Académique Documents
Professionnel Documents
Culture Documents
Accounting for
Managers
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or
transmitted in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without the prior written consent of the University of Leicester.
ACCOUNTING FOR MANAGERS
Contents
Preface
This study book ii
Section 1
Perspectives on Accounting
What is accounting? 3
Financial and management accounting 5
The emergence of accounting 6
Separation of ownership from control 7
Theoretical perspectives 8
Section 2
Principal Financial Statements
Introduction 14
The nature of profit 14
The nature of cash 15
The matching concept 15
The three main financial statements 17
The double entry system 18
Accounting conventions 21
Section 4
Regulation and Governance
Introductory context 63
The nature of regulation 64
International Financial Reporting Standards (IFRS) 66
Corporate governance 66
Contrasting national approaches 70
Supplementary statements 71
Section 5
Capital Markets and Shareholder Value
Role of financial markets 90
Shareholder return 91
Cost of capital 94
Value-based measures 95
Section 7
Marketing Decisions
Simple notions of product profitability 129
Cost, volume and pricing 131
Life cycle analysis 133
Target costing 135
Market pricing 135
Section 8
Operating Decisions
Resources 147
Accounting for resources 150
Advanced manufacturing environments 151
Service environments 154
Section 9
Budgeting Decisions
What are budgets for? 165
Control theory 166
Budget preparation 167
The master budget 169
Budgetary control 170
Criticisms of budgeting 172
Management Accounting Case Study Part IV
Pearl: Budgeting
Section 10
Performance Management
Dimensions of performance 183
Balanced scorecard 184
Divisional performance management 186
Return on investment (ROI) 188
Residual income (RI) 190
Performance review 191
Appendix A
Solutions to Tutorial Exercises
Section 4 201
Section 5 202
Appendix B
Outline Solutions to Case Exercises
Section 2 – Introducing Next plc 207
Section 3 – Next’s Accounts 210
Section 4 – Next and the Impact of Governance
and International Accounting Standards 215
Section 5 – Next Share Prices and Share Options 220
Section 6 – Dynamic Demand 222
Section 7 – Pearl’s Pricing Decisions 223
Section 8 – Pearl’s Operating Decisions 226
Section 9 – Pearl’s Budgeting 228
Section 10 – Pearl’s Performance Measurement 230
ACCOUNTING FOR MANAGERS
Preface
This study book provides the core learning material for those studying the
module Accounting for Managers with the University of Leicester School of
Management.
Accounting for Managers is designed for managers and not for aspiring
accountants. Managers need to interpret, not prepare, accounts. They need to:
The module specifies the following learning objectives; that, at the end of
this course, students will be able to:
This study book is organised into ten sections and you may find it helpful to
review your understanding against the learning objectives given at the start of
each section. Each section uses directed readings and questions, drawn both
from Collier and other sources – use the questions to assist your learning by
providing feedback on progress. References for further reading are provided
on Blackboard – these may take the form of texts, journal articles, and
internet sites of accounting institutions – but also follow up the references
provided in the Collier text.
You should note that most quoted companies now post their annual reports on
their websites and so there is a rich, contemporary source of accounting
information readily available to you. Indeed, one of the two case studies – Next
plc, which weaves a thread through Sections 2 to 5 of the study book – is drawn
from the internet and so can be supplemented and updated to form an
ever-changing story. This case covers financial accounting and reporting
whilst the other, a fictionalised business start-up, covers the management
accounting topics of Sections 6 to 10.
Corporate Governance
Together, the dedicated material and the textbook reading offer an insightful
guide through the subject matter, relating conceptual perspectives to the real
world.
SECTION 1
Perspectives on
Accounting
Section 1
Perspectives on Accounting
Learning Objectives
What is accounting?
The American Accounting Association defined accounting in 1966 as:
Let’s see what we can take from this definition. “Identifying” and “measuring”
requires the collection of appropriate data from primary sources and the
A merchant buys some cotton, turns it into thread, and sells it.
Another merchant buys the thread, dyes it, and sells it to a third
who makes cloth and sells it to a clothing manufacturer who sells
the finished garment. Four individual processes give rise to five
transactions – all made in the market – at prices determined by
the market. If the value of a sale exceeds the value of the related
purchase, a profit is made. In other words, the activity or process
that is undertaken on a particular item is value adding.
In contrast to the market transactions which form the basis for financial
accounting, the origin of management accounting lay in the industrial
revolution of the late 18th Century. Here, individual processes, previously
carried out in the market, were combined under one ‘roof’,
This has since evolved into management accounting where a wider range of
techniques have been designed to meet the requirements of complex
organisational forms in different sectors of the economy. Financial planning,
performance measurement, control and decision making are all supported by
this development.
The aim of these practices – to ensure the proper conduct of the affairs of the
company by its Board of Directors – remains true to this day. Financial
[2] The oldest professional accounting body – which became the Institute of
Chartered Accountants of England and Wales – was formed in 1870.
Theoretical perspectives
You could be excused for thinking that the theory of accounting might be
limited to arithmetic equations representing its renowned double entries.
However, you should now have become aware that accounting operates in a
historical, political, economic, social and organisational setting. Thus, the
regulation, purpose, and use of accounting information add dynamics to its
purely technical function which give rise to many theoretical positions. Collier
summarises these theories in Chapter 5 and explores them further in each
subsequent chapter in his book as they relate to specific applications of
accounting practice.
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
This section provides the context for your subsequent studies. It defines the twin
branches of accounting and gives a theoretical and empirical perspective on
their emergence. Do not be concerned if you don’t fully grasp the theoretical
positions yet: their relevance will become clearer as you work through the
directed readings on Blackboard and as you examine accounting applications
in the rest of the study book.
SECTION 2
Principal Financial
Statements
Section 2
Learning Objectives
This section provides you with the basic building blocks of account
formulation which will later enable you to critically interpret accounting
information. After studying this section and its readings, you should:
At the end of this section, the first case study – Next plc – is introduced.
Your learning can be applied to this reality and reinforced by undertaking
the exercises. The Next case material will be supplemented at the end of
Sections 3, 4 and 5 so that you can develop a comprehensive
competence in financial analysis.
Profit is the value of the sold output of a business less the cost of the related
input. Accountants attribute costs in various ways to the sales to which they
relate – including those that are not immediately or directly spent (e.g. the use
of plant and machinery and allocation of administrative resource).
Sales are often termed ‘turnover’ or ‘income’ (in the US) and costs may be
referred to as ‘expenses’. This can be confusing, especially when we encounter
cash-based terms such as receipts, payments, and expenditure. In common
parlance, these are often used interchangeably but, in interpreting accounting
reports, recognition of the correct terminology is important.
Cashflow is the net movement in the cash balance over an accounting period.
‘Net’ in that it is the cash in (which is termed ‘receipts’) less cash out (termed
‘payments’). Thus, the formulae are,
Accrual refers to the displacement in time between the transaction date and
the cashflow date. An example best illustrates this. In June, a business
purchases 100 widgets from a supplier for $400 cash. It sells widgets for $10
each and 70 are sold on a month’s credit to a customer in July; in August the
remaining widgets are sold for cash. Transactions occur in all three months,
but cash flows out in June and in August and profit is recognised in July and
August because the $4 cost per widget is set against sales in those months.
These events are shown in Figure 2.1. Note that profit and cashflow are the
same over the quarter, but that the phasing is shifted. The differences are due
to the following:
· in June, the cash payment has been used to buy stock (an asset),
1,000
Profit
750 Cashflow
500
250
-250
-500
June July August Total
At the end of August, there is no stock left, nor any amounts owed or owing.
The assets are now represented by a cash balance of $600, complemented as
we see by profits of $600.
The accrual concept means that accountants assess supplies or services that
have been received but not yet invoiced (as a liability), receipts in advance of
work done on a contract (also a liability), and prepayments for supplies of
services like rent (as an asset) in the calculation of profit.
A similar matching process operates in the longer term where assets are
bought that have economic lives of many years. For example: a distribution
company’s trucks, a manufacturing company’s machinery, a shop’s fixtures
and fittings, a software house’s office equipment. All of these ‘fixed assets’
provide commercial benefit over several years – that is they generate sales – so
that it is inappropriate to charge the full cost of these assets against profits in
the year of their purchase. Instead, accountants spread the cost over their
estimated lives and ‘depreciate’ the value of the asset as it ages.
5,000
-5,000
-10,000
-15,000 Profit
Cashflow
-20,000
· as at a specified date,
These three statements form the focus of your studies into financial
accounting and their format and content will be explored in this and the next
section.
Assets are shown as debit entries, whilst liabilities and capital are credits. In a
balance sheet,
CASHFLOW STATEMENT
Receipts Payments
BALANCE SHEET
Cash Overdraft
Current
Liabilities
Current Debtors Creditors
Assets
Capital
Reserves and
Reserves
Costs Sales
Figure 2.3 The relationship between capital and assets/liabilities, and profit and cashflow.
The net assets of a business are funded by capital – ‘debt’ and ‘equity’. Loans
are a common example of debt capital and form a CR in ‘Long-term Liabilities’
when arranged (DR to Cash), falling as they are repaid until they become a
Current Liability. Note that the interest paid to service the loan does not affect
the amount outstanding: it is a DR to Costs and a CR to Cash. Capital and
Reserves represent the invested funds of the shareholder (DR to Cash when
shares are issued) and are supplemented by profit retained by the business
(CR balance on the profit & loss account). Reserves vary in composition, but a
common situation arises from an upward revaluation (CR to Reserves) of Land
and Buildings (DR to Fixed Assets).
Figure 2.4 Illustrating double entry using the three financial statements.
Accounting conventions
Accounts are kept and financial reports produced using certain rules that
accountants are trained to apply and professionally maintain. These rules
have become formalised into quality standards which are now internationally
adopted (see Section 4). For now, we will limit consideration to a simple
interpretation of the most important ones.
A business’ accounts separate the affairs of the business from that of its owner.
