Financial Management 2a Workbook 2017 (Pdfdrive)

IIE Workbook FINM6211
FINANCIAL MANAGEMENT 2A
WORKBOOK 2017
(First edition: 2013)
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Table of Contents
Glossary of Key Terms for this Module .......................................................................3
Learning Unit 1: The Role of the Financial Manager ................................................. 14
1 Recommended Additional Reading................................................................... 14
2 Recommended Digital Engagement and Activities ............................................ 15
3 Activities ........................................................................................................... 15
4 Solutions to Exercises ...................................................................................... 19
Learning Unit 2: Interpreting Financial Results ......................................................... 25
3 Activities ........................................................................................................... 26
Learning Unit 3: Managing Working Capital.............................................................. 54
3 Activities ........................................................................................................... 55
Learning Unit 4: An Introduction to Managerial Accounting ...................................... 78
3 Activities ........................................................................................................... 79
Learning Unit 5: Controlling Inventory and Overhead Costs ................................... 100
1 Recommended Additional Reading................................................................. 100
2 Recommended Digital Engagement and Activities .......................................... 101
3 Activities ......................................................................................................... 101
4 Solutions to Exercises .................................................................................... 108
Learning Unit 6: Accounting for a Manufacturing Enterprise ................................... 130
3 Activities ......................................................................................................... 131
Learning Unit 7: Job Costing .................................................................................. 158
3 Activities ......................................................................................................... 159

Glossary of Key Terms for this Module
Term Definition My Notes
Abnormal The waste or wrecking of inventory

spoilage beyond what is expected in normal
business processes. Abnormal spoilage
can be the result of broken machinery
or from inefficient operations, and is
considered to be at least partially
preventable.
Accountability The obligation of an individual or a
business to account for its activities,
accept responsibility for them, and to
disclose the results in a transparent
manner.
Acid test ratio/ Measures a company’s ability to meet
quick ratio its short-term obligations using its most
liquid assets.
Activity-based- A costing method that assigns the costs
costing (ABC) of making a product to the activities that
are needed to make a product, and then
sums the cost of these activities to
determine the cost of making the
product.
Actual The actual or real cost of overheads to
manufacturing the manufacturing enterprise.
overhead costs
Administrative All the organisational, executive and
costs clerical costs associated with the
general management of an
organisation.
Agency The relationship between management
relationship and the shareholders, whereby
shareholders have delegated the
authority to manage the business to
managers.

Allocated or Overhead costs allocated to the

applied production process during the
manufacturing manufacturing period according to a
overheads pre-determined rate, based on the
budgeted overhead costs as well as the
expected capacity of production.
Appraisal costs Costs incurred to ensure that the
products meet quality standards.
Average creditors The average time it takes for a business
settlement period to pay its creditors.
Average debtors The average time it takes a business to
collection period receive payment from its debtors.
Average inventory The number of times the average
turnover inventory balance is sold during a
reporting period.
Average stock An average of beginning and ending
inventory.
Benchmark A standard by which something can be
measured or judged.
Bottom line Refers to a company’s net income (or
profit for the year). A company that is
growing its income or reducing its costs
is said to be ‘improving its bottom line’.
Break-even A situation where neither a profit nor a
loss is generated. The income
generated from sales will equal the
expenses incurred.
Budget A financial plan used to predict future
income and expenses.
Budget period The period for which a budget is
prepared, normally one year.
Budget variance The difference between the actual and
budgeted figure.
Budgeted The total amount of overheads as
manufacturing expressed in the budget of a
overhead costs manufacturing enterprise.
Buffer stock Material which forms a buffer between
production and usage where production
is constant, but where the supply of
material takes place irregularly.

Business plan A sales document that conveys the

promise and excitement of a business
idea to any potential backer or
stakeholders.
Business strategy A long-term plan of action designed to
achieve a particular goal.
Capital budgeting The process in which a business
determines whether projects such as
building a new plant or investing in a
long-term venture, are worth pursuing.
Capital rationing Placing limits on the amount of new
investment undertaken by a business.
Carrying costs The cost of holding goods in stock,
including storage, insurance, etc.
Cash budget An estimation of the cash inflows and
outflows for a business for a specific
period of time.
Conflict of interest Arises when an individual’s own interest
is adverse to the interests of the
company as a whole.
Continuous A budget system that has in effect a
budget budget for a set number of months,
quarters or years at all times.
Contribution The difference between sales revenue
margin and variable costs.
Controllable costs Any cost over which a manager has
some form of control.
Cost behaviour How a cost will react or respond to
changes in the level of business activity.
Cost driver Any activity or series of activities that
takes place within a business and
causes costs to be incurred.
Cost of sales The net purchase cost of goods that
have been sold during a particular
period.
Cost-volume-profit Another term used for break-even
(CVP) analysis analysis.
Current assets Assets of a business that circulate from
one form to another in the ordinary
course of operations.

Current liabilities Debts that have to be settled within a

year.
Current ratio Indicator of a firm’s ability to meet its
short-term financial obligations.
Direct labour Costs incurred to remunerate workers
that are directly involved in the
manufacturing process.
Direct material Material which can be traced directly to
a finished product.
Dividend The distribution of a portion of the profit
earned by a company.
Earnings per The portion of a company’ earnings
share (EPS) (after taxes and preference dividends),
that is allocated to each ordinary share
in issue.
Economic The quantity of stock ordered that will
ordering quantity minimise both inventory holding costs
(EOQ) and inventory ordering costs.
Ethical behaviour Acting in a way that is consistent with
what society typically thinks are good
values.
Executive A brief description of the proposed
summary business that highlights the important
aspects of the business plan.
External failure Costs incurred when inferior products
costs are delivered to customers.
Finance manager The individual responsible for
organising and managing a business’
financial portfolio. He or she also
prepares financial reports, oversees
investments and helps with cash
management.
Financial budget Consists of the capital budget, the cash
budget, the budgeted Statement Of
Comprehensive Income and the
budgeted Statement Of Financial
Position.
Financial year Any twelve-month period that the
company uses for accounting purposes.
It is also referred to as the ‘fiscal year’.

Finished goods The product which becomes available

for sale after the production process
has been completed.
First-in-first-out An inventory valuation method that
(FIFO) inventory assumes that units of inventory that
valuation were bought first will be sold first.
Fixed costs Expenses which must be paid,
irrespective of the volume of production.
Floating interest An interest rate that fluctuates in direct
rate proportion with changes in the prime
interest rate.
Gross margin The per cent of total sales revenue that
the company retains after deducting the
direct costs associated with producing
its goods and services.
Gross profit The profit from sales before deducting
overheads, interest and tax expenses.
Gross profit What remains from sales after a
percentage company pays out the cost of goods
sold.
Historical financial Information about economic events that
information occurred in the past.
Independent A project of which acceptance or
project rejection is independent of the
acceptance or rejection of other
projects.
Indirect labour The payments made for supervision,
cleaning of the factory, security at the
factory, and other employees who do
not ‘touch’ the products when they are
being manufactured, but who are
nevertheless employed in the factory.
Indirect materials Materials used in the production
process, but which do not form an
integral part of the finished product.
Interest The cost of money.
Internal failure Costs incurred due to the failure of
costs products to meet quality standards.
Internal rate of The discount rate that makes the net
return (IRR) present value of all cash flows from a
particular project equal to zero (0).

Inventory The process of assigning cost to

valuation inventory.
Job cost sheet This is used to track the job number,
customer information, job information
(date started, completed, and shipped),
individual cost information for materials
used, labour, and overhead; and a total
job cost summary.
Lead time The time interval between when an
order is placed and when the order is
finally received from the supplier.
Leverage The amount of debt used to finance a
business’ assets. A business with
significantly more debt than equity is
considered to be highly leveraged.
Liquidity ratios Measure a business’ ability to meet its
short-term financial obligations on time.
Loan amortisation The schedule of payments for paying off
schedule a loan. It breaks down the payments
into interest and the principal amount.
Long-term loan A loan that has to be repaid over a
period of longer than a year.
Manufacturing All the other manufacturing costs
overheads (excluding direct material and direct
labour) incurred in producing a finished
product.
Marginal cost The sum of all variable costs,
irrespective of whether these costs
comprise manufacturing, selling or
administration costs.
Marginal income The difference between sales and
variable/ marginal cost.
Marketing, All costs necessary to secure customer
distribution and orders and to ensure that the product
selling costs ends up in the hands of the customer.
Mark-up The percentage difference between the
percentage actual cost and the selling price.

Master budget The comprehensive, all-encompassing

budget for the enterprise that comprises
many interrelated budgets, including
both the operational and financial
budget.
Maximum stock The highest possible stock volume that
can be carried by the business. It is
limited to the storage space available.
Mission Defines why a business exists, i.e. its
reason for being.
Mutually exclusive Projects that compete with each other in
projects such a way that the acceptance of one
project automatically excludes all others
from further consideration.
Net income/ profit The relationship between total net
ratio income/ profit and total sales.
Net present value The sum of the present values of all
(NPV) future cash flows for a project.
Net profit Profit from sales after accounting for
overheads, interest and tax expenses.
Net profit An indication of how effective a
percentage company is at cost control. The higher
the net profit margin is, the more
effective the company is at converting
revenue into actual profit.
Net sales Sales revenue excluding VAT, less all
sales returns.
Net working The net difference between the current
capital assets and current liabilities of a
business.
Non- The administration, selling and
manufacturing distribution costs of a product.
costs
Normal stock The material which is in the process of
production, material about to enter the
production process, or which has just
been completed.
Obsolete Inventory that a business is unable to
inventory sell because it has become outdated.

Operating budget Consists of the sales budget, the

production budget and the sales and
administrative expenses budget.
Operating Any expenses incurred in carrying out
expenses/ an organisation's day-to-day activities,
Overheads but that is not directly associated with
production.
Opportunity cost The cost of the next best alternative not
chosen when a choice is made.
Ordering costs The costs of preparing, issuing and
paying purchase orders for receiving,
and inspecting the items included on
the orders.
Overstocking The amount of stock held is not justified
by the volume of inventory needed for
production.
Overtrading Growing a business too quickly, to the
detriment of net working capital.
Periodic inventory An inventory system where the outflow
system of sales are not recorded at the point of
sales. Cost of sales is determined at the
end of the financial period.
Perpetual An inventory system where the outflow
inventory system of inventory is recorded at the point of
sale.
Prevention costs Costs incurred to prevent the production
of inferior quality products.
Prime lending rate The interest rate charged by banks to
their largest, most secure, and most
creditworthy customers on short-term
loans.
Production/ The cost of direct material, direct
manufacturing labour, and manufacturing overheads in
costs the fabrication, assembly, and testing of
an end item.
Production cost The production cost statement is the
statement most widely used and summarised
statement of manufacturing costs. The
statement incorporates direct materials,
direct labour and manufacturing
overheads.

Profit The amount by which the total sales

exceeds the total cost for a financial
period.
Profitability ratios Measures that indicate how well a firm
is performing in terms of its ability to
generate profit.
Purchasing costs Costs of goods acquired from suppliers,
including the cost of freight, carriage,
railage, or any other means of transport
necessary to get the goods onto the
shelf, ready for sale.
Quality costs Costs that are incurred to prevent
defective products from going onto the
market, as well as costs incurred as a
result of defective products being
produced.
Ratio analysis Examining the position and potential of
a business by studying the relationships
of key financial variables.
Reorder point Minimum level of inventory at which a
new order must be placed.
Repo-rate The rate at which the South African
Reserve Bank (SARB) lends funds to
commercial banks.
Required rate of The minimum return the investor will
return accept for a particular investment.
Retained income The portion of profits that have not been
distributed to shareholders as a
dividend.
Return on owner’s How much profit a business earned in
equity comparison to the total amount of equity
invested in the business.
Risk tolerance An investor's ability or willingness to
accept declines in the prices of
investments while waiting for them to
increase in value.
Safety stock Similar to buffer stock, but more
extensive as it is specifically aimed at
ensuring that the business can continue
with production as usual if a specific
raw material is not delivered within the
normal delivery time.

Short-term loan A loan that has to be repaid within the

following financial year.
Shrinkage The accounting term used to describe
the loss of gross profit attributable to a
combination of employee theft,
shoplifting, breakage, obsolete stock,
stock rotation, natural disasters or
administrative error.
Solvability ratio Equates the total assets with the total
liabilities at a particular point in time.
Speculative stock Stock held for financial reasons, such
as an expected substantial rise in the
price of the stock in the near future.
Stakeholders Individuals and groups of individuals
that have an interest in the business,
either directly or indirectly.
Stock-in-transit Stock that has already been ordered
and paid for, but which is still in the
process of delivery.
Stock-out costs Costs that occur when a company runs
out of a particular item for which there is
a demand.
Stock-piling An inventory of raw materials kept due
to the time difference between the
acquisition of the material and the use
thereof in the production process.
Sunk costs Costs that have already been incurred
and which cannot be changed by any
decisions now or in the future.
SWOT analysis A tool used to analyse the strengths,
weaknesses, opportunities and threats
of a business.
Technical Occurs when a business defaults on a
insolvency legal obligation, for example when it
does not pay its bills.
Timing of returns When the accrued profits will actually
be received by a business.
Uncontrollable Costs over which a manager has no
costs control and which is not in his or her
power to influence.

