Tools for Business Decision Management Makers_14 potx

Most businesses are far too large and complex for managers to be able to see and assess everything that is going on in their own areas of responsibility merely by personal obser- vation. Managers need information on all aspects within their control. Management accounting reports can provide them with this information, to a greater or lesser extent. These reports can be seen, therefore, as acting as the eyes and ears of the managers, pro- viding insights not necessarily obvious without them. The following accounting information relating to a new service might be useful to a manager: l the cost of providing the service and the level of profit that will be required; l the capital investment that will be necessary to enable the business to provide the ser- vice; and l the extent to which the provision of the service would be expected to enhance the busi- ness’s wealth. There is no doubt that the onus is on accountants to make their reports as easy to under- stand as they can possibly be. A key aspect of accountants’ work is communicating to non-accountants, and they should never overlook this. At the same time, accounting information cannot always be expressed in such a way that someone with absolutely no accounting knowledge can absorb it successfully. The onus is also therefore on managers to acquire a working knowledge of the basis on which accounting reports are prepared and what they mean. The two attributes are: 1 They must relate to the objective(s) that the decision is intended to work towards. In most businesses this is taken to be wealth enhancement. This means that any informa- tion relating to the decision that does not impact on wealth enhancement is irrelevant, where wealth enhancement is the sole objective. In practice a business may have more than one objective. 2 They must differ between the options under consideration. Where a cost will be the same irrespective of the outcome of the decision that is to be taken it is irrelevant. It is only on the basis of things that differ from one outcome to another that decisions can be made. A sunk cost is a past and, therefore, an irrelevant cost in the context of any decision about the future. Thus, for example, the cost of an item of inventories already bought is a sunk cost. It is irrelevant, in any decision involving the use of the inventories, because this cost will be the same irrespective of the decision made. An opportunity cost is the cost of being deprived of the next best option to the one under consideration. For example, where using an hour of a worker’s time on activity A deprives the business of the opportunity to use that time in a profitable activity B, the benefit lost from activity B is an opportunity cost of pursuing activity A. Cost may be defined as the amount of resources, usually measured in monetary terms, sacrificed to achieve a particular objective. A committed cost is like a past cost in that an irrevocable decision has been made to incur the cost. This might be because the business has entered into a binding contract, for exam- ple to rent some premises for the next two years. Thus it is effectively a past cost even though the payment (for rent, in our example) has yet to be made. Since the business can- not avoid a committed cost, committed costs cannot be relevant costs. 2.4 2.3 2.2 2.1 Chapter 2 1.4 1.3 1.2 SOLUTIONS TO REVIEW QUESTIONS 471 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 471 A fixed cost is one that is the same irrespective of the level of activity or output. Typical examples of costs that are fixed, irrespective of the level of production or provision of a ser- vice, include rent of business premises, salaries of supervisory staff and insurance. A variable cost is one that varies with the level of activity or output. Examples include raw materials and labour, where labour is rewarded in proportion to the level of output. Note particularly that it is relative to the level of activity that costs are fixed or variable. Fixed costs will be affected by inflation and they will be greater for a longer period than for a shorter one. For a particular product or service, knowing which costs are fixed and which are variable enables managers to predict the total cost for any particular level of activity. It also enables them to concentrate only on the variable costs in circumstances where a decision will not alter the fixed costs. The BEP is the break-even point, that is, the level of activity, measured either in physical units or in value of sales revenue, at which the sales revenue exactly covers all of the costs, both fixed and variable. Break-even point is calculated as Fixed costs/(sales revenue per unit − variable costs per unit) which may alternatively be expressed as Fixed costs/Contribution per unit Thus break-even will occur when the contributions for the period are sufficient to cover the fixed costs for the period. Break-even point tends to be useful as a comparison with planned level of activity in an attempt to assess the riskiness of the activity. Operating gearing refers to the extent of fixed cost relative to variable cost in the total cost of some activity. Where the fixed cost forms a relatively high proportion of the total, we say that the activity has high operating gearing. Typically, high