The owner’s interest is recorded as capital and reserves – a liability from the
perspective of the business. Accounts are largely prepared from third-party
transactions which have already occurred – an obvious observation in respect
of the cashflow statement. What is significant, however, is that both the
calculation of profit and (most) assets and liabilities in the balance sheet is
based upon ‘historic costs’ and not realisable value. This means that net asset
value is an eclectic collection of cost over the past and does not represent the
market value of a business (see Section 5 for a discussion of this).
Going concern
Accruals
This practice has already been employed earlier in this section. Some small
businesses, public sector and non-for-profit organisations will prepare
Comparability
When accounts are published, figures for the previous year are required. To be
consistent, it is important that the same accounting policies have been used
and, if changed, explanation provided and the comparative figures adjusted.
You should note that this does not overcome the effect of inflation, and caution
is necessary in economies where the purchasing power of money is falling
rapidly.
Reliability
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
Please work through the directed reading as outlined on Blackboard. At the end
of this section (with its accompanying readings), you should be reasonably
familiar with the principles of double entry and the preparation of the balance
sheet. Attempt the questions that have been selected on Blackboard and check
your answers against the solutions. This will provide a useful check on your
Finally, read through the initial case material on Next plc – get a sense of its
business context and an outline feel for what the accounting numbers are
telling you. There are some simple exercises for you to follow, but formal
analysis will follow in Section 3.
FINANCIAL ACCOUNTING
Inevitably, not all the content will be understandable with or explained by the
study book: for example, pension and employee share ownership
arrangements. The data has been simplified where practicable and the
exercises you are asked to undertake will relate to the ontology covered in the
section and reading. You are encouraged to examine the full accounting
information on Next plc by visiting
http://order.next.co.uk/aboutnext/CompanyResults/index.asp
and downloading the Annual Report.
Commercial context
Next plc is a multi-national clothing retailer, headquartered near Leicester in
the UK. The company was originally called J. Hepworth & Sons, established in
1864. The Next brand was launched in 1982 and the company’s name was
changed in 1986. The group has grown dramatically, though not consistently,
over the last 24 years and now has a turnover in excess of £3 billion. Its
principal business (Next Retail) is conducted through over 550 outlets,
including 100 foreign franchise stores, a significant mail order business (Next
Directory), and a growing call-centre operation that developed out of the mail
order operation. Next’s core business remains clothing, but diversification is
evident into home, jewellery, flowers, electrical devices, and financial services.
Next plc has eight wholly owned subsidiaries, including a garment
manufacturer in Sri Lanka and a buying operation in Hong Kong. Next
The figures shown in the final column are shares bought back by Next plc from
their own shareholders. This means that the company pays market prices for
their shares. The shares are shown in the balance sheet at their historic issue
price. There were 246 million shares in circulation at the end of 2006, 90
million less than five years earlier.
Next Retail
“In the year we increased our net selling space by 980,000 square feet to
4,300,000 square feet. Despite difficult trading conditions we are
forecasting that the sales performance of our portfolio of new stores will
be in line with their appraised target, giving payback of the net capital
invested in 18 months.
“The table below shows how the profile of our stores and space has
changed over the last three years:
Next Directory
“NEXT Directory had a good year with sales up 13.7% and profits up
18.5%. Sales continue to benefit from increased use of the Internet,
whilst improved gross margins and tight control of costs moved profit
ahead faster than sales.
Business development
“In particular we will aim to leverage our two million Directory home
shopping customer base. To this end we are trialling an electrical
brochure (NEXTelectric) with 300,000 customers and if this is
successful we can rapidly roll it out to the rest of the customer base in
the Autumn.
Next franchise
Ventura
“Several existing contracts were renewed during the year and three
significant new customers have been added to the client list. Ventura
employs in excess of 7,000 people and its UK call centres are operating
close to full capacity. Its call centre in Pune, India opened during the
year and handles business on behalf of NEXT Directory and two other
clients.
Outlook
Current assets
Prepayments 85 76
Cash 70 72
912 811
Current liabilities
(756) (588)
Non-current liabilities
(462) (432)
256 277
Share capital 25 26
Plant, shop fronts and retail fittings in the high street 16.7%–50.0%
retailing business
(2a) Review the data in the ten-year history. What does this tell you about
the financial performance of Next plc over the last decade?
(2b) Calculate the capital employed as at January 2006 using the formulae
given in Section 2 and the balance sheet data for Next plc. Is it rising?
(2c) What does the ‘shareholders’ funds’ figure in the balance sheet mean?
(2e) What can you determine from the balance sheet about the cash
position of Next plc over the course of the year?
(2f) Why are prepayments shown under ‘current assets’ in the balance
sheet?
(2g) Why are pension obligations shown under non-current liabilities in the
balance sheet?
(2h) Using data in Note 9 to the 2006 Annual Accounts, calculate the
average life over which depreciation is charged on plant and fittings
and the average age of those fixed assets.
(2i) What do you deduce about the rate of fixed asset replacement in view
of the strategic growth of the company?
(2j) What is the likely impact of the historical cost convention on the
reported value of freehold property?
(2k) In view of the above, what is your view of Next plc’s balance sheet and
its reported shareholders funds?
SECTION 3
Interpreting Financial
Statements
Section 3
Learning Objectives
Approach to interpretation
There is a procedure which you can follow as you begin to analyse a set of
accounts. It comprises five simple and fundamental tasks.
Context provides the stage upon which the accounting numbers perform.
How big is this business; its turnover, its assets base? Is the ‘top-line’ (sales)
growing? Calculate the percentage change on last year – roughly! Does this
rate of change repeat itself throughout the profit & loss account to the
‘bottom-line’? Note any major inconsistencies – these can be investigated
later. What’s happening with cash? Is the business cash generative? Has the
asset base expanded or contracted in keeping with the change in sales? Has
new capital been introduced or retired?
Does your quick analysis make any sense? Does this look like a business that
is managing growth well? Is it profitable? Is it under stress – from a lack of
cash? Now you can move to formal analysis that will help confirm your initial
view.
By calculating, comparing and analysing certain ratios from the profit & loss
account and the balance sheet, you can evaluate the profitability, efficiency,
liquidity, or riskiness of a business, and judge whether it is an attractive
investment. The perspective from which you are performing an analysis
determines the relevance of various ratios, so it is important to be selective in
your choice. An investor will be interested in risk and profitability, a bank in
liquidity and the asset backing for a loan (‘balance sheet strength’), a creditor
in liquidity, an employee in profitability and efficiency. The calculated ratio is
not important in itself, but whether it has improved or deteriorated since last
year, or is better or worse than a benchmark figure. The meanings of these
ratios will be explained and demonstrated later. Their limitations will then
become apparent.
Where potentially related ratios show converse changes (e.g. a growth in sales,
but a fall in debtors), the effect of management intervention is indicated (e.g. a
change in credit policy or rigorous chasing of customer debt). Explore this and
other inconsistencies or omissions that become apparent in the data in the
three financial statements or through ratio analysis. Where you are working
with a published set of accounts, this is where recourse to Notes to the
Accounts helps. You should also recognise that these Notes provide further
analysis on individual aspects, for example:
· the form, cost, and term of loans and other debt capital,
The Chairman’s Statement and Report of the Directors also provide a rich
source of information (e.g. remuneration) and tell you much about context.
Describing the context, summating the data, and calculating the ratios is not
enough. It is the objective and critical interpretation of your synthesis and
analysis that is important. Such a commentary forms the basis for judging
performance – for stakeholders – and the taking of decisions.
Illustrative interpretation
Table 3.1 provides some data for NARC Ltd. Other than that NARC is
evidently a medium-sized company, no context is included, so we start with a
quick review of the abbreviated financial statements.
Turnover has fallen by 10% in the year and this percentage change gives the
benchmark for further prior-year comparison. Since cost of sales has reduced
by the roughly the same proportion, gross margins appear unaffected and
mean that management have not responded to the fall in demand by discount
pricing. Operating profit has been cut by 20% because of depreciation – a
pre-defined, though notional, fixed cost. Intriguingly, earnings have risen by a
third because of the dramatic reduction in interest costs – is this because base
rates have fallen or because loans have been repaid? Reference to balance
sheet ‘debt’ suggests the latter. Dividends – a discretionary payment proposed
by the Board of NARC – have been increased, a sign of confidence to the
shareholders despite the sales collapse.
The balance sheet reveals a major contraction (over 50%) in the fixed asset
base of the company including its land and buildings. These could have given
rise to major gains on disposal, though none are evident so perhaps this is a
sale that has been forced upon the Board by lenders. This is possible given the
reduction in debt, but the remaining £1.2m is not shown as ‘current’ liabilities
(indicating that none is due for repayment within the next year). Whatever the
case, it is commendable that management generated the sales that they did
Closing Cash Balance 200 (300) Acc’ Retained Profit 500 400
Table 3.1 Summarised annual accounts for NARC ltd (Not A Real Company).
out of this reduced infrastructure facility. Stock has fallen 20% which either
indicates that buying decisions have been improving, or that stock has
remained on the shelf for less time. Debtors have stayed the same. Creditors,
in contrast, have dropped 60%, and reveal restrictions on credit granted to
NARC by its suppliers or a more liberal payment policy by the management.
Despite this, the cash position has dramatically improved – from overdraft to
surplus. Capital and reserves are stable, with no share capital issued or
The cashflow statement shows receipts in 2002 to be the same as sales (there
being no change in debtors), and you should note that the movement reflects
the change in the balance sheet position over the year. Unlike the other two,
the cashflow statement does not adopt the format – called ‘fundsflow’ – used
in reported accounts, it concurs with the simple ‘cashbook’ form that you met
in Section 2. You will recall from this section that all double entries can be
represented in the three principal financial statements. So it should be no
surprise that, given two of the three statements – and sufficient notes to the
accounts – we can construct the third.
£000s Notes
Capital expenditure less disposals 700 the movement in the gross book value of
fixed assets equal to
1200 + 5000 – (600 + 4500) – 400,
difference between change in depreciation &
the charge
Interest, dividend, & taxation (300) assuming amounts payable are paid giving
100 + 100 +100
Profitability
Gross margin
Gross margin relates sales to its directly attributable purchased and process
costs and provides an indication of the mark-up in selling price. It is therefore
particularly important in retail.
Net margin
Operating Profit
Net Margin = ´ 100%
Sales
Net margin is calculated after all operating costs have been taken into
account, but before taxation and the costs of servicing finance.
