Chapter 3 3.1
Solutions
An accounting system comprises accounts that can be grouped into: c) assets, liabilities, income and expenses
3.2
A transaction to record the sale of goods on credit would involve a double entry for the sales value to the following accounts: d) increase debtors and increase sales Note there also is an associated entry for the cost of goods sold: increase cost of sales and reduce inventory
3.3
A retail business has sales of £100,000 cost of goods sold of £35,000 salaries of £15,000 rental of £4,000 and advertising of £8,000. All of the income and expenses have been paid out of the owner’s initial capital of £25,000. In addition, the business paid cash of £30,000 for stock (which remains unsold) and purchased equipment on credit for £20,000. The financial statements of the business would show: b) Profit of £38,000 cash of £33,000 and capital of £63,000 Profit
Sales Cost of sales Salaries Rent Advertising
100,000 -35,000 -15,000 - 4,000 - 8,000 £38,000
Cash
Capital £25,000 Plus profit 38,000 - Inventory -30,000 £33,000
Capital
Initial Plus profit
£25,000 38,000 £63,000
Assets Cash 33,000 + Equipment 20,000 + Inventory 30,000 = 83,000 Liabilities Creditors (Equipment) 20,000 + Capital 63,000 = 83,000 3.4
A Balance Sheet shows liabilities of £125,000 and assets of £240,000. The Income Statement shows income of £80,000 and expenses of £35,000. Capital is: b) £115,000
Capital = assets – liabilities = 240,000 – 125,000 = 115,000 3.5
A transaction to record the purchase of fixed assets on credit would involve: c) increasing creditors and increasing fixed assets
3.6
For each of the following transactions, identify whether there is an increase or decrease in profit, cash flow, assets or liabilities: Transaction
Profit Income Expenses
Cash Flow
Issues shares to public Borrows money over 5 years
Increases
Pays cash for equipment Buys inventory on credit
Decreases
Increases (Selling price less cost price)
Pays cash for salaries, rent, etc. Pays cash to suppliers
Decreases (Expenses)
Increases (Fixed asset) Increases (Current asset: stock)
Decreases
Increases
Decreases (Depreciation expense)
Increases (Current liability: creditors)
1. Increases (Current asset: debtors @ selling price) 2. Decreases (Current asset: stock @ cost price)
Decreases
Receives cash from customers
Liabilities
Increases (Equity) Increases (Long term debt)
Increases
Sells goods on credit
Depreciates equipment
Assets (excluding cash)
Decreases (Current liability: Creditor) Decreases (Current asset: debtors Decreases (Fixed assets)
3.7
The following balances are shown in alphabetical order in a professional service firm’s ledger at the end of a financial year: Advertising Bank Capital Creditors Debtors Fixed assets Income Rent Salaries
15,000 5,000 71,000 11,000 12,000 100,000 135,000 10,000 75,000
Calculate a. the profit for the year b. the capital at the end of the year
Profit
Balance Sheet
Income Advertising Rent Salaries Profit
135,000 15,000 10,000 75,000
Fixed assets Debtors Bank Creditors Capital Opening capital Plus profit
100,000 35,000 100,000 12,000 5,000 117,000 11,000 106,000 71,000 35,000 106,000
Chapter 6
Solutions
6.1
Explain (with reasons) whether managers are included as users of financial statements. Users of financial statements are defined by the Framework for the Preparation and Presentation of Financial Statements as investors, employees, lenders, suppliers and trade creditors, customers, government and the public. Management is not defined as a user because management has the ability to determine the form and content of the information it needs. The reporting of information to meet the needs of management is beyond the scope of the Framework.
