Cost Accounting: Principles, Techniques, and Investment Appraisal Decisions

This study material from Desklib covers the principles, concepts, and techniques of cost accounting, including solutions to MCQs. It also explains how to calculate payback, evaluate the payback technique, and understand the characteristics, advantages, and disadvantages of the IRR. The content is relevant for students studying cost accounting, investment appraisal, and related subjects in colleges and universities.

Cost Accounting

Contents
Part 1 – Cost accounting principles, concepts and techniques (Solution to MCQs).......................3
Part 2 – Cost accounting techniques................................................................................................4
a) Calculate the payback for both the Edinburgh and Newcastle upon Tyne contracts..............4
b) Critically evaluate the payback technique...............................................................................5
c. Characteristics of investment appraisal decisions and the advantages and disadvantages of
the IRR.........................................................................................................................................5
REFERENCES................................................................................................................................8

Part 1 – Cost accounting principles, concepts and techniques (Solution to
MCQs)
1. d) overstate the predetermined overhead rate.
2. d) None of the above
3. b) Under absorbed by £5,442
4. b) Materials 400, Conversion 200
5. a) direct costs
6. d) Preparation of plans for the future direction of a business
7. d) £168,750
8. d) The Internal Rate of Return is the discount rate at which the net present value is zero
9. a) The business is paying a higher hourly rate than standard
10. b) Providing internal information for use by management
11. b) £188,160
12. b) An accounts department
13. d) £7,210
14. b) Financial and non-financial data.
15. a) £0.08
16. c) £24,000
17. d) Fixed costs.
18. d) £143,750
19. a) The procedures used to calculate unit costs in manufacturing industries are not applicable
to service industries.
20. c) £223,107
21. b) Variable cost.
22. d) £497.45
23. b) £112,378
24. a) £600 Adverse
25. d) Direct materials.
26. d) £1,438,332

27. a) Master budget
28. c) It is that part of the output of a process where two or more products are produced which
have substantial sales value to a business.
29. d) Pro forma statements, a capital expenditures budget, and a cash budget.
30. d) £1,200
Part 2 – Cost accounting techniques
31.
a) Calculate the payback for both the Edinburgh and Newcastle upon Tyne contracts.
Edinburgh Newcastle
Year Cashflows Cumulative
Cashflows
Cashflows Cumulative Cashflows
0 (12820) (12820) (11840) (11840)
1 3,780 (9040) 3,500 (8340)
2 4,150 (4890) 3,850 (4490)
3 4,550 (340) 4,200 (290)
4 5,120 4780 5,150 4860
5 4,900 + 110 9790 4,950 + 95 9905
Payback Period = Last period with negative cumulative cash flow + (Absolute value of
cumulative cash flow at the end of negative cash flow period / Total cash flow in the year
after negative cumulative cash flow )
Edinburgh = 3 + (340 / 5120)
= 3 + (0.066 * 12)
=3 + 0.7
= 3.7 years or 3 Years and 7 Months
Newcastle = 3 + (290 / 5150)

= 3 + (0.056 * 12)
= 3 + 0.6
= 3.6 Years or 3 years and 6 Months
Interpretation: The above results of payback period for the projects of Edinburgh and
Newcastle shows that the project of Newcastle is more viable for the business as it is paying
back its initial cost of investment in just 3 years and 6 months. The other project, i.e., Edinburgh
is taking one extra month and will pay back in 3 years and 7 months. Newcastle project is more
viable for the business to opt.
b) Critically evaluate the payback technique.
A payback method accepts or rejects an investment idea based on the payback duration. The time
it takes for a project to recoup its investment is referred to as the payback period (Sinha, and
Datta, 2020). The majority of the time, it is stated in years.
Advantages of Payback technique are:
 A project with a short payback period can immediately enhance the business's cash
situation. The payback time is critical for businesses that rely heavily on cash.
 An investment with a fast payback period allows cash to be available for investment in
another project quickly (Abdel-Kader, 2019).
Disadvantages of Payback technique are:
 The time worth of money is not taken into account in the repayment approach (Yang,
2018).
 It ignores the asset's useful life and the cash flow that the project may provide after its
payback period.
c. Characteristics of investment appraisal decisions and the advantages and disadvantages of the
IRR.
The following are characteristics of investment appraisal:
 a calculation of the predicted return on investment for a certain amount of money spent
 estimations of future costs and benefits during the life of the project
When evaluating a proposed capital project, the costs and benefits should be considered across
the project's expected lifespan (Baum, Crosby, Devaney, 2021). This is the estimated usable life
of the non-current asset being acquired, which is generally several years. This means that long-
term forecasting is required to determine future costs and benefits. A 'typical' capital project