operating gearing is present in environments where there is a relatively high level of mechanisation (that is, capital-intensive environments). This is because such environments tend simultaneously to involve relatively high fixed costs of depreciation, maintenance, and so on and relatively low variable costs. High operating gearing tends to mean that the effects of increases or decreases in the level of activity have an accentuated effect on operating profit. For example, a 20% decrease in output of a particular service will lead to a greater than 20% decrease in operating profit, assuming no cost or price changes. In the face of a restricting scarce resource, profit will be maximised by using the scarce resource on output where the contribution per unit of the scarce resource is maximised. This means that the contribution per unit of the scarce resource (for example, hour of scarce labour, or unit of scarce raw material) for each competing product or service needs to be identified. It is then a question of allocating the scarce resource to the product or service that provides the highest contribution per unit of the particular scarce resource. The logic of this approach is that the scarce resource is allocated to the activity that uses it most effectively, in terms of contribution and, therefore, profit. 3.4 3.3 3.2 3.1 Chapter 3 APPENDIX C SOLUTIONS TO REVIEW QUESTIONS 472 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 472 In process costing, the total production cost for a period is divided by the number of com- pleted units of output for the period to deduce the full cost per unit. Where there is work in progress at the beginning and/or the end of the period complications arise. The problem is that some of the completed output incurred cost in the preceding period. Similarly, some of the cost incurred in the current period leads to completed production in the subsequent period. Account needs to be taken of these facts, if reliable full cost infor- mation is to be obtained. The only reason for distinguishing between direct and indirect costs is to help to deduce the full cost of a unit of output in a job-costing environment. In an environment where all units of output are identical, or can reasonably be regarded as being so, a process- costing approach will be taken. This avoids the need for identifying direct and indirect costs separately. Direct cost forms that part of the total cost of pursuing some activity that can, unequi- vocally, be associated with that particular activity. Examples of direct cost items in the typical job-costing environment include direct labour and direct materials. Indirect cost is the remainder of the cost of pursuing some activity. In practice, knowledge of the direct costs tends to provide the basis used to charge over- heads to jobs. The distinction between direct and indirect cost is irrelevant for any other purpose. Directness and indirectness is dictated by the nature of that which is being costed, as much as the nature of the cost. The notion of direct and indirect cost is concerned only with the extent to which particu- lar elements of cost can unequivocally be related to, and measured in respect of, a particular cost unit, usually a product or service. The distinction between direct and indirect costs is made exclusively for the purpose of deducing the full cost of some cost unit, in an envir- onment where each cost unit is not identical, or close enough to being identical for it to be treated as such. Thus, it is typically in the context of job costing, or some variant of it, that the distinction between direct and indirect cost is usefully made. The notion of variable and fixed cost is concerned entirely with how costs behave in the face of changes in the volume of output. The benefit of being able to distinguish between fixed and variable cost is that predictions can be made of what total cost will be at particu- lar levels of volume and/or what reduction or addition to cost will occur if the volume of output is reduced or increased. Thus the notion of direct and indirect cost, on the one hand, and that of variable and fixed cost, on the other, are not linked to one another, and, in most contexts, some ele- ments of direct cost are variable, while some are fixed. Similarly, indirect cost might be fixed or variable. The full cost includes all of the cost of pursuing the cost objective, including a ‘fair’ share of the overheads. Generally the full cost represents an average cost of the various elements, rather than a cost that arises because the business finds itself in a particular situation. The fact that the full cost reflects all aspects of cost should mean that, were the business to sell its output at a price exactly equal to the full cost (manufacturing and non- manufacturing cost), the sales revenues for the period would exactly cover all of the cost and the business would break even, that is make neither profit nor loss. 4.4 4.3 4.2 4.1 Chapter 4 SOLUTIONS TO REVIEW QUESTIONS 473 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 473 ABC is a means of dealing with charging overheads to units of output to derive full costs in a multi-product (job or batch costing) environment. The traditional approach tends to accept that once identifiable direct costs, normally labour and materials, have