Accounting for Decision-Maker with Solution

CARDIFF SCHOOL OF MANAGEMENT

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Module Title: Accounting for Decision-Makers
Module Number: MBA7001

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Exam period: January 2022
Exam Duration: 3 hours
The submission portal will open at 09:00 (UK time) on the date of the
examination and will remain open for 48 hours.

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INSTRUCTIONS TO CANDIDATES:

1. This is an open book examination.
2. Non-programmable calculators are allowed.
3. You must answer all questions in a separate Word document, which is
   to be submitted on Moodle. You must show all workings for each
   answer.
4. This paper consists of five questions. Answer four questions in total:
   Section A: one compulsory question (25 marks).
   Section B: Answer three questions out of four (25 marks each).
5. A total of 100 marks is available.
6. A table of rates is available on page 10 of this examination paper.

Module Title: Accounting for Decision-Makers
Module Number: MBA7001

---

Exam period: January 2022
Exam Duration: 3 hours
The submission portal will open at 09:00 (UK time) on the date of the
examination and will remain open for 48 hours.

---

INSTRUCTIONS TO CANDIDATES:

1. This is an open book examination.
2. Non-programmable calculators are allowed.
3. You must answer all questions in a separate Word document, which is
   to be submitted on Moodle. You must show all workings for each
   answer.
4. This paper consists of five questions. Answer four questions in total:
   Section A: one compulsory question (25 marks).
   Section B: Answer three questions out of four (25 marks each).
5. A total of 100 marks is available.
6. A table of rates is available on page 10 of this examination paper.

SECTION A: You must answer all parts of the question in this section.

QUESTION 1

Mike is a shareholder in 4You Ltd. He wishes to assess the management effectiveness and
the company liquidity in utilising the resources. He has approached you to assist him by
analysing the financial statements of 4You Ltd. for the previous two years as follows:

4You Ltd.
Income Statement for the year ended 31 Dec
2021 2020
£000 £000
Continuing Operations
Revenue 9,800 9,000
Cost of Sales (5,194) (4,950)
Gross Profit 4,606 4,050
Operating expenses (2,450) (944)
Distribution costs (980) (1,350)
Administrative Expenses
Operating profit 1,176 1,756
Finance costs (322) (112)
Profit before Tax 854 1,644
Tax (128) (112)
Net Profit 726 1,532

QUESTION 1 (continued)

4You Ltd.
Statement of Financial Position as at 31 Dec
2021 2020
£000 £000
Non Current Assets
Property, Plant and Equipment 16,082 12,400
Current Assets
Inventories 1,298 694
Trade receivables 784 810
Cash 0 158
2,082 1,662
Total Assets: 18,164 14,062
Equity & Liabilities
Share capital 5,000 5,000
Retained Earnings 7,482 6,756
Total Equity 12,482 11,756
Non – Current Liabilities
Bank Loan 4,600 1,600
Current Liabilities
Trade payables 572 594
Tax liabilities 128 112
Bank overdraft 382 0
Total current liabilities 1082 706
Total Equity & Liabilities 18,164 14,062

QUESTION 1 (continued)

Required:
To help Mike analyses the performance of 4You Ltd:
a) Calculate the following ratios for every year:
i) Return on Capital Employed
ii) Return on ordinary shareholders’ funds
iii) Gross Profit margin
iv) Net Profit margin
v) Current Ratio
(10 marks)
b) Debate the limitations of ratio analysis.
(7 marks)
c) Comment critically on the financial position of 4You Ltd. and how this has changed
over the two year period.
(8 marks)
Total: 25 marks

SECTION B: Answer any three of the following four questions.  All questions in this section
are worth equal marks.

