Practice Questions (All Topics)

Financial Analysis and Control
Module BST511
Self-Study and Revision Pack
Set out below are a number of practice questions with

answers on the topics covered in the module.
The questions have been split into sections by topic:
Section A: Accounts Preparation.
Section B: Financial Statement Analysis.
Section C: Relevant Costs for Short Term Pricing

Decisions.
Section D: Investment Appraisal

Section A: Accounts Preparation.
Posy and Pym set up a business running canal boat holidays. They invested
20,000 each and borrowed 80,000 from the Inland Waterways Bank to start
up the business. The loan carried interest of 10%, which was payable in half-
yearly instalments. In their first year of business, which ended on 31
December 2010, they had the following transactions:
i) Purchased 3 fully equipped canal boats for 40,000 cash each on 1
January 2010. They expected to use the boats for ten years and that
they would be worth 8,000 each at the end of that period.
ii) Bought, for cash, bedding, crockery and cutlery for the boats at a cost
of 4,500 on 1 January 2010. They expected that these would need
replacing in two years time.
iii) Agreed to rent a small office in a converted lockkeepers cottage for a
rent of 4,000 per year. They paid 8,000 of rent in advance to cover
the two year period to 31 December 2011.
iv) Paid business rates of 1,400, a years insurance of 600, and
electricity charges of 900. At 31 December 2010 they estimated that
electricity used but not billed would cost another 200.
v) Paid 3,000 for advertising in the year. This included advance
payment of 800 for an advertisement that appeared in early 2011.
vi) Banked 41,000 from boat rentals in the year. At 31 December 2010
another 16,000 was outstanding from a TV company that had hired
the boats to make a childrens programme, but 1,500 of this was in
dispute because the producer claimed that she had suffered nervous
shock from finding a water vole in her bed. They did not intend to sue
for this disputed amount to maintain the clients goodwill.
vii) Paid 13,000 cash for running costs, fuel, cleaning materials and
maintenance of the boats during the year. An invoice for 2,500 was
still unpaid at 31 December 2010. Their accountant suggested that
these costs should be regarded as costs of sales in their accounts.
viii) A stock of cleaning materials which cost 400 was unused at the end of
December 2010, but had deteriorated and was now worth only 150.
ix) Paid the first half years interest on 30 June 2010 but did not pay the
second instalment until January 2011 because the bank was closed on
31 December 2010.
REQUIRED:
a) Prepare a Cash Flow Statement, Income Statement and Statement of
Financial Position for Posy and Pym for the year ended 31 December 2010
b) The Income Statement is suggested to measure performance more

accurately because it matches the revenues of a period with the
appropriate costs, while the Statement of Cashflow records only the cash
paid or received in a period. Identify THREE examples of this from your
workings in (a) and (b) above.
Posy and Pym: suggested answer
Workings:
A.
Statement of cash Flow for the year ended 31 December 2010

Cash received from customers 41,000
Cash paid to suppliers (13,000)
Rent paid (8,000)
Rates paid (1,400)
Insurance paid (600)
Electricity bills paid (900)
Advertising paid (3,000)
(26,900)
Net operating cash flow: 14,100
Servicing of finance: interest paid (4,000)
Investing activities:
Purchase of canal boats (120,000)
Purchase of bedding etc (4,500) (124,500)
Net cash flow before financing: (114,400)
Financing:
Owners equity (2 x 20,000) 40,000
Long term loan proceeds 80,000 120,000
Net increase in cash: 5,600

Income Statement for the year ended 31 December 2010

Sales revenue (41,000 + 16,000) 57,000
Cost of sales:
Purchases (13,000 + 2,500) 15,500
Less: closing stock (400-250) (150) 15,350
Gross profit 41,650
Operating expenses:
Depreciation:
- Boats (120,000-24,000)/10 (9,600)
- Sundry assets (4,500/2) (2,250)
Bad debt written off (1,500)
Rent payable (1 years worth) (4,000)
Rates paid (1,400)
Insurance paid (600)
Electricity bills (900 + 200) (1,100)
Advertising (3,000 800 prepaid) (2,200)
(22,650)
Net operating profit: 19,000
Interest payable (80,000 x 10%) (8,000)
Net profit retained 11,000

Statement of Financial Position AT 31 December 2010
Non Current Assets:

Equipment 112,650
Current Assets:
Inventory at cost 150
Trade receivables less provision 14,500
Prepaid expenses:
Rent 4,000
Advertising 800
Cash 5,600 25,050
Total Assets 137,700
Non Current Liabilities

Long term loan 80,000
Current liabilities
Trade payables 2,500
Accruals (Electric and Interest) 4,200 6,700
Total Liabilities 86,700
Total Assets & Liabilities 51,000
Equity
Paid-in capital 40,000
Profits 11,000
Total equity 51,000
Examples of profit/cash differences
1. The purchase of equipment with a substantial operating life (e.g. canal boats) is
recorded as an expense in the cash flow statement but the cost, less expected residual
value, is spread over the expected useful life in the Income Statement. This is
arguably more realistic as the same expenditure will not be required for several more
years until the equipment ultimately needs replacing
2. Payments for operating expenses may not reflect the amounts relevant to the year in
question. An example is the advance payment of 2 years rent in cash, which is spread
over the two years it benefits.
3. Expenses that have been incurred during the year, but not necessarily settled in
cash, are accrued for. An example is the adjustment to the electricity bill for amounts
used but not invoiced.
Kevin set up in business on 1 October 2003 to manufacture low-intensity car horns,
approved by the Noise Abatement Society, for use at night in built-up areas. A
summary of his transactions for the year ended 30 September 2004 is as follows:
A Paid in 50,000 of his own money to start up the business;
B Borrowed 100,000 at 6% annual interest from his friend Perry as a long term
loan;
C Made sales for cash amounting to 220,000 and, at the end of the year, was owed a
further 30,000 for sales made on credit. 2,000 of this was owed by a customer who
had always claimed to have loads of money but was currently facing fraud charges
and who was not expected to be able to pay;
D Spent 130,000 cash on buying components and processing them into finished
horns. At the end of the year he had finished horns, unsold, which had cost him
20,000;
E Paid 50,000 to purchase a 10-year lease of an industrial building on the Enfield

Estate. He also promised to pay an annual rent of 10,000 per year, payable half in
October and half in April;
F Bought the patented Oldgitz Honk Reduction Machine for 40,000. He expected
this machine to last for 5 years and to have a scrap value of 5,000 at the end of its
working life;
G Paid rent of 5,000 on the building in October 2003, but forgot to pay the amount
due in April 2004 because the landlord had not reminded him;
H Paid wages of 15,000 to his assistant Tim Nicebutdim for the year to 30
September 2004, but forgot to pay him a promised bonus of another 1,000 until 14
October 2004;
I Paid 15,000 in total for electricity and telephone bills. Kevin estimated that
3,000-worth of electricity had been used since the last bill but before the end of
September 2004. He also noted that 300 paid in his September telephone bill was an
advance line rental charge for October to December 2004.
J Paid interest of 5,000 to Perry on 30 September 2004.
REQUIRED:
(a) Prepare a Cash Flow Statement, Income Statement and Statement of Financial
Position for Kevins first year in business.
.
Kevin: suggested answer
Workings
The cash flow statement only includes items that arise from a cash receipt or payment.
Accounting adjustments like stock, depreciation, amounts owed to the business but
unpaid, amounts owed by the business but unpaid, bad debt allowances, etc do not
appear in a cash flow statement. The cash flow statement, however, includes balance
sheet items that do not appear in the Income Statement (such as receipts from owners
paying in equity; receipts from loans advanced to the business; and payments for
fixed assets which are intended to be held and used in the business for more than one
year).
The Income Statement account is concerned only with the income and expenses
arising from running the business for the period measured (usually one year). It
adjusts from a receipts and payments basis to a matching basis and so spreads the
net cost of fixed assets over their useful lives through depreciation; records sales
income, purchases and expenses to reflect transactions during the year, whether or not
settled in cash; and adjusts for items like the value of closing stock (purchases not
used to make sales) and the collectibility of doubtful debts (sales already recorded but
which are now considered unlikely to be paid).
Note that each line adds across to ZERO when the corresponding balance sheet item
is taken into account. The cash flow explains the net increase in balance sheet cash in
the year, while the P&L explains the net increase in equity.
KEVIN:
CASH FLOW STATEMENT FOR THE YEAR ENDED 30 SEPTEMBER 2004

Cash flows from operations:
Payments to and on behalf of employees (15,000)
Other operating cash payments:
Rent paid (5,000)
Utility bills paid (15,000) (20,000)
Net Operating Cash Flow 55,000
Servicing of Finance: interest paid (5,000)
Investment in Fixed Assets:

Investment in 10 year leasehold (50,000)
Investment in production equipment (40,000) (90,000)
Net Cash Flow before Financing: (40,000)
Financing:
Owners Equity 50,000
Long term loan from Perry 100,000 150,000
Net increase in cash for the year: 110,000

KEVIN: INCOME STAEMENT FOR THE YEAR ENDED 30 SEPTEMBER
2004

Sales (based on credit transactions) 250,000
Deduct:
Cost of sales
Purchases (based on transactions completed) 130,000
Less: closing stock not used in sales
Finished goods 20,000
110,000
Trading profit 140,000
Deduct:
Operating expenses
Depreciation charges
Leasehold (50,000/10) 5,000
Equipment (40,000-5,000)/7 7,000
Wages and bonus payable 16,000
Rent payable for the year (5,000+5,000 owed) 10,000
Utility bills payable (15,000+3,000-300) 17,700
Adjustment for possible bad debt 2,000
Total operating expenses 57,700
Operating profit 82,300