been taken out, all of the other costs (overheads) must be treated as common costs and applied to jobs using the same formula, typically on the basis of direct labour hours. ABC takes a much more enquiring approach to overheads. It follows the philosophy that overheads do not occur for no reason, but they must be driven by activities. For example, a particular type of product may take up a disproportionately large part of supervisors’ time. If that product were not made, in the long run, supervision costs could be cut (fewer supervisors would be needed). Whereas the traditional approach would just accept that supervisory salaries are an overhead, which needs to be apportioned along with other over- heads, ABC would seek to charge that part of the supervisors’ salaries which is driven by the particular type of product, to that product. One criticism is on the issue of the cost/benefit balance. It is claimed that the work neces- sary to analyse activities and identify the cost drivers tends to be more expensive than is justified by the increased quality of the full costs that emerge. Linked to this is the belief of many that full cost information is of rather dubious value for most purposes, irrespective of how the full costs are deduced. Many argue that full cost information is flawed by the fact that it takes no account of opportunity costs. ABC enthusiasts would probably argue that deducing better quality full costs is not the only benefit which is available, if the overhead cost drivers can be identified. Knowing what drives costs can enable management to exercise more control over them. This benefit needs to be taken into account when assessing the cost/benefit of using ABC. Generally, a rise in the price of a commodity causes a fall in demand. A commodity is said to have a relatively elastic demand where demand reacts relatively dramatically (stretches more) in the face of a particular price alteration. Elastic demand tends to be associated with commodities that are not essential, perhaps because there is a ready substitute. It can be very helpful for those involved with pricing decisions to have some feel for the elasticity of demand of the commodity that will be the subject of a decision. The sensitiv- ity of the demand to the decision is obviously much greater (and the pricing decision more crucial) with commodities whose demand is elastic than with commodities whose demand is relatively inelastic. A business will make the most profit from one of its products or services at the point where marginal sales revenue equals marginal cost of production, or in other words, the point where the increase in total sales revenue that will result from selling one more unit equals the increase in total costs which will result from selling that unit. A budget can be defined as a financial plan for a future period of time. Thus it sets out the intentions which management has for the period concerned. Achieving the budget plans should help to achieve the long-term plans of the business. Achievement of the long-term plans should mean that the business is successfully working towards its objectives. A budget differs from a forecast in that a forecast is a statement of what is expected to happen without the intervention of management, perhaps because they cannot intervene (as with a weather forecast). A plan is an intention to achieve. Normally management would take account of reliable forecasts when making its plans. 6.1 Chapter 6 5.4 5.3 5.2 5.1 Chapter 5 APPENDIX C SOLUTIONS TO REVIEW QUESTIONS 474 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 474 1 Budgets tend to promote forward thinking and the possible identification of short-term problems. Managers must plan and the budgeting process tends to force them to do so. In doing so they are likely to encounter potential problems. If the potential problems can be identified early enough, solutions might be easily found. 2 Budgets can be used to help co-ordination between various sections of the business. It is important that the plans of one area of the business fit in with those of other areas; a lack of co-ordination could have disastrous consequences. Having formal statements of plans for each aspect of the business enables a check to be made that plans are complementary. 3 Budgets can motivate managers to better performance. It is believed that people are motivated by having a target to aim for. Provided that the inherent goals are achievable, budgets can provide an effective motivational device. 4 Budgets can provide a basis for a system of control. Having a plan against which actual performance can be measured provides a potentially useful tool of control. 