QUESTION 2

Target Ltd. has prepared three forecasted demand quantities for the next period for an
exterior water seal. The original budget was to produce 10,000 litres and the manufacturing
cost per litre per of the product as follows:
Number of Litres 10,000
Costs £
Variable costs
Direct materials 1,200
Direct labour 1,000
Overheads 1,600
Fixed costs:
Indirect labour 700
Overheads 1,600
Total cost 6,100
Cost per litre 0.61
Required:
a) Estimate the manufacturing cost per litre of the product at the other two levels of
demand 14,000 and 18,000 litres.
(10 marks)
b) Explain why the cost per litre of the product changes with the increase in the number
of litres made.
(5 marks)
c) The water seal will be sold for £1.00/litre at 10,000 litres activity level. Calculate the
budgeted break-even sales, in litres, for this product and the margin of safety in
percentage if the budgeted sales is 10,000 litres.
(5 marks)
d) In order to have reliable results from Break-even analysis, assumptions must be met.
Evaluate and discuss those assumptions.
(5 marks)
Total: 25 marks

QUESTION 3

The directors of Jump Plc are considering two investment projects (A and B). Both projects
have estimated life of five years. Project A requires £2,000,000 as an initial expenditure
payable immediately and project B costs also £2,000,000 half payable now and half payable
after one year. Project B requires an additional £130,000 as a working capital to support
the investment.
At the end of five years, it is expected that the residual value of project A will be £130,000
and £200,000 for project B.
The following is the best cash forecasts for net cash flows over the 5 years.
Year Project A Project B
£ £
1 685,000 530,000
2 765,000 558,000
3 831,000 598,000
4 552,000 670,000
5 135,000 900,000
Required:
a) Evaluate the two projects using the following two methods:
i) Payback period.
(4 marks)
ii) Net present value using 13% as a discount rate.
(7 marks)
Note: the discount rates table of present value attached above.
b) You need to comment on your answer in 1 and recommend which project should be
undertaken. The comments should include a discussion of the main advantages and
disadvantages of the two methods and a conclusion stating the reasons for selecting
one of the projects considering the two methods.
(8 marks)
c) In order to obtain a reliable result using any of the investment appraisal methods, you
need to consider all relevant cash inflows & outflows relevant to the projects under
consideration. Sunk costs, working capital and residual values are examples of
such items.
You need to evaluate and discuss each of these three items in terms of their
relevancy to the investment appraisal calculation and, briefly explain the rationale
behind taking or not taking each into consideration during the computation of the two
methods calculated above in a).
(6 marks)
Total: 25 marks

QUESTION 4
Nano Ltd. manufactures three different types of electric scooters: X, Y and Z. It was expected
that the production and demand for the next year on these products as follows:
Product X Product Y Product Z
Units 1500 2250 3000
Additional details about the products are also as follows:
Each unit Product X Product Y Product Z
£ £ £
Selling price 348 680 620
Materials 64 160 120
Labour 80 192 160
Variable overheads 48 120 96
Nano Ltd. pays labour £8 an hour and expects its fixed overheads to be £480,000.
Required:
a) Calculate the production plan that will maximise profit for Nano Ltd. for next year
given that Nano Ltd. has only managed to contract 90,000 labour hours for next year.
(7 marks)
b) Calculate Nano Ltd.’s profit based on the production plan in a).
(3 marks)
c) It was found that Nano Ltd. has already committed to a contract legally obligating it
to supply 2100 units of product Y. Recalculate the production plan that will maximise
profit according to this newly factor.
(3 marks)
d) Discuss the non-financial factors that should be considered by Nano Ltd. before
adopting any of the suggested production plan.
(7 marks)
e) Discuss the benefits of using a marginal costing system in comparison to absorption
costing system when making operational decisions.
(5 marks)
Total: 25 marks

