Accounting and Finance for Non-Specialists with MyAccountingLab 7th edition, 7E Atrill, McLaney Solu

Instructor’s Manual Accounting and Finance for Non-Specialists Seventh Edition

Peter Atrill Eddie McLaney

Contents Section A: Authors’ Note to Tutors

4

Section B: Solutions to Exercises

9

3 .

SECTION A

Authors’ Note to Tutors Using the text The text is designed to provide readers with a sound introduction to accounting and finance. It assumes no previous knowledge of these subjects and recognises that students using the text may come from a wide variety of backgrounds. The text, therefore, tries to avoid technical jargon and does not assume that students have a high level of numerical ability. The text has been class tested by students on various courses and we have modified and refined the material to take account of their comments. We have also taken account of the comments made by lecturers who used the first six editions of the text.

The text aims to encourage an active approach to learning by providing activities and selfassessment questions at appropriate points in the text. This is designed to stimulate thought concerning particular issues and to give the readers the opportunity to test their understanding of the principles covered.

The text is supplemented by a password-controlled lecturers' website and a student website available to all readers.

The structure of the text allows the tutor to deliver the subject in a number of ways. It can be used as recommended reading for a traditional course based on lectures and tutorials. There are review questions and exercises at the end of each chapter that can be used as the basis for tutorials. It could also provide the basis for a distance learning approach for part-time or off-campus students.

For these students, the interactive nature of the text may be extremely useful where access to a tutor is restricted. The text can also be used as the basis for an open-learning approach for fulltime campus-based students. We successfully used it in this way at the University of Plymouth Business School. Accounting ‘surgeries’ were provided to give students the opportunity for oneto-one help with any problems they may face.

The text is appropriate for modules that are designed to be covered in 150 – 200 hours of study.

For full-time students, this will often be covered in one academic year (two semesters). For students who are only studying a one-semester course in accounting and finance, it will be necessary to adopt a selective approach to the chapters to be studied. The first six chapters deal with the nature and role of financial accounting and give a good grounding in the major financial statements. This will, however, take up much of the time available. It should, nevertheless, be possible to select further chapters for study from the remaining chapters in the text.

PowerPoint slides The diagrams in the text, along with other diagrams and materials (including the new ‘bullet point’ chapter summaries), are available as PowerPoint slides. These should help in delivering lectures and tutorials. They can be downloaded from the lecturers' website.

4 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

International financial reporting standards For accounting periods starting on or after 1 January 2005, Stock-Exchange listed companies in EU countries (including the UK) have had to prepare their published, consolidated financial statements in line with International Financial Reporting Standards (IFRSs), formulated by the International Accounting Standards Board (IASB). This represented a major change for UK listed companies because IFRSs not only superseded UK financial reporting standards, but much of UK company law as well.

IFRSs tend to use terminology that used not to be in widespread usage in the UK. They also tend to be less prescriptive about formats of the financial statements than was the case under UK company law. During the early stages of the transition to IFRSs, it was not clear whether UK listed companies would adopt the IASB terminology and whether they would stay with the old companies’ acts formats. By the time of writing this new edition, however, practice had the opportunity to show itself as all listed companies had published several annual reports. It seems that, although listed companies are not following a uniform approach, a clear majority is taking a similar approach, which we have followed in this book.

Though non-listed companies need not make the change to the IASB rules immediately, they may do so. The question then arises as to whether non-listed businesses will follow the same approach as their listed counterparts. We carried out a survey of a number of practitioners and academics with a particular interest in the company financial reporting. The consensus view is that non-listed companies will follow their listed counterparts and will do so fairly quickly.

This edition fully reflects the changes caused by the advent of the IASB rules, which can be summarised as follows:

Changes in terminology Traditional UK term

IASB term

Profit and loss account

Income statement

Balance sheet

Statement of financial position

Cash flow statement

Statement of cash flows

Fixed asset

Non-current asset

Tangible fixed asset

Property, plant and equipment

Creditors: amounts falling due within one year

Current liabilities

Creditors: amounts falling due after more than one year

Non-current liabilities

Debtors

Receivables

Trade debtors

Trade receivables

Creditors

Payables

Trade creditors

Trade payables 5 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

For listed companies, the published annual reports show that the IASB terms have become the norm. We have, therefore, used IASB terms throughout, but refer to their traditional UK equivalents from time to time.

Formats Though the IASB does not require that particular formats be used for the statement of financial position and income statement, a key standard does provide illustrative formats. These formats seem to be widely followed for listed companies and have been adopted in the book. It has been pointed out, however, that other approaches to layout are permitted and do exist.

No doubt the traditional terminology and formats will linger, particularly with smaller companies and unincorporated businesses, but we believe that the financial statements that students are likely to encounter (that is, those of larger, mainly listed, companies) will be consistent with the approach taken in this book.

Ordering of material The order in which topics are dealt with is clearly a matter of opinion. Our broad approach is to try to build up students' knowledge and understanding and to try to avoid situations where reference needs to be made to material appearing later in the text. We have taken the view that financial accounting is a good place to start, partly because students probably know of this aspect of accounting and finance from their background. It tends to be discussed in the news media etc. Also, we feel that this aspect is easier to deal with without knowledge of management accounting and finance. Within financial accounting, we have dealt with the statement of financial position and income statement, then with company accounting, then the statement of cash flows and on to financial accounting ratios. When dealing with the statement of financial position and income statement (in Chapters 2 and 3), we have made no real distinction between companies and unincorporated businesses. This is because we see no great difference between these, except when there is the need to go into detail about the restrictions on withdrawals of equity, and this is covered in Chapter 4 on company accounting. We have left statements of cash flows until after introducing companies, because these statements usually relate to companies and the problem areas often relate to aspects like dividends and taxation.

Double-entry bookkeeping The text does not cover double-entry bookkeeping, in the sense of 'T' accounts. We have taken the view that students can gain a sufficient grasp of both the principles and practice of transaction recording, and their ultimate effect on the statement of financial position and income statement, by dealing with them on a 'plus and minus' basis. We feel that, for the target readership, the recording process is of limited importance and that the key issues relate to the effect of transactions on the overall business. It may be the case that students' understanding of this would be enhanced by a closer look at the recording process, through 'T' accounts, but this will take time, which we believe could be better devoted to other topics.

We are aware that not all of our colleagues agree with us on this and so an appendix – 'Recording financial transactions' – is available for tutors to download. This can be slotted into

6 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

the students' studies, perhaps immediately after dealing with the contents of Chapters 2 and 3.

This supplement is self contained. It includes a number of activities and three Exercises.

Practice/assessment material The activities, which have solutions immediately following them, and self-assessment questions, which have solutions at the end of the text, form an integral part of the text. In addition, there are various other practice/assessment materials. At the end of each chapter there are four review questions. These are short, narrative questions involving recall, explanation and brief discussion. The solutions to these are at the end of the text. At the end of all chapters, except Chapter 1, there are five Exercises. These are questions, many involving calculations, which are similar in nature to exam-style questions. The solutions to three of these are given at the end of the text and are, therefore, accessible to students. Solutions to the other two are in the following pages of this manual and are not accessible to students.

On the lecturers' website, there are: •

PowerPoint slides, as mentioned above.

•

Supplementary questions, with solutions. These questions are similar to the end-of-chapter Exercises.

•

Two progress tests, with solutions. Each of these contains ten multiple choice questions, ten missing word questions and either two or three Exercise-style questions.

•

Four seminar/discussion question, for each chapter, with outline solutions.

•

A set of case studies with solutions.

•

The double-entry bookkeeping appendix, referred to above.

None of the material on the lecturers’ website is accessible to students.

On the student website, there are three types of material: •

A set of revision questions, similar in style to the end-of-chapter Exercises, with solutions.

•

A set of multiple-choice questions (MCQs). Typically, there are ten such questions for each chapter. These are intended to be tackled online, where they will be automatically graded.

•

A set of missing word questions (MWQs), typically ten for each chapter. These too can be attempted and graded online.

Both the MCQs and MWQs are intended to provide students with a quick assessment of their mastery of the material of each chapter.

The solutions to all of this material, except to the multiple-choice and missing-word questions, are fully annotated in order to give the necessary feedback to students.

7 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

We intend to expand the number and scope of the practice/assessment materials on a continuing basis.

We hope that you and your students will find the text both accessible and interesting. We should much appreciate any suggestions you may have on how the text and supplementary material may be improved.

Peter Atrill Eddie McLaney June 2011

8 .

SECTION B

Solutions to Exercises

9 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 2.3 Joe Conday Statement of financial position as at 1 March £ ASSETS Bank

20,000

EQUITY AND LIABILITIES Equity

20,000

Statement of financial position as at 2 March £ ASSETS Bank (20,000 − 6,000)

14,000

Fixtures and fittings

6,000

Inventories

8,000

Total assets

28,000

EQUITY AND LIABILITIES Equity

20,000

Trade payables

8,000

Total equity and liabilities

28,000

Statement of financial position as at 3 March £ ASSETS Bank (14,000 + 5,000)

19,000

Fixtures and fittings

6,000

Inventories

8,000

Total assets

33,000

EQUITY AND LIABILITIES Equity

20,000

Trade payables

8,000

Borrowings

5,000

Total equity and liabilities

33,000

10 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Statement of financial position as at 4 March £ ASSETS Bank (19,000 − 7,000 − 200)

11,800

Fixtures and fittings

6,000

Inventories

8,000

Motor car

7,000

Total assets

32,800

EQUITY AND LIABILITIES Equity (20,000 − 200)

19,800

Trade payables

8,000

Borrowings

5,000

Total equity and liabilities

32,800

Statement of financial position as at 5 March £ ASSETS Bank (11,800 − 2,500)

9,300

Fixtures and fittings

6,000

Inventories

8,000

Motor car

9,000

Total assets

32,300

EQUITY AND LIABILITIES Equity (19,800 − 500)

19,300

Trade payables

8,000

Borrowings

5,000

Total equity and liabilities

32,300

11 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Statement of financial position as at 6 March £ ASSETS Bank (9,300 + 2,000 − 1,000)

10,300

Fixtures and fittings

6,000

Inventories

8,000

Motor car

9,000

Total assets

33,300

EQUITY AND LIABILITIES Equity (19,300 + 2,000)

21,300

Trade payables

8,000

Borrowings (5,000 − 1,000)

4,000

Total equity and liabilities

33,300

12 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 2.5 Statement of financial position as at the end of the week ASSETS

£

Property

145,000

Furniture and fittings

63,000

Motor van

10,000

Inventories (28,000 − 8,000 − 17,000 + 14,000)

17,000

Trade receivables (33,000 + 23,000 − 18,000)

38,000

Total assets

273,000

EQUITY AND LIABILITIES Equity (203,000 + 11,000 − 8,000 + 23,000 − 17,000 + 100,000 + 10,000)

322,000

Borrowings (Bank overdraft) (43,000 − 11,000 − 18,000 − 100,000 + 13,000)

(73,000)

Trade payables (23,000 + 14,000 − 13,000)

24,000

Total equity and liabilities

273,000

Since the bank balance is now positive, we can rewrite this statement of financial position as:

Statement of financial position as at the end of the week ASSETS

£

Property

145,000

Furniture and fittings

63,000

Motor van

10,000

Inventories

17,000

Trade receivables

38,000

Cash at bank

73,000

Total assets

346,000

EQUITY AND LIABILITIES Equity

322,000

Trade payables

24,000

Total equity and liabilities

346,000

13 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 3.2 Singh Enterprises Income statement for the year ended 31 December 2007 (extract) £ Depreciation − machinery

2,000

Statement of financial position as at 31 December 2007 (extract) £ Machinery at cost

