GLOSARIO COMPARADO RUNAK-SANSKRIT

Product Quantity Standard profit £

Average standard profit per unit = 124,000/32,000 = £3·875 per unit Actual sales quantity in actual mix at actual selling price less standard cost:

Actual selling price

Actual sales quantity in actual mix at standard profit:

Product Quantity Standard profit £

Actual sales quantity in standard mix at standard profit:

Using the average standard profit per unit calculated earlier: 31,500 x 3·875 = £122,062 Sales price variance = 141,000 – 121,000 = £20,000 (F)

Sales volume profit variance = 121,000 – 124,000 = £3,000 (A) Sales mix profit variance = 121,000 – 122,062 = £1,062 (A) Sales quantity profit variance = 122,062 – 124,000 = £1,938 (A)

Reconciliation £ £ £

Actual sales at actual price less standard cost 141,000 ––––––––

(b) The sales mix profit variance explains how the change in sales mix contributed to the sales volume profit variance. It compares the actual sales quantity in the actual mix with the actual sales quantity in the standard mix, valued at the standard profit per unit.

The adverse variance calculated in part (a) using the average standard profit per unit was £1,062, indicating that the actual sales mix contained more lower-margin products and fewer higher-margin products. The changes in the sales mix can be shown in tabular form, as follows.

Product Standard mix Actual mix Difference Standard profit £

B 9,844 9,500 (344) £4 1,376(A)

The difference column shows that more of Product R, with the lowest standard profit of £3 per unit, was sold than was budgeted for. Less of Products B and K, with the higher standard profits per unit, were sold than budgeted for. Calculation of the individual mix variances for Products B, R and K does not offer information which is any more useful than that contained in the ‘difference’ column.

Sales mix profit variance has significance only when products are inter-related and these relationships are taken into account at the planning stage. If the products sold are not inter-related, the mix variance offers no useful information, since it incorrectly implies that a possible cause of the sales volume profit variance is a change in the mix¹. In fact, only deviations from the planned volumes for individual products need to be investigated if products are not inter-related. In this case the products are substitutes and so are inter-related. The individual sales mix profit variances may therefore be useful.

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1Drury, C. (2000), Management and Cost Accounting, 5th edition, Thomson Learning, pp.734–8

(c) A standard costing system requires preparation of standard costs, comparison of standard costs with actual costs, investigation of variances and instigation of corrective action if needed, and review of standard costs on a regular basis. Standard costs are predetermined unit costs arising under efficient operating conditions. Standard costing can be applied to repetitive or common operations where the input to produce a required output can be clearly specified.

Preparation of standard costs

Standards are required for amount of materials, labour and services required to perform a particular operation, and cost standards are compiled from the standard costs of the individual operations needed to produce a given product. The quantities and costs needed for each standard can be derived using the engineering approach or through the analysis of historical records.

The engineering approach requires a detailed study of each operation so that the materials, labour and equipment used in the operation can be verified by observation, for example by using time and motion studies.

Analysis of historical records can be carried out using quantitative analysis, including the high-low method, scattergraphs and regression analysis. Standards are set by these methods by averaging historical data and so there is a danger that past inefficiencies may be perpetuated. This approach to standard setting is widely used in practice².

Variance analysis

Variances obtained by comparing standard costs with actual costs form the basis of cost control and support the use of responsibility accounting. A wide range of variances can be calculated, depending in part on the costing system employed.

The causes of individual variances can be investigated if a variance is deemed to be significant, in order to inform the instigation of appropriate corrective action where necessary. Both favourable and adverse variances should be investigated, since useful information can be derived from both.

Review of standard costs

Standard costs must be reviewed and updated if they are to retain their relevance to an organisation. The review should consider changes in the prices of inputs such as labour and materials as well as changes in working practices and production methods. The exception to this is the basic standard, which is left unchanged for long periods of time so that trends over time can be established. However, basic standards are not commonly used. It is more usual to find ideal, current and attainable standards being used and these all need regular review.