QUESTION 5
Printing4All Ltd has been established to open a print studio in Cardiff.
Following a series of meetings by the budget committee of Printing4All Ltd, the following
information has been collected relating to the first 3 months of activity:
Trading:
Sales are expected to be as follows:
September and October £40,000 a month, November £50,000.
90% of sales are for cash, the remainder of sales are on credit terms and collected 1 month
later. 50% of Cash Sales are allowed a 5% NUS discount.
Stock purchases are estimated to be 40% of sales each month purchased as sales are
made. Suppliers are paid one month in arrears.
One experienced staff member will be employed at a cost of £2,500 a month and each of
three directors will initially take £1,000 per month in salary. Overheads are forecast to be
£2,000 per month and paid one month in arrears.
Rent is £36,000 per year, one half payable in September and another in October.
The Shop has been stocked at a cost of £58,500 and this is paid in September.
Fixtures and Fittings will cost £120,000 and will be depreciated at 10% of cost per year on
a straight-line basis.
Financing
Each director will contribute £15,000 in Capital and a £120,000 loan has been arranged with
repayments over 10 years through equal monthly repayments of £1,600, to cover capital
and interest.

QUESTION 5 (continued)
Required:
a) Prepare a monthly cash budget for the three months September to November.
(11 marks)
b) Comment on the cash position from September to November, including any
recommended course of action regarding the cash balance over the period
concerned.
(8 marks)
c) Discuss the differences between fixed and flexible budgets. The discussion should
include the definition of each and the main points of differences.
(6 marks)
Total: 25 marks
Section total: 75 marks

Solutions of Accounting for Decision-Makers

Answer 1 (a)

Ratio Head	Formula	Workings	2021	Workings	2020
Return on capital employed	Earnings before interest and tax Capital employed	1,176,000/ (18164000-1082000)	7%	1756000/(14062000-706000)	13%
Retun on shareholders fund	Earnings after tax Shareholders equity	726000/12482000	6%	1532000/11756000	13%
Gross profit margin	Gross profit  sales	4606000/9800000	47%	4050000/9000000	45%
Net profit margin	Net profit  Sales	726000/9800000	7%	1532000/9000000	17%
Current Ratio	Current assets Current liabilities	2082000/1082000	1.92:1	1662000/706000	2.35:1

Answer 1 (b)

Limitations of ratio analysis are: –
  i) since the ratio analysis is based on the year end historical data, so the organizations may make
     manipulations in such data so as to improve their ratios.

  ii) Ratio analysis only considers the monetary data. So taking decisions solely on the basis of ratios is
       not appropriate as the relevant qualitative factors shall also be considered.

  iii) The comparison of firms with different sizes cannot be done on the basis of ratio analysis.

  iv) There is no defined set of principles and guidelines for ratio analysis.

  v) It does not consider the level of inflation when comparing data of two different periods.

  vi) Ratio analysis may provide misleading results in inter firm comparison when accounting policies
        followed by them are not same.

  vii) It is difficult to interpret the results conveyed by different ratios.

Answer 1 (c)

The financial position of the company is not very good. The company is not performing efficiently as it has a low return on capital employed and return on shareholders. It implies that the company is not able to efficiently deploy its capital and use the available assets. Further the performance of the company is deteriorating as return on shareholders’ funds and on capital employed in decreasing from 13% in 2020 to 6% and 7% respectively in the year 2021.
Gross profit of the company is slightly increasing over the two years. The company is earning a good profit margin. It shows the efficiency of the company in the trading or manufacturing of goods or provision of service.
The net profit margin of the company is not very high. Further it is decreasing over the two years. Decreasing net profit margin is not good for the long term growth of the company. Further there is a wide difference in the gross profit and net profit margin which shows that the company is incurring a large proportion of indirect expenditure.
The current ratio of the company is also decreasing over the two years. Current ratio defines the ability of the company to meet its short term obligation at any point of time. Decreasing current ratio is not a good sign and the company should pay attention to the same.

 Answer 2(a)

The three levels of demand estimated by the company are 10,000 litres, 14,000 litres, and 18,000 litres.
While calculating cost per litre of the product, variable cost per unit of the product will remain same, whereas in case of fixed overheads, total fixed overheads will remain same. Fixed overheads per unit of the product will decrease with the increase in the level of output.

