ACCOUNTING FOR DECISION MAKING MBA ENRICHMENT EXERCISES AND SOLUTIONS

ACCOUNTING FOR DECISION MAKING MBA ENRICHMENT EXERCISES AND SOLUTIONS

CONTENTS ENRICHMENT EXERCISES Page 1. Accounting information and managerial decisions 3 2. Financial statements and accounting concepts 4 3. Accounting for and presentation of assets, liabilities and owners equity 6 4. Income statement and cash flows 9 5. Financial Analysis 18 6. Cost-volume-profit (CVP) relationships 21 7. Cost analysis for planning, control and decision-making 25 8. Transfer pricing for decentralised enterprises 35 9. Corporate governance 36 Present value tables 37 SOLUTIONS 1. Accounting information and managerial decisions 39 2. Financial statements and accounting concepts 41 3. Accounting for and presentation of assets, liabilities and owners equity 45 4. Income statement and cash flows 50 5. Financial Analysis 60 6. Cost-volume-profit (CVP) relationships 68 7. Cost analysis for planning, control and decision-making 77 8. Transfer pricing for decentralised enterprises 90 9. Corporate governance 92 2

TOPIC 1 ACCOUNTING INFORMATION AND MANAGERIAL DECISIONS 1. Accounting information is required by various individuals and organizations in order to make decisions. Explain why each of the following user groups need accounting information relating to a business. 1.1 Customers 1.2 Suppliers 1.3 Government 1.4 Owners 1.5 Lenders 1.6 Employees 1.7 Investment analysts 1.8 Community representatives 1.9 Managers 2. Explain how external auditors and internal auditors differ as far as their main duty is concerned. 3. Tabulate 5 differences between management accounting and financial accounting. 4. Whilst there are differences between the information needs of mangers and other users, use examples to show how there could be an overlap of between the needs of managers and other users. 3

TOPIC 2 FINANCIAL STATEMENTS AND ACCOUNTING CONCEPTS FINANCIAL STATEMENTS 1. The income statement for Heidi Limited revealed an increase in profit of R200 000. However, during the same financial period the bank balance declined by R120 000. How would you explain this apparent discrepancy? FINANCIAL STATEMENT RELATIONSHIPS 2. Discuss how the following financial statements are integrated: Income statement Statement of changes in equity Balance sheet Statement of cash flows ACCOUNTING CONCEPTS 3. Critically discuss the following accounting concepts: 3.1 Materiality 3.2 Conservatism 4. Explain the significance of the following accounting concepts in the preparation of a balance sheet of an enterprise. Support your answer with examples. 4.1 Going concern 4.2 Full disclosure 4.3 Consistency 4

ACCOUNTING EQUATION AND FINANCIAL STATEMENTS 5. Required 5.1 Use the format of the accounting equation presented below to analyse the transactions of Gwala Stores. Use + for an increase and for a decrease. 5.2 Thereafter prepare the: 5.2.1 Income statement the month ended 31 August 20.9. 5.2.2 Statement of changes in equity for the month ended 31 August 20.9. 5.2.3 Balance Sheet at 31 August 20.9. 5.2.4 Statement of changes in Cash Flows for the month ended 31 August 20.9. Assets = Equity + Liabilities Equipment Inventory Receivables Bank = Capital Income Expenses + Payables TRANSACTIONS FOR AUGUST 20.9 01 T Gwala, the proprietor, transferred R90 000 from her personal banking account into a bank account in the name of her business. 05 Purchased equipment by cheque, R50 000. 15 Bought stationery for office use on credit, R4 000. 25 The rent for August 20.9 was paid by cheque, R5 000. 31 Fees collected from customers for services rendered, R10 000. 5

TOPIC 3 ACCOUNTING FOR AND PRESENTATION OF ASSETS, LIABILITIES AND OWNERS EQUITY 1. Pixma Limited began operations in January 20.9 with R900 000 obtained from selling 450 000 ordinary shares at a par value of R2 each. Some of the major transactions for the year included the following: It purchased plant and equipment for R750 000 as well as land and buildings for R450 000, financing the purchase with a mortgage bond of R287 500, a long-term loan of R595 000, and cash for the balance. During the year the company used cash to reduce the mortgage bond balance by R25 000 and to repay R75 000 towards the long-term loan. The company also invested R195 000 in short-term marketable securities. On 01 October 20.9, the company issued a further 200 000 shares at R3 each. Depreciation expense for the year was R200 000. The net profit after tax for the year ended 31 December 20.9 was R250 000. Dividends for the year (declared and paid) amounted to R220 000. REQUIRED 1.1 From the information provided above, calculate the amount that should be reflected for each of the following items in the Balance Sheet of Pixma Limited at the financial year end 31 December 20.9: 1.1.1 Non-current assets 1.1.2 Retained earnings 1.1.3 Total owners equity 1.1.4 Non-current liabilities 1.2 Explain why it is important for Pixma Limited to consistently take advantage of cash discounts offered by creditors for early settlement of accounts. 1.3 Explain how the shareholders of Pixma Limited can benefit from financial leverage. 6

1.4 Name 2 control measures that you would recommend to prevent the following from occurring at Pixma Limited for each of the following situations: 1.4.1 Payments made without proper authorization 1.4.2 Theft of stock from the warehouse 2. Name 4 decisions that need to be made before calculating the depreciation expense for an asset. Also explain what impact these decisions will have on reported profits. 3. The first-in-first-out (FIFO), last-in-last-out (LIFO) and the weighted average cost (AVCO) methods may be used to value inventory. Answer the following questions related to the use of these methods during a period of rising prices: 3.1 Which method will show the highest gross profit? Why? 3.2 Which method will show the lowest gross profit? Why? 3.3 How will the valuation of inventories using the AVCO method compare with the FIFO and LIFO methods? 3.4 Which method will show the highest closing inventory figure in the balance sheet? Why? 3.5 Which method will show the lowest closing inventory figure in the balance sheet? Why? 3.6 Comment on the closing inventory figure if the AVCO method is used. 4. Name 4 instances when the net realizable value of inventory would be lower than the cost price of the inventory held. 5. What would be the effect of not taking into account the fact that a debt is bad, when preparing the financial statements, on the reflection of financial performance and financial position? 6. State which of the following items would appear on the balance sheet of Jensen Manufacturers as an asset. Explain your reasoning in each case. 6.1 R4 000 owing to Jensen Manufacturers by a customer who will never be able to pay. 6.2 The hiring by Jensen Manufacturers of a new marketing manager who is confident of increasing profits by over 50% over the next four years. 6.3 Purchase of a machine that will save Jensen Manufacturers R30 000 per year. It is presently being used by the business but has been acquired on credit and is not yet paid for. 7

7. The following is a list of balances extracted from the financial records of Manhattan Ltd on 30 November 20.9. R Debtors 185 000 Land and buildings 320 000 Inventories 153 000 Bank overdraft 116 000 Equipment 207 000 Loan from Kia Bank 260 000 Motor vehicles 38 000 Creditors 86 000 Required 7.1 Prepare the balance sheet of Manhattan Ltd at 30 November 20.9. 7.2 Provide an interpretation of the balance sheet by making reference to the following: 7.2.1 The liquidity of the business 7.2.2 The mix between current and non-current assets 7.2.3 The financial structure of the balance sheet (finance provided by owners and outsiders) 8

TOPIC 4 INCOME STATEMENT AND CASH FLOWS INCOME STATEMENT 1. Edgar Limited has an authorized share capital of 300 000 ordinary shares at a par value of R2 each. 200 000 shares have been issued at par value. Study the Income statement of Edgar Limited for the year ended 30 September 20.9 and answer the questions that follow: Edgar Limited Income statement for the year ended 30 September 20.9 (R) Net sales 470 000 Cost of sales (206 800) Gross profit 263 200 Selling, general and administrative expenses (163 200) Income from operations 100 000 Other income/expenses Interest expense (6 000) Other income 12 000 Profit on disposal of asset 4 000 Profit before tax 110 000 Income tax (33 000) Net profit 77 000 Earnings per share? 1.1 The earnings per share for the year ended 30 September 2008 was 45 cents. As a director of Edgar Limited would you satisfied with the earnings per share for the year ended 30 September 20.9? Motivate your answer. 1.2 The interest rate on loans is 15% per annum. If there was no increase or decrease in the loan balance during the financial year, calculate the loan balance. 9

1.3 Calculate the gross profit ratio for the year ended 30 September 20.9. Thereafter state two possible reasons why this ratio is lower than the ratio for the previous financial year. 1.4 Recommend two ways in which Edgar Limited can improve its profitability. 2. MVP Ltd presented the income statement below for its most recent financial year. R Sales 743 000 Cost of sales 402 000 Gross profit 341 000 Operating expenses 145 000 Income from operations 196 000 Other income 1 100 Other expenses 26 000 Profit before tax 171 100 Income tax 60 000 Net profit 111 100 Answer the following questions: 2.1 Explain the difference between sales and other income. 2.2 MVP Ltd would like to earn a large gross profit by selling its products at a much higher price than its cost. Describe two factors that may prevent it from doing so. 2.3 Explain how cost of sales, operating expenses and other expenses are different from one another. 2.4 Explain why cost of sales, operating expenses, other expenses and income tax are listed separately in the income statement rather than being lumped together as one item? 2.5 Explain why the income statement presented above is inadequate to provide a proper interpretation of the financial result of MVP Ltd for the financial year. 10

3. The income statement for 20.9 and 20.8 given below were extracted from the accounting records of Afri Manufacturers Ltd: Afri Manufacturers Ltd Income statement for the year ended 31 December 20.9 20.8 Net sales Cost of sales (R) 1 003 600 (905 600) (R) 901 300 (744 300) Gross profit 98 000 157 000 Selling, general and administrative expenses (92 000) (65 000) Income from operations 6 000 92 000 Other income/expenses Non-operating income Interest expense 124 500 (90 500) 18 000 (57 000) Profit before tax 40 000 53 000 Income tax (12 000) (15 900) Net profit 28 000 37 100 Required Refer to the income statement of Afri Manufacturers Ltd for 20.9 and 20.8 and comment on the performance of the company including the operating profit earned. Take into account that the profit margin (percentage net profit after tax to sales) for the industry was 4.51% for 20.8 and 2.60% for 20.9. 11

CASH FLOW STATEMENT 4. What impact would changes in the balance sheet items listed below have on the cash position of an enterprise? Place a tick ( ) in the correct column. Change in balance sheet items Inflow of cash Outflow of cash Increase in current assets other than cash Decrease in current assets other than cash Increase in non-current assets Decrease in non-current assets Increase in current liabilities Decrease in current liabilities Increase in non-current liabilities Decrease in non-current liabilities 5. Study the extracts of the Cash flow statement of Vuyo Limited for the year ended 30 June 20.9 and answer the questions that follow. Extracts of Cash Flow Statement for the year ended 30 June 20.9 R Cash flow from operating activities 100 000 Cash flow from investing activities (300 000) Additions to plant and equipment (300 000) Cash flow from financing activities 250 000 Increase in Long-term borrowings 250 000 5.1 What do you understand by Cash generated from operating activities R100 000? 5.2 Name one transaction that improves cash flow but does not increase profit. 5.3 There is a combination of a positive net cash flow from operating activities (R100 000) and a negative cash flow from investing activities (R300 000). Is this good for the company? Explain. 12

6. The cash flow statement for Mega Ltd is provided below: Mega Ltd Cash flow statement for the year ended 31 December 20.9 R Cash flow from operating activities Profit before interest and tax i.e. operating profit 61 047 Adjustments to convert to cash from operations Non-cash flow adjustments 53 418 Add: Depreciation 53 418 Profit before working capital changes 114 465 Working capital changes (80 485) Increase in inventory (55 170) Increase in receivables (53 061) Increase in payables 27 746 Cash generated from operations 33 980 Cash flow from investing activities 129 767 Proceeds from sale of plant and equipment 129 767 Cash flow from financing activities (172 860) Long-term borrowings redeemed (172 860) Net decrease in cash (9 113) Cash balance (31 December 20.8) 23 243 Cash balance (31 December 20.9) 14 130 Use the cash flow statement to answer the following questions: 6.1 How did the company use its cash flows from operating and investing activities? 6.2 Why were depreciation and increase in payables added to operating profit in computing the cash flow from operating activities? 6.3 Is the cash flow statement above presented according to the direct method or indirect method? Explain how the method used above is different from the alternative method. 6.4 Based on the cash flow information above, how does the company appear to be performing? Explain. 13

