IIUC- Dhaka CampusMBA Program

Course Outline on Managerial Accounting

Course Objective:

The main objective of studying the course is to acquire both the theoretical & technical knowledge on the various aspects of “Managerial Accounting”. The major aspects include concepts significance role of managerial accounting , Cost Behavior Analysis , Cost –Volume Profit Analysis ,Variable Costing vs. Absorption Costing ,Budgeting ,Relevant Costing ,Standard Costing &Variance Analysis , Responsibility Accounting ,Performance Measurement etc. The learners would get ample opportunities to develop their analytical &professional skills after solving practical oriented problems & case studies on the aforesaid main aspects . These skills may be used to take various managerial decisions in a sound manner while one is employed / serving in the managerial positions of any organizations whether business, service, trading, govt. &other non-govt. etc.

Detailed outline

01. Introduction :

Concept of Managerial Accounting (MA) & its significance difference between MA & FA –Role of MA –Business Environment –Professional ethics.

02. Cost terms ,Concepts &Classification :Cost concept –classification of cost & its basis product vs. period costs –Manufacturing vs. Non Manufacturing costs.

03. Cost Behavior Analysis &Use : Concepts of CB & CA scenario –Variable, Fixed &Mixed costs –high low analysis problems &solutions.

04. Cost Volume Profit Analysis (CVPA) : Concepts of CVPA –Assumption & Usefulness ,Contribution Margin & CM Ratio- Break –Even Point, Its computation &graphic presentation –Target Profit Analysis –Margin of Safety –problems and solutions.

05. Variable Costing (VC) & Absorption Costing (A/C): Concepts of VC & A/C, Comparison –Income Statement under VC & AC – Reconciliation –Reasons for difference in Income – Problems & Solutions.

06. Master Budget (MB) & Flexible Budget(FB): Concepts of MB –types of MB –operating and financial advantages of MB –preparation of sales, purchase and production budgets, cash budget–problems &solutions.

07.Relevent Costing :Relevant and irrelevant costs –reasons for isolating RC –Make or Buy & Replacement decisions –special orders – problems and solution.

08.Standard Costing & Variance Analysis : Concepts –purpose –types of variance –computation of variances –variances report – problems and solutions.

09. Responsibility Accounting:Concepts and significance – responsibility centre –cost center -investment centre – profit centre –segment reporting and ROI analysis –segmented statements –problems and solutions;

10.Performance Measurement :Concepts and significance- measurement criteria – profitability and productivity –types of productivity –productivity vs. profitability –problems and solutions

Text Book: Managerial Accounting (Tenth Edition) By, Garrison NoreenReference Book : Cost Accounting- a managerial approach by C.T. Horngren.

Name of Course Teacher: Dr. Md .Jahirul Hoque Designation- Professor of DBA, IIUC-DC

Phone – 8127366, 01716524423

Chapter-1 Introduction

01. Concepts;Managerial accounting (MA) is concerned with providing information to managers for their use internally in the organization. Financial accounting is concerned with providing information to stockholders, creditors and others outside of the organization.

02. Significance;Essentially, the manager carries out three major activities in an organization; planning, directing and motivating, and cont rolling. All three activities involve decision making.

03. Difference between MA & FA;In contrast to financial accounting , managerial accounting ;a) focuses on the needs of the manager,2)places more emphasis on the future ,c) emphasize s relevance and flexibility rather then precision ,d) emphasizes the segment of an organization , e) is not governed by GAAP and f) is not mandatory.

04. Just in time system; a) The characteristics of the JIT approach include the following;

# Reducing the number of suppliers and requiring suppliers to make frequent deliveries of defect –free goods.

# Creating a continuous flow of product through the plan, minimizing the investment in raw materials, work in process, and finished goods.

#Making production operation more efficient by redesigning workstations and improving the plant layout by creating individual product flow lines.

# Reducing setup time.# Reducing defects.#Cross training employees so that all are multiskilled and can perform all functions required at a particular workstation.-

b) A successful JIT system requires suppliers who are willing to make frequent deliveries of defect –free goods in small quantities. This often requires weeding out unreliable suppliers and working intensively with a few, ultra-reliable suppliers.

05. Ethical Standards (Solution to P. 1-7); a) Failure to report the obsolete nature of the inventory would violate the Standards of Ethical conduct as follows;

Competence

Perform duties in accordance with relevant technical standards. Prepare complete reports using reliable information.

By failing to write down the value of the obsolete inventory, Perlman would not be preparing a complete report using reliable information. In addition, generally accepted accounting principles (GAAP) require the write down of obsolete inventory.

Integrity

Avoid conflicts of interest. Refrain from activities that prejudice the ability to perform duties ethically. Refrain from subverting the legitimate goals of the organization. Refrain from discerning the profession.

Members of the management team, of which Perlman is a part, are responsible for both operations and recording the results of operations. Since the team will benefit from a bonus, increasing earnings by ignoring the obsolete inventory is clearly a conflict of interest. Perelman would also be concealing unfavorable and subverting the goals of the organization. Furthermore, such behavior is a discredit to the profession. Objectivity

Communication of information fairly and objectively. Disclose all relevant information.Hiding the obsolete inventory impairs the objectivity and relevance of financial statements.

b) As discussed above, the ethical course of action would be for Perelman to insist on writing down the obsolete inventory. This would not, however, be an easy thing to do. Apart from adversely affecting her own compensation, the ethical action may anger her colleagues and make her very unpopular. Taking the ethical action would require considerable courage and self – assurance.

06. Professional Ethics ;

a) Competence requires qualification, experience, training and understanding.

b) Responsibility and accountability; should go together .responsibility without accountability is meaningless.

c) Objectivity; objectivity ensures communicating information.d) Integrity; should be a man of high integrity which includes

morality.e) Pleasant behavior; behavioral aspect must be pleasant. f) Dutiful.g) Regularity; Must maintain regularity in duties. h) Loyalty of organization; must be loyal.i) Confidentiality of the organization; must maintain

confidentiality.

07. Business environment;

a) TQM; Both from the views of customers and enterprises.b) JIT; provide necessary inventory looking at the minimum level.c) Re-engineering; process engineering ensuring a business process.d) E-commerce; introducing IT in commerce.e) Global business: international business.

Problem 1-8, Ethics: Just in Time

Requirement 01:

Considering the IMS’s standards of ethical conduct Charlie cannot ignore the situation described about WIW, a publicly owned corporation.

Firstly, as part the standard of ethical conduct management account must “avoid actual or apparent conflicts of interest and advice all appropriate parties of any potential conflict”. Charlie has a responsibility to disclose all the relevant information regarding A-1 and advice the concerned management about the situation.

Secondly, J.B told Charlie that WIW has been trying to implement “Just in Time” system. So, as WIW’s controller Charlie’s responsibility is to make sure the proper implementation of JIT approach. As per the situation described on WIW, Charlie is informed that A-1 is more of a jobber than a warehouse. A-1 cannot delivery the order fully from his won warehouse and in addition, some of the orders were late and not complete. So, the present arrangement with A-1 neglects most of the benefits t5hat can acquire from the JIT.

Requirement 02:Charlie should follow some specific steps to resolve this matter is mentioned below: First Step: Charlie has to verify whether the collected information is correct or not.Second Step: He should verify whether the mark up percentage & the figure of profit are obtained or not if WIW is delivered directly from manufacturer other than getting delivery from A-1.

Third Step: He should verify the situation again with J.B before informing the concerned management anything about the relationship between J.B and A-1. He needs to be confirmed that J.B is ignoring the interest of the company for that relationship though A-1 is not fit as supplier for JIT approach.

Forth Step: If J.B refuse to follow this course of action, Charlie’s only alternative is to submit a memorandum to the board of Directors. J.B should be notified of this action in advance. The memorandum should present only the fact. If the board approves the continued relationship with A-1 Charlie may possible conclude that his concerns about an apparent conflict of interest do not represent an actual conflict. This presumes t6hat legal counsel has advised the board that the arrangement with A-1 doesn’t violet any loss and that the company has made adequate disclosure in its public feelings. Only Charlie can makeup the decision as to weather or not he can continue at WIW under these circumstances.

Final Step: After trying every possible step if Charlie fails to establish a proper system in WIW he has to decide whether he will continue with this company or not.

Case Study: 01

Mr. Thomas and Mrs. Linda are the president and assistant controller respectively of a sugar mill of a country which has 20 stores spread over the whole country. Both Mr. Thomas and Mrs. Linda have been working in the mill for the last fifteen years. Mrs. Linda has been given the responsibilities of inspecting the stores for the last ten years and asked to give a report on inventory.

While inspecting the stores Linda has discovered a sizable number of inventories not recorded in the stores account during the period. In the mean time she has discussed the matter with the other members of the management team and sought their opinions on the matter. The members of the management team had advised her just to ignore the matter as obsolete inventory. Other wise, all the members including Linda will have to face adverse impact on their compensation.Required;

a) What would be the responsibility of Linda in respect of the obsolete inventory? Examine in the context of the following standards of ethical conducts;

I. Competence,II. Integrity and

III. Objectivityb) What difficulties Mrs. Linda will face while recording the obsolete inventory

in her report? How she would overcome those.

Chapter -2 Cost terms, Concepts and Classifications

01. Concepts and Classification;A product cost is any cost involved in the purchase or the manufacture of goods. In the in the case of manufactured goods, this costs consists of direct materials, direct labor and manufactured overhead. A period cost is a cost that is taken directly to the income statement as an expense in the period in which it is incurred.

02. Since product cost follow units of product into inventory, they are sometimes called inventoriable cost, the flow is from direct materials, direct labor and manufacturing overhead into work in process. As goods are completed, their cost is removed from work in process and transferred into finished goods. As goods are sold, their cost is removed from finished goods and transferred into cost of goods sold in an expense on the income statement.

03. A variable cost is a cost that varies, in, total. In direct production to change in the level of activity. A variable cost is a constant per unit of product. A fixed cost is a fixed in total, but will vary inversely on a per unit basis with changes in the level of activity.

04. When fixed costs are involved, the cost of a unit of product will depend on the number of units being manufactured. As production increases, the cost per unit will fall as the fixed cost is spread over more units. Conversely, as production declines, the cost per unit will rise, since a constant fixed cost figure will be spread over fewer units.

05. A differential cost is a cost that differs between alternatives in a decision. An opportunity cost is the potential benefit that is given up when one alternative is selected over another. A sunk cost is a cost that has already been incurred and cannot be altered by any decision taken now or in the future.

06. Differential costs can be either variable or fixed. For example, the alternatives might consist of purchasing one machine rather than another in order to make a product. The difference in the fixed costs of purchasing the two machines would be a differential cost.