The manufacturing cost per litre of the product is as follows:-

Number of litres	Per unit	10000	14000	18000
Costs	£	£	£	£
Variable costs:
Direct materials	0.12	1,200.00	1,680.00	2,160.00
Direct labour	0.10	1,000.00	1,400.00	1,800.00
Overheads	0.16	1,600.00	2,240.00	2,880.00
Fixed costs:
Indirect labour	0.07	700.00	700.00	700.00
Overheads	0.16	1,600.00	1,600.00	1,600.00
Total cost	0.61	6,100.00	7,620.00	9,140.00
Cost per litre		0.61	0.54	0.51

Answer 2(b)

Cost per litre of the product is decreasing with the increase in the number of litres made. Variable cost per litre of the product does not change with the change in the level of output. However total variable cost increases based on the level of output produced. Total fixed overheads also remain constant at all the level of output within a defined range, however fixed overheads per litre of output decreases with the increase in number of units produced. This is because total cost is shared by more number of units.

Answer 2(c)

Break even sales is the level of sales at which the company earns no profit or loss and is able to recover its variable and fixed overheads.

Budgeted break even sales (in litres) = Fixed cost / (Sales price per unit – Variable cost per unit)
                                                                   = (£700 + £1,600) / (£1 – £0.61)
                                                                   = 5898 litres

Margin of safety is the level of sales in excess of break even sales. Margin of safety can be calculated as follows:-

Margin of safety sales (in litres) = Total budgeted sales – Budgeted break even sales
                                                          = 10,000 litres – 5898 litres
                                                          = 4102 litres
Margin of safety (in %) = Margin of safety sales / Total sales
                                          = 4,102 litres / 10,000 litres
                                          = 41.02 %

Answer 2(d)

Assumptions to be taken in break even analysis to have reliable results are as follows:-

i)  Semi variable costs are ignored in break even analysis. Only fixed costs and variable costs are
     considered.

ii)  The price of the product is assumed as constant.

iii)  It is assumed that technology used in the production of goods is constant and labour efficiency is
       also assumed as constant.

iv)  The product mix is assumed to be constant in case the company produces and sells more than one
       product.

v)  Inflation rate is assumed to be constant.

Answer 3 (a)(i)

Payback period in case of uneven cash flows can be calculated as follows:

Years before full recovery + unrecovered cost at the start of the year
                                                            cash flow during the year

Year	Cash Inflow – Project A	Cumulative cash inflow	Cash Inflow – Project B	Cumulative cash inflow
1	685,000	685,000	530,000	530,000
2	765,000	1,450,000	558,000	1,088,000
3	831,000	2,281,000	598,000	1,686,000
4	552,000	2,833,000	670,000	2,356,000
5	135,000	2,968,000	900,000	3,256,000

Also, Initial investment in case of project A and B is 2,000,000 and working capital requirement in case of project B is 130,000.

Payback period of both the projects is as follows:

Project A = 2 years + (2,000,000 – 1,450,000)
                                                  831,000

                  = 2 years + 0.6619 years
                  = 2.6619 years

Project B = 3 years + (2,000,000 + 130,000 – 1,686,000)
                                                           670,000
                  = 3 years + 0.6627 years
                  = 3.6627 years

From the above it can be concluded that project A is able to recover its investment in lesser period of time as compared to project B.

Answer 3 (a)(ii)

The net present value of both the projects can be calculated as follows:-

Year	Particulars	Cash flow – Project A	Cash flow – Project B	Present value factor @ 13%	Present value- A	Present value- B
0	Initial Investment expenditure	(2,000,000)	(1,000,000)	1.000	(2,000,000)	(1,000,000)
0	Working capital requirement	–	(130,000)	1.000	–	(130,000)
1	Initial Investment expenditure	–	(1,000,000)	0.885	–	(885,000)
1	Net cash inflow	685,000	530,000	0.885	606,225	469,050
2	Net cash inflow	765,000	558,000	0.783	598,995	436,914
3	Net cash inflow	831,000	598,000	0.693	575,883	414,414
4	Net cash inflow	552,000	670,000	0.613	338,376	410,710
5	Net cash inflow	135,000	900,000	0.543	73,305	488,700
5	Working capital realised	–	130,000	0.543	–	70,590
5	Residual value realised	130,000	200,000	0.543	70,590	108,600
Net present value	263,374	383,978

From the above, it can be said that project B has higher NPV than Project A.

