Strathclyde Business School

Master of Business Administration

MG917 Financial & Management

Accounting

Exam Paper 1

July 2018
2-hour examination

Answer ANY 3 questions

Ratios sheet attached

1
Question 1

Megan Plc manufactures two products, which use the same production
facilities. The details of the products for 2018 are:-
Product M Product D
Budgeted sales – units 30,000 20,000
Material cost per unit £18 £27

The labour rate is £12 per direct labour hour in both production departments.

Product M is made in Department 1 only and it takes one hour to produce

each unit. Product D is made in both Department 1 (10 minutes) and
Department 2 (20 minutes). There is also a service department that is used by
both departments and the labour in the Service department is treated as an
overhead cost.
The budgeted overhead costs for 2018 are:-

Department 1 Department 2 Service Department

£ £ £
Salaries 100,000 40,000 50,000
Depreciation 15,000 3,000 6,000
Other overhead costs (fixed) 25,000 7,000 4,000
140,000 50,000 60,000

The expected use of the service department is 25 per cent by Department 1

and 75 per cent by Department 2.

Required:
(a) Calculate the expected full cost of both products.
(12 marks)

(b)
(i) If Product M sells at £50 per unit and Product D at £60 per unit and the
budgeted sales are achieved, what is the expected operating profit for
the year?
(4 marks)

(ii) If the units sold of each product were 20 per cent below the budget,
and the budgeted selling price and costs were at the levels included in
the budget, what would be the operating profit?

(4 marks)

(c) Explain Activity Based Costing and discuss the benefits that are
claimed for this approach to the apportionment of overhead costs to
products. Give examples and suggest any problems with its use.

(13 1/3 marks)

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 TOTAL 33 1/3 marks

Question 1 – Solution

Department 1 Department 2 Service

Overhead costs 140 000 50 000 60 000
Service 15 000 45 000
155 000 95 000 (3)

Hours – M 30 000
D 3 333 6 666
33 333 6 666

Overhead recovery rate £4.65 £14.25 (2)

M D
Material 18.00 27.00 (1)
Labour - 1 12.00 2.00 (1)
2 4.00 (1)
Overheads – 1 - £4.65 per dlh 4.65 0.78 (1)
Overheads – 2 - £14.25 per dl 0 4.75 (1)
Total cost 34.65 38.53 (2)
(12 marks)
(b)(i) M £50 – 34.65 = £15.35 x 30 000 = 460 500 (2)
D £60 – 38.53 = £21.47 x 20 000 = 429 400 (2)
889 900

OR M £50 - £30 = £20 x 30 000 = 600 000 (2)

D £60 - £33 = £27 x 20 000 = 540 000 (2)
1140 000 – 250 000 = £890 000 (rounding
difference in O/H rates)
(4 marks)
(b)(ii) M £50 - £30 = £20 x 24 000 = 480 000 (1)
D £60 - £33 = £27 x 16 000 = 432 000 (1)
912 000 – 250 000 = £662 000 (2)
(4 marks)

(c) Text book/lecture discussion of ABC with higher marks of discussion of the
problems/limitations and providing examples. Non-adoption of ABC – relative cost
and benefits Usefulness of knowing the full cost of products. Effort and cost of
preparing the information

(13 1/3 marks)

TOTAL 33 1/3 MARKS

3
Question 2

(a) In many countries, the prime purpose of financial statements is to

provide information to the shareholders. However, after publication,
the Annual Report is available to the general public. What are the
main regulations that govern the contents of the annual report?
What parts of the Annual Report are likely to be of interest to the
shareholders and which parts are of interest to competitors? Do
you consider that a typical Annual Report provides all of the
information that they are seeking? If not what areas could be
improved?
(20 marks)
(b) Discuss the importance each of the following:

i. The prudence concept.

ii. Historical cost as the basis of valuation of the company’s assets in
the Statement of Financial Position (Balance Sheet); and
iii. The going concern concept.

