ACCA Certified Accounting Technician Examination Paper T10. Section A

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2 ACCA Certified Accounting Technician Examination Paper T10 Managing Finances December 10 Answers Section A 1 B $ Non-current assets as at 1 December X6 250,000 Add back depreciation 0,000 Non-current assets as at 1 December X5 (0,000) 80,000 Distracters: A Ignore depreciation and look at the change in non-current assets only. C Take closing assets as at 1 December X6. D Deduct rather than add back depreciation. 2 A Payback Time Cash flow ($) Cumulative cash flow ($) 0 (100,000) (100,000) 2 5,000 (65,000) 5,000 (0,000) 4 5,000 5,000 Payback is therefore years and (0,000/5,000) = 9 years Accounting rate of return = average annual accounting profit/initial investment Accounting rate of return = [(4 x 5,000 85,000)/5]/100,000 = 11% Distracters arise if depreciation is excluded from the accounting rate of return or the timing of the cash flows is incorrect in the payback calculation. B 4 C by definition 5 C Cost of not taking the discount = cost/benefit = 2/98 = 0 04% Convert to an annual percentage = [{ } 65/ 1] = 45% Distracters A 2% x 12 = 24% B [{1 + 2/98} 65/0 1] = 28% D [{1 + 2/100} 65/0 1]=27% 6 D The transaction is for cash so accounts receivable are not affected. Inventory is not part of the quick ratio. Cash balances will improve, resulting in the quick ratio increasing. 7 C by definition 1

3 8 B 50% x 25, % x 15, % x,000 Distracters A Months incorrect and start with March (50% x, % x 15, % x 25,000 = 18,250) C Accounting for bad debts within the original sales (50% x 25,000 x % x 15, % x,000 = 19,75) D May s sales 9 C by definition 10 D As the material is in frequent use by the company, the current purchase price is used as the relevant cost. Distracters A 50 x x 8 = 750 i.e. NRV is used for the kgs in inventory B 50 x x 8 = 700 i.e. original cost is used for the kgs in inventory C Using the original cost price of $6 to value the 100kgs required Section B 1 (a) Net Present Value Calculation $ $ $ $ $ $ Revenue Net income from diners (W) 91,5 121, , ,560 Costs Building costs (W4) (50,000) (150,000) Lost income (W5) (,000) (10,000) (10,000) (10,000) (10,000) Cleaners (8,000) (8,000) (8,000) (8,000) Chefs (W2) (,000) (0,000) (0,000) (0,000) Waiting staff (number required at $5,000) (10,000) (15,000) (15,000) (15,000) Overheads (8% x 0,000) (2,400) (2,400) (2,400) (2,400) Professional fees sunk cost Depreciation non-cash Net relevant cash flows (50,000) (170,000) 41,1 56,280 79,160 79,160 Discount Factor (50,000) (154,50),965 42,266 54,066 49,158 Net Present value is $(25,075) and the expansion should not proceed. W1 Number of diners Year Number of diners F S Number of diners M Th Total number of diners per week Per year (at 52 weeks per annum) 10,400 14,040 16,640 16,640 W2 Cost of chefs Year Number of diners per week (w1) Number of chefs required 2 Annual cost (at $10,000 per chef) $,000 0,000 0,000 0,000 W Net income from diners Year Diners Friday Sunday at $10 per person 1,0 1,500 1,800 1,800 Diners Monday Thursday at $7 per person Total weekly income $ 1,760 2,40 2,780 2,780 Annual income (at 52 weeks per annum) $ 91,5 121, , ,560 14

