ZNOTES.

ORG

UPDATED TO 2021 SYLLABUS

CAIE A2 LEVEL
ACCOUNTING
(9706)
SUMMARIZED NOTES ON THE THEORY SYLLABUS
CAIE A2 LEVEL ACCOUNTING (9706)

Benefits of manufacturing account

Separates office and factory costs
1. Preparation of Financial Identifies factory as cost driver
Helps in setting prices o Shows total manufacturing
Statements cost
Reasons to provide for unrealized profit:
1.1. Manufacturing businesses IAS 2 – inventory valued at lower cost
Follows the prudence concept – provisions created for
Manufacturing account: shows the costs of running the potential losses
factory where a final product is made Follows realization concept – only ‘realized’ profits are
Transfer price: production cost + mark-up recorded
Factory profit: transfer price – production cost Avoids overstating profit and current assets
Provision for unrealized profit account
Manufacturing account $ Balance b/d – unrealized profit for op. inventory
Balance c/d – unrealized profit for clos. inventory
Opening inventory $
Missing figure – provision for unrealized profit in I/S
Purchases $
Dr – add to gross profit
Carriage inwards $ Cr – deduct from gross profit
- Closing inventory ($)
Cost of raw materials consumed $ 1.2. Not for profit organizations
Direct costs $
Prime cost $ Changes in terminology

Overheads $
Income statement Income and expenditure a/c
Opening work in progress $
Bank/Cashbook Receipts and payments a/c
- Closing work in progress ($)
Profit Surplus of income over expenditure
Production cost $
Loss Deficit of income over expenditure
Factory profit $
Equity Accumulated fund
Transfer price $
Accrued subs. fees Subscription in arrears
Prepaid subs. fees Subscription in advance
Trading account $
Revenue $
Income and expenditure a/c $
- Cost of Sales $
Income
Opening Inventory $
Shop profit $
Transfer price from manufacturing account
Subscriptions $
- Closing inventory ($)
Events less their costs $
GROSS PROFIT $
Life membership $
Factory profit $
Expenditure ($)
- Office Overheads $
Surplus/Deficit for the year $
- Provision for unrealised profit increase $
PROFIT/LOSS FOR THE YEAR $ • Subscriptions a/c
Dr. Cr.
SOFP EXTRACT $ Balance b/d (op. arrears) Balance b/d (op. advanced)
Current assets Income & expenditure a/c Receipts & payments a/c
Inventory: (missing figure) (subs. paid)
Raw materials $ Balance c/d (clos. advanced) Balance c/d (clos. arrears)
Work in Progress $
Finished goods $ Life membership
Lump sum paid once by members and no further
- Provision for unrealised profit ($)
payment for the rest of their life
Dr – receipts and payments a/c
Unrealized profit: profit on inventory of finished goods
Cr – life membership a/c
that hasn’t been earned yet.
Shown as non-current liability in SOFP
Inventory at cost + profit % / 100+profit % * 100

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CAIE A2 LEVEL ACCOUNTING (9706)

