FIGURE 24 Merufacturing sis Nonmerufacturingcosts Manutacturing and non manuracturng costs Direct Aéinisvatve mates overheads Pime cost ra 4 Marketing overhead labour (ontergetire and + ‘rder-tng costs) conversion cost Monudactrng ‘vethead Distinguishing between direct and indirect costs Sometimes, direct costs are treated as indizect because itis not cost effective to trace costs direct to the ‘cost object. For example, the nals used to manufacture a particular deck can be identified specifically with the desk, but, because the cost is likely to be insignificant, the expense of tracing such items does not justify the possible benefits from calculating more accurate product costs. “The distinction between direct and indirect costs alto depends on the cost abject. A cost can be treated as direct for one cost object but indirect in respect of another, For example, ifthe east object isthe cost of using different distribution channels then the rental of warehouses and the salaries of storekeepers will be regarded as direct for each distribution channel. If, on the other hand, the cost object isthe product, both the warehouse rental and the salaries of the storekeepers will be an indirect cost because these costs ‘cannot be specifically identified with the product. Assigning direct and indirect costs to cost objects Direct costs can be traced easly and accurately to a cost object. For example, where products are the cost ‘object, direct materials and labour used can be physically identified with the different products that an ‘organization produces. It isa relatively simple process to establish an information technology system that records the quantity and cost of direct labour and material resources used to produce specific products. In contrast, indirect costs cannot be traced to cost objects. Instead, an estimate must be made of the resources consumed by cost objects using cost allocations. A cost allocation is the process of assigning costs when a direct measure does not exist for the quantity of resources consumed by a particular cost ‘object. Cast allocations involve the use of surragate rather than direct measures. For example, consider aan activity such as receiving incoming materials, Assuming that the cost of receiving materials is strongly influenced by the number of receipts, then costs can be allocated to products (ie. the cost object) based on the number of material receipts each product requires. If 20 per cent of the total ‘number of receipts for a period were required for a particular product then 20 per cent ofthe total costs of receiving incoming materials would be allocated to that product. If that product was discontinued, and not replaced, we would expect action to be taken to reduce the resources required for receiving ‘materials by 20 per cent. In this example, the surrogate allocation measure is assumed to be a significant determinant of the cost of receiving incoming materials. The process of assigning indizect costs (overheads) and the accuracy of such assignments will be discussed in Chapter 3, but at this stage you should note that only direct costs ccan be accurately assigned to cost objects. Therefore, the mare direct costs that can be traced to a cost object, the more accurate isthe cost assignment.(CHAPTER 2 AN INTRODUCTION TO COST TERMS AND CONCEPTS. 5 EXAMPLE 2.1 Sine ra oa aa @ @, Manufacturing costs: Ditoot labour 400000 Direct materials 200000 Manufacturing overheads 200000, ‘200000 Non-manutacturing costs 300000 ‘The accounting records indicate that 70 per cert of the above costs were assigned to the cost of the goods that \were sold during the petiod, 10 per cent to work in progress and 20 per cent to finished goods inventory. Sales ‘were £940 000 for the period. The opening and closing inventory of raw materia's were identical end there were ro opening WIP and finished goods inventories at the start of the period. The profit statement for period 4 will be as follows: @ o Sales (50000) ‘910000, Menufacturing costs (product costs): Direct labour 400000 Direct materials 200000 Manufacturing overheads 200000 ‘500000 Less closing inventory: WIP (10%) 80000 Finishod good invontory (20%) 160000 240000 Cost of goods sold (70%) 360000 Gross profit 350000 Less nor-manufacturing costs (period costs) 300000 Net profit 50000 During the period 70 per cent ofthe production was sold and the remaining 30 per cent was produced for WIP. ‘and finished goods inventories. Seventy per cent of the product costs are therefore identified 8s en expense for the period and the remainder are included in the closing inventory valuations. if we assume that the closing inventory is sold in the next accounting period, the remaining 20 por cent of the product costs will become ‘expenses in the next accounting period. However, all he period costs became an expense in this accounting Period, because this is the period to which they relate. Note that only product costs form the basis for the ‘caloulation of cast of goods sold, and tat period costs do not form part of this calculation. of direct materials (if applicable) plus direct Labour and overheads that are assigned to cost objects (typically cients/customets) represent