10,000

Accumulated depreciation

(2,000) 8,000

Income statement for the year ended 31 December 2008 (extract) £ Depreciation − machinery (2,000 + 2,500)

4,500

Statement of financial position as at 31 December 2008 (extract) £ Machinery at cost

25,000

Accumulated depreciation (4,000 + 2,500)

( 6,500) 18,500

Income statement (extract) for the year ended 31 December 2009 (extract) £ Depreciation − machinery

4,500

Loss on sale of machine (10,000 − 6,000 − 3000)

1,000

Statement of financial position as at 31 December 2009 (extract) £ Machinery at cost

15,000

Accumulated depreciation (2 × 2,500)

(5,000) 10,000

14 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 3.4 TT and Co. Statement of financial position as at 31 December 2010 ASSETS

£

Delivery van (+9,500 + 13,000 − 5,000)

17,500

Inventories (+65,000 + 67,000 + 8,000 − 89,000 − 25,000)

26,000

Trade receivables (+19,600 + 179,000 − 178,000)

20,600

Cash at bank (+750 − 20,000 − 15,000 − 1,300 − 13,000 − 36,700 − 1,820 − 8,000 + 54,000 + 178,000 − 71,000 − 16,200)

49,730

Prepaid expenses (325)

325

Total assets

114,155

EQUITY AND LIABILITIES

£

Equity (+76,900 − 20,000 + 37,705)

94,605

Trade payables (+22,000 + 67,000 − 71,000)

18,000

Accrued expenses (+ 860 + 690)

1,550

Total equity and liabilities

114,155

Income statement for the year ended 31 December 2010 £ Sales revenue (+179,000 + 54,000)

233,000

Cost of goods sold (+89,000 + 25,000)

(114,000)

Gross profit

119,000

Rent (5,000 + 15,000)

(20,000)

Rates (300 + 975)

(1,275)

Wages (−630 + 36,700 + 860)

(36,930)

Electricity (−620 + 1,820 + 690)

(1,890)

Van depreciation (2,500 + 2,500)

(5,000)

Van expenses (16,200)

(16,200)

Profit for the year

37,705

15 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

The statement of financial position could now be rewritten in a more stylish form as follows:

TT and Co. Statement of financial position as at 31 December 2010 £ ASSETS Non-current assets Property, plant and equipment Motor van at cost

25,000

Accumulated depreciation

(7,500) 17,500

Current assets Inventories

26,000

Trade receivables

20,600

Prepaid expenses

325

Cash

49,730 96,655

Total assets

114,155

EQUITY AND LIABILITIES Equity (owner’s capital) Closing balance

94,605

Current liabilities Trade payables

18,000

Accrued expenses

1,550 19,550

Total equity and liabilities

114,155

16 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 4.3 (a) A dividend is a drawing of equity made by shareholders. Usually, but not necessarily, it is in the form of cash. It often reflects the level of profit made during the year to which it relates, but it is perfectly legal to pay a dividend out of past retained profits. Broadly, that part of the owners’ claim that can be reduced through payment of a dividend is limited to that which arose from normal realised trading profits and realised gains from disposals of non-current assets. (b) An audit fee is an amount paid to an independent firm of auditors. The auditors are paid to undertake an examination of the financial statements and underlying records to form and state an opinion as to whether the financial statements provide a true and fair view of financial performance and position. (c) A share premium account is a reserve – part of the equity or owners’ claim – that arises from shares being issued at above their par (or nominal) value. This reserve is not part of the owners’ claim that can be reduced by paying a dividend.

17 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 4.5 Rose Limited Statement of financial position as at 31 March 2010 £000 ASSETS Non-current assets (2,728 − 74 + 16)

2,670

Current assets Inventories (1,583 − 2)

1,581

Trade receivables (996 + 34 − 21)

1,009

Cash

26 2,616 5,286

Total assets EQUITY AND LIABILITIES Equity Share capital (50p shares, fully paid)

750

Share premium

250

Retained earnings (1,468 − 1,012 + 967)

1,423 2,423

Non-current liabilities Borrowings − Secured loan (2011)

300

Current liabilities Trade payables

1,118

Other payables (417 + 16 +1)

434

Tax

415

Borrowings – Bank overdraft

596 2,563 5,286

Total equity and liabilities

18 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Income statement for the year ended 31 March 2010 £000 Revenue (12,080 + 34)

12,114

Cost of sales

(6,282)

Gross profit

5,832

Labour cost (2,658 + 1)

(2,659)

Depreciation (625 + 74)

(699)

Other operating costs (1,003 + 21 + 2)

(1,026)

Operating profit

1,448

Interest payable

(66)

Profit before tax

1,382

Taxation (1,382 × 30%)

(415)

Profit for the year

967

19 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 5.2 Juno plc £m Operating profit (for last year)

187

Adjustments for: Depreciation

55 242

Increase in inventories (31 − 27)

(4)

Decrease in trade receivables (24 − 23)

1

Increase in trade payables (17 − 15)

2

Cash generated from operations

241

20 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 5.4 Chen plc Statement of cash flows for the year ended 31 December 2010 £m Cash flows from operating activities Profit before taxation (after interest) (see Note 1 below)

25

Adjustments for: Depreciation (10 + 12)

22

Interest expense (Note 2)

4 51

Increase in inventories (25 − 24)

(1)

Decrease in trade receivables (26 − 25)

1

Decrease in trade payables (37 − 34)

(3)

Cash generated from operations

48

Interest paid

(4)

Taxation paid (Note 3)

(11)

Dividend paid

(18)

Net cash from operating activities

15

Cash flows from investing activities Payments to acquire non-current assets (Note 4)

(36)

Net cash used in investing activities

(36)

Cash flows from financing activities Net cash used in financing activities

-

Net decrease in cash and cash equivalents

(21)

Cash and cash equivalents at 1 January 2010 Cash at bank

19

Cash and cash equivalents at 31 December 2010 Bank overdraft

(2)

21 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

To see how this relates to the cash of the business at the beginning and end of the year it can useful to provide a reconciliation, as follows: Analysis of cash and cash equivalents during the year ended 31 December 2010 £m Cash and cash equivalents at 1 January 2010

19

Net cash outflow

(21)

Cash and cash equivalents at 31 December 2010

(2)

Notes: 1

This is simply taken from the income statement for the year.

2

Interest payable expense must be taken out, by adding it back to the profit before taxation figure. We subsequently deduct the cash paid for interest payable during the year. In this case, the two figures are identical.

3

50 per cent of taxation is paid by companies during their accounting year and the other 50 per cent in the following year. Thus the 2010 payment would have been half the tax on the 2009 profit (that is, the figure that would have appeared in the current liabilities at the end of 2009), plus half of the 2010 tax charge (that is, 8 + (1/2 × 6) = 11).

4

Since there were no disposals, the depreciation charges must be the difference between the start and end of the year’s non-current asset values, adjusted by the cost of any additions. £m Carrying amount, at 1 January 2010

172

Additions (balancing figure)

36 208

Depreciation (10 + 12)

(22)

Carrying amount, at 31 December 2010

186

22 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 6.3 Conday and Co. Ltd (a) Return on capital employed ╳

Operating profit Equity + long - term borrowings

100%

378 × 100% 1,265

29.9%

Return on ordinary shareholders funds Profit for the year × 100% Share capital + reserves 225 × 100% 1,065

21.1%

Gross profit margin Gross profit × 100% Sales revenue 980 × 100% 2,600

37.7%

Operating profit margin Operating profit × 100% Sales revenue 378 × 100% 2,600

14.5%

Sales revenue to capital employed Sales revenue Equity + non-current liabilities 2,600 1,065 + 200

2.1 times

Average settlement period for trade receivables Trade receivables × 365 days Credit sales revenue 820 × 365 2,600

115 days

Inventories turnover period Inventories held × 365 days Cost of sales 600 × 365 days 1,620

135 days

23 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

The above ratios reveal that Conday and Co. Ltd is profitable. In particular, the return on ordinary shareholders funds and ROCE ratios seem to be high in relation to the returns achieved by more secure forms of investment such as government securities. However, whether this level of return is sufficient in relation to the risks involved is difficult to judge from the information available.

The settlement period for trade receivables seems very high, which may be due to the nature of the business. However, this high ratio, combined with the fact that the bad debts of the business account for more than 6% of total sales revenue, suggests that some tightening of credit control procedures may be required. The inventories turnover figure also seems high.

The business is carrying more than four months’ inventories. This may indicate a need also to improve inventories control procedures. At present, the business has a large bank overdraft and so major improvements in inventories control and credit control procedures may have a significant effect on both the liquidity and the profitability of the business.

Given the high level of bank borrowing, it is difficult to understand why such a high proportion of the profit for the year was distributed in the form of dividend. This is not a very prudent policy. The sales revenue to capital employed ratio seems quite low. This is due, at least in part, to the high levels of inventories and trade receivables that are being carried. (b) Though the business is profitable, there are some doubts as to the quality of its management.

The business has high levels of inventories and trade receivables and a large overdraft. It is possible that better management would not have allowed this situation to arise. It is possible, too, that better management of existing assets would remove the need for external sources of funds for expansion. It is interesting to speculate how £200,000 received from the issue of shares might be used by the managers. Would it be used to finance even higher levels of inventories and trade receivables without there being a corresponding increase in sales revenue?

The share price of £6.40 is much higher than the net asset value of the shares. At present, the net assets (assets less liabilities) have a statement of financial position value of £1,065,000 and there are 700,000 shares in issue. This gives a net asset value per share of £1.52. To justify paying £6.40, the investor would have to be convinced the business would generate high profits in the future.

24 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 6.4 Threads Ltd 2009

(a)

2010

234/756

= 31.0%

167/845

= 19.8%

Operating profit margin

234/1,180

= 19.8%

167/1,200

= 13.9%

Gross profit margin

500/1,180

= 42.4%

450/1,200

= 37.5%

Current ratio

253/199

= 1.3:1

396/238

= 1.7:1

Acid test ratio

105/199

= 0.5:1

160/238

= 0.7:1

Days trade receivables

102/1,180 × 365

= 32 days

156/1,200 × 365

= 47 days

Days trade payables

60/680* × 365

= 32 days

76/750* × 365

= 37 days

Inventories turnover

148/680 × 365

= 79 days

236/750 × 365

= 115 days

ROCE

* The credit purchases figure is not available, so the cost of sales figure has been used.

This only provides a rough approximation of days trade payables. (b) A supplier seeking to sell a substantial amount of goods to the business will be concerned with both liquidity and longer-term viability (where there is a continuing relationship) as measured by profitability ratios. The supplier will also be interested in the average time taken by the business to pay its current suppliers.

•

The liquidity ratios reveal an apparent improvement over the two years. However, for a manufacturing business, the liquidity ratios seem low and the supplier may feel some concern. The increase in inventories over the period has led to a greater improvement in the current ratio than in the liquid (acid test) ratio. The improvement in the acid test ratio has not been very great and some concern over the business’s liquidity position must remain.

•

The average credit period allowed to credit customers (trade receivables) has increased substantially in 2010. This may be a deliberate policy. However, if this is the case, the effect of a more liberal credit policy has not proved to be very successful as there has only been a slight increase in sales revenue in 2010. The credit period increase may be due, on the other hand, to other factors such as poor credit control or particular customers experiencing financial difficulties. The effect of this change in the trade receivables ratio should be carefully noted by the supplier as the increase in trade receivables outstanding seems to be partly financed by an increase in the average period taken to pay trade payables.

25 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

•

The inventories turnover period has increased significantly in 2010. This might be due to inventories building in anticipation of future sales revenue. However, it might indicate that certain products are not selling as well as expected and are therefore remaining in inventories.

