EXAMINATION GUIDE - NOVEMBER 2009

Accounting for Decision Making

Structure of the Examination Paper

The paper consists of 5 Compulsory questions.

The questions address both theoretical and calculation based aspects of the syllabus.

Coverage

The examination paper covers 6 key chapters from the module.

1. Accounting Ratio and Analysis

2. Cost volume profit relationships
 Cost Analysis
 Material usage variance

3. Calculation of: Net Present Value

: Accounting Rate of Return
: Internal Rate of Return
: Payback Period
4. Cash Flow Statement
5. Cash Budget
6. Financial Statements and Accounting Concepts
 ACCOUNTING FOR DECISION MAKING
QUESTION 1

POST-CLOSING TRIAL BALANCE OF JABULANI TRADERS

AS AT 28 FEBRUARY 2007

Dr Cr
Capital R 160 000
Drawings 20 000
Land & Buildings 220 000
Motor Vehicles 180 000
Accumulated Depreciation on Vehicles 54 000
Furniture & Equipment 30 000
Accumulated Depreciation on Furniture & Equip. 9 000
Debtors Control 12 000
Provision for bad debts 600
Creditors Control 23 400
Inventories 30 000
Bank 23 000
Prepaid expenses 600
Accrued Income 400
Loan from Citi-Bank 200 000
Accrued expenses 12 000
Revenue 400 000
Cost of sales 120 000
Discount received 600
Commission income 900
Rent expense 48 000
Salaries & Wages 40 000
Water & Electricity 18 000
Telephone 17 000
Depreciation (18 000+3 000) 21 000
Interest on loan 32 000
Consumable stores 4 000
Repairs 16 000
Municipal rates 27 700
Bad debts 800 _______
860 500 860 500

You are required to:

1. Calculate the following ratios and comment on each ratio:
1.1 Return on Investment
1.2 Current Ratio
1.3 Acid-test Ratio
1.4 Solvency Ratio
1.5 Accounts Receivable Period (50% of sales are on credit)
1.6 Gearing ratio
1.7 Inventory Turnover Rate
1.8 Debt-Asset Ratio (20)

QUESTION 2

EC Industrials manufactures widgets that sell for R126 each.

The cost of producing and selling 240 000 units are estimated as follows;

Variable costs per unit:

Direct materials R30

Direct labour R18
Factory overhead R12
Selling and administrative expenses R15
R75

Fixed costs:

Factory overheads R3 200 000

Selling and administrative expenses R1 200 000

In the current year, to date 180 000 units were manufactured and sold. An additional 45
000 units are expected to be sold on the domestic market during the remainder of the
year. EC Industrials received an offer from Namibia Wholesalers for 12 000 units at R84
each. Namibia Wholesalers will market the product in Namibia with its own name brand
and no additional expenses will be incurred by EC Industrials. The sale to Namibia
Wholesalers is not expected to affect domestic sales of widgets and the additional units
could be produced during the current year using excess capacity.

As the Marketing Manager you are requested to make a decision to either accept or reject
the above proposal and to motivate the decision you have made. (15)
 QUESTION 3

The following information relates to two projects, Project A and Project B from which
one must be chosen by Construction International.

After-tax cash flows

Year Project A Project B

1 0 36 000

2 18 500 36 000

3 36 200 36 000

4. 123 000 36 000

Both projects require an initial investment of R117 700.

Cost of capital is 12%.

As the project manager of Construction International you are required to:

3.1 Calculate the Net Present Value (NPV) for both projects. (12)
3.2 Which project should be chosen? Why? (3)
(15)

QUESTION 4

The trading results of Fit-All Instruments for its 1st year of operations are expected to be
as follows:

Sales (@ R4 per unit) R 320 000

Less:
Material R 120 000
Wages 48 000
Variable overhead costs 24 000
Fixed overhead costs 50 000 242 000
Profit 78 000

You are required to calculate:

4.1 The break-even point in units.
4.2 The company’s margin of safety in units.
4.3 The number of units the company should sell in order to earn a
net income of R90 000.
4.4 The price per unit at which they should sell to achieve the same profit
in the following year if the total variable cost per unit increased by R0.80.
(20)

QUESTION 5

Astra Ltd intend investing in a new machine. The following details relating to the
machine apply:

Cost of machine R360 000

Expected useful life 6 years
Scrap value R 60 000
Method of depreciation Straight-line
Cost of capital 12%

Year Profit
1 R 6 000
2 R18 000
3 R100 000
4 R66 000
5 R112 000

Required:
5.1 Calculate the pay-back period (4)
5.2 Calculate the accounting rate of return (ARR). Comment on the return. (6)
(10)

QUESTION 6

FAIRWAYS LTD
CASH FLOW STATEMENT FOR YEAR-ENDED
28 FEBRUARY 2007
R
Cash flow from operating activities
Profit before interest and tax (Operating Profit) 122 094
Adjustments to convert to cash from operations
Non-cash flow adjustments 106 836
Add: Depreciation 106 836
Profit before working capital changes 228 930
Working Capital Changes (160 970)
Increase in inventory (110 340)
Increase in receivables (106 122)
Increase in payables 55 492
Cash generated from operations 67 960
Cash flow from investing activities 259 534
Proceeds from sale of plant and equipment 259 534
Cash flow from financing activities (345 720)
Long-term borrowings redeemed (345 720)
Net decrease in cash (18 226)
Cash balance (28 February 2006) 46 486
Cash balance (28 February 2007) 28 260

Use the Cash Flow Statement to answer the following questions:

6.1 How did the company use its cash flows from operating and investing
activities? (2)
6.2 Why were depreciation and increase in payables added to operating profit to
compute the cash flow from operating activities? (4)
6.3 Is the Cash Flow Statement above presented according to the direct method or
indirect method? Explain how the method used above is different from the
alternative method. (5)
6.4 Based on the information provided in the Cash Flow Statement above, explain
how does the company appear to be performing. (9) (20)
(100)
 SUGGESTED SOLUTIONS

QUESTION 1

1.1 Return on Investment: Net Profit x 100 %

Capital 1

= 57 000 x100 %
160 000

= 35.63%

1.2 Current ratio: Current Assets: Current Liabilities

= 65 400 : 35 400

= 1.85 : 1

1.3 Acid-test ratio: Current Assets – Inventories : Current Liabilities

= 65 400 - 30 000 : 35 400

= 35 400 : 35 400

= 1:1

Solvency ratio: Total Assets : Total Liabilities

= 432 400 : 235 400

= 1.84 : 1

Accounts Receivable
Period = Accounts Receivable
Credit Sales
= 12 400_ x 360
200 000 1
= 22 days

1.6 Gearing ratio = Owners Equity: Borrowed funds

= 160 000: 200 000
= 0.8:1

1.7 Inventory Turnover

Rate = Cost of Sales__
 Ave Inventory

= 120 000
30 000
= 4 times per annum

1.8 Debt-Asset ratio = Total Debt_ x 100

Total Assets 1

= 235 400________ x 100

367 000 + 65 400 1

= 235 400 %
432 400

= 54,44% (20)

QUESTION 2

A comparison of the sales offer of R84 with the selling price of R126 indicates
that the offer should be rejected. EC Industrials, however, has excess capacity and
the focus should be on the relevant cost, which is the variable cost. The difference
in the profit from accepting the offer is calculated as follows:

Differential Revenue from accepting the offer:

12 000 units @ R84 R 1 008 000
Differential cost by accepting the offer:
12 000 units @ R60 (R30 + R18 + R12) (R 720 000)
Differential profit from accepting the offer 288 000

The offer should therefore be accepted. (10)

QUESTION 3

PROJECT A

Year Cash Inflow Discount Factor Present Value

1 0 0.8929 0
2 18 500 0.7972 14 748
3 36 200 0.7118 25 767
4 123 000 0.6355 78 611
Total Present Value 119 126
Investment 117 700
NPV (positive) 1 426 (8)
 PROJECT B

