Accounting for Management Decisions

Verified

Added on  2023/06/03

|10
|2481
|306
AI Summary
This text covers topics such as breakeven analysis, accounting rate of return, cash flow statements, and liquidity analysis. It provides explanations, calculations, and recommendations for each topic. The subject is Accounting for Management Decisions and the course code is not mentioned. The college/university is not mentioned either.
tabler-icon-diamond-filled.svg

Contribute Materials

Your contribution can guide someone’s learning journey. Share your documents today.
Document Page
ACCOUNTING FOR MANAGEMENT DECISIONS
STUDENT ID:
[Pick the date]
tabler-icon-diamond-filled.svg

Secure Best Marks with AI Grader

Need help grading? Try our AI Grader for instant feedback on your assignments.
Document Page
Question 1
(a) Let the breakeven agency monthly revenue be $ X
Monthly Variable Costs
Sales staff Commission = (55/100)*X = 0.55X
Supplies & Printing = (12/100)*X = 0.12X
Usage costs for phones & computers = (9/100)*X = 0.09X
Total variable costs = 0.55X + 0.12X + 0.09X = 0.76X
Monthly Fixed Costs
Office rent = $ 4,000
Electricity = $ 700
Multi-line telephone system = $ 600
Computer Cabling Connection = $400
Salary of office manager = $ 8,500
Office furniture depreciation = $ 500
Total fixed costs = 4000 + 700 + 600 + 400 + 8500 + 500 = $ 14,700
Break even Analysis
For break even, Revenue = Costs
Hence, X = 0.76X + 14700
Solving the above, we get X = $ 61,250
Thus, to break even the agency must generate monthly revenue of $ 61,250.
(b) Intended monthly net profit (Assumed before tax) = $ 15,000
Profit = Revenue – Total Costs
Let the requisite monthly revenue be $ Y
Document Page
15000 = Y- 0.76Y -14700
Solving the above, we get Y = $ 123,750
(c) Commission made by the real estate agent is 6% of the gross property sales
Hence, if the real estate agency has to earn $ 15,000 in pre-tax profits, then the property sales should
be such that the commission revenue generated must be $ 123,750.
Let the gross property sales be $ Z
Hence, (6/100)*Z = $ 123,750
Solving the above, Z = $2,062,500
(d) The CVP analysis is based on certain assumptions which are satisfied in the given case. One of the
key assumptions is that the sale price, variable cost per unit and fixed cost would remain constant.
Clearly, this is true for the given business where commission is a fixed percentage of the gross
property sale and all the variable costs are constant functions of the revenue of agency. Further, the
revenue and cost functions are linear as is apparent from the description. Also, there is no issue of any
dynamic product mix owing to which the contribution margin for the business can be assumed to
remain constant (Drury, 2016).
Question 2
(a) Accounting rate of return
The tax rate has been assumed as 30%
This method involves calculating the average profit for the investment.
Project A (Investment) = $ 250,000
Project A (Average annual profit) = [175000-(250000/5)]*0.7 = $ 87,500
Project A (Accounting rate of return) = (87500/250000) = 35%
Project B (Investment) = $ 1,000,000
Project B (Average annual profit) = [300000-(1000000/5)]*0.7 = $ 70,000
Document Page
Project B (Accounting rate of return) = (70,000/1000000) = 7%
Project C (Investment) = $ 500,000
Project C (Average annual profit) = [200000-(500000/5)]*0.7 = $ 70,000
Project C (Accounting rate of return) = (70000/500000) = 14%
Payback Period
Project A (Investment) = $ 250,000
Project A (Annual cash inflows) = 175000*0.7 + (250000/5)*0.3 = $137,500
Project A (Payback period) = 1+ (112500/137500) = 1.82 years
Project B (Investment) = $ 1,000,000
Project B (Annual cash inflows) = 300000*0.7 + (1000000/5)*0.3 = $270,000
Project B (Payback period) = 3+ (190000/270000) = 2.70 years
Project C (Investment) = $ 500,000
Project C (Annual cash inflows) = 200000*0.7 + (500000/5)*0.3 = $170,000
Project C (Payback period) = 2+ (160000/170000) = 2.94 years
Net Present Value
Project A (Investment) = $ 250,000
Project A (Annual cash inflows) = 175000*0.7 + (250000/5)*0.3 = $137,500
Project A (NPV) = -250000 + 137500 (0.877+ 0.769+ 0.675+ 0.592 +0.519) = $ 221,900
Project B (Investment) = $ 1,000,000
Project B (Annual cash inflows) = 300000*0.7 + (1000000/5)*0.3 = $270,000
Project B (NPV) = -1,000,000 + 270,000 (0.877+ 0.769+ 0.675+ 0.592 +0.519) = -$ 73,360
Project C (Investment) = $ 500,000
tabler-icon-diamond-filled.svg