to a financial analyst, who has been asked to estimate the value of the
company in acting as an advisor to a company that is considering
making a bid to acquire a majority holding in the company. Provide
examples if possible.
(13 1/3 marks)

TOTAL 33 1/3 marks

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Question 2: SOLUTION

(a) GUIDANCE ON ANSWER

Potentially all the annual report should be of interest to shareholders but the interest in
detail may depend on whether they are private shareholders or professional fund
managers and brokers. The annual report starts with a page of financial highlights,
followed by narrative reports from the chairman, the chief executive and the finance
director. Reports follow on corporate governance, environmental impact of the
company, attitudes to employees and sometimes the interaction with society. The
annual report then moves into the second part which is heavily regulated by company
law and the stock exchange listing agreement. This contains the directors’ report, the
auditors’ report, the primary financial statements and detailed notes to the accounts.

It could be argued that the annual report is essentially backward-looking and so does
not help the competitor in making decisions about the future. However the backward-
looking aspect meets the needs of accountability for stewardship by the directors. The
annual report is an important document for shareholders in monitoring the activities of
the directors as their agents.
20 marks – some discretion allowed in the marking – 2/3 marks for identifying
areas of interest, and 2/3 marks for some of the weaknesses of financial
information in providing useful information to decision makers.

(b) GUIDANCE ON ANSWER

Importance to a financial analyst.

In this situation the financial analyst is advising the company on a bid and therefore
the annual report may be an important piece of evidence. It may be used to judge the
strengths and weaknesses of the target and it may be used to determine a price to be
offered. However great care is required in both aspects.

If the business is being acquired as a going concern than the primary interest of the
purchaser is whether the assets being acquired are generating sufficient return to
justify the investment. There is a limitation in the accounting balance sheet in that it
identifies only the assets that can be measured in money terms. Assets not included in
the balance sheet are the quality of the workforce, the know-how of the workforce, the
brand name and reputation of the business, and the customer contacts. These are all
put together crudely as ‘goodwill’ in an acquisition but they do not appear in the
balance sheet of the entity being acquired. The assets identified in the balance sheet
are recorded at historical cost and so it is important for the intending purchaser to seek
an up-to-date valuation from an expert. The financial analyst could make the
estimates based on knowledge of other companies in the same industry.

The financial analyst should consider whether the expense of depreciation is adequate
because it is based on historical cost. If the assets are reaching the end of their useful
lives they will need to be replaced. That may increase future depreciation charges and
so reduce profits.

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The financial analyst should be aware that the prudence accounting principle which
makes sure that assets and income are not overstated and liabilities and expenses are
not understated:

 The concept of prudence is used worldwide, hence companies around the

world prepare their financial statements according to this principle
 It enables in the comparability of this principle
 It adheres to the true and fair representation of the financial amounts of all
financial statements
 It helps in not over estimating or underestimating the financial risks
 It helps in minimizing losses
 Helps in management not overestimating the company’s results

The purchaser of the business is looking forward and so the financial analyst needs to
consider whether the past history of the business is a good indicator of its future.
Marks – 13 1/3 marks -– some discretion allowed in the marking – if students
explain the concepts well up to maximum of 10 marks – students need to relate to
the question and focus of the takeover to gain additional marks up to 7 1/3.

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Question 3
Wes plc sells only one product. In 2017, there were sales of 10,000 units.
During 2018, the unit sales increased to 16,000 units but the profit was lower
than expected. The accountant has been asked to prepare a report that can
be used to discuss the company’s performance and financial position at the
next Board meeting. Prior to the meeting, you have received the following
information in respect of the years 2017 and 2018.