07. Exercise-2.9

A few of these costs may generate lively debate .for example, some may argue that the cost of advertising a Madonna rock concert is a variable cost since the number of people who come to the rock concert depends upon how much advertising there is .However, one can argue that if the price is within reason, any Madonna rock concert in New York City will be sold out and the function of advertising is simply to let people know the event will be happening. Moreover, while advertising may affect the number of persons who ultimately buy tickets, the advertising costs don’t go up.

Cost behavior Variable Fixed

1. X-ray film used in the radiology lab at Virginia Mason Hospital in Seattle …………………………… x

2. The cost of advertising a Madonna rock concert in New York city ………………………….. x

3. Depreciation on the Planet Hollywood restaurant building in Hong Kong ……………………. x

4.The electrical cost s of running a roller coasterat Magic Mountain …………………………………… x

5. Property taxes on your local cinema …………………… x6. Commission paid to salespersons at Nordstroms ……………………………………………….. x7.property insurance on a Coca- Cola bottling plant ………………………………………………………… x8. The cost of synthetic materials used to make

Nike running shoes …………………………………………. X9. The cost of shipping Panasonic televisions to retail stores ……………………………………………….. x10. The cost of leasing an ultra-scan diagnostic

machine at the American hospital in Paris …………….. X

08. Exercise-2.5

Cost Behavior Selling and Product Variable Fixed Administrative Cost Cost

1. Hamburger burns at a McDonald’s outlet ……….. x x

2. Advertising by a dental Office ……………………… x x

3. Apples processed and cannedby a Del Monte Corporation. x x

4. Shipping canned apples from aDel Monte plant to customers. x x

5. Insurance on a Bausch and lomb factory producing contract lenses ……………. X x

6. Insurance on IBM’s corporate Headquarter ……………… x x

7. Salary of a supervisor overseeing production of computer board at Hewlett-Packard …………… x x

8. Commissions paid to Encyclopedia Britannica salespersons ……………….. x x

9. Depreciation of factory lunchroom facilities at a General Electric plant ………. x x

10. Steering wheels installed in BMWs …………………… x x

09. Problem-2-14

Name of the Cost Variable Fixed Product cost Period Opp. Sunk Cost Cost Direct Direct Mfg, (selling& cost cost mat. labor O/H adm.cost) Rental revenueForegone,$30,000Per year X Direct materials cost,$ 80 per unit X XRental cost o Warehouse , $500Per month X XRental cost of

Equipment, $4000 per month X XDirect labor cost ,$60 per unit X XDepreciation of annex space ,

$8000 per year X X XAdvertising cost ,$50000 per year X X

Supervisors salary, $1500 per month X X Electricity for machines,$120 per unit X X Shipping cost , $9 per unit X X Return earned on investment , $3000 per year X

10. Problem;2-20

Cost Item Cost Behavior Units of Product Variable Fixed Direct Indirect1. Electricity used in operating

machines …………………. X X 2. Rent on a factory building … X X 3. Cloth used in drapery production X X 4. Production superintendents salary X X5. Wages of labors assembling a product X X

6. Depreciation air purification equipment used in furniture production ………. X X 7. Janitorial salaries …………………… X X 8. Peaches used in canning fruit……….. X X 9.Lubricants needed for machines ……. X X 10. Suger used in soft drink production … X X 11. Property taxes on the factory ………. X X 12. Wages of workers painting a product … X X 13. Depreciation of cafeteria equipment X X 14. Insurance on a building used in producing TV sets ……………….. X X15.Picture tubes used in TV sets ……… X X

Chapter-3 Cost Behavior; Analysis and Use

01. Concepts;

Cost behavior refers to how a cost will react or respond to changes in the level of business activity.

Cost Behavior ScenarioType of cost Total costs Per unit costFixed costs No change Decrease or increase Variable costs Increase / Decrease No change

a) Variable cost ; A variable cost is one that remains constant on a per unit basis, but which changes in total indirect relation to change in volume.

b) Fixed cost; A Fixed cost is one that remains constant in total amount, but which changes, if expressed on a per unit basis, inversely with changes in volume .

c) Mixed cost; A mixed cost is a cost that contains both variable and fixed costs elements.

Allocation of Mixed cost:High-low Method: Under this method the variable cost element is found out from

the mixed cost by applying the following the variable rate formulaValuable rate=Change in cost ÷ Change in equity

After finding out variable cost, fixed cost can be found out by deducting variable cost from total mixed cost

Exercise 5-5:Requirement 01.

Units Produced and sold$60,000 $80,000 $100,000

Variable costs 150000 200000 250000Fixed costs 360000 360000 360000Total cost 510000 560000 610000Cost per unit:Variable cost 2.50 2.50 2.50Fixed cost 6.00 4.50 3.60Total cost per unit 8.50 7.00 6.10

Requirement-02

Income statement for 9000 unitsSales revenue (9000@7.5) 675000Less: Variable cost (9000@2.50) 225000

Contribution Margin 450000Less: Fixed Costs 360000

Net Income 90000

Exercise 5-11

1. Identification of Company’s expenses (see sheet)2. Separation of Mixed Expenses under High-Low Method Units Shipping Exp Salary etc

High level of Activity 4500 56,000 143,000 Low level of Activity 3000 44,000 107,000

Change 1500 12000 36000

A. Valuable Cost Element:Valuable rate=Change in cost ÷ Change in equity

1. Shipping Expense: 12000 ÷ 1500=$82. Salary expense: 36000 ÷ 1500= $24

B. Fixed Cost Element:Shipping Expense Salary Expense

Cost of High level 56000 143000less; VC45000 units @ $8 3600045000 units @ $24 108000FC 20000 35000

C. Cost formula:

Shipping Expense: $ 20000 plus $8 per unit or Y=$20000 + 8X

Salary Etc: $ 35000 plus $24 per unit or Y=$35000 + 24X

Frankel LtdIncome Statement for the month ended June

Sales in unit 4500Sales revenue $ 630000Less: Variable costs:

Cost of goods sold 252000Shipping 36000Salary etc 108000 346000

Contribution Margin 234000Less: Fixed costs:

Advertising 70000Shipping 20000Salary etc 35000

Insurance 9000Depreciation 42000 176000

Net Income $58000

2. Problem; 5-15

1. Costs of goods sold …………………….Variable Advertising expenses …………………… Fixed Shipping expenses ……………………… Mixed Salaries and commission ……………….. Mixed Insurance expenses……………………… Fixed Depreciation expenses…………………… Fixed

2. Analysis of the mixed expenses; Unites Shipping Expenses Salary and Comm. ExpensesHigh level of activity …………...5000 A$38000 A$90000Low level of activity …………….4000 34000 78000Change …………………………...1000 A$ 4000 A$ 12000

A. Variable cost element;

Variable rate= Change in cost Change in activity

1. Shipping expenses; A$4000 1000units =A$4 per unit. 2. Salaries and comm. expense;= A$12000 1000units

=A$12 per unit.

B.Fixed cost element; Shipping Expenses Salary and Com.ExpensesCost of high level of activity… A$38000 A$90000Less variable cost element; 5000 units x A$4 ……. 20000 5000 units x A$12 …….. 60000Fixed cost element …………... A$18000 A$30000

C.The cost formulas are;Shipping expense; A$18000 per month plus $ 4 per unit or Y= A$18000+A$4XSalary and Com.Expenses; A$30000 per month plus A$12 per unit or Y= A$30000+A$12X

Morrisey &Brown, Ltd. Income statement For the month ended September 30

Sales in units …………………………………… 5000Sales revenue (@A$100) ………………………... A$500000Less variable expenses; Cost of goods sold (@A$60) ……………………. A$300000 Shipping expenses (@A$4) …………………….. 20000 Salary and Com.Expenses (@A$12) …………… 60000 380000Contribution margin ……………………………… 120000Less fixed expenses; Advertising expenses ……………………………... 21000 Shipping expense ………………………………… 18000 Salary and Com.Expenses ……………………….. 30000 Insurance expenses ………………………………. 6000 Depreciation expenses …………………………… 15000 90000Net income ………………………………………… A$30000

03. Problem; 1. Maintenance cost at the 90000 machine-hour level of activity can be isolated as follows; Level of activity 60000M 90000MHTotal factory overhead cost ……………… $174000 $246000Deduct; Utilities cost @$0.80/MH* ……………. (48000) (72000) Supervisory salaries ………………... (21000) (21000)Maintenance cost ……………………… $105000 $153000

*$48000/60000MH=$0.80/MH

2. High-low analysis of maintenance cost; Machine hours Machine costHigh activity level ………………. 90000 $153000 Low activity level ………………. 60000 105000 Changes ……………….. 30000 $48000

Change in costVariable rate; Change in activity = 48000 30000MH = $1.60/MH

Total fixed cost; Total maintenance cost at the high activity level………… $153000 Less variable cost element (90000MHx$1.60) ………….. 144000 Fixed cost element ……………………………………… $9000

Therefore, the cost formula for maintenance is; $9000 per month plus $1.60 per machine-hour or Y=$9000÷$1.60X

3. Variable Rate per Fixed Machine-Hour CostMaintenance cost ………………. $1.60 $9000Utilities cost ………………….. 0.80

Supervisory salaries cost ……… 21000Total $2.40 $30000

Thus, the cost formula would be; Y=$30000÷$2.40X.

4. Total overhead cost at an activity level of 75000 machine-hours; Fixed costs ……………………………………… $30000 Variable costs ($2.40 x75000MH) ………………. 180000Total overhead costs …………………………………. $210000

Chapter-4 Cost Volume Profit (CVP) Analysis

01. Concept of (CVP) analysis ;

It is study of the effects of output/ sales volume, sales revenue, expenses (Costs) &net income (profit). Assumptions ; Total costs consist of variable costs & fixed costs. Variable costs ; Costs that change in direct proportion to changes in volume of output. Examples – material cost, direct wages etc. Fixed costs ; Costs that do not change directly with changes in volume of output. 02. Assumption of CVPA ;

Total cost should be divided into VC & FC. Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit and the fixed element is constant in total over the entire relevant range. In multiproduct companies, the sales mix is constant. In manufacturing companies inventories do not change. The number of units produced equals the number of units sold.

03. Usefulness of CVP Analysis;

CVP is one of the important financial management tools & techniques. It is used in profit planning. In order to know the target profit of a company; margin of safety, no profit & no loss point both in terms of quality and amount of that company; CVPA is used.

CVP analysis involves finding the most favorable combination of variable costs, fixed costs, selling price, sales volume and mix of products sold. Trade offs are possible between types of costs as well as between costs and selling price. Sometimes trade-offs are desirable and sometimes they are not. CVP analysis provides the manager with powerful tools for identifying those courses of action that will improve profitability.

04. BEP ;

It is that level of sales at which revenue equals to expenses & net income becomes zero.

