper as the quantities purchased rise (e.g. quantity discounts), so marginal costs may fall as production increases. Long run marginal cost is the marginal cost of increasing capacity over a period long enough that there are no fix restrictions on output (e.g. extra workers can be employed so overtime rates are not paid, machinery can be bought, etc.). .
Activity Based Costing An accounting method that identifies the activities that a firm performs, and then assigns indirect costs to products. An activity based costing (ABC)
system recognizes the relationship between costs, activities and products, and through this relationship assigns indirect costs to products less arbitrarily than traditional methods. Example of Activity Based Costing The cost of the activity of bank tellers can be ascribed to each product by measuring how long each product's transaction takes at the counter and then by measuring the number of each type of transaction. For the activity of running machinery, the driver is likely to be machine operating hours. That is, machine operating hours drive labour, maintenance, and power cost during the running machinery activity. iv. Job costing Job Costing involves the calculation of costs involved in a construction "job" or the manufacturing of goods done in discrete batches. These costs are recorded in ledger accounts throughout the life of the job or batch and are then summarized in the final trial balance before the preparing of the job cost or batch manufacturing statement.
Example of Job Costing Manufacturing companies incorporate job order costing as a means of controlling usage of raw materials, production equipment and labor hours. These businesses consider each customer order a separate job for the purposes of job order costing. Alternatively, manufacturers may group smaller value projects together under a single job heading. How manufacturers group jobs depends on the size of the company. For example, a small business manufacturer may consider any job valued over RM 1,000 as a single job, but they may group smaller customer orders together in blocks of RM 1,000 for costing purposes. Answers to Question 4: (a) i. Break Even Points = Fixed Cost Contribution Margin per Unit = RM 600,000 RM 15 - (RM 500 / 100 BOOKS)
= 60,000 units ii. Targeted Sales = Fixed Cost + Net Profit (Unit) Contribution Margin per Unit = RM 600,000 + RM 50,000 RM 15 - (RM 500 / 100 BOOKS)
= 65,000 units Targeted Sales = Targeted Sales (Unit) X Selling Price (RM) = 65,000 units X RM 15
= RM 975,000.00 iii. Fixed expenses increase by 50%, Therefore, RM 600,000 + 50% = RM900, 000.00 Variable cost increase by 20%, Therefore, (RM 500 / 100 books) + 20% = RM 6.00 iv. Break Even Points = Fixed Cost (Units) Contribution Margin per Unit = RM 900,000 RM 15.00 – RM 6.00 = 100,000 units Break Even Points (RM) = Break Even Points (Units) X Selling Price = 100,000 X RM 15.00 = RM 1,500,000.00 (b) i. Pay-back period:The length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions. Example:
Year 0 1 2 3 4 Cash Flow (200,000) 50,000 80,000 90,000 90,000 Cumulative Cash Flow (200,000) (150,000) (70,000) 20,000 110,000
AA Sdn Bhd is planning to undertake another project requiring initial investment of RM 200,000 and is expected to generate RM 50,000 in Year 1,
RM 80,000 in Year 2, RM 90,000 in year 3, and RM 90,000 in year 4. Calculate the payback value of the project. Note that (RM 50,000 + RM 80,000 = RM 130,000 in the first 2 years + RM 70,000 of RM 90,000 occurring in Year 3). Payback period = 2 + [|-RM70, 000| / RM 90,000] = 2 + [RM 70,000 / RM 90,000] = 2 + 0.78 Advantages of payback period are: 1. 2. Payback period is quite simple to calculate. It can be a measure of risk inherent in a project. Since cash flows
that occur later in a project's life are considered more uncertain, payback period provides an indication of how certain the project cash inflows are. 3. For companies facing liquidity problems, it provides a good
ranking of projects that would return money early. Disadvantages of payback period are:
Payback period does not take into account the time value of money
which is a serious drawback since it could lead to wrong decisions. 2. It does not take into account, the cash flows that occur after the
payback period is reached.
ii. Net Present Value:The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. For Example:
Year 0 1 2 3 4 Project A (200,000) 50,000 80,000 70,000 70,000 Project B (200,000) 80,000 80,000 20,000 60,000
AA Sdn Bhd is considering making an investment and currently they have 2 projects to invest. Referring to the table below, calculate and help AA Sdn Bhd to select the project that offers a highest NPV. ** Cost of Capital is 10%. Solutions: Based on the formula:
- The time of the cash flow - The discount rate - The net cash flow i.e. cash inflow – cash outflow, at time t. Therefore, Discount Factor, Year 1 = 1 / (1 + 10%) ^1 = 0.909 Discount Factor, Year 2 = 1 / (1 + 10%) ^2 = 0.826 Discount Factor, Year 3 = 1 / (1 + 10%) ^3 = 0.751 Discount Factor, Year 4 = 1 / (1 + 10%) ^4 = 0.683
Year 0 1 2 3 4
Cash Inflow (RM) 50,000 80,000 70,000 70,000
NPV PROJECT A Cash Net Cash Outflow flow (RM) (RM) 200,000 (200,000) 50,000 80,000 70,000 70,000
Present Value (RM) (200,000) 72,720 66,080 15,020 40,980 5,200
AA Sdn Bhd to select Project A as it offers the highest NPV comparing to Project B. Advantage: Net present value accounts for time value of money. Thus it is more reliable than other investment appraisal techniques such payback period and accounting rate of return. Also it is fairly easy to calculate. Disadvantage: It is based on estimated future cash flows of the project and estimates may be far from actual results.
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