Life membership fund a/c balance credited to income Statement of cash flows $
and expenditure a/c in equal amounts over a period Net cash from operating activities $
of time – as income but no effect on cash flow
Cash flows from investing activities:
New members’ entrance fees
Fee charged to new members during their first year of Disposal proceeds of non-current assets $
membership, different from the regular annual - Purchases of non-current assets ($)
subscription fee Net cash from investing activities $
If considered revenue income, Cr income and Cash flows from financing activities
expenditure account
Net cash from financing activities $
If considered capital income, Cr to accumulated funds
Donations Net increase/decrease in cash/cash equivalents $
Small donations – revenue income Opening cash and cash equivalents $
Large donations – capital receipts Closing cash and cash equivalents $
Cr – special trust fund
Dr – trust fund a/c annually with expenses related Non-current assets schedule $
to it
Opening cost $
Purchases $
1.3. Limited Companies
- Disposals ($)
Directors must ensure that FS: Closing cost $
Follows International Accounting Standards and Opening accumulated depreciation $
adhere to their selected methods Depreciation for the year $
Display all of the company’s transactions - Depreciation eliminated on disposal ($)
Show a true and fair view
Closing accumulated depreciation $
Complete set of FS (IAS 1):
Income statement Closing NBV $
Statement of financial position Opening NBV $
Statement of cash flows
Statement of changes in equity
1.4. International Accounting Standards
Notes on accounting policies
Chairman’s statement
IAS 1 – Presentation of financial statements
Auditor’s report
Basis for presenting financial statements
Director’s report
Allows for comparisons throughout periods and
States the main activities of the company between companies
Review of previous years’ performance FS should contain a statement of compliance
Review of future development plans FS should be in accordance with accounting concepts
Directors’ names and shareholdings
Company name and time period covered by the
Dividends details statements should be provided
Difference between net book values and market IAS 2 – Inventories
values of land & buildings Inventories include:
Policies for payments to suppliers Goods purchased for resale
Statement of cash flows uses
Raw materials purchased for products
Cash flows are an objective measure Work in progress
Allows for liquidity analyzation – only cash recorded Finished goods
Shows efficient use of cash and cash equivalents
Valued at lower of cost and net realisable value
Reveals information not disclosed in income
Deduct repair costs from recoverable amount for
statement – explains differences
damaged goods
Used for budgeting future cash flows
Accepts FIFO and AVCO, not LIFO
IAS 7 – Statement of Cash flows
Statement of cash flows $
Operating activities
Cash flows from operating activities: Cash flows from the regular trading activities of a
Profit from operations $ business
Adjustments for $ Profit/Loss needs to be adjusted to only include
Cash from operations $ cash transactions

- Interest paid during the year ($)

Cash inflows Cash outflows
- Income tax paid ($)
Profits Losses

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CAIE A2 LEVEL ACCOUNTING (9706)

Cash inflows Cash outflows Acc. Dep. and impairment losses

Depreciation method and rate – can only be
↓ in inventory ↑ in inventory
changed if new one gives fairer representation of
↓ in trade receivables ↑ in trade receivables
asset and the change is noted
↑ in trade payables ↓ in trade payables IAS 36 – Impairment of assets
Loss on disposal Profit on disposal Impairment loss: recoverable amount less than NBV
Interest received Interest paid Impairment loss deducted from retained earnings
Tax refund Taxes paid Asset value falls due to:
Being damaged
Technology redundancy
Investing activities
Market value drop
Cash flows from a business’ investments and the
purchase/disposal proceeds of non-current assets Impairment loss = carrying amount – recoverable
amount
Cash inflows Cash outflows Recoverable amount: the greater of an asset’s fair
value and its value in use.
Non-current asset sale Non-current asset purchase
IAS 37 – Provisions, contingent liabilities and contingent
Investment income received Purchase of investments
assets
Contingent liability: potential liability which can’t be
Financing activities accurately measured
Cash flows from activities that change a business’ Contingent asset: potential asset with economic
capital or long-term borrowing benefit that can’t be accurately measured
Involves external sources of finance Contingent liabilities
If probable – provision created, deducted from
Cash inflows Cash outflows
profit and increase current liabilities
Dividends received Dividends paid If possible – only mention in FS notes
↑ in share capital Redemption of share capital Contingent assets
↑ in debentures Redemption of debentures If probable – mention in FS notes
↑ in long term loans Repayment of long-term loanS If possible – not disclosed
IAS 38 – Intangible assets
IAS 8 – Accounting policies Intangible assets: non-physical non-monetary asset
which is expected to economically benefit the
Similar IAS 1’s requirements but is more specific –
business in the long-term
methods, principles, formats mentioned
Bases – methods of treatment chosen by directors Can be purchased or internally generated; the latter
isn’t recognized nor is goodwill
(e.g., dep. method)
Apply accounting policy given by the standard, use Must be shown at NBV after acquisition
rationale if unavailable Cost – accumulated depreciation and impairment
Material errors should be fixed in the following FS losses
after discovery Revaluation based on fair value – depreciation and
IAS 10 – Events after the reporting period impairment losses
Events after the end of the accounting period but Intangible assets with finite life are amortized
before FS are published Tangible assets with finite life are depreciated
Adjusting events Regular revaluations ensure fair value
Occur at/before the end of accounting period Value increase – record in revaluation reserve
If material, adjust FS to correct figures before Value decrease – expense in I/S
publishing Differentiate capital and revenue expenditure
Social responsibility
Non-adjusting events (e.g., proposed dividends)
Occur after the end of reporting period Consumer awareness of business environmental
No changes made to FS impact increasing and constantly up-to-date
If material, mention in FS notes to inform Managers must show:
IAS 16 – Property, plant and equipment (PPE) Awareness of their social implications
PPE: physical non-current assets held for typically Manufacturing products with more than just
more than one time year financial considerations
PPE cost includes all attributable costs and shown at Bad publicity via social media affects worldwide sales
net book value (NBV) after acquisition
Derecognized assets profit/loss recorded in FS 1.5. Auditing and stewardship of limited
FS notes show:
companies
Useful economic life of asset