Deduct:
Interest payable for year (100,000 x 6%) 6,000
Net profit for the year 76,300

Kevin Statement of Financial Position
Non Current Assets:
Building Lease 45,000
Equipment 33,000
78,000
Current Assets:
Inventory at cost 20,000
Prepaid expenses: 300
Cash 110,000 158,300

Current liabilities
Accruals (Interest, Rent, Wages, Electric) 10,000
Equity
Profits 76,300
Total equity 126,300
Zaphod Beeblebrox (ZB) set up in business to manufacture robots with individual
personalities. On 1 January 2002 he invested 50,000 of his savings in a business
bank account with the Trillian Bank and obtained a loan of 100,000 from the
Magrathea Investment Corporation. The following transactions took place during the
year ended 31 December 2002:
A. Paid 20,000 on 1 January 2002 to take over a leasehold shed on the Dent
Industrial Estate. The lease had 10 years left to run. Rent was 12,000 per year,
payable monthly. All the rent was paid on time except for the December
instalment, which was not paid until 2 January 2003.
B. Paid 120,000 cash on 1 January 2002 for automated manufacturing equipment,
which he expected to last for at least 9 years. The scrap value at the end of 9 years
was estimated at 12,000.
C. On 1 January 2002 he bought a van for 10,000 cash. The dealer offered a
guaranteed trade-in value of 5,000 in two years time.
D. Purchased components on credit costing 400,000. 350,000 of these purchases
were settled in cash before 31 December 2002.
E. Paid electricity bills of 9,000 in total. At 31 December 2002 a further 800 of
electricity was estimated as having been used but not billed.
F. Paid business rates of 1,000 per month. The rates due for January 2003 were
paid in advance on 29 December 2002 to ensure that they were received in time.
G. At 30 December 2002 there were unsold robots that had cost 30,000 to make.
There were also unused components that had cost 3,000, but 300-worth of these
had been badly stored and were valued at only 150 on a sale basis if not used in
robots.
H. Made sales amounting to 600,000. All the sales had been made on 30-day credit
terms and, at 31 December 2002, invoices for 90,000 were still outstanding. One
customer, The Sirius Cybernetics Corporation (SCC), was unhappy with the
personality of a robot called Marvin for which it owed 30,000. ZB expected that
SCC would settle for 24,000. The remaining 60,000 was expected to be settled
in full.
I. Under the terms of the loan agreement interest would be charged at 5% per year
but would not be paid over to the Investment Corporation until the end of
December 2003.
REQUIRED:
Prepare a Cash Flow Statement, Income Statement and Statement of Financial
Position for the year ended 31 December 2002.
If ZB wanted to increase his reported cash flow or profit for the year, what scope
would he have to do so legitimately?
Zaphod Beeblebrox suggested answer
Workings for question:
The cash flow statement only includes items that arise from a cash receipt or payment.
Stock, depreciation, amounts owed to the business but unpaid, amounts owed by the
business but unpaid, bad debt allowances, etc can NEVER appear in a cash flow
statement. The cash flow statement DOES include balance sheet items that do not
appear in the Income Statement (such as receipts from owners paying in equity;
receipts from loans advanced to the business; and payments for fixed assets which are
intended to be held and used in the business for more than one year). The Income
Statement is concerned only with the income and expenses arising from running the
business for the period measured (usually one year). It adjusts from a receipts and
payments basis to a matching basis and so spreads the net cost of fixed assets over
their useful lives through depreciation; records sales income, purchases and expenses
to reflect transactions during the year, whether or not settled in cash; and adjusts for
items like the value of closing stock (purchases not used to make sales) and the
collectibility of doubtful debts (sales already recorded but which are now considered
unlikely to be paid). Note that each line adds across to ZERO when the
corresponding balance sheet item is taken into account.
ZAPHOD BEEBLEBROX:
CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2002

Cash flows from operations:
Other operating cash payments:
Rent paid (11,000)
Electricity bills paid (9,000)
Business rates paid (13,000) (33,000)
Net Operating Cash Flow 127,000
Servicing of Finance: interest paid -
Investment in Fixed Assets:

Investment in 10 year leasehold (20,000)
Investment in production equipment (120,000)
Investment in van (10,000) (150,000)
Net Cash Flow Before Financing: (23,000)
Financing:
Owners Equity 50,000
Long term loan from M.I.C. 100,000 150,000
Net increase in cash for the year: 127,000

ZAPHOD BEEBLEBROX:
INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2002

Sales (based on credit transactions) 600,000
Deduct:
Cost of sales
Purchases (based on transactions completed) 400,000
Less: closing stock not used in sales
Finished goods 30,000
Components (3.000-300+150) 2,850 367,150
Trading profit 232,850
Deduct:
Operating expenses
Depreciation charges
Leasehold (20,000/10) 2,000
Equipment (120,000-12,000)/9 12,000
Vehicle (10,000-5,000)/2 2,500
Rent payable for the year (11.000+1,000 owed) 12,000
Electricity charges payable (9,000+800 owed) 9,800
Rates payable (13,000-1,000 overpaid for year) 12,000
Adjustment for possible bad debt 6,000
Total operating expenses 56,300
Operating profit 176,550

Deduct:
Interest payable for year (100,000 x 5%) 5,000
Net profit for the year 171,550

Statement of Financial Position AT 31 December 2012

Non Current Assets:

Lease 18,000
Equipment 108,000
Van 7,500
133,500
Current Assets:
Inventory at cost 32,850
Prepaid expenses:
Rates 1,000
Cash 127,000 244,850

Current liabilities
Trade payables 50,000
Accruals (Rent, Electric and Interest) 6,800 56,800
Equity
Profits 171,550
Total equity 221,550
Scope for increasing reported cash flow or profit for the year
(Note that the question is not about how ZB could have run the business better with
the benefit of 20:20 hindsight, but about what legitimate scope he has to increase his
reported cash flow and profit by adjusting his results for the year just ended, but
doing so within the accepted accounting rules.)
Cash flow: it is not possible to increase the cash flow after the event, since the cash
flow statement reports objectively on cash transactions and cannot be manipulated.
Profit and Loss: there are several elements of the Income Statement which are
essentially a matter of opinion and judgment rather than objective fact. In ZBs case,
there might be legitimate scope for adjusting some (or all) of the following:
1. The question does not specify the stock valuation method used. It might therefore
be possible to use a FIFO method if prices have been rising during the year and
ZB has used the AVCO method; alternatively, if prices have been falling and he
has used FIFO, the results could be recomputed on AVCO. Either of these options
would increase reported profit.
2. Calculating depreciation involves taking two separate views, one on the
expected useful life of an asset and one on its likely scrap or second-hand resale
value. Assuming that a straight-line depreciation method is used, either useful life
or residual value can be increased so as to reduce the annual depreciation charge
for the production equipment or the van. (Note that there is no scope for this on
the leasehold, where there is no residual value and where the useful life is not
decided by the business but by the terms of the legal contract of purchase.)
3. If ZB considered that the useful life of either the equipment or the van was more
fairly measured in activity (such as production of robots by the equipment, or
mileage covered by the van) and that this activity would be more weighted toward
the later years of use, then it might also be possible to reduce the current years
depreciation charge by the use of activity-based depreciation.
4. The estimate of 800 for electricity used but not billed is a guesstimate and
could be revised down if ZB felt that it might have been over-cautiously
estimated..
5. It could be argued that a net realisable value basis for the badly stored components
is inappropriate, since this value is specifically related to their resale potential as
components, while ZBs intention is to use them in manufacturing robots. The
question does not specify that their functionality has been impaired, and so an
original cost basis might still be valid.
6. The disputed amount owed by the Sirius Cybernetics Corporation is presumably
subject to negotiation between the parties. ZBs expected recovery of 24,000
might be increased if there were a reasonable prospect of recovering more. It
might be prudent to obtain a legal opinion to support this!
Section B: Financial Statement Analysis.
A summarised extract from the accounts of Merrydin Ltd is given below:
Income Statement
Year Ended Year ended

31/12/04 31/12/05
000 000 000 000

Turnover 1,560 2,350
Less
Cost of Sales 910 1,400
Operating expenses 430 630
Interest 27 1,367 38 2,068
193 282
Statement of Financial Position
As at 31/12/04 As at 31/12/05
Fixed Assets 645 695

Current Assets:
Stocks 290 570
Debtors 200 290
Cash/bank 60 90
550 950
Current Liabilities:
Creditors 282 487
Net Current Assets 268 463
Capital Employed 913 1,158
Long-term Loan 300 440
613 718
Shareholders Funds:
Ordinary Shares and
Reserves 613 718
Merrydin Limited belongs to a trade association which operates an inter-firm

comparison scheme. Under this scheme ratios are collected for 12 companies
that are similar to Merrydin. The average ratios for these 12 companies are as
follows:
2004 2005
Return on capital employed 20.1% 24.9%
Profit margin 12.5% 14.6%
Asset turnover 1.6x 1.7x
Liquidity (current ratio) 1.64 1.72
Acid-test 1.13 1.21
Total owing to total assets 38.4% 43.2%
Interest cover 8.2x 8.4x
Long-term debt to capital employed 31.6% 32.1%
Debtor collection period 28.4 days 33.6 days
Stock turnover period 68.7 days 74.4 days
REQUIRED
(a) Calculate the ten ratios given above for Merrydin Ltd for the year
ended 31 December 2004 and the year ended 31 December 2005 (12
marks)
(b) Using the ratios you have calculated for Merrydin Limited and the
ratios given above evaluate, as far as the information permits, the
financial performance of Merrydin Limited. (8 marks)
(c) Discuss briefly the limitations of ratios for analysing company

performance. (5 marks)
(Total 25 marks)
Merrydin: suggested answer (1 of 2)
a) Ratios calculation
2004 2005
ROCE 220 320
913 = 24.1% 1,158 = 27.6%
Profit margin (net) 220 320
1,560 = 14.1% 2,350 = 13.6%
Asset turnover (capital turnover) 1.560 2,350
913 = 1.7x 1,158 = 2.1x
Liquidity:
550 950
Current ratio: 282 = 1.95x 487 = 1.95x
Quick ratio: 260 380

