FINANCIAL DECISION MAKING PRE-ISSUED CASE STUDY & GUIDELINES

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1 JUNE 2015 FINANCIAL DECISION MAKING PRE-ISSUED CASE STUDY & GUIDELINES Instructions to candidates (please read carefully): a) The following case study provides some basic information that can be used in your analysis during the examination b) A copy of this material will be available in the examination and therefore you should NOT take this case study into the examination room c) You are allowed to prepare notes for this examination. Your notes should be a maximum of two pages (four sides) of A4. These notes can be taken into the examination and should be attached to your examination script on completion of the examination d) In the exam there is no requirement to write out the formula or calculations for any ratios that you decide to include in your answers. These should be included in your notes that you submit with your answers. Consequently no marks are awarded for these. e) The three-hour examination will consist of FOUR compulsory questions f) Non-programmable calculators are permitted in this exam J KING PLC J King plc is one of the country s leading housebuilders, with a reputation for quality build and design, high specification and dedicated customer service. They create new, sustainable communities across the South of the country, with properties ranging from one and two bedroom apartments to five and six bedroom family homes. The design and construction of their homes blends tradition with innovation, creating quality properties and developments with contemporary living standards. The company has recently moved into a new area of business by building smaller projects, mainly single-storey extensions to existing homes and conversions of garages, workshops and other outbuildings into additional living space where local conditions do not allow for even the smallest of new communities to be built. The company s head office is in the South East of the country and over the past few years has expanded to include the South West. The company is not very well represented in the capital nor the North of the country though the occasional contract does require them to work in these under-represented areas. The company is currently quoted on the country s main stock exchange, since being floated over 20 years ago. The original owner, Joe King, still holds 51% of the shares in the company but is considering retiring and with no family to take over the company is considering selling his shares back to the company and handing the running of the company over to the existing board of directors who will have full control over the company.

2 There are a number of appendices to this pre-issued case study and they are: Appendix One Some background information about the company. Appendix Two Financial statements for 2013 and 2014 as required for filing with the Authorities. Appendix Three Information regarding the company s management accounting system. Appendix Four Information regarding a problem with the small projects division. Appendix One Company information Since the company s formation, there has always been a management accounting system in place that allowed the board of directors to keep a close eye on all departments of the company. This system comprises a budgetary system, overhead absorption system and system of performance measurement. Each system is described below. Budgetary system This comprises an annual budgetary process with the budget year commencing on 1 January. A budget is produced for each month, both for the company as a whole and for each of the main divisions. Attempts have been made to produce budgets for individual projects. However, these have not been successful. Overhead absorption system This traditional method was introduced to help set selling prices for the larger projects that the company has undertaken since it was first formed. This method also provides information about the performance of each division. One reason for the unsuccessful attempts to bring budgets to individual projects has been the difficulty in identifying acceptable and appropriate absorption rates and bases. The current absorption rate is based upon labour hours. Performance measurement A range of measures are used to assess the performance of the projects and to award the divisional managers. Attempts have been made to provide an award system for individual project managers and project teams but a system that was acceptable to all of the board of directors was never found. The measures used are based upon the traditional accounting ratios where considered appropriate and include: Return on investment measured by Return on Capital Employed (ROCE) Profit Margins both Gross Profit Margin and Operating Profit Margin. The use of Profit Before Interest and Tax (PBIT) was not deemed appropriate at divisional level as finance and tax were based upon the company as a whole Capital Turnover (also known as Asset Turnover) Liquidity using Current Ratio and Acid Test Working Capital Inventory days. Inventory turnover was originally used but found to be difficult for managers to understand. The length of time inventory was held for made better sense to many and so inventory days have been used for many years Capital structure ratios were not considered relevant at divisional level as capital is raised at company level and used where required

3 Appendix Two Financial statements J King plc Income statements For the years ending 31 December Revenue 556, ,533 Cost of Sales -425, ,634 Gross Profit 130,307 96,899 Administration costs -47,476-40,186 Operating profit 82,831 56,713 Finance income 2,815 2,203 Finance expense -7,134-5,926 Share of profits of joint venture Profit before tax 78,795 53,244 Tax -18,727-13,051 Profit for year 60,068 40,193

4 J King plc Balance sheets As at 31 December Non-current assets Property, plant and equipment 13,526 11,910 Financial assets 44,844 43,869 Investments 5,089 5,387 63,459 61,166 Current assets Inventories 971, ,597 Trade receivables 24,856 53,252 Other receivables 12,214 10,039 Cash and cash equivalents 12,025 24,296 1,020, ,184 1,083,570 1,012,350 Equity Issued capital 67,048 66,908 Share premium 213, ,550 Retained earnings 529, , , ,849 Non-current liabilities Loans 30,727 8,197 Trade payables 29,631 50,681 Provisions 2,052 1,668 62,410 60,546 Current liabilities Trade payables 187, ,365 Other payables 14,215 14,871 Current tax 9,154 5, , ,955 1,083,570 1,012,350

5 Appendix Three Small Projects Division Budgeted information for 2015 The following information has been provided by the company s management accounting department. 1. Budget overheads for the year small projects division Cost driver Supervision overhead 90,000 Site visits Planning overhead 70,000 Planning documents produced Building related 240,000 Labour hours 2. Budgeted total labour hours 40,000 hours Budgeted total planning visits 500 visits Budgeted total planning documents required 250 documents 3. Budgeted data for Extensions Materials 8,000 Labour 500 hours Supervision visits 6 Planning documents 5 Conversions Materials 3,500 Labour 300 hours Supervision visits 1 Planning documents 1 Labour Cost per hour

6 Appendix Four Business Problem Despite a promising start the Small Projects Division has not been winning as many contracts as had been expected. Current costings using the existing absorption rates, including a mark up of 50% on total cost: Extensions Conversions Materials 8,000 3,500 Labour 7,500 4,500 Overheads 5,000 3,000 Profit (50%) of total cost 10,250 5,500 Quoted price 30,750 16,500 Competitors quotes 23,000-26,000 13,000-15,000 A member of the management accounting department has recently joined the company having previously worked for a company that used Activity Based Costing (ABC). A comparison of the current costings has been attempted using ABC principles. The current policy of including a mark up of 50% on total cost has been retained for the examples. Extensions Conversions Materials 8,000 3,500 Labour 7,500 4,500 Overheads Supervision 1, Planning 1, Building related 3,000 1,800 Profit (50%) of total cost 10,490 5,130 Quoted price 31,470 15,390 INSTITUTE OF COMMERCIAL MANAGEMENT