Operating Profit
ROCE = ´ 100%
Net Assets
ROCE can also be termed RONA (return on net assets) and is a popular
measure of return. It relates profit to the historic investment in the asset base
used to generate that profit.
2002 2001
results for comparison
Efficiency
Asset turnover
Sales
Asset Turnover =
Total Assets
This ratio indicates how hard assets are being worked and is especially
important for capital intensive industries. When used together with net
margin, it sharply demonstrates how ROCE can be improved by reducing the
asset base (as in NARC). Margins can improve by raising selling price and this
can damage sales, which reduces asset turnover and has the opposite effect on
ROCE. Note then that,
Profit Sales
ROCE = ´
Sales Assets
Stock turnover
Cost of Sales
Stock Turnover =
Stock
This ratio shows how often stock ‘turns over’ in a year by relating the amount
in stock to the amount used in production or sold in retail. It requires a
balanced judgement between having too little in stock and missing sales
opportunities, and having too much and so tying up funds for working capital
and risking obsolescence.
2002 2001
results for comparison
Liquidity
Settlement period
Debtors
Settlement Period = ´ 365 days
Sales
This is a measure of credit granted to customers. The more liberal the policy or
ineffective the debt progression, the more funds are tied up in working capital.
Similar calculations (see NARC) can be made for the credit taken from
suppliers, a flexible and much abused form of funding.
Current ratio
Current Assets
Current Ratio =
Current Liabilities
Acid test
2002 2001
results for comparison
Risk
Gearing
Debt
Gearing =
Debt + Equity
Risk is the degree of volatility in profits. Risk is higher where sales are
cyclical and there is a substantial fixed cost base as changes are multiplied (or
‘geared’) on the bottom-line. Debt finance is ‘fixed’ in that interest payments
must be met, but dividends are discretionary, therefore a high gearing conveys
high financial risk. Where shares are quoted, market values provide a much
more realistic indication of this risk than do the book values in a balance
sheet.
Interest cover
Dividend cover
This is similar in concept to interest cover, except that dividends are paid out
of earnings.
2002 2001
results for comparison
Investor
Note: quoted companies use measures of investor risk and return that are
based upon the market price of the share – price/earnings ratio, earnings and
dividend yield – these are explored in Section 5.
This is a comparable measure to ROCE except that ROE relates the profit
attributable to shareholders to the book value of their investment, whereas
ROCE does not distinguish between the form of capital used to fund the asset
base which generates profits, and hence uses the profit figure before interest
and dividends have been deducted.
This is the major measure reported in published accounts and ensures that
injections of equity are adequately reflected in increased profit. It cannot be
used for inter-firm comparison.
2002 2001
results for comparison
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Finally, undertake the exercise related to the case material from Next plc,
remembering to use the retail context and the company’s financial aims to
interpret the rather surprising results.
FINANCIAL ACCOUNTING
Next’s Accounts:
Interpretation and Ratio
Analysis
Financial Accounting Case Study Part II
Depreciation 81 69
Table 3.8 Next's profit & loss account. (Sources: Income Statement and Notes 2, 3 and 5 to the
Annual Accounts, 2006.)
During the year Next plc purchased for cancellation 9,060,984 of its own
ordinary shares in the open market at a cost of £126.9m, and a further
5,950,000 under off-market contingent purchase contracts at a cost of £90.6m.
The cost of these purchases was set against retained profits for the year (and
not other reserves as in earlier years). On 30 April 2005, Next plc issued 8,031
ordinary shares for a cash consideration of £0.1m (source: Notes 26 and 27 to
the accounts).
Dividends
Accounting entries related to dividend distributions are shown in Table 3.10.
Debt capital
As at January 2006, the amount of the outstanding liability was £401m
(source: Notes 18, 21, 32 and 33 to the accounts), comprising:
Table 3.11 Next's segmental analysis for 2006 (source: Note 1 to the accounts).
Cash Cash
inflows, outflows,
£m £m
Cashflows from operating activities
Profit before interest 471
Depreciation 81
Share option charge 8
Increase in inventories 22
Increase in trade and other receivables 76
Increase in trade and other payables 63
Pension contributions less income statement 12
charge
Corporation taxes paid 113
623 223 400
Cashflows from investing activities
Proceeds from sale of property, plant and 8
equipment
Acquisition of property, plant and equipment 178
8 178 (170)
Cashflows from financing activities
Repurchase of own shares 218
Proceeds/(repayment) of unsecured bank loans 100
Interest paid & received 1 21
Dividends paid 104
Net cash from financing activities 101 343 (242)
Net decrease in cash and cash equivalents (12)
Opening cash and cash equivalents 50
Closing cash and cash equivalents (balance sheet) 38
Table 3.12 Next's cashflow statement Year to January 2006 (source: consolidated cashflow
statement).
(3a) Quickly review the three principal statements using the approach to
interpretation suggested in this section, starting with the profit & loss
account, then moving onto the cashflow statement and balance sheet.
Note any inconsistencies.
(3c) Calculate the following measures for 2005 and 2006 for Next plc:
· acid test,
· gearing,
· interest cover,
· return on equity,
What do the results suggest about the liquidity, risk and investor
performance of Next plc?
SECTION 4
Regulation and
Governance
Section 4
Learning Objectives
Introductory context
The regulation of accounting reports and the wider issue of corporate
governance are of immense contemporary interest: the former to practicing
accountants, the latter in Boardrooms.
There has always been a thin line between ‘creative accounting’ (see Collier,
Chapter 7) and fraudulent disclosure, as there has between tax avoidance and
tax evasion.
Even with a limited knowledge of accounting, one can appreciate that the
concepts of accrual and prudence, and the need for judgement in the full
attribution of costs, provide scope for ‘smoothing’ profits between years.
External transactions, ostensibly with third parties, can also be used to
advance sales and source funds that are ‘off balance sheet’. Regulation has
become necessary because the exercise of expertise essential to measuring and
reporting organisational performance in accounting terms can go beyond a fair
assessment to one that is designed to mislead.
Between the UK and the US, there are significant differences over the
valuation of land, buildings, stock and writing off of goodwill on acquisition
and research and development expenditure. The US enforces historic cost
derived from independently conducted transactions rigorously and its
accounting standards specify appropriate treatment of those transactions and
other business situations.
In the UK, accounting standards are more liberally defined and follow the
principle of ‘substance over form’. This means that the intention behind a
transaction is more important that its mechanics. If a transaction is designed
to conceal a liability, it can fail audit scrutiny in the UK because the intention
is to deceive, whereas in the US it may withstand audit scrutiny because it is
technically valid (e.g. the ‘round-trip’ trades of US energy companies).
However, the greater latitude over measurement in the UK can give rise to
higher profit declarations. The UK requirement is that reported accounts
portray a ‘true and fair view’, whilst the US expects a ‘fair’ presentation.
Reported earnings
for 2004, $bn
US GAAP 17.1
IFRS 17.1
Table 4.1 BP’s earnings for 2004 according to various reporting standards.
Table 4.1 shows data from BP plc. Profits attributable to shareholders under
UK standards are $1.3bn different to those under US rules, but are we to
believe that $15.8bn is the ‘true’ figure when BP’s executives prefer to adjust
historic costs for inflation and declare $15.2bn? Auditors have a convention
termed ‘materiality’ that the disclosed figures are not materially different to
those that could be otherwise argued as correct under the prevailing
accounting standards. They define a percentage range for reported levels of
sales, profit, and net assets within which they will tolerate sampling errors
and discretionary points. There is no absolute truth.
Currently, there are some 40 IFRS covering issues ranging from the
presentation of statements, to the treatment of particular items like
intangible assets, to specific sectors like agriculture. It is unnecessary for you
to know these standards. It is necessary to be aware under which company law
and standards a published set of accounts have been prepared – especially if
you become a director. With quoted companies, there will normally be
supplementary disclosures – in content and frequency – required by the
governing body of the exchange on which the shares are listed. This could be a
self-regulatory body such as the Stock Exchange Council for London market,
but in many countries it is a government ministry. Internationally, these
regulators are represented on IOSCO [Note 6] which supports efforts to ensure
the integrity of financial markets and enhance their efficiency. It works closely
with the IASB and IFAC [Note 7] to improve disclosure and harmonise
accounting standards.
Corporate governance
In step with accounting regulation, corporate governance has developed on a
national basis, sometimes in statutory form but more commonly through codes
of conduct. Developments have often been triggered by high-profile corporate
At an international level, the main body that has contributed to this issue is
the OECD [Note 8] – 30 countries ‘sharing a commitment to democratic
government and the market economy’. In its Principles of Corporate
Governance, first issued in 1999, it effectively provides a definition,
The dual position of the Board in holding management to account, and being
held to account by the owners, is a demonstration of agency and shows the
relevance of corporate governance to the subject of this study book. The use of
independent non-executive directors is an important component in policing
the executive members of the Board. Paragraph E1 in the OECD guidelines
(see Figure 4.1) indicates their role on three committees (paragraph E2):
· audit (the liaison with auditors and review of financial and risk controls).
The OECD principles make significant reference to the need for risk
management (paragraphs D1 and D7), and the audit committee has a number
of responsibilities in this respect. Risks are not just linked to the integrity of
financial reporting, but include all business exposures from the strategic to
the operational, from environmental to internal process. Thus there is a need
to define the Board’s attitude toward risk, monitor extant and emerging
exposures, incorporate risk evaluation and mitigation into decision making,
ensure the effectiveness of internal controls, and maintain systems that
provide adequate information for planning, control, internal audit and review.
This approach to risk management is set out in the widely-adopted COSO
[Note 9] framework, depicted in Figure 4.2.
1 Control Environment
5 Monitoring
4 Control Information
Both regimes encourage use of the COSO framework, but there is a more
rigorous test of the effectiveness of internal controls to manage risk and
prevent fraud under the US system. The leading position of a CEO in
American business culture has prevented the role separation seen under the
British code and remains a potential weakness given the intimidation evident
at Enron and WorldCom. In the US and UK regimes the shareholder is
pre-eminent, but the OECD recognises that some countries accept a wider
responsibility to stakeholders [Note 10].