•

The gross profit margin and operating profit margins are both lower in 2010. Lower margins have, in turn, led to a lower return on capital employed. The lower operating profit margins, the increase in the average credit period allowed to trade receivables and the increase in the inventories turnover period may suggest that the business has a product range that is becoming obsolete and therefore more difficult to sell. It might, however, also suggest a more competitive business environment.

The ratios calculated above do not indicate any serious problems for the business. However, it is clear that 2010 proved to be a more difficult year than 2009. Things may well improve in the future though. At this point, however, the supplier would be well advised to be cautious in its dealings with the business. Certainly, the supplier should not rely too heavily on Threads Ltd for future sales revenue.

26 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 7.1 Alpha, Beta and Gamma (a) Firstly, we need to deduce the total contribution for one unit of each service. This will enable us to deduce the contribution per £1 of labour and so the relative profitability of the three services, given a shortage of labour. Strictly, we should use the contribution per hour, but we do not know the number of hours involved. Since all labour is paid at the same rate, using labour cost will give us the same order of priority as using hours.

Alpha

Beta

Gamma

£000

£000

£000

Materials

(6)

(4)

(5)

Labour

(9)

(6)

(12)

Expenses

(3)

(2)

(2)

Total variable cost

(18)

(12)

(19)

Sales revenue

39

29

33

Contribution

21

17

14

Contribution per £ of labour

2.333

2.833

1.167

2nd

1st

3rd

Variable cost:

Order of profitability

Since 50 per cent of each budget (and, therefore, £13,500 of labour) is committed, only £6,500 (£20,000 − £13,500) of labour is left uncommitted. The £6,500 should be deployed as: £ Beta

3,000

Alpha

3,500 6,500

27 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Total labour committed to each service and resultant profit is as follows: Alpha

Beta

Gamma

Total

£

£

£

£

50% of budget

4,500

3,000

6,000

Allocated above

3,500

3,000

—

Total

8,000

6,000

6,000

Contribution per £ of labour

2.333

2.833

1.167

Contribution per unit of service*

18,664

16,998

7,002

Labour

20,000 42,664

Less Fixed cost

33,000

Maximum profit (after rounding)

9,664

*The contribution per £ of labour × total labour.

(b) The steps include: •

Using all of the surplus labour to render the Beta service (the most efficient user of labour). In other words, could the business sell more than £29,000 of this service? It might be worth reducing the price of the Beta, though still keeping the contribution per £1 of labour above £2.33, in an attempt to expand sales.

•

Dropping the commitment to 50 per cent of budget on each service, in favour of providing the maximum of the higher-yielding services?

•

Finding another source of labour.

•

Subcontracting the labour-intensive part of the work.

Some, possibly all, of these approaches may not be practical in the circumstances, but they seem worth considering. Other approaches may also be worth considering.

28 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 7.2 The hotel group (a) The variable element and, by implication, the fixed element of the hotel’s cost can be deduced by comparing any two quarters, for example: Quarter

Sales

Profit (loss)

Total cost

£000

£000

£000

1

400

(280)

680*

2

1,200

360

840*

revenue

Difference

800

160*

* This is because: Sales revenue – total cost = profit (or loss) So, Sales revenue – profit (or + loss) = total cost

Thus the variable element of the sales price is 20 per cent (that is, 160/800). Now: The fixed cost for quarter 1 = Total cost − Variable cost = £680,000 − (20% × 400,000) = £600,000 To check that this calculation is correct and consistent for all four quarters, we can ‘predict’ the total cost for the other three quarters and then check the predicted results against those that can be deduced from the question, as follows: Quarter 2 Total cost = fixed cost + variable cost = £600,000 + (20% × 1,200,000) = £840,000

Agrees with the question

Quarter 3 Total cost = fixed cost + variable cost = £600,000 + (20% × 1,600,000) = £920,000

Agrees with the question

Quarter 4 Total cost = fixed cost + variable cost = £600,000 + (20% × 800,000) = £760,000

Agrees with the question

Had the fixed and variable elements been deduced graphically, the consistency of the fixed and variable cost elements over the four quarters would have been obvious because a straight line would have emerged.

29 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

The provisional results for this year are as follows: Total

Per visitor (50,000 visitors)

£000

£

Sales revenue

4,000

80

Variable cost (20% of sales revenue)

(800)

(16)

Contribution

3,200

64

Fixed cost (that is, fixed cost a quarter × 4)

(2,400)

(48)

800

16

Profit

(b) (i) At the same level of occupancy as for this year and incorporating the increase in variable cost of 10 per cent, the sales revenue for next year will need to be: £000 Fixed cost

2,400

Variable cost (800,000 × 110%)

880

Total cost

3,280

Target profit

1,000

Sales revenue target

4,280

Hence, the sales revenue per visitor is: £4,280,000 = £85.60 50,000

(ii) If the sales revenue per visitor remains at the current rate, the contribution per visitor will be: £80 − (£16 × 110%) = £62.40 To cover the fixed cost and the target profit, would take: £2,400,000 + 1000 , ,000 ≈ 54,487 visitors £62.40

(c) The major assumptions of profit–volume analysis are that cost can be divided between those that vary with the volume of activity (and with that factor alone) and those that are totally unaffected by volume changes. Further assumptions are that both variable cost and sales revenues vary at a steady rate (straight-line relationship) with volume.

In reality, these assumptions are unlikely to be strictly valid. Variable cost is unlikely to vary in a truly straight-line manner in relation to volume. For example, at higher levels of output, there may be economies of scale in purchasing (for example, bulk discounts) or the opportunity to use materials or labour more effectively. On the other hand, the opposite may be the case. At higher levels of output, cost per unit increases because a shortage may be created by the higher output level. Similarly, the business may not be able to sell more without reducing the selling price.

30 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 8.2 Pieman Products Ltd Indirect cost: £ Indirect labour

25,000

Depreciation

8,000

Rent and rates

10,000

Heating, lighting and power

5,000

Indirect materials

2,000

Other indirect elements

1,000

Total indirect cost

51,000

This list does not include the direct cost because we shall deal with the direct cost separately.

Probably a direct-labour hour basis of charging overheads to jobs is most logical in this case (see below). The direct-labour hours are given as 16,000.

Overhead recovery rate per direct-labour hour: £51,000/16,000 = £3.1875 per direct-labour hour Full cost of the trailer: £ Direct materials

1,150.00

Direct labour

(250 × (£160,000/16,000))

Indirect cost

(250 × £3.1875)

Total cost

2,500.00 796.88 4,446.88

That is, about £4,450.

Direct-labour hours are probably the most logical basis for charging overheads to the job. Those hours probably provide the only measurable thing that is a reasonable assessment of the size/complexity/importance of each job relative to the others undertaken. The business’s work is probably labour intensive; it is probably difficult to introduce work that is very much machinecontrolled into making trailers to individual specifications.

31 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 8.3 Athena Ltd (a) Budgeted overheads for next year Total

Machining

Finishing

Department

Department

£

£

£

Heating and lighting

25,000

12,500

12,500

Machine power

10,000

10,000

—

Indirect labour*

50,000

37,500

12,500

Depreciation

30,000

30,000

115,000

90,000

25,000

* This is divided 150,000:50,000, that is, in proportion to direct labour.

Note that direct labour and materials are not included in this schedule because they are not elements of indirect cost. (b) Machining Department The machine hour rate = £90,000/20,000 = £4.50 per hour Fitting Department The direct labour hour rate = £25,000/(150,000/10) = £1.67 per hour. (Note that the direct workers are paid £10 an hour, so the hours to be worked are 150,000/10.) (c) Job price £ Direct materials

1,200

Direct labour: Machining Department

10 hours × £10

100

Fitting Department

20 hours × £10

200

Machining Department

50 hours × £4.50

225

Fitting Department

20 hours × £1.67

33

Overheads: (to the nearest £)

1,758 Profit loading

20% × £1,758

352 £2,110

Thus the price will be £2,110.

32 .

(to the nearest £)

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 9.1 (a) A budget is a business plan for a future period, usually expressed in financial terms. A forecast is an assessment/estimation of what is expected to happen in the environment.

‘Plan’ implies an intention to achieve. Thus, a budget is a plan of what is intended to be achieved during the period of the budget. Relevant forecasts may well be taken into account when budgets are being prepared, but there is a fundamental difference between budgets and forecasts.

Though a year is a popular period for detailed budgets to be drawn up, there is no strong reason, in principle, why they have to be of this length. (b) The layout described is generally regarded as a useful approach. Budgets are documents exclusively for the use of managers within the business. For this reason, those managers can use whatever layout best suits their purpose and tastes. In fact, there is no legal requirement that budgets should be prepared at all, let alone that they are prepared in any particular form. (c) It is probably true to say that any manager worth employing would not want to work for a business that did not have an effective system of budgeting. Without budgeting, the advantages of: •

co-ordination,

•

motivation,

•

focusing on the future,

•

provision of the basis of a system of control and

•

providing a system of authorisation

would be lost.

Any good system of budgeting would almost certainly have individual managers participating heavily in the preparation of their own budgets and targets. It would also be providing managers with demanding, but rigorous, targets. This would give good managers plenty of scope to show flair and initiative, yet be part of a business that is organised, in control and potentially successful. (d) Any sensible person would probably start with the budget for the area in which the limiting factor lies – that is, that factor that will, in the end, prevent the business from achieving its objectives to the extent that would have been possible were it not for that factor.

It is true that, in practice, sales demand is often the limiting factor. In those cases, the sales budget is the best place to start. The limiting factor could, however, be a shortage of suitable labour or materials. In this case, the labour or materials budget would be the sensible place to start.

The reason why the starting point is important is simply that it is easier to start with the factor that is expected to limit the other factors and for those other factors to fit in.

33 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 9.2 Daniel Chu Ltd (a) The finished goods inventories budget for the six months ending 30 September (in units of production) is:

April

May

June

July

Aug

Sept

units

units

units

units

units

units

0

500

600

700

800

900

500

600

700

800

900

900

(0)

(500)

(600)

(700)

(800)

(900)

500

600

700

800

900

900

Opening inventories (note 1) Production (note 2) Sales (note 3) Closing inventories

(b) The raw materials inventories budget for the six months ending 30 September (in units) is: April

May

June

July

Aug

Sept

units

units

units

units

units

units

0

600

700

800

900

900

Purchases (note 2)

1,100

700

800

900

900

900

Production (note 4)

(500)

(600)

(700)

(800)

(900)

(900)

Closing inventories

600

700

800

900

900

900

Opening inventories (note 1)

The raw materials inventories budget for the six months ending 30 September (in financial terms) is: April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

Opening inventories (note 1) —

24

28

32

36

36

Purchases (note 2)

44

28

32

36

36

36

(20)

(24)

(28)

(32)

(36)

(36)

24

28

32

36

36

36

Production (note 4)

Closing inventories

34 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

(c) The trade payables budget for the six months ending 30 September is: April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

—

44

28

32

36

36

(note 5)

44

28

32

36

36

36

Cash payment

—

(44)

(28)

(32)

(36)

(36)

Closing balance

44

28

32

36

36

36

Opening balance (note 1) Purchases

(d) The trade receivables budget for the six months ending 30 September is: April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

Opening balance (note 1)

—

—

50

60

70

80

Sales (note 3)

—

50

60

70

80

90

Cash received

—

—

(50)

(60)

(70)

(80)

Closing balance

—

50

60

70

80

90

35 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

(e) The cash budget for the six months ending 30 September is:

April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

Inflows Share issue

300

Receipts – trade receivables (note 6)

—

—

50

60

70

80

Total inflows

300

—

50

60

70

80

(note 7)

—

44

28

32

36

36

Labour (note 3)

10

12

14

16

18

18

17

17

17

17

17

17

(note 8)

10

10

10

10

10

10

Non-current assets

250

—

—

—

—

—

Total outflows

287

83

69

75

81

81

(outflows)

13

(83)

(19)

(15)

(11)

(1)

Balance c/f

13

(70)

(89)

(104)

(115)

(116)

Outflows Payments to trade payables

Overheads: Production Non-production

Net inflows

Notes Note 1. The opening balance is the same as the closing balance from the previous month.