7. Required Study the extracts of the Cash flow statement of Siya Limited for the year ended 30 November 20.9 and state your observations. Extracts of Cash Flow Statement for the year ended 30 November 20.9 R Cash flow from operating activities 270 000 Cash flow from investing activities (750 000) Additions to plant and equipment (Property and machinery) Sale of investments (1 000 000) 250 000 Cash flow from financing activities 800 000 Proceeds from issue of ordinary shares Increase in Long-term borrowings 750 000 50 000 Net increase in cash and cash equivalents 320 000 Cash and cash equivalents at beginning of year 180 000 Cash and cash equivalents at end of year 500 000 14

8. You are provided with the following information: Asic Ltd INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20.6 R Sales 1 800 000 Cost of sales (1 125 000) Gross profit 675 000 Operating expenses (474 000) Directors fees 127 500 Auditor s fees 67 500 Depreciation on equipment 39 750 Depreciation on vehicles 41 250 Loss on sale of asset 21 000 Other non-disclosable costs 177 000 Operating profit 201 000 Other income: Investment income 24 600 Interest expense: on debentures (3 900) Profit before tax 221 700 Income tax (77 595) Profit for the year 144 105 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.6 Preference share capital Ordinary share capital Retained earnings Total Balance on 01 January 20.6 120 000 525 000 143 775 788 775 Issue of share capital 150 000 150 000 Profit for the year 144 105 144 105 Dividends:Preference (15 450) (15 450) :Ordinary interim (18 750) (18 750) :Ordinary final (35 250) (35 250) Balance on 31 December 20.6 120 000 675 000 218 430 1 013 430 15

Asic Ltd BALANCE SHEET AS AT 31 DECEMBER ASSETS Non-current assets 996 090 858 075 Property, plant and equipment (Note 1) Financial assets: Investment Subsidiary company Investment Listed shares (at cost) 20.6 R 790 590 85 500 120 000 20.5 R 699 600 60 000 98 475 Current assets 188 925 203 505 Inventories 120 690 119 700 Trade and other receivables 67 335 82 305 Trade debtors 67 335 82 305 Cash and cash equivalents 900 1 500 Bank Petty cash - 900-1 500 Total assets 1 185 015 1 061 580 EQUITY AND LIABILITIES Equity 1 013 430 788 775 Share capital Retained earnings 795 000 218 430 645 000 143 775 Non-current liabilities 30 000 135 000 Long-term borrowings: 13% Debentures 30 000 135 000 141 585 137 805 Current liabilities Trade and other payables 43 185 59 805 Trade creditors 43 185 59 805 South African Revenue Services (Income tax payable) Shareholders for dividends Bank overdraft 45 000 50 700 2 700 30 000 39 000 9 000 Total equity and liabilities 1 185 015 1 061 580 16

Note 1 Property, plant and equipment 20.6 20.5 Land and buildings Equipment Vehicles Land and buildings Equipment Vehicles Cost 462 000 242 340 300 000 346 500 188 100 300 000 Accumulated depreciation (82 500) (131 250) (45 000) (90 000) Carrying value 462 000 159 840 168 750 346 500 143 100 210 000 Additional information 1. Equipment was sold for cash, R16 500. The cost price of the equipment sold was R39 750 and the accumulated depreciation on it to the date of sale was R2 250. Equipment was also purchased for cash. 2. Additions were made to the buildings for cash. 3. Ordinary shares were issued at par value. REQUIRED Prepare the Cash Flow Statement for the year ended 31 December 20.6. 17

TOPIC 5 FINANCIAL ANALYSIS 1. Excerpts of financial data for Polar Enterprises are as follows: Income statement 20.10 (R) 20.9 (R) Sales (10% credit) 32 011 500 19 373 000 Cost of sales (10% credit purchases) 26 180 100 15 993 700 Operating profit 1 931 200 1 327 800 Profit before tax 1 831 400 1 226 420 Tax (25%) 457 850 306 600 Net profit after tax 1 373 550 919 820 Balance sheet 20.10 20.9 Non-current assets 5 200 000 4 700 000 Current assets 2 866 530 4 974 530 Inventories 1 482 200 2 038 860 Accounts receivable 261 290 155 200 Marketable securities 326 950 2 306 440 Cash 796 090 474 030 Current liabilities 1 088 860 588 310 Accounts payable 190 660 192 040 Other current liabilities 898 200 396 270 Required 1.1 Calculate the gross margin, operating margin and profit margin for 20.10 and 20.9. 1.2 Comment on your answers calculated in question 1.1. 1.3 Calculate the current ratio and acid test ratio at the end of each year. How has the enterprise s liquidity changed over this period? 1.4 Compute the following for 20.10 (ratios for 20.9 are given in brackets): Inventory turnover (20.9: 9.04 times) Debtors collection period (20.9: 29.24 days) Creditors payment period (20.9: 42.40 days) Turnover to net assets (20.9 2.13) 18

1.5 What is your interpretation of the enterprise s performance with respect to your answers in question 1.4? 2. Answer the questions below based on the following information. Income tax is calculated at 35% of profit. Vuyo Traders Sipho Stores 20.10 (R) 20.09 (R) 20.10 (R) 20.09 (R) Operating profit 400 000 320 000 420 000 380 000 Profit after tax 120 000 100 000 140 000 80 000 Non-current debt (10% p.a.) 200 000 80 000 1 200 000 1 000 000 Owners equity 800 000 720 000 300 000 280 000 Note: The enterprise has no current liabilities. Required 2.1 Calculate the return on assets for both enterprises for 20.10. 2.2 Calculate the return on equity for both enterprises for 20.10. 2.3 Which enterprise is more profitable? Explain. 2.4 Should Vuyo Traders be satisfied with its return on assets? Explain. 3. In 20.10, Mestle Wholesalers had R2 000 000 of assets, R200 000 of current liabilities and R600 000 non-current liabilities. Operating profit was R500 000, interest expense was R120 000 and the tax rate was 40%. Required 3.1 Calculate the following ratios: Debt to assets Debt to equity Interest coverage 3.2 Comment on your answers obtained in question 3.1. 19

4. The following information was extracted from the financial statements of Premier Limited: Income statement 20.10 (R) 20.9 (R) Profit after tax 10 000 000 7 500 000 Statement of changes in equity Interim dividends 500 000 300 000 Final dividends 1 500 000 1 100 000 Ordinary share capital (par value R2) 80 000 000 60 000 000 Ordinary share premium 20 000 000 4 000 000 Retained earnings 18 000 000 10 000 000 Other Market price per share 4 3.75 Required 4.1 Calculate the following ratios for 20.10 (ratios for 20.9 are given in brackets): Return on equity (10.04%) Earnings per share (25 cents) Dividends per share (4.67 cents) Earnings retention (81.32%) Price/Earnings ratio (15) 4.2 Comment on your answers obtained in question 4.1. 20

TOPIC 6 COST-VOLUME-PROFIT (CVP) RELATIONSHIPS EXPANDED CONTRIBUTION MARGIN MODEL 1. The following budgeted details for 20.9 relate to a product manufactured by Manto Ltd: Sales R50 000 Variable cost per unit sold R7.50 Total fixed cost R12 500 Sales volume 2 500 units Required Consider the following situations independently: 1.1 Calculate the operating profit. 1.2 Suppose sales increase by R10 000 without changes to any costs. By what amount will contribution margin and operating profit increase? 1.3 Suppose fixed costs increase by R3 000. By how much must sales increase if operating profit was to remain unchanged? 1.4 Would you recommend an advertising programme costing R5 000 that would generate an additional R10 000 of sales? Why? 1.5 Calculate the volume of sales required to achieve an operating profit of R20 000. Consider the following situations independently and in each case motivate your answer by doing the relevant calculations: 1.6 Should management consider a drop of R2 per unit in the selling price if sales volume is expected to increase by 200 units? 1.7 Should management adopt the following proposal? Decrease the selling price by R4 and increase marketing costs by R8 000 with the expectation of an increase in sales to 5 000 units. 21

2. Rissik Limited manufactures product D. The budgeted details for 20.9 are as follows: Selling price per unit R12 Variable cost per unit sold R5 Total fixed cost R700 000 Required Calculate the number of units that must be sold in order to earn an operating profit of R260 000 (answer expressed to the nearest whole number). BREAK-EVEN POINT 3. Sepata Enterprises makes sandals. The fixed costs of operating the workshop for a month total R5 000. Each pair of sandals requires material that cost R20. Each pair of sandals takes 2 hours to make, and the business pays the sandal makers R12.50 an hour. The sandal makers are all on contract and if they do not work for any reason, they are not paid. Each pair of sandals is sold to shoe stores at R70. The business expects to sell 350 pairs of sandals per month. Questions 3.1 Calculate the number of pairs of sandals that the business must sell in order to break even each month. 3.2 Why is it necessary for the management of Sepata Enterprises to know the break-even point? 3.3 Suppose the business has an opportunity to rent a sandal-making machine. Doing so would increase the total fixed costs of operating the workshop for a month to R9 375. Using the machine will reduce the labour time to 1 hour for each pair of sandals. The sandal makers will still be paid R12.50 per hour. 3.3.1 Calculate the break-even quantity if the machine is rented. 3.3.2 After considering the information given and the calculations you made, should the machine be rented or not? 3.3.3 Calculate and comment on the margin of safety (calculated in units) for each option i.e. without the machine and with the machine. 22

4. The following budgeted data relates to a product produced by Gnome Manufacturers and to a similar product produced by Humpty Manufacturers for 20.9: Gnome Humpty R R Selling price per unit 60 60 Direct material cost per unit 16 14 Direct labour cost per unit 12 6 Direct overhead cost per unit 8 4 Fixed factory overhead costs 10 000 20 000 Fixed administration costs 5 000 10 000 Expected sales for each manufacturer is 2 000 units. Required 4.1 Calculate the total revenues required to break even for each manufacturer. 4.2 Which manufacturer experiences a higher operating leverage? Motivate your answer by doing the relevant calculations. 4.3 What is the consequence of a small drop in sales to an enterprise that has a high operating leverage? Use a calculation to support your answer. 4.4 Calculate the margin of safety (expressed as a percentage) for each manufacturer. 23

5. The following budgeted information for the year ended 31 October 20.9 is provided by Sonke Ltd, a manufacturer of a single product called Rimex: Sales (30 000 units X R12 per unit) R360 000 Total variable cost (30 000 units X R5.40 per unit) R162 000 Total fixed costs R78 000 The sales forecast for the year ended 31 October 20.9 is 15% less than the actual sales for the year ended 31 October 20.8. The sales director produced three proposals to improve the position: Proposal A involves launching an aggressive marketing campaign. This would involve a single additional fixed cost of R18 000 for advertising. Sales commission will increase by R1.20 per unit. Sales volume is expected to increase by 10% above the budgeted sales of 30 000 units with no change in the unit selling price. Proposal B involves a 10% reduction in the unit selling price. Fixed selling overheads will also reduce by R12 000. The sales volume is expected to be 34 000 units. Proposal C involves a 10% reduction in the unit selling price and this is estimated to bring the sales volume back to the level as the year ended 31 October 20.8. Required For each of the three proposals, calculate the break-even quantity (answer expressed to the nearest whole number). 24

TOPIC 7 COST ANALYSIS FOR PLANNING, CONTROL AND DECISION-MAKING BUDGETS 1. Budgets are half used if they serve only as a planning device. Comment on this statement. 2. What are the principal considerations involved in preparing a production budget? 3. The following is the sales forecast (in units) of Manco Ltd that manufactures two products viz. product X and product Y: November 20.6 December 20.6 January 20.7 Product X Product Y 3 000 4 000 4 500 6 000 4 000 5 000 The selling price per unit of product X is R20 and the selling price of product Y is R30. Required Prepare a sales budget for the period 1 November 20.6 to 31 January 20.7. 4. PC Solutions makes and sells computers. On 31 March 20.6, the entity had 60 computers in inventory. The company s policy is to maintain a computer inventory of 5% of the following month s sales. The sales forecast of the entity for second quarter of the year is: April 1 200 computers May 1 000 computers June 900 computers Required Draw up a production budget for April and May 20.6. 25