Computation; Two approaches— a) Equation Technique;

BEP in quantity = Sales – Variable Costs- FC Or; Sales =VC+ FC

Or; (Sales per unit x Q) = (VC per unit x Q) +FC

BEP in amount = Q x Sales per unit.

b) Contribution Margin Approach; Contribution Margin =Sales –VC

FC BEP in unit= CM per unit

Or FC S .PU –VC PU

FC BEP in amount = CM. Ratio Or FC

CM/ Sales

Or FC 1- VC pu/ S pu Where CM Ratio = CM Sales

C) Changes in Costs- Must is adjusted. d) Changes in CM – Must be adjusted e) Changes in Sales -- Must be adjusted

05. Sales in case of target net profit;

a) CM Approach

Sales in Unit =FC+ Target NP(TNP) CM per unit

Sales in Amount=FC + TNP CM Ratio

b) Equation Technique

Sales in unit= VC + FC +TNPOr; (S. pu x Q) = (VC pu x Q) + FC + TNP

Sales in Amount = Sales in Quantity x S pu

06.Problem ;

Voter Company’s contribution format income statement for the most recent year is given below; Total Per Unit Percent of SalesSales (20000 units) …….. $1200, 000 $60 100%Less variable expenses …... 900,000 45 ? %Contribution margin …… 300,000 $15 ?%Less fixed expenses ………. 240,000 Net operating Income …… $60,000

Requirement;

a) Compute the company’s CM ratio and variable expenses ratio.b) Compute the company’s break even point in both units and sales

dollars. c) Assume that sales increase by $400,000 next year .if cost behavior

pattern remain unchanged .How much will the companies net operating income increase? Use the CM ratio to determine your answer.

d) Assume that next year management wants the company to earn a minimum profit of $90,000.how many units will be sold to meet this target profit?

e) Compute the company’s margin of safety in both dollar and percentage form

.

Solution ;

a) CM ratio =Contribution margin Selling price =$15÷$60 =25% Variable Expense Ratio= Variable expense x 100 Selling price = ($45÷$60) x 100 = 75%

b)

Break Even Sales = Variable expenses+ Fixed expenses +Profits $60 Q= $45Q +$240000+$0 $15Q=$240,000 Q = $240,000/0.25 Q=16,000 units.

BEP in Amount = 16000 units x $60 PU = $960000 c) Increase in sales ……………… $400000 Multiply by the CM ratio …….. X 25% Expected increasing in contribution margin $100000Since the fixed expenses are not expected to change, net operating income will increase by the entire $100000 increasing in contribution margin computed above.

d) Equation method; Sales = Variable expenses+ Fixed expenses +Profits $60Q= $45Q +$240000 + $90000 $ 15Q = $330000 Q= $330000/$15 per unit Q= 22000 units.

Contribution margin method; = Fixed expenses +Target profit Contribution margin per unit = $240000+$90000 $15per unit =22,000units

e) Margin of safety in dollars = Total sales- Break –even sales =$1200000-$960000 =$240000

Margin of safety percentage = Margin of safety in dollars Total sales =$240000/$1200000

=20%

07. Concept of CM Ratio;

The contribution margin (CM) ratio is the ratio of contribution margin to total sales revenue. The CM ratio shows the change in contribution margin that will result from increase and decreases in sales revenue. a dollar increases in contribution margin will result in a dollar increase in net income .therefore for planning purpose a knowledge of a products CM ratio is extremely helpful in projecting potential contribution margin and potential net income.

08. Concept of MS:

The margin of safety is the excess of budgeted sales over the break-even volume of sales. It states the amount by which sales can drop before losses begin to be incurred.

Exercise 6-6: Solution;

1. a) BEP in units: FC ÷ CM (PU) where CM $ 12= $ 150000 ÷ $ 12=12500 units

b) BEP in amount: SP (PU) x Units= $40 x 12500=$ 500000

2. Total CM at BEP in $ 150000 since CM is equal to fixed expenses at BEP. or. CM 12500 units x $12 PU = $ 1500003. Target Sales= ( Fixed Expenses + Target Profit) ÷ Unit CM

= (150000+18000) ÷ 12= 14000 units

Income StatementTotal Unit

Sales ( 14000 units @ $40) $ 560000 $ 40Less: Variable expense(14000@$28) 392000 28

168000 12Less: Fixed expense 150000

Net Income 18000

4. Margin of Safety (MS)a) In $ MS= Total Sales – BE Sales

= $ 600000-500000= $ 100000

b) MS ( in %)= MS ÷ TS= $ 100000 ÷ $ 600000= 16.67%

5. CM Ratio= CM ÷ Sales= 180000 ÷ 600000= 30%

New Sales: $ 600000 + $80000= $ 680000Expected Total CM ( 680000@ 30%)=204000Present Total CM ( 600000 @ 30%) = 180000

Increased CM or NI = 24000

Income StatementTotal

Sales $ 680000Less: Variable expense(70 % of sales) 476000

CM 204000Less: Fixed expense 150000

Net Income 54000Less present NI 30000

Increased NI 24000

Note: Variable exp. Ratio=VE ÷ Sales= 420000 ÷ 600000=70%

09. Exercise;6-6

a) Sales = Variable expenses+ Fixed expenses +Profits $30Q=$12Q+$216000+$0 $18Q=$216000 Q=$216000/$18 Q=12000units, or at $30 per unit, $360000

Alternative solution; Break-even point= Fixed expenses Unit contribution margin =$216000/$18 = 12000 units or ar$30 per unit, $360000

b) The contribution margin is $216000 since the contribution margin is equal to fixed expenses at the break-even point.

c) Target sales = Fixed expenses + Target profit

Unit contribution margin =4216000+ $90000 $18 =17000 units.

Total Unit Sales (17000units x $30) …………. $510000 $30Less variable expenses (17000 units x $12) 204000 12Contribution margin ……………………. 306000 $18Less fixed expenses …………………….. 216000Net income ……………………………... $90000

d) Margin of safety in dollar terms; Margin of safety = Total sales – Break –even sales $450000-$360000=$90000

Margin of safety in percentage terms; Margin of safety in dollars Total sales =$90000/$450000 =20%

e) The CM ratio is 60%

Expected total contribution margin ($500000 x 60%) $300000 Present total contribution margin ($ 450000 x 60%) 270000 Increased contribution margin $ 30000

Alternative solution; $50000 incremental sales x 60% =$ 30000

Since in this case the company’s fixed expenses will not change, quarterly net income will also increase by $30000.

10. Exercise;

1. Variable expenses; $40 x (100%- 30%)

=$28

2. a) Sales price $40 100% Less variable expenses 28 70 Contribution margin $12 30%

Let Q = Break –even point in units.

Sales = Variable expenses+ Fixed expenses +Profits$40Q = $28Q +$180000+$ 0$12Q =$180000Q = $ 180000/$12Q = 15000 units.

In sales dollar; 15000 units x $40 = $600000

Alternative solution; Let X =Break-even point in sales dollars. X = 0.70X + $180000+ $0 0.30X = $180000 X = $180000÷0.30 X =$600000

In units; $600000/$40 = 15000 units.

b) $40Q = $28Q + $180000+ $60000 $12Q = $240000 Q = $240000/$12 Q = 20000 units

In sales dollars; 20000 units x $40 = $800000

11. Exercise;

1. The contribution margin per person would be

Price per ticket $35Less variable expenses Dinner $18Favors and program 2 20

Contribution margin per person $15

The fixed expenses of the dinner-dance total $6000. The break-even point would be;

Sales = variable expenses+ fixed expenses +profits $35Q = $20Q + $ 6000 + $ 0 $15Q = $6000 1 Q = $6000/$15 Q = 400 persons; or, at $35 per person, $14000

Alternative solution

Fixed expenses $6000 Unit contribution margin $15 = 400 persons.

Or, at $35 per persons, $14000.

2. Variable cost per person ($18+$2) $20 Fixed cost per person ($ 6000/300) 20 Ticket price per person to break-even $40

Chapter-5 Variable Costing (VC)&Absorption Costing (A/C)

01. Concepts ;

Under V/C fixed manufacturing O/H are excluded from cost of product .but under A/C such O/H are included in cost of products. In other words, V/C signifies that fixed factory O/H is not inventoried. In contrast, A/C indicates that inventory values include fixed factory O/H.

02. Comparison;

A. Variable costingCosts to Account for Inventoried Costs on B/S Exp.on Income Statement

D.M Initially applied as goods Become Expired D.W . --------- to Inventory as are sold ---- when Inventory is

Variable F. O/H Unexpired costs sold.

Fixed F. O/H ………Expires Immediately………..Becomes Expired immediately .

B.Absorption CostingCosts to Account for Inventoried Costs on B/S Exp.on Income Statement

D.M Initially applied as goods Become Expired D.W . --------- to Inventory as are sold ---- when Inventory is

Variable F. O/H Unexpired costs sold. Fixed F. O/H

03. Income Statement under V/C Method;

In this method, Income Statement is prepared on the basis of variable costing approach when C.M is found out first & the income is determined.

04. Income Statement under A/C Method ;

In this method, Income Statement is prepared on the basis of absorption costing approach when income is found out first & then income is determined.

05. Difference between these two methods;

Unit product cost varies. Fixed F/O/H does not appear as a separate item in A/C income statement. But under V/C, fixed O/H is included in two places one, as a part of the cost of goods sold & as a production volume variance. The format for A/C income statement separate & costs into the major categories of manufacturing & non manufacturing. In contrast, under V/C income statement separate costs into fixed & variable. In A/C revenues less manufacturing costs is G.P. But in V/C revenue less variable costs is C.M.

06. Reasons for differences in Income;

Valuation of inventories is different. Under V/C, inventories are valued according to only variable (standard) factory O/H rate. Under A/C, inventories are valued according to variable & fixed factory O/H rate (i.e.’ full cost rate).

07. Reconciliation of income between V/C & A/C;

Differences between income under V/C & income under A/C can be reconciled as follows;Fixed O/H rate x Change in inventory units (both opening &ending)

Where, F.O/H Rate= Budgeted fixed O/H Expected volume of production

Exercise 7-1:1. a) Computation of Unit product cost:

Production: $Direct Materials 18Direct Labor 7Variable M. O.H 2Fixed M. O. H 8

Unit Product Cost 35

b) Income Statement under A.C$ $

Sales (16000 @50) 800000Less: Cost of Goods SoldBeginning Inventory 0Cost of goods manufactured(20000@$35) 700000Goods available for sale 700000Less: Ending inventory(20000-16000)x$35 140000 560000

Gross Margin 240000Less: Selling and Admin. expenseFixed Selling & Admin. O/H 110000Variable Selling & Admin. O/H 80000 190000

Net Income 50000

2. a) Computation of Unit product cost:Production: $Direct Materials 18Direct Labor 7Variable M. O.H 2

Unit Product Cost 27

b) Income Statement under V.C$ $

Sales (16000 @50) 800000Less: Variable expenseCost of goods sold(16000@$27) 432000Selling and Admin O/H(16000@$5) 80000 512000CM 288000Less: Fixed expenseManufacturing O/H 160000Selling & Admin O/H 110000 270000

Net Income 18000

Reconciliation Statement:NI as per AC 50000NI as per VC 18000Difference 32000Difference is explained as follows:Fixed Manufacturing Overhead Rate (160000÷20000) = $8Change in Inventory= 4000 units @ $8= $ 320000

Exercise 7-2: Solution

Computation Unit Product Cost Under VC.