Supplementary statements
Whilst not mandated, many companies portray the ethical relation of business
in society by incorporating sections on social and environmental responsibility
in their annual report. This may be rhetorical, but the current concern about
health, safety, community, human rights, organic food, recycling and climate
change means that stakeholder and ecological interest is no longer seen by
corporations as minimising negative effects (e.g. consumer boycotts, pollution
fines, or industrial injury claims). They recognise that substantial sections of
their markets will seek to buy ethical products.
[10] Of all national systems, the South African code most emphasises stakeholder
interests as the country strongly pursues social justice alongside economic
development.
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
(4.2) For your own country, establish which organisation regulates the
preparation and publication of annual accounting reports. How do the
formats for the principal financial statements differ from those
prescribed by IAS1 and IAS7 (International Financial Reporting
Standards)?
FINANCIAL ACCOUNTING
(p36)
“The Group has not adopted early the requirements of IFRS 7 Financial
instruments: disclosures, which will become mandatory with effect
from 1 January 2007.”
(p39)
Reported data is also no longer comparable with prior years compiled under
the old regulatory regime, and so the last year’s results are restated under the
new standards. At the point of transition, the effect of changes on the opening
balance sheet and on the previous year’s profit & loss account are reported.
Note that no changes are necessary to the cashflow statement because it is not
subject to accrual and matching. For Next plc, the overall effect of the change
in standards was:
Taxation – £3m
The adoption of IAS related to financial instruments would have had the effect
of reducing the net asset value of the opening balance sheet by £44m. This is
because the fair value of these instruments would have had to have been
adjusted.
Corporate governance
The following are extracts from the section on Corporate Governance in Next
plc’s 2006 Annual Report,
“The Group has complied throughout the year under review with the
provisions set out in Section 1 of the July 2003 FRC Combined Code on
Corporate Governance.
“The Board has appointed committees to carry out certain of its duties,
three of which are detailed below. Each of these committees is chaired
by a different director and has terms of reference which are available
for inspection on the Company’s website …”
(p15)
Audit Committee
(p15)
Remuneration Committee
(p16)
Nomination Committee
(p16)
Chairman
“It is intended that he will retire from the Board at this year’s Annual
General Meeting in May and be replaced by the current Deputy
Chairman (John Barton), who is an independent director.”
(p16)
Management Delegation
(p16)
Risk Management
“The Board sets guidance on the general level of risk which is acceptable
and has a considered approach to evaluating risk and reward.
“The risk management process has been in place for the year under
review … and is in accordance with … Internal Control: Guidance for
Directors on the Combined Code.
(p17)
External Auditors
“Ernst & Young LLP have reported to the Audit Committee that, in
their professional judgement, they are independent within the meaning
of regulatory and professional requirements and the objectivity of the
audit engagement partner and audit staff is not impaired. The Audit
Committee has reviewed this statement and concurs with its
conclusion.
(p17)
(p17/18)
Directors’ responsibilities
(p18)
Going Concern
(p18)
“Next is a company that believes that it can only deliver long term value
to its shareholders if we take an ethical approach to the way we do
business. Put simply. this means being fair and honest in our
relationships with suppliers, customers and employees.”
(p3)
Next plc has appointed a CR & Environment Manager and conducts policy
through a forum of 17 internal managers that is subject to six monthly review
meetings with a Group Board Director. The report provides ‘key facts and
figures’ for seven aspects of social responsibility for the year to January 2005:
· economic:
· FTSE4GOOD:
· suppliers:
· customers:
· people:
· community:
· environment:
Exercises
(4a) What has been the effect of the adoption of international, rather than
UK, accounting standards on Next plc’s reported redults?
(4b) The directors of Next plc state, ‘they have continued to adopt the going
concern basis in preparing the financial statements’. What is the
meaning of ‘going concern’ and its implication for valuations in the
balance sheet?
(4c) The Board of Next plc have stated that they have complied with the
requirements of the UK Combined Code. Review the report and
identify ten examples of good governance – note, these do not have to
specifically relate to the UK regulation, but can draw upon other
examples provided in Section 4.
(4d) Identify the five steps in the COSO framework. What evidence is there
that Next plc’s approach to risk management reflects this framework?
SECTION 5
Learning Objectives
The cost of finance is also determined by the markets and is used in the
evaluation of strategic projects considered in Section 6. Taken together
with newly introduced criteria for assessing shareholder value, these
provide an unusual but appropriate entry into management accounting
which forms the remaining content of this study book.
· understand the role of capital markets and how the data they
convey is used to assess the performance of quoted companies,
Shareholders Bondholders
Capital Money
Markets Markets
loans and
overdraft
leases
Retained
Profit Asset Base
Operating Profit
Figure 5.1 is a simplified form of this interaction. A quoted company may issue
shares or bonds (a loan from the holder) on a capital market. Shares form the
equity capital of a company, shown in the balance Sheet as ‘Capital and
With a growing business, additional stock and debtors are required and this
‘working capital’ is funded by debt capital and bank overdraft facilities.
Shareholders’ funds, long-term and short-term liabilities, therefore represent
the cash raised to purchase fixed and net current assets. From this asset base,
sales are generated, and cash flows back into the business to repay the
borrowing (reducing the liability) and service the borrowing (reducing the
profit). Interest on debt is paid first, then the dividend, and finally the
retained profit, which adds to shareholders’ funds, becomes an internal source
of funds for further growth in the business. For the sake of simplicity, only the
injection of funds and their servicing is shown in the diagram – the repayment
of loans, redemption of bonds, and buy-back of shares is excluded.
For the purposes of this study book, we can limit our consideration to the
capital markets, where stocks and bonds are traded, and focus on only two
aspects: shareholder return and the cost of capital.
Shareholder return
Shareholders can earn returns in two ways: from the dividends they receive
from the company, and from the change in the market value of their shares –
which they can sell at any time. By setting these two components against the
price at which the shares were bought, the return on a share can be assessed
as,
1
Share Price = Earnings per Share ´
Earnings Yield
The reciprocal of earnings yield is called the ‘price-earnings ratio’ and this is
the leading indicator of potential return.
Table 5.1 Share performance data for companies in the defence sector
(source: The Independent, August 10, 2006).
Illustration
Let’s return to the NARC example which we used in Section 3. Assume that
NARC’s share price was 200p at the end of 2002, up from 120p a year earlier,
Table 5.2 shows the effects that this would have on NARC’s performance. The
halving in gearing has reduced risk (more than calculated using book values).
This, together with the increased profitability on a rationalised asset base, has
excited market interest and boosted the p/e ratio. Despite the rise in profits
after tax and dividends, however, yields have fallen because the market’s
expectation of the company is much higher.
Table 5.2 Effects of ratio analysis for NARC using market data.
Cost of capital
Since the majority of trading activity on a stock market is secondary (i.e. the
sale of ‘used’ shares from one investor to another), changes in share price do
not directly affect the company. Only when capital is raised or retired does the
share price have a direct consequence – in the amount of cash raised or repaid.
One might therefore expect the price performance of a share subsequent to its
issue to have little significance to the financial management in a company.
This is not so.
Most companies want to enhance their share’s price (agency theory), and the
Board is keen to avoid the displeasure of its shareholders (especially at the
annual general meeting) and retain their loyalty. So the cost to the company of
servicing equity finance is not regarded as the cash-driven stream of dividends
its Board proposes. If the annual return is insufficient in relation to
alternatives in the market, shareholders will sell their holding and the price
will fall. Therefore the aim of a Board is to deliver sufficient dividends and
capital gain to prevent this occurring.
As it is with equity capital, so it is with debt finance – bond prices rise and fall
like shares. For bank loans, the cost is equal to the risk-specific lending rate of
the bank.
Why is all this important? Well, the fundamental financial role for a Board is
to ensure that,
Therefore, the Board can use the cost of capital as a basis for evaluating all its
productive investment opportunities. That way, it ensures that the return
from the use of funds exceeds the cost of funding. You will see how this is
applied in strategic decisions in Section 6, next.
Since most companies are funded from a pool of different types of funds, the
cost of capital is an average of the cost of all the individual sources weighted by
the amount of each that is used. As debt finance is cheaper than equity (and
the cost is tax deductible), gearing is an important influence on the overall cost
of capital, and the merit of applying market values in its calculation is
considerable.
You do not need to be able to calculate the cost of capital for this module of your
studies, just understand its relevance to financial decisions for now.
Value-based measures
The importance of shareholder return, when coupled with shareholder
activism in the 1990s, found expression in a series on new measures that were
value-based. In Chapter 2 of his book, Collier describes many of these
measures, but you simply need to recognise what they have in common and
why conventional accounting parameters were found wanting.
Value of equity present value of future share price x number of shareholders’ funds
dividends shares (market value) (capital and reserves)
Value of the firm present value of future MV of equity plus the capital employed
cashflows value of debt
Acquisition value value of the firm plus what someone is fair value of assets
the value of any willing to pay for acquired plus goodwill
synergies control
Economic value book value of the firm plus the value of intellectual capital
[11] EVA – Economic Value Added; SVA – Shareholder Value Added; CFROI –
CashFlow Return on Investment.
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
5.1 From the following data, calculate the return of capital employed, the
return on equity, the earnings yield and the dividend yield:
dividend cover 2x
Ignore taxation.
5.2 Get the main business newspaper for your country and look at the
stock market data. Find your best known clothes retailer and note its
data in the categories used in Table 5.1 earlier in this section. Compare
the movement in its share price with the stock market’s index over the
last year, and its yield and p/e ratio with the sector average. Why is it
divergent? If you can’t offer plausible reasons, read business
commentaries on the sector or visit the company’s website and see if its
annual report provides clues.
FINANCIAL ACCOUNTING
Number of shares in issue as at Jan. 31st (millions) 337 331 287 265 261 246
Table 5.4 Selected share and shareholder information for Next (source: Next plc Annual
Reports).
“Over the past five years, there have been significant achievements by
NEXT in many areas.