282 = 0.92x 487 = 0.78x
Total owing: total assets 582 927
1,195 = 0.48:1 1,645 = 0.56:1
Financial structure:
Interest cover: 220/27 320/38
= 8.1x = 8.4x
Debt: Debt+Equity 300/913 440/1,158

(Debt: Capital Employed) = 32.9% 38.0%
Debtor collection period 200/1560 290/2,350

x 365 = x 365 =
46.8 days 45.0 days
Stock turnover period 290/910 570/1,400

x 365 = x 365 =
116.3 days 148.6 days
b) Position and performance
On a standalone basis, Merrydin seems to be improving its overall profit performance

in the periods studied. Although its net margin has declined very slightly at a time
when its comparator firms margin has increased, it is achieving a higher return on
capital employed and making more effective use of its investment base to generate
additional sales. Not only are both these key ratios showing an uptrend, but they are
ahead of the equivalent results of the peer group in the inter-firm comparison.
The firms liquidity, however, appears to offer some cause for concern. Both current
and quick ratios are below those of the peer group; and the quick ratio, which focuses
on the availability of cash and near-cash assets to meet current liabilities, has not only
declined against the comparator group but also in absolute terms between 2004 and
2005. This suggests that the firm may be hard pushed to meet its short-term liabilities
as they fall due. The worsening of the total owing to total assets position, which was
already looking more vulnerable than in the peer group, also suggests that unsecured
creditors are at a slightly higher risk in dealing with this firm although a ratio of
0.56:1 still means that the break-up value of the firm could be over 40% below book
value in a fire sale before creditors lost money.
A possible explanation for this apparently stretched liquidity position may lie in the
firms relatively poor management of working capital: debtor collections have
improved only marginally since 2004, while stock turnover has seemingly worsened
by a further month. Working capital management in the peer group has also declined
since 2004, but is still at a much higher level of overall efficiency (for both debtors
and stock) than in Merrydin. (Against this, it is quite possible that the significant
(over 50%) upturn in sales since 2004 may be distorting the firms ratios if there are
high closing balances of stock (held in anticipation of increased future sales) and of
debtors (the result of high sales late in 2005) and these are compared with lower
annualised figures for cost of sales and sales respectively. If the peer group has not
experienced a similar sales upturn, we may not be comparing like with like).
Merrydin is slightly more highly geared than its peer group at the end of 2005,
although its operating profits cover interest obligations 8.4 times an identical ratio to
that of the peer group and suggesting that there is ample spare capacity for further
longer-term borrowings to cover short-term liquidity exposures. Higher gearing
would also operate to the benefit of shareholders; Merrydin is currently paying
interest of around 8.6% on its loans (38/440 8.6%) while earning 27.6% on capital
employed, so higher borrowings would provide shareholders with an extra 19% return
on every pound borrowed.
In summary, the firm is clearly outperforming its peers in terms of earning a return on
its asset base and of working this asset base to generate sales, which have sharply
increased in the year. Whether this rapid growth alone can explain its much more
stretched liquidity position and its apparently less effective working capital control is
a more debatable point, although there seems to be capacity to meet any short-term
cash crisis by further longer-term borrowings to take advantage of a generous level of
interest cover.
c) See the lecture notes.

Section C: Relevant Costs for Short Term Pricing Decisions.
Frogspawn Fittings (FF) has been invited to tender for the contract to supply 4,000
sets of security locks for a new luxury apartment block to be built in the Splott area of
Cardiff. FFs management are keen to win the contract because of the favourable
publicity it will bring, but are reluctant to lose money on the deal by quoting too low a
price. The companys finance department has produced the following estimate for the
contract:
Designers fees: 120,000

Materials at cost: 550,000
Keypads and alarms at cost: 40,000
Manufacturing wages: 280,000
Installation costs: 40,000
Variable overheads: 70,000
Fixed overheads: 140,000
Total cost of contract: 1,240,000
The following information is also available:
i) The designer is under contract to FF and is paid 20,000 per month as a

standby charge whether or not she is given any work. The 120,000 in
the schedule reflects two months standby charges with the balance
representing extra fees.
ii) Most of the material required for the contract is in stock at a total cost of
380,000. 60,000 of this has no alternative use in future and, if not used
on this project, could be sold for its scrap value of 8,000. A further
240,000 is regularly used by FF: the suppliers have recently announced a
5% price increase. Special alloys with a stock value of 80,000 can be
transferred from another contract, which has been delayed because of
planning problems; these alloys can be replaced at a cost of only 59,000
as a cheaper source for the material has been found. 60,000 of materials
will need to be purchased and a bulk purchase discount of 5% is available.
The finance department does not allocate discounts to individual contracts
and this discount has not been reflected in the cost estimates above.
iii) The keypads were purchased last year for another contract that did not
proceed. They are in stock at a cost of 25,000. If not used on this
contract they could be re-sold for 35,000 because of a shortage of supply.
The alarms, purchased for 15,000, were made to special order for FF but
are now being produced more cheaply in bulk by the manufacturers. If not
used on this contract, their second-hand value would be only 9,000.
iv) FFs staff are paid a flat-rate minimum wage for a guaranteed working
week in which overtime is not normally incurred. Manufacturing wages in
the schedule include 12,000 hours of flat-rate wages paid at 15 per hour
and 2,000 hours of overtime paid at 20 per hour. Temporary labour
costing a total of 60,000 will also need to be hired for the contract.
v) Installation costs of 40,000 include a fixed availability charge of 4,000
per month for the installation service, which FF uses regularly. Two
months installation work would be involved.
vi) Variable and fixed overheads have been allocated to the project in line with
FFs normal practice of charging a standard mark-up based on wage costs.
On enquiry you discover that actual variable overheads are forecast as
25,000 for power and consumables and 35,000 representing activity-
related depreciation on specialist machinery. Actual fixed overheads will
consist of the rent apportionment for the production area of 84,000 and
straight-line depreciation of equipment amounting to 22,000. In both
cases the standard mark-up exceeds the actual overheads expected, and the
finance department has used the standard amounts because these are larger.
REQUIRED:
(a) Redraft the schedule using the principles of decision-relevance to show the
minimum price FF could charge for the contract without losing money. Explain
briefly why you have excluded or amended any items on the original schedule, or
included items not on the schedule. (15 marks)
(b) Using data from your answer to (a) above, illustrate the main differences between
conventional accounting and the principles of decision-relevance.
(10 marks)
(Total 25 marks)
Q1. Suggested answer: Frogspawn Fittings
A) Redraft of schedule
Item: Detail:
(i) Designers fees:
2 x 20k is a committed cost -
Balance of fees is incremental 80,000
(ii) Materials:
60k of material with no alternative use: sunk costs -
Scrap value represents opportunity cost of use 8,000
240k at cost: sunk and therefore irrelevant, but the consequential -
cost of using it is the replacement cost of 240k plus 5% 252,000
Alloys at cost of 80k: this is a sunk cost, but consequential -
replacement for the delayed contract will only cost 59k 59,000
Remaining 60k-worth that needs to be purchased: in principle this
is an incremental outflow, but decision-relevance uses the actual
cash cost, including discount, and ignores the accounting treatment 57,000
Balance of stock (550k minus the 440k dealt with above) must be
assumed to be incremental purchases at current market prices * 110,000
(iii) Keypads: original cost of 25k is sunk -
The opportunity cost of using them is 35k (the resale value 35,000
forgone) -
Alarms: once more the original 15k cost is sunk 9,000
Opportunity cost of using is 9k
(iv) Flat-rate wages (15 x 12,000 hours) are committed costs -
2,000 hours overtime x 20 is incremental cash flow 40,000
Temporary labour is also an incremental cash flow 60,000
(v) The 8k of availability charges are committed costs, but the
remaining 32k is an incremental outflow 32,000
(vi) Standard mark-ups for overheads can be ignored as they do not
relate to any proven incremental cash flows -
Actual variable overheads are relevant where they involve cash
flows: 25,000
Power and consumables are incremental: -
Any form of depreciation is an allocation of a sunk or committed -
cost
None of the actual fixed overheads represent an incremental cash
flow
Total incremental cash impact of proceeding therefore: 767,000
*NB this is not specifically mentioned in the question and is intended as a hurdle
for more aware students!
(b) Conventional accounting uses several principles that almost contradict the ideas of
decision-relevance. Examples include:
o The historic cost convention, where items such as stock are valued at acquisition
cost until matched with a sale. Decision-relevance, in contrast, regards historic
cost as an irrelevant sunk cost and substitutes either the opportunity cost of
using an item such as the material for which no alternative use exists, or the
replacement cost of, for example, the regularly used material that will need to be
replaced. (The only overlapping feature between conventional accounting and
decision-relevance is the lower of cost and NRV rule.)
o The matching concept sets out to marry up the income of a period with an
appropriate proportion of the costs involved in earning that income. This may
include direct matching, as in matching stock usage with sales, or indirect
matching (where for example the annual depreciation of long-term fixed assets, or
the total wages paid in a period, are treated as a charge against that income for no
other reason than that they occur in the same time period). This process has been
described by Arnold and Turley (1996) as matching or recovering past costs.
Decision-relevance takes a much narrower view of matching: only the incremental
cash inflows and outflows arising from a decision are matched. Depreciation of a
fixed asset (even the activity-based depreciation in the question that is an
incremental accounting cost of undertaking the project) would be ignored entirely,
whereas the loss of scrap value involved by using that asset on a contract would
be considered a direct consequence.
o Conventional accounting would not distinguish between the flat-rate wages paid
to existing staff and the rate wages paid to temporary staff in the question. Both
would be costed to the project as direct wage costs. From a decision-relevance
point of view, however, the former would be paid whether or not the project went
ahead, while the latter are consequential costs of proceeding cash outflows that
result directly from the decision.
o Fixed costs are always reflected in conventional accounting (accounting standards
insist that product cost must reflect both the variable and fixed elements of
manufacturing overhead costs). Pricing formulae (as in the standard hourly
charge to cover fixed overheads) are usually constructed to ensure full cost
recovery (at least, on average across the entire range of expected outputs) even
when pricing decisions are delegated. Decision-relevance ignores fixed costs that
are committed or unavoidable, but includes them if they are incremental cash
flows that happen to be classified as fixed costs under accounting nomenclature.
o Conventional accounting tends to consider only the amount paid for a resource as
being a cost, while decision-relevance considers wider impacts on the whole
organisation. An example is the cost of the alloys that were bought for a delayed
project elsewhere. Normal accounting would treat the acquisition cost as
incremental costs of the current project, and would probably charge the other,
delayed project with the lower replacement costs. Decision-relevance would
ignore the irretrievable acquisition cost and charge the current project with the
consequential cost of using stock that needs ultimately to be replaced.
To summarise, conventional accounting may include items which decision-relevance