Secure Best Marks with AI Grader

Need help grading? Try our AI Grader for instant feedback on your assignments.
Document Page
Project C (Annual cash inflows) = 200000*0.7 + (500000/5)*0.3 = $170,000
Project C (NPV) = -500000 + 170000 (0.877+ 0.769+ 0.675+ 0.592 +0.519) = $ 83,440
(b) The best investment would be project A since it has the highest ARR, lowest payback period and
highest positive NPV. The next in line would be project C which has a positive NPV. This ranking is
not supported by payback period and ARR since both those measures fail to take the time value of
money in consideration. Project B is not feasible and hence rejected owing to the NPV being negative
(Parrino and Kidwell, 2014).
(c) Besides NPV also, there are several other alternative techniques of project analysis and capital
budgeting. The various advantages of NPV are indicated below (Arnold, 2015).
It considers the time value of money into cognizance which is essentially considering the fact
that money has opportunity cost. ARR, payback period fail to consider this.
NPV considers the cash flows of the project over the complete project life unlike payback
period which considers cash flows till the achieving of break even.
Also, NPV is very useful in reliable ranking of different projects.
The various shortcomings of NPV are listed below (Petty et. al., 2015).
NPV computation is quite sensitive to discount rate and hence it needs to be computed
accurately which is not easy.
Forecasting of the future cash flows especially over a longer period can be quite challenging
and often unreliable.
People lacking finance background find difficulty in interpreting this.
Question 3
(a) The requisite reasons are as indicated below (Bhimani et. al., 2017).
The cost of sales as reflected in the accrual income statement is only $ 850,000. In
comparison, the actual amount that has been given to suppliers during the year is 1,610,000
which is leading to operational cash flow being negative.
In the income statement, the sales are reported as $ 1,800,000 whereas the corresponding cash
receipts in cash flow statement are significantly lower at $ 1,330,000.
In the income statement, the other expenses are $ 22,000. In sharp contrast, the corresponding
payment to these other expenses during the year is $ 112,000 which is leading to cash flow
from operations being negative.
Document Page
(b) The performance is more accurately reflected by the income statement since it is based on accrual
basis. The accrual basis considers the revenue that is earned from the business operations and also
considers the various expenses incurred in this process. The actual cash flow may have a lag and the
same presents a distorted picture as the effect of transactions in multiple periods is captured in the
cash flow statement. Hence, accrual system based income statement is more representative of
financial performance (Heisinger, 2014).
(c) Balance sheet highlights the financial position of the company and provides information about the
asset and liabilities outstanding on a given date for the company. It provides information about capital
structure, liquidity and solvency. The income statement is reflective of the profitability of the
operations and hence indicates the profits generated by the company during the given year. The cash
flow statement is prepared on cash basis and highlights the transactions in cash that take place to
reflect the closing cash balance (Arnold, 2015).
Question 4
(a) Based on the given data, it is apparent that the accounts receivable days have surged during the
period at a rate which is significantly higher than the industry average. This indicates difficulty on the
company’s part in collection of receivables arising from credit based sales. The effect of this is
witnessed on the cash cycle which becomes longer and hence leads to working capital requirement
increase (Petty et. al., 2015).
With regards to inventory days, the trend is similar to that which has been witnessed for the accounts
receivable days. Also, consideration needs to be given to the continuously rising closing inventory
balance which is indicative of the lack of demand for the products of the company which leads to
rising inventory and lower sales for the business (Parrino & Kidwell, 2014). The accounts payable
days for the company are on the rise which potentially can imply lowering cash cycle and limited
working capital requirements. But, in this case considering the rising accounts payable balance
coupled with the decreasing cash balance, it seems likely that the company is facing a severe cash
crunch and thereby delaying the payment to the suppliers (Damodaran, 2015).
On the basis of the above, it is apparent that the company currently is facing a short term liquidity
crunch which is negatively impacting the company’s operations and the severity of the issue can be
gauged from the fact that at FY2017 end, the cash balance for the company stood at $ 5,000 only
(Arnold, 2015).
(b) The various actions that need to be urgently taken by the company to improve the situation are
outlined as follows.
Document Page
There is a need to bring down the accounts receivable days. This can be enabled by extending
attractive discounts to those customers who pay in cash instead of credit or make early
payment. The concern of this strategy is in the form of shrinking margins but it should prove
effective for resolving the liquidity crisis (Damodaran, 2015).
There is a need to reduce the inventory turnover days. The inventory is continuously piling
owing to the company’s inability to generate sales. Lucrative discounts should be given on the
inventory so that this could be converted into cash. The concern of this strategy is in the form
of shrinking margins but it should prove effective for resolving the liquidity crisis (Petty et.
al., 2015).
Even though accounts payables days have increased but this increase is not because of
favourable terms from suppliers but delay in payments. The company should make efforts to
provide payments to as many suppliers as possible so as not to default on any payment.
Further, for those suppliers for whom payment would be delayed, some financial incentive
should be provided (Parrino and Kidwell, 2014).
Question 5(a)
(a) Method A = Straight line depreciation
Reasoning: Depreciation remains same in 2017 and 2018
Method B = Units of production depreciation
Reasoning: Depreciation increases in 2018 and so does the production
Method C = Declining balance depreciation
Reasoning: 2017 has the higher depreciation while the depreciation expense for 2018 is lower
tabler-icon-diamond-filled.svg