the product costs. All other costs represent the period costs. The beginning WIP, plus the cast assigned to the clients during the period, less the closing WIP represents the cost ofthe services sold for the period. This is equivalent to the cost of goods sold in a manufacturing organization.PERIOD AND PRODUCT COSTS For profit measurement and inventory/stock valuation (ie. the valuation of completed unsold products ‘and partly completed products or services) purposes it is nevessary to classify costs as either product costs ‘or period costs. Product costs are those costs that are identified with goods purchased or produced for resale. In a manufacturing organization they are costs that are attached to the product and that are included in the inventory valuation for finished goods, or for partly completed goods (work in progress), until they are sold; they are then recorded as expenses and matched against sales for calculating profit. Period costs are those costs that are not included in the inventory valuation and asa result are treated 2 ‘expenses in the period in which they are incurred. Hence no attempt is made to atiach period costs to products for inventory valuation purposes. In 2 manufacturing organization all manufacturing costs are regarded as product costs and non- manufacturing costs are regarded as period costs. The treatment of period and product costs for a ‘manufacturing organization is illustrated in Figure 2.2. You will see that both product and period costs are eventually classified as expenses. The major difference is the point in time at which they are so lasstied. ‘There are two reasons why non-manufacturing costs are treated as period costs and not induded in the inventory valuation. First, inventories are assets (unsold production) and assets represent resources that have been acquired and that are expected to contribute to future revenue. Manufacturing costs incurred in making a product can be expected to generate future revenues to cover the cost of production. There is no guarantee, however, that non-manufacturing costs will generate future revenue, because they do not represent value added to any specific product. Therefore, they are not included in the inventory valuation. Second, many non-manufacturing costs (eg. distribution costs) are not incurred when the product is being stored. Hence itis inappropriate to include such costs within the inventory valuation. ‘You should now refer to Example 2.1, which provides an illustration of the accounting treatment of period and product costs for income (profit) measurement purposes for a manufacturing organization. Do merchandising and service orgenizations need to distinguish between product and period costs? The answer is yes. Companies operating in the merchandising sector purchase goods for resale without ‘changing their basic form. The cost of the goods purchased is regarded as a product cost and all other ‘costs, such as administration and selling and distribution expenses, are considered to be period costs. ‘Therefore, the cost of goods sold for a merchandising company would consist of the beginning merchan- ddise inventory, plus the purchase of merchandise during the period, less the closing merchandise inventory. Note that the opening and closing inventories would be valued at the purchase cost of ‘acquiring the inventories. Service organizations do not have beginning and closing finished goods inventories since itis not possible to store services but they may have work in progress (WIP). The cost fBGURE 2.2 FResorded as an eset of ie 7 arid the beence sheet product costs nae See ‘and becomes an ‘expense in the profit anc toss al products soed FResorded as an ‘oxpence in tho‘The following items relate to the learning objectives listed at the beginning of the chapter. Explain why it Is necessary to understand the meaning of different cost terms. ‘The term ‘cost’ has multiple meanings and different types of costs are used in cifferent situations. A knowledge of cost and management accounting depends on a clear understanding of the teminol- ogy it uses. Dofine and illustrate a cost object. A cost object Is any activiy for which a separate measurement of cost Is required. In other words managers often want to know the cost of something and tie thing” that they want to Know the cost of sa cost object. Examples of cost objects include the cost of a new product, the cost of operating a ‘sales outlet, the cost of operating a specific machine and the cost of providing a service for a client. Explain tho meaning of cach of the key torms listed at the ond of this chapter. ‘You should check your understanding of each of the terms or concepts highlighted in bold by referring to the Key Terms and Concepis section. Explain why in the short term some costs and revenues are not relevant for decision making. In the short term some costs and revenues may remain unchanged for all altematves under con- sideration. For example, if you wish to determine the costs of arving to work in your own car or using public transport, tne cost of the road fund taxation licence and insurance will emain the same for both, alternatives, assuming that you intend to keep your