ignores - and vice versa. Many current developments in accounting theory (for
example, the UK Accounting Standards Boards Statement of Principles) are growing
increasingly responsive to the idea of decision-relevance in accounting, particularly in
terms of measuring the use of resources at current values.
Morgon Ltd has been invited to tender for the manufacture of a Flemish Clackett, a
huge reproduction 15th century musical instrument, for a major UK concert
hall. Winning this contract would open up a worldwide market in such
reproduction instruments and Morgons directors are keen to offer a
competitive bid. However, they are also unwilling to lose money in case
their bid is accepted, and so wish to establish the minimum tender price that
they could offer and still cover their costs. The following information is
available:
i) Research into the design of the Clackett at a cost of 3,000 was commissioned
to see if the bid was feasible. Based on the research, it has been decided to
proceed with the bid. A further 1,500 would be payable for a second report
on the authenticity of the finished instrument.
ii) Five different sets of strings would be required. Set A is regularly used by the
company for harpsichords and is already in stock at a cost of 1,800, although
a replacement set would cost 2,300. Set B cost 3,600 but was bought for
use in a line of instruments that has now been discontinued. If not used for the
Clackett, it would be sold second-hand for 1,600. Set C has already been
ordered for another project at an agreed price of 4,500; if used for the
Clackett then a replacement set for the other project would need to be
purchased from the USA at an all-inclusive price of 6,000. Set D has
deteriorated in storage and its original cost of 8,000 has been written down to
a realisable value of 1,200; to make it fit for use on the Clackett, 40 hours of
reworking by contractors who charge 40 per hour would be needed, and this
would increase its realisable value to 3,500. Set E is only available to special
order at a cost of 3,000; normal delivery is 8-10 weeks, which would mean it
will not be available in time to make the Clackett; a premium price of 4,500
would be charged for earlier delivery.
iii) Morgons production staff are paid a minimum weekly wage equivalent to 15
per hour. 400 hours of labour by existing staff would be required, of which
100 would be at overtime rates of 22 per hour. 2 new employees would need
to be hired on fixed wages for the project and would work 100 hours each,
including 20 hours each of overtime. It is expected that one of these
employees would be made redundant at the end of the project at a cost of
1,500, but the second would continue to be employed on other work.
iv) Sounding boards that originally cost 1,500 but with no alternative use to the
company, and which would cost a further 200 to dispose of because of
dangerous varnish, would be used for the Clackett. 27 bells and 39 whistles
would need to be purchased for 20 and 15 each respectively. However, a
bulk purchase of 40 bells could be obtained for 500 and a container of 60
whistles could be purchased for 630. Surplus bells and whistles could be
resold for half the market price.
v) Originally, Clacketts were powered by a team of donkeys on treadmills. The

company has spent 5,000 on legal fees to establish whether health and safety
and animal welfare legislation would allow this authentic practice to be
reproduced. They have been advised that a modern electric motor will be
needed as a substitute. This will need to be specially manufactured at a cost of
3,000.
vi) Mechanical cranks and pedals to enable players of less than 2 metres tall to
operate the bass notes of the Clackett would cost 1,600 to buy in. It is
however possible to buy seven second-hand bicycles from Cardiff University
students for 40 each, and a local blacksmith would charge 1,200 for
converting the bicycles to perform the same function. Spare parts from the
bicycles could then be sold for an estimated 60.
vii) Protective screens (to shield the players from rotten vegetables hurled by the
audience) would be manufactured in-house by a team of carpenters, paid at
piecework rates. Material for the screens would cost 500; 480 of labour
costs would be required. A further 500 of overtime would need to be paid on
another project if the carpenters are hired for this operation.
viii) Morgons standard pricing procedure is to charge 100 per production staff
labour hour to recover fixed overheads. It is proposed to exclude from the
minimum price calculation an estimated 2,000 of specialist equipment rentals
that would be incurred in support of the Clackett production, since these
rentals would be more than covered by the standard loading for fixed
overheads.
ix) It is estimated that additional overdraft interest of 500 and activity-based

depreciation of 2,000 will be incurred if the project goes ahead.
REQUIRED:
a) Prepare a statement showing the minimum price that Morgon Ltd could
bid for the manufacture of the Clackett. Provide brief explanations of the
items you have included or excluded from the calculation.
b) Decisionrelevance is based on two key principles future incremental

cash flows and opportunity costs. Normal accounting, by contrast, mixes
up the past and future and rarely considers opportunity costs. From
your answer to part a) above, illustrate this principle.
a) Minimum price calculation:

Feasibility research: irrelevant to the decision, as already paid (sunk cost) -
Authenticity report: incremental cash outflow, which will only be paid if
the instrument is constructed 1,500
Strings:
Set A: original cost of 1,800 is sunk but the replacement cost represents a
relevant future outflow (the strings are regularly used and need replacing) 2,300
Set B: original cost is irrelevant. The cost of using this set is the cash that
could otherwise have been earned from selling the set (opportunity cost) 1,600
Set C: the price of 4,500 is a future cash outflow but is a committed cost
it will have to be paid whether or not the project goes ahead. The
replacement cost of 6,000 is the consequential cost of this project going
ahead (even if it is incurred on another project) 6,000
Set D: Even normal accounting recognises that the original cost of 8,000 is
irrelevant! The existing realisable value is 1,200 and this is one possible
opportunity cost; however, by spending 1,600 on reworking the realisable
value increases to 3,500. The commercial reality is that the stock will be
reworked, even if the Clackett does not proceed, and the opportunity cost is
therefore 3,500. 3,500
Set E: the incremental cash outflow is the premium price of 4,500 4,500
Staff wages:
300 hours of minimum wages would be paid anyway and are committed -
costs.
100 hours of overtime at 22/hr are an incremental cost of proceeding 2,200
2 new hires: basic wages AND overtime are incremental costs of the project
(2 x 80 hours x 15) + (2 x 20 hours x 22) = 3,280
Redundancy cost: a direct consequence of hiring the person for the project 1,500
Sounding boards: using these would save a disposal expense of 200 (a sort
of negative opportunity cost); the original cost is sunk and there is no (200)
alternative use value.
Bells: (27 x 20) = 540, whereas 500 (13 x 10) = 370 370
Whistles: (39 x 15) = 585, whereas 630 (21 x 7.50) = 472.50 473
Donkeys: legal fees are a sunk cost but the motor is incremental outflow 3,000
Cranks: 1,600 new, compared with [(7 x 40) + 1,200 60] = 1,420 1,420
Screens: all these items are relevant (materials, wages and substitution costs) 1,480
Fixed overheads: the standard procedure is a convenience to allow pricing
decisions to be delegated. Fixed overheads (by definition) are normally
committed costs unless (as here) they are incremental cash outflows that
happen to be labelled fixed by the accounting system. 2,000
Overdraft interest: an incremental outflow, so relevant 500
Activity-based depreciation: depreciation is the accounting allocation of a
sunk or committed cost and is ALWAYS irrelevant -
_____
Minimum price to be charged to cover all relevant costs: 35,423
b) Conventional accounting uses several principles that almost contradict the ideas of
decision-relevance. Examples include:
o The historic cost convention, where items such as stock are valued at acquisition
cost until matched with a sale. Decision-relevance, in contrast, regards historic
cost as an irrelevant sunk cost (as in the original value of Set A strings in the
question) and substitutes either replacement cost (the replacement value of Set A
strings), alternative use value (the improved realisable value of Set D strings), or
scrap value (for example, Set B strings) according to the circumstances. (The
only overlapping feature between conventional accounting and decision-relevance
is the lower of cost and NRV rule.)
o The matching concept sets out to marry up the income of a period with an
include direct matching, as in matching stock usage with sales, or indirect
matching (where for example the annual depreciation of long-term fixed assets, or
the total wages paid in a period, are treated as a charge against that income). This
process has been described by Arnold and Turley (1996) as matching or
recovering past costs. Decision-relevance takes a much narrower view of
matching: only the incremental cash inflows and outflows arising from a decision
are matched. Depreciation of a fixed asset (even the activity-based depreciation in
the question that is an incremental accounting cost of undertaking the project)
would be ignored entirely, whereas the loss of scrap value involved by using that
asset on a contract would be considered a direct consequence; wages that would
be paid anyway are considered to be committed costs and ignored, whereas extra
overtime that is incurred as a consequence of an action is included.
o Conventional accounting would not distinguish between the flat-rate wages paid
to existing staff and the flat rate wages paid to the newly hired staff in the
question. Both would be costed to the project as direct wage costs. From a
decision-relevance point of view, however, the former would be paid whether or
not the project went ahead, while the latter are consequential costs of proceeding
cash outflows that result directly from the decision.
o Fixed costs are always reflected in conventional accounting (accounting standards
insist that product cost must reflect both the variable and fixed elements of
recovery even when pricing decisions are delegated. Decision-relevance ignores
fixed costs that are committed or unavoidable, but includes them if they are
incremental cash flows.
o Conventional accounting tends to consider only the amount paid for a resource as
organisation. An example is the piecework rates paid to the carpenters. Normal
accounting and decision-relevance would treat these identically as incremental
costs of the project, but normal accounting would not charge the project with the
cost of the replacement labour elsewhere in the company even though this is a
direct consequence of proceeding.
To summarise, conventional accounting may include items which decision-relevance