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CAIE A2 LEVEL ACCOUNTING (9706)
Auditors: qualified accountants who carry out an audit
i.e., examine a business’ financial records
External auditors: independent of the company and
selected by shareholders
Internal auditors: staff who report to management
Role of auditor
Check that FS apply relevant accounting concepts
Check that FS consistent with previous periods
Check that FS give true and fair view
Verify that transactions have actually taken place and
recorded accurately
Sole traders are not required by law to audit – no divorce
of ownership and control
Qualified audit report: due to misstated balances or lack
of evidence
Shareholder duties
Appoint auditors to guarantee directors are preparing
true and fair FS
Appoint trustworthy directors
Provide finance for the smooth running of the
business
Vote during AGM
Role of directors
Divorce of ownership and control – shareholders are
the owners while directors manage the business
Keep proper accounting records and present FS
Take care of business assets
Select accounting policies to apply
Shareholders are the principal and directors are the
agent
Benefits of auditing
Increases FS credibility
Helps detect errors and frauds
Ensures FS give fair and true view
Some investors require it
Auditor is an independent third party – more reliable
2. Business Purchase and
Merger
Merger: two companies or more combining to make a
new company. It can also mean when one limited
company acquires another
Financial benefits of mergers
Synergy – higher value when combined
Previous experience/skills brought to merger
Vertical integration – controlling suppliers &
producers
Chance of gaining higher profits in the future
Larger market
More skilled workforce
Non-financial benefits
Larger market share
Internal economies of scale
Research and development easier
Diversification of products
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Merger – 2 sole traders
Both SOFP combined and owners decide the new
values of assets and liabilities for the new business
Appropriate payments and withdrawals made to
reach new capital
Add new revaluated figures to FS
Purchase of sole trader by a limited company
Sole trader paid by cash, issue of shares or both
Purchase consideration may be more, less or the
same amount as the acquired business’s assets
Add sole trader’s revaluated assets and liabilities to
limited company FS
Purchase consideration: amount payable by a company
when taking over a business
Purchase of partnership by a limited company
Follows the previous process
Likely to have some issues when allocating shares and
debentures between partners
Merger – 2 limited companies
One limited company buys the assets and takes on
the responsibility of liabilities for another business
Assets and liabilities of both companies are combined
Goodwill = purchase consideration – revaluated net
assets
Acquisition of another limited company’s shareholding by
a limited company
Company purchases shares in another company like a
regular investment
Limited company purchasing shares FS:
Current assets – ordinary shares cost
Total assets unchanged because current assets
are used for purchase
Original non-current assets and equity unchanged
Limited company that owns the shares FS:
Only equity affected – ordinary share capital and
share premium
3. Consignment and Joint
Venture Accounts
Consignment: transferring goods from a consignor who
owns them to a consignee, who is typically in another
country
Consignor: sends goods to an agent
Consignee: the agent that collects, stores and sells goods
for the consignor
Del credere agent: type of consignee that guarantees sale
of goods and receives higher commission
Consignee is paid % of the revenue from the goods on
consignment • Until consignee sells the goods, they are
under the consignor
Consignment a/c
Dr – expenses, goods on consignment
Cr – sales
Missing figure – I/S (profit)
Consignee a/c
CAIE A2 LEVEL ACCOUNTING (9706)