Understocking The amount of stock held is too low with

regard to the volume of production and
the business is at risk of running out of
stock.
Value-added tax Indirect tax on the domestic
(VAT) consumption of goods and services.
Variable costs Expenses which will vary (more or less
proportionately) with production.
Vision What the business aims to achieve in
the future.
Weighted average An inventory valuation method where
cost inventory the unit price of each unit will change
valuation when subsequent purchases of the item
are made at prices differing from those
prior purchases.
Weighted average A mathematically calculated figure
cost of capital showing what it costs to fund the
business through a combination of debt
and equity capital.
Working capital Current assets minus current liabilities.
Working capital measures how many
liquid assets a company has available
to build its business.
Work-in-process Materials which have already entered
the production process and to which
some labour and overhead costs have
been added, but which are not yet
completed and therefore not ready to be
sold.

Learning Unit 1: The Role of the Financial Manager

Learning Objectives: My Notes on this
 Explain the primary roles of the financial Learning Unit:
manager – performing financial analysis and
planning, making investment decisions and
making financing decisions.
 Demonstrate how a financial manager balances
the timing of returns and cash distributions to
equity participants in lieu of prevalent and
pending risks.
 Critically evaluate the ethical considerations that
underlie a financial manager’s conduct.
 Describe the agency problem and the associated
risk posed by a financial manager to the
corporate entity that it purports to serve.
Material used for this Learning Unit:
 Prescribed text pp.1–13.
How to prepare for this Learning Unit:
 Before the first class, be sure that you read
pp.1–13 in the textbook.
 As you read these sections, see if you can find
the answers to the following questions:
o What is the purpose of the financial
management function in a business?
o What is the key objective of a business?
o What are the primary and secondary
responsibilities of a financial manager?
o What tools can a financial manager use to
indicate what the business’ funding
requirements will be in the immediate and
longer term?
o Why is it important for a financial manager
to comply with an ethical code of conduct?
o When does the ‘agency problem’ arise?
1 Recommended Additional Reading Make sure that you

complete Revision
Gitman, LJ. 2008. Principles of managerial finance. 12th edition. Exercise 1 and 2 once you
Boston, (MA): Pearson, Addison Wesley. Chapter 1. have worked through
Learning Unit 1 in the
prescribed textbook.

2 Recommended Digital Engagement and Activities

Visit the following link and answer the questions that are posed on the website:
Accounting Coach. 2012. Accounting careers. [Online]. Available at:

http://www.accountingcoach.com/accounting-careers/blog
[Accessed 25 November 2016].
Note: subscribers to the Business Channel from Upload Media have access to a wide
variety of conceptual videos on business topics such as bookkeeping, accounting,
economics, financial management, income tax, cost and management accounting,
financial management and business law. Visit:
Upload media. 2015. Browse business channel. [Online]. Available at: http://upload-
media.com/channels/bc [Accessed 25 November 2016].
Resources needed:
3 Activities The annual reports and
codes of ethics of different
3.1 Izimvo Exchange 1 companies, financial
newspapers and
magazines.
The reality of compound interest has bearing on many aspects of our lives. Many of us
have heard a parent or an experienced relative say: Start saving when you are young!
Let us see if there is any truth in this.
Assume you started saving R500 a month from the day you turned 20. At 12% effective
interest, your savings would have grown to R115 019.34 the day you turned 30. By
that time, the total amount invested would have been R60 000. Assume you stopped
paying your premiums with immediate effect, but left the R115 019.34 to earn effective
interest of 12% p.a. until the day you reached 65. Calculate how much the meagre R2
400 you invested during your youth would have grown to at age 65, had the interest
rate remained constant over the whole period.
The answer you received above is enormous, is it not? Unfortunately it might not be
so great after all. There is always a cost to any investment. Apart from the usual bank
charges and fees, there is always the cost of inflation to contend with. To ascertain
whether the future value calculated above is as significant as it seems, we need to
‘discount’ the future value by a factor that reflects the inflation over the investment
period. Try to work out the true present value (PV) of the maturity value at 65 (in other
words: what is that amount worth in today’s terms), if 10% and 13% inflation rates are

applied throughout the 45 years. The true PV at age 20 is required. Interpret your
results.
3.2 Izimvo Exchange 2
It is the task of the financial manager to ensure proper management of creditors,

overdrafts and other liabilities. Failure to pay liabilities in time can create serious cash-
flow problems for the business. When dealing with suppliers, good relations can be
very useful. For example, a supplier may sell goods to a business and offer them terms
of 30, 60 or even 90 days. This means that the supplier allows the business a specified
period to pay its account, either from the date of the sale or from the last day of the
month in which it took place. The longer your business takes to pay its debts beyond
the agreed period, the larger the amount becomes because interest will be charged by
the supplier on late payments.
Consider the following scenario:
The following account statement was sent by Lindell Hooters CC to Pontsho Traders
on 30 November 20.5:

Required:
Answer the following questions that relate to the account statement shown above:
(i) How much did Pontsho Traders owe Lindell Hooters on 1 November 20.5?
(ii) How much did Ponthso Traders owe Lindell Hooters by the close of business on
30 November 20.5?
(iii) How much money was paid back to Lindell Hooters by Pontsho Traders during
November 20.5?
(iv) What was the percentage discount allowed on the payment made on 30
November 20.5?
(v) There seems to be a mistake on the age analysis. Explain what the mistake is.
3.3 Activity 1 – Question 1.1 For Activity 1 consult p.7 in

the textbook.
Purpose:
The purpose of this activity is to identify and discuss one of the responsibilities of a
financial manager in more detail.
Task:
Complete Question 1.1 in the prescribed textbook.
Commentary Related to Activity Design:

This activity is designed for you to apply your background knowledge of accounting to
identify more profitable ways of using capital that is tied up in unused assets.

the textbook.
Purpose:
The purpose of this activity is to reflect on the different stakeholders that a financial
manager has to consider when making business decisions.
Task:

This activity is designed to make you realise that financial managers do not act in
isolation, and that all of their decisions have an impact on both internal and external
stakeholders, and ultimately on the business itself.


the textbook.
Purpose:
The purpose of this activity is to distinguish between an entrepreneur and a financial
manager and the roles they play in a business.
Task:

This activity is designed in order for you to realise that entrepreneurs often act as the
financial managers of their businesses, if the business is very small. The larger a
business becomes, the more the need for the financial function to be separated from
the overall management function.
3.6 Activity 4 – Question 1.4

For Activity 4 consult p.12
in the textbook.
Purpose:
The purpose of this activity is to identify the role that performance-related incentives
play in motivating financial managers to act in a certain way.
Task:

This activity is designed to encourage you to look at both sides of an argument, and to
identify both the positive and negative aspects of linking a financial manager’s
performance to his or her remuneration.
3.7 Revision Exercise 1
Answer the following questions:
1. Identify who the stakeholders of a company are.
2. Discuss how the company can interact with the shareholders in a healthy
engagement.
3. If a company builds a relationship with stakeholders through healthy engagement

there will still be some disadvantages to this. Discuss these disadvantages.

4 Solutions to Exercises
The number of compounding periods left as from age 30 until retirement would have
been 35. The future value (FV) at age 65 could then be calculated as follows:
R115 019.34 × 1.1235 = R6 072 977.40
10% inflation rate  R6 072 977.40 ÷ 1.1045 = R83 316.46

13% inflation rate  R6 072 977.40 ÷ 1.1345 = R24 824.00
From EDGE Resource Files © 2013 EDGE Learning Media CC
(i) R12 090
(ii) R35 858.72
(iii) R11 787.75
(iv) R302.25/(R11 787.75 + R302.25) × 100 = 2.5%
(v) The age analysis shows that the R12 090 that was outstanding on 1 November
20.5 is still due, However, the payment was made on 30 November 20.5, so the
full balance of R35 858.72 should be ‘current’.
Excess or idle assets are not being used by the business and are not generating any
returns through use. The business is paying some form of ‘cost of capital’ on the asset,

represented by the money tied up in the asset which can only be realised by selling it
(as the business is not using it to generate any cash flows).
One of the key objectives of the financial manager is to maximise shareholder wealth.
In order to achieve this, the financial manager needs to only invest in assets that is
likely to earn a return greater than the ‘cost of capital’. Therefore, the financial manager
should choose to dispose of assets that do not meet this requirement.
Should the financial manager choose to dispose of these assets, the cash proceeds
from the sale could be used in more productive ways through investment (in assets or
projects that will be used to generate cash flows) or by paying off borrowings. Either
approach will enhance the return on capital employed of the entire business and result
in the more effective use of the business’ assets.
(i) Shareholders provide one form of capital to the business. Their objective is for
their wealth (represented by the share price) to be maximised. The frequency
of cash flows in the form of dividends as well as long-term share price
appreciation will influence whether shareholders will buy/ sell shares in the
company.Share price movements are in turn influenced by the market’s
perception of how the business is managed, so major decisions made by the
financial manager will have an impact on the perceptions of the market, giving
rise to a movement in the share price.
(ii) Creditors provide goods and services to the firm. Generally, they will have the
same business objectives as the business and will want to be paid in a prompt
manner, whilst still maintaining the trading relationship with the business. The
financial manager’s role here is to preserve this business relationship, ensuring
that the credit terms negotiated are beneficial to the business.
(iii) Long-term credit providers are usually banks who provide the business with the
other form of capital. Their objective is to ensure that the business makes the
scheduled loan capital and interest repayments. The financial manager’s role
here is to negotiate loan capital and interest rates that are favourable to both
parties, and ensure that the business has sufficient funds to meet its debt-
servicing requirements (so that there are no defaults on the loan). Not having
defaults on payments and maintaining a good relationship, will allow the
financial manager to negotiate better rates/ payment terms with the bank in
future.

(iv) Employees of the business seek to maximise their remuneration and continuity
of employment. The financial manager needs to ensure that employees are
remunerated appropriately and on a timely basis. If employees feel they are
unfarily remunerated, they may become less productive, look for employment
elsewhere or even engage in strike action.
Hint: Find some articles or columns written about the effects of strikes on South
African businesses and the economy as a whole. Here are a couple of links
that may assist in this research:
Mail and Guardian. [s.a]. Mass Cosatu strike grips South Africa. [Online].
Available at: http://mg.co.za/article/2008-08-06-mass-cosatu-strike-grips-south-
africa [Accessed 25 November 2016].
UPIU. 2013. Crippling effect of South African strikes. [Online]. Available at:
http://www.upiu.com/business/2010/10/10/Crippling-effect-of-South-African-
strikes/UPIU-8741286529646/ [Accessed 25 November 2016].
Wonkie Cartoons. 2008. Strikes in South Africa. [Online]. Available at:

http://www.wonkie.com/2010/08/25/strikes-in-south-africa/ [Accessed 25
November 2016].
(v) The various government departments influence the firm’s activities through
government policies and taxes. Government policy usually has the overall
objective of ensuring economic growth and reducing unemployment. The
financial manager needs to be mindful of these objectives and manage the
business’ finances in a way that will not, in any way, contravene the
government’s laws and regulations.
An entrepreneur is a person whose objective is to find new and innovative ways of

doing something through inventing and selling a new product or service. They are
inventors and are willing to take risks in exploiting opportunities. In most cases an
entrepreneur is the owner of the business he/ she created, and might not necessarily
be formally educated in business and finance.
The smaller the entrepreneur’s business, the more involved they will be in the ‘financial
management’ aspects of their business. The bigger their business, the greater the
likelihood that they will employ financial managers to manage the business on their
behalf.