Answer 3 (b)

	Advantages	Disadvantages
Payback period method	Simple and easy to calculate	ignores time value of moneyignores cash flows that are generated beyond the payback period
Net present value method	Considers the time value of moneyConsiders all the cash flows during the life of the project	Not suitable for comparison of projects with different investment sizesNo set of principles and guidelines to calculate the required rate of return

The above 2 projects have been evaluated on the basis of payback period method and net present value method. Payback period is the time period in which the initial investment is recovered. Both methods have its own advantages and disadvantages, some of which are stated below:-

Since the payback period method ignores time value of money, therefore net present value method is more logical to evaluate both the projects. Considering the net present value, project B should be undertaken as it has higher NPV as compared to project A.

Answer 3 (c)

Treatment of sunk cost, working capital and residual value in the investment appraisal decisions is as follows:-

1. Payback period method
   Payback period method considers the cash flows generated or incurred during the payback period. Any cash flow generated after the payback period are not considered in this method. Since sunk cost is the cost that has already been incurred in the past, hence is not considered in the decision making.
   Working capital introduced at the beginning of the project is considered as a part of initial expenditure.
   Working capital realized at the end of the project life and the residual value are not considered in the payback period method as this method do not take into account any cash flows after the payback period and the payback period is usually before the end of project life only.
2. Net present value method
   Net present value considers the residual value and working capital both at the beginning and end of the project. However it does not considers the sunk cost as it is the cost that has already been incurred in the past.

Answer 4 (a)

	Product X	Product Y	Product Z
Units	1500	2250	3000
	£	£	£
Selling price per unit	348	680	620
Variable cost per unit:
Material	64	160	120
Labour	80	192	160
Variable overheads	48	120	96
Total variable cost per unit	192	472	376
Contribution per unit	156	208	244
Total Contribution	234000	468000	732000
Labour cost per hour (£)	8	8	8
Labour hours required for 1 unit of output (Labour cost per unit / labour cost per hour)	10	24	20
Total labour hours required
Product X	15000
Product Y	54000
Product Z	60000
	129000
Labour hours available	90000

In the given case labour hours is the limiting factor as total labour hours required to produce the given level of output is 129000 hours whereas only 90000 labour hours are available. Therefore the output shall be produced in the order where there is maximum contribution per hour.

 (£)

Statement showing ranking
	Product X	Product Y	Product Z
Contribution per unit	156	208	244
Labour hours required per unit	10	24	20
Contribution per labour hour	16	9	12
Ranking	1	3	2

Statement of optimum production
Product	Number of units	Labour hours required	Remaining labour hours
X	1,500.00	15,000.00	75,000.00
Z	3,000.00	60,000.00	15,000.00
Y	625.00	15,000.00	–

Conclusion
In order to maximize the profit the company should produce 1500 units of product X, 3000 units of product Z, and 625 units of product Y.

Answer 4 (b)

The company’s profit based on production plan as above would be as follows:-

	Product X	Product Y	Product Z	Total
Units	1500	625	3000
	£	£	£	£
Selling price per unit	348.00	680.00	620.00
Variable cost per unit:
Material	64.00	160.00	120.00
Labour	80.00	192.00	160.00
Variable overheads	48.00	120.00	96.00
Total variable cost per unit	192.00	472.00	376.00
Contribution per unit	156.00	208.00	244.00
Total Contribution	234,000.00	130,000.00	732,000.00	1,096,000.00
Less : Fixed overheads				480,000.00
Profit				616,000.00

Answer 4 (c)

If the company has already accepted the order of 2100 units of product Y which is legally binding on it, then it shall be required to produce 2100 units of product Y first and then the remaining labour hours shall be used to produce the other products in the order of their ranking.