Note 2. This is a balancing figure.

Note 3. This figure is given in the question.

Note 4. This figure derives from the finished inventories budget.

Note 5. This figure derives from the raw materials inventories budget.

Note 6. This figure derives from the trade receivables budget.

Note 7. This figure derives from the trade payables budget.

Note 8. This figure is the non-productive overheads less depreciation, which is not a cash expense.

36 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 10.2 C. George (Controls) Ltd (a) and (b) The potential variable cost savings per unit of the product is as follows: £ Labour

2.10

(that is, £3.30 − £1.20)

Materials

0.45

(that is, £3.65 − £3.20)

Variable overheads

0.18

(that is, £1.58 − £1.40)

2.73 × 50,000 = £136,500 each year

Incremental cash flows Year 0

Year 1

Year 2

Year 3

Year 4

£000

£000

£000

£000

£000

136.5

136.5

136.5

136.5

Variable cost savings New equipment

(670.0)

70.0

Old equipment

150.0

(40.0)

Working capital

130.0

____

____

____

(130.0)

(390.0)

136.5

136.5

136.5

36.5

Discount factors

1.000

0.893

0.797

0.712

0.636

Present values

(390.0)

121.9

108.8

97.2

23.2

NPV

(38.9)

(c) Since the NPV is negative, the project would have an adverse effect on the wealth of the shareholders of the business and should not be pursued. (d) Cash flow projections are used rather than profit projections since it is cash that gives command over resources. It is only when the cash is paid or received that the opportunity to deploy it elsewhere is lost or gained respectively.

In the long run, profit and cash flows should be equal; however, the timing of the flows will be different.

37 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 10.3 The accountant (a) Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

£000

£000

£000

£000

£000

£000

Sales revenue

450

470

470

470

470

Working capital recovered

___

___

___

___

180

450

470

470

470

650

Materials

126

132

132

132

132

Labour

90

94

94

94

94

Overheads

30

30

30

30

30

Working capital

180

New equipment

500

___

___

___

___

___

680

246

256

256

256

256

(680)

204

214

214

214

394

Incremental cash flows

Notes: •

Working capital invested in this project at the start will be recovered at the end of the project’s life.

•

The relevant overheads figure is £30,000 a year additional expense that the project is expected to cost.

•

Depreciation is not a cash flow.

•

Interest on the working capital investment, and indeed on other aspects of this investment, is dealt with by discounting.

•

The development cost is not a relevant cost, since it has been incurred already and is not affected by the decision to be made.

•

The cost of the equipment to start this project is the £500,000 that must be spent. The carrying value of the old machine is not relevant since this does not represent an outlay or an opportunity cash flow.

38 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

(b) (i) Payback period

Incremental cash flows

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

£000

£000

£000

£000

£000

£000

(680)

204

214

214

214

394

(680)

(476)

(262)

(48)

166

560

Cumulative incremental cash flows

Thus, the payback point occurs in Year 4, that is, after just over 3 years (assuming cash flows accrue evenly over the year). (ii) NPV Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

£000

£000

£000

£000

£000

£000

Incremental cash flows

(680)

204

214

214

214

394

Discount factor

1.000

0.893

0.797

0.712

0.636

0.567

Present values

(680)

182.2

170.6

152.4

136.1

223.4

NPV

184.7

(c) A memo to the board might include the following points: •

The fact that the project has a significant positive NPV, which would increase shareholder wealth.

•

The fact that the project has a relatively short payback period.

•

The figures in the analysis ignore taxation, which should be considered before a final decision is made.

•

The question of risk should be considered before a final decision is made.

39 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 11.4 Gainsborough Fashions Ltd (a) The major factors that a bank should take into account are as follows: •

Need – Is the overdraft necessary? The statement of financial position shows that the business probably has over three months’ inventories. It seems very likely that this level could be reduced, without damaging its ability to meet the needs of its customers. This certainly should be looked at first. It does not require the compliance of those outside the business. It may also have advantages of saving on storage space and, particularly in the fashion trade, the risk of obsolescence.

•

Purpose – What is the purpose of the overdraft? Is it to help finance a temporary cash shortage? Will the purpose ensure that the overdraft is self-liquidating? If not, how will the overdraft be repaid?

•

Repayment period – When will the overdraft be repaid? Has a cash flow projection been prepared, clearly showing the repayment period and financing requirements? Are the underlying assumptions of the forecast valid and reliable?

•

Security – What assets can be offered as security for the overdraft? Are the assets readily realisable?

•

Financial strength – What is the financial position and performance of the business?

What are the risks involved in the business in which it is engaged? Can the business cope with a downturn in sales volume?

•

Directors – What are the abilities and characteristics of directors? Are they managing the business efficiently? Would they make every effort to repay the overdraft when required?

•

Track record – Has the business taken out loans before and, if so, did the business comply with the terms of these loans?

(b) A number of points can be made concerning the business's request for an overdraft: •

Ability to repay – The information available does not indicate how the proposed increase in overdraft might be repaid. In order to reduce the average credit period taken from suppliers from three months to one month, the finance required will be £108,000 (that is, 2/3 × £162,000). This is more than four times the business’s current profit for the year (after taxation). It does not seem likely, therefore, that the overdraft, which is meant to be a short-term form of borrowing, could be repaid out of short-term future profits. As the purpose of the overdraft is to repay trade payables, the overdraft will not generate further cash flows for the business and so will not be self liquidating.

•

It is interesting to note that the loan notes are due for repayment in the near future (one year’s time). Were the loan notes to be repaid before the overdraft is due for repayment, it is likely to make it even more difficult for the business to repay the overdraft.

•

Risk – The purpose of the overdraft is to replace one form of short-term borrowing with another. This will mean that the financing risks will be transferred from the trade payables to the bank. These financing risks are quite high. If the overdraft is granted for one year, the annual interest payments would increase by approximately £13,000 (that is, £108,000 @ 12%). Assuming profits remain constant, this would reduce the interest

40 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

cover ratio from 7.6 times (that is, 38/5) to 2.1 times (that is, 38/(5 + 13)). The total debt to total asset ratio would not be changed by the new financing arrangements. However, the ratio is already high at 85.1% (that is, (194 + 40)/(74 + 201)) and the new arrangements would increase the bank’s exposure.

•

Security – The statement of financial position does not reveal any assets that the bank is likely to find particularly attractive as security for the loan. Although it is possible that the directors may be able to provide personal guarantees, it should be noted that they already offer personal guarantees in respect of the loan notes outstanding. (However, if the loan notes are repaid, this would release some debt capacity.)

•

Undercapitalisation – The main problem with the business appears to be one of undercapitalisation. It really requires an injection of long-term finance in order to provide a sounder financial base. Given the business’s high level of gearing, lenders are likely to expect a significant proportion of any new long-term finance to be raised through the issue of equity shares. At present, the return to equity shareholders is very high at 56.1% (that is, 23/41) and so raising additional equity finance may not be a problem. An issue of equity shares to raise all the necessary finance would mean that, if operating profit remains constant, the return to equity could still prove attractive to investors.

If inventories levels can be reduced, the problem could be solved without the need for additional external finance. Should inventories reduction not solve the problem, the request for an overdraft is unlikely to prove successful. Instead, the business should attempt to improve its long-term financial structure.

41 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 11.5 Telford Engineers plc (a) Projected income statement for the year ending 31 December Year 10 Debt

Shares

£m

£m

Operating profit

21.00

21.00

Interest payable

(7.80) [5 + (20 × 14%)]

(5.00)

Profit before taxation

13.20

16.00

Taxation (30%)

(3.96)

(4.80)

Profit for the year

9.24

11.20

Dividends payable

4.00

5.00

Debt

Shares

£m

£m

Share capital 25p shares

20.00

25.00

(20 + (20 × 0.25))

Share premium

—

15.00

(20 × (1.00 − 0.25))

Reserves*

48.24

49.20

68.24

89.20

50.00

30.00

118.24

119.20

Equity

Non-current liabilities

*The reserves figures are the Year 9 reserves plus the Year 10 (after taxation) profit less dividend paid. The Year 9 figures for share capital and reserves was 63, of which 20 (that is, 80 × 0.25) was share capital, leaving 43 as reserves. Add to that the retained profit for Year 10 (that is, 5.24 (debt) or 6.20 (shares)).

(b) Earnings per share Loan notes (9.24/80)

11.55p

Shares (11.20/100)

11.20p

42 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

(c) The loan notes option will raise the gearing ratio and lower the interest cover of the business. This should not provide any real problems for the business as long as profits reach the expected level for Year 9 and remain at that level. However, there is an increased financial risk as a result of higher gearing, and shareholders must carefully consider the adequacy of the additional returns to compensate for this higher risk. This seems a particular problem since profit levels seem variable over recent years. The figures given above suggest only a marginal increase in EPS compared with the equity alternative at the expected level of profit for Year 9.

The share alternative will have the effect of reducing the gearing ratio and is less risky.

However, there may be a danger under this alternative of the dilution of control by existing shareholders. This may prove unacceptable to them. An issue of equity shares may, however, provide greater opportunity for flexibility in financing future projects.

Information concerning current loan repayment terms and the attitude of shareholders and existing lenders towards the alternative financing methods would be useful.

43 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 12.2 International Electric plc (a) The approximate equivalent annual percentage cost of allowing 2% discount for receiving cash 40 days earlier is: (365/40) × 2%

=

18.25%

(b) Value of trade receivables outstanding Old scheme

New scheme

£m

£m

0.5 × (£365m × 30/365)

15.0

15.0

0.5 × (£365m × 70/365)

35.0

0.25 × (£365m × 30/365)

—

7.5

0.25 × (£365m × 70/365)

____

17.5

50.0

40.0

Trade receivables owing

(c) Cost of discounts allowed = (0.75 × £365m) × 2%

= £5,475,000

(d) Net cost of the discount scheme £ Cost of discounts

£ 5,475,000

Less Interest charges saved ((£50m − £40m) @ 12%)

1,200,000

Bad debt savings

300,000

Net cost

1,500,000 3,975,000

The calculations reveal that the costs of the discounts scheme heavily outweigh the benefits. (e) To manage its trade receivables, the business should consider doing the following: •

Establish clear policies concerning who should receive credit and how long the credit period should be.

•

Establish a system for investigating creditworthiness.

•

Ensure that customers are invoiced promptly and that statements and reminders are issued at appropriate points.

•

Establish systems for monitoring and controlling trade receivables, such as ageing schedules, average settlement period ratios and so on.

•

Set up procedures for dealing with slow payers.

44 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

Solution to Exercise 12.3 Sparkrite Ltd (a) last year

this year

Inventories turnover period (160 + 200) / 2 × 365 1,080

61 days

(200 + 250) / 2 × 365 1,125

73 days

Average settlement period for trade receivables *

375 × 365 1,800

76 days

480 × 365 1,920

91 days

* Year-end trade receivables figures were used because opening figures were not available in both years. (b) (i) Ways in which the business can exercise control over inventories levels include: •

Use of sales forecasting methods in order to assess demand for inventories.

•

Use of inventories management models in order to determine the economic order quantity.

•

Proper authorisation procedures for ordering inventories.

•

Establishing an accurate inventories-recording system.

•

Use of the just-in-time method, improving supplier lead times and so on to minimise inventories holding.

•

Regular physical checks to ensure accuracy of inventories records and to identify slow-moving and obsolete items.

•

Ensuring levels of inventories monitoring and security are appropriate to the value of the inventories held.