car for leisure purposes. Therefore, the costs of these items are not relevant for assisting you in your decision to travel to work by public transport or using your own car. Costs that remain unchanged for all alternatives under consideration are not relevant for decisionmaking. Describe the three purposes for which cost information Is required. ‘A cost and management accounting system should generate infomation to meet the following requirements: (@) to allocate costs between cost of goods soid and inventories for intemal and extemal profit reporting and inventory valuation; (b) 10 provide relevant information to help managers make better decisions; (©) 10 provide information for planning. conti and performance measurement. [A database should be maintained with costs appropriately coded or classified, so that relevant information can be extracted for meoting each of the above requirements.KEY TERMS AND CONCEPTS: Avoidable costs Costs that may be saved by not adopting a gen atematve ‘Conversion cost The sum of ect labour and manufacturing ovemead costs; itis the cost of converting aw materials in to frished products. Cost allocation The process of assigning costs to cost objects where @ direct measure of he resources consumed by these cost objects dees net eist. ‘cost abject. Any activity for which a separate measurement of costs is desired. Ditferentil costs Tha dference between tha costs of each ‘atemative action under consideration, also known as Ineremantal costs Direct labour costs Labour costs that can be soectficlly ‘nd exoteivey idantitiod with 2 particular 203 object Direct material costs Material costs that can be specifically ‘nd exoiively idontitid with 2 particular coat object Fixed costs Costs that remein constant fora speced ime pried and which are nat affectad by the volume of ‘activity. Incremental costs. The diference between the costs of ‘each altemauve acto under consideration, also known, ‘35 differentia coste Inclnect costs Costs that cannot be identied specifically ‘ond exclusively witha given cost object, also known 2s, ‘overheads, Irrelovant costs end revenues Future costs and revenues ‘at wil ot be aected by a decision. Marginal cost The additional cost of one extra unit of ‘cutout. Mardinal revenue The addtional revenue from one exte unit of cutout. ‘Mixed costs Costs that contain both a fxed and a variable ‘component, also known as somivarable costs. Opportunity costs Costs thet measure the opportunity thet is eaorficad whon the choise of one couree of action requles that an alteratve is ghen up. Overheads Coete that carnet be identified epecfally and ‘exclusively with a gen cost object, also known as indirect costs. eviod costs. Costs that are net incluse in the inventory valuation of goods and which ave sated as expenses for ‘the perod in which they are incurred Prime cost The sum of al rect manufectulng costs. Prociuct costs Coat that are idontifed with goode purchased ‘or produced for resale and whicn are aiached 10 products ‘end included in the inventor valustin of goods. Relevant costs and revenes Future costs and revenues, that will be changed by a decision. Responsibility accounting Accounting that involves tracing costs ard revenues to responsibilty certres. Responsibility contre A unt or department within an ‘rganizeton for whose perfomance a manage is held responsible. ‘This chapter has explzined the meaning of important ‘torme that you will encounter when reading this book. For @ more comprehensive description and cetalled ‘Sembfxed costs Costs that remain fbed within specified ‘activity levels for @ gen ameunt of time but wich ‘eventually Inctease or decrease by a constant ‘amount at efitcal activity lvel; cleo known as stop fixed ‘Semivariable costs Coste that contin both a fxed and ‘a vatable component, also known as mixed costs. ‘Steptixed costs Costs that resin fed within specifed ‘activ levels for @ gen amount of me but whieh ‘evenualyinctease or decrease by a constant ‘amount at critical activity levels; alse known as ‘Senitibed costs, ‘Sunk costs Coats that have been incurred by a decision ‘made in the past and that cannot he changed by any decision that wll be made in te future. LUnavoidable costs Costs that cannot be savec, whether oF ‘at en altematve is adopted. Vaile costs Costs that vary in direct proportion to the volume of activi. ‘explanation of various cost terms you should refer to ‘te Charterod Institute of Managomont Ascountante” Off ‘ial Terminology (2005).REVIEW QUESTIONS 24 Delve the mearing ofthe term ‘cost object’ a prove ‘thre exsmplos of east abocte (p23) 22 bistngush betwen a direct and indvect cost. (p. 26) 23 Deseribe how a given diet cost item ean ba bath a dact ‘and nlect cos. 26) 24 Provide exampes ofeach ofthe flowing a) dct labour, (0)iraectiour, (caret materia, c) ntrct materials, ‘and () indirect expenses. (9.25) 2:5 Explain te meaning of te tens: (a) rime cost, (0) overheads, and (cos allocations. (p.25) 26 Distinguish beeen prouct costs anc period coss.