Unit: Advanced Management Accounting
Sign in to download the full Topic PDF and enable offline revision mode.
Login to Access| 1. | The replacement cost of a new machine is Sh.1 million with expected useful life of five years. |
| 2. | The machine will have no salvage value after decommissioning it. |
| 3. | It is expected that the 20,000 units of Salfa will be produced and sold at a transfer price of Sh.300 per unit over a five-year period as follows: |
| 3. | Year | 1 | 2 | 3 | 4 | 5 |
| Units sold “000” | 6 | 5 | 4 | 3 | 2 |
| 4. | Variable costs are expected to be Sh.165 per unit produced and sold. |
| 5. | The incremental fixed costs, mainly the wages of a maintenance engineer, are expected to be Sh.200,000 per year. |
| 6. | Alumax Ltd. uses an imputed interest cost of capital of 13% for the investment appraisal purposes. |
| 7. | Depreciation on this machine is calculated on initial cost of the investment at the start of the year. |
Required: | |
| (i) | The residual income (RI) for each of the five years. |
| (ii) | The return on investment (ROI) for each of the five years. |
| Year | 2025 Sh.“000” | 2026 Sh.“000” | 2027 Sh.“000” | 2028 Sh.“000” | 2029 Sh.“000” |
| Revenue per year | 3,900 | 4,900 | 5,400 | 5,350 | 5,950 |
| Operating expenses | 3,200 | 3,700 | 3,900 | 4,100 | 4,250 |
| Depreciation expenses | 1,100 | 1,100 | 1,100 | 1,100 | 1,100 |
| Division | Subunit X Sh.“000” | Subunit Y Sh.“000” |
| Sales turnover | 875,000 | 1,368,000 |
| Less cost of sales: | ||
| Variable costs | (342,500) | (454,000) |
| Contribution | 532,500 | 914,000 |
| Controllable fixed cost | (450,000) | (800,000) |
| Operating income | 82,500 | 114,000 |
| Sh.“000” | Sh.“000” | |
| Average total assets | 250,000 | 456,000 |
| Current liabilities | (62,000) | (268,000) |
| Capital employed | 188,000 | 188,000 |
| Cost of capital | 12% | 12% |
| Target rate of return | 16% | 16% |
| Tax rate | 30% | 30% |
| Division | Subunit X | Subunit Y |
| Residual income | Sh.30 million | Sh.30 million |
| Return on investment | 25% | 20% |
| Economic value added | Sh.33 million | Sh.55 million |
| Asset turnover ratio | 2.36 | 4.12 |
| Sh.“000” | |
| Sales | 3,200,000 |
| Non-interest bearing current liabilities | 64,000 |
| Interest expense | 41,000 |
| Interest-bearing current liabilities | 55,000 |
| Assets | 1,210,000 |
| Net income | 98,930 |
| 1. | The replacement cost of a new machine is Sh.1 million with expected useful life of five years. |
| 2. | The machine will have no salvage value after decommissioning it. |
| 3. | It is expected that 20,000 units of Salfa will be produced and sold at a transfer price of Sh.300 per unit over the five year period as follows: |
| Year | 1 | 2 | 3 | 4 | 5 | |
| Units sold (“000”) | 6 | 5 | 4 | 3 | 2 | |
| 4. | Variable costs are expected to be Sh.165 per unit produced and sold. | |||||
| 5. | The incremental fixed costs, mainly the wages of a maintenance engineer are expected to be Sh.200,000 per year. |
| 6. | Alumax Ltd. uses an imputed interest cost of capital of 13% for the investment appraisal purposes. |
| 7. | Depreciation on this machine is calculated on initial cost of the investment at the start of the year. |
Required: | |
| (i) | The residual income (RI) for each of the five years. |
| (ii) | The return on investment (ROI) for each of the five years. |
| Sh. "000" | |
| Sales revenue (100,000 units at Sh.120) | 12,000 |
| Variable costs (100,000 units at Sh.80) | (8,000) |
| Contribution | 4,000 |
| Fixed costs including depreciation | (2,500) |
| Net operating profit | 1,500 |
| Venus Division investment (at initial cost) | 5,000 |
| 1. | The target rate of return on investment is expected to be 20% per year on written down values (WDVs). |