Dr – sales
Cr – expenses, commission
Missing figure – bank (remittance)
Consignor acc opposite entries of consignee
Divide bundled costs with no. of units
Disadvantages
No risk to agent, only consignor
Have to pay commission
Joint venture: temporary partnership by 2 or more parties
for a beneficial business opportunity
Joint venture a/c (for both parties)
Dr – expenditure incurred
Cr – sales
Missing figure – profit/loss
Member accounts are opposite Dr/Cr for each member,
missing figure is bank
Joint venture with other member a/c
Each party opens one and only records their own
transactions in this account
Dr – expenditure incurred owner
Cr – sales by owner
Missing figure – cash settlement
Dr – cash to other party
Cr – cash from other party
Memorandum a/c
Memorandum a/c created to analyse venture’s
profitability and calculate the cash needed to close it
Each party only records their own transactions so all
the info combined into a memorandum a/c
Used as I/S for joint venture
Memorandum a/c reveals venture’s profit/loss,
divided by given ratios and placed into partner’s accs
Cash settlement from individual parties’ joint venture
accs - amount transferred to close the venture
4. Computerised Accounting
Systems
Need to computerize
Businesses these days are extremely competitive in
the global economy
Make use of all technology available o Fundamental
system unchanged, just more efficient
Provides the latest information in real time
Advantages
Data entry is quicker and multiple files can be
accessed at once
Less error since one entry is used through many files,
assuming no error of original entry
Provides reliable information accessible anywhere
and available to staff
Easy to access info required by tax authorities and
calculate accurate figures
Automatically creates accurate invoices
Computer data always legible unlike handwriting
Increases efficiency – time can be invested elsewhere
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Computerized systems require more skill so training
motivates staff, improves job satisfaction and career
prospects
Disadvantages
Hardware costs like initial and repair costs
Software costs are long-term since technology is
constantly updating
Training employees – expensive
Workers may fear redundancy – lower morale o Error
of original entry due to repetitive work
Health hazards like eye strains and RSI
Back-up is necessary but hardcopies costly
Robust anti-virus protection needed – costly
Benefits to managers
Business’ IASs can be programmed into system
Use accounting information for strategic planning
Regular updated FS and budgets will show if
adjustments are required
Allows them to analyse possible outcomes
Spreadsheets can be used to prepare budgets and FS
Can monitor receivables and inventory easily
Get up-to-date information about payroll
Moving to computerized system process
Double check all original entries with multiple staff –
compare manual records to computer data
Implement multiple security measure e.g., firewalls
Every staff member should make their own password
and limited access according to their rank
5. Analysis and
Communication of
Accounting Information
Working capital cycle o Involves the period from when a
business pays for goods and receives cash from
customers for their sale
No. of days to convert net current assets to cash
Shorter cycles are better – means less external
finance required to cover it
Net working assets to sales
How much of sales revenue is in the form of net
current assets, which is less liquid
Measures the amount of net working assets that is in
a non-cash form
Less is better – indicates good inventory management
Income gearing
Shows the value interest paid by a business as a
percentage of its profit from operations
Less than 15% is optimum percentage
High value – reduces profit so less dividends paid
Gearing ratio
Measures how reliant a business is on outside finance
(non-shareholders)
High geared
more than 50%
CAIE A2 LEVEL ACCOUNTING (9706)