6.2
The cost of sales is: d) All of the above
6.3
Operating profit is the same as: d) All of the above
6.4
Inventory is an example of: b) a current asset
6.5
If a business has fixed assets of £750,000 working capital of £150,000 and long term debt of £300,000 its shareholders’ funds can be calculated as: d) £600,000 Assets 750,000 + 150,000 = 900,000 less debt of 300,000 = 600,000
6.6
A business has agreed to undertake an advertising campaign that will cost £240,000 to be carried out equally over the financial year beginning 1st January. Half of the annual cost is to be paid six-monthly in advance on the first days of January and July. At 31st March the financial statements would show: b) an expense of £60,000 and a prepayment of £60,000 The monthly cost of advertising is £20,000 (£240,000/12). At 31st March £120,000 has been paid in advance (a prepayment on 1st January) but this has been reduced by 3 months expenditure of £20,000 a total of £60,000. The balance of £60,000 paid in advance for the period April to June remains a prepayment.
6.7
Virko PLC buys a new computer system for £180,000 on 1st January. It expects the system to last for four years. If the company’s financial year is from 1st January to 31st December, the value of the computer system in Virko’s Balance Sheet at 31st December of the same year will be: b) £135,000 Depreciation of £180,000 over 4 years is £45,000 per annum. At the end of the year the asset will be valued at £180,000 - £45,000 = £135,000.
6.8
Thomas Investments has an operating profit for the year of £185,000. An examination of the Income Statement and Balance Sheet shows that depreciation was £65,000 taxation was £40,000 new capital investment was £100,000 and repayment of borrowings was £65,000. The change in cash over the period was: a) an increase of £45,000 Operating profit + Depreciation
Less
Taxation Capital Borrowings Increase in cash
185,000 65,000 A non-cash expense previously deducted from profit 250,000 40,000 100,000 65,000
205,000 45,000
6.9
The amounts shown as taxation and dividends in the Income Statement and cash Flow Statement: d) are different because of the timings of cash outflows
6.10
A company pays its insurance policy for the calendar year of £78,000 on 1st January. On 31st March, what is the impact on the Income Statement, Balance Sheet and Cash Flow? £78,000 / 12 = £6,500 per month At 31st March, expense of £6,500 x 3 = £19,500 Prepayment (Current asset) is £6,500 x 9 = £58,500 Cash has reduced by £78,000
6.11
A company incurs gas costs for heating of £12,000 per year, although three-quarters of the annual cost is incurred between January and June. Bills are received quarterly at the end of March, June, September & December and paid two weeks later. What is the accrual at the end of June and where does this appear in the financial statements? Average cost is £12,000 / 12 = £1,000 per month BUT effect of timing! January – June ¾ of £12,000 = £9,000 / 6 = £1,500 per month Accrual is £1,500 x 3 = £4,500 – expense and accrual (current liability)
6.12
A company has bought a new computer system for cash at the beginning of its financial year at a cost of £30,000. It is expected to last 4 years with no value at the end of that period. What is the impact on the Income Statement, Balance Sheet and Cash Flow at the end of the year? Depreciation is £30,000 / 4 = £7,500 per annum – expense in Income Statement Cash flow is £30,000 Balance Sheet shows asset cost of £30,000 less depreciation of £7,500 = £22,500 net (book value or written down value).
6.13
Regal Farms Ltd has sales of £2.5 million, a gross profit of £1.7 million and expenses of £800,000. Regal has paid interest of £72,000 and has to provide for Corporations Tax of £310,000 and dividends of £300,000. Calculate the EBIT, profit after tax and retained profits for the year. Sales Gross profit Expenses EBIT Interest Profit before tax Income tax Profit after tax Dividends Retained profits
6.14
A professional services firm has income of £1,750,000. It incurs salaries of £1.6 million of which 60% is allocated as a cost of sales and the balance as selling and administration. The only other cost charged to cost of sales is travelling of £50,000. Other administration costs are £80,000. Calculate the gross profit and net profit. Sales Cost of sales 60% of 1,600,000 Travel Gross profit Salaries 40% of 1,600,000 Other administration costs Net profit
6.15
2,500,000 1,700,000 800,000 900,000 72,000 828,000 310,000 518,000 300,000 218,000
1,750,000 960,000 50,000 1,010,000 740,000 640,000 80,000 720,000 20,000
On 1st January, QRS Ltd is formed with capital of £250,000, all of which is held in the company’s bank account. On the same day, QRS purchases an existing business from Taylor plc for £400,000. An independent valuer has valued the assets as follows: Plant & Equipment £100,000 Trade receivables £ 50,000 Inventory £ 75,000 QRS funds the acquisition by a long-term borrowing of £150,000 and using its available cash. a. Show the Balance Sheet of QRS after these transactions have taken place.