In summary, ‘entrepreneurs’ start up their own businesses, whereas a financial

manager manages a business on behalf of somebody else.
(i) Bonuses: Many organisations use performance-related bonus schemes to

incentivise management. For example, a financial manager might be entitled to
a maximum 20% bonus, of which 10% will be related to personal performance
(evaluated and assessed using employee appraisals) and 10% will be related to
the overall performance of the business.
Share schemes: Many listed companies will give employees the option of
participating in a share scheme. Employees are granted a number of share
options entitling them to subscribe to a given number of shares in the company
after a certain date at a fixed price (this is usually set at a value that will be lower
than the current share price). Share schemes serve to align the financial
manager’s personal objectives with that of other shareholders i.e. shareholder
wealth maximisation.
(ii) Advantages of performance-related reward schemes:

 Motivates employees to improve their performance levels;
 May attract strong candidates to the organisation and improve employee
loyalty;
 By aligning organisational key performance indicators to employee
rewards, employees know what sort of performance will generate a strong
business performance;
 It fosters a culture of continuous improvement throughout the organisation;
 Schemes based on shares encourage employees to focus on the long-term
interests of the organisation by engaging in activities that will increase the
business’ market value.
(iii) Disadvantages of performance-related reward schemes:

 It may encourage dysfunctional behaviour – to make bonuses more
achievable, many managers may lower budgets and standards;
 Managers may be more willing to take on projects with an unacceptably
high level of risk in the hope of achieving high returns – this could be to the
detriment of the business as a whole;
 Schemes with a long-term focus may put managers off as they are too
long-term;
 Performance objectives of an individual might not provide an indication of
what the individual has actually achieved and their assessment is still
subjective;

 Individual performance objectives may be to the detriment of team work;

 The high level of output required by performance objectives might come at
the expense of quality.
 Once staff members have met the required performance level to qualify for
their bonuses, motivation levels might drop, as no marginal benefit may be
available to them beyond reaching this target.
1. Customers, suppliers, employees, shareholders, government, financial service

providers.
2. Encourage the shareholders to attend the Annual General Meeting (AGM) in the
case of a public company. The board needs to take its own responsibilities in
regard to the AGM seriously and present an opportunity to generally discuss the
affairs of the company and to deal comprehensively with questions raised by the
shareholders. Good attendance by directors and the chairpersons of committees
should be ensured in order to answer questions relating to their responsibilities.
The board needs to appreciate that a formal process such as the AGM need not
be the only mechanism for dealing with shareholders. Informal processes such
as direct contact, websites, advertising and press releases should also be
considered.
It will of course depend on the number of shareholders and on whether the

company is listed or not, as there are stock exchange requirements to be
considered. Care must be taken when dealing with information that is price-
sensitive. In principle it should be shared with all stakeholders as soon as
possible. Regarding shareholders, the board needs to be aware of insider trading
rules. Listed companies are required to have sponsors who will assist and advise
in ensuring compliance with JSE requirements and proper use of the Stock
Exchange News Service (SENS).
The board needs to be aware of the rights that shareholders enjoy under the
Companies Act 2008 and in terms of common law. For example, only two
shareholders are sufficient to propose a resolution. Common law rights relate to
matters such as the right to be heard at a meeting. The JSE Listings
Requirements relating to shareholders should be analysed. This should entail an
analysis of the shareholder spread for each class of listed securities (including
any listed debt), split between public and non-public shareholders, with a further
analysis of the latter and, secondly disclosure of any major shareholders, being
those interested in 5% or more of any class of shares.

Companies should ensure the equitable treatment of shareholders, both among

shareholders of the same class and also between various classes of
shareholders.
3. Information derived may be anecdotal, self-interested or unreliable. A company

should not allow itself to get into a position of permitting interference or undue
influence in the running of the company. A company should not go to the other
extreme of using legal or other processes to block engagement with
stakeholders. A company should take care to ensure, as far as practicable, even-
handedness as between various classes of stakeholders and within classes of
stakeholders, relationships can be seriously damaged, and trust destroyed if it is
felt that some stakeholders are privy to information which is being denied to
others.
Visit the following link for more information on the duties and liabilities of directors
and the Corporate Laws Amendment Act, 2006:
Bowman Gilfillan Attorneys. 2006. Duties and liabilities of directors and the
corporate laws amendment act 2006. [Online]. Available at:
http://services.bowman.co.za/Brochures/DutiesAndLiabilities/DutiesAndLiabiliti
esBrochure-lr.pdf [Accessed 25 November 2016].

Learning Unit 2: Interpreting Financial Results

 Outline the main elements and components of a set of Learning Unit:
financial statements.
 Explain the difference between gross profit, net profit
and cash on hand.
 Explain causes of increases and decreases in
expenses, and suggest ways in which costs can be
reduced.
 Identify and demonstrate ways to reduce shrinkage in
business.
 Describe the difference between technical and
fundamental analysis.
 Apply profitability, liquidity and investment ratios to a
set of financial statements for a sole trader, and
appraise the efficiency and profitability of a business
using these tools.
 Before the first class, be sure that you read pp.14–62
in the textbook.
 As you read these sections, see if you can find the
answers to the following questions:
o Which items in the Statement of Comprehensive
Income have a direct or indirect effect on the
profitability of a business?
o How can you increase the demand for a
product?
o What methods can be used to reduce the costs
of sales of a product?
o What is the definition of gross profit?
o How can a business reduce its expenses?
o What are the causes of shrinkage?
o How can shrinkage be minimised?
o What is the difference between the perpetual
inventory system and the periodic inventory
system?
o Why should financial managers perform a ratio
analysis on financial statements?
o When does an investor make use of technical
analysis?
o When does an investor make use of
fundamental analysis?
o What is meant by gearing, and why is it
important in business?

1 Recommended Additional Reading

Gitman, LJ. 2008. Principles of managerial finance. 12th edition. Make sure that you
Boston, (MA): Pearson, Addison Wesley. Chapter 2.
complete Revision
Exercise 1 and 2 once
2 Recommended Digital Engagement you have worked through
and Activities Learning Unit 2 in the
Visit the following link and answer the questions that are posed
Notes on Learning Unit 2
on the website:
in the textbook:
The textbook provides an
Accounting Coach. 2012. Financial Ratios. [Online]. Available at:
overview of the importance
http://blog.accountingcoach.com/category/03/ [Accessed 25
of interpreting financial
November 2016].
statements.
Note: subscribers to the Business Channel from Upload Media
have access to a wide variety of conceptual videos on business
topics such as bookkeeping, accounting, economics, financial
management, income tax, cost and management accounting,
Upload media. 2012. Browse business channel. [Online].

Available at: http://upload-media.com/channels/bc [Accessed 25
November 2016].
Resources needed:
3 Activities Calculator and financial
statements of different
3.1 Izimvo Exchange 1 companies.
Some experts are of the opinion that the perpetual inventory system offers more
advantages to a business than the periodic system.
Discuss in groups whether you agree with these experts or not. Motivate your answer.

Column A Column B (Accumulated Profit)

(Profit for the Year)
Statement of Statement of Financial
Comprehensive Income Position
28 Feb. 20.1 R1 000 000 R1 000 000
28 Feb. 20.2 R1 000 000 R2 000 000
28 Feb. 20.3 R1 000 000 R3 000 000
28 Feb. 20.4 (R500 000) ?
(i) What is the value of the missing amount in column B?
(ii) The Statement of Comprehensive Income measures financial performance, whilst

the Statement of Financial Position measures financial position.
Discuss in groups why stakeholders need to peruse the Statement of

Comprehensive Income and the Statement of Financial Position to make an
informed decision about the well-being of a business. Refer to the information in
Columns A and B (above) in your reasoning.
(iii) The business made R1 000 000 profit per year (refer to year 1–3 above).
Is this a lot of money (i.e. has the business performed well)?
3.3 Activity 1 – Question 2.1 For Activity 1 consult p.17

in the textbook.
Purpose:
The purpose of this activity is to determine how successful the offering of discounts by
various businesses is in increasing the profitability of the businesses.
Task:

This activity is a practical exercise to show that financial managers should always weigh
the cost of implementing a decision against the potential benefits the business could
derive.


in the textbook.
Purpose:
The purpose of this activity is to illustrate the effect that a reduction in cost of sales has
on the net profit of a business.
Task:

This activity is designed to make you realise the effect that a small reduction in
expenses could have on the profitability of a business, and that financial managers
should therefore always strive to negotiate the most beneficial terms with the business’
suppliers.

in the textbook.
Purpose:
The purpose of this activity is to distinguish between operating expenses and other
expenses incurred in a business.
Task:

This activity is designed to ensure that you understand the difference between operating
expenses and other expenses in a business, which is an important distinction to make
when drafting financial statements.

in the textbook.
Purpose:
The purpose of this activity is to introduce you to preparing a budgeted Statement of
Comprehensive Income based on specific information provided.
Task:

This activity is designed to revise drafting a Statement of Comprehensive Income.
Furthermore it introduces the concept of a financial manager taking changes in the
business into account to prepare a budgeted Statement of Comprehensive Income,
which will illustrate the profit a business expects to make during a future financial period.


in the textbook.
Purpose:
The purpose of this activity is to test your knowledge on calculating the amounts to
include for tax and dividends on the Statement of Comprehensive Income.
Task:

This activity is designed to show that tax and dividend payments are not regarded as
operating expenses, and are therefore shown separately on the Statement of
Comprehensive Income.

in the textbook.
Purpose:
The purpose of this activity is to introduce the concept of shrinkage and stock losses.
Task:

This activity is designed to revise some basic calculations such as determining profit
margin, cost of sales, gross profit and net profit. You will need to master these
calculations before moving on to ratio analysis in Activity 8.

in the textbook.
Purpose:
The purpose of this activity is to assess the knowledge acquired thus far in the Learning
Unit. Topics include: income, expenses and profit, shrinkage, stock losses and margins.
Task:

This activity is designed to show how important it is for a financial manager to
understand how margins are affected through changes in the components that
contribute to them.


in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on performing ratio
analysis.
Task:

This activity has been designed to show the different ratio analysis tools a financial
manager can use to evaluate and monitor the financial well-being of a business. This
activity requires some creative thinking to come up with ways of increasing income and
reducing costs.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on performing ratio
analysis.
Task:

This activity has been designed to show the different ratio analysis tools a financial
manager can use to evaluate and monitor the financial well-being of a business.
Furthermore, it shows how important it is to not interpret financial statements in

isolation, but to compare the results to those of previous years or to industry standards.

in the textbook.
Purpose:
The purpose of this activity is to stimulate critical thinking about the usefulness of the
P/E ratio.
Task:

This activity has been designed to encourage you to think about the P/E ratio and
whether the ratio on its own has any real significance.

The following financial information relates to Shebeen Shoe Store at the end of their
financial year:
Extract from the general ledger:
Trading Account F1
Date Details Fol. Amount Date Details Fol. Amount
20.8 20.8
Jan. 31 Cost of sales GJ12 369 180.00 Jan. 31 Sales GJ12 879 000.00
Profit and loss GJ12 509 820.00
879 000.00 879 000.00
Profit and Loss Account F1

20. 20.
8 8
Ja 3 GJ1 28 Ja 3 GJ1 509
Rent expense Trading account
n. 1 2 567.50 n. 1 2 820.00
GJ1 16 Recording services GJ1 13
Rates and services
2 261.50 rendered 2 185.00
GJ1 16 GJ1 10
Electricity Interest on fixed deposit
2 296.66 2 811.70
GJ1
Stationery 7 823.10
2
Wages and GJ1 47
salaries 2 466.00
GJ1
Telephone and fax 6 592.50
2
Trading inventory GJ1
2 812.80
deficit 2
GJ1
Discount allowed 6 856.20
2
GJ1 10
Credit losses
2 635.90
GJ1
Advertising 8 350.50
2
GJ1 382
Capital (Net profit)
2 154.04
533 533
816.70 816.70

Statement of Financial Position of Shebeen Shoe Store on 31 January 20.8
R R R
Accumulated
Assets Cost price Carrying Value
Depreciation
Non-current assets
Land and buildings 835 050.00 - 835 050.00
Furniture and equipment 580 140.00 116 028.00 464 112.00
1 415 190.00 116 028.00 1 299 162.00
Financial asset: R 1 Ordinary shares (Met Ltd) 96 690.00
1 395 852.00
Current assets 100 206.00
Trading inventories 48 345.00
Trade receivables 30 765.00
Cash and cash equivalents 21 096.00
Total assets 1 496 058.00
Owner's equity and liabilities
Owner's equity 1 402 884.00
Capital 1 060 284.96
Plus: Net profit 382 154.04
Less: Drawings (39 555.00)
Non-current liabilities 57 135.00
Mortgage loan: Africa Mortgage 57 135.00
Current liabilities 36 039.00
Trade creditors 20 217.00
Visa credit card 15 822.00
Total equity and liabilities 1 496 058.00
Note:
 No capital contributions were made during the year;
 Assume a 365 day year. 70% of all sales are on credit;
 Purchases constitutes 75% of cost of sales; 65% of all purchases are on credit;
 Net trade debtors balance on 1 February 20.7 was R34 456.80;
 Net trade creditors balance on 1 February 20.7 was R21 227.85;
 Trade inventory on hand as at 1 February 20.7 was R52 212.60.
Required:
Calculate the following ratios for the year ended 31 January 20.8 and comment on the
business’ profitability and liquidity.