2017 2018
£000s £000s
Turnover (Sales) 2,000 2,400
Net profit before interest and tax 700 360
Interest expense for the year 100 170
Tax payable 180 57
Net profit after tax 420 133

Ratios (using the attached formulae)

Profitability
Gross Profit Percentage 55% 40%
Net Profit Percentage (after tax) 21% 5.6%
Return on Capital Employed 17.4% 7.8%
Return on Shareholders’ Funds 13.0% 3.9%
Liquidity
Current ratio 3.70 4.00
Quick ratio 2.20 1.50
Efficiency ratios
Stock Holding Period (days) 122 127
Debtor Payment Period (days) 44 46
Creditor Payment Period (days) 81 51
Financial Structure
Gearing 20% 27%
Interest Cover 7.0 times 2.1 times

Required:
(a) Identify possible causes of the changes in the profitability, liquidity and
financial position of the company over the period of two years between
2017 and 2018.
(20 marks)

(b) Based on your findings in part (a) provide some changes that could be
made to improve the short term performance and financial position of
Wes plc. However, note the selling price per unit cannot be increased
without a major loss of market share. In addition, reductions in the cost of
materials and labour are not possible in the short term.
(13 1/3 marks)
TOTAL 33 1/3 marks

7
Question 3: SOLUTION

(a)

Profitability

The profitability in 2018 has worsened since 2017 all the way down from the gross
profit percentage on sales to the net profit percentage on sales and the return on
shareholders’ funds. I will examine each in turn.

Gross profit is calculated as sales minus cost of goods sold. Either sales have
worsened or costs have increased, or both causes have occurred. Sales may have
worsened because prices have been held down or they may have worsened because
prices have been increased and there has been a reduction in volume of sales. We can
see that sales have increased by 25% so perhaps the price has been kept down to
increase sales volume but the overall effect on revenue has not been sufficient to
match the increase in costs. Cost of sales involves costs of making the goods or
service ready for sale. This could include costs of materials, labour costs and
production overhead. An investigation should look to the unit costs, buying policy and
efficiency of operation. One possible explanation of a fall in gross profit percentage
is theft of input materials or finished goods. Checks should be made on stock control.

Net profit is calculated as gross profit minus administration costs, interest and tax.
We can see that the interest expense has increased due to higher borrowing. Tax
payable has fallen in proportion to profit because tax is paid as a percentage of profit.
Many administration costs are fixed costs and there needs to be a review of
unnecessary administration and selling costs. It could be that advertising or
promotional expenditure has been undertaken to promote sales. If that is the case it
has increased costs without having the desired effect on profit.

An explanation of the decrease in return on capital employed may lie in acquiring new
fixed assets that have not yet begun to show their profit-generating potential.

Liquidity

The quick ratio is relatively high at 1.50, even though it has fallen from 2017. This
suggests that there is idle cash which could be reinvested in long-term growth of the
business. Alternatively there is too long a period of credit being given to customers
(debtors). We can see from the debtor payment days that they are treated quite
generously at 46 days on average and this has crept up from 2017. The company has
paid its suppliers faster (51 days compared to 81 days) which has reduced the quick
ratio. This may be beneficial if it has reduced interest charges for late payment or it
has made better use of discounts for prompt payment.

The current ratio appears excessively high at 4.0 times and reflects the long stock
holding period of 127 days (increased from 122 days in 2017). Unless there are very
special reasons for holding stock for so long, the period should be reduced. It
indicates either very slow sales of finished goods or very high stocks of raw materials.

8
Financial position

Gearing has increased, possibly because the company is not generating sufficient new
wealth from profit. The increase in gearing may indicate acquisition of fixed assets, as
indicated also in the fall in return on capital employed. The decrease in interest cover
exposes the loans to greater risk and so lenders may react by increasing the rate of
interest that they charge. There is also increased risk for shareholders because there is
less cover available for their dividend.

MARKS – 20 MARKS AVAILABLE

There is some discretion in the marks available for this question.
However as a guide 5 marks for comments on each of the three main areas and 5
marks for overall impression of understanding the ratios and interpretation.

(b)

Generally: Profitability needs attention to cost control. Liquidity needs attention to

cash flow. Financial position needs attention to the maturity profile and cost of debt
and the balance between debt and equity.

1. Review the control of production overheads to reduce the cost of goods sold.

2. Move stock faster to reduce costs of holding stock, improve liquidity and reduce
the risk of obsolescence. Alternatively review the production schedules to match
demand more closely.