Fixed assets Goodwill Plant & Equipment Current assets Bank Debtors Inventory Total assets Long term debt Equity
175,000 100,000 275,000 50,000 75,000 125,000 400,000 150,000250,000
b. If QRS wishes to amortise its goodwill over 10 years, how will goodwill appear in the Balance Sheet at the end of the first year? Amortise £175,000 / 10 = £17,500 p.a. At end of year 1, Balance Sheet shows: Goodwill Less provision for amortization
175,000 17,500 157,500
Chapter 7 7.1
Solutions
XYZ Ltd’s Income Statement shows the following: 2006 Sales 1,250,000 Cost of sales 787,000 Selling & Admin. Expenses 324,000
2005 1,175,000 715,000 323,000
Based on these figures, which of the following statements is true: d) Although the operating profit has increased, the operating margin has decreased as a result of a reduction in the gross margin and higher expenses, despite sales growth Although the operating profit has increased (from £137,000 to £139,000), the operating margin has decreased (from 11.6% to 11.1%) as a result of a reduction in the gross margin (from 39% to 37%) and higher expenses (from £323,000 to £324,000), despite sales growth (of 6.4%). 2008 2007 Sales 1,250,000 1,175,000 Sales growth 6.4% Cost of sales 787,000 715,000 Gross profit 463,000 460,000 Gross margin 37% 39% Selling & Admin. Expenses 324,000 323,000 Operating profit 139,000 137,000 Operating margin 11.1% 11.6%
7.2
Using the above information for Monitor Services PLC, the Return on Capital Employed: a) has improved from 40.3% to 56.4%
ROCE is PBIT/ Total capital employed Total capital employed = shareholders’ funds plus long term debt PBIT Shareholders funds + Long term debt 2008
2007
54,094 = 56.4% 95,871
38,507 = 40.3% 95,450
7.3
In reviewing liquidity and gearing ratios for Monitor Services PLC, we can say that: b) long term debt has reduced as a proportion of total capital employed, and liquidity has declined due to the increase in current liabilities
Liquidity is current assets/current liabilities (i.e. creditors) 2008 2007 Liquidity 134,950 = 1.06 111,817 = 1.18 127,799 94,301 Gearing is long term debt shareholders funds plus long term debt Gearing 2,088 = 2.2% 12,264 = 12.8% 95,871 95,450 Therefore, long term debt has reduced as a proportion of total capital employed, and liquidity has declined due to the increase in current liabilities (relative to the increase in current assets). 7.4
Tubular Steel has 1 million shares issued that have a market price of £5.00 each. After tax profits are £350,000 and the dividend paid is 25p per share. d) All of the above Dividend paid is 25p x 1 million = £250,000 Dividend payout ratio = dividend paid/after tax profits = 250,000/350,000 = 71.4% Earnings per share = after tax profits/number of shares = 350,000/1 million = 35 pence P/E ratio = market value/EPS = 5.00/.35 = 14.3
7.5
When considering the working capital ratio for a company with inventory, the acid test ratio will: b) always be worse As current assets will be reduced by the value of inventory
7.6
If ROCE declines from 12% to 10% from one year to the next and shareholders’ funds have remained constant, it is most likely because: c) PBIT is lower and/or long-term debt is higher Although b and d are also possible
7.7
Sales have increased since the previous year and the gross profit to sales ratio has increased but the operating profit to sales ratio has fallen. This is most likely because: a) expenses have increased