Production: $Direct Materials 10Direct Labor 4Variable M. O.H 2

Unit Product Cost 16

Income Statement under VC

$ $Sales (40000 @33.75) 1350000Less: Variable expenseCost of goods sold(40000@$16) 640000Selling and Admin O/H(40000@$3) 120000 760000CM 590000Less: Fixed expenseManufacturing O/H 250000Selling & Admin O/H 300000 550000

Net Income 40000

Reconciliation Statement:NI as per AC 900000NI as per VC 40000Difference 50000Difference is explained as under:Fixed Manufacturing Overhead Rate = $5Change in Inventory= (0-10000) units= 10000 unitsDifference=10000 units x FM O/H Rate

=10000 X $5=$50,000

08. Practical problem # 16.31

Solution

Income statement under V/C $ $Sales …………………………………… 1054000Less variable expenses; Direct materials …………………... 285000 Direct labor ………………………… 174200 Factory O/H ……………………… 36000 Selling &Admen. Costs ……………. 118400 613600Less Opening Inventory at Standard ………….. 440400Rate (2000 X 44) ………………………… 88000Add ending inventory at standard ……….. 352400Rate (1000 X 44) ………………………….. 44000 Contribution margin ………………. 396400

Less fixed costs; Factory O/H …………………………. 95000 S & A O/H ………………………….. 75000 170000Operating income …………………………… 226400

Income statement under A/C $ $Sales 1054000Less cost of goods Manufactured;

Direct materials …………………... 285000 Direct labor ……………………… 174200

Factory O/H (Fixed & variable) 131000 (95000+36000) 590200

463800Less operating inventory at absorption rate (44+7) i.e. (2000 X 51) 102000 361800Add ending inventory at absorption rate (1000 X 51) 51000Gross profit ……………………………………… 412800Less non-manufacturing costs;

Sales & admin. Costs (75000+118400) …….. 193400Operating income ……………………………….. 219400

Reconciliation Statement Operating income under V/C 226400Operating income under A/C 219400Differences to be explained $7000Fixed O/H rate $7Change in inventory units; Operating inventory 2000 Ending inventory 1000 Fixed O/H rate X change in inventory $7 x1000 7000

09. Exercise;7-5

a) The unit product cost under absorption costing would be ; Direct materials ………………………… $ 6 Direct labor ……………………… 9Variable manufacturing overhead ………. 3

Total variable costs ……………………. $18Fixed manufacturing O/H (300000/25000 U) 12Unit production cost ………………… 30

b) The absorption costing Income statement;Sales (20000units X $50) …………….. $1000000Less cost of goods sold; Beginning inventory …………… $0 Add cost of goods manufactured (25000 units x $ 30) ………… 750000Goods available for sale ………………….. 750000

Less Ending inventory (5000 units x $30) ……………. 150000 600000 Gross margin …………………………….. 400000 Selling & administrative expenses ………. 270000 Net income ……………………………….. $130000

11. Exercise; 7-7

1. Sales (35000 units at $25) …………… $875000 Less variable expenses;

Variable cost of goods sold (35000 units at $12) ………………. $420000

Variable Selling & administrative expenses (35000 units at $12) ………………….. 70000 490000 Contribution margin …………………….. 385000 Less fixed expenses; Fixed manufacturing O/H ……………… 160000

Fixed Selling & administrative expenses 210000 370000 Net income …………………………….. $15000

Direct materials ……………….. $5 Direct labor …………………… 6 Variable manufacturing overhead 1 Total variable manufacturing cost $12

2. The difference in net income can be explained by the $20000 in fixed manufacturing O/H differed in inventory under the absorption costing method;

Variable costing net income ……………. $15000Add; Fixed manufacturing O/H differed in inventory under the absorption costing; 5000units X $4 in fixed manufacturing cost per unit ………… 20000

Absorption costing net Income ……. $35000

11. Exercise;

1. a. Direct materials ……………….. $20

Direct labor …………………… 8 Variable manufacturing overhead 2 Fixed manufacturing O/H ($100000/10000units) ………. 10 Unit production cost …… $40

b. Sales (8000 units x $75) …………… $600000 Less cost of goods sold;

Beginning inventory ……………… $ 0 Add cost of goods manufactured ($ 10000 units x $40) …………. 400000 Goods available for sale ………… 400000

Less Ending inventory (2000 units x $ 40) 80000 320000Gross margin …………………. 280000 Less Selling & administrative expenses 248000

Net income ……………………... $32000

Variable (8000 units x $6) $48000

Fixed 200000 Total $248000

2. a. Direct materials $20 Direct labor 8 Variable manufacturing overhead 2 Unit product cost $30

12. Exercise; 7-10

1. The unit product costs under the variable costing method would be computed as follows ;

Direct materials $4 Direct labor 7 Variable manufacturing overhead 1

Unit product cost $12

With this figure, the variable costing income statements can be prepared; Year 1 Year 2 Sales …………………….. $1000000 $1250000 Less variable expenses; Variable cost of goods sold (@$12) 480000 600000

Variable Selling & administrative expenses (@$2) 80000 100000 Total variable expenses 560000 700000 Contribution margin ………….. 440000 550000 Less fixed expenses; Fixed manufacturing O/H 270000 270000 Fixed Selling & administrative expenses 130000 130000 Total fixed expenses 400000 400000Net income $ 40000 $ 150000

Year 1 Year 2 2. Variable costing net income $40000 150000Add; fixed manufacturing overhead deferred in inventory under absorption costing (5000 units x $6per unit) 30000 ---Deduct; fixed manufacturing overhead released from inventory under absorption costing(5000 units x $6 per unit) --- 30000Absorption costing net income $70000 $120000

Chapter -6Master Budget (MB) and Flexible Budget

01. Concept of MB:A budget that immerses the planned activities of all the sub units of an enterprise like sales, purchases, productions, finance etc is called MB. A budget is a pre lustration of plans is terms of numerical figures according to predetermined period.

02. Components of MB:A) Operating Budgets:

Sales budget Purchase budget Production budget Cost of production budget Cost of goods sold budget Operating expenses budget Budgeted income statement

B) Financial Budgets: Capital budget Cash budget Budgeted balance sheet.

03. Advantages of MB: Means of communicating management plans. Forces FM to think ahead their plans. Provides a means of allocating financial resources effectively. Aids FM in coordinating their efforts effectively. Defines properly the goals &objectives that can serve as benchmarks for evaluating

actual performances. Can uncover potential bottlenecks before they occur.

04. Preparation of main MB:

4.1. Sales Budget: It is the starting point of budgeting because production & inventory levels, purchases & operating expenses all are geared to the rate of sales activities. It is a statement of cash and credit sales & collection of cash from credit sales.

4.2. Purchase Budget : It is a statement of desired ending inventory plus cost of goods sold less opening inventory. It shows cash &credit purchases and payments for credit purchases.

4.3. Production & Cost of production Budget: It is a statement of sales plus closing inventory less opening inventory. All this should be in terms of quantity. Whenever, quantity of production will be multiplied by the rate of cost of production per unit, we shall get cost of production.

Exercise: 9-1Requirement-1:Schedule of expected Cash Collection:

Particulars July August September TotalMay Sales ( $430000x 10%) 43000 43000June Sales $540000 x 70%$540000 x 10% 432000

37800054000

July Sales$600000 x 20%$600000 x 70%$600000 x 10% 600000

120000420000

60000August Sales$900000 x 20%$900000 x 70% 810000

180000630000

September Sales$500000 x 20% 100000100000Total Cash Collection 541000 654000 790000 1985000

Requirement 2:Accounts Receivable on September 30:From August Sales (900000 x 10%) =$90000From September Sales (500000x 80%) = $400000

= $490000

Exercise: 9-7

ParticularsQuarter

Year

Cash Balance Beginning 9 5 5 5 24Add collections 76 90 125 100 391

Total Cash Available 85 95 130 105 415Less DisbursementPurchase of inventory 40 58 36 32 166Operating expense 36 42 54 48 180Equipment Purchase 10 8 8 10 36Dividends 2 2 2 2 8

Total disbursement 88 110 100 92 390Expenses ( Deficiency) cash available (3) (15) 30 13 25Financing:Borrowing 8(3+5) 20 - - 28Repayment - - (25) (7) (32)Total financing 8 20 (25) (7) (4)Cash Balance Ending 5 5 5 6 21

Exercise: 9-14Requirement: 01Schedule of expected cash collection

Particulars April May June TotalFrom Accounts Receivable $141000 $7200 148200From Budget Sales:April Sales $200000 x 20%$200000 x 75%$200000 x 4% 198000

40000150000

8000May Sales$300000 x 20%$300000 x 75%

285000

60000225000

June Sales$250000 x 20% 5000050000Total Cash Collection 181000 217200 283000 681200

Requirement 2:

ParticularsMonths

TotalApril May June

Cash Balance Beginning 26000 27000 30000 83000Add. cash collection 181000 217200 283000 681200Total cash collection 207000 244200 313000 764200

Less cash disbursementMerchandising purchase 108000 120000 180000 408000Payroll 9000 9000 8000 26000Lease Payment 15000 15000 15000 45000Advertising 70000 80000 60000 210000Equipment Purchase 8000 ------- -------- 8000Total cash Disbursement 10000 224000 263000 697000Excess/ Deficit Cash (3000) 20200 50000 67200

FinancingBorrowing 30000 30000Repayments (30000) (3000)Interest (1200) (1200)Total financing 30000 31200 (1200)Cash Balance ending 27000 20200 18800 66000

Requirement: 03If the company needs $20000 minimum cash balance to start each month, then loan can not be repaid in full by June 30. If the loan is repaid in full, the cash balance will drop only to $ 9000 on June 30 as shown above. Some portion of loan will have to be carried over to July.