3. Consider the benefits and risks of paying creditors later, say 60 days rather than 52
days. What are the penalties – in cash or in loss of reputation?

4. Review the repayment schedule of the long-term loans and ensure that there will be
cash available on the due dates. Arrange bank facilities if necessary.

MARKS – 13 1/3 MARKS AVAILABLE

2/3 marks per relevant point and 2/3 marks for general comments.

9
Note for information. The following financial statements are not part of the answer
but are included here to show the information from which the ratios in the question
were generated.

Income Statement (Profit and Loss account)

2017 2018
Units sold 10000 x £200 16000 x £150

£000 £000
Sales 2,000 2,400
Cost of Sales 900 1,440
Gross Profit 1,100 960
Expenses 400 600
Net Profit before interest 700 360
and tax
Interest 100 170
Net Profit before tax 600 190
Tax 180 57
Net Profit 420 133

Statement of Financial Position (Balance Sheet)

2017 2018 2017 2018

£000 £000 £000 £000
Fixed Assets 3,500 4,000

Current Assets
Stock 300 500
Debtors 240 300
Cash 200 740
740 800
4,240 4,800
Less: Current Liabilities – Creditors 200 200
4,040 4,600
Less long-term debt 800 1,227
3,240 3,373

Issued Share Capital 2,000 2,000

Retained Profit 1,240 1,373
3,240 3,373

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Question 4
In both commercial and public sector organisations, budgeting is an integral
part of the management process.

(a) “Many managers consider the preparation of an annual budget to be a

waste of time”. Prepare a report to emphasise the benefits of preparing
an annual budget.
(17 marks)

(a) Discuss the reasons that budgets “fail” and suggest ways in which the
effect on the organisation can be minimised.
(16 1/3 marks)
TOTAL 33 1/3 marks

11
Question 4: SOLUTION

(a) GUIDANCE ON ANSWER

Students answers can could contain the main functions of a budget. These are:

 Formalisation of planning and control

 Goal definition
 Goal congruence
 Clarification of authority and responsibility
 Framework for judging performance

In each case the text book explains the meaning of the heading and gives an
explanation of how this function benefits the organisation.

Marks 17 1/3 marks students need to describe each function and explain the benefit,
3 / 4 marks for each function.

(b) GUIDANCE ON ANSWER

Students can provide a number of reasons why budgets might fail, including technical
(poor methods) and behavioural.

Marks 2 1/3 marks students should explain each of their reasons carefully (3 / 4
marks each) and then suggest a way of minimising each risk (2 / 3 marks each) to
total 16 1/3 marks

12
Question 5

(a) Discuss what is meant by the Balanced Scorecard performance

management approach and describe appropriate performance
measures that could be shown in each section of the report.
(16 marks)

(b) What benefits that could be obtained from adopting Economic Value
Added (EVA) as a measure of performance. You should also point out
some the problems of this measure and compare it to the Return on
Capital Employed (ROCE).

(17 1/3 marks)

TOTAL 33 1/3 marks

Question 5:
(a) Balanced scorecard
Marks 16 marks - there are four main categories to describe (up to 9 marks). Good
examples of performance measures that are appropriate to each category (7 marks in
total).

(b) EVA
Marks 17 1/3 marks - 7 marks for explaining what EVA is and 10 1/3 marks for the
benefits/problems in comparison to ROCE.