Net Inflow R 36 000

Discount factor x 3.0373
Total Present Value 109 342
Investment 117 700
NPV (negative) ( 8 358) (4)

DECISION:

Project A should be chosen because the NPV is positive. Reject Project B

because it has a negative NPV. (3) (15)

QUESTION 4

Workings:
Per unit x Volume = Total
Sales R4 80 000 320 000
Variable costs R2.40 80 000 192 000
Contribution margin R1.60 80 000 128 000
Fixed costs (50 000)
Operating profit R78 000

4.1 Break-even point = Fixed Cost________

Contribution per unit

Variable cost per unit = 120 000 + 48 000 + 24 000

80 000
= R2.40

Therefore Break-even point = R50 000_____

R4.00 – R2.40
= R50 000
R 1.60
= 31 250 units (5)

4.2 Margin of safety = Budgeted sales – Breakeven sales

= 80 000 - 31250

= 48750 units (3)

4.3 Target Income (no. of units) = Fixed Cost + Target Income
Contribution per unit

= R50 000 + R90 000

R1.60

= R140 000
R1.60

= 87 500 units (4)

4.4 Break-even point = Fixed Cost + Target Income

Unit Price – Variable Cost Per Unit

80 000 units = R50 000 + 78 000

(x – R2.40)
80 000 (x – R2.40) = R50 000 + 78 000

80 000x – R192 000 = R128 000 + R192 000

80 000x = R128 000 + R192 000

x = R320 000
80 000

Thus price = R4.00 (8)

(20)

QUESTION 5

Depreciation = R360 000 – 60 000 = R300 000/ 6 = R50 000

Account
Year Profits Depreciation Cash inflows
1 R 6 000 R50 000 R56 000
2 R18 000 R50 000 R68 000
3 R100 000 R50 000 R150 000
4 R66 000 R50 000 R116 000
5 R112 000 R50 000 R162 000
6 R118 000 R50 000 R168 000
5.1 Pay-back Period

Investment: (R360 000)

Year1 Cash flow 56 000
(304 000)
Year 2 Cash flow 68 000
(236 000)
Year 3 Cash flow 150 000
(86 000)
Year 4 Cash flow 116 000 86 000 x 12
116 000
8.89 months
.89 x 30
= 27 days
Pay-back period = 3 years, 8 months and 27 days (4)

5.2 Accounting Rate of Return

ARR = Ave. annual profits x 100

Ave. investments
= R420 000 / 6 x 100_____
(R 360 000 + R60 000) /2
= R 70 000 x 100
R 210 000 1
= 33.33% (4)

If the firm’s target ARR is more than 33.33%, then this project must not be (2)
undertaken. However, if the firm’s target is less than 33.33% - accept this project.
(10)

QUESTION 6

6.1 Cash flows from operating and investing activities were used to redeem long-term loans. (2)

6.2 Depreciation is a book entry and as such does not require a cash payment. It is therefore,
added back to the profits to determine cash flows.(2)
An increase in payables implies that resources have been used for which payments have not
yet been made. Increase in payables is added to profit to calculate operating cash flow. (2)

6.3 The indirect method is used. (1)

The indirect method explains cash flows from operating activities by explaining the change
in each of the non-cash operating accounts in the balance sheet.(2)
The direct method explains how much cash was received or paid during the year for each
item reported. It reflects the operating expenses such as cash received from debtors, cash paid
 to creditors, cash paid to employees, cash paid for operating expenses, cash payments of
interest and cash paid for taxes. (2)
6.4 The company does not appear to be performing well.
Its cash flows from operations (R67 960) is significantly lower than its operating profit
(R122 094).
The increase in inventory suggests that the company was not selling its merchandise in good
time.
The increase in receivables suggests that the company was having difficulty in collecting
from its customers.
The increase in payables suggests that the company was having difficulty in paying its
suppliers.
The sale of plant and equipment to generate cash is a sign of poor financial performance.
(9)
(20)