44
41
35
31
Dividend 27.5
per Share
(pence)
(p10)
(p14)
2000p
high = 1772
1800p
1600p
1400p
1200p
1000p
800p
600p low = 700
400p
01 Jan 02 01 Jan 03 01 Jan 04 01 Jan 05 01 Jan 06
Figure 5.3 Next’s share price in pence on the London Stock Exchange
(source: www.citywire.co.uk).
(p20)
Number of share options outstanding at 12.7 10.5 9.0 9.3 9.7 10.6
January 31st (millions)
Table 5.5 Next’s employee share ownership scheme (source: Next plc Annual Reports).
(5a) Explain the meaning of the terms ‘share price’, ‘exercise price’, and
‘face value’.
(5b) Explain the term ‘market capitalisation’ and roughly calculate its latest
value for Next using the tabulated and graphical data.
(5c) Recalculate the gearing ratio using market values and contrast the level
with the previous assessment in Section 3. Assume the market value of
debt is close to its book value.
(5d) Using the dividend and share price data, roughly assess the shareholder
return over the five year period and its annualised equivalent (note that
you will find this easier on a ‘per share’ basis).
(5f) Undertake calculations that show how David Jones came to the figure
of £1.4 billion.
(5g) To what extent do you think that the directors’ remuneration package
has contributed to Next plc’s financial performance?
(5h) Assume you are an employee of Next plc and ‘bought’ options in 2001,
2002, and 2003, exercised them after three years, and sold the shares
on the open market. Perform rough calculations of the percentage gain
you would have made on each of the three holdings. If you had
subscribed to the maximum amount per month, what would your total
gain have been?
SECTION 6
Strategic Investment
Decisions
Section 6
Learning Objectives
Decision theory
Figure 6.1 sets out the logical steps in the decision making process: in reality,
many decisions are not comprehensively considered, are made under time
pressure with incomplete knowledge, and omit one or many of the steps
outlined:
problem recognition
Problem Analysis
Step 0
investigation and diagnosis
assess priority
Step 1
define objectives
identify alternatives
Step 2
ascertain data
Step 3
Step 4
implement
feedback
Characteristics of decisions
The nature of decisions, and the management accounting information that
supports them, is heavily dependent upon the level within an organisation at
which they are taken. Robert Anthony [Note 12] suggested that organisational
management can be classified into three components:
· project, not period, orientation, e.g. life cycle analysis (see Section 7),
investment appraisal (see this section),
Investment appraisal
The financial evaluation of productive investment opportunities is commonly
termed ‘investment appraisal’, and it is commonly used in decisions to buy
fixed assets since their benefits flow over many years (and are thus strategic
purchases). It can however, be applied to any project, including a product
launch, marketing campaign, and even corporate acquisitions.
Put simply, $1 today is worth more than $1 in the future since inflation will
reduce its spending power in terms of goods and services, and its value could
have been increased through investment over the intervening period. This is
an opportunity cost, since we are not able to use the $1 to, for example, buy
things whilst the money has, for example, been lent to someone else. Thus, we
make a charge for that loss of liquidity. We will also require compensation for
any price inflation which erodes the purchasing power of the money lent when
it is finally returned – if it is returned. And risk is the third reason for making
a charge – risk of non-payment, a risk that will depend on the riskiness of the
use to which the money is put.
Since the growth rate of money supply (inflation) and the availability of credit
(liquidity) will be consistent across an economy, it is the perceived risk of a
business and the projects in which it invests that will determine a credit rating
and thus the ‘price’ of the funds that are lent to its management. As first
discussed in Section 5 then, the cost of capital incorporates a risk assessment
and communicates a benchmark, above which productive returns must be
earned in order that economic value is created.
and the resulting compounded amount (i.e. $1.1267) is called the terminal
value.
Cashflow y
Present Value =
(1 + Discount Rate) y
0 Outlay =1 Column
2 = 1 ÷(1+Discount Rate)2
NPV = sum
The sum of all the present values is the net present value of the investment
opportunity. If the NPV is positive, then the project is financially viable; if
negative, not. The discount rate which results in an NPV of zero is called the
internal rate of return and indicates the break-even point in terms of the
cost of its funding. An illustration based on Project 2 in Collier’s Chapter 14 is
shown in Tables 6.3 and 6.4, and Figure 6.2.
Table 6.3 Cashflow table, Project 2 (see Collier’s Table 14.7 where the discount rate is 12.4%).
Net £60,000
Present
Value
£40,000
Internal Rate of Return = 12.4%
£20,000
£0 Discount Rate
0% 5% 10% 15% 20% 25% 30% 35%
£20,000
£40,000
£60,000
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
Note when working out the exercises that the four techniques provide
inconsistent signals over the viability and ranking of the different examples.
This is because of theoretical limitations with the techniques, which are
discussed in the directed readings. You should remember that NPV is
considered to be the technique that will provide a correct indication for a
strategic decision in virtually all contexts and is therefore the approach that
should consistently be adopted.
Also note that in investment appraisal the discount rate chosen does affect the
viability of different projects. In the example on Blackboard experiment with
changes in the discount rate. You will be able to calculate an accurate internal
rate of return for the project by trial and error: if the NPV is positive, increase the
discount rate until the NPV becomes zero; if negative, reduce the rate.
MANAGEMENT ACCOUNTING
Context: Dynamic
Demand
Management Accounting C ase Study Part I
The technology
“Any electrical appliance that is time-flexible (in other words, is not too
sensitive to when its energy is delivered) could be used. These could
include industrial or commercial air conditioners, water heaters and
refrigeration. Thousands (and eventually millions) of such loads acting
in aggregation could provide an extremely simple and cost-effective
way of helping to manage the power grid. To date, Dynamic Demand
has focused its attention on the potential for such services in relation to
domestic and industrial refrigeration.
The economics
“At every second of every day, the National Grid must ensure that
electricity supply precisely matches the continually changing demand.
“For these reasons, the National Grid pays for reserve which involves
certain power plants running at reduced output so they are able to
inject extra power into the grid as it is needed. The National Grid also
has to pay for some of these generators to go into a special ‘response’
mode whereby they continually change their power output to respond to
random changes in demand.
Political support
“The Secretary of State must, not later than 12 months after this
section comes into force, publish a report on the contribution that is
capable of being made by dynamic demand technologies to reducing
emissions of greenhouse gases in Great Britain.”
At the Kyoto summit on climate change in 1994, targets for greenhouse gas
emissions were agreed for 2012. Any country struggling to fulfil these legal
obligations could buy spare emission allowances from those that had been
successful. In this way, environmental damage could be turned into financial
penalty.
Megawot supplies 50% of the UK’s electricity using a combination of gas and
coal-fired power stations. As gas is currently cheaper and less pollutive, the
base demand for electricity is provided by this fuel, leaving older, less efficient
coal-fired plants to meet the peak load. Megawot’s heavy reliance upon fossil
fuels means that it breaches CO2 emission allowances and therefore has to
purchase carbon credits (i.e. spare allowances) on the ECX, and these
represent a cost to its business. With rising demand for electricity, Megawot’s
cost of compliance with emission allowances will rise further – though of
course, it benefits from the profit made in supplying the additional electricity.
With rising public concern over climate change, Megawot – as a major emitter
of greenhouse gases – has been recently subject to organised protests outside
some of its coal-fired power stations. Adverse media coverage has damaged its
image. Megawot sees the ‘dynamic demand’ legislation and technology as
providing it with the scope to meet its supply obligations to the national grid
and balancing its load, thus reducing its dependence on coal-fired electricity
generation, and consequently its need for CO 2 emission allowances.
There are about 45 million domestic fridge/freezers in the UK. Their average
life is nine years. Three million new appliances are sold every year.
Exercises
(6a) Assume that every new appliance sold from 2008 is fitted with the
device, that Dynamic Demand’s assessment of savings in CO2
emissions is correct, and that Megawot will continue to supply 50% of
UK electricity generation. Work out the accumulated saving in CO 2
emissions for Megawot’s output between 2008 and 2022. (Note, a
megaton = one million tonnes.)
(6b) Evaluate the saving in carbon credits that would otherwise have to be
purchased (in ¤) based on the futures prices from the ECX. Assume the
annual increase will continue until the year 2022. These represent
cashflow savings to Megawot over the fifteen year period.
(6c) Megawot’s cost of capital has been stable at 10% since the year 2000,
but the share price has been in decline as concerns have grown about
the amount of investment needed in clean technologies with no
commercial gain. Megawot believes that the dynamic demand
technology will be regarded as a cheaper way to meet its obligation
and reduce its business risk. It therefore intends to use a discount rate
of 10% in its evaluation of the potential cashflow savings. Calculate the
present value of these savings over the 15 years to 2022 to determine
the maximum sum it should be prepared to contribute to the European
consortium development.
SECTION 7
Marketing Decisions
Section 7
Marketing Decisions
Learning Objectives
This section primarily concerns itself with pricing. The second and third
objectives in the Module Outline are particularly pertinent: to critically
question the parameters under which accounting information has been
provided and to call for appropriate accounting data. After studying this
section and its reading, you should:
Accountants attribute costs to the sales to which they relate (Section 2), but
the basis of attribution varies [Note 13] so external users cannot be sure what
these costs contain.
Some of these costs vary with the volume sold (e.g. the purchase price of goods
sold in retailing or wholesaling), but others are more fixed in behaviour (e.g.
depreciation, rent, administrative staff) and are only partially affected by
changes in volume. This is good when sales are rising as the effect of
(operational) gearing means that there will be a greater than pro-rata increase
in profit. However, if sales fall a business with a substantial proportion of fixed
costs can easily find itself making a loss.
For internal purposes, the analysis of cost can reflect its behaviour in relation
to volume and accountants use the concept of ‘contribution’ to depict this,
thus,
So, if sales of $1m are made on volumes of 50,000kg, where the variable cost is
$8 per kg and fixed costs are $400,000,
[13] Common approaches include marginal costing, full (or absorption) costing, activity
based costing, and throughput accounting.
The break-even point is where contribution equals fixed cost, in this case
$400,000,
$400,000
= 33,333kg in volume
$12 per kg
= £666,666 in sales
From these linear relationships, charts can be drawn which depict the
break-even point for a business or a product. Examples of these and the
associated formulae are provided in Collier’s Chapter 10. This is useful for
marketers as they can target a minimum volume to be sold in a campaign,
however, this assumes that the selling price will not deter customer demand.