TOTAL 33 1/3 MARKS

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Question 6

(a) Sammy Plc organises trade fairs. The manager has decided to arrange a
fair at a new venue. There are two possible venues and she has asked you to
advise on the best course of action. The company will incur promotional and
travel expenses of £30,000 if the fair is organised. The details of the in-
country costs of the two possible venues are:-

Venue 1
Rental of facilities £120,000
Cost of providing refreshments and publicity materials £1 per visitor
Estimated number of people who will pay £3.50 a visit 120,000 people

Venue 2
Rental of facilities £80,000
Cost of providing refreshments and publicity materials £1 per visitor
Estimated number of people who will pay £3.00 a visit 100,000 people

Required:
(i) How many visitors must be attracted to each venue if the company
is to make a profit of £20,000 by organising this fair?
(5 marks)

(ii) What will be Sammy’s profit (or loss) if 150,000 visit the fair at either
venue?
(5 marks)

(b)
Lee Engineering Limited has two production departments, Machining
and Assembly. The Machining department has a monthly capacity of
1,500 machine hours and the Assembly department a monthly capacity
of 3,000 direct labour hours. This production capacity cannot be
increased for at least 15 months.

The company at present makes three products all of which use the
same machining and assembly facilities. The expected demand, unit
selling price and variable cost are given below together with the time
which each unit takes in machining and assembly.

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Product A B C

Unit selling price £100 £200 £250

Variable cost £50 £130 £134
Machining time 2 hours 4 hours 6 hours
Assembly time 3 hours 6 hours 8 hours
Monthly demand 200 units 200 units 100 units

The company has fixed overheads of £20,000 per month.

Required:

(i) Calculate the mix of production and sales that will maximise profits
within the constraints under which the company operates (use
machining time as your constraint in your calculations).
Calculate the profit at this mix.
(14 1/3 marks)

(ii) Costs can be defined in a number of different ways for managerial

decision making. Define the following costs:
a. Relevant costs
b. Overheads
c. Sunk costs

(9 marks)

TOTAL 33 1/3 marks

15
Solution Question 6
(a)
(i)
Venue 1 Venue 2
Fixed costs + Profit 120,000+30,000+20,000= 80,000+30,000+20,000=
£170,000 £130,000
Contribution per visitor 3.50 – 1.00 = £2.50 3.00 – 1.00 = £2.00
Thus, break-even number 68,000 65,000
of visitors
5 marks – 2 marks for contribution and 3 for breakeven point.
(ii)
Venue 1 Venue 2
Total contribution 150,000 x £2.50 = £375,000 150,000 x £2.00 = £300,000
Fixed costs £150,000 £110,00
Thus, Profit £225,000 £190,000
5 marks - total contribution 2 marks and profit 3 marks.

(b) (i)

A B C
Selling Price 100 200 250 (1)
Variable Cost 50 130 134 (1)
Contribution 50 70 116 (1)
Hour - machine 2 4 6 (1)
Contribution per 25 17.5 19.3 (3)
Machine Hour
rank 1 3 2 (1)

PRODUCT UNITS MACHINE CONTRIBUTION

HOURS
A 200 400 10000 (1)
C 100 600 11600 (1)
B 125 500 8750 (1)
Total 1500 (1) Total 30350

16
 LESS FIXED 20000 (1)
COSTS
PROFIT 10350 (2)

14 1/3 marks

ii. 9 marks - Standard definition of costs – 3 marks each.

17
 COMMONLY USED RATIOS
Profitability

Return on Capital Employed Profit before deducting interest and taxation

Equity (Shareholders’ funds) plus long term
borrowing (debt)
Return on Shareholders’ Funds
(also called Return on Equity) Net profit after taxes
Equity (Shareholders’ funds)
Net Profit Percentage Net profit after taxes
Revenue (sales)
Gross Profit Percentage Gross profit
Revenue (sales)

Liquidity Ratios

Current Ratio
Current Assets
Current Liabilities
Quick Ratio (Acid Test)
Current Assets less Inventory (stock)
Current Liabilities

Efficiency Ratios

Inventory (stock) holding period

(days) Inventory (stock)
Cost of Sales
Receivables (debtor) payment period
(days) Trade receivables (debtors)
Revenue (sales)
Payables (creditor) payment period
(days) Trade payables (creditors)
Purchases or Cost of sales

Financial Structure

Leverage (gearing)
Long Term borrowing (debt)

Long Term borrowing plus Equity

Interest Cover
Profit before interest and tax

Interest expense

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