entails the purchase of a non-current asset right away. The asset is subsequently put to use for a
number of years, during which time it is employed to boost sales or reduce operating expenses.
There will also be ongoing expenditures associated with the asset (Hartzell, and Baum, 2020).
It's possible that the asset will have a'residual value' at the conclusion of its economically useful
life. It might, for example, be scrapped or sold on the secondary market. (Items with a high
residual value, such as automobiles and printing presses, are common examples.)
One issue with long-term income, savings, and cost forecasting is that estimates might be wrong.
Despite the fact that producing solid predictions is incredibly difficult, every effort should be
taken to make them as accurate as possible (Arnold, and Lewis, 2019). A company should aim to
avoid investing in non-current assets based on too optimistic and unrealistic projections. The
assumptions that are used to make projections should be communicated explicitly (Sayed, and
Sabri, 2022). The estimates may be examined for reasonableness by the persons who are
requested to sanction the spending if the assumptions are explicit.
Return on Capital Employed (ROCE) and Payback are two key assessment approaches
discussed here.
Other more complex investment assessment methodologies include Net Present Value (NPV)
and Internal Rate of Return (IRR).
In a discounted cash flow analysis, the IRR is a discount rate that makes the net present value
(NPV) of all cash flows equal to zero.
IRR is calculated using the same methodology as NPV. Keep in mind that the IRR is not the
project's real financial worth. The yearly return is what brings the NPV to zero.
Advantages of the IRR:
 The first and most crucial point is that while evaluating a project, the internal rate of
return takes into account the time value of money (Magni, 2020).
 The most appealing aspect of this technique is how easy it is to read once the IRR has
been calculated. Accept the project if the IRR exceeds the cost of capital, but not
otherwise.

 The IRR hurdle rate or the minimum rate of return are not required to be determined in
IRR. Because it isn't reliant on the hurdle rate, the chance of erroneous hurdle rate
determination is reduced (Wang, and Wan, 2020).
Disadvantages of the IRR
 The IRR technique has a drawback in that it overlooks the real financial worth of
benefits. Because the IRR of 50 percent is higher than 18 percent, the IRR technique
will rank the latter project—with a far lesser financial benefit—first.
 When using the IRR approach to analyse a project, it implicitly implies that the
positive future cash flows will be reinvested at IRR over the project's remaining time
span. If a project has a low IRR, it will assume a low rate of return on reinvestment;
on the other hand, if a project has a very high IRR, it will assume a very high rate of
return on reinvestment.
 Investors occasionally come across projects that are mutually incompatible, meaning
that if one is acceptable, the other is not. A mutually exclusive project is one that
involves the construction of a hotel or a business complex on a specific tract of land.
Knowing if they're worth investing in isn't enough in these cases. The difficulty is
determining which investment is the best (Letmathe,and Doost, 2018). The IRR
technique produces a % interpretation number; however, this is insufficient. This is
related to the first drawback of scale economies, which the IRR overlooks.

REFERENCES
Books and Journals
Abdel-Kader, M.G., 2019. Investment decisions in advanced manufacturing systems: a review
and identification of research areas. Issues in accounting and Finance, pp.189-216.
Arnold, G. and Lewis, D.S., 2019. Corporate financial management. Pearson UK.
Baum, A.E., Crosby, N. and Devaney, S., 2021. Property investment appraisal. John Wiley &
Sons.
Hartzell, D. and Baum, A.E., 2020. Real Estate Investment and Finance: Strategies, Structures,
Decisions. John Wiley & Sons.
Letmathe, P. and Doost, R.K., 2018. Environmental cost accounting and auditing. In Green
Accounting (pp. 359-365). Routledge.
Magni, C.A., 2020. Internal Average Rate of Return and Aggregate Return on Investment.
In Investment Decisions and the Logic of Valuation (pp. 555-611). Springer, Cham.
Sayed, A.I.A. and Sabri, S.R.M., 2022. TRANSFORMED MODIFIED INTERNAL RATE OF
RETURN ON GAMMA DISTRIBUTION FOR LONG TERM STOCK
INVESTMENT MODELLING. Journal of Management Information & Decision
Sciences, 25.
Sinha, R. and Datta, M., 2020. Investment Appraisal of Sustainability Projects: An Assortment
of Financial Measures. In Social, Economic, and Environmental Impacts Between
Sustainable Financial Systems and Financial Markets (pp. 43-56). IGI Global.
Wang, Q. and Wan, G., 2020. Cost accounting methods and periodic-review policies for serial
inventory systems. Computers & Operations Research, 118, p.104902.
Yang, M.H., 2018. Payback period investigation of the organic Rankine cycle with mixed
working fluids to recover waste heat from the exhaust gas of a large marine diesel
engine. Energy Conversion and Management, 162, pp.189-202.