business considered risky, much debt & borrowing
Low geared
less than 50%
business is safe, little debt and borrowing
Investment ratios – Potential shareholders may pay more
Identifies activities that incur each overhead
Links cost recovery to cost behaviour
Cost drivers: activities are responsible for incurring the
costs.
Cost driver rate = Costof Activity
CostDriver​

attention to these Cost pools: the grouping of the accounts responsible for
Earnings per share (EPS) the activity costs.
Measures the amount of profit attributable to each Applying the ABC system
ordinary share Identify the indirect/overhead costs
Earnings: profit for the year after deducting tax and Find out which activities responsible for the
preference dividends overheads
Low value – low profits or too many shares Identify cost drivers
Price earnings ratio (P/E ratio) Allocate overheads to the related cost drivers
Calculates to buy one share, how many years’ worth Use the formula to find the cost driver rate
of earnings per share will potential shareholders give Absorb the total cost into the appropriate product
up? Advantages
Measures company’s ability to maintain earnings in More accurate cost system – realistic
the future Recognizes overheads and which activity incurs them
Compares the share’s market price to the EPS More efficient cost allocation
High ratio – investors have high confidence in the Implementing effective strategies from one branch to
company’s growth or overvalued share others increases efficiency
Low ratio – investors have low confidence for Assists in preparing estimate figures other areas
business growth or undervalued share Points out products that are under/overpriced
Dividend yield Disadvantages
Measures the dividends shareholders received as a Difficult to accurately allocate certain overheads
percentage of the share’s market price Complex process
High value – high return in short term, good cash flow Costly
Dividend cover
Measures how many times a business is capable of
paying its shareholders dividends, at its current rate, 7. Budgeting and Budgetary
in the future
High figure means Control
Dividend rates unlikely to fall if profit falls because
company can afford it Budgetary control: planning the use of resources and
Lower proportion of profit used for dividends money through budgets to achieve objectives
High levels of retained earnings – capital growth Advantages
Low number of dividends paid Aids in business planning
Low figure means Sets targets
Not much of profit is reinvested into the company Identifies limiting factors
Fall in profits may lead to fall in dividends Increases efficiency
Dividend per share Promotes coordination between departments
Measures the actual dividend paid to shareholders on Limitations
one ordinary share they hold Time consuming
High value Possible inaccuracies
Preferred by shareholders Financial perspective is the only one considered
Decreases retained earnings and slows growth Rigid decision making
Better for short term investment May be costly
Sales budget
Shows the sales and revenues expected for the
6. Activity Based Costing budget period
Based on sales forecasts for the budget period
(ABC) First budget prepared and info used for other budgets
Error in sales budget will affect the rest too
Activity based costing: when indirect costs and overheads Uncontrollable variables:
are assigned to products based on their activities – this is Competitors changing prices
because these costs cannot otherwise be allocated to Customers changing suppliers
specific products. Economic and political climate
Allocates costs according to how they are consumed Import taxes, tariffs and trade sanctions

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CAIE A2 LEVEL ACCOUNTING (9706)

Sales budget $ Trade payables budget $

Budgeted sales $ Credit purchases $
Budgeted sales revenue $ Total credit purchases $
- Cash paid to credit suppliers ($)
Production budget - Discount received ($)
Shows the production and inventory levels required
Balance c/d $
to match budgeted sales

Production budget $ Cash budget

Sales $ Shows future cash incomes and cash expenditures
from both capital and revenue transactions
Closing Inventory $
Ensures business is prepared for cash flows
Total production needed $ Advantages:
- Opening Inventory ($) Ensures sufficient cash is always available for the
Units to be produced $ business’ day-to-day activities
Makes business aware of cash surpluses – can
Purchases budget plan short-term investments for maximum return
Shows purchase quantities required to sustain Makes business aware of cash deficits – can find
production levels for the budget period other sources of finance to make up for it
Prepared weekly or monthly and examined frequently
Purchases budget $ Negative balance possible – when expenditure is
Production units $ more than income

Closing inventory $ Cash budget $

Total purchases needed $ Receipts
- Opening inventory ($) Cash sales $
Materials to be purchased $ Cash received from credit customers $
$
Labour budget
Shows the labour required to meet budgeted levels of Payments
production for the budget period Cash expenditure ($)
This includes: ($)
Labour hours required Net receipts/payments $
No. of workers required
Balance b/d $
Cost of employing this labour
Trade receivables budget Balance c/d $
Shows how much trade receivables are owed from
credit customers for the budget period Master budget
Takes into account the credit customer’s A comprehensive financial planning summary of the
outstanding balances and the allowed credit business for the budget period
periods Includes all the budgets
Consists of:
Trade receivables budget $ Budgeted manufacturing a/c
Balance b/d $ Budgeted I/S
Budgeted SOFP
Credit Sales $
Budgeted I/S:
Total credit sales $ Figures are totals of specified months
- Cash received from credit customers ($) Op. inventory is first month
- Discount allowed ($) Clos. inventory is last month
Balance c/d $ Limiting factor (or principal budget factor): restricts a
business from achieving its desired level of output
Trade payables budget Flexed budgets
Shows how much trade payable is owed to credit Budgets are control mechanisms to compare actual
suppliers for the budget period results to budgeted figures
Actual results affected by limiting factor cannot be
Trade payables budget $ compared to a fixed budget so they’re ‘flexed’
Balance b/d $ Adverse variances reduce profits and need to be fixed
to avoid further occurrences