5. Exercise 9-5

1. April May June Total February sales: $230000 x 10% $23000 $ 23000March sales: $2600000 70% 10% ………. 182000 $26000 208000April sales $300000 x 20% 70% 10% ……. 60000 210000 $30000 300000May sales $500000 x 20% 70% …………… 100000 350000 450000June sales $200000 x 20% 40000 40000Total cash collection $265000 $336000 $420000 $1021000

2. Accounts receivable at June 30: From May sales: $500000 x 10% ……………….. $50000

From June sales: $200000 x (70% + 10%) ….... 160000 Total accounts receivable …………………… &210000

6. Problem 9-13

1. Schedule of expected cash collection: Month July August September Quarter From accounts receivable: May sales $250000 x 3 % …………. $ 7500 $7500 June sales $300000 x 70% 3% 210000 $9000 219000From budgeted sales: July $400000 x 25% 70% , 3% ………… 100000 280000 $12000 392000 August $600000 x 25%, 70% 150000 420000 570000 September $320000 x 25% ……… 80000 80000 Total cash collections …… $317500 $439000 $512000 $1268500

2. Cash budget: Month July August September Quarter Cash balance beginning ………. $44500 $28000 $ 23000 $44500Add receipts: Collection from customers 317500 439000 512000 1268500

Total cash available ……… 3621000 467000 535000 1313000Less cash disbursements: Merchandise purchases 180000 240000 350000 770000 Salaries and wages 45000 50000 40000 135000 Advertising ………. 130000 145000 80000 355000 Rent payments ……… 9000 9000 9000 27000 Equipment purchases 10000 - - 10000 Total cash disbursements 374000 444000 479000 1297000Excess (deficiency) of receipts over disbursement (12000) 23000 56000 16000Financing: Borrowings ………………… 40000 -- -- 40000 Repayments ………………… -- -- (40000) (40000) Interest ……………………. -- -- (12000) (12000) Total financing ………. 40000 -- (41200) (12000)Cash balancing ending $28000 $23000 $14800 $14800

3. If the company needs$20000minium cash balance to start each month, than the loan cannot be repaid in full by September 30. If the loan is repaid in full, the cash balance will drop to only $14800 on September 30 ,as shown above . Some portion of the loan balance will have to be carried over to October, at which time the cash inflow should be sufficient to complete repayment.

Cash BudgetingConcepts of Cash Budget and Cash Budgeting

Cash budget is a schedule of estimated cash receipts, cash disbursements and cash balances of a

firm over specified period of time. It is an important technique of cash planning and control. The

task of preparing cash budget is known as cash budgeting. The net cash position, surplus or

deficiency of a firm as it moves from one budgeting sub – period to another is highlighted by the

cash budget. Therefore, the financial management of a firm should project the future cash

receipts, cash disbursements with various cash balances, subtract the disbursements from the

receipts to determine net cash flows and then select that cash balance which maximizes the

present value of the net cash flows. Such projection of cash receipts (cash inflows) and cash

disbursements (cash outflows) is known as cash budgeting.

Purposes of Cash Budget

The main purpose of a cash budget is to determine the requirements of cash in advance for a

particular period of time in order to smooth running of a firm. To achieve the main purpose the

following specific purposes should be considered :

i) To coordinate the timings of cash needs,

ii) To pin point the period(s) when there is likely to be excess cash,

iii) To enable a firm having sufficient cash to take advantage of cash discount on its

accounts payable

iv) To help arrange requisite funds on the most favorable terms and prevent the

accumulation of excess funds.

Elements of Cash Budget

The following are the main elements of cash budgeting system:

i) Selection of time period to be covered by the budget. It is known as planning horizon.

It should be determined in the light of the circumstances and requirements of a

particular case.

ii) Selection of the factors that have a bearing on cash flows.

Cash flows may be two types which are presented below:

Operating Cash Flows:

Inflows Outflows

1. Cash sales of Inventories

2. Collection of Accounts Receivables

3. Disposal of Fixed Assets

1. Accounts Payable

2. Purchase of Raw Materials

3. Payroll

4. Overhead Expenses

5. Maintenance Expanses

6. Purchase of Fixed Assets

Financial Cash Flows

Inflows Outflows

1. Loans

2. Sale of Securities

3. Interest Receipts

4. Dividend Receipts

5. Rent Receipts,

6. Refund of tax

1. Tax Payments

2. Repayment of Loan

3. Repurchase of share

4. Interest Paid

5. Dividend Paid

6. Rent Paid

Preparation of Cash Budget and Format for a Cash Budget

After the time span of the cash budget has been decided and the pertinent operating and financial

cash flows have been identified, the final step is the preparation of cash budget. While preparing

cash budget one has to consider the flowing main points:

i) Target or minimum cash balance which a firm desires to maintain in order to run its

business smoothly,

ii) Net cash flows which is determined by estimating the cash disbursements and cash

receipts expected to be generated each period.

The flowing figure 14.1 presents the Format for a Cash Budget

Particulars Months

A. Cash Inflows

1. Cash sales of Inventories

2. Collection of Accounts

Receivables

3. Disposal of Fixed Assets

4. Loans

5. Sale of Securities

6. Interest Receipts

7. Dividend Receipts

8. Rent Receipts,

9. Refund of tax

B Cash Outflows

1. Accounts Payable

2. Purchase of Raw Materials

3. Payroll

4. Overhead Expenses

5. Maintenance Expanses

6. Purchase of Fixed Assets

7. Tax Payments

8. Repayment of Loan

9. Repurchase of share

10. Interest Paid

11. Dividend Paid

12. Rent Paid

C Net Cash Flows (A- B)

D Beginning Cash Balance

E… Ending Cash Balance

F. Target/Minimum Cash Balance

G. Surplus (deficit) Cash (E – F)

Methods

There are three methods of preparation of cash budget namely : i) Maintaining Target/Minimum

Cash Balance, ii) Scheduling of Receipts and Disbursement Method and iii) Combination of (i)

and (ii). The following paragraphs follow discussion on each of the methods:

i) Maintaining Target/Minimum Cash Balance: Under this method, the firm desires

to maintain a target or minimum cash balance in order to conduct its business without

interruption. As a result, if the net cash flows and the beginning cash balance together

which comprise the ending cash balance exceeds the target cash balance, that

exceeding amount is treated as surplus cash balance. On the other hand, if the ending

cash balance is lower than the target cash balance that shortfall amount is considered

as deficit cash balance.

ii) Scheduling of Receipts and Disbursements Method : Under this method, the net

cash flow is determined by deducting total cash disbursements from total cash

receipts. Whenever the total receipts exceed the total disbursement, the exceeding

balance is called positive net cash flow. On the other hand, when total cash

disbursement exceed the total receipts the exceeding balance is termed as negative

cash flow which is unexpected for a firm.

iii) Combination of (i) and (ii) methods : Under this method, both the target method

and scheduling method are followed simultaneously. This method is regarded as the

best one since it considers both the target and scheduling methods.

Problems and Solutions

Unilever Ltd. wants to prepare a cash budget for the months of September through December.

From the following information prepare the cash budget and state if the company will need to

invest excess funds or borrow funds during these months :

1. Sales were $50,000 in June and $60,000 in July. Sales have been forecasted to be $65,000,

72,000, $63,000, $59,000 and $56,000 for the months of August, September, October, November

and December respectively. In the past, 10% of sales were on cash basis and the collections were

50% in the first month, 30% in the second month and 10% in the third month following the sales.

2. Every 4 months 500 of dividends from investments are expected. The first dividend payment

was received in January.

3. Purchases are 60% of sales, 15% of which are paid in cash, 65% are paid 1 month later and the

rest is paid 2 months after purchase.

4. $8,000 dividends are paid twice a year in March and September.

5. Monthly rent is $2,000.

6. Taxes are paid $6,500 payable in December.

7. A new equipment will be purchased in October for $2,300.

8. $1,500 interest will be paid in November.

9. $1,000 loan payments are paid every month.

10. Wages and salaries are $1,000 + 5% of sales in each month.

11. August’s ending cash balance is $3,000.

12. The company would like to maintain a minimum cash balance of $10,000.

Solution

Unilever Ltd.

Cash Budget for the Months of September to December

(In Dollar)

Particulars September October November December

A. Cash Receipts/Inflows :

Cash sale (10% of sales) 7,200 6,300 5,900 5,600

Collections of Accounts Receivables(i)

50% in the 1st month following sales 32,500 36,000 31,500 29,500

30% in the second month following 18,000 19,500 21,600 18,900

sales

10% in the 3rd month following sales 5,000 6,000 6,500 7,200

Cash Dividend (3rd Installment) 500 - - -

Total Cash Receipts 63,200 67,800 65,500 61,200

B. Cash Disbursements/Outflows

15% cash purchases (ii) 6,480 5,670 5,310 5,040

65% are paid one month later 28,080 24,570 23,010 21,840

20% are paid two months after 8,640 7,560 7,080 6,720

Dividend payment 8,000 - - -

Rent 2,000 2,000 2,000 2,000

Taxes - - - 6,500

Purchase of Equipment - 2,300 - -

Interest - - 1,500 -

Loan repayment 1,000 1,000 1,000 1,000

Wages and Salaries 4,600 4,150 3,950 3,800

Total Cash Disbursement 58,800 47,260 43,850 46,900

C. Net Cash Flows (A - B) 4,400 20,540 21,650 14,300

D. Beginning Cash Balance(iii) 3,000 7,400 27,940 49,590

E. Ending Cash Balance 7,400 27,940 49,590 63,890

F. Minimum Cash Balance 10,000 10,000 10,000 10,000

G. Surplus (Deficit) Cash (E- F) (2,600) 17,940 39,590 53,890

Summary :

The company will need to invest surplus funds during October, November and December. But it

will need to borrow fund during September in order to meet its deficit cash.

Notes :

(i) a. In September, 50% are collected from August’s sale and so on for other months.

b. In September 30% are collected from July’s sales and so on for other months.

c. In September 10% are collected from June’s sales and so on for other months.

(ii) Total purchases for September, October November and December are 60% of the sales of the

respective months i.e., $43,200, 37,800, 35,400 and 33,600.

(iii) August’s ending cash balance is the beginning balance for September and so on for other

months

Review Questions

Short Questions

1. Define cash budget and cash budgeting.

2. What are the purposes of cash budget? Explain.

3. Discuss the elements of cash budget.

4. Show the format for a cash budget.

Broad Questions

1. What are the methods of preparation of cash budget? Explain in detail.

2. Describe the main elements of cash budget.

3. How do you prepare a cash budget?

Review Problem

Problem – 1

Consider the balance sheet of Beximco Textile Ltd. The company has received a large order and

anticipates the need to go to its Bank to increase its borrowing. As a result, it has to forecasts its

cash requirements for January, February and March. The company collects 20% of its sales in

the month of sale, 70% in subsequent month and 10% in the second month after sale. All sales

are on credit.

(in ‘000)

Tk. Tk.

Cash

Accounts Receivable

Inventories

Net Fixed Assets

Total

50

530

545

1836

2961

Accounts Payable

Bank Loan

Accruals

Long – term debt

Common Stock

Retained Earnings

Total

360

400

212

450

100

1439

2961

Purchases of raw materials are made in the month prior to the sale an amount to 60% of sales in

subsequent month. Payments for these purchases occur in the month after the purchase. Labor

costs are expected to be 1,50,000 in January, 2,00,000 in February and 1,60,000 in March. Other

expenses are expected to be 1,00,000 par month. Actual sale are as follows (in ’000):

November 500, December 600, January 600, February 1,000, March 650, April 750.