Refer in particular to the past figures shown below.
 Net profit percentage (20.7 = 40%; 20.6 = 35%; average net margin for the
industry = 50%;
 Acid test/ Quick ratio (20.7 = 0.75:1; 20.6 = 0.5:1; the acid test/ quick ratio for the
industry is 1:1);
 Average trade creditors settlement period (20.7 = 60 days; 20.6 = 30 days; the
average trade debtors collection period for the industry is 30 days).
When using the perpetual inventory system, the accountant or financial manager is able
to calculate the balance on the inventory account without the use of a stock count.
However, this balance will then reflect what the balance should be – not necessarily
what the balance actually is. A sad truth of our society is that it is plagued by theft. Thus,
even though the accountant does not need a stock count, the business need to do one
as a control measure. The balance calculated in the inventory account is therefore
verified via a proper stock count (usually at the end of the financial year).
Under a periodic inventory system, the accountant does not have any idea of what his
inventory balance is or should be until such time as the stock-take has been done. The
problem with this system is this: if the accountant does not know what the balance
should be, the stock count will not be able to highlight any stock thefts or deficits – these
will all automatically be debited to cost of sales. Thus, in principle stock losses and
deficits generally end up as part of cost of sales – irrespective of whether a perpetual
or periodic system is in use. The only problem with the periodic system is that there is
no indication of what portion of this cost of sales expense can be attributed to stock
losses and which portion to actual sales. It is therefore much easier to ascertain the true
extent of theft in a business when using a perpetual inventory system instead.

(i) R2 500 000.
(ii) One can see that the performance of the business for each of the first three
years was similar, but that the performance during the 4th year was pretty poor.
However, stakeholders must not look at the Statement of Comprehensive
Income (SOCI) in isolation. According to the Statement of Financial Position
(SFP), the business is still solvent. It is therefore possible that the SOCI can
paint a very different picture of the wellbeing of a business than would the
Statement of Financial Position. Stakeholders need to know about the
accumulated wealth as well as the relative performance for a financial period in
order to make informed decisions about their stake in the business. As each
entry on the SOCI affects the SFP, one needs to look at both sides to determine
the nature of income and expenses.
Also, from the SOCI we are unable to assess whether a business is actually
earning cash returns, as earnings can be tied up in accounts receivable. Write-
offs may occur when companies realise that some of these receivables are
irrecoverable.
(iii) It is impossible to say at face value whether R1 million profit a year is a good
return or not. A Rand value on its own is no indication of good or poor
performance. It has to be compared with something else. If you started your
business with R100, then R1 million return per annum is phenomenal. If however,
your initial capital contribution was R100 million, then R1 million return is pretty
poor. One needs to look at one’s return on investment/ equity to assess the real
performance of an entity.
(i) The following analyses can help us determine which business makes the highest
net profit in Rand value:
Shortened Statement of Comprehensive Income of Business A:
Sales revenue (142 × R400) R56 800

Cost of sales (142 × R200) (R28 400)

Gross profit R28 400

Weekly overhead expenses (R18 500)
Net profit before interest and tax R9 900
Shortened Statement of Comprehensive Income of Business B:
Sales revenue (75 × R1 500) R112 500

Cost of sales (75 × R1 000) (R75 000)
Shortened Statement of Comprehensive Income of Business C:
Sales revenue (15 × R8 000) R120 000

Cost of sales (15 × R4 500) (R67 500)
Thus: Business B is the most profitable in Rand value, because it makes the
highest net profit (R16 500) during an average sales week.
(ii) The gross profit percentage for each business can be calculated as follows:
Gross profit/Sales × 100
Thus:
 Gross profit % for Business A: 28 400/56 800 × 100 = 50%
 Gross profit % for Business B: 37 500/112 500 × 100 = 331/3%
 Gross profit % for Business C: 52 500/120 000 × 100 = 43.75%
Business A has the highest gross profit percentage
(iii) The net profit percentage for each business can be calculated as follows:
Net profit/ Sales × 100
Thus:
 Net profit % for Business A: 9 900/56 800 × 100 = 17.43%
 Net profit % for Business B: 16 500/112 500 × 100 = 14.67%
 Net profit % for Business C: 12 500/120 000 × 100 = 10.42%
Business A has the highest net profit percentage

(iv) Clearance sales profitability analysis for Business A:
Shortened Statement of Comprehensive

Income for a Normal Sales Week (142
Income if 210 Units are Sold:
Units):
Sales revenue (142 × R400) R56 800 Sales revenue (210 × R300) R63 000
Cost of sales (142 × R200) (R28 400) Cost of sales (210 × R200) (R42 000)
Gross profit R28 400 Gross profit R21 000
Weekly overhead expenses (R18 500) Weekly overhead expenses (R18 500)
Net profit before interest and Net profit before interest and
R9 900 R2 500
tax tax
Clearance sales profitability analysis for Business B:

Units):
Sales revenue
Sales revenue (75 × R1 500) R112 500 R146 250
(130 × R1 125)
Cost of sales (75 × R1 000) (R75 000) Cost of sales (130 × R1 000) (R130 000)
Net profit before interest and
R16 500 Net loss (R4 750)
tax
Clearance sales profitability analysis for Business C:

Units):
Sales revenue Sales revenue
R120 000 R126 000
(15 × R8 000) (21 × R6 000)
Cost of sales Cost of sales
(R67 500) (R94 500)
(15 × R4 500) (21 × R4 500)
Net profit before interest and

R12 500 Net loss (R8 500)
tax
Conclusion:
The clearance sale was not profitable for any of the businesses. Both Business B and
C made a loss during the clearance sale week, while Business A made a lower than
usual net profit.

(i)
Business A Business B Business C
Selling price per unit, excluding VAT R400 R1 500 R8 000
Cost price per unit, excluding VAT R200 R1 000 R4 500
Gross profit per unit R200 R500 R3 500
(ii)
Profitability analysis for Business A, after receiving the 5% bulk discount:

Income if 5% Discount is Offered by the
Income for Normal Sales Weeks:
Supplier:
Sales revenue (142 × R400) R56 800 Sales revenue (142 × R400) R56 800
Cost of sales (142 × R200) (R28 400) Cost of sales (142 × R190) (R26 980)
R9 900 R11 320
tax tax
Thus, the weekly net profit before interest and tax increases by R1 420.
Profitability analysis for Business B, after receiving the 5% bulk discount:

Supplier:
R112 500 R112 500
(75 × R1 500) (75 × R1 500)
(R75 000) (R71 250)
(75 × R1 000) (75 × R950)
R16 500 R20 250
tax tax
Profitability analysis for Business C, after receiving the 5% bulk discount:


Supplier:
R120 000 R120 000
(15 × R8 000) (15 × R8 000)
(R67 500) (R64 125)
(15 × R4 500) (15 × R4 275)
R12 500 R15 875
tax tax
The following will be classified as operating expenses:
 Wages and salaries;  Advertising;

 Insurance;  Telephone;
 Repairs and maintenance;  Credit losses (bad debts);
 Water and electricity.  Stationery.
Note: Operating expenses are expenses incurred in the day-to-day running of the
business, but which are not directly linked to production.
(i)
Statement of Comprehensive Income of Kgomotso Enterprises for the year ended 28

February 20.1
R R
Sales (411 000 – 3 000) 408 000
Less: Cost of sales (160 000)
Gross profit 248 000

Plus: Other operating income 3 400

Settlement discount received 3 400
Gross operating income 251 400
Less: Operating expenses (223 180)
Wages and salaries 88 000
Water and electricity 32 970
Insurance 10 600
Advertising 9 700
Packing materials 3 460
Rent paid 54 000
Vehicles expenses 17 260
Stationery 4 590
Settlement discount granted 2 600
Operating profit 28 220
Add: Interest income 230
Profit before interest expense 28 450
Less: Interest on overdraft (780)
Profit before tax 27 670
(ii) Kgomotso Enterprises

Budgeted Statement of Comprehensive Income for the year ended 28 February 20.2
R R
Sales (408 000 + 10%) 448 800
Less: Cost of sales (160 000 – 8%) (147 200)
Wages and salaries (88 000 – 10%) 79 200
Water and electricity (32 970 – 10%) 29 673
Insurance (R10 600 – 10%) 9 540
Advertising (R9 700 – 10%) 8 730
Packing materials (3 460 – 10%) 3 114
Rent paid (R54 000 – 10%) 48 600
Vehicles expenses (R17 260 – 10%) 15 534
Stationery (R4 590 – 10%) 4 131
Settlement discount granted (R2 600 – 10%) 2 340
Add: Interest income 230
Profit before interest and tax 104 368
Less: Interest on overdraft (780 – 20%) (624)

Statement of Comprehensive Income of Dorcas (Pty) Ltd for the year ended 31 August
20.1:
R R
Sales 940 000
Rent received 84 000
Wages and salaries 15 000
Insurance 5 000
Telephone 15 000
Repairs and maintenance 8 000
Advertising 7 000
Stationery 3 000
Packing materials 9 000
Add: Interest income 16 000
Profit before interest expense 582 000
Less: Interest expense (12 000)
Less: Taxation expense (R570 000 × 28%) (159 600)
Profit after tax 410 400
Less: Dividends expense (250 000 × 0.08) (20 000)
Retained income 390 400

(i)
(a) Sales increased by R120 000 or by 20% in 20.2.
1
(b) 200 000/600 000 × 100 = 33 %
3
(c) 206 000/720 000 × 100 = 28.61%
(d) 20.1: 600 000 – 200 000 = 400 000
20.2: 720 000 – 280 000 = 440 000
(ii) A negative effect, because it will decrease profits without the usual corresponding
increase in income you would receive from sales.
(iii)
(a) R150 000 + 30 000 + 5 000 + 500 = R185 500
(b) R185 500 – 15 500 – 13 200 – 25 000 – 2 500 – 6 000 = R123 300
(iv) Perpetual/ Continuous inventory system; or periodic inventory system.
(i)
(a) There was an increase of R150 000 in the sales total.
(b) R128 000 – 115 000 = R13 000 difference.
(c) The net profit has increased by R57 000.
(d) Cost of sales for 20.1: R700 000 – 280 000 = R420 000
Cost of sales for 20.2: R850 000 – 350 000 = R500 000
(ii) Theft, breakages, obsolete stock, stock rotation, literal shrinking, natural disasters
(in the absence of comprehensive insurance), and administrative errors.

(iii)
(a) R540 000 – 300 000 = R240 000
(b) R540 000 + 60 000 = R600 000
(c) R360 000 – 160 000 = R200 000
(iv)
 Tighten up security inside your shop. Install surveillance equipment such as
closed-circuit TVs;
 Keep accurate records of all stock movements;
 Provide adequate and secure storage facilities;
 Ensure that the correct products and quantities are shipped to customers.
(v) 3 x R50 = R150. Therefore three broken glasses reduces Jason's profits by R150.
In statement form, this can be illustrated as follows:
Abbreviated Statement of Comprehensive Income assuming no glasses were broken:

R R
Sales [(R50 + 80% of R50) × 42] 3 780
Opening inventory (40 × R50) 2 000
+ Purchases (60 × R50) 3 000
5 000
- Closing inventory (58 × R50) (2 900)
Gross profit 1 680
Abbreviated Statement of Comprehensive Income assuming three glasses were

broken:
R R
Sales [(R50 + 80% of R50) × 42] 3 780
Opening inventory (40 × R50) 2 000
+ Purchases (60 × R50) 3 000
5 000
- Closing inventory (55 × R50) (2 750)
Gross profit 1 530
The breakage will decrease Jason’s profit with R150 for March 20.9.

(i)
Comparative/ Benchmark
Name of Ratio Ratio Results for the Years Ended 31 August…
Figures:
The average gross 20.7 20.6 20.5
margin for the industry is
40%. 45.55% 42.14% 40.20%
Gross Profit
Calculation: Comments:
Percentage
 Trend is favourable;
338 880/744 000 × 100
 Returns are higher than the industry
= 45.55%
average.
Figures:
The average net margin 20.7 20.6 20.5
for the industry as a whole
is 15%. 10.83% 11.02% 11.25%
Net Profit  Trend is unfavourable;

Percentage  Net profit returns are lower than that of the
80 542.96/744 000 × 100 industry;
= 10.83%  It seems as if soaring overhead costs are
a problem for the business. These costs
have to be reduced.
Figures:
Return on average 20.7 20.6 20.5
owner’s equity for the
industry as whole is 13.04% 18.10% 18.43%
20.5%.
Return on
Average
Owner’s Equity 80 542.96/[ (582 514.80
 Trend is unfavourable;
+ 653 137.76)/2] × 100 =
 Same issues as with the net profit
13.04%
percentage.

Figures:
Standard norm of 2 : 1 20.7 20.6 20.5
2.84 : 1 2.41 : 1 2.39 : 1
Current Ratio
 Compares favourably with the standard
47 035.96 : 16 552.20 norm of 2 : 1;
= 2.84 : 1  Business liquidity is sound; short-term
debts are adequately covered.
Figures:
Standard norm of 1: 1 20.7 20.6 20.5
1.28 : 1 1.22 : 1 1.17 : 1
Acid Test/ Quick
 Compares favourably with the standard
Ratio
norm of 1: 1;
(47 035.96 - 25 890):
 Business liquidity is sound; short-term
16 552.20
debts are adequately covered. Business is
= 1.28 : 1
not overly dependent on inventory to cover
current liabilities.
Figures:
The average debtor’s 20.7 20.6 20.5
collection period for the
industry as a whole is 31 19.43 days 27.55 days 35.66 days
days.
Debtors
Collection Period  Trend is favourable, tremendous
[(21 145.96 + improvement;
22 424.82)/2 × 365]/(55%  19 days for collection is excellent;
of 744 000)  Considerably better than the industry
= 19.43 days benchmark.