4 (a) Analysis of data provided

Year 2004 2003 2002 2001 2000

Dividend per share 2·8p 2·3p 2·2p 2·2p 1·7p

Annual dividend growth 21·7% 4·5% nil 29·4%

Earnings per share 19·04p 14·95p 11·22p 15·84p 13·43

Annual earnings growth 27·3% 33·2% –29·2% 17·9%

Price/earnings ratio 22·0 33·5 25·5 17·2 15·2

Share price 418·9p 500·8p 286·1p 272·4p 204·1p

Annual share price growth –16·3% 75·0% 5·0% 33·5%

Dividend per share 2·8p 2·3p 2·2p 2·2p 1·7p

General price index 117 113 110 105 100

Real dividend per share 2·4p 2·0p 2·0p 2·1p 1·7p

Annual dividend growth 20·0% nil –4·8% 23·5%

Average dividend growth:

Arithmetic mean = (21·7 + 4·5 + 0 + 29·4)/4 = 55·6/4 = 13·9%

Equivalent annual growth rate = [(2·8/1·7)^0·25– 1] x 100 = 13·3%

Average earnings per share growth:

Arithmetic mean = (27·3 + 33·2 – 29·2 + 17·9)/4 = 49·2/4 =12·3%

Equivalent annual growth rate = [(19·04/13·43)^0·25– 1] x 100 = 9·1%

Average share price growth:

Arithmetic mean = (–16·3 + 75·0 + 5·0 + 33·5)/4 = 97·2/4 = 24·3%

Equivalent annual growth rate = [(418·9/204·1)^0·25– 1] x 100 = 19·7%

Average real dividend growth:

Arithmetic mean = (20·0 + 0 – 4·8 + 23·5)/4 = 38·7/4 = 9·7%

Equivalent annual growth rate = [(2·4/1·7)^0·25– 1] x 100 = 9·0%

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2Drury, C. (2000), Management and Cost Accounting, 5th edition, Thomson Learning, pp.675–8

Discussion of analysis and views expressed by chairman

The chairman’s statement claims that RZP Co has delivered growth in every year in dividends, earnings and ordinary share price, apart from 2002. Analysis shows that the chairman is correct in excluding 2002, when no growth occurred in dividends, earnings fell by 29·2%, and real dividends fell by 4·8%. Analysis also shows that no growth in real dividends occurred in 2003 and that the company’s share price fell by 16·3% in 2004. It is possible the chairman may not have been referring to real dividend growth, in which case his statement could be amended. However, shareholders will be aware of the decline in share price in 2004 or could calculate the decline from the information provided, so the chairman cannot claim that RZP Co has delivered share price growth in 2004. In fact, the statement could explain the reasons for the decline in share price in order to reassure shareholders. It also possible for the five-year summary to be extended to include annual share price data, such as maximum, minimum and average share price, so that shareholders have this information readily available.

The chairman’s statement claims that RZP Co has consistently delivered above-average performance. The company may have delivered above- or below-average performance in individual years but without further information in the form of sector averages for individual years, it is not possible to reach a conclusion on this point. The average growth rates for the sector cannot therefore be used to comment on the performance of RZP Co in individual years. If the company has consistently delivered above-average performance, however, the company’s average annual growth rates should be greater than the sector averages.

The growth rates can be compared as follows:

Arithmetic mean Equivalent annual rate Sector

Nominal dividends 13·9% 13·3% 10%

Real dividends 9·7% 9·0% 9%

Earnings per share 12·3% 9·1% 10%

Share price 24·3% 19·7% 20%

It can be seen that if the sector average growth rates are arithmetic mean growth rates, the chairman’s statement is correct.

If the sector average growth rates are equivalent annual growth rates, however, only the nominal dividend growth rate is greater than the sector average. The basis on which the sector average growth rates have been prepared should therefore be clarified in order to determine whether the chairman’s statement is correct.

(b) The dividend yield and capital growth for 2004 must be calculated with reference to the 2003 end-of-year share price. The dividend yield is 0·56% (100 x 2·8/500·8) and the capital growth is –16·35% (100 x (418·9 – 500·8)/500·8), so the total shareholder return is –15·79% or –15·8% (0·56 – 16·35). A negative return of 15·8% looks even worse when it is noted that annual inflation for 2004 was 3·5% (117/113).

While the negative total shareholder return is at odds with the chairman’s claim to have delivered growth in dividends and share price in 2004, a different view might have emerged if average share prices had been used, since the return calculation ignores share price volatility. The chairman should also be aware that share prices may be affected by other factors than corporate activity, so a good performance in share price terms may not be due to managerial excellence. It also possible that the negative return may represent a good performance when compared to the sector as a whole in 2004: further information is needed to assess this.

Note that total shareholder return can also be found as (100 x (2·8 + 418·9 – 500·8)/500·8).

(c) The objectives of managers may conflict with the objectives of shareholders, particularly with the objective of maximisation of shareholder wealth. Management remuneration package are one way in which goal congruence between managers and shareholders may be increased. Such packages should motivate managers while supporting the achievement of shareholder wealth maximisation. The following factors should be considered when deciding on a remuneration package intended to encourage directors to act in ways that maximise shareholder wealth.

Clarity and transparency

The terms of the remuneration package should be clear and transparent so that directors and shareholders are in no doubt as to when rewards have been earned or the basis on which rewards have been calculated.