Statement of optimum production
Product	Number of units	Labour hours required	Remaining labour hours
Y (Order already accepted)	2,100.00	50,400.00	39,600.00
X	1,500.00	15,000.00	24,600.00
Z	1,230.00	24,600.00	–

Answer 4 (d)

Non financial factors that the company should consider before adopting any of the above suggested production plan are as follows: –

1. The company should make sure that selling more or less of 1 product do not affect the sale of other product i.e. sale of each of the three product are independent of each other.
2. Selling less of a certain product which is less profitable do not affect the goodwill of the company.
3. Labour have the efficiency to produce the changed composition of the product.
4. No change in manufacturing facility would be required to produce the changed composition of the product.

Answer 4 (e)

Benefits of using marginal costing system in comparison to absorption costing system when taking operational decisions are as follows : –

1. Marginal costing system do not considers fixed overheads. So there is no arbitrary apportionment of fixed overheads to the cost of the product.
2. The decision making is based on contribution earned on the product and thus is a more reliable measure.
3. Marginal costing system is simple and easy to understand as there is no calculation of fixed overheads.
4. It is very beneficial for taking short term decisions as pricing is based on variable cost of production and fixed cost is not considered which do not vary in short run. Thus it does not lead to rejection of orders which is yielding positive contribution.
5. Marginal costing system helps the firm to face the competition. In many cases the firm prices the export orders on the basis of marginal cost only.

Answer 5(a)

Monthly cash budget
Particulars	September	October	November
	£	£	£
Opening cash balance	–	(3,000.00)	(7,000.00)
Add:
Cash sales	35,100.00	35,100.00	43,875.00
Realization from debtors	–	4,000.00	4,000.00
Capital contribution by directors	45,000.00	–	–
Loan taken	120,000.00	–	–
Less:
Payment to creditors	–	16,000.00	16,000.00
Salary of experienced staff member	2,500.00	2,500.00	2,500.00
Salary of directors	3,000.00	3,000.00	3,000.00
Payment of overheads in next month	–	2,000.00	2,000.00
Payment of rent	18,000.00	18,000.00	–
Shop cost	58,000.00	–	–
Purchase of furniture and fixture	120,000.00	–	–
Payment of monthly loan installment	1,600.00	1,600.00	1,600.00
Closing cash balance	(3,000.00)	(7,000.00)	15,775.00
Cash sales
Total sales	40,000.00	40,000.00	50,000.00
Cash sales (90% of total sales)	36,000.00	36,000.00	45,000.00
Less : NUS Discount	900.00	900.00	1,125.00
Net cash sales	35,100.00	35,100.00	43,875.00
Realization from debtors
Total credit sales	4,000.00	4,000.00	5,000.00
Realization from debtors in next month	–	4,000.00	4,000.00
Payment to creditors
Total stock purchase (40% of sales)	16,000.00	16,000.00	20,000.00
Payment to suppliers in next month	–	16,000.00	16,000.00

Answer 5(b)

 The cash balance during the first two months is negative. However, the position has improved during the month of November. Negative cash balance during the first two months is due to the capital nature transactions that have been incurred such as the purchase of furniture and fixtures and payment of yearly rent. Cash balance can be further improved by making all the sales on a cash basis.

 Answer 5(c)

Fixed Budget	Flexible Budget
Fixed budget is the budget that remains constant at all the level of production.	Flexible budget is the budget that is created for different level of production.
There is only 1 level of production.	There is multiple level of production.
Cannot be modified for comparison with the actual level of production.	Can be modified for comparison with actual level of production.
Fixed budgets are based on assumptions.	Flexible budgets are more realistic and accurate.
It is much simple to prepare fixed budget.	It is quite complex to prepare flexible budget as it needs to be prepared at different levels of production.
Fixed budget is prepared on the basis of past data.	Flexible budget is prepared on the basis of realistic and current situations.

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