Figures:
The average creditor’s 20.7 20.6 20.5
settlement period for the
industry as a whole is 35 32.44 days 29.00 days 29.15 days
days.
Creditors
Settlement  Trend is generally unfavourable;
Period  Increased liquidity due to improved
[(12 261.80 +
debtors collection period is not really
18 222.48)/2
utilised to improve the creditors settlement
× 365]/171 500
period;
= 32.44 days
 Ratio is good based on general norms and
compared with industry averages.
Figures:
Average inventory turns 20.7 20.6 20.5
for the industry = 11.5
times a year. 11.88 times 11.70 times 11.60 times
Trade Inventory Calculation: Comments:

Turnover  Trend is favourable;
405 120/[(25 890 +
 The business inventory turns are in excess
42 300)/2]
of the industries’ as a whole. Also attributes
= 11.88 times
to improved liquidity position.
Overall comment:
The business seems to be quite efficient and liquid. The only cause for concern is the
unfavourable trend in the profitability ratios. Notice that the gross margin shows an
upward trend, but that the net margin shows a downward trend. This means that the
business is experiencing difficulties keeping their overheads down.
(ii) There are many advantages to preparing final accounts and financial statements.
If this is not done, the following will happen:
 The business will not have reliable information which it can present to its
stakeholders;
 The business might run into trouble with the authorities, since taxes are
determined on the basis of the net profit as calculated in the profit and loss
account, as adjusted;
 Management and investors (with access to such data) will not be able to
calculate reliable ratios in order to ascertain in which areas the business is
under- or overspending or in which areas the business needs to improve
their efficiency;
 Income and expense accounts will not close off at year-end which will create
serious bottlenecks from an operational as well as a compliance point of
view. To ‘fix’ this problem in the future will be an arduous task.

(iii) Gross profit is the ‘trading profit’, i.e. the pure profit derived by subtracting cost of
sales from net sales. It is the profit earned in the business that is available to cover
overheads. Think of ‘gross’ as before deductions. When we refer to a payslip,
gross salary is before deductions. The same argument can be used here. The
gross profit is the profit before deducting the running expenses.
After we have deducted the total running expenses from the gross profit, we arrive
at the ‘bottom line’ (i.e. the net worth that has been added to the owner’s equity).
We call this amount the net profit. Net profit is derived by deducting total expenses
(including cost of sales) from total income (including sales).
Business people often say that ‘profit is an opinion, but cash is a fact’. It is
important to realise that profits do not refer to cash flows. It does not mean that a
business has money in the bank if it has earned a lot of profit. A business could
be very strong financially in terms of its Statement of Financial Position and
Statement of Comprehensive Income, but could still be on the verge of
sequestration. The easiest way to explain this is to make reference to credit sales.
Suppose a business were to sell all their goods on credit to debtors. Debtors will
be debited and sales (and output VAT) will be credited. The income is therefore
‘earned’ although it has not been turned into cash as yet. The liquidity trap
emerges when the business is unable to turn these profits into cash (i.e. they
struggle to collect the outstanding amounts from debtors). This is the reason why
a third financial statement, namely a ‘Cash Flow Statement’ needs to be drawn
up to explain how purchases and receipts were converted into cash. It is also the
reason why ratios like debtors collection periods and creditor’s settlement periods
are so important.
(iv) The most prevalent strength of this business is its liquidity. The business does
very well in collecting debtors’ outstanding accounts, and cash flow seems to be
sound, although the business runs a small overdraft from time to time. The
business is also quite profitable in the trading account. Gross margins are
favourable as compared to those of their competitors. The obvious weaknesses
of the business are controlling overheads and other costs. Although the gross
margins are profitable, the net margin and return on equity are lagging behind the
rest of the industry.
It might be useful to note that, although the trends in the current and quick ratios
for this business are favourable, the high level of liquidity might also be a bad
thing for business. For example, for the current ratio the optimal level is 2:1. If this
ratio ends up much higher, it either means you have short payment terms with
creditors (unfavourable), too much stock (unfavourable), or your debtors are
taking a long time to pay (unfavourable), or you are sitting on a lot of cash
(unfavourable) that could otherwise be utilised for higher returns.

(v) There may be several ways to improve the efficiency of a business. Here are the
five sure ways to improve the efficiency of your business.
Tracking your marketing and MAKING improvements
Basically, every time you contact your prospect or customer, you are involved in
the marketing process. The marketing process may be considered as a three step
process, namely advertisement, sales and the closing process. As a business
owner, you must always find ways to move the prospect acquired as a lead from
your advertising campaign to the sales process and then from sales to the closing
process as soon as possible. You also need to consider whether or not marketing
and advertising costs are paying off, as you might be wasting money with no real
return.
Automation
Automation has helped both small and large businesses in improving the
efficiency of their business. Data entry, bookkeeping, customer service, email
marketing and fulfilment are some operations that can easily be automated.
Reducing costs
This may seem very obvious, but most often the business owners fail to track the
cost while focusing on increasing their sales/ revenue. You could have a system
to monitor both expenses and income every week. You can reduce cost by
eliminating a service that is no longer required or locating vendors that can give
you a better deal. The key is to be aware and create a system to reduce cost.
Offer back-end products to your current customers
It is far easier to sell a product to a current customer than to acquire a new

customer. You could sell your own product or strike a deal with a business that
sells to the same market as you do. This can be a win-win lucrative situation for
both the businesses.
Increase profit earned per customer
There are several ways to increase profit earned per customer. You could use the
following three methods:
Price increase – You could increase the price of your product and thereby
increase profit. This may seem difficult in the beginning, but you must take the
bold step and do it anyway.
Offering package deals – You could combine two or more products/ services,
create packages and sell with a higher profit margin.

Loyalty programs – You can offer benefits to customers that spend greater than
the average spend. As long as the reward is significant in the eyes of the
customer, they will activity try to meet the required spend.
(vi) The cost-to-income ratio shows the proportion of total costs of a business as
opposed to their total revenue. It should be a priority of the business to reduce the
cost-to-income ratio at all times. Increases in sales and reduction in costs are very
important, but it is the ratio between costs and income that will give a better
indication of performance.
The methods to reduce costs and enhance income as outlined in question (v)
above can be applied to enhance the cost-to-income ratio. The key is to reduce
costs and to increase income at the same time.
Total cost = R698 265.34 and

Total income = R778 808.
Thus, the cost-to-income ratio is
Total cost : Total income
R698 265.34 : R778 808
= 0.90 : 1
(vii) Liquidity refers to the cash flow in a business. It is of no use for a business to
increase its profitability, but at the same time struggle to collect outstanding debts
from debtors. It is quite possible for a business to increase their inventory
turnover, but find it difficult to convert the sales into cash. While profit is an opinion,
cash is a fact. Ultimately, a highly profitable business which is constantly cash-
strapped is doomed to failure.
(viii) The following are limitations of ratio analyses:
 One year's accounts are insufficient for proper analysis to be undertaken;

 The analysis of trends, taken from, say, five years of accounts, would give a better
insight;
 Differences in accounting policies between two companies will affect
comparisons;
 The use of historical costs brings about many distortions;
 The use of industry inter-firm comparisons would make the ratios more
meaningful;
 The plans of the companies for the future expressed in their budgets would be of
more interest than past figures;
 The accounts from which the conclusions have been drawn are necessarily
summarised.

Ratio for the Years Ended 28/ 29 February

Name of ….
Comparative Figures:
Ratio:
The average gross margin 20.13 20.12 20.11
Gross Profit
for the industry is 51%. (calculated) (given) (given)
Percentage
50% 50% 61%
Comments:
Formula: Calculation:  The gross margin remained the same
as the previous year (20.12) for the
Gross profit × 462 319.16 × 100 business;
100 924 638.32  The gross margin is still 1% less than
Total sales = 50% that of industry. This is an
unfavourable trend.
Ratio for the years ended 28/29 February ….

Name of ratio: Comparative figures:
20.13 20.12 20.11
Net profit The average net margin for
(calculated) (given) (given)
percentage the industry is 45.00%.
35.54% 45% 60%
Comments:
Formula: Calculation:
 The net margin has unfavourably
decreased by 9.46% since 20.12;
Net profit × 328 579.47 × 100
 The net margin is also 9.46% below
100 924 638.32
the industry level. This is an
Total sales = 35.54%
unfavourable trend.

Return on The return on average 20.13 20.12 20.11
average owner's equity for the (calculated) (given) (given)
owner's equity industry is 62%.
26.48% 57% 58%
Comments:
 The return on average owner’s equity
has decreased unfavourably by
Net profit × 328 579.47 × 100
30.52% since 20.12;
100 [(1 097 212.82 +
 The return on average owner’s equity
Average owne 1 384 183.57)/2]
is unfavourably below the industry
r's equity = 26.48%
level with 35.52%.


20.13 20.12 20.11
Current ratio The current ratio for the
industry is 2:1.
2.78:1 3:1 1.5:1
Comments:
 There was a decrease in the current
ratio of the business since 20.12. This
Current assets: 105 408.77 :
is an unfavourable trend;
Current 37 910.17
 The current ratio is still favourably
liabilities = 2.78:1
above the industry norm of 2:1.

20.13 20.12 20.11
Acid test/quick The acid test/quick ratio
ratio for the industry is 1:1.
1.44:1 1:1 0.5:1
Comments:
Formula:
Calculation:  There was a favourable increase in the
acid test ratio of the business since
(Current assets
(105 408.77 – 20.12;
– inventory) :
50 855.11) : 37 910.17  The acid test ratio of the business is
Current
= 1.44:1 favourably above the industry norm of
liabilities
1:1.
Comparative figures: Ratio for the years ended 28/29 February ….

Name of ratio:
The average trade
Average trade 20.13 20.12 20.11
debtor’s collection period
debtors (calculated) (given) (given)
for the industry is 28
collection period
days. 17.57 days 10 days 8 days
Comments:
Calculation:  There was an unfavourable increase of
Formula:
7.57 days in the average trade debtors
[(28 155.24 + collection period since 20.12;
Average trade
32 362.34)/2 × 365]  The average trade debtor’s collection
debtors × 365
924 638.32 × 68% period of the business is still
Credit sales
= 17.57 days favourably below the industry period of
28 days.

Comparative Ratio for the years ended 28/29 February ….

figures:
Name of ratio:
The average trade 20.13 20.12 20.11
Average trade
creditor’s (calculated) (given) (given)
creditors
settlement period
settlement period
for the industry is
51.82 days 15 days 15 days
30 days.
 The average trade creditors settlement
Formula:
[(21 054.01 + period has increased unfavourably with
21 266.68)/2 × 36.82 days since 20.12;
Average trade
365]  The average trade creditor’s settlement
creditors × 365
462 319.16 × 52% period is 21.82 days more than that of
Credit purchases
× 62% industry. This is an unfavourable trend.
= 51.82 days
Comparative Ratio for the years ended 28/29 February ….
figures:
Name of ratio:
The average trade 20.13 20.12 20.11
Average trade
inventory turnover (calculated) (given) (given)
inventory turnover
for the industry is
four times. 9.05 times 4 times 4 times
Comments:
Calculation:
 The average trade inventory turnover has
Formula:
favourably increased by 5.05 times since
462 319.16
20.12;
Cost of sales [(51 363.66 +
 The average trade inventory turnover is
Average inventory 50 855.11)/2]
5.05 times more than the industry norm of
= 9.05 times
four times. This is a favourable trend.
Although the P/E ratio can provide a good approximation of how ‘expensive’ a particular
share is relative to its underlying earnings stream, it is by no means a perfect gauge of
a company's value. P/E ratios have a number of drawbacks, including:
Earnings Manipulation
Companies often use a variety of accounting techniques to alter their reported net
income. As a result, the reported earnings figures we read about are often not entirely
representative of a company's true financial situation. Since net income is a critical
component of a firm's P/E ratio, manipulated earnings can lead to misleading P/E data.

Industry Differences
Different industries typically have different historical growth rates, risk levels, etc.; and
hence different average P/E ratios. Thus, shares that may appear cheap in one industry
may look expensive when stacked up against another.
For this reason, it is typically more appropriate to compare a firm's P/E ratio to those of
other companies within the same sector.
Other Factors
It is important to remember that P/E ratios only take two items into account – a firm's
current share price and its net profit. As a result, P/E ratios completely ignore a variety
of other important factors. One of the most notable of these factors is a firm's projected
future growth rate. Two shares could be identical in every respect (including on a P/E
basis), but if one company is growing at twice the rate of the other firm, then the high-
growth firm will likely make a better investment over the long haul. With this in mind,
many investors prefer to examine PEG ratios as opposed to traditional P/E ratios.
Volatility and Risk
P/E ratios also ignore such critical items as risk and volatility. Two firms may have
identical P/E ratios, but if one firm's revenue and earnings base is extremely reliable,
yet the other firm's earnings are highly uncertain, then the more reliable firm could make
a better investment over the long haul. With the above limitations in mind, when
attempting to assess the value of a particular security, most experienced investors
choose to analyse P/E ratios in conjunction with a variety of other ratios, including
Price/Sales (P/S), Price/Cash Flow (P/CF), etc.