(p.27) 2.7 Provide exzrpls of decisiens that eae knowledge of how ‘costs ad everues vary wih cflewent eels of actly (9.28) 2:14 Bade. Classlya2oh of ho flowing as boing usually fed (F, ‘arabe (), sem-ed (SF or sembariable (SV): (i) rect abou, Ui), apreciaten of mzchiney: (u) tact erat (is) supplies ane ether intact materiale: () advertising (0) Martanance of machine: (vs) factry manager's salary, (st supervisory personnel (0) rojary payments. 12.28 Bade. Which of te folowing chould be classed at inact labour? (2) macnne operators ina ectry producing turntue; (@) angers in 2 lag fi (©) mantarance worcers in power genaravon ‘xganatior: (@) lary eres in a road nauege compeny. ACCA Finarcainermation for Management 2:16 Bade. Which one ofthe folowing would be eansiod a Irceect labour? (2) assembly worers on a car producto ine: (@) bikers 9 a house buleieg corppary: {@) macnnisis na factory produsig comes; (@) fori ck drivers a tho ator of an engineering company. ACCA 1.2: Franca internation for Management 12:17 Basie, Fixed coats are cerwentonally deemed tobe: (2) constant per uit of euput: (@) constat total when socuction volume changes: (€) outside the contol of management, (those unatfected by lation. (INA Stage 1 Cost Accounting 28 Exglan the meaning of each of the folowing terms: (@) vera costs, fb) fxed cots, c)semified cess, and (6) serrevarabie cosis. Prove examples of cass or e301 ‘ofthe four categories. (po. 20-20) 2.9 Distinguish between relevant (avodsble) an Inelevart (urmidabe) costs and prone sxamples of each typo of (ost 69.22) 2.10 Explain the meaning ofthe tm ‘sunk cos. (0. 33) 2.14 Distngulsh between heremental ard argh costs. (p. 20) 212 What en oppomuniy cast? Ge some examples. ip. 23) 243 explain esponsioty accouring (2.36) Total eo for Total coe or 25 unts 1180 unts cet pe £ € ” 41000 1250 m 4750 2520 1m 2875 12826 1% 3225 fos Wich cost types woul te classified as berg semivaiabe? (ats rz (re ara ADCA Financ Intormation fr Management 2.19 Intermediate. Propare a ropa forthe Managing Director of your company explaining now costs mey be dassifed by er Dbehavour with parca reference tthe aflets oth on ttal ant (unit o0sts. Your report shewc: 1) Say why cts necessary to classy cos by melr bene, |W) be tustretedby sketch graphs within the body of the repr. (a5 mais) ns stago 1 Accounting 12.20 Intermediate. Cost classicatons ustd in costing include: Regu Explain each ofthese classficatens, wih examples ofthe types of eaete tht may be included (27 mane) ACCA Level 1 Costing|i) Variable costs are conroabie are hes costs re re |i) “Su costs are tetra when towdre ceision smakeg mioreaten (@ mass) ACCA Love Costing 222 itemodiate. “Cons may be clasies in a vay of “ways atcordng toto rete andthe normaion reads of ‘management Explan and dscuss ts Sateen, stating ‘with examples of te eassifenionsrequred for aerent purposes. 122 mass) St Mansgemert Aecountng 2.28 Itemedit. is comnony suggested that a management ‘sceouting stem shoud be cable of supling cifere ‘measures of cost for erent purses. You are raul o set ‘ut te man ype of purpose fr whi cost infomation ‘may bo raguredin a Business agarizten, cra wo disuse the semaine meaoues of ost when might be appoint er each pupese. |cAeW Maragemert Rocouning 228 itemedite Oportnty coe an sunk cot ate areng tna cereops of cast commen caused. Yeu ae vequiad: (i) te deine hase tea preset (matey (1) suggest for each of them stantions in whch the concept mghtbe applied: (mats) (0) to. assess ony the sizifearc of wan of me carcaps. nas) {ABW Maragimert Accounting 2.25 Itemediate.Disngichbotnon. and proud a lsvaten of () ‘metie’ and urawneane costs (0) “eoet cones" and eect nt! @ mats) ‘ACCA Foundation Paper 2 2.20 itemodiate: Cont bohaviot (eat of ator ear "Tadeo pce afte 2 years cr €0000 rites is expecta tobe Matzerareo Srmonthy sanice costes ‘Spores /replecoment pats, per 1000 mies Vesicle cence, per annurt Insurance. er aera “ye ertacements er 25 000 miles, four at "£37.50 aon atc, er gallon 4.90 ‘Awrage mileage rom one gon is 25 mies. (a) Fem te above cata you ae equted: |) To pecare a schecute 1 be presented to management ‘shonng fore mieages of 50¢0, 10000. 15000 and '30000 mos pane 2 tia faad cost, ‘wu east ‘alable cost per mile (n pence 1 nearest pen: aed cost per ren pene rearest Demy) ‘otal cout por mien pence to rearest perry). 1m casstying to cost, you conser at seme can be vested a9 cer vale hed, state the assumptions) (whic our ase" s based togete: with bref supporting veaserts |i) On raph paper ott the ifoation gen in your ansner to () above forthe cos Ist aainst (1). (2) Gane. i) Te read ff tem your phi (i and tate the approunate tl costs apptcabe to 18.000 mies and 25000 rales ad the tacos erie a es Wo. ieages. (0) Tee mee sues you travel, the cnoaperitpecomes: Commant bit on th etaerant. (25 mate) 42.27 ltervedat: Sunk and opportunity cost for decison. © © aes 75000 Lose Ve sed tax AY 36000 ‘Sales Lave VAT 100000 Cost of goods sol 0000 Wages and wage relat cass 200 Fant rcuding tne doan payment 10000 Fates, hoategigtergerdinavareo 13000 ‘AuSt legal and general expenses _ 2000 87000 ‘et prom etre ta 2000 ‘nthe fees no provision has been made for cost of ‘vated othe business. She ie undecided wheter to certin® wth her lan, because she knows that she can sitet te shop to a ‘end fora ony rere of £880 she does nt use tie St "You oro rood to: (2) 