Appropriate performance measure

The managerial performance measure selected for use in the remuneration package should support the achievement of shareholder wealth maximisation. It is therefore likely that the performance measure could be linked to share price changes.

Quantitative performance measure

The managerial performance measure should be quantitative and the manner in which it is to be calculated should be specified. The managerial performance measure should ideally be linked to a benchmark comparing the company’s performance with that of its peers. The managerial performance measure should not be open to manipulation by management.

Time horizon

The remuneration package should have a time horizon that is linked to that of shareholders. If shareholders desire long-term capital growth, for example, the remuneration package should discourage decisions whose objective is to maximise short-term profits at the expense of long-term growth.

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Impartiality

In recent years there has been an increased emphasis on decisions about managerial remuneration packages being removed from the control of managers who benefit from them. The use of remuneration committees in listed companies is an example of this. The impartial decisions of non-executive directors, it is believed, will eliminate or reduce managerial self-interest and encourage remuneration packages that support the achievement of shareholder rather than managerial goals.

Appropriate management remuneration packages for RZP Co

Remuneration packages may be based on a performance measure linked to values in the profit and loss account. A bonus could be awarded, for example, based on growth in turnover, profit before tax, or earnings (earnings per share). Such performance measures could lead to maximisation of profit in the short-term rather than in the long-term, for example by deferring capital expenditure required to reduce environmental pollution, and may encourage managers to manipulate reported financial information in order to achieve bonus targets. They could also lead to sub-optimal managerial performance if managers do enough to earn their bonus, but then reduce their efforts once their target has been achieved.

RZP Co has achieved earnings growth of more than 20% in both 2003 and 2004, but this is likely to reflect in part a recovery from the negative earnings growth in 2001, since over the five-year period its earnings growth is not very different from its sector’s (it may be worse). If annual earnings growth were to be part of a remuneration package for RZP Co, earnings growth could perhaps be compared to the sector and any bonus made conditional upon ongoing performance in order to discourage a short-term focus.

Remuneration packages may be based on a performance measure linked to relative stock market performance, e.g. share price growth over the year compared to average share price growth for the company’s sector, or compared to growth in a stock market index, such as the FTSE 100. This would have the advantage that managers would be encouraged to make decisions that had a positive effect on the company’s share price and hence are likely to be consistent with shareholder wealth maximisation. However, as noted earlier, other factors than managerial decisions can have a continuing effect on share prices and so managers may fail to be rewarded for good performance due to general economic changes or market conditions.

RZP Co recorded negative share price growth in 2004 and the reasons for this should be investigated. In the circumstances, a remuneration package linked to benchmarked share price growth could focus the attention of RZP managers on decisions likely to increase shareholder wealth. The effect of such a remuneration package could be enhanced if the reward received by managers were partly or wholly in the form of shares or share options. Apart from emphasising the focus on share price growth, such a reward scheme would encourage goal congruence between shareholders and managers by turning managers into shareholders.

5 (a) TNG has a current order size of 50,000 units

Average number of orders per year = demand/order size = 255,380/50,000 = 5·11 orders Annual ordering cost = 5·11 x 25 = £127·75

Buffer stock held = 255,380 x 28/365 = 19,591 units Average stock held = 19,591 + (50,000/2) = 44,591 units Annual holding cost = 44,591 x 0·1 = £4,459·10

Annual cost of current ordering policy = 4,459·10 + 127·75 = £4,587 (b) We need to calculate the economic order quantity:

EOQ = ((2 x 255,380 x 25)/0·1)^0·5= 11,300 units

Average number of orders per year = 255,380/11,300 = 22·6 orders Annual ordering cost = 22·6 x 25 = £565·00

Average stock held = 19,591 + (11,300/2) = 25,241 units Annual holding cost = 25,241 x 0·1 = £2,524·10

Annual cost of EOQ ordering policy = 2,524·10 + 565·00 = £3,089 Saving compared to current policy = 4,587 – 3,089 = £1,498 (c) Annual credit purchases = 255,380 x 11 = £2,809,180

Current creditors = 2,809,180 x 60/365 = £461,783

Creditors if discount is taken = 2,809,180 x 20/365 = £153,928 Reduction in creditors = 461,783 – 153,928 = £307,855 Finance cost increase = 307,855 x 0·08 = £24,628 Discount gained = 2,809,180 x 0·01 = £28,091

Net benefit of taking discount = 28,091 – 24,628 = £3,463 The discount is financially acceptable.

An alternative approach is to calculate the annual percentage benefit of the discount.

This can be done on a simple interest basis:

(1/(100 – 1)) x (365/40) = 9·2%

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