Paraphrase This Document

Need a fresh take? Get an instant paraphrase of this document with our AI Paraphraser
Document Page
(b) Method A
Method B
Method C
(c) In accordance with the matching principle, the recognition of expense and revenue must be carried
out in the same period. As depreciation constitutes an expense, thus, it should be captured in
accordance with the asset usage which leads to generation of revenue. Hence, based on the usage and
asset type, the suitable depreciation method must be selected (Arnold, 2015).
(d) I am in disagreement with the given statement as there can be sizable divergence between the asset
carrying value and market value. The asset carrying value is dependent on depreciation driven by
accounting policies and standards but the actual depreciation in value of asset could be different
which leads to different market value (Emmauel and Otley, 2015).
(e) Asset carrying value (2018) = Purchase price – Accumulated depreciation = 132000 = 24000 = $
108,000
This asset is liquidated for $ 98,000 and hence there is a loss of $ 10,000 on asset disposal.
Document Page
Asset change = Increase in cash (98,000) = Decrease in non-current assets (108,000) = -$ 10,000
The liabilities would not change. Further, the loss on the sale would be reflected in the equity which
would be decreased by $ 10,000 and hence lead to the accounting equation balancing.
References
Document Page
Arnold, G. (2015) Corporate Financial Management. 3rd ed. Sydney: Financial Times Management.
Bhimani, A., Horngren, C.T., Datar, S.M. and Foster, G. (2017), Management and Cost Accounting
4th ed. Harlow: Prentice Hall/Financial Times
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John
& Sons.
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York: Cengage
Learning
Emmauel, R.C. and Otley, T.D. (2015) Accounting for Management Control. 8th ed. London: Cengage
Learning.
Heisinger, K.(2014) Essentials of Managerial Accounting 4th ed. London: Cengage Learning.
Parrino, R. & Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London: Wiley
Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., & Nguyen, H. (2015).
Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French Forest
Australia
chevron_up_icon
1 out of 10
circle_padding
hide_on_mobile
zoom_out_icon
[object Object]

Your All-in-One AI-Powered Toolkit for Academic Success.

Available 24*7 on WhatsApp / Email

[object Object]