0) explain ard ident to “sunk ae opportunity’ cots in ‘he station cepted above (i) state wat decison Ws Jomston should make econ tote nxaion ever, ppore your cercusen wih afeancalesterert, (24 made) (©) axa the meaning and uso of notional (oF inp) out and quote we euppoting examples. (4 marks) (IVA Found Cost Asccunting 12.1 Basie: Coat elaniication For the relat ost tain ems (2}{7) ndeate nich ofthe flonrg the best lassticoton, (4) aun cot: (0) ecemea cost; (6) vale cos:748 ANSWERS To REVIEW PROBLEMS. stem. n patel, tho potntal for improved ‘communication and the accentance of budgets 2s ‘elevant standards to achieve snould lead to improved ‘notnaton. ‘Creag budget certres at lover Ives wil pla eater acinitatve demande on eperating the syetom nd lngtnen the budget oreoaraton perio. In aden, the cost of reporting wil be increased, \Whethor er no the acéioral banefsexseed the ‘aciucnal costs iely to depend on the ecumstances, ‘ofthe company Fr example, in an emironmert where ‘an oanzato faces corsderbie unceraaty oF where ‘an organization undertakes a diverse enge of ects, ‘econtaltion and the creation of budget cartes at lower toes mg be prterable. However wrere the [ctl of an erganization can be pogranimed in cell ‘and close coordration ar sai. reacten is necessan, t ‘night be peotrtie not to create badgt centres at wer lovee pacar, the sete of bigot centres a neavly dependent on the acttles of other centes, tere 's gator Ehouheod thet the benoit rom ineroased ‘motivation wl ot outwoin he administatve and ‘coordination affcuties, 18.20 Forth answer's thete quostions soe ‘eitleme of standard costing and the tue rl of stardad costre’ Leamire Netes 48.4 and 12 © onthe CoursMate online resources. In par () the answer should aso ince adscussen of he ‘ole ef norfrancial measutes, See Le section an operaven rocostes in Captat 22 fora dscucsion ef non francal measures in nonmaruacturrg oganzatons. he answer could leo inclu o discussion of actitiybased ‘maragemeet. This tpi is coveted in Chapter 22. 18.21 (a) For Ue ans’ to Us questen see “imesigaton of valance! in Chapt 18. In parca the apenas should ‘xpiain fat aiances maybe due o several causes. and hotell are worthy of investigation. in edition he answer hee stoas the pots approaches to mvestistng vances: (Use! ade of nun percentages: For wari. a ‘atonces in excess of 10 per con of standard cost ‘might be inestigated. This approach igrres the ‘costs and benefs of iestgtion. (i) Usvof tata! qulty conta charts: Contra lente are set using an anaisis of storia! results to Inceate sulle condence Itenals This mead Ulzes a staeical prebanity approach of nt Investgacng a vance unless there isa ng rcbabiity tht the proces is ut of corte. Use of a ststea! decision theory aproaer: This ‘epproach is described in Loaring Note 26.3 on he Convsallate rine resources. 1c uray that stasetea desion thea can bo pled grace, because ofthe dtcuty in estimate cea ard benofts of rvesigaton. Nevertheless, the Preach ede a Suitable med tat eves a marager an inst imo the important factors that should be ensdored whan deiing whethor a et to nvectgat 2 ‘arlance, Experience and an undertancing oF e model kay tobe the best way of establishing whether er rot ivestigtion is worth. () See Chapter 16 forte answer tothe quoston. () Tholevol of budget felt tal te havo a ‘metvational tence on a manager's actors to ‘linivae veriances. 9 manager boleves a target ‘obo uatiainabe, he oF shes unlike to stv to wm o ” climnate valance. (See the effect of budget camcuty on motnation anc peromance" CCaagter 6) [Managers ay manipulate information inorder to ‘avoid adverse varerces. This is most ely t occur Ita budgetconstaned eiye of podormance evaluation is used. Genuine pertornance Irmponements are mostly to occur ia proft: conscious sve of evataton is sed. Fra cetalod ‘scussion of sve of evaluation see ‘se effets from vaingcezeuning Infomation in peormares| cevaluaton’n Cater 36. Managers ae mest lel to stve to lininate variances they accent the get and tis becomes @ motvatorel target. Butet acceptance oto lay tobe achieved by pariepation ana ‘ot by inoased budgets. See “parcipaton in me budgeting and target soting process in Chapter 18 fer amor detaled discussion of th influance cf patisbaten en acceptance of oud. The eertte which prfomance appa, tro rorratio and cash boruses are ied tomeeting De Dadget wil prove arr metiaton stimulus 2 ‘ating the budgat However, too math ste laced on meeting te budge, tee is a danger tht over goereus budget wil be seught er information wl te cstored so. te a seers vances, Posfemance repens compaing cual with budget ‘Should be provided coon aerthe ero ha get etad(weeky or moni). A marageris more key to be mothated to elinnate vriancos I feedback regots are tmely ard undersiandabe. climate ct {alle ad punishmert srould be avlded, ard be fempasis shoud ba en helsing manager to femnate aaverse varlances. Bom x ‘8 backs ‘Curent depreciation (120 ~ 20%) 2400 Development cast £9.60 x 2/3) ‘640 Loss: Replacement depreciaton (£368 x 20%) 33.60, ‘ejuntod prot 600 Loss: Cost of capil charge (13% » £168)" 4 vA ease TR se assets e168 — 5565) + wong ane e27.2)+ ‘eto cate 68) Aaswer = (0) er pet ater