7.8
Risk is highest when: d) gearing ratio is higher and the interest cover ratio is lower
7.9
The asset turnover ratio represents: b) the efficiency of use of assets to generate sales
7.10
Brigand Ltd has 2 million shares issued with a market price of £2.50 each. The company wants to pay a dividend of 60% of its after-tax profits of £1,750,000. The dividend yield would be: d) 21%
1,750,000 x 60% = dividend of £1,050,000/2,000,000 shares = 52.5 pence per share Dividend yield = .525/2.50 = 21% 7.11
Calculate the following ratios: o Return on investment (ROI) o Return on capital employed (ROCE) o Operating margin o Gross margin o Sales growth
o Working capital to sales o Gearing o Asset turnover 2008
2007
Return on (shareholders’) investment/equity (ROI/ROE) net profit after tax
13.8
shareholders’ funds
131.5
=
10.5%
16.3
=
12.9%
=
10.8%
126.6
Return on capital employed (ROCE) profit before interest & tax
27.2
=
11.9%
S’h funds + long term debt
131.5+96.7=228.2
29.5
126.6+146.1=272.7
Operating margin (profit/sales) profit before interest & tax
27.2
sales
141.1
=
19.3%
29.5
=
21.3%
=
60.3%
138.4
Gross margin Gross profit
82.2
Sales
141.1
=
58.2%
83.5 138.4
Sales growth Sales year 2 – Sales year 1
141.1-138.4=2.7
Sales year 1
138.4
=
+1.95%
Working capital/sales Working capital
-38.5 =
sales
141.1
-27.3%
7.4
=
5.3%
146.1 =
53.6%
138.4
Gearing ratio long term debt
96.7
=
42.4%
s’h funds + long term debt
131.5+96.7=228.2
126.6+146.1=272.7
sales
141.1 =
138.4 =
total assets
266.7+28.3=295
Asset turnover
7.12
47.8%
46.1%
265.3+35=300.3
Calculate the days’ sales outstanding, stock turn, days’ stock held and days’ purchases outstanding. Average daily sales is 9,000,000/250 = £36,000 Days’ sales outstanding = 1,200,000/36,000 = 33.33 days Cost of sales is 40% of 9,000,000 = £3,600,000 Stock turn is Cost of sales/ stock = 3,600,000/450,000 = 8 Days’ stock held is 250/8 = 31.25 days Average daily purchases is 3,600,000/250 = 14,400 Days’ purchases outstanding = 1,400,000/14,400 = 97.2 days
7.13
Calculate sufficient ratios for both 2008 and 2007 to demonstrate the changes in profitability, liquidity, efficiency, gearing and shareholder return of Tamalan plc and comment on the most important changes between 2008 and 2007. Ratios: 2008 2007
Sales growth
20.5%
Gross profit/sales Expenses growth Operating profit/sales ROCE ROI Interest cover
16.3% 64.6% 11.6% 58.5% 40.0% N/A
16.2%
Dividend per share Dividend payout ratio Dividend yield
0.0750 38.4% 5.0%
0.0660 39.5% 4.7%
12.7% 71.8% 45.3% N/A
Asset turnover
254.7%
253.6%
Stock turn DSO
6.3 N/A
6.7 N/A
Working capital Acid test Days purchases
1.09 0.24 68.2
0.96 0.26 76.9
Gearing
6.4%
7.6%
P/E Ratio
7.0
7.6
Main comments: • High sales growth with margin retained but large expense increase and reduced rate of operating profit • Significantly lower ROCE and ROI due largely to increase in shareholders’ funds (retained profits) • Virtually no borrowings so very low gearing and insignificant interest cover • Dividend ratios show slight improvement • Very high asset turnover (typical for retail) • Slightly reduced stock turn, as retail DSO not applicable • Working capital finely balanced, acid test demonstrates need to sell stock to pay creditors which are quite high, although slight improvement – pressure from creditors? • P/E over 7 years.