5 Budgets can provide a system of authorisation. Many managers have ‘spending’ budgets such as research and development, staff training, and so on. For these people, the size of their budget defines their authority to spend. Control can be defined as ‘compelling things to occur as planned’. This implies that con- trol can only be achieved if a plan exists. Budgets are financial plans. This means that, if actual performance can be compared with the budget (plan) for each aspect of the business, divergences from plan can be spotted. Steps can then be taken to bring matters back under control where they are going out of control. A budget committee is a group of senior staff that is responsible for the budget prepara- tion process within an organisation. The existence of the committee places the budget responsibility clearly with an identifiable group of people. This group can focus on the tasks involved. Feedforward controls try to anticipate what is likely to happen in the future and then assist in making the actual outcome match the desired outcome. They contrast with feedback controls, which simply compare actual to planned outcomes after the event. Feedforward controls are therefore more pro-active. A variance is the effect on budgeted profit of the particular cost or revenue item being con- sidered. It represents the difference between the budgeted profit and the actual profit assum- ing everything, except the item under consideration, had gone according to budget. From this it must be the case that Budgeted profit + favourable variances − unfavourable variances = actual profit. The purpose of analysing variances is to identify whether, and if so where, things are not going according to plan. If this can be done, it may be possible to find out the cause of things going out of control. If this can be discovered, it may then be possible to put things right for the future. Where the budgeted and actual volumes of output do not coincide it is impossible to make valid comparison of ‘allowed’ and actual costs and revenues. Flexing the original budget to reflect the actual output level enables a more informative comparison to be made. Flexing certainly does not mean that output volume differences do not matter. Flexing will show (as the difference between flexed and original budget profits) the effect on profit of output volume differences. 7.3 7.2 7.1 Chapter 7 6.4 6.3 6.2 SOLUTIONS TO REVIEW QUESTIONS 475 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 475 Deciding whether variances should be investigated involves the use of judgement. Often management will set a threshold of significance, for example 5 per cent of the budgeted figure for each variance relating to revenue or cost items. All variances above this threshold would then be investigated. Even where variances are below the threshold, any sign of a sys- temic variance, shown, for example, by an increasing cumulative total for the factor, should be investigated. Knowledge of the cause of a particular variance may well put management in a position to take actions that will be beneficial to the business in the future. Investigating variances, however, is likely to be relatively expensive in staff time. A judgement needs to be made on whether the value or benefit of knowing the cause of the variance will be justified by the cost of this knowledge. As with most investigations of this type, it is difficult to judge the value of the knowledge until after the variance has been investigated. NPV is usually considered the best method of assessing investment opportunities because it takes account of: l The timing of the cash flows. By discounting the various cash flows associated with each pro- ject according to when it is expected to arise, it recognises the fact that cash flows do not all occur simultaneously. Associated with this is the fact that, by discounting using the opportunity cost of finance (that is, the return which the next best alternative oppor- tunity would generate), it is possible to identify the net benefit after financing costs have been met (as the NPV). l The whole of the relevant cash flows. NPV includes all of the relevant cash flows irrespec- tive of when they are expected to occur. It treats them differently according to their date of occurrence, but they are all taken account of in the NPV and they all have, or can have, an influence on the decision. l The objectives of the business. NPV is the only method of appraisal where the output of the analysis has a direct bearing on the wealth of the business. (Positive NPVs enhance wealth; negative ones reduce it). Since most private sector businesses seek to increase their value and wealth, NPV clearly is the best approach to use, at least out of the methods we have considered so far. NPV provides clear decision rules concerning acceptance/rejection of projects and the ranking of projects. It is fairly simple to use, particularly with the availability of modern computer software that takes away the need for routine calculations to be done manually. The payback method, in its original form, does not take account of the time value of money. However, it would be possible to modify the payback method to accommodate this requirement. Cash flows arising from a project could be discounted, using the cost of finance as the appropriate discount rate, in the same way as with the NPV and IRR methods. The discounted payback approach is used by some businesses and represents an improve- ment on the original approach described in the chapter. However, it still retains the other flaws of the original payback approach that were discussed: for example, it ignores relevant data after the payback period. Thus, even in its modified form, the PP method cannot be regarded as superior to NPV. The IRR method does appear to be preferred to the NPV method among many practising managers. The main reasons for this seem to be as follows: l A preference for a percentage return ratio rather than