tox ae Ast: Intoroet 22 Development costs 63 Aaveriing a6 102 Loss devlopmont costs (1/3) on ier Lace cost ofeaptal charge (£30m » 13%) 2a BA pe148.16 (a) Reuum on investment (ROH) Pro 35000 Net assets £50000 Reuun on knactrnet ~ 35000/150000 ~ 23.3% Prone 70006 Net esate 228000, enum on knastrnet — 7000/3295 000% — 21.5% Resid some Divsion A ~ £35000 - [150000 v0.15) - £12500 isin B — £70000 ~ (325000 0.15) - £21250 Divison A nas a higher RO! but a tower resto! hrcome. (Rot cn vestment woul e ihe beter measure when comparing avssons sits arelave measure (.e. tased (9 Innovation: (resource uttzaton erconcy 48.17 (a) The annual FOL and resol come caluatons foreach ant are as flows 2012 2012 2014 2018 Total ()Netcashow(en) «2424 2k 2k 8 {2} Depreciaten 46 48 46 is 2) Prot Osos os 03 a ()cestoteoptal(L6Kof6) (102) 10.71) O54) (0. (6) Resiuaneame (6) Opening WOV of ascot GA 4.8 {G2a) 003 020 054 aa 48 (7) ROI Row 3/Row 6s) 42.5% 36.67% 25% 60% (2) Met cath tow 26 22 45 19 78 (2) Depreciaten 424243 43 G) Prot 130902 0327 (4) Gost of capital 15%) (052) 042 (021 (6) Rescue ncome (O4] 0281022) O51) (6) Opening Wov ot asset “5239-26 13 (ROH BR IK — 7.7% 23%) ‘The arener she inate: () Over tne whale te of we pect bot ROK ane residual income (Rd axour tw orate plant. The average AD. an i gues are 25 per ent ard {£0.16 millon £0.64r/4) for the Aromat part ‘ad 20 pr vert and £5605 mien (20.0207) for ‘the Zoman plant The ROI calculations are based on ‘emeessng the average grafts a |G) An exenaten that MF Eto wil favour tho Zeman Part bocausoityilde a higher ROL an oer te ‘rattwo yeers- Nr Eton il probably fous ena 40 {year te hofson becavee of ve persona ‘umetanees, since shoes the Amati part Is thay 2 ost Pe losing ni ous. Thertere ANSWERS TO REVIEW PROBLEMS 749 he wil choose the plant with the ower NPV and wm (©) Managers may use pretax pois to evaluate disiorat perfomance because is assumed tat talon pa ‘certroabe,Tataton payable s based on total gouP pots and presen! and past captal expendture rather ‘han edcunl disionalpeoftabity. At tox cash Nowe ‘10 used o appraise capil investments because the {eaus son dosicen marge aocepting those pejets that eam a atu in exceue ofthe investor” opportnty ‘oat of capital Todo is IRE an NPV shal be ‘besa on aftr tac cath flows. he ‘clio poxetia prabloms can aie: (W)Maragers may ore the taton impact at ne ecistrvnake stage because Is rot consered ‘when evant Bo pevforrance. |) Contusen and denetivaten can occur when ‘ferent cera ere used for decisionmaking and perormonce evaluation Posstie solitons ielde evsuatingcvsinal rotanity ater txos or erahating perfomarce based fon a comparison of tugeted and actual cashflows. Acooting the later approach isan ate to ensure ‘nat he came ert is Used decisionmaking and perrarce evaluation. () Stape that canbe tskan te avlédyfunetional betavour leade: Net pizcng too much erenasts on shorienn erormance measues and pacre greater ‘ernst on te or tan by adcing pot ‘conscious ste of erauetion. (a) Focusing on contoliabe residual Income of ‘economic valeadded combined with asset ‘alations derved fom depreciation modes that ‘re oncletnt with NPV cautions, ‘Atoratialy petrmance evaluation might bo ‘booed ono comparison of budgoted and actu ‘ash flows. The bucgsted aah flows anould bo ‘banad on cath flows that ar used to appraise ‘apa investments (eco Learrng Note 19-4 n ‘the CoureaMate online resources). (Gi) Suplamening tenes! perfomance meseures “nth renfiancial measures wren evaluating Porommance (see “addrssing tha dystunetonal ‘consequonces of sorterm francial measures! in ‘chapter 19.Division & £ Prone "35000 et acsata 50000 etum cn investment = 35000/150000 = 23.3% ision & £ Prot 70000 Net ascate 225000 70000 - (325000 « 0.15) Divison & has a highor ROL ut 2 lower residual income. () Return en invostnent would ko the batter maasur wen comparing disions as itis a eiathe measure (ie. based fon porcertage reurs) (6) Approprate azpests of pedermares inclu: ()compettiveness: (i) thandal perfomance: (quality of sevice; ww) r ro) wo 49.47 (a) The annual ROLand esival Income calculations foreach plant are at fotows: 2012 2012 2014 2015 Total Fromatie (Netcast tow(én) «2424 2a 24 88 (2) Depreciation is i6 16 36 (ype 0S 08 08 08 32 (A) costot capital 16% of8) (1.02) (0.77) O51) (0.26) (6) Residual income (022) 003 079 0-54 (G)Opering WOV of asset “6448 3216 (7)ROI Row 3/Row 8) 125% 4B67KI5% SOK zeman (2) Net cash tow 25 22 15 10 73 (2) Daprecistion 4243 4343 (pet 1308023) 2 (Coster capeat ase) (083) (62) 0.42) 0.24 (6) Residual income aT 028 022) 10-51 (0) Opening WOV of asset “5239-2613 (7) RO 28 OK 7.7K (238) ‘The answer shoud indicate: ©) Over the whole ite ofthe project bot ROI and residual income (fe) evour the Avomatic pia THe ‘everage PO! and Pius are 25 percent and +£0.16 milion (£0.64m/4) fr te Aromatic pant ‘and 20 percent and £9.05 milion (£0.02m/4 for ‘he Zara part. The ROI caleulaiens are bad on ‘eoressing tre average orotts as a percentage of ‘he avorage Investmert(Seired as oneal f the Inia captal investment. ()Anexplanaton that Mr Eton wil favour the Zoman Plane because it yelds 2 highor RO! and Rover the ‘irsttwo years. Melton wil robaDly 124s. on a Wo- year tine horizon because of his personal ‘ieumsiancas, since ehoosirg the Seer plane 1s they to resut in tim sing his bonus. Theetoe te will choose the pant wit he ower NEY anc ‘her wil be 6 lek of goal congrveneo. (Gi) Suggestions 26 to how atemative accountng techniques can assist nreconcling the conflict Datwoen accounting performance measures an DOF techniques: 2 Moding shorttern evaluations and evauating perfomance et the end of the project's Ife Thus bonuses would be awarded with inosignt. 