5. Computek Ltd sells computers. At the beginning of May 20.9 the business had an overdraft of R70 000 and the bank had asked that it be settled by the end of October 20.9. As a result, the directors decided to review their plans for the next 6 months and the following is the cash budget that was subsequently drawn up for the 6 months ending 31 October 20.9. Computek Ltd Cash Budget for the 6 months ended 31 October 20.9 May Jun Jul Aug Sep Oct R 000 R 000 R 000 R 000 R 000 R 000 Cash receipts 454 630 492 276 236 216 Cash sales 454 630 492 276 236 216 Cash payments 404 528 506 328 264 240 Cash purchase of merchandise 270 360 284 188 150 132 Administration expenses 80 82 76 66 62 60 Loan repayments 10 10 10 10 10 10 Selling expenses 44 48 56 52 42 38 Shop refurbishment 28 36 12 Tax payment 44 Cash surplus (shortfall) 50 102 (14) (52) (28) (24) Opening cash balance (70) (20) 82 68 16 (12) Closing cash balance (20) 82 68 16 (12) (36) Additional information (a) The business maintains a minimum monthly inventory level of R80 000 of merchandise. (b) The gross profit margin is 40%. Question What problems are likely to be faced by Computek Ltd during the 6 month period May to October 20.9? Suggest ways in which the business may deal with these problems. 26

VARIANCE ANALYSIS 6. GMX Ltd uses the standard costing system. The standards are as follows: Standards Material J Labour Variable overheads Fixed overheads Normal production 2kg @ R5 per kg 4 hours @ R50 per hour R11 per labour hour R14 000 12 000 per month Actual information for the month October 20.8 is: Material J used 20 050kg @ R5,20 per kg Labour 39 500 hours @ R48 per hour Variable overheads R12 per labour hour Fixed overheads R14 500 Production 10 000 units manufactured Required 6.1 Calculate the raw material usage variance. Also provide possible reasons for the variance. 6.2 Calculate the direct labour rate variance. 6.3 Calculate the direct labour efficiency variance. 6.4 Calculate the variable overhead efficiency variance. 27

7. Zimba Manufacturers uses the standard costing system. The following information for September 20.9 is available in respect of product H that it manufactures: Budgeted figures Variable manufacturing overheads Fixed manufacturing overheads Number of labour hours Expected production R32 000 R76 800 6 400 1 600 units Actual results Variable manufacturing overheads Fixed manufacturing overheads Number of labour hours worked Actual production R30 616 R79 808 6 880 1 680 units Required 7.1 Calculate the fixed overhead spending variance. 7.2 Calculate the fixed overhead volume variance. 7.3 Calculate the variable overhead efficiency variance. Also provide possible reasons for the variance. 28

ACCEPTANCE OF A SALES OFFER 8. Kremo Limited produces only premium ice cream. The factory has a capacity of 10 million litres but only plans to produce 8 million litres. The variable costs per litre associated with producing and selling 8 million litres are as follows: R Ingredients 5.00 Packaging 1.00 Direct labour 2.00 Variable overheads 0.50 Sales commission 0.50 Total variable costs 9.00 The selling price per litre is R12 and the fixed costs for producing the ice cream is R4 656 000. An ice cream distributor from Gauteng not normally served by Kremo Limited has offered to buy 2 million litres at R8.90 per unit. Since the distributor approached the company directly, there is no sales commission. REQUIRED 8.1 Calculate the operating profit or loss. 8.2 As the manager of Kremo Limited, would you accept or reject the offer? Substantiate your answer by calculating the differential profit or loss from accepting the offer. 29

9. Femino Enterprises produces product Z that it sells for R63 each. The costs of producing and selling 120 000 units of product Z are estimated as follows: Variable costs per unit: Direct materials R15.00 Direct labour R9.00 Factory overhead R6.00 Selling and administrative expenses R7.50 R37.50 Fixed costs: Factory overhead R1 600 000 Selling and administrative expenses R600 000 To date, this year, 90 000 units have been produced and sold. An additional 22 500 units are expected to be sold on the domestic market during the remainder of the year. Femino Enterprises received an offer from Zambesi Traders for 6 000 units of product Z at R42 each. Zambesi Traders will market the product in Zambia under its own brand name, and no additional selling and administrative expenses associated with the sale will be incurred by Femino Enterprises. The sale to Zambesi Traders is not expected to affect domestic sales of product Z and the additional units could be produced during the current year using excess capacity. Required Should the proposal be accepted? Motivate your answer. MAKE OR BUY DECISION 10. Dubai Ltd needs a component for one of its products. It can subcontract production of the component to a subcontractor who can provide the component at R20 each. Dubai Ltd can produce the component internally for total variable costs of R15 per component. Dubai Ltd has no spare capacity, so it can only produce the component internally by reducing its output of another of its products. While it is making each component it will lose contributions (contribution margin) of R12 from the other product. Required 10.1 Should the component be subcontracted or produced internally? Motivate your answer. 10.2 Name two problems Dubai Ltd may experience if it decides to subcontract any of its components. 30

11. Trike Enterprises assembles tricycles with motors. It also produces a component for assembly. The costs of making this component for May 20.9 are as follows: R Direct Material 866 000 Labour and other variable costs 844 000 Fixed overheads allocated 267 000 Total cost 1 977 000 Number of units produced 8 500 Per unit cost 232.59 A recently established spare part manufacturer approached Trike Enterprises with a proposal of supplying this component at R210. Required What would be your advice to Trike Enterprises? 31

CAPITAL INVESTMENT APPRAISAL NOTE: WHERE APPLICABLE, USE THE PRESENT VALUE TABLES SUPPLIED AT THE END OF THE ENRICHMENT EXERCISES. 12. The following information relates to two capital expenditure projects. Because of capital rationing, only one project can be accepted. Project A Project B Initial cost R800 000 R920 000 Expected life 5 years 5 years Expected scrap value R40 000 R60 000 Expected net cash inflows: R R End of year 1 320 000 400 000 2 280 000 280 000 3 260 000 200 000 4 240 000 200 000 5 220 000 200 000 The company estimates its cost of capital is 12%. Depreciation is calculated using the straight-line method. Required 12.1 Calculate the payback period for project B. (Answer expressed in years and months) 12.2 Calculate the accounting rate of return for project A. (Answer expressed to 2 decimal places) 12.3 Calculate the net present value of project A. (Round off amounts to the nearest Rand) 12.4 Using your answers from questions 12.2 and 12.3, should project A be considered for acceptance? Why? 13. The financial manager at Reno Ltd had to choose between these two projects, Turbo and Gusto, which have the following after-tax cash inflows: 32

Year 1 2 3 4 Turbo 0 R27 750 R54 300 R184 500 Gusto R54 000 R54 000 R54 000 R54 000 Both projects require an initial investment of R176 550. All cash flows take place at the end of the year except the original investment in the project which takes place at the beginning of the project. Required 13.1 Calculate the net present value (NPV) for each project, using a discount rate of 12%. Which project would you choose? Why? 13.2 Calculate the Internal Rate of Return (IRR) for both projects. Which project should be chosen? Why? 14. Your company has the option to invest in machinery in projects F and G but finance is only available to invest in one of them. You are given the following projected data: Project F Project G R R Initial cost 140 000 150 000 Net cash inflows: Year 1 Year 2 Year 3 Year 4 Year 5 30 000 36 000 40 000 44 000 26 000 40 000 50 000 50 000 80 000 0 Additional information 1. All cash flows take place at the end of the year except the original investment in the project which takes place at the beginning of the project. 2. Project F machinery will be disposed of at the end of year 5 with a scrap value of R20 000. 3. Project G machinery will be disposed of at the end of year 4 with a nil scrap value. 33

4. Depreciation is calculated on a straight line basis. 5. The discount rate to be used by the company is 14%. Required 14.1 Calculate the payback period for project F. (Answer must be expressed in years and months) 14.2 Calculate the accounting rate of return for project F. (Answer expressed to 2 decimal places) 14.3 Calculate the net present value of each project. (Round off amounts to the nearest Rand) 14.4 Using the answers from question 14.3, which project should be chosen? Explain why. 15. A machine with a purchase price of R140 000 is estimated to eliminate manual operations by R40 000 per year. The machine will last 5 years and have no residual value at the end of its life. Required Calculate the internal rate of return. 34

TOPIC 8 TRANSFER PRICING FOR DECENTRALISED ENTERPRISES 1. Briefly discuss the use of market-based transfer price as the transfer price between divisions of the same entity. 2. It is possible to adopt an approach that allows divisional managers to arrive at negotiated prices for inter-divisional transfers. 2.1 Under what circumstances would you recommend negotiated transfer prices? 2.2 Discuss the possible implications of negotiated transfer pricing on divisional performance of a selling division that sells the whole of its output to another division. 3. A company has two divisions. The output of Division A is product Alpha. There is a market outside the company for product Alpha, but this product is mainly used by Division B which has first call on Division A s output. The output of division B is Product Beta and is sold on the external market. Product Alpha has the following cost structure: Variable cost per unit R8 Fixed cost per unit R2 Management has decided on a target rate of return of 12% for each division. The cost structure of product Beta is given below: Transfer price? Variable cost per unit R15 Fixed cost per unit R7 Market price per unit R28 Required 3.1 Determine the transfer price of product Alpha per unit using the variable cost method. 3.2 Determine the transfer price of product Alpha per unit using the cost-plus method. 3.3 Calculate the selling price of product Beta (for each of the two transfer methods). 3.4 Explain two drawbacks of using variable cost transfer prices. 35

TOPIC 9 CORPORATE GOVERNANCE 1. The King Report states that contracts of directors of companies should not extend to more than three years and that these contracts should no longer be open-ended. Do you agree with this recommendation? Motivate your answer. 2. Explain how the board of directors of a company should manage the company's ethics performance. 3. How can the board (of directors) ensure that the company acts as a responsible corporate citizen? 4. Explain the role played by internal audit in a company and also explain the responsibility of the board in this regard. 5. What steps may be taken by a company to ensure that appropriate persons are appointed as directors? 6. The board is not only responsible for the company s financial bottom line, but for the company s performance in respect of its triple bottom line. Explain what you understand by triple bottom line. 7. A director is a steward of the company. The ethics of governance requires that in this stewardship role, each director be faithful to the four basic ethical values of good corporate governance (responsibility, accountability, fairness and transparency). In performing their stewardship role directors need to exercise the following five moral duties: conscience, care, competence, commitment and courage. Explain what is meant by each of these five moral duties. 8. Explain the function of external auditors. 36