7.14 a. Explain how ratio analysis can be used to interpret business performance, with an emphasis on the different types of ratios that can be used The main points here are to identify ratios as requiring either trends or benchmarks for interpretation. Also, the need to use a mix of profitability, liquidity, gearing, activity/efficiency and shareholder return ratios. b. Use the above ratios to explain the strengths and weaknesses of the financial performance of Corollary plc over the last four years. Ratio Comment Sales growth Increasing sales growth Return on shareholders' investment (ROI) Return on capital employed (ROCE) Operating profit/sales Gross profit/sales
Increasing, due to dependence on LT debt Reduced (therefore more LT debt) Increased GP but higher overheads Increasing GP (prices or CoS)
Working capital Acid test (quick ratio)
Reducing, close to 100% Reducing, reliance on stock
Gearing Interest cover
Increasing debt Lower coverage
Asset turnover Days' sales outstanding Stock turn Days' purchases outstanding
Stronger level of sales for asset base Poor credit control Higher stock turnover Taking longer to pay creditors
Dividend per share Dividend payout ratio Dividend yield Price/earnings ratio
Paying higher ppn of profit to maintain constant DPS Constant DPS so falling share price Declining operating profit; share price may be declining
Overall, sales are increasing but profits are declining, mainly due to expense increases despite increases in GP. There is more LT debt and working capital is tight with the company facing risk in paying its debts and covering its interest charges. Although stock turn has improved, there seems to be poor management of debtors contributing to this. Dividends are being maintained by paying out a higher proportion of profits but the share price may be falling in recognition of risk and declining profitability.
Question 8 8.1
Solutions
National Retail Stores has identified the following data from its accounting records for the year ended 31st December: sales £1,100,000; purchases £650,000; expenses £275,000. It had an opening stock of £150,000 and a closing stock of £200,000. Based on this information, the gross profit and operating profit/loss is: b) a gross profit of £500,000 and an operating profit of £225,000
Sales Less cost of sales Opening stock Purchases
1,100,000 150,000 650,000 800,000 200,000
- Closing stock Cost of sales Gross profit - Expenses Operating profit
8.2
600,000 500,000 275,000 225,000
Opening stock is £350,000. Closing stock is £325,000. Purchases are £650,000. Sales are £1,000,000. The cost of sales is: d) £675,000
Sales Op stock Purchases Cl stock Cost of sales GP
1,000,000 350,000 650,000 1,000,000 325,000 675,000 325,000
8.3
In a retail organization, sales: d) decrease inventory and increase cost of sales
8.4
Using the information provided above, calculate the cost of sales and inventory value using the weighted average method.
Units
Unit price Total cost 2500 £ 12.00 1500 £ 11.50 1000 £ 11.00 5000 £
Weighted average cost 58,250/5,000 Cost of sales Inventory
8.5
Units
30000 17250 11000 58,250
£
11.65
3000 £ 2000 £
34,950 23,300
Using the information provided above, calculate the cost of sales and inventory value using the FIFO method. Unit price Total cost 2500 £ 12.00 1500 £ 11.50 1000 £ 11.00
FIFO Cost of sales 2500 £ 500 £ 3000
12.00 11.50
Inventory (FIFO) 1000 £ 1000 £ 2000
11.50 11.00
30000 17250 11000
£
30000 5750 35,750
£
11500 11000 22,500
8.6
Calculate: • The total job cost and the cost per table • The cost of sales • The value of inventory • The gross profit for the tables that were sold Units Unit cost Total cost Plastic 100 12 1200 Timber 70 20 1400 Metal 15 35 525 3125 Labour 20 40 800 Overhead 20 30 600 Total job cost 4525 Cost per table 20 226.25 Cost of sales Inventory
5
3393.75 1131.25
Sales Cost of sales Gross profit
15
450
6750.00 3393.75 3356.25
8.7 a. Calculate the cost per equivalent unit for the month of April using the weighted average method of process costing. b. Calculate the value of work in progress and the value of completed stock transferred to finished goods during the month