45 .

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 7th Edition, Instructor’s Manual

(ii) Ways in which the business can exercise control over trade receivables’ levels include: •

Establishing creditworthiness checks on potential customers.

•

Establishing credit limits.

•

Offering discounts for prompt payment.

•

Charging interest on late payment.

•

Calculating average settlement periods and preparing ageing schedules of trade receivables outstanding.

•

Invoicing customers promptly and sending reminders and statements at appropriate points.

•

Checking to see where credit limits have been breached.

•

Establishing a policy for dealing with late payers.

•

Factoring (that is allowing a finance institution to manage the trade receivables and obtaining finance on the strength of the amounts owing to the business), where appropriate.

46 .

Slide 1.1

Chapter 1 Introduction to accounting and finance LEARNING OUTCOMES

You should be able to: Explain the nature and roles of accounting and finance

Identify the main users of financial information and discuss their needs

Distinguish between financial accounting and management accounting

Explain why an understanding of accounting and finance is likely to be relevant to your needs Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.2

Main users of financial information relating to a business

Owners

Customers

Competitors

Employees and their representatives

Managers

Business Lenders

Suppliers

Government

Investment analysts

Community representatives

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.3

The characteristics that influence the usefulness of accounting information Materiality

Cost/Benefit

Comparability

Relevance

Characteristics that make financial information useful

Reliability

Understandability

Necessary for including information in the financial statements

Limitation to the application of the qualitative characteristics

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.4

The accounting information system

Information identification

Information recording

Information analysis

Information reporting

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.5

Financial and management accounting The major differences concern:

Nature of the reports produced

Level of detail

Regulations

Reporting interval

Time orientation

Range and quality of information Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.6

Changes in the business environment Increasing sophistication of customers Development of a global economy

Rapid changes in technology

Deregulation of domestic markets Increasing pressure from owners (shareholders) for competitive returns Increasing volatility of financial markets Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.7

Return

Relationship between risk and return

Risk

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 1.8

What you need to know

How accounting reports should be read and interpreted How financial plans are made

How investment decisions are made

How businesses are financed

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.1

Chapter 2 Measuring and reporting financial position LEARNING OUTCOMES You should be able to: Explain the nature and purpose of the three major financial statements

Prepare a simple statement of financial position and interpret the information that it contains

Discuss the accounting conventions underpinning the statement of financial position

Discuss the uses and limitations of the statement of financial position for decision-making purposes

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.2

The major financial statements – an overview

Statement of cash flows

Income statement

Statement of financial position

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.3

Relationship between the statement of financial position, the income statement and the statement of cash flows

Statement of financial position

Statement of financial position

Statement of financial position

Income statement

Income statement

Statement of cash flows

Statement of cash flows

Period 1

Period 2

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Time

Slide 2.4

Assets Major characteristics

A probable future benefit must exist The business must have the right to control the resource

The benefit must arise from some past transaction or event The asset must be capable of measurement in monetary terms Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.5

Claims

There are essentially two types of claim against a business:

Equity

Liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.6

The accounting equation

plus

equals

Assets

Equity

Liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.7

The effect of trading transactions on the accounting equation

The accounting equation can be extended as follows:

plus (minus)

equals

Assets

Equity

plus

Profit (Loss)

Liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.8

The classification of assets

The classification of assets may vary according to the nature of the business:

Current assets

Non-current assets

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.9

Current assets

Held for sale or consumption during the business’s operating cycle Expected to be sold within the next year

Held principally for trading

They are cash or near equivalents to cash

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.10

Non-current assets

Do not meet the definition of current assets

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.11

The circulating nature of current assets

Inventories (stock)

Cash

Trade receivables (trade debtors)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7 th Edition, .

Slide 2.12

The classification of claims

Current liabilities

Non-current liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.13

Current liabilities

Expected to be settled within the business’s normal operating cycle Held principally for trading purposes Are due to be settled within a year after the date of the relevant statement of financial position No right to defer settlement beyond a year after the date of the relevant statement of financial position

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.14

Non-current liabilities

Do not meet the definition of current liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.15

Example 2.5 Brie Manufacturing Statement of financial position as at 31 December 2009 £000 ASSETS Non-current assets Property Plant and equipment Motor vans

45 30 19 94

Current assets Inventories Trade receivables Cash at bank

23 18 12 53 147

Total assets EQUITY AND LIABILITIES Equity Non-current liabilities Long-term borrowings Current liabilities Trade payables Total equity and liabilities

60 50 37 147

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.16

Example 2.6 Brie Manufacturing Statement of financial position as at 31 December 2009 £000 ASSETS Non-current assets Property Plant and equipment Motor vans

45 30 19 94

Current assets Inventories Trade receivables Cash at bank

23 18 12 53 147

Total assets LIABILITIES Non-current liabilities Long-term borrowings Current liabilities

(50)

Trade payables

(37)

Total liabilities

(87)

Net assets EQUITY

60 60 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.17

The equation for the standard layout

Noncurrent assets

+

Current assets

=

Equity

Non+ current liabilities

+ Current

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

liabilities

Slide 2.18

The equation for the non-standard layout

Noncurrent assets

+

Current assets

-

Current liabilities

-

Noncurrent liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

=

Equity

Slide 2.19

Accounting conventions influencing the statement of financial position

Business entity convention

Statement of financial position

Dual aspect convention

Historic cost convention

Prudence convention

Going concern convention

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.20

Money measurement

Key resources of a business that normally defy reliable measurement:

Goodwill and brands

Human resources

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 2.21

Uses of the statement of financial position

It shows how the business is financed and how its funds are deployed It can provide a basis for assessing the value of the business Relationships between assets and claims can be assessed

Performance can be better assessed

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.1

Chapter 3 Measuring and reporting financial performance LEARNING OUTCOMES You should be able to:

Discuss the nature and purpose of the income statement Prepare an income statement from relevant financial information and interpret the information that it contains Discuss the main recognition and measurement issues that must be considered when preparing the income statement Explain the main accounting conventions underpinning the income statement Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.2

Measuring profit

Profit (or loss) for the period

=

Total revenue for the period less Total expenses incurred in generating that revenue

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.3

Arsenal’s revenue for the year ended 31 May 2009

Player trading 1%

Property development 28%

12% Commercial

4% Retail

Gate and other match day revenues 32%

23% Broadcasting

Source: based on information in Arsenal Holdings plc Annual Report 2009, Note 3 to the financial statements.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.4

Relationship between the income statement and the statement of financial position

Assets

=

Equity

+ (-)

Profit (Loss)

+ Liabilities

The above equation can be extended to:

Assets

=

Equity

+

Sales revenue

- Expenses + Liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.5

Better-Price Stores Income statement for the year ended 31 October 2009 £

Sales revenue

232,000

Cost of sales

154,000

Gross profit

78,000

Salaries and wages

(24,500)

Rent and rates

(14,200)

Heat and light

(7,500)

Telephone and postage

(1,200)

Insurance

(1,000)

Motor vehicle running expenses

(3,400)

Depreciation – fixtures and fittings

(1,000)

Depreciation – motor van

(600)

Operating profit

24,600

Interest received from investments

2,000

Interest on borrowings

(1,100)

Profit for the year

25,500 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.6

Calculating gross profit for Better-Price Stores

£ Sales revenue

£ 232,000

Cost of sales: Opening inventories

40,000

Goods bought

189,000

Closing inventories

(75,000)

Gross profit

(154,000)

78,000

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.7

Profit measurement and the recognition of revenue Basic criteria that must be met before revenue is recognised:

The amount of revenue can be measured reliably It is probable that the economic benefits will be received Additional criterion is to be applied where the revenue comes from the sale of goods: Ownership and control of the items should pass to the buyer Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.8

Accounting for sales commission

Income statement

Statement of cash flows

Sales commission expense £6,000

Cash £5,000

Statement of financial position at year end

Accrual £1,000

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.9

Accounting for rent payable

Income statement

Statement of cash flows

Rent payable expense £16,000

Statement of financial position at year end

Cash £20,000

Prepaid expense £4,000

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.10

Accounting conventions and the income statement

Materiality

Accruals

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.11

Profit measurement and the calculation of depreciation

To calculate a depreciation charge for a period, four factors have to be considered:

The cost (or fair value) of the asset

The useful life of the asset

Residual value (disposal value) Depreciation methods

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.12

Carrying amount (£000)

Graph of carrying amount against time using the straight-line method 80

60

40

20

0

1

2

3

4

Asset life (years) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.13

Reducing-balance method

Deriving the fixed percentage

P

n

= (1 - R/C x 100%)

where: P = the depreciation percentage n = the useful life of the asset (in years) R = the residual value of the asset C = the cost, or fair value, of the asset

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.14

Carrying amount (£000)

Graph of carrying amount against time using the reducing-balance method 80

60

40

20

0

1

2

3

4

Asset life (years) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.15

Calculating an annual depreciation charge Cost (or fair value) less

Residual value equals

Depreciable amount

Year 1

Year 2

Year 3

Year 4 and so on

Depreciation

Depreciation

Depreciation

Depreciation

Asset life (Number of years) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.16

Profit measurement and inventory costing methods

Common assumptions used are:

First in, first out (FIFO)

Last in, first out (LIFO)

Weighted average cost (AVCO)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.17

Bad debts written off

Reduce trade receivables

Increase expenses

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 3.18

Uses of the income statement

Helps in providing information on:

How effective the business has been in generating wealth

How the profit was derived

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.1

Chapter 4

Accounting for limited companies

LEARNING OUTCOMES You should be able to:

Discuss the nature of the limited company

Describe the main features of the equity (owner’s claim) in a limited company Discuss the framework of rules designed to safeguard the interests of shareholders

Explain how the income statement and statement of financial position of a limited company differ in detail from those of sole proprietorships and partnerships Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.2

Main features of limited companies

Legal nature

Perpetual life

Limited liability

Legal safeguards

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.3

Two main forms of limited company

Public limited company (plc)

Private limited company (Ltd)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.4

The economic importance of public limited companies – an example Market share of the four largest grocers: 12 weeks to 24 January 2010 Other 23.8%

Tesco 30.5%

12.5% Morrison 16.3% Sainsbury

16.9% Asda

Source: complied from information in Mills, E., 'Tesco's grocery market share rises to 30.5% in 12 weeks - Kantar', Dow Jones Newswires, 2 February 2010.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.5

Principles underpinning a framework of rules

Disclosure

Framework of rules

Fairness

Accountability

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.6

The UK Corporate Governance Code

Every listed company should have a board of directors

There should be a clear division of responsibilities between the chairman and the chief executive officer There should be a balance of skills, experience, independence and knowledge

The board should receive timely information Appointments to the board should be the subject of rigorous, formal and transparent procedures

All directors should submit themselves to re-election at regular intervals Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.7

The UK Corporate Governance Code (Continued)

Remuneration levels should be sufficient to attract, retain and motivate directors of the appropriate quality There should be formal and transparent procedures for developing policy on directors’ remuneration The board should present a balanced and understandable assessment of the company’s position and prospects

The board should try to ensure that a satisfactory dialogue with shareholders occurs Boards should use the annual general meeting to communicate with investors

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.8

The UK Corporate Governance Code (Continued)

Institutional shareholders should use their votes and enter into a dialogue with the company

The board should define the company’s risk appetite and tolerance and maintain a sound risk management system Formal and transparent arrangements for financial reporting and internal control should be in place The board should formally and rigorously examine its own performance each year

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.9

Altering the nominal value of shares

Share splits

Share consolidation

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.10

Raising share capital

Rights issues

Public issues

Private placings

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.11

Sources of long-term finance for a typical limited company

Long-term finance

Share issues

Retained profits

Long-term borrowings

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.12

Availability for dividends of various parts of the shareholders’ equity Share capital (at nominal or par value)