APPENDIX 1 Present value of R1: PVFA (k,n) = Number of 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 25% Periods 1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8547 0.8475 0.8403 0.8333 0.8000 2 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.7972 0.7831 0.7695 0.7561 0.7432 0.7305 0.7182 0.7062 0.6944 0.6400 3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.7118 0.6931 0.6750 0.6575 0.6407 0.6244 0.6086 0.5934 0.5787 0.5120 4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.6355 0.6133 0.5921 0.5718 0.5523 0.5337 0.5158 0.4987 0.4823 0.4096 5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.5674 0.5428 0.5194 0.4972 0.4761 0.4561 0.4371 0.4190 0.4019 0.3277 6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.5066 0.4803 0.4556 0.4323 0.4104 0.3898 0.3704 0.3521 0.3349 0.2621 7 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.4523 0.4251 0.3996 0.3759 0.3538 0.3332 0.3139 0.2959 0.2791 0.2097 8 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.4039 0.3762 0.3506 0.3269 0.3050 0.2848 0.2660 0.2487 0.2326 0.1678 9 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606 0.3329 0.3075 0.2843 0.2630 0.2434 0.2255 0.2090 0.1938 0.1342 10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.3220 0.2946 0.2697 0.2472 0.2267 0.2080 0.1911 0.1756 0.1615 0.1074 11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 0.3173 0.2875 0.2607 0.2366 0.2149 0.1954 0.1778 0.1619 0.1476 0.1346 0.0859 12 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 0.2858 0.2567 0.2307 0.2076 0.1869 0.1685 0.1520 0.1372 0.1240 0.1122 0.0687 13 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 0.2575 0.2292 0.2042 0.1821 0.1625 0.1452 0.1299 0.1163 0.1042 0.0935 0.0550 14 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 0.2320 0.2046 0.1807 0.1597 0.1413 0.1252 0.1110 0.0985 0.0876 0.0779 0.0440 15 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 0.2090 0.1827 0.1599 0.1401 0.1229 0.1079 0.0949 0.0835 0.0736 0.0649 0.0352 16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 0.1883 0.1631 0.1415 0.1229 0.1069 0.0930 0.0811 0.0708 0.0618 0.0541 0.0281 17 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 0.1696 0.1456 0.1252 0.1078 0.0929 0.0802 0.0693 0.0600 0.0520 0.0451 0.0225 18 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 0.1528 0.1300 0.1108 0.0946 0.0808 0.0691 0.0592 0.0508 0.0437 0.0376 0.0180 19 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 0.1377 0.1161 0.0981 0.0829 0.0703 0.0596 0.0506 0.0431 0.0367 0.0313 0.0144 20 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784 0.1486 0.1240 0.1037 0.0868 0.0728 0.0611 0.0514 0.0433 0.0365 0.0308 0.0261 0.0115 25 0.7798 0.6095 0.4776 0.3751 0.2953 0.2330 0.1842 0.1460 0.1160 0.0923 0.0736 0.0588 0.0471 0.0378 0.0304 0.0245 0.0197 0.0160 0.0129 0.0105 0.0038 30 0.7419 0.5521 0.4120 0.3083 0.2314 0.1741 0.1314 0.0994 0.0754 0.0573 0.0437 0.0334 0.0256 0.0196 0.0151 0.0116 0.0090 0.0070 0.0054 0.0042 0.0012 40 0.6717 0.4529 0.3066 0.2083 0.1420 0.0972 0.0668 0.0460 0.0318 0.0221 0.0154 0.0107 0.0075 0.0053 0.0037 0.0026 0.0019 0.0013 0.0010 0.0007 0.0001 50 0.6080 0.3715 0.2281 0.1407 0.0872 0.0543 0.0339 0.0213 0.0134 0.0085 0.0054 0.0035 0.0022 0.0014 0.0009 0.0006 0.0004 0.0003 0.0002 0.0001 * 60 0.5504 0.3048 0.1697 0.0951 0.0535 0.0303 0.0173 0.0099 0.0057 0.0033 0.0019 0.0011 0.0007 0.0004 0.0002 0.0001 0.0001 * * * * 37

APPENDIX 2 Present value of a regular annuity of R1 per period for n periods : PVFA (k,n) = n i=1 = Number of 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Periods 1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8547 0.8475 0.8403 0.8333 2 1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591 1.7355 1.7125 1.6901 1.6681 1.6467 1.6257 1.6052 1.5852 1.5656 1.5465 1.5278 3 2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.5313 2.4869 2.4437 2.4018 2.3612 2.3216 2.2832 2.2459 2.2096 2.1743 2.1399 2.1065 4 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.2397 3.1699 3.1024 3.0373 2.9745 2.9137 2.8550 2.7982 2.7432 2.6901 2.6386 2.5887 5 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897 3.7908 3.6959 3.6048 3.5172 3.4331 3.3522 3.2743 3.1993 3.1272 3.0576 2.9906 6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.4859 4.3553 4.2305 4.1114 3.9975 3.8887 3.7845 3.6847 3.5892 3.4976 3.4098 3.3255 7 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.0330 4.8684 4.7122 4.5638 4.4226 4.2883 4.1604 4.0386 3.9224 3.8115 3.7057 3.6046 8 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348 5.3349 5.1461 4.9676 4.7988 4.6389 4.4873 4.3436 4.2072 4.0776 3.9544 3.8372 9 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952 5.7590 5.5370 5.3282 5.1317 4.9464 4.7716 4.6065 4.4506 4.3038 4.1633 4.0310 10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177 6.1446 5.8892 5.6502 5.4262 5.2161 5.0188 4.8332 4.6586 4.4941 4.3389 4.1925 11 10.3676 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.8052 6.4951 6.2065 5.9377 5.6869 5.4527 5.2337 5.0286 4.8364 4.6560 4.4865 4.3271 12 11.2551 10.5753 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607 6.8137 6.4924 6.1944 5.9176 5.6603 5.4206 5.1971 4.9884 4.7932 4.6105 4.4392 13 12.1337 11.3484 10.6350 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869 7.1034 6.7499 6.4235 6.1218 5.8424 5.5831 5.3423 5.1183 4.9095 4.7147 4.5327 14 13.0037 12.1062 11.2961 10.5631 9.8986 9.2950 8.7455 8.2442 7.7862 7.3667 6.9819 6.6282 6.3025 6.0021 5.7245 5.4675 5.2293 5.0081 4.8023 4.6106 15 13.8651 12.8493 11.9379 11.1184 10.3797 9.7122 9.1079 8.5595 8.0607 7.6061 7.1909 6.8109 6.4624 6.1422 5.8474 5.5755 5.3242 5.0916 4.8759 4.6755 16 14.7179 13.5777 12.5611 11.6523 10.8378 10.1059 9.4466 8.8514 8.3126 7.8237 7.3792 6.9740 6.6039 6.2651 5.9542 5.6685 5.4053 5.1624 4.9377 4.7296 17 15.5623 14.2919 13.1661 12.1657 11.2741 10.4773 9.7632 9.1216 8.5436 8.0216 7.5488 7.1196 6.7291 6.3729 6.0472 5.7487 5.4746 5.2223 4.9897 4.7746 18 16.3983 14.9920 13.7535 12.6593 11.6896 10.8276 10.0591 9.3719 8.7556 8.2014 7.7016 7.2497 6.8399 6.4674 6.1280 5.8178 5.5339 5.2732 5.0333 4.8122 19 17.2260 15.6785 14.3238 13.1339 12.0853 11.1581 10.3356 9.6036 8.9501 8.3649 7.8393 7.3658 6.9380 6.5504 6.1982 5.8775 5.5845 5.3162 5.0700 4.8435 20 18.0456 16.3514 14.8775 13.5903 12.4622 11.4699 10.5940 9.8181 9.1285 8.5136 7.9633 7.4694 7.0248 6.6231 6.2593 5.9288 5.6278 5.3527 5.1009 4.8696 25 22.0232 19.5235 17.4131 15.6221 14.0939 12.7834 11.6536 10.6748 9.8226 9.0770 8.4217 7.8431 7.3300 6.8729 6.4641 6.0971 5.7662 5.4669 5.1951 4.9476 30 25.8077 22.3965 19.6004 17.2920 15.3725 13.7648 12.4090 11.2578 10.2737 9.4269 8.6938 8.0552 7.4957 7.0027 6.5660 6.1772 5.8294 5.5168 5.2347 4.9789 40 32.8347 27.3555 23.1148 19.7928 17.1591 15.0463 13.3317 11.9246 10.7574 9.7791 8.9511 8.2438 7.6344 7.1050 6.6418 6.2335 5.8713 5.5482 5.2582 4.9966 50 39.1961 31.4236 25.7298 21.4822 18.2559 15.7619 13.8007 12.2335 10.9617 9.9148 9.0417 8.3045 7.6752 7.1327 6.6605 6.2463 5.8801 5.5541 5.2623 4.9995 60 44.9550 34.7609 27.6756 22.6235 18.9293 16.1614 14.0392 12.3766 11.0480 9.9672 9.0736 8.3240 7.6873 7.1401 6.6651 6.2402 5.8819 5.5553 5.2630 4.9999 38

TOPIC 1 ACCOUNTING INFORMATION AND MANAGERIAL DECISIONS 1.1 Customers: To assess the ability of the business to continue in business and satisfy the needs of customers. 1.2 Suppliers: To assess the ability of the business to pay for the goods and services provided. 1.3 Government: To assess the amount of tax the business should pay. 1.4 Owners: To assess how effectively the business is managed and to make judgements about likely levels of risk and return in the future. 1.5 Lenders: To assess the ability of the business to pay interest and the principal sum lent. 1.6 Employees: To assess the ability of the business to provide employment and to reward them for their labour. 1.7 Investment analysts: To assess the possible risks and returns associated with the business in order to determine its investment potential so that they could advise their clients accordingly. 1.8 Community representatives: To assess the ability of the business to continue to provide employment for the community and use community resources, to engage in corporate social responsibility projects etc. 1.9 Managers: To assist them in making decisions and plans for the business and to help them to exercise control to ensure that plans succeed. 2. The main duty of external auditors is to report to shareholders and others whether, in their opinion, the financial statements show a true and fair view, and comply with statutory, regulatory and accounting standard requirements. The role of internal auditors is to provide an independent appraisal function within an organisation to examine and evaluate its activities as a service to the organisation with the aim of assisting members of the organisation in the effective discharge of their responsibilities. 39

3. Management accounting Financial accounting User groups Internal users: Managers External: Owner(s); Lenders, Creditors; Investors Nature of reports Reports tend to be specific usually with some decision in mind. Reports tend to be general-purpose useful to a wide range of users. Legal requirements Management accounting reports are not required by law since they are for internal use only. Financial reports are required by law and are also regulated in terms of content and format. GAAP Management accounting reports are not subject to the practices and principles of GAAP (Generally Financial reports must conform to the practices and principles set by GAAP. Accepted Accounting Practice). Time focus The emphasis is on the future but also provides information on past It reflects on the financial result and financial position for the past period. performance. Nature of information Information used may be less objective and verifiable. Objective and verifiable information is needed to prepare reports. Frequency of reporting Reports are produced as often as required by managers even on a weekly basis. Reports are produced annually although some businesses prepare half-yearly or even quarterly reports. Focus on the whole or parts of the business Focuses on parts of the business e.g. a certain department as well as the business as a whole. Focuses on the performance of the business as a whole. 4. Managers will at times be interested in the historic overview of business operations of the sort provided to other users. Equally, other users would be interested in receiving information relating to the future e.g. profit forecasts, non-financial information such as product innovations. Etc 40

TOPIC 2 FINANCIAL STATEMENTS AND ACCOUNTING CONCEPTS 1. Due to the practice of adhering to the recognition of revenue concept, accrual concept and matching concept, revenue and expenses are not the same as cash received and cash paid and the net profit does not normally reflect the net cash flows for the period. Although making a profit will increase wealth, cash is only one form in which wealth may be held. Wealth may also be held in other forms such as inventory, land and buildings, equipment etc. 2. The net profit in the income statement also appears in the statement of changes in equity as an addition to retained earnings. The net profit also affects the retained earnings component of equity in the balance sheet. The statement of changes in equity and balance sheet are integrated. The retained earnings also appear as part of equity in the balance sheet. The balance sheet and the statement of cash flows are also integrated. The cash that appears in the balance sheet also appears as the end of the financial year cash in the statement of cash flows. 3. 3.1 Materiality The materiality principle urges one to disclose significant matters in the financial reports and to eliminate trivial details. What may be significantly material in one instance to warrant full disclosure may not justify complete reporting in another circumstance. For instance, an item involving R1 000 may be material enough to justify full disclosure for a small business, but would probably not justify disclosure as a separate item for a company as large as, say, Samsung. No objective test of materiality exists. Deciding what is material or not depends largely on management policy. 41

3.2 Conservatism This principle calls for a conservative approach on the part of the accountant in his/her estimations, opinions and selection of procedure. Losses should be recognized and reflected in the financial statements if a reasonable likelihood exists that they may occur. On the other hand, anticipated gains and other financial benefits should not be realized. A drawback of this principle is that it may make the business appear to be in a more unfavourable position than is actually the case. 4. 4.1 Going concern The balance sheet is prepared on the assumption that the entity will continue to operate in the future. If for example the entity is aware of its intention to liquidate, the amounts shown in the balance would now have to show the liquidation values. 4.2 Full disclosure Lack of full disclosure by not including all the necessary information in the balance sheet may result in its users being misled or making inappropriate decisions. For example certain explanations or notes about investments may be omitted. 4.3 Consistency This concept is important when making trend comparisons of the balance sheet for several years. For example, the change in the valuation method of inventories would make trend comparison difficult. 42