Opening WIP Units commenced Closing WIP Completed
Units 25,000 35,000 60,000 15,000 33.3% complete as to conversion 45,000
Cost per unit: Openin Cost Total £ Complete WIP Total Cost per g WIP £ for d units Equivalen equivalen equivalen month t units t units t unit £ £ Material 18,500 300,00 318,500 45,000 15,000 60,000 £5.31 0 Conversio 36,750 230,00 266,750 45,000 5,000 50,000 £5.34 n 0 Total £55,250 530,00 £585,25 £10.65 0 0 Work in progress: Materials 15,000 @ £5.31 £79,650 Conversion 5,000 @ £5.34 £26,700 £106,350 Finished goods: 45,000 units @ £10.65 Total costs 8.8
£479,250 £585,600 Rounding differences ignored
The Gargantuan Company has the following transactions during December. Prepare a combined cost of goods sold and Income Statement showing all these transactions and identify the value of inventory to be included in the Balance Sheet at the end of December. Sales 435,000 Opening stock 120,000 Purchases 300,000 420,000 Closing stock 150,000 270,000 Gross profit 165,000 Rental 30,000 Salaries & wages 45,000 Depreciation 12,000 Marketing expenses 15,000 102,000 Net profit 63,000
Inventory in Balance Sheet = 150,000
Note: 1. Cost of sales calculated as 435,000 - 165,000 = 270,000 2. Purchases calculated as 270,000 + 150,000 - 120,000 = 300,000
Chapter 10 10.1
Solutions
Godfrey’s target selling price per hour is: c) £50.88
Direct labour costs Variable costs Fixed costs £250,000/20,000 Target return (750,000 x 25%)/20,000 Price 10.2
25.00 4.00 12.50 9.38 50.88
Assuming that both activity levels are within the relevant range, the semivariable costs for December are: c) £25,000 Variable costs are £2 per unit (£10,000/5,000) for December 10,000 @ £2 = £20,000 Fixed costs do not change with activity, for December £30,000 As total costs are £75,000 semi-variable costs for December are £25,000 (£75,000 - £20,000 - £30,000)
10.3
A business sells a single product and incurs fixed costs of £60,000. The average selling price is £45 and variable costs are £20. The total sales revenue to achieve a profit of £20,000 is closes to: b) £144,000 Using CVP analysis 60,000 + 20,000 = 80,000 = 3,200 (45-20) 25 3,200 @ £45 is £144,000 or unit contribution as a% of sales is 45-20 = 45 60,000 + 20,000 = £144,144 0.5555
10.4
0.5555
Within its relevant range, MaxiVent sells its highest volume of 150,000 units at a total cost of £85,000. Selling its lowest volume of 100,000 units incurs total costs of £75,000. Variable costs per unit are: b) £0.20 Hi Lo
150,000 100,000 50,000
£85,000 £75,000 £10,000
VC = £10,000/50,000 = £0.20 Proof: 100,000 @ .20 = £20,000 – 75,000 therefore FC = £55,000 150,000 @ .20 = £30,000 – 85,000 therefore FC = £55,000
10.5
A business has fixed costs of £100,000, an average selling price of £15 and a unit contribution of 40% of sales. The number of units that need to be sold to breakeven is: d) 16,667 Contribution = £6 (40% of £15) B/Even = 100,000/6 = 16,667 units
10.6
Budgeted sales are 100,000 units and the breakeven level of sales are 80,000. The selling price is £18 per unit. The margin of safety is: c) 20% 100,000 – 80,000 = 20,000/100,000 = 20%
10.7
The effect on Travesty’s operating profit of deleting the Porcelain product line will be to: d) make it worse by £500
Sales Variable costs Avoidable product-related fixed costs Contribution to corporate fixed overhead
Allocated corporate fixed costs Operating profit
10.8
Cutlery 30,000 15,000 5,000
Glassware 35,000 20,000 7,500
Porcelain 10,000 7,000 2,500
Total 75,000 42,000 15,000
10,000
7,500
18,000
5,000
5,833
500 if product discontinued will lose this contribution 1,667
5,000
1,667
-1,167
5,500
12,500
The level of sales (in units) that will maximise profits is: c) 30,000 Units
25,000 30,000 35,000 40,000
Price per unit £10 £9 £8 £7
Revenue 250,000 270,000 280,000 280,000
Costs 150,000 160,000 175,000 190,000
Contribution 100,000 110,000 MAX. 105,000 90,000
10.9 a. Calculate the possible price/quantity combinations within the relevant range of production and the permissible pricing range and determine the optimum level of sales that will maximise profitability. b. What will be Webster’s net profit for that optimum price/quantity combination?