an absolute figure as a means of expressing the outcome of a project. This preference for a ratio may reflect the fact that 8.3 8.2 8.1 Chapter 8 7.4 APPENDIX C SOLUTIONS TO REVIEW QUESTIONS 476 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 476 other financial goals of the business are often set in terms of ratios (for example, return on capital employed). l A preference for ranking projects in terms of their percentage return. Managers feel it is easier to rank projects on the basis of percentage returns (though NPV outcomes should be just as easy for them). We saw in the chapter that the IRR method could provide mis- leading advice on the ranking of projects, and the NPV method was preferable for this purpose. Cash flows are preferred to profit flows because cash is the ultimate measure of economic wealth. Cash is used to acquire resources and for distribution to shareholders. When cash is invested in an investment project an opportunity cost is incurred, as the cash cannot be used in other investment projects. Similarly, when positive cash flows are generated by the project it can be used to reinvest in other investment projects. Profit, on the other hand, is relevant to reporting the productive effort for a period. This measure of effort may have only a tenuous relationship to cash flows for a period. The conventions of accounting may lead to the recognition of gains and losses in one period and the relevant cash inflows and outflows occurring in another period. The objective of strategic management accounting (SMA) is to provide information to man- agers that will help them to run the business in a way that will work towards achievement of the business’s strategic objectives. Traditional management accounting is not necessarily so much different, but lacks the clear focus on achievement of strategic objectives. Given its focus, SMA necessarily needs to be more outward looking and more customer oriented than the traditional approach. It also needs to focus on beating the competition. Finally, it must monitor the business’s strategies and be concerned with bringing these to a successful conclusion. Possible reasons for Customer A being preferred to Customer B include: l A may place fewer orders than B, so saving the business’s order handling costs. l A may have the service provided in larger quantities than B. This might lead to savings in travel costs or similar, if the service is provided on the customers’ premises. l A may require fewer visits by sales representatives than B. l A may be a quicker payer than B, assuming that sales are on credit. There may well be other possibilities. Shareholder value analysis is based on the principle that there are just a few key value drivers that generate shareholder value, for example, investment in working capital. If man- agers are focused on maximising performance with each of these so-called value drivers, the maximum increase in shareholder wealth will be generated. This can be used to relate the objectives of individual managers throughout the business to the primary objective for the business as a whole. This should lead to managers working directly towards shareholder value enhancement. It is claimed that more traditional approaches to management target setting tend not always to lead to the desired outcome for the business as a whole. The four main areas in the balanced scorecard are: 1 Financial. Here targets for measures such as return on capital employed will be stated. 2 Customer. Here the market/customers that the business will aim for is established, as will be targets for such things as measures of customer satisfaction and rate of growth in cus- tomer numbers. 9.4 9.3 9.2 9.1 Chapter 9 8.4 SOLUTIONS TO REVIEW QUESTIONS 477 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 477 3 Internal business process. Here the processes that are vital to the business will be estab- lished. This might include levels of innovation, types of operation and after-sales service. 4 Learning and growth. In this area issues relating to growing the business and development of staff are identified and targets set. Reporting non-financial measures may pose a number of problems. These include: l resistance to the introduction of new measures (and, by implication, new ways of being assessed); l scepticism of proposed measures (the latest ‘flavour of the month’); l the cost of reporting new measures; l data integrity (the lack of common measurement bases and objectivity associated with many non-financial measures); l the difficulty of measuring the benefits (for example, establishing the link between a particular non-financial measure and the achievement of business objectives). Four possible measures may include: l Sales per employee l Output per employee l Total output during the period l Sales to assets employed. Other measures may have been suggested which are equally valid. Three non-financial measures might include: l Turnover of staff during period l New clients obtained during period l Level of client satisfaction during period. We saw in the chapter that negotiated prices can create problems for both the efficient use of resources and divisional autonomy. They can also tie up central management in arbitra- tional matters and deflect them from their more strategic role. This method is best used when