Required :

a) Preparation of cash budget for the month of January, February and March.

b) Determine the amount of additional bank borrowings necessary to maintain a minimum

cash balance of 50,000 taka.

Chapter -7Relevant Costing

01.Concepts of Relevant Information (RI)The predicted future costs & revenues will differ among alternative courses of actions Note that R.I. is a prediction of future & not a summary of the past. Historical cost (past cost) has no direct bearing on a decision. So, these costs are not relevant. Because a decision can not affect past data. Decision always affects the expected future data, only those that will differ from alternative to alternative are relevant to the decision .Any item that will remain the same regardless of the alternative selected in irrelevant. For instance, if a departmental manager’s salary will be the same regardless of the products stocked or not; the salary is irrelevant to the selection of products.

02.ExampleCost of direct material of an ashtray goes as follow;

Aluminum Copper Difference Direct Materials $.20 $.30 .10

Here, the relevant cost is the expected future cost of copper compared with expected future cost of aluminum. Again, consider cost of direct material which will remain same regardless of material used .So labor cost is irrelevant.

03. Avoidable & Unavoidable costsAvoidable costs; Cost that will not continue if an ongoing operating is changed for deleted are relevant. Avoidable costs include departmental salaries & other costs that could be eliminated by not operating specific dept.Unavoidable costs; Costs that continue even if an operation is halted are not relevant because they are not affected by a decision to delete the dept.

04.Make or Buy or Replacement or Not decisionb) Opportunity , outlay & differential costs ;

An opportunity cost is the maximum available contribution to profit forgone by using limited resources for a particular purpose. Such definition indicates that opportunity cost in not the usual outlay cost recorded in Accounting. As example, Salary forgone by a person who quits a job to start a new business Differential costs ; (Incremental costs ) The difference in total cost between two alternatives known as D.C or I.C

c) Make or Buy Decision; Companies often must decide whether to make a product or service or Buy it from outside supplies .They apply relevant cost analysis to such a decision .What quantitative factors are relevant to such a decision? A key factor is whether there are idle facilities or not.The key to make or Buy Decision is identifying the additional costs for making (or costs avoided by buying)d) Replacement or not of old machine ;

Book value of old machine is irrelevant. Depreciation is also irrelevant. Disposal value is relevant. Gain or loss on disposal; Combination of I&R. Costs of new machine are relevant.

Exercise: 13-41. Analysis of Make or Buy Decision:

ParticularsPer unit differential cost Costs of 15000 unitsMake Bye Make Bye

Cost of Buying 20 300000Cost of MakingDirect Materials 6 90000Direct Labor 8 120000Variable M O/H 1 15000Fixed M. O/H-traceable 2 30000Total cost 17 20 255000 300000

So, Difference is favor of making $ 3Comment: No, outside suppliers offer is not accepted.

2. Analysis of Make or Buy Decision:

Particular s Make ByeCost of Buying ( As above) 300000Cost of Making ( as above) 255000Segment Margin foregone on new product ( Opportunity cost)

65000

320000 300000

So, Difference in favor of Buying from outside SuppliersComment: Thus the Co. should accept the offer & Purchase from outside suppliers.

Exercise: 13-101. Analysis of Make or Buy Decision:

ParticularsPer unit differential cost Costs of 20000 unitsMake Bye Make Bye

Cost of Buying 23.50 470000Cost of MakingDirect Materials 4.80 96000Direct Labor 7.00 140000Variable M O/H 3.20 64000Fixed M. O/H-traceable 4.00 80000Total cost 19.00 23.50 380000 470000

The remaining $6 fixed manufacturing overheads would not be relevant, since it would continue even if the specific part were purchased.

The $ 150000 rental value of the space being used to produce part R-# represent an opportunity cost of continuing to produce internally.Thus complete analysis goes as follows:

Particular s Make ByeCost of Buying ( As above) 470000Cost of Making ( as above) 380000Segment Margin foregone on new product ( Opportunity cost)

150000

Total cost 530000 470000Net Advantage in favor of Buying 60,000

Comment: Thus the Co. should accept the offer & bye from the outside suppliers.

05. Exercise;

No the bilge pump product line should not be discontinue. The computations are; Contribution margin lost if the line is dropped DR (460000)Fixed cost that can be avoided if the line is dropped; Advertising …………………………… DR270000 Salary of the product line manager ……… 32000 Insurance of inventories …………. 8000 310000Net disadvantage of dropping the line ……… DR (150000)

The same solution can be obtained by preparing comparative income statement;

Keep product Drop product Difference net income Line Line increase or decrease

Sales …DR850000 DR 0 DR (850000) Less variable expenses; Variable manufacturing expenses 330000 0 330000 Sates commission 42000 0 42000 Shipping 18000 0 18000Total variable expenses 390000 0 390000 Contribution margin … 460000 0 (4600000)… Less fixed expenses; Advertising 270000 0 270000 Deprecation of equipment 80000 80000 0 General factor overhead 105000 105000 0 Salary of product line manager 32000 0 32000 Insurance on inventories 8000 0 8000 Purchasing department expenses 45000 45000 0Total fixed expenses 540000 230000 310000 Net loss DR (80000) DR (230000) DR (150000)

06.Exercise;

1. per unit

differential cost 15000 units Make Buy Make BuyCost of purchasing …………… $35 $525000

Direct materials ……………….. $14 $210000 Direct labor ……………….. 10 150000 Variable manufacturing overhead 3 45000 Fixed manufacturing O/H traceable 2 30000 Fixed manufacturing O/H common - - Total costs $29 $35 $435000 $525000

Difference in favor of continuing to make the parts ……………… $6 $90000

Only the supervisory salaries can be avoided if the parts are purchased. The remaining book value of the special equipment is a sunk cost; hence the $4 per unit depreciation expense is not relevant to this decision. Based on this data, the company should reject the offer and should continue to produce the parts internally.

2. Make Buy Cost of purchasing (part-1) …………… $525000Cost of making (part -1) ……………. $435000Opportunity cost- segment margin foregone on a potential new product line 150000 Total cost ……………….. $585000 $525000Difference in favor of purchasing from the outside supplier ……………….. $60000

Thus the company should accept the offer and purchase the parts from the outside supplier.

The costs that are relevant in a make or buy decision are those costs that can be avoided as a result of purchasing from the outside. The analysis for this exercise is;

. Per unit Differential cost 30000 units

Make Buy Make BuyCost of purchasing …………… $21.00 $630000Cost of making;

Direct materials ……………….. $3.60 $108000 Direct labor ……………….. 10.00 300000 Variable overhead 2.40 72000 Fixed O/H ………………… 3.00 90000

Total costs …………….. $ 19.00 $21.00 $570000 $630000

The remaining $6 of fixed overhead cost would not be relevant. Since it will continue regardless of whether the company makes or buy the parts.

The $ 80000 rental value of the space being used to produce part s-6 represents an opportunity cost of continuing to produce the internally. Thus, the completed analysis would be Make Buy Total cost as above ....................... $570000 $630000Rental value of the space (opportunity cost) 80000Total cost including opportunity cost $650000 $630000Net advantage in favor of buying ....... $2000007. Exercise;

Keep the Drop the Difference net flight flight income Increases or decreasesTicket revenue ................................... $14000 $ 0 $(14000) Less Variable expenses ..................... 1050 0 1050Contribution margin .......................... 12950 0 (12950)Less flight expenses Salaries, flight crew ......................... 1800 1800 0 Flight promotion .......................... 750 0 750 Depreciation of aircraft ..................... 1550 1550 0 Fuel for air craft ................................. 6800 0 6800 Liability insurance ............................ 4200 2800 1400 Salaries, flight assistance ...................... 500 0 500 Baggage loading ....................................... 1700 1700 0 Overnight cost for flight crew ..................... 300 0 300 Total flight expenses ................................... 17600 7850 9750 Net loss ............................................................. $(4650) $(7850) $(3200)

Chapter -8 Standard costing &Variance Analysis

Concepts Standard refers to benchmark or predetermined. Hence

standard in relation to costs refers to benchmark or predetermined costs of production. Standard costs are determined on the basis of budgeted costs. As for example, budgeted Direct material cost, Direct Labor costs, & Overheads costs. Determination of standard costs is known as Standard Costing.

Variance refers to the difference between Standard & Actual. So variance related to Cost of Production is the difference between Standard costs & Actual costs. Whenever, actual cost are higher than the standard costs; the variance is called Unfavorable (U). On the other hand, if actual costs are lower than the standard costs; the variance is called as favorable (F).

Purpose of Standard Costing & Variance Analysis The main purpose of Standard Costing & Variance Analysis is to control costs of production of the various elements of cost i.e. Direct material cost (DMC), direct labor cost (DLC) and overhead costs (O/H C). The control process involves comparison of actual costs with standard costs. After comparison, if variance is U, then necessary corrective action needs to be undertaken.

Types of Variance: Based on three elements of costs, the cost variances are classified

into three types. Material Variance: They are known as Material Cost variance

(MCV). MCV is the difference between standard cost of the materials that should have been incurred and the cost of materials that has been actually incurred.

It is divided into 2 sub variances. Material price variance (MPV) = It is difference between price to

be paid for materials and actual price, Material Usage Variance (MUV) = It is difference of actual usage

of materials and the standard usage Labor Variance: They are known as Labor Cost variance

(LCV). LCV is the difference between standard labor cost and actual labor cost.

It is divided into 2 sub variances.

Labor Rate Variance (LRV) = It is difference between standard wages rate and actual wages rate,

Labor Efficiency / Usage Variances (LEV / LUV) = It is difference actual efficiency of labor and the standard efficiency of labor.

i. Overhear Variance: They are known as Overhead Cost variance (OHCV). OHCV is the

difference between standard overhead cost and actual overhead cost. It is two types i.e Variable Overhead Variance & Fixed Variance.