c. What is the number of units that must be sold, at the optimum selling price to achieve Webster’s target profit of £3.5 million? a. & b. Price per unit
250
300 350 400 450 500 550
600
Quantity
Revenue (£’000) Price x Qty
Variable costs (£’000)
Contribution
@ £85
33750
30500 27250 24000 20750 17500 14250
O/SIDE RELEV RANGE 9537.5 9600.0 9337.5 8750.0 7837.5
2316.25 2040.00 1763.75 1487.50 1211.25
7221.25 7560.00 7573.75 7262.50 6626.25
** MAX
O/SIDE RELEV RANGE
11000
b. As fixed costs are the same at each level of activity they can be ignored in the above Table as the maximum contribution is also the maximum profit. Optimum sales are at price of £450, selling 20,750 units for a maximum contribution of £7,573,750 less fixed costs of £4,500,000 is a profit of £3,073,750 c. The contribution per unit at the optimum sales level is £365 (£450 - £85). The breakeven sales units to generate a profit of £3.5 million is 4,500,000 + 3,500,000 = 21,918 units 365
10.10 a. By how much does the average cost change between processing 10,000 and 20,000 documents? Why? b. Does the marginal cost change in the same way?
Volume 10,000 20,000
Variable 70,000 140,000
Fixed 100,000 100,000
Total 170,000 240,000
Avg cost/unit £17 £12
a. The average cost reduces by £5 from £17 to £12. This is because the fixed costs of £100,000 are spread over 20,000 documents (£5 per document) rather than 10,000 documents (£10 per document). b. The marginal cost is £7, i.e. the variable cost. It does not change per unit irrespective of volume within the relevant range.
10.11 Terrier Financial Services has fixed costs of £12,500,000. Shareholders expect a profit return before interest and taxes of £5,000,000. Terrier achieves an average margin of 1.5% on the volume of client money handled. What is the volume of money that has to be handled to achieve the profit target? Contribution is 1.5% (0.015) Fixed costs + Target profit = 12,500,000 + 5,000,000 Unit contribution as a % of sales .015 (i.e. £1.167 billion or £1,167 million)
= £1,166,666,667
10.12 The national Hospital Purchasing Authority is negotiating with Clinical Services to reduce its selling price by 20% although a volume of at least 1,200 kits per month has been promised. Should Clinical Services accept this offer? If so, why? If not, what would be your suggestion in order for Clinical Services to maintain its current level of profitability? If selling price reduces by 20% to £120 Sales 1,200 @ £120 £144,000 Cost of sales 1,200 @ £85 102,000 Gross profit 42,000 Fixed costs 50,000 Net loss 8,000 Clinical Services should not accept this offer. However, if it loses the contract, the company will need to look for a replacement customer to cover its fixed costs. To maintain the current level of profitability: The new margin is £35 per kit (£120 - £85). To cover fixed costs of £50,000 and the current profits of £25,000, Clinical Services would need to sell £75,000 = 2,143 kits £35/unit Clinical Services should therefore negotiate over the minimum number of kits to be sold to hospitals. 10.13 What is the profitability of Unfocused Books’ three departments and what recommendations would you make to the owners?