| 2. | Planet Group is organised into profit centres and each centre manager is delegated substantial autonomy to review its operations |
| 3. | As part of planned review operations, two scenarios are being considered for Venus division as follows: Scenario A: Venus Division to accept a special order of 20,000 units at Sh.100 from Simba Ltd, an external customer. Variable costs per unit will be the same as budgeted, but to enable capacity to increase by 20,000 units, additional investment inform of an extra special purpose equipment will be acquired at a cost of Sh.800,000. The equipment will have a four-year life and the Planet Group depreciates assets on a straight-line basis. No extra fixed cost will be incurred. Scenario B: Included in the current plan of operations of Venus Division is the sale of 20,000 units to Pluto Division of Planet Group. A competitor of Venus Division from external market has offered to supply Pluto Division at Sh.110 per unit. Venus Division intends to adopt a strategy of matching the price quoted from outside Planet Group in order to retain the order. |
Required: Calculate the annual residual income of Venus Division based on: | |
| (i) | The original planned operation. |
| (ii) | Only scenario A added to the original plan. |
| (iii) | Only scenario B added to the original plan. |
| 1. | The forecast of the increase in sales revenue per annum from the premises is as follows: |
| Year | Sales revenue Sh.“000” | |
| 2022 | 700 | |
| 2023 | 600 | |
| 2024 | 500 | |
| 2025 | 400 | |
| 2026 | 300 |
| 2. | The average contribution to sales ratio is expected to be 40%. |
| 3. | The cost of capital is 16% on the net book values of the investment at the beginning of the year. |
| 4. | At the end of the five-year period, the premises improvements will have nil residual value. |
| 6. | Depreciation is charged on straight line basis. |
| 7. | The Diamond division has a target return on capital employed of 20%. |
Required: | |
| Prepare summary performance statement for the years 2022 to 2026 showing: | |
| (i) | Residual income (RI). |
| (ii) | Return on investment (ROI). |
| Balanced scorecard perspective | Objectives | Measurements | Target | Initiative |
| S1 |
| M1 Seat revenue | 30% profit margin | J |
| Plane lease cost | 20% customer retention 5% drop in cost | ||
| S2 |
| Arrival on time M2 | Best ranked | Quality management customer loyalty programme |
| S3 |
| On ground time On time departure | 30 minutes | K |
| S4 |
| % Ground crew trained | Year 1: 70% Year 2: 90% Year 5: 100% | - ESOPS - Ground crew training |
| Division | Head Office | Total | |||
| X Sh. "million" | Y Sh. "million" | Z Sh. "million" | Sh. "million" | Sh. "million" | |
| Sales | 610 | 330 | 1,125 | - | 2,065 |
| Profit before tax and interest | 32 | 24 | 25 | (9) | 72 |
| Total assets less current liabilities | 140.5 | 121.5 | 118.5 | 12 | 392.5 |
| 1. | Head office liabilities and net assets are to be shared equally between all the divisions. |
| 2. | Division X spent Sh.8,200,000 on research and development. |
| 3. | Advertising expenditure amounting to Sh.9,250,000 was spent by Division Y. |
| 4. | Goodwill amounting to Sh.65,000,000 and Sh.97,500,000 was amortised during the year from Division Y and Division Z reserves respectively. |
| 5. | Cost of capital of XYZ Ltd. is 14%. |
| 6. | A summary ofthe borrowings, interest received and interest paid on borrowings is as follows: | |||||
| Division | Head Office | Total | ||||
| X Sh. "million" | Y Sh. "million" | Z Sh. "million" | Sh. "million" | Sh. "million" | ||
| Borrowings | - | 37 | 38 | 7.5 | 82.5 | |
| Interest received | 1.5 | - | - | - | 1.5 | |
| Interest paid | - | 2.2 | 4.3 | 3.1 | 9.6 | |
| Automatic plant Sh. | Manual plant Sh. | |
| Initial capital investment | 9,600,000 | 7,800,000 |