5. 5.1 Assets = Equity + Liabilities Equipment Inventory Receiv. Bank = Capital Income Expenses + Payables +50 000 +90 000-50 000 +90 000-4 000 +4 000-5 000 +10 000-5 000 +10 000 +50 000 +45 000 +90 000 +10 000-9 000 +4 000 5.2.1 Gwala Stores INCOME STATEMENT FOR THE MONTH ENDED 31 AUGUST 20.9 R Revenue 10 000 Expenses (9 000) Net profit 1 000 5.2.2 Gwala Stores STATEMENT OF CHANGES IN EQUITY FOR THE MONTH ENDED 31 AUGUST 20.9 Opening balance 0 Additional capital contributed 90 000 Net profit 1 000 Closing balance 91 000 43

5.2.3 Gwala Stores BALANCE SHEET AT 31 AUGUST 20.9 ASSETS Non-current assets: Property, plant and equipment 50 000 Current assets: Cash 45 000 Total assets 95 000 EQUITY AND LIABILITIES Equity 91 000 Current liabilities: Accounts payable 4 000 Total equity and liabilities 95 000 5.2.4 Gwala Stores STATEMENT OF CHANGES IN CASH FLOWS FOR THE MONTH ENDED 31 AUGUST 20.9 R Cash flows from operating activities 5 000 Net profit 1 000 Working capital changes Increase in accounts payable 4 000 Cash flows from investing activities (50 000) Purchase of plant, machinery and equipment (50 000) Cash flows from financing activities 90 000 Capital contributed 90 000 Net increase in cash for the year 45 000 Cash (opening balance) 0 Cash (closing balance) 45 000 44

TOPIC 3 ACCOUNTING FOR AND PRESENTATION OF ASSETS, LIABILITIES AND OWNERS EQUITY 1.1.1 NON-CURRENT ASSETS R Land and buildings 450 000 Plant and equipment 750 000 Less: Depreciation (200 000) 550 000 1 000 000 1.1.2 RETAINED EARNINGS R Balance (31 December 20.8) 0 Net profit 250 000 Dividends (220 000) Balance (31 December 20.9) 30 000 1.1.3 TOTAL OWNERS EQUITY R Ordinary share capital (900 000 + 400 000) 1 300 000 Share premium 200 000 Retained earnings 30 000 1 530 000 1.1.4 NON-CURRENT LIABILITIES R Mortgage bond (287 500 25 000) 262 500 Long-term loan (595 000 75 000) 520 000 782 500 45

1.2 The percentage cash discount, when converted to an annualised return on investment, can be a very attractive return. The creditworthiness of a company, when evaluated by credit rating agencies and credit grantors, is affected by its consistent use of cash discounts. Etc. 1.3 If Pixma Limited can borrow money at an interest rate of, say, 12% and use the money to purchase assets that realise a return that is greater than 12%, then the shareholders will get a greater return on investment than if they provided the funding. 1.4 1.4.1 Cheques must be signed by two persons. Payments should only be made when supported by authorized vouchers. Etc 1.4.2 Proper records must be kept of all stock received and issued. Requests for stock from the warehouse must be authorised. Security cameras may be installed. Etc 2. Four decisions *The cost of asset (e.g. whether to include interest charges or not) *The expected residual or disposal value of the asset *The expected useful life of the asset *The choice of the depreciation method *The percentage per annum Effect on reported profits Making different choices for the above matters will result in a different pattern of depreciation charges over the life of the asset and therefore a different pattern of reported profits. 46

3.1 FIFO will show the highest gross profit because sales are matched with the earlier (and cheaper) purchases. 3.2 LIFO will show the lowest gross profit because sales are matched with the more recent (costlier) purchases. 3.3 The AVCO method will usually give a figure which is between these two extremes. 3.4 The closing inventory figure in the balance sheet will be highest with the FIFO method. This is because the cost of inventory still held will be based on the more recent (and costlier) purchases. 3.5 The closing inventory figure in the balance sheet will be lowest with the LIFO method. This is because the cost of inventory still held will be based on the earlier (and cheaper) purchases. 3.6 The AVCO method will usually give a figure between these two extremes. 4. *The inventory is damaged or deteriorated. *The inventory is obsolete. *The market price of the inventory has fallen. *The inventory item is being used as a loss leader. 5. The effect would be to overstate the assets (debtors/accounts receivable) in the balance sheet and to overstate profit in the income statement as the loss/expense (which has been recognized) will not result in any future benefits. 6. 6.1 The amount owing by any customer is typically shown as an asset (accounts receivable). However, since the debtor is unable to pay, the item cannot provide future benefits and the R4 000 owing would not be regarded as an asset. 6.2 The hiring of a new marketing manager cannot be considered as an acquisition of an asset. One reason is that the business does not have exclusive rights of control over that manager (perhaps only to his/her services). Furthermore the value of the manager cannot be measured in monetary terms with any degree of reliability. 6.3 The machine can be considered as an asset even if it has not yet been paid for. Once the business has agreed to purchase the machine and has accepted it, the machine is legally owned by the business even if payment is still outstanding. 47

7. 7.1 Manhattan Ltd Balance Sheet at 30 November 20.9 ASSETS Non-current assets 565 000 Land and buildings 320 000 Plant and equipment 207 000 Motor vehicles 38 000 Current assets 338 000 Inventories 153 000 Accounts receivable 185 000 Total assets 903 000 EQUITY AND LIABILITIES Equity 441 000 Non-current liabilities 260 000 Loan from Kia Bank 260 000 Non-current liabilities 202 000 Accounts payable 86 000 Bank overdraft 116 000 Total equity and liabilities 903 000 7.2.1 The liquidity of the business Liquid assets amounting to R338 000 (R153 000+R185 000) is available to meet the short-term obligations of R202 000 (R86 000+R116 000). Whilst the liquid assets are greater, none of it is cash and furthermore it is not easy to convert inventories to cash at short notice. Also, a large amount is tied up in accounts receivable and if debtors do not abide by the credit terms and/or if credit terms are greater than 30 days, the business may experience liquidity problems. 48

7.2.2 The mix between current and non-current assets Current assets total R338 000 whilst the non-current assets equal R565 000. When too much of funds are tied up in non-current assets, the business could be vulnerable to business failure. This is because non-current assets are typically not easy to turn into cash in order to meet short-term debts. Converting many non-current assets into cash may lead to substantial losses as such assets are not always worth in the open market what the business paid for them or what they may be worth to the business. 7.2.3 The financial structure of the balance sheet The own capital (equity) is 1.70 times greater than the outside capital (long-term liability). However, the long-term liability of R260 000 brings with it the obligation to pay interest and make large capital repayments at regular intervals. 49

TOPIC 4 INCOME STATEMENT AND CASH FLOWS 1. Edgar Limited 1.1 Earnings per share = R77 000 X 100c 200 000 = 38.5 cents No. EPS has dropped by 6.5 cents. 1.2 R6 000 = 15% Loan balance = R6 000 X 100 15 = R40 000 1.3 Gross profit ratio = Gross profit X 100 Net sales = R263 200 X 100 R470 000 = 56% - Goods may have been sold below the normal selling price. - Monthly or seasonal sales may have been held. - Some goods may have been incorrectly priced (lower). 1.4 - Negotiate with suppliers for higher discounts, to reduce costs. - Seek alternative suppliers for better deals. - Use substitute materials but do not compromise quality. - Reduce administrative expenses by cutting down on overtime. - Pay off the loan as soon as possible to reduce interest expense. 50

2. MVP Ltd 2.1 Sales reflect the amount an enterprise earns by selling its products. It is revenue generated through the enterprise s primary operating activities. Other income is not directly related to the enterprise s primary operating activities. They are considered non-operating items and are reported separately on the income statement, example interest on investment. 2.2 Competition is one factor that will prevent it from doing so. The products must be also be priced at amounts that customers are willing to pay. 2.3 Cost of sales refers to the cost to the enterprise of goods sold to customers. It is an expense linked directly with the revenue generated through sales. Operating expenses are costs of resources incurred as part of operating activities that are not directly associated with specific goods. Other expenses are expenses not directly related to the enterprise s primary operating activities. They are considered non-operating items. 2.4 A separate disclosure is required as each item is relevant to various decision makers (concept of materiality). If they were grouped together it would diminish the ability of decision-makers to make important economic decisions. The separate listing also distinguishes expenses that result from the enterprise s primary operating activities. 2.5 The income statement of the previous year is not provided to enable one to make a comparison of the performance of the enterprise over the past year. Income statements of the previous years will enable users to do a trend analysis. 51

3. Afri Manufacturers Ltd The performance of the company in 20.9 appears lacklustre compared to 20.8. The profit after tax dropped from R37 100 to R28 000. Since profit is a function of turnover, let s examine the profits of both years in relation to their respective turnovers. The ratio of profit to sales (profit margin) for 20.9 was 2.79% whilst that of 20.8 was 4.12%. The previous year performance appears better. However, when one compares the profit margins achieved to the industry average, one finds that the company s performance in 20.8 was below the industry average of 4.51% whereas in 20.9 the performance was better than the industry (2.60%). Operating profit on sales decreased from 10.21% to 0.60%. Etc 4. Change in balance sheet items Inflow of cash Outflow of cash Increase in current assets other than cash Decrease in current assets other than cash Increase in non-current assets Decrease in non-current assets Increase in current liabilities Decrease in current liabilities Increase in non-current liabilities Decrease in non-current liabilities 5. Vuyo Limited 5.1 The operating activities the company yielded a positive inflow of funds of R100 000. It has sufficient funds to finance its day-to-day activities. 5.2 A debtor pays an amount owed. A bank loan is received. Additional capital is raised. Etc 52

5.3 Yes. It is a sign of both good performance and growth. The excess cash from operating activities is available for the purchase of plant and equipment. The value of the company increases as it grows. As the company expands by purchasing additional assets, more products are produced and sold, which in turn improves profitability and operating cash flows. 6. Mega Ltd 6.1 Cash flows from operating and investing activities were used to redeem longterm borrowings. 6.2 Depreciation expense does not require the payment of cash (non-cash item) and is thus added to profit to determine cash flows. An increase in payables implies that resources have been used but payment has not been made. Increase in payables is added to profit to calculate operating cash flow. 6.3 The indirect method is used. The indirect method explains cash flows from operating activities by explaining the change in each of the non-cash operating accounts in the balance sheet. The direct method explains how much cash was received or paid during the year for each item reported. It thus reflects (as operating activities) cash received from customers, cash paid to merchandise suppliers, cash paid to employees and cash paid for operating expenses. 6.4 The company does not appear to be performing well. Its cash flow from operations (R33 980) is significantly lower that it s operating profit (R61 047). The increase in merchandise suggests that the company was not selling the inventory it was purchasing fast enough. The increase in receivables suggests that the company was experiencing difficulty in collecting from its customers. The increase in payables implies that the company was having difficulty in paying its suppliers. 53

The sale of plant and equipment to generate cash is a sign of poor financial performance. The cash from operating activities was inadequate to meet its obligations resulting in the sale of assets to raise cash. In the long-term the company cannot continue selling assets to repay debt. 7. Siya Limited s operations appear to be quite profitable (Cash generated from operating activities is R270 000). The company appears to be on an expansion spree. The company s expansion is most likely funded by the issue of shares (R750 000) and the divestment of non-current investment (R250 000) although funds were available from operations (R270 000) and long term borrowings (R50 000). The company seems to be building up a large cash balance. One needs to explore the reasons for increasing the cash balance. 54