Determination of Variances (Formulas Used) Material Cost Variance (MCV) = Total Standard Costs (TSC) –

Total actual costs (TAC) Material Price Variance (MPV) = (Standard Price – Actual Price)

Actual Quantity Material Usage Variances (MUV) = (Standard Quantity – Actual

Quantity) Standard Price Labor Cost Variance (LCV) = Total Standard Costs (TSC) – Total

Actual Costs (TAC) Labor Rate Variance (LRtV) = (Standard Rate – Actual Rate)

Actual Hour Labor Usage / Efficiency Variance (LUV/LEU) = (Standard Hour

– Actual Hour) Standard Rate.Problem:

A firm makes a product with the following standards

Particulars TakaDirect Materials (2kg @ Tk 2 per kg) 4.00Direct Labor (2 hr @ 2.50per hr) 5.00Variable overheads (Tk 2 per DL hr) 4.00Total 13.00

In May 1990 the production manager receives a very favorable report from the purchase dept. The firm bought direct materials for Tk 1.50 per kg. In June the materials purchased were used with the following results.Budgeted production 8000 unitsActual production 7200unitsDirect labor (16200 hrs) Tk 40000Variable Overhead Tk 33000Materials used 1 15840 kg

Required:A. Determine the relevance Materials and labor Variance.B. Prepare the Variance report showing the probable reasons for the

Variance. SolutionComputation of relevant variances:Direct Material variance: 1. Material Price Variance =(Standard Rate – Actual Rate) ×Actual

Quantity = (Tk2 – Tk1.50) × 15840

= Tk7920 ( F ) 2. Material Usage Variance = (Standard Quantity – Actual Quantity) ×

Standard Rate = [(7200 × 2kg) - 15840] ×Tk2 = Tk2880 (U)

3. Material Cost Variance = [Total Standard Material Cost - Total

Actual Material cost] = (14400 × 2) – (15840 × 1.50) = Tk 28800 –Tk 23760 = Tk 5040 ( F )

Computation of relevance variable: Direct Material variance: Confirmation: Direct Material Cost Variance = Direct Material Price Variance + Direct Material Usage Variance

Solution Computation of relevance variable:Direct Labor Variance:D.L Rate Variance = (Standard wage rate – Actual wage rate) × Actual

hour = (Tk2.50 – Tk2.469) × 16200

= Tk500 (F)Actual wage rate = tk 40000/16200=2.469 tkLabor Efficiency Usage Variance =(Standard hour – Actual Hour)

× Standard wage rate= (14400 - 16200) × 2.50= Tk4500 (U)

Standard Hour = (7200units × 2hrs) = 14400hrs

Labor cost Variance = (Total Standard labor Cost – Total Actual labor Cost)

= (14400 × 2.50) – Tk40000 = Tk4000 (U)

Types of Variances Nature of Variance

Main Reason Responsibility

Material cost variance F Lower Actual Material Price Purchase ManagerMaterial Price variance F Lower Actual Material Price Purchase ManagerMaterial usage variance U High Material use Production ManagerLabor cost variance U High actual use Production ManagerLabor Rate variance F Lower labor/ wage rate Production ManagerLabor Efficiency Variance U Higher actual hours Production Manager

Solution Computation of Relevance Variable: Direct Labor Variance: Confirmation: Labor cost Variance = Direct Labor Rate Variance + Labor Efficiency

usage VarianceExercise:1 1.Number of helmets ……………. 35000 Standard kilograms of plastic per helmet x 0.6 Total standard kilograms allowed … 21000 Standard cost per kilograms ……… x RM8 Total standard cost ………………. RM168000 Actual cost incurred (given) RM171000 Total standard cost (above) 168000 Total material variance – unfavorable RM 3000

2.Material price variance = AQ (AP -SP) 22500kgs. (RM7.60 per kg – RM8.00 per kg) = RM9000 F RM171000/22500kgs = RM7.60per kg Material quantity variance = SP (AQ – SQ) RM8 per kg. (22500kgs – 21000 kgs) = RM 12000 U

Exercise-2Material price variance = AQ (AP -SP)20000lbs. ($2.35per lb -$2.50 per lb) =$3000 FMaterial quantity variance = SP (AQ – SQ)$2.50per lb (20000lbs – 18400 lbs) = $4000U Exercise-3

Labor rate variance = AH (AR - SR) 750hrs ($13.90per hour - $12.00per hour) = $1425 U10425/750hrs = $13.90 per hour Labor efficiency variance = SR (AH-SH)$1200per hour (750 hrs – 800 hrs) = $600F

Exercise-4Number of units manufactured ……… 20000Standard labor time per unit …………… x 0.3 Total standard hours of labor time allowed 6000Standard direct labor rate per hour x $12Total standard direct labor cost $7200018 minutes /60 minutes per hour = 0.3 hours Actual direct labor cost …………………. $73600Standard direct labor cost ……………. 72000Total variance – unfavorable $ 1600

Actual hours of input Actual hours of input Standard hours allowed at the Actual Rate at the standard rate for output at the

standard rate (AH x AR) (AH x SR) (SH x SR) $73600 5750 hrs x1200 per 6000hrs x $12000 hr = $69000 per hr = $72000

Exercise-5Variable overhead spending variance = AH (AR – SR)5750 hrs ($3.80 per hr - $4.00 per hr) = $ 1150 F$21850/5750 hrs = $3.80 per hr Variable overhead efficiency variance = (AR –SR)$4.00 per hr (5750 hrs – 6000 hrs) = $ 1000 F

01. Exercise

1. Number of helmets ……………. 35000Standard kilograms of plastic per helmet x 0.6Total standard kilograms allowed … 21000Standard cost per kilograms ……… x RM8Total standard cost ………………. RM168000

Actual cost incurred (given) RM171000Total standard cost (above) 168000Total material variance – unfavorable RM 3000

2. Material price variance = AQ (AP -SP)

22500kgs. (RM7.60 per kg – RM8.00 per kg) = RM9000 F

RM171000/22500kgs = RM7.60per kgMaterial quantity variance = SP (AQ – SQ) RM8 per kg. (22500kgs – 21000 kgs) = RM 12000 U

02. Exercise;

Material price variance = AQ (AP -SP)20000lbs. ($2.35per lb -$2.50 per lb) =$3000 F

Material quantity variance = SP (AQ – SQ $2.50per lb (20000lbs – 18400 lbs) = $4000U

03. Exercise ;

Labor rate variance = AH (AR - SR) 750hrs ($13.90per hour - $12.00per hour) = $1425 U

10425/750hrs = $13.90 per hour

Labor efficiency variance = SR (AH-SH)$1200per hour (750 hrs – 800 hrs) = $600F

04. Exercise;

Number of unites manufacturer ……… 20000Standard labor time per unit …………… x 0.3

Total standard hours of labor time allowed 6000Standard direct labor rate per hour x $12Total standard direct labor cost $72000

18 minutes /60 minutes per hour = 0.3 hours

Actual direct labor cost …………………. $73600Standard direct labor cost ……………. 72000Total variance – unfavorable $ 1600

2. Actual hours of input Actual hours of input Standard hours allowed at the Actual Rate at the standard rate for output at the standard rate (AH x AR) (AH x SR) (SH x SR) $73600 5750 hrs x1200 per 6000hrs x $12000 hr = $69000 per hr = $72000

05. Exercise;

Variable overhead spending variance = AH (AR – SR)5750 hrs ($3.80 per hr - $4.00 per hr) = $ 1150 F$21850/5750 hrs = $3.80 per hr

Variable overhead efficiency variance = (AR –SR)$4.00 per hr (5750 hrs – 6000 hrs) = $ 1000 F

Chapter -9 Responsibility Accounting Concept:Cost Center: A cost center is a business segment whose manager has control

over costs but not over revenue or in investment fund. As for example, Prime cost center, overhead cost center etc.

Profit Center: In contrast to a cost center, a profit center is any business segment whose manager has control over both cost and revenue. As for example, Production cost center, cost f sales enter, gross profit center, net profit center etc.

Investment Center: An investment center is any segment of an organization whose manager has control over cost, revenue and investments in operating assets. As for example, Fixed asset investment center and current asset investment center

Responsibility Center: Responsibility Center is broadly defined as any part of an organization whose manager has control over cost, revenue or investment funds. Cost centers, profit centers and investment centers are all known as responsibility center.

Segmented Financial Statement: Those Financial Statements which are prepared segment wise of an organization. Such segment, may be product segment, market segment etc. As for example, Segmented Income statement, segmented balance sheet etc.

Return on Investment (ROI): ROI can be found out as follows:Computation of ROI=

Margin X Turnover

=Net operating Income

XSales

Sales Average Operating Assets

Residual Income (RI): RI is the excess of net operating income over minimum required return on operating assets:

Segmented Income Statement

Exercise: 12-501.

Total Co. South Central North$ % $ % $ % $ %

Sales 1500000 100 400000 100 600000 100 500000 100

Less Variable Expense 588000 39.2 208000 52 180000 30 200000 40

CM 912000 60.8 192000 48 420000 70 300000 60

Less: Traceable fixed Expense

770000 51.3 240000 60 330000 55 200000 40

Segment Margin 142000 9.5 (48000) (12) 90000 15 100000 20

Less: Common F.E. (not Traceable)(945000-770000)

(175000) (11.7)

Net loss (33000) (2.2)

02. Incremental Sales (600000 x 0.15) $90000CM Ratio 70%Incremental CM 63000Less: Advertising 25000Incremental NOI $38000

Yes the increased advertising program is recommended since it would lead to an incremental Net operating Income of $ 38000

Exercise: 12-7

01. Completion of ROI=Margin X Turnover

Net operating IncomeX

SalesSales Average Operating Income

Eastern Division:90000

X1000000

1000000 500000= .09 X 2=18%

Western Division:105000

X1750000

1750000 500000= .06 X 3.5=21%

02. From the data available, it can be said that Western Division Manager is doing better job as compared to DM of Eastern. This is so because of higher ROI of Western Division 21% than that of Eastern Division 18%.

Exercise: 12-9

01. Computation of ROI=Margin X Turnover

Net operating IncomeX

SalesSales Average Operating Assets

Perth Division:630000

X9000000

900000 3000000= .07 X 3

= 21%

Darwin Division:1800000

X20000000

20000000 10000000= .09 X 2= 18%

02. Computation of Residual Income:

Average Operating AssetPerth Division Darwin Division

Average Operating Asset (a) 30,00,000 1,00,00,000Net Operating Income 6,30,000 18,00,000Minimum RequiredReturn on operating Asset 16% on (a) (480000) (1600000)

Residual Income 150000 200000

03. No. The Darwin Division is simply larger than the Perth Division in terms of operating asset & for this reason one would expect that it would have a greater amount of residual income.

01. Exercise ; 12-5

1. Total company East Central West

Sales …………………. $1000000 100% $250000 100% $400000 100% $350000 100% Less variable expenses 390000 39.0 130000 52 120000 30 140000 40Contribution margin …… 610000 61 120000 48 280000 70 210000 60Less traceable fixed expenses 535000 53.5 160000 64 200000 50 175000 50Divisional segment margin 75000 7.5 $(40000) (16%) $80000 20% $35000 10%Less common fixed expenses not traceable to divisions 90000 9.0Net income (loss) ………. (15000) (1.5)

$6 25000-$ 535000 = $90000

2. Incremental sales ($3500000 x 20%) $70000Contribution margin ratio x 60%Incremental contribution margin ………….. 42000Less incremental advertising expenses ……… 15000Incremental net income ………………….. $27000

Yes, the advertising program should be initiated.