| Net cash flows before tax: | ||
| Year: 1 | 3,600,000 | 3,900,000 |
| 2 | 3,600,000 | 3,300,000 |
| 3 | 3,600,000 | 2,250,000 |
| 4 | 3,600,000 | 1,500,000 |
| Net present value at 16% | 473,451 | 284,422 |
| 1 | The returns of each investment of a division is determined using the following formula: Return = Divisional revenues (sales to outsiders and insiders) - direct divisional costs - allocated central corporate costs |
| 2 | The investment of a division is determined as follows: Investment = Book value of assets |
| 3 | Book value of assets is the aggregate of the accounts receivable net of accounts payable, inventories including raw materials, work in-progress and finished goods and long term assets net of accumulated depreciation. |
| 4 | The actual ROI is calculated monthly for each division and the formula is uniform across all divisions as it is centrally determined. |
| 5 | In undertaking performance evaluation, emphasis is laid on trends rather than absolute goals and standards. |
| 6 | The management also lays emphasis on divisions whose performance is improving or deteriorating and has set a minimum expected ROI below which the manager is required to face disciplinary action. This minimum ROI is however loosely set hence easily achievable. |
| 7 | The minimum ROI is determined by applying different weights to the three investment components as follows; 20% of depreciable assets, 12% for inventories and 6% for account receivables. |
| 8 | Transfer prices between divisions are negotiated between themselves. |
| 2016 | 2017 | 2018 | ||
| Percentage of staff promoted | Actual Budget | 6% 30% | 5% 30% | 8% 30% |
| Average lead time for re-stocking | Actual Target | 3days 3days | 3.25days 3days | 4.1days 3days |
| Sales/Turnover (Sh. billion) | Actual Target | 200 208 | 192 210 | 169 215 |
| Loyalty points awarded to customers (percentage of sales value) | Actual Target | 1.4% 1.5% | 1.3% 1.5% | 1.2% 1.5% |
| Total number of staff grievances lodged in a year | Actual Target | 47 Nil | 101 Nil | 123 Nil |
| Operating expenses (Sh. billion) | Actual Target | 190 180 | 196 182 | 199 185 |
| Customer satisfaction index | Actual Target | 78% 95% | 63% 95% | 59% 95% |
| Processing time for goods returned on warranties (Replacements) | Actual Target | 2weeks 1week | 3weeks 1week | 3weeks 1week |
| 1 | The budgeted sales volume in the first year of operation is 18,000 units. This sales volume is expected to grow at the rate of 10% for years one, two and three but no further growth is expected from year four. |
| 2 | The selling price will be set at Sh.900 per unit for the first two years but then reduce by 5% per annum for each of the next two years. |
| 3 | Gross profit is expected to be 40% of sales in the first year, but will reduce as the sale price reduces. The purchase price on goods for resale will remain constant for the four years. |
| 4 | The overheads including depreciation are budgeted at Sh.5,250,000 for the first two years rising to Sh.6,000,000 in years three and four. |
| 5 | The new outlet requires an investment of Sh.7,500,000 at the start of its first year of trading. |
| 6 | STM Ltd. depreciates its non-current assets at the rate of 25% on cost with nil residual value expected. |
| Units produced: | Existing product | 25,000 |
| New product | 5,000 | |
| Production cost (Sh.): | Existing product | 375,000 |
| New product | 70,000 | |
| Sales revenue (Sh.): | Existing product | 550,000 |
| New product | 125,000 | |
| Hours worked: | Existing product | 5,000 |
| New product | 1,250 | |
| Development cost (Sh.) | 47,000 |
| 1 | The cost of capital for both divisions is 13%. |
| 2 | The current return on investment of each division is 15%. |
| 3 | The divisions' planned investments have the following features: |