Sales Cost of sales Gross profit Departmental costs Contribution to shared fixed costs Shared fixed costs Net profit
Fiction 250,000 45% 112,500 137,500 50,000
Non-Fiction 100,000 50% 50,000 50,000 35,000
Children’s 75,000 55% 41,250 33,750 35,000
Total 425,000
87,500
15,000
-1,250
101,250
30,000
30,000
30,000
90,000
57,500
-15,000
-31,250
11,250
203,750 221,250 120,000
Unfocused Books makes substantial profits from fiction books and at least makes a positive contribution toward shared fixed costs from non-fiction sales. However it is losing money on Children’s books. Unless sales can be increased (breakeven for children’s books before contributing to shared fixed costs is £77,778 (£35,000/0.45)) the children’s department should be closed, to improve profits by £1,250. If the shared fixed costs cannot be reduced, they will need to be covered from the remaining two departments. As fiction books have the highest sales value and lowest cost of sales, it may be that sales can be increased by using the Children’s department space to sell more fiction books. 10.14 a. If the average selling price is £21, calculate the breakeven point in quantity and money terms and draw a rough sketch of a cost-volumeprofit (CVP) graph that shows the relationships between the elements of CVP.
Breakeven FC/CMpu = 150,000/(21-7) = 10,714 services 10714 @ £21 = £224,995 (£225,000)
Revenue
Total costs
VC £7pu
Breakeven £225,000
FC £150K
Breakeven 10714
b. Ignoring any market demand or capacity limitations, calculate the optimum selling price for Greentown Industries and identify which customer group is most profitable Selling Quantity Revenue Variable Contribution Ranking price costs @ £7 MNC £19 13,000 247,000 91,000 156,000 5 CORP £20 12,500 250,000 87,500 162,500 3 SM BUS 12,000 252,000 84,000 168,000 ** 1 £21 GOV £22 11,000 242,000 77,000 165,000 2 PVT £23 10,000 230,000 70,000 160,000 4
Optimum selling price is Small Business £21 c. Based on the calculation of optimum selling prices in (b) above but with the capacity and demand assumptions taken into consideration, calculate the maximum profits that Greentown can earn and the customer mix and quantity by which that profit can be achieved. Ranking as above 1. 20,000 Small Business @ £21 = £420K - £140K = £280K 2. 20,000 Govt @ £22 = £440K - £140K = £300K 3. 20,000 Corporate @ £20 = £400K - £140K = £260K Total contribution = £840K – FC £150K = PBIT £690K max profits 10.15 a. Present the financial information in a more meaningful form, showing the contribution each division makes to total profitability (in £’000) I.T. Finance Strategy M&A Total Income 1,200 1,700 900 1,500 5,300 % of total 22.6% 32.1% 17% 28.3% 100% Variable staff costs 600 900 350 600 2,450 Contribution 600 800 550 900 2,850 margin Margin % 50% 47% 61% 60% 53.8% Fixed staff costs 200 500 600 150 1,450 identifiable with segment Contribution to 400 300 (50) 750 1,400 business-wide costs Business-wide 271 385 204 340 1,200 costs (allocated as % of income) Operating 129 (85) (254) 410 200 profit/(loss) b. Ignoring any redundancy payments, advise the senior partners as to i. which, if any, divisions should be closed, and ii. the likely profit, assuming constant sales, if those divisions were closed As the unavoidable fixed costs for Strategy division exceed the contribution, this division should be closed, increasing profits by £50K. As Finance makes a positive contribution to business-wide costs, it should be retained.
c. By re-presenting the financial information, explain the consequences to remaining divisional profitability if any division is closed (in £’000) I.T. Finance M&A Total Income 1,200 1,700 1,500 4,400 % of total 27.3% 38.6% 34.1% 100% Variable staff costs 600 900 600 2,100 Contribution 600 800 900 2,300 margin Margin % 50% 47% 60% 53.8% Fixed staff costs 200 500 150 850 identifiable with segment Contribution to 400 300 750 1,450 + 50 business-wide costs Business-wide 328 463 409 1,200 costs (allocated as % of income) Operating 72 (163) 341 250 + 50 profit/(loss) Note effect on divisional profits is to reduce each, due to allocation of overhead previously charged to Strategy division.