there is an external market for the services or goods of both buying and selling divi- sions and when divisional managers are free to reject offers made by other divisions. Market-based prices are, generally speaking, more appropriate as they reflect the oppor- tunity cost of the goods. However, where the division is operating below capacity, a variable- cost-based approach is more appropriate. Although the credit manager is responsible for ensuring that receivables pay on time, Tariq may be right in denying blame. Various factors may be responsible for the situation described which are beyond the control of the credit manager. These include: l a downturn in the economy leading to financial difficulties among trade receivables; l decisions by other managers within the business to liberalise credit policy in order to stimulate sales; l an increase in competition among suppliers offering credit, which is being exploited by customers; 11.1 Chapter 11 10.4 10.3 10.2 10.1 Chapter 10 APPENDIX C SOLUTIONS TO REVIEW QUESTIONS 478 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 478 l disputes with customers over the quality of goods or services supplied; l problems in the delivery of goods leading to delays. You may have thought of others. The level of inventories held will be affected in the following ways. (a) An increase in production bottlenecks is likely to result in an increase in raw materials and work in progress being processed within the plant. Therefore, levels of inventories should rise. (b) A rise in interest rates will make holding inventories more expensive if they are financed by debt. This may, in turn, lead to a decision to reduce inventory levels. (c) The decision to reduce the range of products should result in fewer inventories being held. It would no longer be necessary to hold certain items in order to meet customer demand. (d) Switching to a local supplier may reduce the lead time between ordering an item and receiving it. This should, in turn, reduce the need to carry such high levels of the par- ticular item. (e) A deterioration in the quality of bought-in items may result in the purchase of higher quantities of inventories in order to take account of the defective element in invent- ories acquired and, perhaps, an increase in the inspection time for items received. This would lead to a rise in inventory levels. Inventories are held: l to meet customer demand, l to avoid the problems of running out of inventories, and l to take advantage of profitable opportunities (for example, buying a product that is expected to rise steeply in price in the future). The first reason may be described as transactionary, the second precautionary and the third speculative. They are, in essence, the same reasons why a business holds cash. (a) The costs of holding too little cash are: l failure to meet obligations when they fall due which can damage the reputation of the business and may, in the extreme, lead to the business being wound up; l having to borrow and thereby incur interest charges; l an inability to take advantage of profitable opportunities. (b) The costs of holding too much cash are: l failure to use the funds available for more profitable purposes; l loss of value during a period of inflation. 11.4 11.3 11.2 SOLUTIONS TO REVIEW QUESTIONS 479 Z03_ATRI3622_06_SE_APP3.QXD 5/29/09 10:43 AM Page 479 Appendix D Solutions to selected exercises Strategic management involves five steps: 1 Establish mission and objectives. The mission statement is usually a brief statement of the overall aims of the business. The objectives are rather more specific than the mission and need to be both quantifiable and consistent with the mission or aims. 2 Undertake a position analysis. Here the business is seeking to establish how it is placed rela- tive to its environment (competitors, markets, technology, the economy, political cli- mate and so on), given the business’s mission and objectives. This is often approached within the framework of an analysis of the business’s strengths, weaknesses, opportuni- ties and threats (a SWOT analysis). Strengths and weaknesses are internal factors that are attributes of the business itself, whereas opportunities and threats are factors expected to be present in the environment in which the business operates. The SWOT framework is not the only possible approach to undertaking a position analysis, but it seems to be a very popular one. 3 Identify and assess the strategic options. This involves attempting to identify possible courses of action that will enable the business to reach its objectives in the light of the position analysis undertaken in Step 2. 4 Select strategic options and formulate plans. Here the business will select what seems to be the best of the courses of action or strategies (identified in Step 3) and will formulate a strategic plan in the form of long- and short-term budgets. 