Comparative Ratio for the years ended 31 January ….

Name of ratio: figures:
20.8 20.7 20.6
Net profit The average net
percentage margin for the
industry is 50% 43.48% 40.00% 35.00%
Formula:
 The return is unfavourable, being 7.52%
382 154.04 × 100 below the industry average;
Net profit × 100
Total sales
879 000.00  The return has increased over the past two
= 43.48% years.
figures:
Name of ratio: 20.8 20.7 20.6
The acid test/quick
Acid test/quick ratio (calculated) (given) (given)
ratio for the
industry is 1:1 1.44:1 0.75:1 0.5:1
Formula:
 The business is very liquid in terms of the
(100 206.00 – generally accepted norm;
(Current assets –
inventory):
48 345.00) :  The liquidity of the business increased over
36 039.00 the past two years.
Current liabilities
= 1.44:1

Name of ratio: figures:
Average trade The average trade 20.8 20.7 20.6
creditors collection debtors collection (calculated) (given) (given)
period period for the
industry is 30 days 42.03 days 60 days 30 days
Formula:  It takes much longer for the business to
[(21 227.85 + settle their creditors than the industry
Average trade 20 217.00)/2 × 365] average;
creditors 369 180.00 ×  The rate increased in 20.7 but has
Creditor purchases 0.75% × 0.65% decreased in 20.8.
= 42.03 days

Learning Unit 3: Managing Working Capital

Learning Objectives: My Notes on this Learning
 Calculate the level of working capital in a business. Unit:
 Identify and explain the dangers of overtrading.
 Understand the effects on cash flow of external
and internal events and actions.
 Prepare a debtors collection schedule as well as a
creditor’s settlement schedule.
 Calculate an effective interest rate.
 Calculate an approximate Annual Percentage Rate
(APR).
 Before the first class, be sure that you read pp.63–
84 in the textbook.
o What is working capital?
o Why is it important for a financial manager to
manage the working capital of a business?
o When does overtrading occur?
o Why should both individuals and businesses
prepare budgets?
o What are the dangers of overtrading?
o What is the role of interest rates in business?
o What is an Annual Percentage Rate (APR)
and how is it calculated?

Gitman, LJ. 2008. Principles of managerial finance. 12th edition. Make sure that you
Boston, (MA): Pearson, Addison Wesley. Chapter 14. complete Revision
Exercise 1 and 2 once you
2 Recommended Digital Engagement have worked through
and Activities
Visit the following link and answer the questions that are posed on the website:
Accounting Coach. 2012. Improving Profits. [Online]. Available Resources needed:

at: http://blog.accountingcoach.com/category/02/ [Accessed 25 A calculator.
November 2016].


have access to a wide variety of conceptual videos on business
in the textbook:
management, income tax, cost and management accounting,
overview of the importance
of managing the working
capital in a business.
Provide students with the
Available at: http://upload-media.com/channels/bc
opportunity to discuss in
groups the different
activities in a business that
3 Activities influence the cash flow of
the business. Also allow
3.1 Izimvo Exchange 1 students to discuss the
benefits for a business of
having accurate budgets in
place.
In business, we often hear of firms that have become ‘technically insolvent’. Discuss in
groups what this means, and how it is different from absolute insolvency.
When budgeting and forecasting is done, management will have to investigate any
information which may have an influence on how their enterprise is expected to perform
in the future. Two sources of information which they may refer to are:
 Published statistics;
 Time-series analysis.
Discuss in groups how this information will assist management in the planning process.

in the textbook.
Purpose:
The purpose of this activity is to determine how overtrading can quickly cause serious
damage to the cash flow situation in a business.

Task:

This activity is designed to make you realise that a financial manager should always
compare different scenarios before deciding on a course of action.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on preparing a
schedule of budgeted receipts from debtors.
Task:

This activity is designed to help you practise preparing a schedule of budgeted receipts
in isolation. You need to master this skill in order to be able to complete a cash budget
in subsequent activities.

in the textbook.
Purpose:
The purpose of this activity is to determine how different activities in a business will
influence the amount of working capital available to the business.
Task:

This activity is designed to make you realise that a financial manager should always
consider the impact that any activity will have on the working capital of a business before
entering into that activity. Activities that reduce the working capital in a business
significantly should be avoided, or a more efficient alternative should be explored.

in the textbook.
Purpose:
The purpose of this activity is to assist you in gaining an understanding of the power of
compound interest, and the benefits of starting to save early in your working life.
Task:


This activity is designed to make you realise that more than half of your retirement
savings potentially comes from the investment you make during the first eight years of
your working life.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge of simple interest
and compound interest, as well as your ability to make informed investment and
financing decisions based on calculations involving interest.
Task:

This activity is designed to integrate your knowledge of calculations involving simple
and compound interest.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge to draft a cash
budget.
Task:

This activity is designed to integrate your knowledge of calculations involving the Annual
Percentage Rates (APR), and the interpretation of such rates.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge to draft a cash
budget.
Task:

This activity is designed to integrate your knowledge of Annual Percentage Rates
(APR), with particular reference to the pitfalls and hidden costs involved.


Purpose: in the textbook.
The purpose of this activity is to calculate the level of
working capital in a business at a particular point in time.
Task:

This activity is designed to illustrate the importance of setting budgets by the financial
manager, and the advantages accurate budgets could have for a business.

For Activity 9 consult p.83 in
Purpose: the textbook.
The purpose of this activity is to test your newly-
acquired knowledge from the topics covered in this Learning Unit.
Task:

This activity is designed to assess acquired knowledge of margins, debtor’s collection
schedules, the effects of overtrading, and Annual Percentage Rates (APR).
Solve the following problems. Where applicable, show all calculations.
(a) You want to make an investment at a bank at a simple interest rate of 15% p.a.
that will yield a future value of R6 462.50 after nine years. Determine the principal
to be invested.
(b) Determine the difference in interest earned when R15 000 is invested for eight
years at an interest rate of 10% p.a. in the following ways:
 Simple interest;
 Interest compounded annually.

(c) An investor invests R318 750 for six years at an interest rate of 17% per annum.
What will the value of his investment be at the end of the six years, if interest is
calculated as follows:
 Simple interest;
 Interest compounded annually.
(d) An investment will be worth R49 912.50 if invested for three years at a rate of 10%
p.a., compounded annually. What is the present value of the investment?
(e) Calculate the amount that was invested at a rate of 16% per annum, quarterly
compounded, if the future value is expected to be R95 990.29 after four years?
(f) An investment is worth R 20 184 after two years at 16% interest per annum,
compounded annually. What is the present value of the investment?
(g) Calculate the amount that was invested at a rate of 17½% p.a., half-yearly
compounded, if it yielded R231 362.33 over five years.
(h) An investment is worth R 90 749.30 after ten years at 9% p.a., compounded daily
(assume 365 days in every year). What is the present value of the investment?

If a company (or person) is technically insolvent that basically means that it has a
negative net asset value – i.e. its liabilities are greater than its assets. The significance
of technical insolvency depends on circumstances: it may be an indicator of serious
problems that may lead to actual insolvency, or it may be perfectly acceptable.
It is perfectly possible to be technically insolvent, while still being able to repay debt. It
is also possible to be technically solvent and unable to repay debt. This is because
technical insolvency is based only on the balance sheet and ignores cash flows. In
addition book values/ carrying values are often quite different from market or resale
values.
A simple example of technical insolvency that does not lead to actual insolvency would
be a private individual who has negative equity in a mortgaged property, no other
assets, but an income sufficient to keep up with the mortgage repayments. A business
might become technically insolvent through similar reductions in asset values, or
through heavy expenditure that cannot be capitalised (such as research).
Legally, technical insolvency in itself presents no problems in most countries. An

individual can only be declared bankrupt by a court at the request of themselves or an
unpaid creditor. A technically insolvent company is free to keep trading as long as the
directors reasonably believe that the company will be able to pay its debts, and, again,
as long as an unpaid creditor does not use the courts to force a liquidation.
Published statistics
Statistics are generally published by government and academic institutions and will
give information on (among others) the following:
 Population growth;
 Birth rate;
 Age analysis of population in specified areas;

 Property being purchased and sold in specified areas;

 Number of children at schools;
 Unemployment rate;
 Average income of population in areas;
 New enterprises opening;
 Which businesses closed down;
 Etc.
This can assist greatly in the planning process, but management must always be
aware of misinterpreting statistics as it can only give an indication of what can be
expected in future, but must never be used as the only yardstick to measure growth
and development by.
Time series analysis
This is a study of the components of demand and the behaviour of demand over time.
Looking at demand as a time series is useful in both historical analyses and future
projections. The components of time series analysis are:
 Trends: This indicates the positive or negative shift in demand value over a
period of time;
 Seasonal variation (Seasonality): This indicates demand patterns which usually
occur within one year and recur annually
 Cyclical pattern: This also indicates demand patterns which recur, but usually
spanning several years;
 Random events: There are two types of random events:
o Explained events such as natural disasters and accidents;
o Unexplained events for which there are no known causes.
(i) The mark-up percentage can be calculated as follows:
Gross profit ÷ cost of sales × 100

= 87 500/ 87 500 × 100
= 100%
(ii) The gross profit percentage can be calculated as follows:
Gross profit ÷ sales × 100

= 87 500 ÷ 175 000 × 100
= 50%

(iii)
Scenario 1: Keeping the collection period constant, causing no change in sales
March 20.8 April 20.8 May 20.8 June 20.8
Abbreviated statement of
comprehensive income
Sales (all on credit) 175 000 00 175 000 00 175 000 00 175 000 00
Cost of sales (87 500 00) (87 500 00) (87 500 00) (87 500 00)
Gross profit 87 500 00 87 500 00 87 500 00 87 500 00
Expenses paid in cash (32 000 00) (32 000 00) (32 000 00) (32 000 00)
Net profit 55 500 00 55 500 00 55 500 00 55 500 00
Bank balance
Opening balance for the month 200 000 00 168 000 00 223 500 00 279 000 00
Movements during the month (32 000 00) 55 500 00 55 500 00 55 500 00
Creditors settled in cash 0 00 (87 500 00) (87 500 00) (87 500 00)
Cash receipts from debtors 0 00 175 000 00 175 000 00 175 000 00
Closing balance for the month 168 000 00 223 500 00 279 000 00 334 500 00
Scenario 2: Increasing the collection period, causing a rise in expected sales

March 20.8 April 20.8 May 20.8 June 20.8
Abbreviated statement of
comprehensive income
Sales (all on credit) 175 000 00 190 000 00 220 000 00 368 000 00
Cost of sales (87 500 00) (95 000 00) (110 000 00) (184 000 00)
Gross profit 87 500 00 95 000 00 110 000 00 184 000 00
Net profit 55 500 00 63 000 00 78 000 00 152 000 00
Bank balance
Opening balance for the month 200 000 00 168 000 00 48 500 00 96 500 00
Movements during the month (32 000 00) (119 500 00) 48 000 00 48 000 00
Creditors settled in cash 0 00 (87 500 00) (95 000 00) (110 000 00)
Cash receipts from debtors 0 00 0 00 175 000 00 190 000 00
(iv) No, in this instance taking the risk could be justified. Since the bank balance
remains in positive territory at all times, the business is not guilty of overtrading.