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CAIE A2 LEVEL ACCOUNTING (9706)

Favourable variances increase profits and need to be Direct material price sub-variance
identified so they may be implemented elsewhere Calculates changes between budgeted and actual
Reconciling flexed cost with actual production cost = costs caused by change in price of direct materials
variances total Favourable – direct materials cost < budgeted
Variance: the difference between actual figures and Trade discount
budgeted figures Poor quality materials
\ Deflation
Currency appreciation – imports cheaper
Fixed Actual Variances Adverse – direct materials cost > budgeted
Direct Materials $ $ $ Favourables Better materials
Direct Labour $ $ ($) (Adverse) Inflation
Currency depreciation – imports expensive
Variable Overheads $ $ $
Direct labour variances
$ $ $ Total direct labour variance = direct labour efficiency
Fixed Costs $ $ $ sub-variance + direct labour rate sub-variance

Sq Sp Direct labour efficiency

8. Standard Costing Direct labour rate Aq Sp Sub variance
Sub Variance Aq Ap
Sets costs and revenues that should be achievable with
reasonable performance and efficient working practices
Direct labour efficiency sub-variance
to manufacture a product
Favourable – used less labour hours than budgeted
Standard hour: work levels that should be achieved in an
Highly skilled workers
hour
Better machinery
Sub-variance: a part of total variance; sub-variances are
Motivated workforce
added together to get total variance
Adverse – used more labour hours than budgeted
Advantages
Less skilled workers
Assists budget preparation
Poor machinery
Predicts future costs and helps set prices
Demotivated workers
Evaluates managerial performance
Direct labour rate sub-variance
Highlights areas of responsible for variances –
Favourable – labour wage rate is less than budgeted
increasing efficiency
Less skilled workers
Disadvantages
Fall in overtime rates
Complex
Wage deflation
Time-consuming
Adverse – labour wage rate is higher than budgeted
Predictions may be inaccurate
Highly skilled workers
Needs to be regularly updated
Rising overtime rates
Direct material variances
Wage inflation
Total direct material variance = direct material usage
Direct expenses variance = total materials variance + total
sub-variance + direct material price sub-variance
direct labour variance
Sq Sp Materials usage Fixed overhead expenditure variance
Budgeted overhead (not flexed) – actual overhead
Materials price Aq Sp Sub-variance
Difference between actual spending on overheads
Sub - variance Aq Ap and budgeted
Favourable – actual expenditure less than budgeted
Aq/Ap/Sq/Sp = Actual/Selling quantity/price Adverse – actual expenditure more than budgeted
Direct material usage sub-variance Fixed overhead volume variance
Calculates change in total costs as a result of change Budgeted overhead – (actual units x OAR)
in the material quantity used Difference between overheads absorbed and
Favourable – used less materials than budgeted budgeted due to production
Better materials Favourable – actual production more than budgeted,
Highly skilled workers over absorbed
High quality machinery Adverse – actual production less than budgeted,
Adverse – used more materials than budgeted under absorbed
Poor quality materials Total fixed overhead variance = expenditure variance +
Less skilled workers – mistakes more likely volume variance
Poor machinery Fixed overhead capacity variance
Materials stolen

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CAIE A2 LEVEL ACCOUNTING (9706)