Not available for dividend

Capital reserves

Revenue reserves

Available for dividend

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.13

Da Silva plc: Income statement for the year ended 31 December 2010 £m Revenue

840

Cost of sales

(520)

Gross profit

320

Wages and salaries

(98)

Heat and light

(18)

Rent and rates

(24)

Motor vehicle expenses

(20)

Insurance

(4)

Printing and stationery

(12)

Depreciation

(45)

Audit fee

(4)

Operating profit

95

Interest payable

(10)

Profit before taxation

85

Taxation

(24)

Profit for the year

61 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.14

Da Silva plc: Statement of financial position as at 31 December 2010 ASSETS Non-current assets Property, plant and equipment Intangible assets Current assets Inventories Trade receivables Cash

£m 203 100 303 65 112 36 213 516

Total assets EQUITY AND LIABILITIES Ordinary shares of £0.50 each Share premium account Other reserves Retained earnings

200 30 50 25 305

Non-current liabilities Borrowings Current liabilities Trade payables Taxation Total equity and liabilities

100 99 12 111 516 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.15

Malik plc Statement of comprehensive income for the year ended 31 July 2010 Revenue

£m 97.2

Cost of sales

(59.1)

Gross profit

38.1

Other income

3.5

Distribution expenses

(16.5)

Administration expenses

(11.2)

Other expenses

(2.4)

Operating profit

11.5

Finance charges

(1.8)

Profit before tax

9.7

Tax

(2.4)

Profit for the year

7.3

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.16

Malik plc Statement of comprehensive income for the year ended 31 July 2010 (Continued)

£m Other comprehensive income

Revaluation of property, plant and equipment

6.6

Foreign currency translation differences for foreign operations

4.0

Tax on other comprehensive income

(2.6)

Other comprehensive income for the year, net of tax

8.0

Total comprehensive income for the year

15.3

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.17

Miro plc Statement of changes in equity for the year ended 31 December 2010 Share Share Revaluation. Translation. Retained Total capital premium reserve reserve earnings £m

£m

£m

£m

£m

£m

100

_

20

40

150

310

Issue of ordinary shares

50

20

_

_

_

70

Dividends

_

_

_

_

(27)

(27)

120

(10)

42

152

140

30

165

505

Balance as at 1 January 2010 Changes in equity for 2010

Total comprehensive income for the year Balance at 31 December 2010

150

20

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.18

Accounting Standards Deal with issues such as:

What information should be disclosed How information should be presented

How assets should be valued

How profit should be measured Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.19

Sources of external accounting rules for a UK public limited company listed on the London Stock Exchange

Company law

External accounting rules

International Financial Reporting Standards

Stock Exchange rules imposed by FSA

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 4.20

The relationship between the shareholders, the directors and the auditors

Directors review account elect report

Shareholders

elect

Auditors

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.1

Chapter 5 Measuring and reporting cash flows LEARNING OUTCOMES You should be able to:

Discuss the crucial importance of cash to a business Explain the nature of the statement of cash flows and discuss how it can be helpful in identifying cash flow problems

Prepare a statement of cash flows

Interpret a statement of cash flows Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.2

A definition of cash and cash equivalents (IAS7)

Definitions:

Notes and coins in hand and deposits in banks and similar institutions that are accessible on demand

Cash

Cash equivalents

Short-term, highly liquid investments that are readily convertible to known amounts of cash

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.3

The relationship between the statement of financial position, the income statement and the statement of cash flows

Equity

Income statement

Equity

Statement of financial position at the start of the accounting period

Statement of financial position at the end of the accounting period

Cash and cash equivalents

Cash and cash equivalents

Cash flow Statement

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.4

Standard layout of the statement of cash flows Cash flows from operating activities plus or minus

Cash flows from investing activities plus or minus

Cash flows from financing activities equals

Net increase (or decrease) in cash and cash equivalents over the period Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.5

Diagrammatical representation of the statement of cash flows

Operating activities

Cash and cash equivalent balances

Investing activities

Financing activities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.6

Tesco plc Summarised statement of cash flows for the year ended 28 February 2009 £m Cash generated from operations

4,978

Interest paid

(562)

Corporation tax paid

(456)

Net cash from operating activities

3,960

Net cash used in investing activities

(5,974)

Cash flows from financing activities Dividends paid

(883)

Other net cash flows from financing activities

4,498

Net cash from financing activities

3,615

Net increase in cash and cash equivalents

1,601

Source: Tesco Annual Review 2009, www.tescocorporate.com, p. 24.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.7

Deducing net cash flows from operating activities

There are two approaches that can be taken:

The direct method

The indirect method

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.8

The indirect method of deducing the net cash flows from operating activities Profit before taxation plus Depreciation expense plus Interest expense plus or minus Increase (minus) or decrease (plus) in inventories plus or minus Increase (minus) or decrease (plus) in receivables plus or minus Increase (plus) or decrease (minus) in trade payables less

Interest paid less Taxation paid less Dividend paid equals

Net cash flows from operating activities Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.9

Torbryan plc Cash flow statement for the year ended 31 December 2010 £m

Cash flows from operating activities Profit before taxation (after interest)

193

Adjustments for: Depreciation

79

Interest receivable

(17)

Interest payable Increase in trade receivables (139 – 121)

23 (18)

Decrease in trade payables (55 – 54)

(1)

Decrease in inventories (44 – 41)

3

Cash generated from operations

262

Interest paid

(23)

Taxation paid

(39)

Dividend paid

(50)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.10

Torbryan plc Cash flow statement for the year ended 31 December 2010 (Continued) £m

Net cash from operating activities

150

Cash flows from investing activities Payments to acquire tangible non-current assets Interest received

(95) 17

Net cash used in investing activities

(78)

Cash flows from financing activities Repayments of loan notes

(150)

Issue of ordinary shares

90

Net cash used in financing activities

(60)

Net increase in cash and cash equivalents Cash and cash equivalents at 1 January 2010 Cash and cash equivalents at 31 December 2010

12 (68) (56)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 5.11

Torbryan plc Analysis of cash and cash equivalents during the year ended 31 December 2010

£m Overdraft balance at 1 January 2010

(68)

Net cash inflow

12

Overdraft balance at 31 December 2010

(56)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.1

Chapter 6 Analysing and interpreting financial statements LEARNING OUTCOMES You should be able to: Identify the major categories of ratios that can be used for analysis purposes

Calculate key ratios for assessing the financial performance and position of a business

Explain the significance of the ratios calculated

Discuss the limitations of ratios as a tool of financial analysis Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.2

Financial ratio classification Categories

Profitability

Efficiency

Liquidity

Financial gearing

Investment

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.3

Ratios benchmarks

Ratios may be compared with:

Past periods

Similar businesses during the same period

Planned performance

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.4

Profitability ratios Return on ordinary shareholders’ funds (ROSF) Profit for the year less any preference dividend x 100 Ordinary share capital + Reserves

Return on capital employed (ROCE) Operating profit x 100 Share capital + Reserves + Non-current liabilities

Operating profit margin Operating profit Sales revenue

x 100

Gross profit margin Gross profit x 100 Sales revenue Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.5

Efficiency ratios Formula Average inventories turnover period

Average inventories held Cost of sales

x 365

Average settlement period for trade receivables

Average trade receivables Credit sales revenue

x 365

Average settlement period for trade payables

Average trade payables Credit purchases

x 365

Sales revenue to capital employed ratio

Sales revenue________________ Share capital + Reserves + Non-current liabilities

Sales revenue per employee

Sales revenue Number of employees Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.6

The main elements of the ROCE ratio

Operating profit Sales revenue multiplied by

Sales revenue Long-term capital employed equals

Return on capital employed

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.7

Liquidity ratios

Formula

Current ratio

Current assets Current liabilities

Acid test ratio

Current assets (excluding inventories) Current liabilities

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.8

The effect of financial gearing

Operating profit

Returns to ordinary

shareholders

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.9

Gearing ratios

Formula

Gearing ratio

Long-term (non-current) liabilities x 100 Share capital + Reserves + Long-term (non-current) liabilities

Interest cover ratio

Operating profit Interest payable

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.10

Investment ratios (1)

Formula

Dividend payout ratio

Dividends announced for the year x 100 Earnings for the year available for dividends

Dividend cover ratio

Earnings for the year available for dividends Dividends announced for the year

Dividend yield ratio

Dividend per share/(1 – t ) Market value per share

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

x 100

Slide 6.11

Investment ratios (2)

Formula

Earnings per share

Earnings available to ordinary shareholders Number of ordinary shares in issue

Price/earnings (P/E) ratio

Market value per share Earnings per share

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.12

5

4

4.30

Average for all SE listed businesses

Beverages

Life insurance/ assurance

Electricity

Food and Drug retailers

Media

Travel and leisure

Tobacco

Pharmaceuticals and biotechnology

Chemicals

Industrial engineering

6

Construction and materials

%

Oil and gas

Average dividend yield ratios for businesses in a range of industries

5.22

4.45 4.25

4.23

4.14

3 2.65 2

2.18

3.12

2.96

2.81

2.62

2.19

1

0 Constructed from data appearing in The Financial Times, 3/4 April 2010 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.13

21.78

Average for all SE listed businesses

Beverages

Life insurance/ assurance

Electricity

Food and Drug retailers

Media

Tobacco

Travel and leisure

20.0

Pharmaceuticals and Biotechnology

28. 79

Industrial engineering

25.0

Construction and materials

times

30.0

Oil and gas

Average price/earnings ratios for businesses in a range of industries

19.07 17.34 15.0

15.58

17.17

17.73

17.20

15.11

14.10 12.77

12.31

5.0

11.31

Chemicals

10.0

0 Constructed from data appearing in The Financial Times, 3/4 April 2010 Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.14

Graph plotting current ratio against time Current ratio

0.9 0.8

J. Sainsbury plc

0.7

William Morrison plc

0.6 0.5 0.4

Tesco plc

0.3 0.2 0.1 2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: ratios calculated from information in the annual reports of the three businesses for the years 2001 to 2009.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 6.15

Limitations of ratio analysis

Quality of financial statements

Inflation

Overreliance on ratios

The basis for comparison

Statement of financial position ratios

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.1

Chapter 7 Cost–volume–profit analysis LEARNING OUTCOMES You should be able to:

Distinguish between fixed cost and variable cost and use this distinction to explain the relationship between cost, volume and profit Prepare a break-even chart and deduce the break-even point for some activity

Discuss the weaknesses of break-even analysis

Demonstrate the way in which marginal analysis can be used when making short-term decisions Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.2

The behaviour of costs

Costs may be broadly classified as:

Fixed

Those that stay fixed (the same) when changes occur to the volume of activity

Variable

Those that vary according to the volume of activity

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.3

Graph of fixed cost against the volume of activity

Cost (£)

F

0

Volume of activity (units of output)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.4

Graph of rent cost against the volume of activity

Rent cost (£)

R

0

Volume of activity

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.5

Graph of variable cost against the volume of activity

Cost (£)

0

Volume of activity

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.6

Graph of electricity cost against the volume of activity

Electricity cost (£)

The slope of this line gives the variable cost per unit of activity

Fixed cost element

0

Volume of activity

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.7

Graph of total cost against the volume of activity

Cost (£)

Total costs

Variable costs F Fixed costs 0

Volume of activity (units of output)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.8

Break-even chart

Total sales revenue

Revenue/ cost (£)

Break-even point Total cost Variable cost

F

Fixed cost 0

Volume of activity (units of output)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.9

Calculating the break-even point

b=

Fixed cost Sales revenue per unit – Variable cost per unit

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7 th Edition, .