12 Use altamative asset valuation othr then historic cost (eg. replacement cost |3 Choose atenatve denelaton metiods that sr most consistent with NPV ealeuatone leg arnaty deprecation. 4 Incerpocte range of vats (both fnancial and ron inane when evaluating manager Derfrance| wat gve a beer inicacn of ‘Rnure route that ean be oxpoctad rem curort actions (©) Managers may use pretax ref to evauate dsioral perormance because i's assumed that twain Is ron ‘contolble. Taxation poyebe is based on total group bats anc present and past cantal exbendure rather ‘then icvidul disienal profitably. Aterax cash Rows ‘are usa to appraise capital imestmrts because the {locus is on decision-making and accepting hose projects ‘thet eer a vtum I eceae of the nestor’ eppertuniy ‘cost of canta. To do this IRRS and NPVS should be ‘based on atertac cash ows. “he foloning potrtal pcblome can ao: () Menagors may gnere tho taxation impact at he \ecisior-makin stage because tis rot consicered ‘when evaluat the perfomance. (8) Confusion and demotion ean occur wen ‘erent erteta se used or decison making ane pedennarce evaluation. Possittesoutlons Ince evaluathg dvstnat frofiality after tes or walisting perfomance based ‘na comparison of budgeted and actual cash ows. ‘Adopting te lator approcch is an attr to ensure ‘that the same ertera is used for decisionmaking and perfomance evaluation. (©) Steps nat can ve taken to avoid dystunctonal benavour Ince: (©) Not pacing too much enghasis en shertterm poermaren mecsuros and pacing greater ‘errpasis on te long term by acoptng 2 prot. ‘conecout ete ef exatustion. {Focusing on conliate residual neome or ‘ecoromic value-added combined wit asset ‘Valuations derived from depreciation medals that fare consistert wih NPV calculatons. ‘Atomatwely, pavirmence evaluation might bo ‘based on a comparison of budgeted and acta ‘cash fows. The budgeted cast fows should be ‘bated en cath flows that are usad to appraise ‘capital mestrents (see Leaming Note 19.1 6n ‘the Courselate online resources). Supplementing ancial perermance measures wit nonfnareial measures wen evaluating Podermaren (ose ‘secressing the eysturcinal ‘consoavences of sorttem financial measures ‘Chapter 19)catelaion of acting fquied Tt) Renu mn—Rail foot) "nee asseb | oninesinet name (Say van Goon) eer” oe Now mat me questen states that tal essa a6 comming Spat coi ara mote, "pete $000) Tar uat ea (feo, (Bon) tee “ove” Rca) 6000) ‘Taxis payable at 30% s0 the ater tx cperateg Proll s 70% othe pest oowate peat. The cost ‘of cata charges 18 67% of taal asses ess ‘unr apie, WACC i ealeate 98 flows: art vat (6000) ‘oto 73.02 1180.00 42.08, eetown 4395 ‘sco 12027 Cceetown 4840 187-00 20.09 ‘Ayetoun th mest suecosti of othe cents ‘besod en ROL Arma nentnass of Olio hate rte rabies tan an absolie measure ord tus ‘oes nt oeus on meas valued. RIS an ‘nat evcoeseh cre butte ol ghee ‘succesful than Aja. Becton’ lord EVA la secant ower thn teeter to coe. ‘Ayetom haste highest EVA ard is eon cenee ‘which ras poste EVA. Vale is ade when re ‘arta: operate pe exceeds he cost finan ‘he requis cpt. Therefore i err to ngrove [EVA managers need toon move operating oat ‘kg th some areunt of capt crimes cape hienerearning sees. EVA'S genera peter 16 lnasaisewineoperates gustan caver the ‘ran acourthg prt tan approinaton of ‘economic oft and, byincerortnga coe of eit choge, poidesaberter measure the economic ‘elu adoed. The above aalysis suszests hat ‘yatoun ta most succast cre (i) Theoret ectown ie cmenty £3.95 perce. a ‘riot obtah an RO a 20 par cont, apt prot wouldnoad to increase o 20%. $3 160000) $652 000, base or te cuert eve of net sets. Te cueson leis the lowing ANSWERS TO REVIEW PROBLEMS 751. tera ways (bbe corded) by wich otaget otf 20 per cent could be achieved 1 rerase revenues, The ourentcortbon/ ‘ses rao Is 73 percent (1535/82 100) Cpratne pri reeds to increase oy $181 000 ($622 000. $241 000) t9 seme 2 Rt 20 por cent. Terao avenue needs te ‘vero by $101 000/6.73 ~ $262648 (Co 12.46 nor cen to achieve the tet ROL 2 Tos open costs woud nee fa 4 ‘$191 000 nero obtain ROI 20 perce. ‘Ts rapes a povertage sereate tal outa (657 + 1092) ef 1% 000/2 859000 ~ ‘19%, fed cost remain uncharged hen ‘able costs would ned teflon 8557 00012 ‘presents a percentage decease of 130.2 per cert ($3.10 00042208 000= ‘5000/3150 000 = 30.78. (ii) The marketing decors conect in wecogning tat succes Is cooendert ch lees sance vat Drewes but ts sen ene tment oF surcess.t ‘he name templets eorpersta io ‘Stoudaso dren atertion tothe fat that he erie’ of comnts tae resi of eure prot ane ther a ee fora perfomance Imeseurerent syste toicerperate Bot agng tnd eading moaource (200 Chapter 22 fron