8. Asic Ltd CASH FLOW STATEMENT FOR THE YEAR ENDED 31 DECEMBER 20.6 R Cash flows from operating activities 200 715 Profit before interest and tax (Operating profit) (a) 201 000 Adjustments to convert to cash from operations Non-cash flow adjustments 102 000 Add: Depreciation (b) 81 000 Loss on disposal of asset (c) 21 000 Profit before working capital changes 303 000 Working capital changes (2 640) Increase in inventory (d) (990) Decrease in receivables (e) 14 970 Decrease in payables (f) (16 620) Cash generated from operations 300 360 Interest paid (g) (3 900) Investment income (h) 24 600 Dividends paid (i) (57 750) Income tax paid (j) (62 595) Cash flow from investing activities (240 015) Investment in listed shares (k) Investment in subsidiary company (l) Non-current assets purchased (m) Proceeds from sale of equipment (n) (21 525) (25 500) (209 490) 16 500 Cash flow from financing activities 45 000 Proceeds from issue of ordinary shares (o) 150 000 Long-term borrowings redeemed (p) (105 000) Net increase in cash and cash equivalents 5 700 Cash and cash equivalents at beginning of year (q) (7 500) Cash and cash equivalents at end of year (r) (1 800) 55

(a) Calculations and explanatory notes: Profit before interest and tax This amount is obtained from the Income statement (operating profit). (b) Depreciation The amount is obtained from the Income statement. (c) Loss on disposal of asset The amount is obtained from the Income statement. (d) Increase in inventory The increase is calculated by comparing the inventory figures for both years: R120 690 R119 700 = R990 (The amount is bracketed as it represents a use of cash.) (e) Decrease in receivables The decrease is calculated by comparing the Trade and other receivables figures for both years: R82 305 R67 335 = R14 970 (The amount represents a source of cash.) (f) Decrease in payables The decrease is calculated by comparing the Trade and other payables figures for both years: R59 805 R43 185 = R16 620 (The amount is bracketed as it represents a use of cash.) (g) Interest paid The amount is obtained from the Income statement. (h) Investment income The amount is obtained from the Income statement. 56

(i) Dividends paid The amount paid is calculated as follows: Dividends due on 31 December 20.5 (39 000) Dividends for the year (69 450) Dividends due on 31 December 20.6 50 700 (57 750) Note: Dividends due on 31 December 20.5/20.6 is obtained from the item Shareholders for dividends in the Balance sheet. Dividends for the year are obtained from the Statement of changes in equity: R13 200 + R21 000 + R35 250 = R69 450 (j) Income tax paid The amount paid is calculated as follows: Income tax due on 31 December 20.5 (30 000) Income tax for the year (77 595) Income tax due on 31 December 20.6 45 000 (62 595) Note: Income tax due on 31 December 20.5/20.6 is obtained from the item South African Revenue Services in the Balance sheet. Income tax for the year is obtained from the Income statement. (k) Investment in listed shares The amount is calculated by comparing the figures for Investment Listed shares (in the Balance sheet) for both years: R120 000 R98 475= R21 525 (The amount is bracketed as it represents a use of cash.) 57

(l) Investment in subsidiary company The amount is calculated by comparing the figures for Investment Subsidiary company (in the Balance sheet) for both years: R85 500 R60 000= R25 500 (The amount is bracketed as it represents a use of cash.) (m) Non-current assets purchased The amount is obtained by using the figures for both years for Land and buildings and Equipment in the Balance sheet and after consideration was given to the additional information: Land and buildings purchased: R462 000 R346 500 = R115 500 Equipment purchase is calculated as follows: Carrying value of equipment on 31 December 20.5 143 100 Additions (Purchase of equipment) *93 990 Disposals at carrying value (Cost R39 750 Acc. dep. R2 250) (37 500) Depreciation (R45 000 R2 250) (R82 500) (39 750) Carrying value of equipment on 31 December 20.6 159 840 *Purchase of equipment is calculated as follows: (R143 100 R37 500 R39 750) (R159 840) = R93 990 Non-current assets purchased = R115 500 + R93 990 = R209 490 (n) Proceeds from sale of equipment The amount is calculated by using figures from the Income statement (Loss on sale of equipment) and after consideration was given to the additional information: Carrying value of equipment sold is : Cost R39 750 Acc. dep. R2 250 = R37 500 However, the equipment was sold at a loss of R21 000. Therefore the proceeds from the sale of equipment is R16 500 (R37 500 R21 000). (o) Proceeds from issue of ordinary shares The amount is obtained from the Statement of changes in equity. 58

(p) Long-term borrowings redeemed The amount is obtained by comparing the figures for both years for 13% Debentures (Long-term borrowings) in the Balance sheet: R135 000 R30 000 = R105 000 (The amount is bracketed as it represents a use of cash.) (q) Cash and cash equivalents at beginning of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.5: Cash and cash equivalents 1 500 Bank overdraft (9 000) Net unfavourable balance (7 500) (r) Cash and cash equivalents at end of year This is calculated by using the figures for Cash and cash equivalents and Bank overdraft as at 31 December 20.6: Cash and cash equivalents 900 Bank overdraft (2 700) Net unfavourable balance (1 800) Other calculations Profit before working capital changes R201 000 + R102 000 = R303 000 Cash generated from operations: R303 000 R2 640 = R300 360 Cash flows from operating activities: R300 360 R3 900 + R24 600 R57 750 R62 595 = R200 715 Net increase in cash and cash equivalents This amount can be calculated by comparing the cash balances of 20.5 and 20.6 i.e. a net unfavourable balance of R7 500 (20.5) turned into a net unfavourable balance of R1 800 (20.6) resulting in a net increase in cash and cash equivalents of R5 700. The net increase can be verified as follows: R200 715 R240 015 + R45 000 = R5 700 59

TOPIC 5 FINANCIAL ANALYSIS 1.1 20.10 20.9 Gross margin = Gross profit X 100 Gross margin = Gross profit X 100 Sales 1 Sales 1 = R5 831 400 X 100 = R3 379 300 X 100 R32 011 500 1 R19 373 000 1 = 18.22% = 17.44% 20.10 20.9 Operating margin Operating margin = Operating profit X 100 = Operating profit X 100 Sales 1 Sales 1 = R1 931 200 X 100 = R1 327 800 X 100 R32 011 500 1 R19 373 000 1 = 6.03% = 6.85% 20.10 20.9 Profit margin Profit margin = Net profit after tax X 100 = Net profit after tax X 100 Sales 1 Sales 1 = R1 373 550 X 100 = R919 820 X 100 R32 011 500 1 R19 373 000 1 = 4.29% = 4.75% 1.2 Gross margin has increased marginally while operating margin and profit margin showed a slight decrease. The cost of sales is high in relation to sales. It thus appears that Zebcom Enterprises is operating on very low profit margins. Operating expenses does appear to be high as there is a large difference between the gross margin and profit margin. 60

1.3 20.10 20.9 Current ratio Current ratio = Current assets = Current assets Current liabilities Current liabilities = R2 866 530 = R4 974 530 R1 088 860 R588 310 = 2.63:1 = 8.46:1 20.10 20.9 Acid test ratio Acid test ratio = Current assets Inventory = Current assets Inventories Current liabilities Current liabilities = R2 866 530 R1 482 200 = R4 974 530 R2 038 860 R1 088 860 R588 310 = 1.27:1 = 4.99:1 The liquidity has deteriorated considerably from the previous year. However, one could say that high liquidity ratios for 20.9 may point towards slack management in respect of the inventories and idle cash. The ratios for 20.10 have dropped to more acceptable levels. 1.4 20.10 Inventory turnover = Cost of sales Average inventory = R26 180 100 R1 760 530 = 14.87 times N.B. Average inventory = (R1 482 200 + R2 038 860) 2 = R1 760 530 61

20.10 Debtor collection period = Accounts receivable X 365 Credit sales = R261 290 X 365 R3 201 150 = 29.79 days 20.10 Creditor payment period = Accounts payable X 365 Credit purchases = R190 660 X 365 R2 562 344 = 27.16 days Note: Credit purchases are calculated as follows: R Cost of sales 26 180 100 Add: Closing inventory 1 482 200 27 662 300 Less opening inventory (2 038 860) Total purchases 25 623 440 Credit purchases = 10% of R25 623 440 = R2 562 344 62

20.10 Turnover to net assets Sales Net assets = R32 011 500 R8 066 530 R1 088 860 = R32 011 500 R6 977 670 = 4.59:1 1.5 Inventory turnover has increased from 9.04 times to 14.87 times per annum suggesting that the enterprise sold inventory at a faster rate. Debtors collections seem to be good with the outstanding debt expected to be collected within 30 days. Creditors accounts are being settled earlier than the previous year and the enterprise should not settle accounts earlier than required unless a discount for early settlement is forthcoming. The sales generated by each rand of net assets have increased greatly from R2.13 to R4.59. This also indicates that the net assets required to support a level of sales have decreased. 2.1 Vuyo Traders Sipho Stores Return on assets Return on assets = Operating profit X 100 = Operating profit X 100 Total assets 1 Total assets 1 = R400 000 X 100 = R420 000 X 100 R1 000 000 1 R1 500 000 1 = 40% = 28% N.B. Total assets = R200 000 + R800 000 = R1 000 000 (Vuyo Traders) Total assets = R1 200 000 + R300 000 = R1 500 000 (Sipho Stores) 63

2.2 Vuyo Traders Return on equity = Profit after tax X 100 Owners equity 1 = R120 000 X 100 R800 000 1 = 15% Sipho Stores Return on equity = Profit after tax X 100 Owners equity 1 = R140 000 X 100 R300 000 1 = 46.67% 2.3 Sipho Stores. It achieved a return of 46.67% compared to Vuyo Traders return of 15%. 2.4 Yes. A 40% return is greater than the cost of borrowing funds (10%). It is also greater than the inflation rate and the return that one could get from alternative investments e.g. fixed deposits. 3.1 20.10 Debt to assets = Total debt X 100 Total assets 1 = R800 000 X 100 R2 000 000 1 = 40% 64

20.10 Debt to equity = Non-current debt X 100 Owners equity 1 = R600 000 X 100 R1 200 000 1 = 50% N.B. Owners equity = R2 000 000 R600 000 R200 000= R1 200 000 20.10 Interest coverage = Operating profit Interest expense = R500 000 R120 000 = 4.17 times 3.2 The debt to assets ratio indicates that 40% of Mestle Wholesalers assets come from borrowed funds. The debt to equity ratio indicates that the creditors supply Mestle Wholesalers with 50 cents for every Rand supplied by the owners. Mestle Wholesalers earned its interest obligations 4.17 times over in 20.10; or one could say that profit before interest and tax was 4.17 times as large as interest. The business can therefore meet its interest obligations 65

4.1 Return on equity = Profit after tax X 100 Owners equity 1 = R10 000 000 X 100 R118 000 000 1 = 8.47% Earnings per share = Net profit after tax Number of ordinary shares issued = R10 000 000 X 100 40 000 000 = 25 cents Dividend per share = Dividends for the year Number of ordinary shares issued = R2 000 000 X 100 40 000 000 = 5 cents Earnings retention ratio = Earnings per share Dividend per share X 100 Earnings per share 1 = 25 cents 5 cents X 100 25 cents 1 = 20 cents 25 cents = 80% OR 66

Earnings retention ratio = Retained earnings for the year X 100 Profit due to ordinary shareholders 1 = R10 000 000 R2 000 000 X 100 R10 000 000 1 = R8 000 000 X 100 R10 000 000 1 = 80% 20.9 Price earnings ratio = Market price per share Earnings per share = 400 cents 25 cents = 16 times 4.2 Return on equity has decreased slightly (from 10.04% to 8.47%). A comparison with alternative investments of a similar risk would indicate whether the profitability is low or not. Earnings per share remained stable and there was a slight drop in the dividends per share. The company retains a high percentage of the net profit (over 80%) which may not please all shareholders. The price earnings ratio has increased from (15 to 16 times) indicating greater investor confidence in the company. Investors are willing to pay 16 times earnings for the shares. 67