How do we set the price?
sales Profit
total costs
Volume
marginal
revenue
marginal cost
Volume
sales
profit
risk
birth
research
development
launch
growth
maturity
saturation
decline
death
cashflow
It is evident then, that prices and costs are dynamic over time and are not
simply subject to the influence of volume. The ability to command ‘high’ prices
results from product leadership or significant market share and these
advantages are likely to decline in time as competitors respond and demand is
satiated. Unit costs reduce with experience, value engineering and economies
of scale, but competitors following up the innovator will seek to reduce the cost
base further.
Target costing assumes that the level of this profit will equate to the average
return on investment of the sector, and that by deducting this margin from the
forecast long-run price a unit cost can be targeted. If the product team believe
that cost can be reduced to the target cost in the time it takes to reach
maturity, then the product is viable and should be launched. To recover
development costs, a minimum margin must be maintained on the planned
cost reduction so that selling prices are also planned – starting at maturity and
working back to a ‘market-skimming’ price at launch. The direction of the
arrows on the price and cost curves indicates this process.
Money
long-run
selling price
selling price
sector
unit cost average
return
target
cost
Launch Maturity
Time
Market pricing
For most businesses, products are not innovative or covered by patent, and
face many substitutes in the market: they do not possess significant market
share (and hence market power) and are ‘price followers’. The pricing decision
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
Please work through the set readings and exercises on Blackboard. These
readings demonstrate some of the scepticism about traditional accounting
approaches to pricing that have been explored in this section. Remember those
limitations as you work through the directed exercises on break-even and
contribution analysis. Consider what other techniques might be used in the
price-setting process and how they relate (or not) to accounting models.
MANAGEMENT ACCOUNTING
Pearl has costed the design and production engineering resource required at
HK$1.5 million. The metallic, silicon and other raw materials are standard for
micro-chip manufacturer and minimal in cost – some HK$2 per unit;
protective packaging, a further HK$1. Shipment and air freight cost to the EU
for batches of 1,000 of these small, light-weight components is HK$5,000.
Micro-chips are manufactured in a highly automated, sterile environment, the
cost of which is almost wholly fixed. Pearl attributes a portion of this fixed cost
to each production order – in Eurac’s case, it would be HK$12 million.
Exercises
(7a) Assuming Pearl prices its micro-chip in line with the Korean company,
calculate the contribution per unit, the net profit margin, and the
break-even point in units. Pearl wishes to recover the cost of design
and engineering over the first year’s order. The exchange rate of the
Hong Kong dollar to the Euro is 10HK$ = ¤1.
(7b) By 2009, the Korean company will have established market leadership
with a 20% share. The UK market is 3 million units with a further 1
million in other EU countries and 1 million in the rest of the world as
the potential of the technology attains wider recognition. It is forecast
that the demand outside the UK will rise by 500% next year and will
continue to grow until 2017 at least. The mature market price of
dynamic demand chips is forecast to be ¤3. Because of past
over-ambitious investment, the global micro-chip industry has
significant under-utilised capacity and pricing is competitive. Average
net margins are low (4%), and returns on investment are barely
covering the cost of capital. Dynamic demand technology will help
redress the imbalance between supply and demand.
Assuming Pearl could find orders to utilise this uplifted capacity and
that 24 hour working would increase fixed costs by only 10%, what
would the fixed cost per unit become?
If the Eurac order’s size and variable costs are generally representative
but subsequent design and engineering costs could be halved per
order, what would the total unit cost of a dynamic demand micro-chip
fall to?
The Euro and £ sterling have appreciated against the Hong Kong $ over
the last year. What implication might this have strategically for Pearl
Delta Manufacturing?
SECTION 8
Operating Decisions
Section 8
Operating Decisions
Learning Objectives
Resources
Operating decisions are about resources. They are about how management
select and organise resources to most effectively meet output requirements.
What are these resources? They can be referred to as the ‘five Ms’: money,
manpower, materials, machines, and managers.
· funding for fixed and current assets, and for innovation and
development.
Farming
Harvesting
Wholesaler
Canning
Processing
Refridgeration
Ready
Meals
Consumer
Figure 8.1 A simplistic value chain for the food processing industry.
Consider food processing – Figure 8.1 shows a simplistic industry value chain.
The blocks and arrows show value-adding activities. The blocks include
organic produce from the farm gate to prepared meals at hotels (which may
have been bought in cook-chill packs). The arrows range from herding cattle to
market to pizza deliveries. Is each activity undertaken by a separate entity?
Why do some companies vertically integrate to different degrees and over
different ranges of the supply chain? Why do some outsource their logistics
while others have their own fleets? Why are some farms heavily mechanised
whilst others use manual labour? Why do some restaurants employ full-time
staff whilst others use casuals? Why do some processors out-source their
support functions?
By observation, research and analysis, we can form views of the relative costs
of operations and the value added at each stage of the chain. This informs the
strategic engagement of activities and resource dependencies.
Marginal costing, which you first met in the last section, classifies resource
costs according to whether they vary with production volumes. In practice this
means that treatment of direct costs is similar to absorption costing. However,
marginal costing ignores fixed overhead costs when costing a product, writing
them off against profit in the period in which they occur. This will result in a
lower value of finished stock and different profits being reported than with the
other approaches. Nevertheless, decisions about volume changes (as we saw
with break-even analysis), product prioritisation, or resource constraints can
only be made using marginal costing. This is because fixed costs, by definition,
won’t change and are irrelevant to a decision and only marginal costing
recognises this. Similarly, decisions about whether to outsource parts of the
manufacturing process can only be made when the contribution foregone
toward fixed costs is considered. Examples of these decision scenarios are
provided in Collier, Chapter 11.
TQM sets a standard of zero defects – popularly applied in the six sigma
statistical test – achieved through an all pervasive culture of quality where
everyone is responsible for compliance and for continuously improving the
process of manufacture. Independent inspections don’t occur as they relieve
responsibility and do not add value. Suppliers are, however, vetted and
required to have equivalent quality assurance protocols and culture. The
costing of prevention versus non-compliance is irrelevant and accounting
information has shifted toward the provision of non-financial indicators and
variance analysis against a perfect standard. Decision making over quality no
longer has a cost trade-off. As zero defects are an essential condition, the aim
of management accounting is to reduce the overall cost of its achievement and
devise measures to monitor continuous improvement.
Just-in-time (JIT)
Production Push
Demand Pull
JIT uses all these capabilities to pursue the goal of manufacturing to customer
order where that orders triggers a requirement in finished stock, a routing
through the manufacturing process, and a parts list to be satisfied by
upstream processes and suppliers. All this has to be incredibly rapid, flexible,
and of perfect quality since any component failure will delay the entire
assembly. Demand sucks the product along its supply chain.
Accounting documentation cannot keep pace with this speed and actual costs
are largely irrelevant since they would not be known until long after the
product had been delivered. Moreover, costs are largely irrelevant since the
installed capacity is fixed, the cells of direct workers are salaried, and only the
bought-in supplies will vary with volume sold. The key financial need is for
throughput to be high and, as with a pipeline of fixed diameter, this means
that the speed with which products flow through the process is critical.
Conventional costing priorities had to shift, as seen in Figure 8.4.
from Priority to
costs 1 inventories
sales 2 throughput
inventories 3 costs
æ 1 ö
Profit = f çç ÷÷
è Production Cycle Time ø
Throughput
Throughput Accounting Ratio =
Production Cycle Time
Cost management will focus on fixed costs and may use activity-based costing
as it provides a better analysis of overhead and its causation.
Service environments
Management accounting has traditionally concentrated upon manufacturing,
but service industries comprise an increasing, if not dominant, proportion of
our economies. Some services, like professional advice or plumbing, can use
[15] Cost book-keeping does not try to represent transactions through the production
process, but flushes aggregate purchases through the accounts when sales are
made, reducing administrative costs. This technique is called ‘backflush
accounting’.
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
Please work through the set readings and exercises on Blackboard. These
exercises should provide a range of operational decision situations to examine
– try to consider the applicability of these exercises in ‘the real world’ as you are
working through them.
MANAGEMENT ACCOUNTING
Pearl: Operating
Decisions
Management Accounting Case Study Part III
Deposition
Patterning
Etch
repeat until
complete
Ion Implantation
Annealing
Cutting
Testing
Packaging
This contrast has important implications for production scheduling and cycle
times as the copper inter-connections of the Eurac chips place greater
demands upon the deposition process.
The validity of the engineered design, accuracy of the process, and reliability
of the materials used are critical to sustained use of a micro-chip. Pearl Delta
Manufacturing is proud of its quality certification and uses six sigma as a
philosophy and statistical tool. Testing in its manufacturing process
comprises the identification of physical defects at each stage in layer
formation and inter-connection, and in individual testing of each completed
micro-chip. This occurs after they have been ‘cut’ from the wafer and takes the
form of insertion into an electrical wiring loom that mimics the inputs/outputs
of a Eurac refridgerated appliance under power from a public grid. Every
micro-chip that is produced is subjected to this application test, and six sigma
criteria have been fulfilled on the initial order for 2009.
The availability of each process for production depends upon set-up times,
preventative and incidental maintenance. Most processes have a single
computer-controlled machine, but others have two, partly because of need and
partly because of advances in technology. These include deposition of
conductive and insulating film, etching of photo-resistant chemicals, ion
implantation, and testing which requires different rigs for each user
application. Based on the planned three-shift working for 2010, the following
annual capacities are available:
Exercises
(8a) Pearl is reviewing its planned use of capacity in 2010. It assumes that
the volume of audio micro-chips will continue at their current level of
2.7 million units per annum. This should enable it to produce 3.3
million dynamic demand units on a three-shift system.
(8b) The contribution from the sale of a dynamic demand micro-chip was
calculated in Part II of the case study at HK$42 per unit. The equivalent
contribution of an audio micro-chip is only HK$20 per unit.
(8c) The average selling price of an audio micro-chip is HK$33 and its cost
is HK$30. A Shanghai manufacturer has offered to supply them for
HK$25. Pearl would have to spend an additional HK$1 on testing to
assure their quality and the supplier has agreed to replace any defective
chips free-of-charge. Should Pearl accept this offer?