(i) Schedule of budgeted receipts from debtors for the period 1 May 20.8 – 31 October
20.8
Budgeted Budgeted Budgeted Budgeted Budgeted Budgeted
Credit sales (R) receipts receipts receipts receipts receipts receipts
May (R) Jun. (R) Jul. (R) Aug. (R) Sep. (R) Oct. (R)
Jan.
330 000 00 72 600 00
20.8
Feb.
309 000 00 108 150 00 67 980 00
20.8
Mar.
384 750 00 153 900 00 134 662 50 84 645 00
20.8
Apr.
471 000 00 188 400 00 164 850 00 103 620 00
20.8
May
487 500 00 195 000 00 170 625 00 107 250 00
20.8
Jun.
540 000 00 216 000 00 189 000 00 118 800 00
20.8
Jul.
570 000 00 228 000 00 199 500 00
20.8
Aug.
600 000 00 240 000 00
20.8
Totals 3 692 250 00 334 650 00 391 042 50 444 495 00 490 245 00 524 250 00 558 300 00
(ii) Schedule of budgeted payments to creditors for the period 1 May 20.8 – 31 October
20.8
Budgeted Budgeted Budgeted Budgeted Budgeted Budgeted
Credit purchases
payments payments payments payments payments payments
(R)
May (R) Jun. (R) Jul. (R) Aug. (R) Sep. (R) Oct. (R)
Jan.
132 000 00
20.8
Feb.
96 000 00
20.8
Mar.
160 800 00 56 280 00
20.8
Apr.
151 600 00 * 93 613 00 53 060 00
20.8
May
160 000 00 98 800 00 56 000 00
20.8
Jun.
168 000 00 103 740 00 58 800 00
20.8
Jul.
176 000 00 108 680 00 61 600 00
20.8
Aug. 113
184 000 00 00 64 400 00
20.8 620
Total 175
1 228 400 00 149 893 00 151 860 00 159 740 00 167 480 00 00 64 400 00
s 220

* (151 600 × 65%) – 5% = 93 613

OR: 151 600 x 65% x 0.95 = 93 613
(i)
Trading inventory 33 768.43
Input VAT 43 440.73
Petty cash 3 046.34
Debtors control 17 987.64
Creditors control (12 841.77)
VAT output (48 345.72)
Working capital 37 055.51
(ii)
Debtors taking extra credit
Extending the credit limit of debtors (accounts receivable) is a common occurrence in

the modern world of business. Customers are being hooked into continuous buying
patterns, and are ‘rewarded’ with higher credit limits when they show diligence in
paying their accounts. The key to the supplier is, of course, to base the extended limit
on a carefully constructed risk model, derived from buying and paying patterns. The
risk of credit losses to the supplier increases as the credit limits of their debtors are
raised, because the more indebted a person is, the harder it becomes to settle those
debts. Of course, if the supplier manages to keep the level of credit losses low and is
able to collect all outstanding amounts, such a model can be very lucrative in terms of
profits and cash flows.
Offering ‘interest-free credit’ to customers for up to six months
This is also a relatively new way of doing business. It is also very successful.
Customers are often misled to believe that they are paying no interest, where in fact
the discounted value of the interest they would have paid has been added to the price
of the product upfront. One would also find that these vendors would offer clients a
deal that, if they were to pay cash for their purchase, they are entitled to a 10% trade
discount. Of course, this discounted price is actually the benchmark price that they
would have sold to the client had none of these special deals existed in the first place.
The client is led to believe that it is a discount, since they compare the price to the

‘six (6) months zero interest’ deal. Nevertheless, such schemes are useful in
enhancing sales and working capital. In the long run this could have a positive impact
on cash flows, but in the short term would have a negative impact, as we are paying
for the goods and only collecting the money in six months.
An increase in credit losses
An increase in credit losses has a detrimental effect on cash flows, since expected
cash inflows never materialise. It often happens that businesses make purchases of
assets or pay for expenses using a credit card or an overdraft facility, on the back of
the expected receipts from debtors. When these debtors fail to pay their accounts, it
can cause serious cash flow problems, which is usually accentuated by high rates of
interest on the credit facilities they have used. When these facilities become
exhausted, it may create very serious bottlenecks in the operations of the business,
and could even lead to technical or absolute insolvency.
Receiving payment by credit card
Receiving payment by credit card is a very popular alternative to accepting cheques

from customers. Almost all businesses today have a credit card facility. When
customers pay by cheque, there is a risk that the cheque might not be honoured by the
bank. This risk is largely reduced when accepting credit card payments, since
clearance by the bank is almost immediate and verification takes place at the point of
sale. Cheques are expensive to deal with and thus a large number of companies are
no longer accepting cheques. As technology advances, online banking is becoming
more prevalent, as each time you receive payment from a credit card you have to pay
commission for the service. The risk of credit card fraud often causes banks to charge
exorbitant bank charges to the recipient of credit card payments (i.e. the vendor). Most
banks will offer a credit card holder free transaction fees if the outstanding balance is
paid in full on the required date. This offer is most attractive but in reality it is the vendor
that will be paying the bank charges.
This is why some vendors prefer not to receive credit card receipts below a minimum
amount because the value of the bank charges will exceed the consideration for the
transaction.
The loss of settlement discounts received
To try and avoid possibilities of overtrading and falling into a subsequent ‘debt trap’,
businesses might try to extend their creditors settlement period and reduce their
debtors collection period. However, in doing so, there may well be an opportunity cost.
The business might have received discounts from their suppliers due to the fact that
they paid them so timeously in the past, which are now forfeited due to the extension
of the settlement period. This has a negative effect on cash flows and the relative cost
of such practices should be weighed up against the relative benefit of postponing the
payment.

Allowing cash discounts
To avoid having to take the risk of incurring credit losses on credit sales, many
merchants offer cash discounts for immediate settlement by customers. The price paid
to offer these discounts will generally be higher than the savings on credit losses, but
such offers often attract more customers and increase turnover, which could improve
the net cash flow at the end of the day.
Factoring debtors
Factoring is a way of turning the debtor’s book into cash quickly. The debtor’s book is
sold to a financial institution (the factor) that specialises in factoring.
The process to factor your debtors is as follows:
The client approaches the factor with detailed information about their business. This
includes detail about the owners, auditors, products, suppliers and bankers of the
business. A history of the business as well as three years of audited financial
statements along with a detailed analysis of both debtors and creditors will also be
required. This enables the factor to assess the risk of the business as well as of the
individual debtors included in the debtors list. This risk assessment needs to be done
to arrive at an appropriate interest rate for the loan being made. A typical agreement
between a factor and a client is known as a Debtor Finance (Factoring) Agreement.
Generally speaking, the factor undertakes to purchase the client’s existing debtors
book and all future credit sales. The agreement will not be without recourse. This
means that the client’s customers will be aware of the existence of the facility and that
debts which cannot be collected or prove to be bad are for the client’s own account.
The factor provides advance funding of up to 80% against the client’s existing
receivables (the actual percentage will be dependent on the specific risk of the deal).
The percentage agreed upon is then applied to all future credit sales as well. The
balance is a retainer held by the factor, and will become available as and when
customers pay their accounts.
Although factoring is the process of purchasing an asset (debtors), funds are advanced
against debtors, which are only to be collected in the future. Therefore interest is
charged on any amount advanced. The interest rate on such deals in South Africa is
typically equal to or slightly higher than the prevailing prime overdraft rate.

The factor undertakes to do all the credit control work associated with the client’s
receivables book: collecting outstanding amounts, sending out statements, and
providing a computerised management reporting system to the client. A service fee
(normally a percentage of the gross value of invoices sold during a calendar month is
charged for these activities). The fee will depend on the volume of invoices to be
processed, the quality of the debtor’s book and the amount of work the factor
estimates will go into the management of the account. It can range from 0.25% to 3%
of sales revenue, although the average charge is usually around 1%. For more
information, visit this link:
Invoice Factoring. 2010. Debtors discounting. [Online]. Available at:

http://www.invoicefactoring.co.za/debtors.html [Accessed 25 November 2016].
The effect of factoring your debtors on your cash flow is immediate. Credit sales are
effectively turned into cash sales (at a cost). Growth is enhanced through additional
working capital that is being supplied. But, probably the most significant advantage of
factoring is the fact that management now has time to concentrate of the business,
rather than on the collection of money from debtors that are overdue. Indirectly, this
should have another positive impact on cash flow.
Slow moving inventory and overstocking
The management of cash flow in a business is largely dependent on the efficient flow
of inventory. This is particularly prevalent in high-tech environments, where keeping
inventory on the shelf for long periods could mean that the business might lose
significant cash flow at the end of the day, since the goods might not even be sold if it
becomes obsolete. Systems like JIT (Just-in-Time) are often employed to ensure
efficient movement of inventory, which will improve the cash flow in the business.
Management needs to monitor the movement of stock and ensure that if stock is going
to become obsolete or go off, they try and sell it by using mark-downs or sales.
Purchase and lease back or hire purchase?
A business often has to make a decision whether to lease an asset or whether to

purchase it by means of a hire purchase (HP) contract. The decision that will be made
is crucial for the future cash flows of the entity.
A lease is a contractual agreement between two parties: the lessee and the lessor.
The lessee is the user of an asset in a leasing agreement. The lessee makes payments
to the lessor. The lessor is the owner of the asset. Think of leasing like you think of
paying rent. The tenant has full use of the property, but it does not become his property
in the end. For a lessee the use of the asset is what is important, not necessarily who
has the title to it. With a purchase-leaseback agreement (also called a sales-leaseback
agreement) the lessor acquires some of the lessee’s existing assets and leases them
back to the lessee once they have been acquired. The lessee receives cash for the
assets involved, which may then be used to finance operations or to increase working
capital.

An example would be a furniture manufacturer that sells its head office land and
buildings to a property company and then leases them back from them.
Many companies do not regard property ownership as part of their core business and
may prefer to use their capital as optimally as possible for their core business. The
lessee may deduct lease payments for income tax purposes if the lease is for an asset
employed in the production of income.
When an asset is bought on hire purchase, the purchase price as well as interest
payments must be paid over a certain period. Unless there is a residual value, the
asset becomes the property of the payer at the end of the term. Most hire purchase
transactions require at least a 10% deposit, which means the immediate cash outflow
is higher than required with a lease, where no deposit will be required. Of course, with
a lease there is no cash inflow at the end of the usage term of the asset, whereas with
a hire purchase transaction there is. The choice of whether to opt for the lease or the
HP contract will therefore have a distinct bearing on the cash flow of the enterprise. It
is often advisable to opt for a lease when the asset is prone to become obsolete
quickly. The choice between whether to lease or purchase largely depends on the tax
deductibility of related expenses, like lease payments or depreciation on the asset
bought under HP.
The number of compounding periods left as from age 20 until retirement would have
been 45. The future value (FV) at age 65 could then be calculated as follows:
R2 697.35 × 1.1245 = R442 331.96

10% inflation rate: R442 331.96 ÷ 1.1047 = R5 015.24
13% inflation rate: R442 331.96 ÷ 1.1347 = R1 415.99
Note that the investment is only lucrative in real terms if the growth rate is higher than
the rate of inflation. You could mention that the inflation rate has been used as the
discount rate in this instance, since that is consumers ‘cost of capital’. In business, a
much higher discount rate than inflation is often used, since the required rate of return
would be much higher than the inflation rate. To ascertain whether an investment will
be lucrative enough, the business would need to know whether the growth on the
investment would exceed a rate that they could have earned if investing the money on
some other project. The growth rate on the alternative project, instead of the inflation
rate could then be used as a discount rate.

(i) Rembank: [1 + 0.15/ 365)]365 – 1 = 16.18%

Sembank: [1 + 0.15/ 4)4 – 1 = 15.87%
Tembank: Since the quoted rate is annually compounded, it is an effective rate
per se = 16%.
(ii) An investor would prefer the highest possible effective return. Therefore, in order
of preference investors would opt for Rembank, then Tembank, and lastly
Sembank.
(iii) A borrower would prefer the lowest possible effective rate. Therefore, in order of
preference borrowers would opt for Sembank, then Tembank and lastly
Rembank.
Note: You will not be required to calculate APR in any of the tests and examinations,
but they should be able to explain the principles behind it.
(i) 18.1876109 x 1 = 18.19%. Use the following function arguments in excel:

Note: The payment of R 1 120 000 p.a. over 10 years pays off a loan amount of
R5 100 000, but this illustration above indicates what the APR is if that R1 120 000
annual payment is applied to the principal loan amount of R5 000 000.
(ii) 0.011450921 x 12 = 13.74%
Note: The payment of R1 488.48 p.m. over four years pays off a loan amount of R56
000, but this illustration above indicates what the APR is if that R1 488.48 monthly
payment is applied to the principal loan amount of R54 730.
(iii) 0.013558949 x 12 = 16.27%

Note: The payment of R7 905 p.m. over 20 years pays off a loan amount of
R 577 200, but this illustration above indicates what the APR is if that R7 905 monthly
payment is applied to the principal loan amount of R560 000.
(iv) 0.007239839 x 12 = 8.69%
Note: The payment of R1 680.78 p.m. over 12 years pays off a loan amount of
R157 500, but this illustration above indicates what the APR is if that R1 680.78
monthly payment is applied to the principal loan amount of R150 000.
(v) 0.014934909 x 12 = 17.92%

Note: The payment of R28 513.51 per month over thirty (30) years pays off a loan
amount of R 2 000 000, but this illustration above indicates what the APR is if that R
28 513.51 monthly payment is applied to the principal loan amount of R 1 900 000.
(i) The following fees are generally included in the calculation of APR:
 Any upfront or lump-sum payments made;
 Pre-paid interest. The interest paid from the date the loan closes to the end
of the month;
 Loan processing fee;
 Underwriting fee.
The following fees are generally excluded from the calculation of APR:
 Title or abstract fee;
 Escrow fee;
 Attorney fee;
 Notary fee;
 Documentation preparation (charged by the closing agent);
 Home inspection fees;
 Recording fee;
 Transfer taxes;
 Credit report;
 Appraisal fee, i.e. the costs of valuing a fixed property.