ignores - and vice versa. Many current developments in accounting theory (for
example, the UK Accounting Standards Boards Statement of Principles) are growing
increasingly responsive to the idea of decision-relevance in accounting, particularly in
terms of measuring the use of resources at current values.
GOOSANDER GROUP
Goosander Group Ltd specialises in building enormous model railway layouts for the
super-rich. They have just completed a commission for a client who, it turns out, had
been misled by a junk mail letter into thinking he had won millions. The client cannot
afford the layout and they are advised that there is no point in suing him for the
money. A rock star has offered to buy the layout, subject to extensive modifications
being made, but she is not prepared to pay more than 200,000. Goosanders
accountant suggests that her offer should be rejected as unprofitable and has produced
the following schedule setting out a calculation of the full cost of the modifications:

Original manufacturing cost of the layout 97,000
Less: deposit paid by original client 9,700
87,300
Add: legal advice on pursuing claim against
the original client: 5,400
92,700
Modification materials at cost:
Material X 12,300
Material Y 7,000
Material Z 15,200
Conversion kits at transfer price 58,200
Direct labour: Goosander employees 4,200
External contractors 5,500
Depreciation of specialist equipment 5,000
Rental charges for machinery to be used 500
Variable overheads 8,400
Fixed overheads 8,400
Delivery charges 2,400
On-site assembly charges after delivery 5,000
Total cost of conversion: 224,800
The following information is also available:
A. The original deposit was paid partly in cash (100) and partly by cheque
(9,600). The bank has today returned the cheque unpaid.
B. An in-house lawyer who charges a flat fee of 1,000 per case provided the
legal advice. The 5,400 represents the standard legal costs that would have
been sought from the original client had the case gone to court.
C. Modification materials consist of three items. X is always in stock and is
frequently used. Its book cost is 12,300; the supplier has recently announced
a 5% price increase. Y has a book value of 5,000 and would be scrapped if
not used on this project; its scrap value is 500. However, only 38 metres of Y
are in stock and another 12 metres would need to be bought in for 2,000. Z is
in stock, having been bought for another project which is not due to start for 4
months. Replacing Z will cost 20,000.
D. The conversion kits will be used for converting replica engines and carriages
into the types specified by the new customer. The kits are supplied by Gander
Ltd, a wholly-owned trading subsidiary of Goosander, and will be transferred
to Goosander at an inter-company mark-up of 25% on purchase cost to match
the open market price that would be charged to an external customer. This
mark-up is included in the 58,000 scheduled above.
E. Direct labour represents the cost of four technicians who will work on the
project. 2,000 relates to two full-time employees whose contractual
minimum wages will be 750 each, with overtime of 250 each. 1,000
relates to a freelance worker who is paid a weekly retainer of 50 for making
himself available at short notice and who will be paid another 450 per week
for the two weeks he will work on the job. 1,200 relates to a retired landscape
modeller who already receives a weekly pension of 300 and who will return
to work for two weeks on the conversion for a further 300 per week.
F. The sum charged to the project for external contractors represents the
contractors charges plus an administrative mark-up of 10% that Goosander
routinely charges to clients when contractors are employed.
G. The specialist equipment was to have been sold for a current scrap value of
2,000. Its value after use on the project will be 1,600. Its current book
value is 6,600 and the depreciation charge represents the write-down from
book value to scrap value if it is used on the project.
H. The 500 for machinery rental represents normal hire rates. As a frequent user
of the hire firm, Goosander receives a 10% discount. This has not been
included in the calculation above, since it is Goosanders policy that discounts
are not accounted for at an individual project level.
I. Variable and fixed overheads have been included at a standard charge based on
200% of labour costs. It is estimated that variable overheads attributable to
this project will not exceed 2,200.
J. Delivery charges and on-site assembly charges are based on a standard pricing
formula applied by Goosander. The actual costs of delivery will be 3,400,
but on-site assembly will be performed by full-time employees who are paid a
minimum wage, without overtime. Their travel and accommodation expenses
are however estimated at 500 in total.
REQUIRED:
(a) Prepare a revised draft of the accountants schedule using the principles of
decision-relevance. Provide concise explanations of each item on the original
schedule that you have retained, modified or excluded, and of any additional
items you have included that are not in the original schedule. What is the
minimum price that Goosander Ltd could charge to leave itself no better and no
worse off in cash terms by taking on the project?
(17 Marks)
(b) Identify and explain FOUR differences between conventional full cost
accounting and decision-relevance, illustrating your explanations from your
calculations in (a) above. (8 Marks)
(Total 25 Marks)
Suggested answer: Goosander Group
a) Redraft of schedule
Item: Detail:
A. Original manufacturing cost and deposit are both sunk cash flows
historical items which cannot be changed by the decision of whether
or not to proceed with the conversion. -
B. Legal advice is also irrelevant to the decision whether or not to
proceed. The distinction between the 5,400 and the flat fee of
1,000 is therefore a red herring! -
C. Modification materials:
12.3k of material X: the book value of X is a sunk cost but,
because it is regularly used, its replacement cost, the consequential -
cost to the company of using it, is a relevant cashflow (12,300 + 12,915
5%)
Scrap value of Y is the opportunity cost of use (original cost is
sunk) 500
Buy-in costs of extra Y are incremental cashflow 2,000
Zs 15.2k book cost is sunk but replacement cost is relevant 20,000
D. Conversion kits: as the 58,200 includes a 25% inter-company mark-
up which is not a cash cost to the organisation, this needs to be
deducted. NB if a 25% mark-up on cost has been added then the
final price will be 125% of the original cost and so the original cost
can be calculated as 58,000 x 100/125 46,560
E. Flat-rate wages (750 x 2 technicians) are committed costs which -
will be paid anyway. Only their overtime is incremental. 500
The retainer is a committed cost: incremental wages are relevant 900
The pension is being paid anyway: only incremental cashflow is 600
relevant
F. External contractors: the mark-up is not an incremental cashflow that
is relevant in computing the minimum price (5,500 x 10/11) 5,000
G. Depreciation is always irrelevant as the allocation of a sunk cost -
Loss of resale value (from current resale value of 2,000 to future
value of 1,600) is a valid consequence of proceeding 400
H. The actual cash rental cost to Goosander is 500 less 10% discount
(the accounting treatment is not relevant as it does not affect how
much is actually paid) 450
I. Standard mark-ups for overheads can be ignored as they do not relate
to any proven incremental cash flows -
Actual variable overheads are incremental to proceeding 2,200
J. Delivery and on-site assembly: 3,400 plus 500 is the only
cashflow incurred by the whole firm 3,900
Total incremental cash impact of proceeding, and thus minimum
price to leave the firm no better and no worse off: 95,925
(b)
The key conflict between decision-relevant principles and normal financial reporting
lies in the areas of
(i) cost allocation for product costing; and
(ii) the principle of matching between costs and revenues for computing the profit
in a period.
Allocation-based accounting reflects all transactions that relate to the period being
measured, whereas decision-relevance narrows this to future differential cash flows.
Cost allocation aspects of this include:
Depreciation of a fixed asset (e.g. the depreciation in the question that is an
accounting cost of undertaking the project) would be ignored entirely, whereas the
loss of scrap value involved by using that asset on a contract would be considered
a direct consequence. Unless activity-based, this depreciation would be booked
on a time basis for accounting purposes whether or not a particular project was
undertaken.
Conventional accounting would not distinguish between the flat-rate wages paid
to existing staff and their overtime. Both would be costed to the project as direct
wage costs. From a decision-relevance point of view, however, the former would
be paid whether or not the project went ahead, while the latter are consequential
costs of proceeding cash outflows that result directly from the decision. Fixed
costs are always reflected in conventional accounting (accounting standards insist
that product cost must reflect both the variable and fixed elements of
recovery (at least, on average across the entire range of expected outputs) even
when pricing decisions are delegated. Decision-relevance ignores fixed costs that
are committed or unavoidable, but includes them if they are incremental cash
flows that happen to be classified as fixed costs under accounting nomenclature.
Conventional accounting tends to consider only the amount paid for a resource as
organisation. An example is the cost of material Z, bought for a delayed project
elsewhere. Normal accounting would treat the acquisition cost as incremental
costs of the current project, and would probably charge the other, delayed project
with the higher replacement costs. Decision-relevance would ignore the
irretrievable acquisition cost and instead charge the current project with the
consequential cost of using stock that needs ultimately to be replaced.
The matching concept sets out to marry up the income of a period with an
include direct matching, as in matching stock usage with sales that used that stock,
or indirect matching (where for example the annual depreciation of long-term
fixed assets, or the total wages paid in a period, are treated as a charge against that
income for no other reason than that they occur in the same time period).
Decision-relevance takes a much narrower view of matching: only the incremental
cash inflows and outflows arising from a decision are matched.
Section D: Investment Appraisal.
Lion Ltd, no Residual Value on sale of assets.
Lion ltd manufactures golf clubs and accessories, including golf balls. Lion is
considering the manufacture of a new golf club, the Bertha, which can increase the
length a ball can be driven by up to 10%. Details of the Bertha are as follows:
i. Development costs of 750,000 have been incurred on the Bertha.