4 W4 Building costs 25% at beginning of the project 0 25 x $0,000 = $50,000 75% at the end of the building work 0 75 x $0,000 = $150,000 W5 Lost income Year % of $0,000 $,000 5% of $0,000 $10,000 $10,000 $10,000 $10,000 A relevant cash flow is a future incremental cash flow: The flow must arise because the project is being taken on. It arises as a consequence of the decision to run the project. Thus the current overheads of $0,000 are not relevant because they arise whether or not the diversification project proceeds. However, the increased overheads of $2,400 are relevant. They only arise if the project is taken on. It must occur in the future. Past or sunk costs are irrelevant. Thus the professional fees of $8,000 are not a relevant cost. The flow must be a cash flow. Non-cash flows are irrelevant so the depreciation is not a relevant cash flow. Opportunity costs are relevant cash flows. Opportunity costs are revenues that are lost (or costs that arise) due to the decision made. Thus the revenue lost from current operations (the café) due to the disruption is a relevant cash flow. As inflation rises, so the required rate of return of the investor will also rise. For example, an investor requires a rate of return of 5%. If $100 was invested now, then in one year s time the investor would require $105. If however, there was inflation of 10% and the investor still required a return of 5% then the situation would be different. The investor would require his $100 to have become $110 to have the same purchasing power, and then the return of 5% would still be required. The investor would require $ in one year s time, an overall return of 15 5%. 2 (a) (i) The just in time inventory management system (JIT) tries to ensure that negligible levels of inventory need to be held at every stage of the production process. There will be a continuous flow of raw material inventory, into and through the production process, and finished goods are shipped straight to the customer. JIT can be described as a pull system. The stock orders and production schedules are based on customer demand, and goods are made in response to customer demand. (ii) The requirements for JIT to operate are: Guaranteed quality of raw materials production would be stopped if materials were defective. Suppliers and customers are geographically close, to reduce delivery times. Suppliers and customers have a close working relationship. Flexible workforce, able to expand and contract hours as required to ensure that work-in-progress is kept to a minimum. Efficient production systems, to reduce the production time. Note only three were required. (iii) JIT is unlikely to work for Expand Co at the moment because: Inefficiencies have arisen in the production process They have many different suppliers, weakening the relationship between the supplier and Expand Co The economic order quantity ignoring discounts: {(2 x 00 x 2 x 50,000)/(0 2 x 1 5)} 1/2 = 14,142 units The total cost or purchasing, ordering and holding inventory must now be calculated using the EOQ and any higher order level at which a discount applies. EOQ $ Cost of purchases 100,000 x $ ,000 Ordering cost {100,000/14,142} x $00 2,121 Holding cost 0 2 x $1 5 x 14,142/2 2, ,242 15

5 ,000 units $ Cost of purchase 100,000 x $1 5 x ,500 Ordering costs {100,000/,000} x $00 1,500 Holding costs 0 2 x $1 5 x 0 95 x,000/2 2, ,850 The order size to minimise costs would be,000 units. Three factors other than price that should be considered before purchasing goods from a new supplier are: The reliability of the supplier The quality of the goods The credit terms available Delivery time. Note only three were required (a) Overdraft An overdraft is a facility that a company can negotiate with their bank. This allows a company to pay more out of their current account, than there is cash available in the account. An overdraft should be a temporary form of short-term finance as it is technically repayable on demand. An overdraft would not be a suitable form of financing for the expansion and re-equipping of the factory, as a form of longterm finance is required. An overdraft could however be used to cover any temporary shortfall in working capital that could arise due to the expansion. Venture Capital Funding Venture capital is the provision of risk bearing capital, to companies with a high growth potential. This is usually in return for an equity stake. Providers of finance will usually require a seat on the board and will be looking for an exit route from the company via for example flotation. Bake Co meets many of a potential venture capital investors requirements: Defined strategy Defined market Substantial turnover Growth potential However, as a family owned company, Bake Co may not want to reduce their voting control now, or be able or willing to provide the exit route required. Venture capital would provide a reasonable form of financing for the expansion. Its suitability for this company depends partially on the wishes of the family. Term loan A term loan is a medium or long-term loan that is for a defined period and repaid according to a specific schedule. The repayment schedule can be negotiated to meet the needs of the company, but once negotiated, must be adhered to. The loans are usually secured against assets held by the company. The project is of a long-term nature, so a term loan would be a reasonable method of funding and the company has probably got sufficient assets on which to secure the loan. There will not be income immediately from the expansion, but if current activities do not generate sufficient returns to make the repayments, it would be possible to negotiate a bullet or balloon repayment schedule to allow the returns from the expansion to arise before substantial repayments are due. This would be a suitable method of funding. 16