TOPIC 6 COST-VOLUME-PROFIT (CVP) RELATIONSHIPS 1. 1.1 Per unit x Volume = Total % Sales Variable costs 20.00 7.50 2 500 2 500 50 000 18 750 Contribution margin 12.50 x 2 500 = 31 250 62.5% Fixed costs 12 500 Operating profit 18 750 1.2 Contribution margin and operating profit will increase by R6 250 (R10 000 X 62.5%). 1.3 Contribution margin must increase by the same amount if operating profit was to remain the same. Sales must increase by R4 800 (R3 000 62.5%). 1.4 Yes. The increase in contribution margin would be R6 250 (R10 000 X 62.5%) which is R1 250 more than the cost of the advertising (R5 000). 1.5 Per unit x Volume = Total % Sales Variable costs 20.00 7.50 Contribution margin 12.50 x 2 600 = 32 500 62.5% Fixed costs 12 500 Operating profit 20 000 Work to the middle to obtain the required sales volume (R32 500 R12.50 = 2 600 units) 68

OR 1.5 Target sales volume = = = Fixed costs + Target profit Contribution margin per unit R12 500 + R20 000 R12.50 2 600 units 1.6 Per unit x Volume = Total Sales Variable costs 18.00 7.50 Contribution margin 10.50 x 2 700 = 28 350 Fixed costs 12 500 Operating profit 15 850 No. They should reject the proposal. Contribution margin and operating profit will decrease by R2 900. 1.7 Per unit x Volume = Total Sales Variable costs 16.00 7.50 Contribution margin 8.50 x 5 000 = 42 500 Fixed costs 20 500 Operating profit 22 000 Yes. Operating profit increases from R18 750 to R22 000 i.e. by R3 250. 69

2. Per unit x Volume = Total Sales Variable costs 12 5 Contribution margin 7 x 137 143 = 960 000 Fixed costs 700 000 Operating profit 260 000 Work to the middle to obtain the required sales volume (R960 000 R7 = 137 143 units) OR 2. Target sales volume = Fixed costs + Target profit Contribution margin per unit = = R700 000 + R260 000 R7.00 137 143 units 3. Workings Per unit x Volume = Total Sales R70 350 24 500 Variable costs R45 Contribution margin R25 x 350 = R8 750 Fixed costs (5 000) Operating profit R3 750 Note: Variable costs include material cost of R20 per unit and labour cost of R25 per unit (R12.50 X 2 hours). 70

3.1 Break even quantity = Fixed costs Contribution margin per unit = = R5 000 R25 200 units 3.2 It makes it possible to compare the expected volume of activity (350 units) with the break-even point (200 units) and so make a judgement about risk. Planning to operate slightly above the break-even point is risky as a small drop in volume of activity could lead to loss. 3.3 Workings Per unit x Volume = Total Sales R70 350 24 500 Variable costs R32.50 Contribution margin R37.50 x 350 = R13 125 Fixed costs (9 375) Operating profit R3 750 Note: Variable costs include material cost of R20 per unit and labour cost of R12.50 per unit (R12.50 X 1 hour). 3.3.1 Break even quantity = Fixed costs Contribution margin per unit = = R9 375 R37,50 250 units 71

3.3.2 With both options, a profit of R3 750 is expected. However, the break-even point differs. Without the machine, the actual volume of sales could drop by 43.86% (from 350 to 200) before the business will fail to make a profit. With the machine a 28.67% drop in sales (from 350 to 250) would be enough to cause the business to fail to make a profit. On the other hand, for each additional pair of sandals above the expected 350, an additional profit of only R25 would be made without the machine whereas R37.50 would be made with the machine. 3.3.3 Without the machine With the machine Margin of safety = 350 200 = 150 units 350 250 = 100 units The option of not renting the machine might be preferable since the margin of safety between the expected volume of activity and the break-even point is greater. For the same level of activity, the risk will be lower without renting the machine. However, ones attitude towards risk is important. As pointed out previously, sales above 350 units mean a higher profit per unit with the use of the machine. 72

4. Workings -Gnome Per unit x Volume = Total % Sales Variable costs 60 36 120 000 72 000 Contribution margin 24 x 2 000 = 48 000 40% Fixed costs 15 000 Operating profit R33 000 Workings Humpty Per unit x Volume = Total % Sales Variable costs 60 24 120 000 48 000 Contribution margin 36 x 2 000 = 72 000 60% Fixed costs 30 000 Operating profit R42 000 4.1 Gnome Total revenues at break even = = = Total fixed cost Contribution margin ratio R15 000 40% R37 500 73

Humpty Total revenues at break even = = = Total fixed cost Contribution margin ratio R30 000 60% R50 000 Note: Alternative method is to calculate break even quantity and then multiply by selling price per unit. 4.2 Gnome Operating leverage = Contribution margin Operating profit = R48 000 R33 000 = 1.45:1 Humpty Operating leverage = Contribution margin Operating profit = R72 000 R42 000 = 1.71:1 The above calculations show that Humpty Manufacturers has a higher operating leverage. 4.3 Humpty Manufacturers has a higher operating leverage. Suppose that its sales drop by 10%. Let us see by what percentage operating profit will fall. 74

R Sales (1 800 X R60) Variable costs (1 800 X R24) 108 000 (43 200) Contribution margin 64 800 Fixed costs 30 000 Operating profit 34 800 Operating profit dropped from R42 000 to R34 800, a percentage decrease of 17.14%. One can therefore see that the consequence of a small drop in sales is a relatively larger percentage decrease in operating profit. 4.4 Gnome Margin of safety = Sales Break even sales X 100 Sales = R120 000 R37 500 X 100 R120 000 = 68.75% Humpty Margin of safety = Sales Break even sales X 100 Sales = R120 000 R50 000 X 100 R120 000 = 58.33% 75

5. A B C (R) (R) (R) Sales 12.00 10.80 10.80 Variable cost 6.60 5.40 5.40 Marginal income 5.40 5.40 5.40 Fixed cost 96 000 66 000 78 000 PROPOSAL A Break-even quantity = Total fixed cost Marginal income per unit = = R96 000 R5.40 17 778 units PROPOSAL B Break-even quantity = Total fixed cost Marginal income per unit = = R66 000 R5.40 12 222 units PROPOSAL C Break-even quantity = Total fixed cost Marginal income per unit = = R78 000 R5.40 14 444 units 76

TOPIC 7 COST ANALYSIS FOR PLANNING, CONTROL AND DECISION-MAKING BUDGETING 1. A budget is a planning device as it guides executives to anticipate the influence and impact of a given set of events on the firm s business and its resources. A budget also serves as an effective tool for managerial control by providing a proper yardstick for the evaluation of actual performance. Etc. 2. Quantity required to meet projected sales. Opening and closing levels of inventories. Maximum production capacity of the firm. Available storage facilities. Amount of investment required. Etc. 3. Sales budget Product November December January Product X Product Y Units/price 3 000@R20 4 000@R30 R 60 000 120 000 Units/price 4 500@R20 6 000@R30 R 90 000 180 000 Units/price 4 000@R20 5 000@R30 R 80 000 150 000 180 000 270 000 230 000 4. Production budget April May Sales forecast (in units) Desired closing inventory of finished goods 1 200 50 1 000 45 Total budgeted production needs Opening inventory of finished goods 1 250 (60) 1 045 (50) Required production 1 190 995 77

5. Problems: The company will not be able to achieve the requirement of settling the overdraft by the end of October. Although the initial overdraft is expected to be eliminated in June, a study of the closing cash balance each month thereafter suggests that the cash balance is expected to get worse each month. Except for the first 2 months, a cash shortfall is expected for the rest of the budgeted period. The company expects a decline in sales each month from July to October. Dealing with the problems: The shop refurbishment could be postponed. The company could obtain funds from the shareholders or other investors. It may try to stimulate sales in some way. Ways could be found to reduce overhead expenses. Sales were declining, yet selling expenses are high investigate this. 6.1 Raw material usage variance (Actual quantity Standard Quantity) X Standard price = (20 050 20 000) X R5 = R250 (unfavourable) Possible reasons for the variance: Poor control over materials Faulty standards Changes in the quality of material supplied Etc 6.2 Direct labour rate variance (Actual rate Standard rate) X Actual hours = (R48 R50) X 39 500 = R79 000 (favourable) 78

6.3 Direct labour efficiency variance (Actual time worked Standard time allowed) X Standard rate = (39 500 hrs 40 000 hrs) X R50 = R25 000 (favourable) 6.4 Variable overhead efficiency variance (Actual hours Standard hours) X Standard rate = (39 500 40 000) X R11 = R5 500 (favourable) 7.1 Fixed overhead spending variance Actual fixed overheads Budgeted fixed overheads = R79 808 R76 800 = R3 008 (unfavourable) 7.2 Fixed overhead volume variance Budgeted fixed overheads Standard fixed overheads = R76 800 (1 680 units X 4 hrs X R12) = R76 800 R80 640 = R3 840 (favourable) Note: Standard fixed overheads = Number of units produced X Standard time to make 1 product X Standard rate per hr Standard time to make 1 product = 6 400 hrs 1 600 units = 4 hours Standard rate per hour = Standard fixed overheads standard number of labour hrs = R76 800 6 400 = R12 79

7.3 Variable overhead efficiency variance (Actual hours Standard hours) X Standard rate = (6 880 6 720) X R5 = R800 (unfavourable) Note Standard hours = Number of units produced X Standard time to make 1 product = 1 680 X 4 hours = R6 720 Standard rate = R32 000 6 400 hours = R5 Possible reasons for the variance: Absenteeism Efficiency of employees Working conditions Etc 8.1 R Sales (8 000 000 X R12) 96 000 000 Variable costs (8 000 000 X R9) (72 000 000) Contribution margin 24 000 000 Fixed costs (4 656 000) Operating profit 19 344 000 8.2 R Differential revenue from accepting the offer (2 000 000 X R8.90) 17 800 000 Differential cost by accepting the offer (2 000 000 X [R9 R0.50]) (17 000 000) Differential profit from accepting the offer 800 000 Accept the offer as a differential profit of R800 000 is expected. 80

9. A comparison of the sales offer of R42 with the selling price of R63 indicates that the offer should be rejected. However, Femino Enterprises has excess capacity and one should focus on the relevant cost, which in this case is the variable cost. The differential profit from accepting the offer is calculated as follows: Differential revenue from accepting the offer: 6 000 units @ R42 R252 000 Differential cost by accepting the offer: 6 000 units @ R30 (R15+R9+R6) (R180 000) Differential profit from accepting the offer. R72 000 The offer should therefore be accepted. 10. 10.1 The relevant cost of internal production of each component is: Variable cost of production of the component R15 Opportunity cost of lost production of the other product R12 R27 It is obviously more costly (R27) than the R20 per component which will have to be paid to the subcontractor. Dubai Ltd should therefore subcontract the component. 10.2 Loss of control of quality Potential unreliability of supply Etc. 11. The relevant cost is the variable cost per unit which is calculated as follow: R Direct Material 866 000 Labour and other variable costs 844 000 Total variable costs 1 710 000 Number of units produced 8 500 81

Variable cost per unit (R1 710 000 8 500) R201.18 The variable cost of making the component (R201.18) is cheaper than buying it (R210). Trike Enterprises should therefore make the component in its plant. 12.1 Project A Investment (920 000) Year 1 Cash flow 400 000 (520 000) Year 2 Cash flow 280 000 (240 000) Year 3 Cash flow 200 000 (40 000) Year 4 cash flow 200 000 Payback period is 3 years 3months Note: R40 000_ X 12 mths R200 000 = 2.4 months 12.2 Accounting rate of return (Project A) = Average annual profit X 100 Average investment 1 = R104 000 X 100 R420 000 1 = 24.76% Note: Depreciation = R800 000 R40 000 5 = R760 000 5 = R152 000 per year 82

Calculation of accounting profit Cash flow Depreciation/Scrap value = Accounting profit 320 000 280 000 260 000 240 000 220 000 (152 000) (152 000) (152 000) (152 000) (152 000) *(40 000) R168 000 128 000 108 000 88 000 28 000 R520 000 *(40 000) is scrap value Average annual profit = R520 000 5 years = R104 000 12.3 Project A Year Cash inflow Discount Factor Present value 1 2 3 4 5 320 000 280 000 260 000 240 000 220 000 0.8929 0.7972 0.7118 0.6355 0.5674 285 728 223 216 185 068 152 520 124 828 Total PV 971 360 Investment (800 000) NPV (positive) 171 360 12.4 Yes. ARR is higher than the cost of capital. NPV is positive. 83