ii. A market survey report, costing 150,000 has been commissioned and this
suggests that the Bertha will have a market life of three years.
iii. Production of the Bertha will require new equipment at a cost of 1,300,000
that will have no residual value at the end of three years.
iv. Sales of the Bertha are expected to be 18,000, 15,000 and 10,000 clubs in
years 1, 2 and 3 respectively. The selling price of the Bertha will be 250.
vi Variable costs per unit are estimated at: materials 105, labour 45 and
variable overhead 30. Annual fixed costs of producing the Bertha are
estimated to be 700,000. This cost includes straight line depreciation on the
new equipment, an allocation of head office costs of 100,000 and warehouse
rent of 125,000 on a building that is currently on a 10 year lease with six
years to run.
vi. Corporation taxation will be payable on the Bertha, assume tax is payable
annually at a rate of 30% of operating cashflow, where operating cashflow
includes relevant sales, variable and fixed cost cashflows.
vii. Working capital requirements for the project are expected to amount to 20% of
the expected annual sales value, 90% will be recovered when production
ceases in year 3. Working capital cash outflows are payable at the start of each
relevant year and cash inflows at the end of each relevant year.
viii. Lion Ltds cost of capital is 15%.
ix. Assume all cash flows, including corporation tax, are payable at the end of the
year in which the relevant cashflows arise, unless otherwise indicated.
REQUIRED:
Calculate the Net Present Value, Internal Rate of Return, Payback Period and
Accounting Rate of Return for the Bertha.
Advise the directors of Lion, with explanations, whether to put the Bertha into
production.
Answer:
The
Bertha
NPV (38,283)
IRR 14.0%
Pay Back Period,

years 2.31
ARR 36.9%
Although payback is within the three year period and the ARR is greater than the Cost of Capital, the
NPV is negative and the IRR is lower than the cost of Capital. As NPV and IRR are considered
superior to Payback and ARR the company should not proceed with the Bertha.
Workings:
The Bertha Irrelevant Year 0 Year 1 Year 2 Year 3

Development Costs (750,000)
Market Survey (150,000)
Production equipment (1,300,000)
Working Capital (900,000) 135,000 225,000 450,000
Operating Cashflow 1,218,333 1,008,333 658,333
Tax (365,500) (302,500) (197,500)
(2,200,000) 987,833 930,833 910,833
DV
Discount Factor 1.10 1 0.9091 0.8264 0.7513
NPV @ 10% (2,200,000) 898,030 769,284 684,323 151,637
Discount Factor 1.15 1 0.8696 0.7561 0.6575

NPV @ 15% (2,200,000) 858,986 703,844 598,888 (38,283)
IRR 10% 0.80 0.05 0.04 14.0%
Cumulative (2,200,000) (1,212,167) (281,333) 629,500
Pay Back years 2.31
ARR 36.9%
1 Operating Cash Flow and
Tax Var. OH Total Operating
Sales Vol SP Sales per Unit OH Cont.
Contribution per annum (yr 1): 18,000 250 4,500,000 (180) (3,240,000) 1,260,000
Contribution per annum (yr 3): 10,000 250 2,500,000 (180) (1,800,000) 700,000
Annual Investment Annual HO Warehouse Annual

FC Cost RV Years Dep Charge Cost Cash FC
Cash Fixed Costs: 700,000 1,300,000 0 3 433,333 100,000 125,000 41,667
Operating Cash Flow per

annum Year 1 Year 2 Year 3 Total
Contribution 1,260,000 1,050,000 700,000 3,010,000
Cash Fixed Cost (41,667) (41,667) (41,667) (125,000)
0
Total Operating Cashflow 1,218,333 1,008,333 658,333 2,885,000
Tax rate 30% 30% 30%
Tax 365,500 302,500 197,500 865,500
2 Working Capital Sales WC % WC Movement Recovery

Required @ 90%
Year 1 4,500,000 20.0% (900,000) (900,000)
Year 2 3,750,000 20.0% (750,000) 150,000 135,000
Year 3 2,500,000 20.0% (500,000) 250,000 225,000
Year 4 - 20.0% 0 500,000 450,000
3 ARR
Average Profit
Total Operating Cashflow 2,885,000
Less Non Cash fixed Costs, Depreciation (1,300,000)
Less Total Tax (865,500)
Total Profit 719,500
Aaverage annual profit over 3 years 239,833
Average Investment
Initial Investment 1,300,000

Closing Investment 0
1,300,000
Average (divide by 2) 650,000
ARR = 239,833 36.9%

650,000
Strength and weaknesses should include discussion of:
Lion Ltd, with Residual Value on sale of assets.
Lion ltd manufactures golf clubs and accessories, including golf balls. Lion is
considering the manufacture of a new golf club, the Bertha, which can increase the
length a ball can be driven by up to 10%. Details of the Bertha are as follows:
i. Development costs of 750,000 have been incurred on the Bertha.

ii. A market survey report, costing 150,000 has been commissioned and this
suggests that the Bertha will have a market life of three years.
iii. Production of the Bertha will require new equipment at a cost of 1,300,000
with a residual value of 400,000 at the end of three years.
iv. Sales of the Bertha are expected to be 18,000, 15,000 and 10,000 clubs in
years 1, 2 and 3 respectively. The selling price of the Bertha will be 250.
vi Variable costs per unit are estimated at: materials 105, labour 45 and
variable overhead 30. Annual fixed costs of producing the Bertha are
estimated to be 700,000. This cost includes straight line depreciation on the
new equipment, an allocation of head office costs of 100,000 and warehouse
rent of 125,000 on a building that is currently on a 10 year lease with six
years to run.
vi. Corporation taxation will be payable on the Bertha, assume tax is payable
annually at a rate of 30% of operating cashflow, where operating cashflow
includes relevant sales, variable and fixed cost cashflows.
vii. Working capital requirements for the project are expected to amount to 20% of
the expected annual sales value, 90% will be recovered when production
ceases in year 3. Working capital cash outflows are payable at the start of each
relevant year and cash inflows at the end of each relevant year.
viii. Lion Ltds cost of capital is 15%.
ix. Assume all cash flows, including corporation tax, are payable at the end of the
REQUIRED:
Accounting Rate of Return for the Bertha.
Advise the directors of Lion, with explanations, whether to put the Bertha into
production.
The Bertha
NPV 11,622
IRR 15.3%
Pay Back Period,

years 2.38
ARR 32.9%
Payback is within the three year period and the ARR is greater than the Cost of Capital, the NPV is
positive and the IRR is greater than the cost of Capital. All measures are favourable and so the
company should proceed with the Bertha.
Workings:
The Bertha Irrelevant Year 0 Year 1 Year 2 Year 3

Development Costs (750,000)
Market Survey (150,000)
Production equipment (1,300,000) 400,000
Working Capital (900,000) 135,000 225,000 450,000
Operating Cashflow 1,085,000 875,000 525,000
Tax (325,500) (262,500) (157,500)
(2,200,000) 894,500 837,500 1,217,500
DV
Discount Factor 1.15 1 0.8696 0.7561 0.6575
NPV @ 15% (2,200,000) 777,826 633,270 800,526 11,622
Discount Factor 1.20 1 0.8333 0.6944 0.5787

NPV @ 20% (2,200,000) 745,417 581,597 704,572 (168,414)
IRR 15% 0.06 0.05 0.00 15.3%
Cumulative (2,200,000) (1,305,500) (468,000) 749,500
Pay Back years 2.38
ARR 32.9%
Tax Var. OH Total Operating
Sales Vol SP Sales per Unit OH Cont.
Contribution per annum (yr 3): 10,000 250 2,500,000 (180) (1,800,000) 700,000
Annual Investment Annual HO Warehouse Annual

FC Cost RV Years Dep Charge Cost Cash FC
Cash Fixed Costs: 700,000 1,300,000 400,000 3 300,000 100,000 125,000 175,000

Contribution 1,260,000 1,050,000 700,000 3,010,000
Cash Fixed Cost (175,000) (175,000) (175,000) (525,000)
0
Total Operating Cashflow 1,085,000 875,000 525,000 2,485,000
Tax rate 30% 30% 30%
Tax 325,500 262,500 157,500 745,500

Required @ 90%
Year 1 4,500,000 20.0% (900,000) (900,000)
Year 2 3,750,000 20.0% (750,000) 150,000 135,000
Year 3 2,500,000 20.0% (500,000) 250,000 225,000
Year 4 - 20.0% 0 500,000 450,000
3 ARR
Average Profit
Less Non Cash fixed Costs, Depreciation (900,000)
Average Investment
Initial Investment in Fixed