6 (d) (e) Equity Equity finance can be raised through a number of different channels: Bake Co does not have a listing on the stock exchange and is unlikely to be able to obtain one due to its size. The family although it is unknown if the family have sufficient private resources to make an investment of this size. Private placing it is usually difficult to obtain large amounts of investment by this method. Business Angel these are wealthy individuals or groups of individuals who are willing to invest in the company. This form of financing can however be difficult to set up. If the family do not have the required funds, then the most likely form of equity financing would be from Business Angels. Business Angels often have a knowledge of the industry, so the brand and reputation that Bake Co have built up will aid them in any application made. If a suitable investor can be found, then this would be a reasonable method of financing the expansion. Trade Credit When one company sells goods or services to another it does not usually expect to be paid immediately. These unpaid bills are referred to as trade credit. To use trade credit as a form of finance, the payment to suppliers is delayed further. Although useful to cover temporary cash flow shortages, it is not a form of financing that is used for large projects, as the amounts available are usually insignificant in comparison to the size of the project. Due to the size of the investment required, trade credit is not a form of financing that can be used for expanding and re-equipping the factory. It could be used to help finance the increased working capital that will be required due to the expansion, but Bake Co must consider the principal disadvantages: The cost of any prompt payment discounts lost. The possible loss of supplier goodwill. The company has built a reputation for quality and must ensure that it maintains a good relationship with its suppliers to ensure the quality of inputs. 4 (a) (i) Total cost = fixed cost + variable cost x number of tourists $45,000 = fixed cost + variable cost per tourist x 10,000 $67,500 = fixed cost + variable cost per tourist x 25,000 Subtracting one equation from the other $22,500 = 15,000 x variable cost per tourist $1 5 = variable cost per tourist Alternatively the high low method of cost estimation could have been used: Variable cost per tourist = {($67,500 $45,000)/(25,000 10,000)} = $1 5 per tourist. Full marks will be awarded whichever method is used. The variable cost per tourist is $1 5. Substitute this into either of the first equations to give the fixed costs. $0,000 = fixed cost Contribution = Sales price variable cost Contribution = $4 $1 5 = $2 5 per tourist Breakeven Point = Fixed costs/contribution per unit Breakeven Point = $0,000/$2 5 = 12,000 tourists. Margin of safety = 15,000 12,000 =,000 tourists. This can be represented as,000/15,000 = % Either answer gains the mark for margin of safety. (ii) Units to make a target profit = (fixed costs + target profit)/contribution per unit Tourists to make a target profit of $6,000 = ($0,000 + $6,000)/$2 5 = 14,400 tourists (iii) It can be argued that Joe has a large margin of safety as the number of tourists can fall by % before nil profit is made. However, he has a small margin of safety compared with his current income. The number of tourists has only got to drop by 4% (15,000 14,400)/15,000 before he makes less profit than he did fishing. 17

7 and (i) Line 1 relates to Line 2 relates to (i) (i) Because the sales and variable costs per unit are not altering, the slope of the P/V line will not alter. The increase in fixed costs will alter the point of intersection on the y axis, and therefore the breakeven point. (ii) profit/ (loss) $ 000 Line 1 Line Fixed costs{ Breakeven point } Profit of $6, tourists 000 The new breakeven point is 14,800 units. The margin of safety is now considerably smaller, and the likelihood of Joe not making a profit much higher. 18

8 ACCA Certified Accounting Technician Examination Paper T10 Managing Finances December 10 Marking Scheme Marks Section A 2 marks for each of the 10 questions, totalling Section B 1 (a) Net Present Value Diners per year 1 Net income from diners 2 Building costs 1 Lost income 1 Cleaners 0 5 Chefs 1 Waiting staff 1 Overheads 1 Professional fees ignore 0 5 Depreciation ignore 0 5 Relevant cash flow 0 5 Discounted cash flow 0 5 Net present value 0 5 Conclusion 1 12 Relevant cash flow Each valid theoretical point 1 Each valid illustration of theoretical points 1 Max 5 Inflation 1 Illustration 2 2 (a) Just in time system (i) Concept Each valid point 1 mark 2 (ii) Three requirements to operate Each valid point 1 mark (iii) Advice 1 Reasons 1 2 Order size to minimise costs EOQ calculation 2 Total cost at EOQ Total cost at discount level 4 Conclusion 1 10 Three factors Each valid point 1 mark 19

9 Marks (a) Each valid point 1 mark 4 Each valid point 1 mark 4 Each valid point 1 mark 4 (d) Each valid point 1 mark 4 (e) Each valid point 1 mark 4 4 (a) (i) Calculation of fixed and variable costs 4 Contribution 1 Break even point 1 Margin of safety 1 7 (ii) Units to make $6,000 profit 2 (iii) Each valid point 1 mark 2 X axis 0 5 Y axis 0 5 Fixed costs 1 Break even point 1 Profit of $6, (i) Explain effect 1 Effect shown on graph 1 2 (ii) New break even point 1 Interpretation, 1 mark per valid point 2