Slide 7.10

Break-even and load factors in the airline industry

%

Load factor

100%

Break-even 80

60

82 67

64

71

40

20

0

Ryanair

BA

Source: based on information contained in 2008 annual reports of the two businesses concerned.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.11

Contribution margin ratio (CMR)

CMR =

Contribution Sales revenue

x 100%

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.12

Break-even chart for Cottage Industries’ basket-making activities without the machine 5

Revenue/ cost (£000)

Break-even point

4

Total costs

3 2

Total revenue

1

0

Fixed costs

100

200

300

400

500

Volume of activity (number of baskets) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.13

Break-even chart for Cottage Industries’ basket-making activities with the machine Revenue/ cost (£000) 6 5

Total costs Break-even point

4 3

Fixed costs 2

Total revenue

1 0

100

200

300

400

500

600

Volume of activity (number of baskets) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.14

BA’s margin of safety 1,100

11.9 Margin of safety

10.0

10.6

1,000

Operating profit 900

9.0 875 8.4

8.0

8.3

800 700

7.0 694 6.3

6.0

600

602 540

5.0 4.0

4.2

500 400

405

300

3.0 295 2.0

200

1.0

100

0 –1.0

2002

2003

2004

2005

2006

2007

2008

–110

0 –100

–1.5

–200

–2.0 Source: derived from information in British Airways plc Annual Reports 2002 to 2008.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Operating profit

Margin of safety (as a percentage of break-even point)

12.0

Slide 7.15

Achieving a target profit

Fixed cost + Target profit Sales revenue per unit – Variable cost per unit

t=

where

t = the required number of units of output to achieve the target profit

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.16

The effect of operating gearing

Volume of output

Profit

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.17

Profit-volume chart

Profit (£) Break-even point 0

Fixed cost

PROFIT Volume of activity

LOSS

Loss (£)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.18

Weaknesses of break-even analysis

Three general problems

Non-linear relationships

Stepped fixed cost

Multi-product businesses

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 7.19

Marginal analysis

Can be used for the following short-term decisions: Pricing/assessing opportunities to enter contracts

The most efficient use of scarce recourses

Make-or-buy decisions

Closing or continuation decisions

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.1

Chapter 8 Full costing LEARNING OUTCOMES You should be able to: Discuss the usefulness, for decision-making purposes, of deducing the full cost of a unit of output

Deduce the full cost of a unit of output in both a single-product and a multi-product environment using the traditional full cost method

Discuss the problem of charging full cost to jobs in a multi-product environment

Explain the role and nature of activity-based costing Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.2

Uses of full cost by managers Assessing relative efficiency

Pricing and output decisions

Uses of full cost

Exercising control

Assessing performance

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.3

Direct and indirect costs

Categories of costs

Direct costs

Indirect costs or overheads

Costs that can be identified with specific cost units – the effect of the cost can be measured in respect of each particular output

These are all other costs: that is, those that cannot be directly measured in respect of each particular unit of output

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.4

Direct and indirect costs in practice

A survey of 176 fairly large UK businesses, conducted during 1999, revealed that, on average, total costs of businesses are in the following proportion:

Direct cost

69 per cent

Indirect cost

31 per cent

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.5

The relationship between direct cost and indirect cost

Direct cost of the unit

Fair share of indirect cost (overheads)

Full cost of the unit

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.6

The relationship between fixed cost, variable cost and total cost

Fixed cost

Variable cost

Total (or full) costs

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.7

The relationship between direct, indirect, variable and fixed costs of a particular job

Fixed cost

Indirect cost (overheads) Direct cost

Variable cost

Total (or full) cost of a particular job

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.8

How the full cost is derived for the sail to be made

by Marine Suppliers Ltd in Activity 8.6 Overheads

Ascertain the total overheads for Marine supplies Ltd for the period

Derive a suitable overhead absorption rate for the business as a whole

Apply the overhead absorption rate (based on the specifics of the job, for example direct labour hours)

A particular sail (job) Direct costs Direct labour Cost of direct labour for the sail

Direct materials Cost of the direct materials to make the sail Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.9

Dealing with overheads on a departmental basis

Reasons for dividing a business into departments include:

Size and complexity

Expertise

Accountability

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.10

The effect of different bases of charging overheads to jobs in Example 8.2

Total overheads for month (£20,000) Direct labour hour basis Job 1 (£10,000)

Job 2 (£10,000)

Machine hour basis Job 1 (£14,000)

Job 2 (£6,000)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.11

A cost unit (Job A) passing through Autosparkle Ltd’s process Preparation Department

Paintshop Department

Finishing Department

* Any further direct cost * A share of the Paintshop Department’s overheads

* Any further direct cost * A share of the Finishing Department’s overheads

Customers

Costs accumulated

Job A

* Direct materials * Direct labour * A share of the Preparation Department’s overheads

+

+

=

Full cost of the job

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.12

UK businesses (%)

Analysis of the number of cost centres within a business

40

36 30

28 20

10

0

21 14

1–5 cost centres

6–10 cost centres

11–20 cost centres

more than 20 cost centres

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.13

Deriving the cost of one cost unit where production is in batches The full cost of the batch, delivered on a ‘job-costing’ basis divided by The number of cost units (products) in the batch equals

The full cost of one cost unit (product)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.14

Costing and pricing products in the traditional way

Direct-labour-intensive and direct-labour-paced production

A low level of indirect cost relative to direct cost

A relatively uncompetitive market

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.15

Costing and pricing products in the new environment

Capital-intensive and machine-paced production

A high level of overheads relative to direct costs

Highly competitive international market

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.16

Activity-based costing – what drives the costs

Identify:

Each support activity involved in making products/services

The costs attributed to each support activity

The factors that cause a change in these costs (cost drivers)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.17

Activity-based costing – attributing overheads

Establish an overhead cost pool for each activity

Allocate the total cost of each support activity to the relevant cost pool

Charge the total cost in each pool to output using the relevant cost drivers

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.18

Benefits of ABC

Provides more accurate cost for each unit of product or service

Provides managers with a better understanding of the business

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.19

Traditional versus activity-based costing Traditional approach Overheads are first assigned to product cost centres

Total overheads

Overheads are then allocated to cost units using an overhead recovery rate

Product cost centre 1

Cost centre overhead recovery rate 1

Product cost centre 2

Cost centre overhead recovery rate 2

Product cost centre 3

Cost centre overhead recovery rate 3

Products A B C D

ABC approach Overheads are then assigned to cost units using cost driver rates

Overheads are first assigned to cost pools

Total overheads

Activity cost pool 1

Activity cost driver rate 1

Products

Activity cost pool 2

Activity cost driver rate 2

A B C D

Activity cost pool 3

Activity cost driver rate 3

Activity cost pool 4

Activity cost driver rate 4

Source: adapted from Innes, J. and Mitchell, F., Activity Based Costing: A Review with Case Studies, CIMA Publishing, 1990.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.20

Criticisms of ABC

Time consuming and costly

Does not provide relevant information for decision making

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 8.21

Percentages of businesses in different sectors that use ABC 70

% 60

50 40 30 20 10 0 Manufacturing Retail

Service

Financial and commercial

Source: Al-Omiri, M. and Drury, C., ‘A survey of factors influencing the choice of product costing systems in UK organisations’, Management Accounting Research, December 2007.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.1

Chapter 9

Budgeting

LEARNING OUTCOMES You should be able to: Define a budget and show how budgets, strategic objectives and strategic plans are related

Explain the budgeting process and the interlinking of the various budgets within the business

Indicate the uses of budgeting and construct various budgets, including the cash budget, from relevant data

Show how flexing the budget can be used to exercise control over the business Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.2

The planning and control process Establish mission and objectives

Undertake a position analysis

Identify and assess strategic options Select strategic options and formulate longterm (strategic) plans Prepare budgets Perform and collect information on actual performance Respond to variances and exercise control

Revise plans (and budgets) if necessary Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.3

The interrelationship of operating budgets Trade receivables budget

Sales budget

Overheads budget

Finished inventories budget

Trade payables budget

Cash budget

Capital expenditure budget

Production budget

Direct labour budget

Raw materials purchases budget

Raw materials inventories budget

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.4

The vertical relationship between sales budgets

Overall sales budget

Sales budget North region

Sales budget South region

Sales budget East region

Sales budget West region

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.5

The five main benefits to a business of budgets

Promote forward thinking and identification of short-term problems

Budgets

Help co-ordinate the various sections of the business

Motivate managers to better performance

Provide a basis for a system of control

Provide a system of authorisation

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.6

Budgeting practice in SMEs 78

Sales budget

76

Budgeted income

73

Overheads budget

63

Cash budget

46

Budgeted balance sheet

35

Purchases budget Production budget

21 0

20

40

60

80 Frequency of preparation (%)

Source: Chittenden, F., Poutziouris, P., and Michaelis, N. Financial management and working capital practices in UK SMEs, Manchester Business School, 1998, p.22, Figure 16

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.7

An example of a budget – the cash budget Jan

Feb

Mar

Apr

May

June

£000

£000

£000

£000

£000

£000

60

52

55

55

60

55

Payables

30

30

31

26

35

31

Salaries and wages

10

10

10

10

10

10

Receipts Receivables Payments

Electricity Other overheads

14 2

2

Van purchase

2

9 2

2

2

11

Total payments

42

42

68

38

47

52

Cash surplus

18

10

(13)

17

13

3

Opening balance

12

30

40

27

44

57

Closing balance

30

40

27

44

57

60

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, © Pearson Education Limited 2011

Slide 9.8

Flexible budgets A more valid comparison can be made between the budget (using the flexed figures) and the actual results.

Output (production and sales)

Original budget

Flexed budget

1,000 units

900 units

Actual

900 units

£

£

£

Sales revenue

100,000

90,000

92,000

Raw materials

(40,000)

(36,000) (36,000 m)

(36,900) (37,000 m)

Labour

(20,000)

(18,000) (2,250 hr)

(17,500) (2,150 hr)

Fixed overheads

(20,000)

(20,000)

(20,700)

Operating profit

20,000

16,000

16,900

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.9

Relationship between the budgeted and actual profit

Budgeted profit plus

All favourable variances minus

All adverse variances equals

Actual profit

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.10

Degree of importance attached to flexible budgeting

Moderately important 40%

Not important 27%

Important 33%

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.11

Frequency of use of flexible budgets %

1 = Never 5 = Very often

30

29 25

23 20

19 15

16 13

10

448

5 0

1

2

3

4

5

Scale Source: based on information in Abdel-Kader, M. and Luther, R., An Empirical Investigation of the Evolution of Management Accounting Practices, Working Paper No. 04/06, University of Essex, October 2004.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.12

Making budgetary control effective A serious attitude taken to the system Clear demarcation between areas of managerial responsibility Budget targets that are challenging yet achievable Established data collection, analysis and reporting routines Reports aimed at individual managers Fairly short reporting periods Timely variance reports Action being taken to get operations back under control Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 9.13

Behavioural aspects of budgetary control

The existence of budgets generally tends to improve performance

Demanding, yet achievable, budget targets tend to motivate better than less demanding targets

Unrealistically demanding targets tend to have the adverse effect on managers’ performance

The participation of managers in setting their targets tends to improve motivation and performance

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.1

Chapter 10 Making capital investment decisions LEARNING OUTCOMES You should be able to: Explain the nature and importance of investment decision making

Identify the four main investment appraisal methods found in practice

Use each method to reach a decision on a particular investment opportunity

Discuss the attributes of each of the methods

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.2

The nature of investment decisions

Large amounts of resources are often involved

It is often difficult and/or expensive to bail out of an investment once undertaken

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.3

The scale of investment by UK businesses Business

Expenditure on additional non-current (fixed) assets as a percentage of: Annual sales revenue