Assets 1,300,000
Closing Investment 400,000
1,700,000
ARR = 279,833 32.9%

850,000
Dundee Ltd is a beef farmer, but is considering diversifying into Crocodile meat.
Dundee is considering the purchase of a three-year lease on a large farm for the
production of farmed crocodile meat. A suitable farm has been identified with a lease
premium of 11 million payable on 1 January 2010 and annual lease payments of
500,000 will also be payable at the end of each year. The lease premium will be
depreciated on a straight line basis over the three year lease. Other details of the
project are as follows.
1. A firm of surveyors has been employed to carry out a structural survey of the
farm buildings. Their fees of 450,000 will be payable on 1 January 2010,
whether or not the project goes ahead.
2. Six barns costing 300,000 each will be required and paid for on 1 January
2010. These barns will be depreciated on a straight line basis over the three
years. All the barns are expected to have a scrap value of 10,000 each at the
end of 2012.
3. Meat sales are expected to be 10 million in 2010 and to increase by 4
million per year for years two and three. All sales will be made to a national
chain of butchers, who will settle the annual bill at the end of each calendar
year.
4. The farm will be managed by specialist contractors. Their fees, payable at the
end of each year, will be charged at 10% of meat sales
5. Feedstuff and veterinary services are expected to be 20% of the value of meat
sales, payable at the end of each calendar year.
6. Other fixed costs of the operation will be 900,000 per year and includes
depreciation on the new barns and a charge of 100,000 by head office for use
of the transferred equipment.
7. Working capital requirements for the project are expected to amount to 15% of
the expected annual sales value, 95% will be recovered when farming ceases
at the end of year 3. Working capital cash outflows are payable at the start of
each relevant year and cash inflows at the end of each relevant year.
8. Tax is payable at a rate of 30% on operating cashflows, where operating
cashflow includes relevant sales, variable and fixed cost cashflows.
9. Dundee Ltds cost of capital is 15%.
10. Assume all cash flows, including corporation tax, are payable at the end of the
REQUIRED:
Accounting Rate of Return.
Advise Dundee, with explanations, whether to invest in the crocodile farm.
Answer:
Dundee
NPV 547,118
IRR 17.0%
Pay Back Period,

years 2.43
ARR 32.8%
Payback is within the three year period and the ARR is greater than the Cost of Capital, the NPV is
positive and the IRR is greater than the cost of Capital. All measures are favourable and so the
company should proceed with the farm.
Dundee Irrelevant Year 0 Year 1 Year 2 Year 3

Farm Surveyor (450,000)
Lease Premium (11,000,000)
Six Barns (1,800,000) 60,000
Working Capital (1,500,000) (600,000) (600,000) 2,565,000
Operating Cashflow 6,280,000 9,080,000 11,880,000
Tax (1,884,000) (2,724,000) (3,564,000)
(14,300,000) 3,796,000 5,756,000 10,941,000
DV
Discount Factor 1.15 1 0.8696 0.7561 0.6575
NPV @ 15% (14,300,000) 3,300,870 4,352,363 7,193,885 547,118
Discount Factor 1.20 1 0.8333 0.6944 0.5787

NPV @ 20% (14,300,000) 3,163,333 3,997,222 6,331,597 (807,847)
IRR 15% 0.40 0.05 0.02 17.0%
Cumulative (14,300,000) (10,504,000) (4,748,000) 6,193,000
Pay Back years 2.43
ARR 32.8%

Tax Farm Feed/ Operating
Sales Vol SP Sales Manage. Vet Cont.
Contribution per annum (yr 1): 10,000,000 (1,000,000) (2,000,000) 7,000,000
Annual Investment Annual HO Annual

FC Cost RV Years Dep Charge Cash FC
Cash Fixed Costs: 900,000 1,800,000 60,000 3 580,000 100,000 220,000

Contribution 7,000,000 9,800,000 12,600,000 29,400,000
Cash Fixed Cost (220,000) (220,000) (220,000) (660,000)
Annual lease payments (500,000) (500,000) (500,000) (1,500,000)
Total Operating Cashflow 6,280,000 9,080,000 11,880,000 27,240,000
Tax rate 30% 30% 30%
Tax 1,884,000 2,724,000 3,564,000 8,172,000

Required @ 95%
Year 1 10,000,000 15.0% (1,500,000) (1,500,000)
Year 2 14,000,000 15.0% (2,100,000) (600,000)
Year 3 18,000,000 15.0% (2,700,000) (600,000)
Year 4 - 15.0% 0 2,700,000 2,565,000
3 ARR
Average Profit
Less Non Cash fixed Costs, Depreciation:
Barns (1,740,000)
Lease (11,000,000)
Less Total Tax (8,172,000)
Total Profit 6,328,000
Aaverage annual profit over 3 years 2,109,333
Average Investment
Initial Investment in fixed

assets 12,800,000
12,860,000
Average (divide by 2) 6,430,000
ARR = 2,109,333 32.8%

6,430,000
Dundee Ltd has also had discussions with one of his neighbours who has suggested
that Crocodile meat is not the future, Buffalo meat is what he should be investing in.
Buffalo farming has the advantage in that the resources required are similar to those
of his existing beef farm, meaning less investment will be required, albeit that buffalo
meat does not command a premium selling price. Details of the project are as follows:
i. Dundee has spent 100,000 on a market survey on evaluating the demand for Buffalo
meat, this suggests a three project would be viable.
ii. The Buffalo operation would require additional agricultural land that could be rented
from 1 January 2010 at an annual cost of 250,000, payable a year in arrears.
iii. New equipment costing 750,000 would be required on 1 January 2010, the equipment
could be sold in three years time for 100,000.
iv. Meat sales are expected to be 3 million in 2010 and to increase by 2 million per year
for years 2 and 3. All sales will be made to a national chain of butchers, who will settle
the annual bill at the end of each calendar year.
v. To manage the farm Dundee will have to employ a manager and five additional labourers
at a total an annual cost of 250,000.
vi. Feedstuff and veterinary services are expected to be 40% of the value of meat sales,
payable at the end of each calendar year.
vii. Fertilizer cost is expected to be 1.4m per annum.
viii. Other fixed costs of the operation will be 700,000 per year and includes 100,000 per
annum relating to the cost on an existing warehouse lease that has six years to run and
annual depreciation on the new equipment.
ix. Working capital requirements for the project are expected to amount to 10% of the
expected annual sales value and 95% will be recovered when farming ceases at
the end of year 3. Working capital cash outflows are payable at the start of
each relevant year and cash inflows at the end of each relevant year.
x. Tax is payable at a rate of 30% on operating cashflows, where operating
cashflow includes relevant sales, variable and fixed cost cashflows.
xi. Dundee Ltds cost of capital is 15%.
xii. Assume all cash flows, including corporation tax, are payable at the end of
the year in which the relevant cashflows arise, unless otherwise indicated.
REQUIRED:
Accounting Rate of Return.
The Crocdile farm and the Buffalo farm are mutually exclusive, can only choose one,
advise Dundee, with explanations, whether to invest in the crocodile farm or the
Buffalo farm.
Dundee
NPV 95,155
IRR 17.9%
Pay Back Period,

years 2.61
ARR 67.1%
When evaluating projects NPV and IRR are preferred to Payback and ARR as NPV and IRR both take
into account the time value of money and cost of capital.
The Buffalo farm has a higher IRR than the Crocodile farm, 17.9% v 17%, suggesting Dundee should
opt for the Buffalo farm. However, a weakness of IRR when comparing mutually exclusive projects is
that it does not take scale of return into account and as such when comparing mutually exclusive
projects NPV should be used. Reviewing the NPV gives a different answer, the Crocodile farm has a
higher NPV compared to the Buffalo farm, 547,118 compared to 95,155. On this basis Dundee
should proceed with the Crocodile farm.
Workings;
Dundee Irrelevant Year 0 Year 1 Year 2 Year 3

Farm Surveyor (100,000)
New Equipment (750,000) 100,000

Working Capital (300,000) (200,000) (200,000) 665,000
Operating Cashflow (483,333) 716,667 1,916,667
Tax 145,000 (215,000) (575,000)
(1,050,000) (538,333) 301,667 2,106,667
DV
Discount Factor 1.15 1 0.8696 0.7561 0.6575
NPV @ 15% (1,050,000) (468,116) 228,103 1,385,168 95,155
Discount Factor 1.20 1 0.8333 0.6944 0.5787

NPV @ 20% (1,050,000) (448,611) 209,491 1,219,136 (69,985)
IRR 15% 0.58 0.05 0.03 17.9%
Cumulative (1,050,000) (1,588,333) (1,286,667) 820,000
Pay Back years 2.61
ARR 67.1%
Tax Farm Feed/ Operating
Sales Vol Sales Manage. Vet Fertilizer Cont.
Contribution per annum (yr 1): 3,000,000 (250,000) (1,200,000) (1,400,000) 150,000
Contribution per annum (yr 2): 5,000,000 (250,000) (2,000,000) (1,400,000) 1,350,000
Contribution per annum (yr 3): 7,000,000 (250,000) (2,800,000) (1,400,000) 2,550,000
Annual Investment Annual HO Annual

FC Cost RV Years Dep Charge Cash FC
Cash Fixed Costs: 700,000 750,000 100,000 3 216,667 100,000 383,333

Contribution 150,000 1,350,000 2,550,000 4,050,000
Cash Fixed Cost (383,333) (383,333) (383,333) (1,150,000)
Annual land rent (250,000) (250,000) (250,000) (750,000)
Total Operating Cashflow (483,333) 716,667 1,916,667 2,150,000
Tax rate 30% 30% 30%
Tax -145,000 215,000 575,000 645,000