(8d) A new machine that would increase deposition capacity by 50% could
be bought for HK$50m. If the additional capacity could be wholly
devoted to manufacturing dynamic demand devices would this solve
the problem? What else might need to be done?
SECTION 9
Budgeting Decisions
Section 9
Budgeting Decisions
Learning Objectives
This section addresses the second and fourth objectives in the Module
Outline: to critically question the parameters under which accounting
information has been provided, and to understand the relevance and
limitations of accounting data. After studying this section and its reading,
you should:
Control theory
Budgeting is probably the quintessential activity associated with
management accounting practice. The notion that the future actions can be
objectively controlled is a comforting one. One that is based on the planning
model being an accurate predictor – the feed-forward system – and
management being able to correct any subsequent deviation from the plan –
the feedback system shown in Figure 9.1.
feed-forward
Strategic Plan feed-back
budgetary
One-Year Financial Plan control
budgeting
Budget preparation
The budgeting process is described by Collier in Chapter 16. The process itself
sits in three contextual frameworks:
· a time framework:
· an organisational framework:
· a technical framework:
Figure 9.2 shows how these three contexts shape the preparation of the
budget. The result is validated against the outline parameters set by the
Board or budget committee which will, at a minimum, mean meeting the key
performance indicators envisaged in the strategic planning process. If it fails,
then a re-examination of subsidiary budgets occurs that can involve arbitrary
Budget Co-ordinator
KPIs projections
preparation of
subsidiary budgets
within organisation
demand
modelling
capacities
validation
purchases
materials
personnel labour
payments
overhead creditors
investment
Budgetary control
In Figure 9.4, profit is £400 higher than budget with adverse variances on
material and human resources and a favourable position on overhead.
Depreciation is a fixed charge. Let’s assume that 50% of labour varies with
volume and overheads are absorbed on labour cost. You will note that the
volume produced and sold has increased by 200 units and we would expect a
related increase of 10% in all variable costs. If the control budget is ‘flexed’ by
the actual level of output, a different picture emerges, as seen in Figure 9.5.
With the sales increase of 10%, we would have expected a profit of £1,675 (the
flexed budget) and an increased contribution of £675. The sales variance has
reversed showing that selling prices were cut (£800A) to obtain the greater
volume (£2,000F). Savings were made in material costs (£100F) either
through reduced consumption, or because they were cheaper. The adverse
£250 variance in labour cost reported originally is entirely due to output and
productivity is as budgeted. Overall costs have been well managed.
This example illustrates the importance of adjusting the control budget by the
actual level of activity before any informative conclusions can be drawn about
the variances.
Criticisms of budgeting
The criticisms levelled at budgeting are technical and behavioural in nature.
Conventional control budgets are:
Budgeting decisions are about how you do it and why you are doing it, but the
most fundamental decision is whether you should do ‘it’ at all.
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
Please work through the set readings and exercises on Blackboard. Pay
particular attention to the cash budget, which is the most important in practice.
Consider examples of budgets that you have encountered both in and out of
work. How do people approach them and are they effective in what they
attempt to manage?
MANAGEMENT ACCOUNTING
Pearl: Budgeting
Management Accounting Case Study Part IV
Pearl: Budgeting
Pearl continues to prepare for 2010. Its optimism about the dynamic demand
market has been encouraged by a dramatic increase in requirement from Eurac, a
substantial purchase order from a US fridge/freezer manufacturer, and enquiries
and requests for quotations. In short, it appears that demand is currently
exceeding supply. Prices have remained stable since 2008, and show no sign of
falling over the coming year. Pearl has priced its dynamic demand micro-chips at
HK$45 – a 10% discount on the market leader with no currency risk. Table 9.1
shows Pearl’s projected sales for chips over the four quarters of 2010.
Pearl has raised the prices of its audio chips to HK$35 per unit, and expects
average contribution to rise to HK$22. The variable cost of the Eurac order
provided in Part II of this case study remains valid for the supply of dynamic
demand micro-chips.
To cope with the expansion, Pearl has ordered a new deposition machine for
HK$50m which will be installed during the second quarter. It has also
improved the productivity of its ion implanter by a technical upgrade from the
manufacturer. Other capital expenditure of HK$20m is expected during the
first half of 2010. The effect of these investments will be to provide adequate
capacity for the projected demand, but the annual depreciation costs for the
fabrication facility will rise to HK$125m.
(9a) Evaluate the projected operating profit for the year overall.
HK$m
– raw materials 2
Debtors 60
Cash 18
Bank Overdraft –
Creditors (15)
200
Reserves 70
The new deposition machine will be leased over a four year period at
quarterly payments of HK$4m. The remaining capital expenditure will
be met from internal cashflow. A third of the long-term debt is due to
be repaid in September 2010 and interest payments of HK$31m on
outstanding loans are anticipated during the year. Customers take 90
days on average to settle their debts. Stock and creditors are expected
to maintain the levels shown in the opening balance sheet.
Sales 86 83 3 (Adverse)
Other cost –2 –2 –
Prepare a flexed budget for the last quarter and reassess the variances.
SECTION 10
Performance
Management
Section 10
Performance Management
Learning Objectives
Dimensions of performance
The review of management accounting concepts in the second half of this
study book has been necessarily selective in order to display the scope for
decision support available to management. We have seen how context – both
in the decision and the organisation – shapes the relevance of information and
takes it beyond the financial, to the quantitative and the qualitative. We have
Corporate Goal
feed-forward
Individual Goal
feed-back
Balanced scorecard
Probably the most well-known multi-dimensional performance framework,
the balanced scorecard is a generic model developed from empirical
Financial
Goals Measures
Targets Initiatives
Internal
Customer Business Process
Vision
Goals Measures and Goals Measures
Strategy
Targets Initiatives Targets Initiatives
Innovation
and Learning
Goals Measures
Targets Initiatives
Figure 10.2 The balanced scorecard model (after Kaplan and Norton, 1996).
These might be routinely reported at Board level, but one of the characteristics
of the scorecard is that it can be cascaded down the organisation so that each
function and even individuals have a version that reflects their specific
contexts, but still retain the four perspectives. After all, every organisational
unit can develop, has a core role which it provides to a ‘customer’ (albeit an
internal one), and has a financial cost or value. In particular, corporate
parameters are mirrored where an organisation is divided into strategic
business units.
strategy
makers
managers divisional
manager
operations
divisions or sbus
(strategic business units)
Just as with agency theory and the relationship between shareholders and the
executive Board, the Board strives to ensure that divisional managers act in a
manner that does not disadvantage the company as a whole. The role of
management accounting is thus important in setting protocols for the pricing of
inter-divisional work and defining the boundaries of divisional responsibility.
The bases upon which the performance of the unit and its manager are
monitored may well differ because the cost of the remaining centralised
functions (e.g. IT services) are attributed to the division even though its
manager has no control over them. Table 10.1 illustrates how performance can
be differentiated between the divisional unit and its manager. The ‘total’ profit
includes a full attribution of cost, irrespective of source, and would be the
benchmark for comparing performance against other divisions. The
‘controllable’ profit represents the scope of autonomy of the manager and
would be used for the setting of personal targets and individual reward.
Contribution 70 70
Managerial Performance
Divisional Performance
Strategic and working capital finance will remain with HQ and the division
will be funded from a corporate treasury. The divisional balance sheet will
thus have an abbreviated form and will represent the net asset value and the
central funding. The division can therefore be regarded as an investment by
corporate HQ, designated an investment centre (see Section 9), and charged
with making a return on the funds invested. Recalling the book-based
accounting ratios in Section 3, the relevant measure is return on capital
employed, appropriately reduced in scope and termed ‘return on investment’.
The calculation and consequences of adopting this and a competing measure,
‘residual income’, are now explored.
Current assets 45 45 45 45
Total assets 75 65 55 45
Operating profit 15 15 15 15
[17] An annuity is a constant annual sum. Rather than multiply the same amount by
different discount factors in successive years, it is quicker to multiply the annuity
by the sum of the discount factors.
In the previous example, the notional charge could be based on a 12% cost of
capital and multiplied by the division’s net assets of 75, or 9 per annum. It is
possible however, to adjust this charge to reflect the relative level of risk
between divisions, so,
RI = 15 - 9
=6
Cashflow 10 10 10
Operating profit 3 3 3
Cashflow 10 10 10
The residual income is constant at 1.3, unlike the return on investment which
still rises over the three years, although at a reduced rate than if a
conventional depreciation policy had been used. Residual income is thus the
recommended criteria for divisional performance management.
Performance review
‘WYMIWYG’ is an oft recounted acronym that means ‘What You Measure Is
What You Get’. Performance measures influence behaviour, so influence
performance. From the market-based measures of Section 5 and the
accounting ratios of Section 3 to the budgetary targets of Section 9 and the
Blackboard
Now check Blackboard for the details of your directed and other reading for this
section. You are expected to do all of the directed reading before carrying on.
Concluding Comments
Please work through the set readings and exercises on Blackboard. The
principal reading examines the behavioural implications of choices made
regarding performance measurement, and the prices at which supplies are
MANAGEMENT ACCOUNTING
Pearl: Performance
Measurement
Management Accounting Case Study Part V
(10b) The two founders are concerned, but not entirely surprised, by the exit
strategy of the AV company. Li recognises that sale of their 50% stake
could present an uncertain and unwelcome future for the close-knit
group of staff that have been established. Li proposes that Pearl be split
into two divisions, the first responsible for manufacture (MA) and the
second for design and engineering (DE). MA is capital intensive, whilst
DE is labour intensive and could be divested from the Pearl company if
necessary.
MA division, DE division,
HK$m HK$m
Profit 51 9
Calculate the return on capital employed and residual income for each
division.
APPENDIX A
Solutions to Tutorial
Exercises
Appendix A
Section 4
4.1 Accounting dates back to 2200BC in China, where it was used to
value wealth and assess performance. In the communist era,
accounting was part of the central economic planning system and
was industry-specific. Financial reporting enabled the centre to
monitor output, compare costs, provide funding, and vet the use of
those funds.