02. Exercise ;

1. ROI computation;

ROI = Margin x Turnover = Net operating income x sales Sales average operating assets

Queensland division = $360000 x $7000000 $4000000 $2000000 = 6% x 3.5% = 21%

03.

The manager of the New South Wales division seems to be doing doing job. Although his margin of the Queensland division. His turn over is higher (a turn over of 3.5 as compared to a turnover of two for the Queensland division). The greater turnover more than offsets the lower margin, resulting in a 21%ROI as compared to an 18% ROI for the other division.

04. Exercise;12-13

1. ROI = Margin x Turnover = Net operating income x sales Sales average operating assets

Osaka division = $210000 x $3000000 $3000000 $1000000 = 7% x 3% = 21%Yokohama division = $720000 x $9000000 $9000000 $4000000 = 8% x 2.25% =18%

2. Osaka Yokohama

Average operating assets $1000000 $4000000Net operating income $210000 $720000Minimum required return on average operating assets- 15% x (a) 150000 600000Residual income …… $60000 $120000

3. No. the Yokohama division is simply larger than the Osaka division and for this reason one would expect that it would have a grater amount of residual income.

05. Exercise ;12-16

1. ROI = Margin x Turnover = Net operating income x sales Sales average operating assets Asia = $600000 x $12000000 $12000000 $3000000 = 5% x 4% = 20%Europe = $560000 x $14000000 $14000000 $7000000 = 4% x 2%

=8%North America = $800000 x $25000000 $25000000 $5000000 = 3.2% x5%

=16%

2. Asia Europe North AmericaAverage operating assets $3000000 $7000000 $5000000Required rate of return x 14% x 10% x 16% Required operating income $420000 $700000 $800000Actual operating income $600000 $560000 $800000

Required operating income 420000 700000 800000Residual income $ 180000 $ (140000) $ 0

Chapter -10Performance measurement

01. Concepts;

Performance refers to job or activities & measurement refers to evaluation or assessment. So by P.M. is meant evaluation or assessment of job of an organization.

02. Types of performances;

Performances are of 2 types namely; financial & non financial.a) Financial performance refers to performance which is subject to

measurement financially or quantitatively. As for example, profit / loss, sales, purchase etc. performance of an organization.

b) Non financial performance refers to refer to performance which is subject to qualitative measurement only. As for example, managers efficiency, quality of product.

03. Types of measurement;

A. Profitability measurement; Ratios Standard Norm a) Profit margin = Net Profit x 100 = 5%- 6% Sales

b) Return on investment = Net Profit x 100 = 10%- 12% Investment

c) Return to Equity = Net Profit x 100 = 13%- 15% Equity d) Return on Capital Employed = Net Profit x 100 = 15%-16% Capital Employed

B) Productivity Measurement;Productivity refers to production / output in relation input . that is production / output divided by input like raw materials ( units &costs ),labor (hours &costs)etc . Is known as productivity.

Measures of productivity;

Resources Possible outputs Possible InputsLabor Standard Labor Hours Actual Labor Hours Value of output Cost of raw materials Output in Units Raw materials in units Sales Revenue Raw materials cost Materials Output in Units Raw materials in units No. of good Units Total No. of units Capital Sales revenue Cost of sales Sales revenue Total Machine Hours

04.Practicle Problem (P.8-39)page 325 &326

Solution ;

1. Labor productivity in terms of physical measuresFor 19 X 4 = Sales Revenue

Pounds of L.P = 720000 1360000 =0.53 times

For 19 X 7 = Sales Revenue X Inflation Pounds of L.P = 1394000 X 1.4

1525000 =1.27 times

Comparison; = 1.27-0.53 X 100 0.83 = 139.6%(increase)

2. Labor productivity in terms of financial measures For 19 X 4 = Sales Revenue Direct labor cost = 720000

316000 = 2.28 times

For 19 X 7; = Sales Revenue X Rate of Inflation Direct labor cost = 1394000 X 1.4 498000 =3.92Comparison; = 3.92-2.28 X 100 2.28 = 71.9%(increase)

3. productivity measures in terms of Direct Labor Hours ;

For 19 X 4 = Sales Revenue Direct labor Hours

= 720000 45100 = 15.96 times

For 19 X 7; = Sales Revenue X Rate of Inflation Direct labor Hours = 1394000 X 1.4 46600 =41.83 timesComparison; = 41.83 – 15.96 X100 15.96 = 162.09% (Increase)

05.Productivity defined ;

Productivity refers to a comparison between the output and input. More specifically it is the ratio between input and output. in other word it is a measure over time comparing the performance of this year with previous year which shows the improvement achieved by the organization and reflect the return of resources employed. In order to measure productivity output/ value added can be compared with capital or with labor or with all the input factors taken together. The comparison between the labor and the value of output/ value added is labor productivity and the comparison between capital and the value of output/ value added is capital productivity .taking all these productivity concepts into consideration total productivity may be defined as the ratio of the value of total output/ value added to the value of all input factors.

Productivity analysis is important for productivity improvement. In enterprises productivity is measured to help analyzing effectiveness and efficiency. It’s measurement can stimulate operational improvement; the very announcement, installation and operation of a measurement system can improve labor productivity, sometimes by 5 to 10 percent with no other organizational change or investment. Productivity indices help to indices help to establish realistic targets and checkpoints for diagnostic activities during an organization development process, pointing to bottle –necks and barriers to performance. These are also useful in inter- country and inter-firm comparisons. Furthermore there can be no improvement in industrial relations or proper correspondences between productivity, wages levels and gain – sharing policies without a sound analysis system.

06. Models and techniques of productivity analysis;

There are many models of productivity measurement and analysis in enterprises. The following major categorization of models is possible in on the basis of approaches or concepts on which they have been constructed.

a) Production function models.b) Financial ratios as measurement of productivity.c) Production based models.d) Product – oriented models.e) Surrogate models.f) Economic utility models.g) System approach based models.

Each of the above models has its merits when seen in the proper perspective. But there is no single universal model for productivity measurement and analysis. Before selecting any model one should go through the model to see whether the model fulfils the following characteristics for a sound productivity measurement model.

It should provide simple and unambiguous signals to improve performs (productivity , profit ,quality);

It should breakdown change in profit to reflect the contribution from each recourse use in production (labor, capital ,materials ,energy)

It should broken-down the contribution to profit change from each resource into productivity terms and a price recovery term;

It should transform the above measures of change in profit into corresponding measures of change in profitability, change in cost per unit of output and change in performance index numbers.

It should be consistence signals for profit improvement regardless of the units in which the measure in express.

07.. Quick Productivity Appraisal (QPA) Approach;

It is a systematic assessment of the company’s profitability and productivity performance. The purpose of this approach is two fold; # To isolate problem areas and identify priority areas for improvement. # To establish productivity indicators for the whole organization.QPA consists of the three components;

a) Company performance appraisal (CPA)b) Qualitative assessment.c) Inter-firm comparison.

CPA; the approach suggests a flow of company performance.Qualitative Assessment; Qualitative assessment can be done by evaluating profitability and productivity trends.

Inter-firm comparison ; It is an exchange of information regarding costs, performance , efficiency and other relevant data between firms engaged in similar activities .

08. Productivity and Profitability Relationship;

Profitability refers to profit earning capacity of an enterprise. It is one of the best measurements of evaluating of overall performance of an enterprise. But measurement of productivity alone cannot identify the causes of productivity changes. Profitability may be changed due to productivity or price cost movement. Therefore it is necessary to segregate profitability into productivity and price recovery. Considering the relationships among 3ps (Productivity, Profitability and Price recovery) profitability is defined as the product of productivity and price recovery. The following demonstrates this relationship:

Output Value = Output Quantity x Unit Price

Profitability = Productivity x Price Recovery

Input Value = Quantity Used x Unit Cost Where:

Profitability = Output Value Input Value Productivity = Output Quantity Quantity Used Price Recovery = Unit Price Unit Cost

09. Trends in producitivity:

The economic performance of the company is discussed in this section with the help of productivity. generally the trend exhibited by total producitivity indicates the overall performance of the company , labor productivity shows how well the labor force has been used and capital productivity evaluation shows how well available capital is allocated and managed . In order to get the picture of above productivity performance, primary productivity ratio is to be calculated. But primary ratios are not enough to identify the priority area for improvement. For this purpose it is important to look into the secondary producitivity ratios too.

Productivity Analysis Chart Primary Ratios Total Productivity Value added Labor + capital Labor Productivity Capital Productivity1) Value added Total working-hours worked 2) Value added Value added Value added Number of workers Total assets Fixed assets3) Value addedSalaries/Wages

Secondary Producitivity Ratios Value added Value added Value added Value added Value added Value added Direct/salaries Indirect salaries Inventory Accounts Plant & Machinery Building &wages &wages Machinery receivable construction

10. Productivity / Profitability Relationship:

IF THEN Case Profitability Productivity What will happen What should be done

1 HIGH LOW Financial condition will be sound and stable

Maintain or increase productivity further

2 HIGH LOW High profitability may not be sustained on a long-term basis .In the long run low productivity will eat up profits.

Improve productivity

3 LOW HIGH The company may soon be operating at a loss and may be on the bring of a shut down.

Improve profitability; strengthen market strategy, market research, market promotion, advertising and pricing policy.

4 LOW LOW Shut down / bankruptcy. Improve productivity and strengthen market.

11.Capital / Labor Relationship:

IFTHEN

Case Labor productivity

Capital productivity

C/L ratios

What happens What should be done

1 / / / Good productivity performance

Maintain or increase productivity further

2 / / \ Good productivity performance

Maintain or increase productivity further

3 / \ / Unfavorable productivity performance

Increase capital productivity

4 \ / / Satisfactory productivity performance

Increase labor productivity by a) developing identifying other jobs for displaced labor. b) Retraining displaced labor for other jobs.

5 \ \ / Poor productivity performance

First increase capital productivity .Adapt available manpower to machines.

6 / \ \ Satisfactory productivity performance

Increase capital productivity

7 \ / \ Unfavorable productivity performance

Increase labor productivity

8 \ \ \ Poor productivity performance

First increase labor productivity, and then increase capital productivity.

I nternational I slamic University Chittagong Program - MBA

Autumn Semester - 2007 Class test on “Managerial Accounting “

Batch –26th (2nd Semester)

Time: 30minutes Full Marks: 15 ID NO:

NAME:

A. Tick the correct answer:

01. Managerial Accounting (MA) deals with providing information to:

a) Owners

b) Creditors

c) Functional managers

d) Financiers.

02. MA focuses on the needs of :

a) Internal managers

b) Shareholders

c) Creditors

d) All

03. MA places more emphases on the :

a) Present

b) Future

c) Past

d) None

04. JIT system is related to :

a) Production planning

b) Production control

c) Inventory management

d) None.