Required @ 95%
Year 1 3,000,000 10.0% (300,000) (300,000)
Year 2 5,000,000 10.0% (500,000) (200,000)
Year 3 7,000,000 10.0% (700,000) (200,000)
Year 4 - 10.0% 0 700,000 665,000
3 ARR
Average Profit
Less Non Cash fixed Costs, Depreciation:
Equipment (650,000)
Average Investment
Initial Investment in fixed

assets 750,000
850,000
ARR = 285,000 67.1%

425,000
Tartini Transformers Ltd (TTL) makes electrical equipment and is considering the purchase of a highly
automated production line to replace its current labour-intensive manufacturing process. This is
expected to have the following financial impacts on the company over the five year life of the new
machinery:
(i) The new production line would cost 10 million, payable when the line
was fully installed and operational. TTL would regard this point as the
start of the project.
(ii) 35 members of current production staff would be made redundant. Their
redundancy would cost 30,000 per head, payable at the start of the
project. However, wage savings of 14,000 per head per year for the next
5 years would be achieved as a result.
(iii) A training programme for the remaining 10 members of production staff to
be retained would cost a total of 250,000, payable at the start of the
project.
(iv) A productivity bonus of 5,000 per head would be payable to the retained
staff at the end of the first year. This bonus is expected to increase by
1,000 per head per year for the next 4 years.
(v) The expected production of transformers in the first year is 5,000 units and
it is estimated that the new production process will produce other non-
wage cost savings of 800 per unit for each of the next 5 years.
(vi) Insurance and maintenance of the new equipment will cost 200,000 per
year, payable in advance at the start of each year.
(vii) The new equipment is expected to have a scrap value of 800,000 at the
end of the fifth year. TTLs policy is to use straight-line depreciation.
TTLs long-term cost of capital is 15%. All payments can be assumed to take place
at the end of the relevant years except where clearly indicated otherwise.
REQUIRED:
(a) Advise the board of TTL whether they should proceed with this option. Use NPV, IRR and
payback techniques in support of your recommendation. Assume the company requires a
payback period of no longer than 3 years.
(b) TTL has the option to rent the production line for 5 years at an annual cost of 1.75 million,
payable in advance each year. Is this option worth pursuing?
(c) Why is NPV seen as more superior to IRR?

Tartini Transformers Ltd: suggested answer
Workings: Cash flow forecast (k)

Item: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Purchase of prodn line (10,000)

Redundancy costs (1,050)
Wage savings - 490 490 490 490 490
Training programme (250)
Productivity bonus (50) (60) (70) (80) (90)
Non-wage cost savings 4,000 4,000 4,000 4,000 4,000
Insurance and (200) (200) (200) (200) (200)
maintenance
Scrap value (1) 800
Total cash flows: (11,500) 4,240 4,230 4,220 4,210 5,200

Notes:
1) The depreciation of the equipment is not a cash flow.
2) Wage savings relate to the 35 staff made redundant; ongoing wage costs for the retained staff are
committed costs and do not differ between the alternative options
a) It is possible to perform a Payback calculation:

Cash flow Cumulative
Year 0 (11,500) (11,500)
Year 1 4,240 (7,260)
Year 2 4,230 (3,030)
Year 3 4,220 1,190
Year 4 4,210 5,400
Year 5 5,200 10,600
Payback period therefore 2 years plus (3,030/4,220) x 365 days

= 2 years 262 days
NPV calculation:
Cash flow PV factor PV of flows
Year 0 (11,500) 1.000 (11,500)
Year 1 4,240 0.8696 3,687
Year 2 4,230 0.7561 3,198
Year 3 4,220 0.6575 2,775
Year 4 4,210 0.5718 2,407
Year 5 5,200 0.4972 2,585
NPV of project: 3,152
IRR calculation:
Cash flow PV factor @27% PV of flows
Year 0 (11,500) 1.000 (11,500)
Year 1 4,240 0.7874 3,339
Year 2 4,230 0.6200 2,623
Year 3 4,220 0.4882 2,060
Year 4 4,210 0.3844 1,618
Year 5 5,200 0.3027 1,574
NPV of project: (286)
IRR = 15% + (3,152/(3,152+286) x 0.12 = 26%
The company should proceed with the investment provided that the cash flow forecasts are reliable:
The payback period is 2 years 262 days, less than the maximum 3 year requirement.
The NPV calculation suggests that the companys wealth would be increased by over 3m by
the investment.
The return on the investment, the IRR, is 26% higher than the companys cost of capital and
required return to shareholders.
b) The company has the choice of buying the equipment in Y0 for 10m and banking a resale value of
800k in Y5, or of paying 1.75m of rent in advance for 5 years for the use of the same equipment.
Other things being equal (cost savings, insurance etc) this might seem like a straight choice between
paying a net 9,200k and paying total rent of 8,750k but, crucially, this neglects the time value of
money. Comparing the NPVs of both options it is clear that renting will increase the NPV still further:
NPV cost of purchase option: (10,000) x 1.0000 = (10,000)

800 x 0.4972 = 398
(9,602)
NPV cost of rental option:

1.75m x annuity Y4 factor 3.8550
(Y4 cumulative because payments are made in advance) (6,746)
Improvement in NPV therefore: 9602 6,746 = 2,856k
NB it was possible to multiply 1.75m by 1.000, 1.75m by 0.8696 and so on to achieve the same
result, but using the cumulative (annuity) factors is quicker.
c) NPV v IRR
Discussion around:
Relative strengths and weaknesses of each technique.
Advantages of NPV in terms of evaluating the scale of projects and choosing between
mutually exclusive projects.
Advantages of NPV when cashflows are unconventional.
Product: A B C Total
Contribution per unit () 26.00 44.00 38.00
Kg per unit: 0.5kg 1.5kg 2.0kg
Contribution per kg 52.00 29.33 19.00
Ranking order: 1 2 3
Total kg of material needed 5,000 12,000 8,000 25,000
Usage (kg) ranking by 5,000 12,000 1,000 18,000

contribution (restricted)
No of units that can be made: 10,000 8,000 500
Total contribution from this (): 260,000 352,000 19,000 631,000
NB that fixed costs can be ignored in the above calculation as they can be assumed to
remain the same over all three options. Total fixed costs can be calculated as:
A: 10 x 10,000 = 100,000
B: 16 x 8,000 = 128,000
C: 8 x 4,000 = 32,000
260,000
The profit of the three options will therefore be 260,000 less than the contributions
calculated above.
b) Other factors may include:
o Product interdependence and possible loss of customer goodwill if the full range
of items cannot be supplied.
o Alternative sources of supply for the material (might competitors have surplus
stocks, for example?).
o Alternative materials (unlikely to be feasible in a short timeframe, but worth
considering if the supply problem is likely to recur).
o Industrial relations impacts of the shorter production.
o Existing contractual commitments to supply specific quantities of each product.
o The possibility that existing customers may already hold stocks of one or more
types of product and may be prepared either to scale down orders temporarily or
to release some of their stocks for resale.

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Financial Analysis and Control

Self-Study and Revision Pack

Set out below are a number of practice questions with

The questions have been split into sections by topic:

Section A: Accounts Preparation.

Section B: Financial Statement Analysis.

Section C: Relevant Costs for Short Term Pricing

Section D: Investment Appraisal

b) The Income Statement is suggested to measure performance more

Servicing of finance: interest paid (4,000)

Net cash flow before financing: (114,400)

Net increase in cash: 5,600

Interest payable (80,000 x 10%) (8,000)

Net profit retained 11,000

Non Current Assets:

Non Current Liabilities

Total Assets & Liabilities 51,000

Examples of profit/cash differences

A Paid in 50,000 of his own money to start up the business;

E Paid 50,000 to purchase a 10-year lease of an industrial building on the Enfield

J Paid interest of 5,000 to Perry on 30 September 2004.

Net Operating Cash Flow 55,000

Servicing of Finance: interest paid (5,000)

Investment in Fixed Assets:

Net Cash Flow before Financing: (40,000)

Net increase in cash for the year: 110,000

Operating profit 82,300

Net profit for the year 76,300

Non Current Liabilities

Total Assets & Liabilities 126,300

Net Operating Cash Flow 127,000

Servicing of Finance: interest paid -

Investment in Fixed Assets:

Net Cash Flow Before Financing: (23,000)

Net increase in cash for the year: 127,000

Operating profit 176,550

Net profit for the year 171,550

Non Current Assets:

Non Current Liabilities

Total Assets & Liabilities 221,550

A summarised extract from the accounts of Merrydin Ltd is given below:

Year Ended Year ended

000 000 000 000

Statement of Financial Position

Fixed Assets 645 695

Merrydin Limited belongs to a trade association which operates an inter-firm

(c) Discuss briefly the limitations of ratios for analysing company

Quick ratio: 260 380

Debt: Debt+Equity 300/913 440/1,158

Debtor collection period 200/1560 290/2,350

Stock turnover period 290/910 570/1,400

b) Position and performance

On a standalone basis, Merrydin seems to be improving its overall profit performance

c) See the lecture notes.

Designers fees: 120,000

The following information is also available:

i) The designer is under contract to FF and is paid 20,000 per month as a

To summarise, conventional accounting may include items which decision-relevance

v) Originally, Clacketts were powered by a team of donkeys on treadmills. The

ix) It is estimated that additional overdraft interest of 500 and activity-based

b) Decisionrelevance is based on two key principles future incremental

a) Minimum price calculation:

To summarise, conventional accounting may include items which decision-relevance

Lion Ltd, no Residual Value on sale of assets.