| Bee | Cee | ||
| Capital required for investment (Sh.) | 800,000 | 400,000 | |
| Revenue generated by investment (Sh.) | 450,000 | 210,000 | |
| Net profit margin (%) | 30 | 35 |
| W Ltd. Design Division Sh."000" | Gearbox Division Sh."000" | Zed Ltd. Sh."000" | |
| External sales | 14,300 | 25,535 | 8,010 |
| Sales to Gearbox division | 7,550 | ||
| 15,560 | |||
| Cost of sales | (4,900) | (16,200) | (5,280) |
| Administrative costs | (3,400) | (4,200) | (2,600) |
| Distribution costs | - | (1,260) | (670) |
| Operating profit | 6,000 | 3,875 | 7,010 |
| Capital employed | 23,540 | 32,320 | 82,975 |
| 1 | Summary of financial data for Everlast Ltd. for the financial year ended 30 June 2016: |
Revenue: | Western Sh. "000" | Eastern Sh. "000" | Central Sh. "000" | Total Sh. "000" | |
| Fees received | 1,800 | 2,100 | 4,500 | 8,400 | |
| Variable cost | (468) | (567) | (1,395) | (2,430) | |
| Contribution | 1,332 | 1,533 | 3,105 | 5,970 | |
| Fixed cost | (936) | (1,092) | (2,402) | (4,430) | |
| Operating profit | 396 | 441 | 703 | 1,540 | |
| Interest cost on long-term debt at 10% | (180) | ||||
| Profit before tax | 1,360 | ||||
| Income tax for the year | 408 | ||||
| Profit for the year | 952 | ||||
Average book values for 2016: | |||||
| Assets: | |||||
| Non-current assets | 1,000 | 2,500 | 3,300 | 6,800 | |
| Current assets | 800 | 900 | 1,000 | 2,700 | |
| Total assets | 1,800 | 3,400 | 4,300 | 9,500 | |
Equity: | |||||
| Share capital | 2,500 | ||||
| Retained earnings | 4,400 | ||||
| Non-current liability: | |||||
| Long-term borrowing | 1,800 | ||||
Current liabilities | 80 | 240 | 480 | 800 | |
| Total equity and liabilities | 9,500 |
| 2 | Everlast Ltd. defines residual income (RI) for each centre as operating profit minus required rate of return of 12% of the total assets of each centre. |
| 3 | At present, Everlast Ltd. does not allocate long-term borrowings of the group to the three separate centres. |
| 4 | Each centre faces similar risk. |
| 5 | Tax is payable at the rate of 30%. |
| 6 | The market value of the equity capital of Everlast Ltd. is Sh.9 million and the cost of equity is 15%. |
| 7 | The market value of long-term borrowing is equal to its book value. |
| 8 | The directors are concerned about the return on investment (ROI) generated by Eastern centre and are considering using sensitivity analysis in order to show how target ROI of 20% might be achieved. |
| 9 | The marketing director stated at a recent board meeting that "The Group's success depends on the quality of service to our clients. In my opinion, we need only to concern ourselves with the number of complaints received from clients during each period as this is the most important performance measure of our business. The number of complaints received from clients is a perfect performance measure. As long as the number of complaints received from customers is not increasing from period to period, then we can be confident about our future prospects". |
| (a) | The most successful centre. Your report should include commentary on return on investment (RO1), residual income (RI) and economic value added (EVA) as measures of financial performance. Detailed calculations regarding each of the three measures must be included as part of your report. |
| (b) | The percentage change in revenue, total cost and net assets during the period that would have been required in order to achieve a target ROI of 20% for Eastern centre. |
| (c) | State whether you agree with the statement of the marketing director in note (9) above. |
| Investment Opportunity | Annual profit Sh. | Cost of investment Sh. |
| A | 300,000 | 900,000 |
| B | 300,000 | 1,600,000 |
| C | 240,000 | 1,200,000 |
| D | 280,000 | 800,000 |
| E | 260,000 | 1,000,000 |