5 Perform, review and control. Here the business pursues the plans derived in Step 4, using the traditional approach to compare actual performance against budgets, seeking to control where actual performance appears not to be matching plans. SWOT analysis of Jones Dairy Ltd Strengths l A portfolio of identifiable customers who show some loyalty to the business. l Good cash flow profile. Though credit will be given, a week is the normal credit period. l An apparently sound distribution system. l A monopoly of doorstep delivery in the area. l Barriers to entry. There are probably relatively high fixed costs, which implies a ‘critical mass’ of volume is necessary. l Good employees and ease of recruitment. l Differentiated product; clearly different from what is supplied by the supermarket in that it is delivered to the door. l Apparently good marketing, since the decline in business is less than the national average. l Good knowledge of the local market. 1.2 1.1 Chapter 1 Z04_ATRI3622_06_SE_APP4.QXD 5/29/09 10:43 AM Page 480 [...]... departments, they will be apportioned on some logical basis For certain costs – for example, rent – the floor area may be the most logical; for others, such as machine maintenance costs, the floor area would be totally inappropriate It is relatively unusual for the ‘job cost’ to be able to dictate the price at which the manufacturer can price its output For many businesses, the market dictates the price (a) Charging... the business as a whole The overheads of ‘service’ cost centres must then be apportioned to the product cost centres At this point, all of the overheads for the whole business are divided between the ‘product’ cost centres, such that the sum of the ‘product’ cost centre overheads equals those for the whole business Dealing with overheads departmentally is believed to provide more fair and useful information... each month the business will buy £1,000 more inventories than it will sell In June, the business will also buy its initial inventories of £22,000 This will be paid for in the following month For example, June’s purchases will be (75% × £8,000) + £1,000 + £22,000 = £29,000, paid for in July 4 This is 5 per cent of 80 per cent of the month’s sales revenue, paid in the following month For example, June’s... preferred minimum level for each of the last three months However, to rectify this situation it will be necessary to purchase more inventories, which will, in turn, exacerbate the cash flow problems of the business The budgeted income statement reveals a very low net profit for the period For every £1 of sales revenue, the business is only managing to generate 0.4p in profit The business should look carefully... binding estimates for the work from various garages, most people would not normally do so As a result, garages normally charge cost-plus prices for car repairs 5.3 Kaplan plc (a) The business makes each model of suitcase in a batch The direct materials and labour costs will be recorded in respect of each batch To these costs will be added a share of the overheads of the business for the period in which... but sold in a subsequent one l For budgetary planning and control Often budgets are set in terms of full costs If budgets are to be used as the yardsticks that actual performance is to be assessed, the information on actual performance must also be expressed in the same full-cost terms Knowing the full cost of the suitcases could be helpful in these activities l General decision making Knowing the full... for the variable overheads, on the basis of experience during months 1 to 6, are as follows: Expense Staffing Power Supplies Other Amount for 2,700 patients £ 59,400 27,000 54,000 8,100 148,500 Amount per patient £ 22 10 20 3 55 Since the expected level of activity for the full year is 6,000, the expected level of activity for the second six months is 3,300 (that is, 6,000 − 2,700) Thus the budget for. .. 2nd Therefore, produce: 3,400 product B using 3,200 product C using 3,400 hours 1,600 hours 5,000 hours (b) Assuming that the business would make no saving in variable production costs by subcontracting, it would be worth paying up to the contribution per unit (£5) for product C, which would therefore be £5 × (5,100 − 3,200) = £9,500 in total Similarly it would be worth paying up to £6 per unit for product... the management is to be indifferent between the products, the contribution per skilled labour hour must be the same Thus for product Y the selling price must be [£(14 × (9/12)) + 9 + 4 + 25 + 7] = £55.50 (that is, the contribution plus the variable costs), and for product Z the selling price must be [£(14 × (3/12)) + 3 + 10 + 14 + 7] = £37.50 (b) The business could pay up to £26 an hour (£12 + £14) for. .. required for the period Normally, businesses seek to enhance their wealth through trading The extent to which they expect to do this is normally related to the amount of wealth that is invested to promote wealth enhancement Businesses tend to seek to produce a particular percentage increase in wealth In other words, they seek to generate a particular return on capital employed It seems logical, therefore, . for 20 performances: (£16,400 × 50% × 20) £164,000 Touring company ticket sales: Total revenue for each performance for a full house: £ 200 @ £22 = 4,400 500 @ 14 = 7,000 300 @ £10 = 3,000 14, 400 £ Ticket. helpful for those involved with pricing decisions to have some feel for the elasticity of demand of the commodity that will be the subject of a decision. The sensitiv- ity of the demand to the decision. be [£ (14 × (9/12)) + 9 + 4 + 25 + 7] = £55.50 (that is, the contribution plus the variable costs), and for product Z the selling price must be [£ (14 × (3/12)) + 3 + 10 + 14 + 7] = £37.50 (b) The business