End-of-year non-current assets

British Airways plc

6.7

7.4

British Sky Broadcasting plc

7.5

15.3

Go-Ahead Group plc

2.6

11.1

Marks and Spencer plc

7.4

11.4

Wm Morrison Supermarkets plc

4.7

9.5

Ryanair Holdings plc

23.9

19.3

Severn Trent Water Ltd

47.1

11.0

Tate and Lyle plc

9.3

16.1

Source: Annual reports of the businesses concerned for the financial years ending in 2009.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.4

Methods of investment appraisal Four methods of evaluation Accounting rate of return (ARR)

Payback period (PP)

Net present value (NPV)

Internal rate of return (IRR) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.5

Accounting rate of return (ARR)

ARR =

Average annual operating profit x 100% Average investment to earn that profit

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.6

ARR decision rule

For a project to be acceptable, it must achieve a target ARR as a minimum

Where two (or more) competing projects exceed the minimum rate, the one with the higher (or highest) ARR should be selected

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.7

Payback period (PP)

Payback period (PP)

The payback period is the length of time it takes for an initial investment to be repaid out of the net cash inflows from a project.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.8

PP decision rule

For a project to be acceptable, it should have a shorter payback period than the maximum payback period set by the business

If two (or more) competing projects have payback periods shorter than the maximum payback period, the project with the shorter (shortest) payback period should be selected

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.9

The cumulative cash flows of each project in Activity 10.6 Initial outlay

Payback period

Project 1

Yr 1

Project 2

Yr Y Y 1 12

Project 3

Yr 1

0

Yr 2

Yr 3

Yr 3

Yr 2

100

Yr 5

Yr 4

Y Y 4 5

Yr 3

Yr 4

200

300

Yr 5

400

500

600

700

800

900

Cash flows (£000) Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.10

The factors influencing the returns required by investors from a project

Interest foregone

Required return

Inflation

Risk premium

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.11

NPV decision rule

If the NPV of a project is positive, it should be accepted; if it is negative it should be rejected

If two (or more) competing projects have positive NPVs, the project with the higher (or highest) NPV should be selected

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.12

Present value of £1 receivable at various times in the future, assuming an annual cost of capital of 20 per cent Pence

100

£1

90 80 70 60

50 40 30 20 10

0

1

2

3

4

5

6

7

8

9

10

Years into the future Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.13

Why NPV is superior to ARR and PP

NPV fully addresses each of the following:

The timing of the cash flows

The whole of the relevant cash flows

The objectives of the business

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.14

Internal rate of return (IRR)

Internal rate of return (IRR)

The internal rate of return is the discount rate, which, when applied to the future cash flows of a project, will produce an NPV of precisely zero.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.15

IRR decision rule

For a project to be acceptable, it must meet a minimum IRR requirement. (This should be the opportunity cost of finance.)

If two (or more) competing projects exceed the minimum IRR, the one with the higher (or highest) IRR should be selected

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.16

The relationship between the NPV and IRR methods

NPV (£000)

70 60 50 40 30 20

IRR 10 0 –10

10

20

30

40

Cost of capital (%)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.17

Some practical points related to investment appraisal

Past costs

Cash flows not profit flows

Common future costs

Year-end assumption

Opportunity costs

Interest payments

Taxation

Other factors

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.18

Investment appraisal in practice Many surveys have shown the following features:

Businesses tend to use more than one method

NPV and IRR have become increasingly popular

Continued popularity of the PP and ARR methods

Larger businesses rely more heavily on NPV and IRR than smaller businesses do Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 10.19

The use of investment appraisal methods among US businesses IRR NPV Payback ARR

0

10

20

30

40

50

60

70

Percentage of CFOs who always or almost always use a given technique Source: based on information in Graham, R. and Harvey, C., ‘How do CFOs make capital budgeting and capital structure decisions?’, Journal of Applied Corporate Finance, vol. 15, no. 1, 2002.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

80

Slide 11.1

Chapter 11

Financing a business

LEARNING OUTCOMES You should be able to: Identify the main sources of finance available to a business and explain the advantages and disadvantages of each

Outline the ways in which share capital may be issued

Explain the role and nature of the Stock Exchange

Discuss the ways in which smaller businesses may seek to raise finance Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.2

The major sources of internal finance

Short-term

Long-term

Reduced inventories levels Delayed payment to trade payables

Retained profits

Total internal finance

Tighter credit control

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7 th Edition, .

Slide 11.3

The major sources of external finance Finance leases

Ordinary shares

Preference shares

Longterm

Hire purchase agreements Securitisation of assets

Borrowings

Total finance Debt factoring Bank overdrafts

Shortterm

Invoice discounting

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.4

The risk/return characteristics of long-term financing

Ordinary shares

Preference shares

Borrowing

Return

Risk

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.5

Loan covenants

May deal with such matters as:

Financial statements

Other borrowings

Dividend payments Liquidity

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.6

Finance leases

Advantages

Ease of borrowing

Cost

Flexibility Cash flows

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.7

Asset finance provided by members of the Finance and Leasing Association, 2004 to 2008 30

£ billion

25 20 15 10 5 0 2004

2005

2006

High value asset finance

2007

2008

Other asset finance

Source: Finance and Leasing Association Annual Review 2009, www.fla.org.uk, p. 9. Copyright © 2009 Finance and Leasing Association.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.8

Hire purchase

HP agreements often involve three parties:

The supplier

The customer

A financial institution

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.9

The hire purchase process

Customer Asset delivered (4)

HP agreement (1)

Initial deposit (2)

Financial institution

Supplier Asset purchased and paid for immediately (3)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Regular payments made over time (5)

Slide 11.10

Share issues

The most common methods of share issues for cash are as follows:

Rights issues

Offers for sale and public issue

Private placings

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Banks

Public sector

Private non-financial companies

Charities

Other financial institutions

Investment trusts

Unit trusts

Individuals

Pension funds

Insurance companies

%

Rest of the world

Slide 11.11

Ownership of UK listed shares, end of 2008

40

35

30

25

20

15

10

5

Slide 11.12

Number of businesses

Distribution of AIM listed companies by equity market value 350

283

300 250

190

200 150

200

198

124

120

95 100

39

50

10

2

0 0 to 2

2 to 5

5 to 10 10 to 25

25 to 50

50 to 100

100 to 250

250 to 500

500 to Over 1,000 1,000

Market value range (£m) Source: London Stock Exchange, AIM Market Statistics, January 2010.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.13

The factoring process

Client business

Factor pays 20% balance to client (less fees) when credit customer pays amount owing (5)

Goods supplied on credit (1)

Factor pays 80% to client immediately (3)

Credit customer

Factor invoices credit customer (2)

Factor

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Customer pays amount owing to factor (4)

Slide 11.14

Client sales: domestic invoice discounting and factoring, 2001 to 2008 180

18,307

19,083

2001

2002

2003

2004

2005

2006

175,019 19,377

17,740

68,464

17,632

0

17,222

20

16,374

40

82,995

80

60

109,664

100

124,095

120

159,526

Factoring

20,311

145,064

140

94,647

Sales revenue £m

Invoice discounting

2007

2008

Source: compiled from information published by the Asset Based Finance Association, www.abfa.org.uk.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.15

Long-term versus short-term borrowing

Issues that should be taken into account include:

Matching

Flexibility

Refunding risk Interest rates

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.16

Short-term and long-term financing requirements

Total funds (£)

Short-term finance

Fluctuating current assets

Permanent current assets

Long-term finance

Non-current assets Time

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.17

Providing long-term finance for the small business

Venture capital

Business angels

Government assistance

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 11.18

Financing small businesses, 2002 to 2004

Venture capital

Banks

4%

Partners and shareholders 7%

Asset-based finance (for example HP, factoring and trade 21% finance)

57%

11% Other Source: Cosh, A. and Hughes, A., British Enterprise: Thriving or Surviving?, Centre for Business Research, University of Cambridge, 2007.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.1

Chapter 12

Managing working capital

LEARNING OUTCOMES

You should be able to:

Identify the main elements of working capital

Discuss the purpose of working capital and the nature of the working capital cycle Explain the importance of establishing policies for the control of working capital Explain the factors that have to be taken into account when managing each element of working capital Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.2

The nature of working capital Major elements

Major element

Inventories

Trade payables

Trade receivables

Cash (in hand and at bank)

Working capital

Current assets

equals

Current liabilities

less

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.3

The working capital cycle

Cash sales

Cash/ bank overdraft

Finished goods Credit sales

Work in progress

Trade receivables

Raw materials

Cash

Trade payables

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.4

Working capital investment by large European businesses as a percentage of sales revenue % 15

10

11.7

12.6

12.1

12.3

11.7

2005

2006

2007

2008

5

2004

Source: compiled from information in REL/CFO Europe 2009 European Working Capital Survey, www.relconsult.com.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.5

Cost of holding inventories

Business

Type of operations

Cost of capital

Average inventories held

Cost of holding inventories

Operating expenses

Cost as % of operating expenses

(a)

(b)

(a  b)

%

£m

£m

£m

%

Associated British Foods

Food producer

9.5

1,152

109

8,639

1.3

British Airways

Airline

8.9

120

11

9,212

0.1

Kingfisher

Home improvement

8.3

1,833

152

8,606

1.8

J. Sainsbury Supermarket

10.0

685

69

18,448

0.4

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.6

Managing inventories

Procedures and techniques

Budgeting future demand

Inventories management models

Financial ratios

Materials requirements planning (MRP) systems

Recording and reordering systems

Just-in-time (JIT) inventories management

Levels of control

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.7

ABC method of analysing and controlling inventories

100 Cumulative value of inventories items (%)

A

B

C

100

Volume of inventories items held (%)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.8

Inventories level

Patterns of inventories movements over time

Time

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.9

Inventories holding and order costs

Ordering costs

Annual costs (£)

Total costs

Holding costs

0

E

Average inventories level (units)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.10

The economic order quantity (EOQ) model

EOQ

=

2DC H

Where: D = the annual demand for the inventories item (expressed in units of the inventories item); C = the cost of placing an order; H = the cost of holding one unit of inventories for one year

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.11

Managing receivables Questions to ask

Which customers should receive credit How much credit should be offered What length of credit it is prepared to offer Whether discounts will be offered for prompt payment What collection policies should be adopted How the risk of non-payment can be reduced Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.12

Which customers should receive credit?

The five Cs of credit

Capital Capacity Collateral Conditions Character

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.13

Collection policies and reducing the risk of non-payment Develop customer relationships Publicise credit terms Issue invoices promptly Monitor outstanding debts Produce an ageing schedule of trade receivables Answer queries quickly Deal with slow payers

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.14

Ageing schedule of trade receivables at 31 December

Customer

Days outstanding 1 to 30 31 to 60 days days

Total

61 to 90 days

More than 90 days

£

£

£

£

£

A Ltd

20,000

10,000

-

-

30,000

B Ltd

-

24,000

-

-

24,000

C Ltd

12,000

13,000

14,000

18,000

57,000

Total

32,000

47,000

14,000

18,000

111,000

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.15

Controlling the cash balance

Cash balance (£)

Outer limit Inner limit Target cash balance

Inner limit Outer limit

0

1

2

3

4

5

6

7

8

9

10

11

12

Time (days)

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.16

The operating cash cycle

Purchase of goods on credit

Payment for goods

Sale of goods on credit

Cash received from credit customer

Inventories turnover period

Operating cash cycle

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.17

Calculating the operating cash cycle Average inventories turnover period plus

Average settlement period for trade receivables minus

Average payment period for trade payables equals

Operating cash cycle

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .

Slide 12.18

Days

The average OCC of large US and European businesses

50

42.6

46.0

44.3

44.7

42.5

2005

2006

2007

2008

30

10

2004

Source: compiled from information in REL/CFO Europe 2009 European Working Capital Survey, www.relconsult.com.

Atrill and McLaney, Accounting and Finance for Non-Specialists, 7th Edition, .