planar). () tis assumed that HFG is uno t SFO 20 0 melor, petlem sy shou SFO ohare fermason with @ etre ure compete? Many opznztions are ‘eluant o reveal corona infomation 1 compen. Toanaure maf cooperation of =O wile ncessayy fer HFG top sere arguments Poti proces wil ‘eo be benefice to SFO. Afuther probleme that bonchmarng could have a averse mothetioalinpact on be sia of HFG since bey may consi that oo maragerert awe not coven ate Tave the abe ‘change ener business procosses and ates. 0 ‘ef ma consider hat benchmarking wil ead changes ‘ht may estn thes big ond noting onatons Under Breat Final, benching ‘ces 50 maragenert must be ass ha theresa igh etaniy that ha Donets wt oxen coms 11920 (a) The ansner to thls question shoud Incase mach of the conte cided he secon ent esonarve vale ‘act Chapter 19. adn, te answer shuld Ire he flow pointe: (Somer recrumoxpencince sien 25 ese ‘nd dovlopmant and sdverting provide Me ovata ovr ser! your but financia accounting requrenertsoten eae such expend c be ‘ettoneff nthe yearn which bey ave ures. THs Unersatsineive adandcsinganerteaard.(i) The pot computed to mect facil sezourtng rogurerarts do ot tke into cesourt the eeat af {equi hance provide by th shavcoidors ‘The erly costo eaptl thats taken into cecourt ie Irerest on berowod furdo (Le. te cost dt “inenca- Prefs shuld ret te ost of bot dobt and eauity finance. (i) Nbetermesaue ofthe manages’ ality to cate ‘ale isto adurt the vadtera nano stamens “er those expences that a kl to prove berate Infutur potods. The econamevalis added necsue steps to met th equrerert ‘Tne tolowre comments relate to the weatment of ‘Specie acustments. Research ond devetopment ‘The oxpentur of £21 mllenis added back bocauso it egrecente an testo that wil ye future benott, ‘Therefore shouldbe cantalzed and alecated tthe ‘tur pviode based tho bona ecahes in he artculat perod. The expondiure of £17 4m i edo ‘ack, based onthe eesumeton tht the company ie continuing ta benefit fom auch exoenduree that Nave revouly boon wvtan of aganat pots: There should Doan clemert ofthis oxponturewrtn ft oprocation basod ent value that Fas boon eredod ddteg th poi ‘versing [Adversing eoencture ads vaue by suppering fuure ‘sais arising rom increasing castor awareness art ‘rnd oy. asec on he Same stcaten 2s research and dewnrrent eomndiuze, aensing shoud be aptaled forte EVA calculation ard acted back 12 ‘ets. Tue £105 added back the balance sheet Fefects ie costs cured in bulking up aur income. ‘Som cf tis cost sould e deprecat basec onthe ‘value of ture benef eroded Gurr the period. Interest rd boron ‘Tha am ino saceran wheter value is blag ae for the shoreiger in the cance of wheter te rd Invostadie the busiass gonerate 2 etum in oxcoss of the opportunity cost of eal (a8e Chapter 18). To do thie a prft gue i calelated at intaly doesnot ‘natu ary charges fer the eest of capita ltorest on Dorewings ie heraor adcod bak wo aed the stator nore to cet of eaptl on doo! areal neludod in ‘he Wacinera posit calelaten whereas to cost of ‘uly capa tno. Toascartin the ttl eau of ‘uns mest inthe business, terevings are acted ack o ts capil base n te baarece sect. The ‘recasred cet (0. te oppo cost of cape) ot E17 Sm on the sting capital pase calcated and comparod wih the adistod pret of £15.4m geveratad ‘nom te fos. This Comparison captures the Cost of Doin get and equity 2nd inceates that value-added is 3 negate ree, ood ‘Goodall refers tote pce paid fer te business In feicess ofthe current costo net assets. Goodwll payments should therefore ca vats othe company. Hence the amount rten of ie ded beck to pretes ‘shoe Itropeserts pat of the riangte asset vlue of the busines, The cumulative mite of 40.7 ‘des bac in oto t provide amar rout val of ‘the eoptalbooe fem which a atu should be generated. This is because represents an ctonent of {he value ofthe business The vat goed shoud be ‘ogulaty rviwed and th emeurtoveded wetton of egorat profits, (0) Revised sion! profit sttenenss (en) in) tem tem em mime 57 55 seo, i & 6 cmcemommes O80 G2) 19 cn ws = Moe “ ee seco met fg "rotten nthe sane 3 2 reves gout WORE (103/60.7 ison 6 and 3.4740, to sn oonarod ot bao ea tuner ely hadi oot ‘Pode sata hes ee bn rte ye ‘hse en te basi fpf eee rect ro es has eco ‘loezed costs pus tious read tess ets fa Te cuore oS (sata £81 Dalen A An son Ban fr (Biclen stan teats point tens Sg ‘aman luetor en tetas! sacs ever aber Save ac:3t01 “Tne ebove analysis suggests that ele is being “desteyed in Dvision Cand o a miner extent Dision B. Division A adding valuo. This a act apparont tem ‘inal presontation when incites a ROCE of 25 por cont [£5.6/£23-2n) fer Dison C. The imtatons of ‘the analysis inoue: (©) Traune of ativary apgenioemerts 0 toete had oe expensos, hot tblty ana nea ‘ton ret ascets tothe busress, (0 Tow assumpton tat the sare cost of capa s applica tal anions. (0m) Toe use of nstoreal asset values rarer tran ceconemie vate (0x) The fie to alstraush between managerial and feconomie disoral oertermance. Te anaysis focuses on the economic performance o he visors. (6) Seo “etum en ivestmant’ andthe dicussion of the suney evidonc wihia the section enti “reel neem” In Chapt 10 forthe answer to this questen.