Budgeted overhead – (actual hours worked x OAR) $ $ $

Difference between actual hours worked and hours - Variances Favourable Adverse $
absorbed o Identifies whether business has managed
$ ($) ($)
to use its planned capacity
Favourable – actual hours more than budgeted, over Actual Costs $
absorbed
Adverse – actual hours less than budgeted, under
absorbed
9. Investment Appraisal
Fixed overhead efficiency variance
(Budgeted hours worked – actual hours worked) x Only considers additional revenue and expenditure,
OAR per direct labour hour existing ones disregarded
Identifies whether labour force has achieved Reasons to appraise
budgeted efficiency levels Huge amounts of money involved
Favourable – actual hours less than budgeted so Long-term commitment of money
business is efficient Affects profits
Adverse – actual hours more than budgeted so Not an easy to reverse choice
business is inefficient Net Present Value (NPV)
Fixed overhead volume variance = capacity + efficiency NPV = acc. present values – initial investment cost
variances Present value: net cash flow x discount factor
Sales variances Calculates present (discounted) value of future net
Total sales variance = sales volume sub-variance + cash flows (cost of capital) and deducts the initial
sales price sub-variance investment cost
Positive NPV projects should be considered
Sq Sp Sales volume Negative NPV projects should be declined financially,
Sales price Aq Sp Sub variance but can be kept for other reasons
If all options yield negative NPV then accept none
Sub Variance Aq Ap
Discount factor: calculate future cash value in its
present value today
Sales volume sub-variance
Favourable – more units sold than budgeted Year Net cash flow Discount rate Present value
Higher market share
0 (initial cost) 1 (initial cost)
Certain goods in season
Less competition x x x x
Changed consumer tastes NPV = xx
Adverse – less units sold than budgeted
Fall in market share Advantages
More competition Considers time value of money as future net cash
Damaged products flows are adjusted for present value
Sales price sub-variance Easy to understand
Favourable – price higher than budgeted Earlier cash flows valued higher
Costs may have risen so need to cover them Disadvantages
After effect of penetration pricing Figures are speculative as they are projections
Adverse – price less than budgeted Cash flows can change so it’s hard to estimate
Bulk sales Cost of capital could change over project life
Penetration pricing Difficult to estimate project life
Reconciling standard cost to actual cost Accounting rate of return (ARR)
AverageP rof its
AverageInvestment * 100
​

$ $ $ Average profits = (total net cash flows – initial cost) ÷ n

Standard costs $ n = expected useful life
Flexed standard costs Favourable Adverse $ Average investment = (Initial cost + scrap value) ÷ 2
- Variances $ ($) $ Similar to ROCE, return on investment shown as a %
of average investment over the time period
$ ($) ($)
If additional capital is injected, add the figure to
Actual Costs $/
average investment
Advantages
Reconciling standard profit to actual profit Calculations are easy
Projects’ profitability can be analysed
$ $ $
Disadvantages
Standard profit $

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CAIE A2 LEVEL ACCOUNTING (9706)
Ignores time value of money
Projects have different cash flow patterns – may
be more profitable in the future
Payback
Only uses cash flows
Longer payback periods generally lead to less reliable
cash flows
Payback period: the time period in which a project’s
total cash flows equals its initial investment cost and
is recorded in years
If profits are given, add back non-cash expenses and
calculate
If cash inflows and outflows are given, find net cash
flows and calculate
Advantages
Calculations are easy
Can be understood by non-accountants
Good for initial screening
Cash is more objective than profits, which can
change depending on the accounting policies
applied
Since smaller payback periods are preferred – it’s
easy to identify the risk of each project
Disadvantages
Doesn’t consider time-value of money
Doesn’t take into account the life expectancy of
the project, like cash flows that occur after
payback period
Projects may have different cash flow patterns –
may be more profitable in the future despite long
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payback period
Internal rate of return (IRR)
+NP V
P + [ ( N - P ) * +NP V +−npv ]
​
Calculates rate of return of a project
P = positive discount factor
N = negative discount factor
IRR % should be higher than cost of capital %
-NPV is added, not subtracted from +NPV
If both NPVs positive, then one should be deducted
from the other
Advantages
Considers time value of money
Calculations are simple
Disadvantages
Doesn’t take into account the life expectancy of
the project, like cash flows that occur after
payback period
Projects may have different cash flow patterns –
may be more profitable in the future despite long
payback period
Ignores size of project
Sensitivity analysis
Initial investment cost, cash flows and IRR will be
given
Find +NPV % and –NPV % using trial and error
Put new figures into IRR formula and equate to given
IRR
CAIE A2 LEVEL
Accounting (9706)

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