13. 13.1 Project Turbo Year Cash inflow Discount Factor 1 0 0,8929 2 R27 750 0.7972 3 R54 300 0,7118 4 R184 500 0,6355 Total PV Investment NPV (positive) Present Value 0 R22 122 R38 651 R117 250 R178 023 (R176 550) R1 473 Project Gusto Net inflow Discount factor Total Present value Investment NPV (negative) R54 000 X 3,0373 R164 014 (R176 550) (R12 536) Project Turbo should be chosen since the NPV is positive. The NPV for project Gusto is negative and is therefore rejected. 84

13.2 Project Turbo Step 1 We notice that the NPV is positive, and above zero, but not by a large margin. Step 2 We now pick a higher rate e.g. 13%. (Trial-and-error is used to obtain the higher rate.) Year 1 2 3 4 Total PV Investment NPV Cash inflow 0 R27 750 R54 300 R184 500 Discount Factor 12% 0,8929 0.7972 0,7118 0,6355 Project Turbo Discount Factor 13% 0,8850 0,7831 0,6931 0,6133 Present value 12% 0 R22 122 R38 651 R117 250 R178 023 (R176 550) R1 473 Present value 13% 0 R21 731 R37 635 R113 154 R172 520 (R176 550) (R4 030) Step 3 Interpolation: The IRR is between 12% and 13%. IRR = 12% + 1 473 1 473 + 4 030 = 12% + 1 473 5 503 = 12.27% 85

Project Gusto Step 1 We notice that the NPV is negative. Step 2 We now pick a lower rate e.g. 10%. (Trial-and-error is used to obtain the higher rate.) Year 1-4 Cash inflow p.a. Disc. Factor 10% Disc. Factor 9% Disc. Factor 8% Present value 10% R54 000 3,1699 3,2397 3,3121 171 175 Present value 9% 174 944 Present value 8% 178 853 Investment 176 550 176 550 176 550 NPV (R5 375) (R1 606) R2 303 Step 3 Interpolation: The IRR is between 8% and 9%. IRR = 8% + 2 303 1 606 + 2 303 = 8% + 2 303 3 909 = 8.59% Decision: Project Turbo should be chosen as the IRR is greater. 86

14. 14.1 Payback period (Project F) Investment (140 000) Year 1 Cash flow 30 000 (110 000) Year 2 Cash flow 36 000 (74 000) Year 3 Cash flow 40 000 (34 000) Year 4 Cash flow 44 000 Payback period is 3 years 10 months Note: R34 000 X 12 mths R44 000 = 9.27 months 14.2 Accounting rate of return (Project F) = Average annual profit X 100 Average investment = R7 200 X 100 R80 000 = 9% Note: Depreciation = R140 000 R20 000 5 = R120 000 5 = R24 000 per year 87

Calculation of accounting profit Cash flow Depreciation/Scrap value 30 000 (24 000) 36 000 (24 000) 40 000 (24 000) 44 000 (24 000) 26 000 (24 000) *(20 000) *(20 000) is scrap value = Accounting profit R6 000 12 000 16 000 20 000 (18 000) R36 000 Average annual profit = R36 000 5 years = R7 200 Average investment = [140 000+20 000] 2 = R80 000 14.3 Project F Year Cash inflow Discount Factor Present value 1 2 3 4 5 30 000 36 000 40 000 44 000 26 000 0.8772 0.7695 0.6750 0.5921 0.5194 26 316 27 702 27 000 26 052 13 504 Total PV 120 574 Investment (140 000) NPV (negative) (19 426) 88

Project G Year Cash inflow Discount Factor Present value 1 2 3 4 40 000 50 000 50 000 80 000 0.8772 0.7695 0.6750 0.5921 35 088 38 475 33 750 47 368 Total PV 154 681 Investment (150 000) NPV (positive) 4 681 14.4 Choose project G. The NPV is positive. 15. Use trial and error method Year 1-5 Investment NPV Cash inflow p.a. Discount Factor 13% Discount Factor 14% Present value 13% R40 000 3.5172 3.4331 140 688 140 000 R688 Present value 14% 137 324 140 000 (R2 676) IRR = 13% + 688 688 + 2 676 = 13% + 688 3 364 = 13.20% 89

TOPIC 8 TRANSFER PRICING FOR DECENTRALISED ENTERPRISES 1. These are the actual prices that the supplying division sells the product to external clients for or they may the prices a competitor is offering. If a perfectly competitive market exists, the current market price is the most suitable basis for setting the transfer price. The supply of transfer goods at market prices usually results in optimal profits for the entire enterprise. In a perfectly competitive market, the supplying division should supply as much as is required by the receiving division at the current market price. If the receiving division s demand is greater then the supplying division can meet, additional supplies must be obtained from an outside supplier at market price. If the supplying division cannot sustain a profit in the long term at the current outside market price, then the enterprise will be better off not producing the product internally. It should rather purchase from outside suppliers 2. 2.1 Negotiated prices is suited to circumstances where there is an external market for the goods supplied by the buying and selling divisions and where divisional managers are free to accept or reject offers made by other divisions. Negotiated transfer prices are also appropriate when there are market imperfections for the product. 2.2 By not being able to sell outside the enterprise, the selling division is likely to be in a weak bargaining position and the transfer price may result in an under-par divisional performance. The inability of the manager of the selling division to negotiate with authority would affect the division s profitability negatively. 90

3. 3.1 The transfer price of product Alpha using the variable cost method would be R8. 3.2 Variable cost per unit R8.00 Fixed cost per unit R2.00 Total cost R10.00 Profit (12%) R1.20 Transfer price R11.20 3.3 Using variable cost method Transfer price R8.00 Variable cost per unit R15.00 Fixed cost per unit R7.00 Total cost R30.00 Profit (12%) R3.60 Selling price R33.60 Using cost plus method Transfer price R11.20 Variable cost per unit R15.00 Fixed cost per unit R7.00 Total cost R33.20 Profit (12%) R3.98 Selling price R37.18 3.4 The biggest problem with this method is that the receiving division will generate a profit at the expense of the supplying division. Quite often supplying divisions are reluctant to transfer their products at variable costs. Another problem is that variable cost per unit may not be constant over the entire range of output as increases may occur. Where the division is operating at full capacity, variable cost transfers will mean that inter-divisional sales will be less profitable than sales to external customers. 91

TOPIC 9 CORPORATE GOVERNANCE 1. Yes. Directors often abused their powers with regard to the duration of their contracts. Directors remained in their posts even though company performance was poor. Etc or No. Directors want job security. May lead to instability in the company. Etc 2. Good corporate governance requires that the board takes responsibility for creating and sustaining an ethical corporate culture in the company. The establishment and maintenance of an ethical corporate culture requires the governance of ethics, that is, that the board should ensure that the company has a well designed and properly implemented ethics management process consisting of the following four aspects: Ethics risk and opportunity profile: The board should ensure that an ethics risk profile is compiled, reflecting the company's negative ethics risks (threats) as well as its positive ethics risk (opportunities). Code of ethics: The board should ensure that a company code of ethics is developed, stipulating the ethical values or standards as well as more specific guidelines guiding the company in its internal and external stakeholders. Integrating ethics: The board should ensure that the company's ethical standards (code of ethics and related ethics policies) are integrated into the company's strategies and operations. This requires, among others, ethical leadership, management practices, structures and offices, education and training, communication and advice, and prevention and detection of misconduct for example, through whistle-blowing. 92

Ethics performance reporting and disclosure: The board should assess the company's ethics performance, and report and disclose findings to internal and external stakeholders. An ethical corporate culture will require that: -ethical practices for directors is a non-negotiable requirement; -the stewardship of a director is firstly towards the company and its shareholders. -sound moral values and ethics are propagated by the conduct of individuals; -the effectiveness of free enterprise and the market economy demands responsibility and it is important that business activity is directed by people with integrity, fairness and vision; -because fair competition is fundamental to the free enterprise system directors support laws regulating restraints of trade, unfair practices, abuse or the unscrupulous use of economic power and avoidance of collusion; and -ethics can never become an excuse for poor performance 3. The board should ensure that the company, as a responsible corporate citizen, does not undermine the sustainability of its social and natural environments, but rather protects and enhances them. Responsible corporate citizenship is necessary to protect the sustainability of the company and to ensure the ability of future generations to meet their needs. The interests of shareholders and stakeholders coincide over the long term. 4. Internal audit plays an important role in providing assurance to the management and the board regarding the effectiveness of internal controls. The board should ensure that assurance of internal control procedures provides reliable, valid and timely information for purposes of monitoring and evaluating the management and company performance. Internal controls should be established not only over financial matters but also operational, compliance and sustainability matters to manage the risks facing the company. The board should ensure that the internal audit plan is risk-centric, and that the internal audit function has given the audit committee a written assessment of the adequacy of the internal controls. 93

This assessment should be discussed by the audit committee, which should report the outcomes of that discussion to the board. 5. Boards should ascertain whether potential directors are competent to be appointed and can contribute to the business decisions to be made by the board. Prior to their appointment, their backgrounds should be investigated along the lines of the approach required for listed companies by the JSE. It is also important to ensure that new directors have not been declared delinquent nor are serving probation in terms of section 162 of the Act. The nomination committee should play a role in this process. 6. This means that the board should report to its shareholders and other stakeholders on the company s economic, social and environmental performance. Although a company is an economic institution, it remains a corporate citizen and therefore has to balance economic, social and environmental value. The triple bottom line approach enhances the potential of a company to create economic value. It ensures that the economic, social and environmental resources the company requires to remain in business are treated responsibly. By looking beyond immediate financial gain, the company ensures that its reputation, its most significant asset, is protected. There is growing understanding in business that social and environmental issues have financial consequences. The triple bottom line performance approach recognises the effect of the modern company on society and the natural environment. It acknowledges that companies need to act with economic, social and environmental responsibility. It is unethical for companies to expect society and future generations to carry the economic, social and environmental costs and burdens of its operations. Business itself needs to ensure that its impact on society and the natural environment is socially and environmentally sustainable. Good corporate citizenship is the establishment of an ethical relationship of responsibility between the company and the society in which it operates. As good corporate citizens of the societies in which they do business, companies have, apart from rights, also legal and moral obligations in respect of their social and natural environments. 94

The company as a good corporate citizen should protect, enhance and invest in the wellbeing of society and the natural ecology. Corporate citizenship and sustainability require business decision makers to adopt a holistic approach to economic, social, and environmental issues in their core business strategy. Only a holistic approach will allow for the effective management of business opportunities and risks. The expectation that business has an important role to play in responding to social and environmental challenges has become widely accepted. The debate on the need for voluntary business action or government regulation is being superseded by an understanding that an appropriate mix of both approaches is important. 7. Conscience: A director should act with intellectual honesty in the best interest of the company and all its stakeholders in accordance with the enlightened shareholder value approach. Conflicts of interest should be avoided. Independence of mind should prevail to ensure the best interest of the company and its stakeholders is served. Care: A director should devote serious attention to the affairs of the company. Relevant information required for exercising effective control and providing innovative direction to the company needs to be acquired. Competence: A director should have the knowledge and skills required for governing a company effectively. This competence should be developed continuously. Willingness to be regularly reviewed is a prerequisite for ensuring competence Commitment: A director should be diligent in performing directors duties. Sufficient time should be devoted to company affairs. Effort needs to be put into ensuring company performance and conformance. Courage: A director should have the courage to take the risks associated with directing and controlling a successful sustainable enterprise, but also the courage to act with integrity in all board decisions and activities. 95

8. External audit is an independent assurance function performed primarily for the benefit of the shareholders. The objective of an audit of financial statements is to enable the auditor to express an opinion as to whether the financial statements fairly present, in all material respects, the financial position of the company at a specific date and the results of operations and cash flow information for the period ended on that date, in accordance with an identified financial reporting framework and/or statutory requirements. The auditor s opinion enhances the credibility of the financial statements, but does not guarantee the future viability of the company or the effectiveness or efficiency with which the management has conducted the affairs of the company. 96