Section 5
5.1 Operating Profit
ROCE =
Capital Employed
= $4m + £1m
= $5m
$1m
ROCE =
$5m
= 20%
= $1m - $0.1m
= $0.9m
$0.9m
ROE =
$4m
= 22.5%
1 Earnings
Earnings Yield = =
Price-Earnings Ratio Market Capitalisation
1
=
12
= 8.3%
$0.9m
Market Capitalisation =
8.3%
= $10.8m
Dividend
Dividend Cover =
Earnings
$0.9m
Dividend =
2
= $0.45m
$0.45m
Dividend Yield =
$10.8m
= 4.2%
APPENDIX B
Outline Solutions to
Case Exercises
Appendix B
Outline Solutions to
Case Exercises
(2b)
or
· accumulated reserves.
CR Cash £5.00
DR Reserves £4.90
It should be noted that a £100m bank loan was taken out in 2006,
but since this is only withdrawn if there is a breach of the loan
contract, it should not be treated as a deduction from cash even
though it is repayable within the ensuing year.
643
=
81
= 8 years
Accumulated Depreciation
Average Age = ´ Average Life
Cost
360
= ´8
802
= 3.6 years
(2j) Property prices tend to rise – and have done so dramatically in the
UK over the long term. A policy that depreciated freehold
buildings by 2% per annum is therefore likely to severely
understate the realisable value of retail premises. Given the cost
of such premises is stated as £76m and that acquisition could have
been made 20 years ago, it is possible that sale could add
substantially to shareholders’ funds.
(2k) Next plc has cash in hand, current assets that cover current
liabilities, and fixed assets that cover the debt finance (i.e. the
loan and the bond). The growth in fixed assets and stock is
adequate to keep pace with the growth in sales, and there is no
sign of under-capitalisation (i.e. insufficient capital to fund
productive investment for the future). The shareholders’ funds
figure (of £256m) is low for a £3bn turnover business, but the
cause of this has already been explained (in Question 2c).
Providing retained profits sustain their current level, there
appears to be no problem in meeting the longer-term liabilities
and the balance sheet looks strong.
· sales have grown, but by less than 10% which is the lowest
rate in many years and reflects the CEO’s comment about
‘difficult trading conditions’,
320
Next Retail = = 14%
2217
Next sourcing = 5%
Ventura = 9%
Operating Profit
Return on Capital Employed =
Assets
320
Next Retail = = 11%
2905
Next Directory = 9%
Ventura = 12%
Sales
Asset Turnover =
Assets
2217
Next Retail = = 0.8´
2905
Ventura = 1.4´
UK = 2.1´
RoEurope = 3.3´
Middle East = 5´
Asia = 0.2´
Debtors
Debtor Settlement Period = ´ 365
Sales
415
= ´ 365
3106
912 - 311
=
756
Debt
Gearing =
Debt + Equity
(298 + 100 + 3)
=
(298 + 100 + 3) + 256
471
=
22
= 21 ´ (for 2006)
= 23 ´ (for 2005)
Earnings
Return on Equity =
Shareholders’ Funds
313
=
256
Earnings
Earnings per Share =
Number of Shares in Issue
£313m
=
246.1m
The second pair of measures relate to risk. Gearing has risen, but
the cover for interest on debt is generous. Equity has been
artificially reduced by the repurchasing policy of management,
and the asset base of the balance sheet can support more debt if
necessary. Technically, gearing is high but the risk is being
controlled by Next’s management.
The overall impact on both the balance sheet and the profit & loss
account appears to be negligible, though the deferred adoption of
IFRS7 does involve what was a materially significant amount –
£44m or 16% of the shareholders’ net asset value. Of the changes
implemented, the small net change hides substantial movement in
the classification of assets and liabilities: in particular, fixed
assets have risen by 6% and long-term liabilities have risen by
14%. Given that the historical cost convention is common to both
approaches, the inference from Next plc’s statement is that the
changes are due to where ‘fair values’ and not historical cost has
been applied (the main impact is actually due to restatement of
pension fund liabilities).
· going-concern declaration,
(5) Monitoring:
(4e) The forum – is purely internal and has a Board presence only
bi-annually. To be genuinely engaging in social responsibility,
participating external representatives of stakeholder groups,
including environmental advisors and pressure groups, would be
expected.
401
Gearing = = 9%
(401 + 4200)
(5d) Share price in 2001 is about £10, so there is a gain of £7 over five
years. In addition dividends of (27.5 + 31 + 35 + 41 + 44 =) 178.5
pence have been declared. In total, a return of £8.785 on an
investment of £10, or 88%. This can be annualised by taking the
fourth root of 1.88, which is 1.17 or 17% pa.
(5e) The £400m debt costs 4%, the £4.2bn equity costs 17%. The
weighted average is,
£1434m
(5g) There is a very significant alignment between the package and the
characteristics of financial performance. One incentive specifically
targets earnings per share, whilst the other targets share price
relative to the sector. Taken together, they can increase salary by
170%. In addition there is a further share price growth driven
incentive. The package has obviously been designed to fit the
financial objectives of Next plc but, with its singular pursuit of eps
growth, is it possible the financial strategy has fitted the package?
(5h) Average exercise price in 2001 was 502p, and these could be
exercised in 2004 when shares were about 1000p for a gain of
about 100%.
For 2002, exercise price was 606p, and the 2005 share price was
1400p for a gain of 130%.
For 2003, exercise price was 701p, and the 2006 share price was
1500p for a gain of 115%.
2007 1.000
2008 3,000,000 1,500,000 66,667 € 15.50 € 1,033,333 0.909 € 939,394
2009 6,000,000 3,000,000 133,333 € 16.00 € 2,133,333 0.826 € 1,763,085
2010 9,000,000 4,500,000 200,000 € 16.50 € 3,300,000 0.751 € 2,479,339
2011 12,000,000 6,000,000 266,667 € 17.00 € 4,533,333 0.683 € 3,096,328
2012 15,000,000 7,500,000 333,333 € 18.00 € 6,000,000 0.621 € 3,725,528
2013 18,000,000 9,000,000 400,000 € 19.26 € 7,703,375 0.564 € 4,348,354
2014 21,000,000 10,500,000 466,667 € 20.60 € 9,615,600 0.513 € 4,934,323
2015 24,000,000 12,000,000 533,333 € 22.05 € 11,757,551 0.467 € 5,484,984
2016 27,000,000 13,500,000 600,000 € 23.59 € 14,152,004 0.424 € 6,001,831
2017 30,000,000 15,000,000 666,667 € 25.24 € 16,823,795 0.386 € 6,486,301
2018 33,000,000 16,500,000 733,333 € 27.00 € 19,800,000 0.350 € 6,939,779
2019 36,000,000 18,000,000 800,000 € 28.89 € 23,110,125 0.319 € 7,363,598
2020 39,000,000 19,500,000 866,667 € 30.91 € 26,786,313 0.290 € 7,759,041
2021 42,000,000 21,000,000 933,333 € 33.07 € 30,863,571 0.263 € 8,127,343
2022 45,000,000 22,500,000 1,000,000 € 35.38 € 35,380,009 0.239 € 8,469,693
(6e) This initiative will reduce the need for Megawot’s coal-fired
generation – which is good in ecological and image terms, though
not necessarily in commercial terms. The initiative is aligned with
Megawot’s social responsibility aims. Is this the best use of ¤78m
(ca £50m) that Megawot could make in this respect? Alternative
investments could include clean technologies to reduce the
ecological impact of burning fossil fuels or renewables (e.g. wind
turbines).
5000
Variable Cost = 2 + 1 + = HK$8
1000
Therefore,
And,
Profit
Net Margin = = –6%
Sales
Fixed Cost
Break-even (in units) =
Contribution per Unit
HK$13.5m
= = 321,429 units
HK$42
HK$132m
= HK$22 per chip
6m chips
HK$1.5m
Unit Cost (design and engineering) = = HK$2.5
2 ´ 300,000
Therefore,
Total Costs (per unit, revised capacity) = HK$22 + HK$2.5 + HK$8 = HK$32.50
This is a fall of over HK$20 from the unit cost of Eurac’s order of
HK$53.
Pearl should exit the market before maturity unless it can replace
(or expand) its manufacturing capability for a lower investment
than is currently the case, or otherwise reduce its fixed costs.
Time per
Time per dynamic Dynamic
Three shift audio demand demand Total
capacity wafer Audio total wafer total requirement
(hours) (hours) (hours) (hours) (hours) (hours) Utilisation
(8b)
(8c) The total cost is irrelevant in a make or buy decision, since fixed
costs will not be saved. Contribution would fall from HK$20 per
unit to HK$7 (33 – 25 – 1).
Time per
Time per dynamic Dynamic
Three shift audio demand demand Total
capacity wafer Audio total wafer total requirement
(hours) (hours) (hours) (hours) (hours) (hours) Utilisation
(8e) Not particularly. Raw materials are not diverse, have common
use, and are a relatively minor cost, so JIT purchasing has few
advantages. The cost of a stock-out in copper or silicon wafers is
huge because of the delay to manufacturing processes. It is these
processes where value is added and batch manufacture is
essential to limit the cost of setting up. Once produced,
HK$ million
Sales 291
– audio 31.2
–68
Other cost –8
Operating Profit 60
(9b) Pearl’s cash budget for 2010 is shown below. Note that Year End
debtors will be equal to fourth Quarter Sales such that,
Depreciation 125
– opening 60
–26
Lease finance 50
–4
(9c) Flexed budget figures for the fourth Quarter of 2010 would be as
follows.
82 86 4(A)
– audio 10.4
Staff cost –8 –8 –
Other costs –2 –2 –
82 83 1(F)
– audio 10.4
Staff cost –8 –8 –
Other costs –2 –2 –
· the first two customer criteria also reflect the industry and, in
particular, the impact of the life cycle on Pearl’s market niche.
The third is a critical parameter for durability of the chip in
use. It might represent the number of warranty claims
received, the average number of failures per million supplied,
or the life before failure occurred. Any failure is likely to
trigger investigative action in order to identify and attribute
responsibility for its cause.
(10b) First,
MA division DE division
Profit, HK$m 51 9
Also,
MA division DE division