The following fees are sometimes included, and sometimes excluded from the
calculation of APR:
 Loan application fee;

 Credit life insurance (insurance that pays off the mortgage in the event of
the borrower’s death).
(ii) According to the Financial Intermediary Services Act (FAIS) of 2002, financial
services providers are requested to disclose the ‘reduction in yield’ on their
investment quotations. The reduction in yield is the eroding effect of
administrative and contract costs on the growth that is expected to be earned on
a client’s investment. Assume a client invests in a policy, and the reduction in
yield is 2.5%. What this effectively means is that, for the client to actually earn
20% on his / her investment, the growth rate needs to be 22.5%, from which the
2.5% in costs will then be recouped, and the net growth of 20% will be distributed
back to the client. In general though, the growth on investment products should
be quoted as an annual percentage yield, which will be a lower rate than the
effective interest, due to the product and initiation charges.
(i)
28 February 20.5 28 February 20.6

Trading inventory R100 000 00 R110 000 00
Debtors control 33 500 00 R41 000 00
Accrued income 9 300 00 11 800 00
Savings account 13 400 00 18 000 00
Fixed deposit (maturing on 30 April 20.6) 0 00 30 000 00
Prepaid expenses 7 000 00 4 500 00
Input VAT 2 700 00 3 400 00
Level of working capital (current assets) 165 900 00 218 700 00

(ii)
28 February 20.5 28 February 20.6

Creditors control R140 000 00 R165 000 00
Accrued expenses 15 800 00 10 200 00
Bank overdraft 0 00 4 100 00
Output VAT 6 200 00 11 100 00
Income received in advance 1 500 00 900 00
Level of current liabilities 163 500 00 191 300 00
(iii) The net working capital in Rand value:
On 28 February 20.5: R165 900 – 163 500 = R2 400

On 28 February 20.6: R218 700 – 191 300 = R27 400
Current ratio:
On 28 February 20.5 – R165 900: 163 500 = 1.01: 1

On 28 February 20.6 – R218 700: 191 300 = 1.14: 1
(The current ratio is below the general acceptable norm of 2:1)
Acid test (quick ratio):
On 28 February 20.5 – (R165 900 – 100 000): 163 500 = 0.40: 1

On 28 February 20.6 – (R218 700 – 110 000): 191 300 = 0.57: 1
(The acid test shows results that are below the general acceptable norm of 1:1)
The business is showing considerable working capital risk. Management of

working capital should be on top of their list of priorities from now on.
(i) If one takes the sales, cost of sales and gross profit figures for any of the months
in the question, the same result is obtained, since the business uses a constant
mark-up and there are no stock losses. Using the figures for May 20.9, the mark-
up percentage can be calculated as follows:
R29 000/ R116 000 × 100 = 25%
(ii) The gross margin is the gross profit as a percentage of sales, i.e.:
R29 000/ R145 000 × 100 = 20%

(iii)
Schedule of expected receipts from debtors:
September November December
October 20.9
20.9 20.9 20.9
Re: Credit sales for May 20.9
(60% of R145 000) 13 050 00
Re: Credit sales for June 20.9
(60% of R152 000) 27 360 00 13 680 00
Re: Credit sales for July 20.9
(60% of R161 000) 48 300 00 28 980 00 14 490 00
Re: Credit sales for Aug. 20.9
(60% of R170 000) 51 000 00 30 600 00 15 300 00
Re: Credit sales for Sept. 20.9
52 200 00 31 320 00
(60% of R174 000)
Re: Credit sales for Oct. 20.9
55 500 00
(60% of R185 000)
88 710 00 93 660 00 97 290 00 102 120 00
Abbreviated Statement of Comprehensive Income

September November December
October 20.9
20.9 20.9 20.9
Sales 174 000 00 185 000 00 194 000 00 210 000 00
Cost of sales (139 200 00) (148 000 00) (155 200 00) (168 000 00)
Gross profit 34 800 00 37 000 00 38 800 00 42 000 00
Net profit 19 800 00 21 000 00 21 800 00 24 000 00
Bank balance
Opening balance for the
195 320 00 202 630 00 215 090 00 224 980 00
month
Movements during the month 7 310 00 12 460 00 9 890 00 12 920 00
Creditors settled in cash (136 000 00) (139 200 00) (148 000 00) (155 200 00)
Cash sales for the month 69 600 00 74 000 00 77 600 00 84 000 00
Cash receipts from debtors 88 710 00 93 660 00 97 290 00 102 120 00
(iv) No, Daveyton Wholesalers have it correct as they are growing sales and there
cash flow is continually positive.

(a) P + 0.15P × 9 = R6 462.50

P = R2 750
(b) Simple interest = P × r × t
= 15 000 × 0.10 × 8
= R12 000
Compound interest =A–P

= P(1+i)n – 15 000
= 15 000(1 + 0.1)8 – 15 000
= R17 153.83
The compound interest is R17 153.83 – R12 000 = R5 153.83 more

than the simple interest for the same period.
(c) 318 750 + 318 750 × 0.17 × 6 = R643 875
318 750(1 + 0.17)6 = R817 646.09
(d) PV PV = FVn
(1 + i)n
= R49 912.50
(1 + 0.10)3
= R49 912.50
(1.1)3
= R49 912.50
(1.3333)
= R37 500
(e) The future value (FV) is R80 421.86
The interest rate per period (quarter) is i = 8% ÷ 4 = 2%.
The number of periods (quarters) is n = 4 × 6 = 24
The original amount invested is the present value (PV):
PV = FVn
(1 + i)n
= R95 990.29
(1 + 0.16/ 4)4x4
= R95 990.29
(1.04)16
= R 95 990.29
(1.8730)
= R51 250

(f) PV = R20 184 = R20 184 = R15 000

(1.16)2 (1.3456)
(g) FV = PV + Yield
FV = PV(1+r)^t
PV + yield = PV(1+r)^t
PV + yield = PV(2.313623337)
PV + 231 362.33 = 2.313623337PV
231 362.3/PV=1.313623337
Therefore PV = R 176 125.30
(h) PV = R90 749.29/ (1 + 0.09/ 365)365x10 = R36 900

Learning Unit 4: An Introduction to Managerial

Accounting
 Calculate the total production, administration, Unit:
selling and distribution costs of a product.
 Distinguish between fixed, semi-fixed, semi-
variable and variable costs.
 Carry out a simple break-even analysis.
 Calculate a selling price by using the mark-up or
the margin.
 Apply the concepts of chargeable hours and total
hours worked.
 Before the first class, be sure that you read pp.85–
111 in the textbook.
o Why is it important for a financial manager to
calculate the costs of a product accurately?
o What are the categories that the costs of a
product can be classified as?
o What is the difference between production
costs and non-manufacturing costs?
o Where can the financial manager find the
information necessary to calculate the costs
of a product?
o What are the steps that should be followed
when calculating the total cost of a product?
o What is the break-even point?

Make sure that you
Vigario, F. 2007. Managerial Accounting. 4th edition. Durban: complete Revision
LexisNexis. Chapter 1 Exercise 1 and 2 once you
have worked through
2 Recommended Digital Engagement Learning Unit 4 in the
and Activities prescribed textbook.
Visit the following link and answer the questions that are posed Resources needed:
on the website: A calculator.

Accounting Coach. 2012. Break-even point. [Online]. Available Notes on Learning Unit 4
at: http://blog.accountingcoach.com/category/01/ [Accessed 25 in the textbook:
November 2016].
overview of the costing and
Note: subscribers to the Business Channel from Upload Media pricing of products. Make a
have access to a wide variety of conceptual videos on business list of different costs
involved in manufacturing a
management, income tax, cost and management accounting, product on the board, and
financial management and business law. Visit: allow students to discuss
and debate the categories
under which these costs
Available at: http://upload-media.com/channels/bc should be placed.
3 Activities
When moving in managerial accounting circles, you might come across the terms ‘prime
cost’ and ‘conversion cost’. Discuss in groups what the meaning of these costing
terminologies is.
‘Timeliness is more important than precision when product costing is done in a business.’
Discuss in groups what is meant by this statement, and why timeliness is so important in
the business world.


in the textbook.
Purpose:
The purpose of this activity is to reflect on the different industries where costing models
can be useful.
Task:

This activity is designed to challenge any pre-conceived ideas you might have had about
cost accounting, and to make you realise that the techniques and principles you learn in
this subject can be used across various different industries, and not just in manufacturing.

in the textbook.
Purpose:
The purpose of this activity is to distinguish between the different types of costs that can
be incurred when manufacturing a product.
Task:

This activity is designed to illustrate the different costs that can be involved in the
production of only one product. Furthermore it allows you to categorise costs according
to different types, which is an important skill for a financial manager to master in order to
calculate the cost of a product accurately.

in the textbook.
Purpose:
The purpose of this activity is to distinguish between semi-variable and semi-fixed costs.
Task:

This activity is designed to make you realise that the categorisation of costs is not always
a clear-cut process, and that financial managers sometimes have to create additional
categories for costs to fall under.


in the textbook.
Purpose:
The purpose of this activity is to test your knowledge on which manufacturing costs
constitute fixed costs, and which constitute variable costs.
Task:

This activity is designed so that you can practise categorising costs correctly.
Furthermore it illustrates the concept of break-even, which is an important concept for
financial managers to take into account when making manufacturing decisions.

The purpose of this activity is to distinguish between
costing terms that are often confused.
Task:

This activity is designed to illustrate that it is important for financial managers to
understand the different terms used in practice, and the influence that using different
methods of calculations may have on their results.

The purpose of this activity is to distinguish between the
different types of costs that can be incurred when manufacturing a product.
Task:

This activity is designed to illustrate the different costs that can be involved in the
production of only one product. Furthermore it allows you to categorise costs according
to different types, which is an important skill for a financial manager to master in order to
calculate the cost of a product accurately.


in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on performing a
break-even analysis.
Task:

This activity is designed to show how a break-even analysis is done in practice. It also
embeds your understanding of the different elements of the CVP graph, by providing you
with an opportunity to draw the graph yourself.
The following is a basic costing model for the single product produced and sold by Lassy
Sweets CC:

Required:
(a) Create a mathematical formula for each of the following functions:

 Total revenue curve (TR);
 Total cost curve (TC);
 Variable cost curve (VC);
 Net profit curve (NP);
 Gross profit/ Marginal income curve (MI).
(b) Calculate the expected net profit if 450 units of the product were to be sold.
(c) Calculate the marginal income if 66 units were to be sold.
(d) By looking at the graph it seems as if the TC curve and the VC curve are parallel
to one another. Is this indeed the case? Prove your answer through algebra.
(e) Jacob Sethu made a bulk purchase of 55 units from Osborne Products. Osborne
Products made a gross profit of R17 531.25 on this sale. What was the
percentage discount allowed to Jacob?
Hulluway (Pty) Ltd manufactures a standard type TV Cabinet. The following are the
budgeted costs:
Raw materials used: R620 per unit produced

Direct labour: R310 per unit produced
Factory foreman’s wages R1 860 per month
Rental of factory: R2 480 per month
Rates and taxes: R930 per month
Sales representatives’
commission: R465 per unit sold
Advertising costs: R1 085 per month
Glue and nails: R31 per unit produced
Short-term insurance on factory: R248 per month
Quality controller: R186 per month
Carriage on sales: R93 per unit sold
The business intends to sell the manufactured TV Cabinets at R2 367.63 each plus VAT
@ 14%.

Required:
(a) Calculate the variable cost per unit produced.
(b) Calculate the fixed costs per month.
(c) Calculate the contribution margin per unit sold.
(d) Calculate the break-even point in units.
(e) How many units of the product needs to be sold in order to make a net profit after
tax of R10 260.74? Assume a flat tax rate of 29% for companies.
(f) Use the following grid to make a graphical CVP-analysis of this product.
Use monthly Rand values where applicable, and clearly show the following on your
graph:
 The fixed cost curve;
 The variable cost curve;
 The total cost curve;
 The total revenue curve (sales);
 The break-even point.

The term ‘prime cost’ refers to the total cost of direct material and direct labour. These
are the costs that are the most directly related to the actual product being manufactured.
The term ‘conversion cost’ refers to the total cost of direct labour and manufacturing
overheads. In other words, it is the cost which has been incurred to convert the direct
material into a final product, ready for sale.

Managers must often make decisions on short notice. In order to make such decisions, it
is more important for the manager to receive a fair estimate now than to wait a week for
a precise answer. Providing data that is precise is costly in terms of both time and
resources and managerial accounting places less emphasis on precision than financial
accounting. Data needed for management decision making can often not be expressed
in monetary form. For example, data about customer satisfaction is very important to
management, but is difficult to express in monetary form.
Banks often make use of cost analysis in determining the cost of offering services like
cheque accounts, personal loans and credit cards. Take for example, FNB that
introduced a service product called the Million-a-Month Account during 20.5. Clients that
opened such an account forfeited some or all of their interest that they could have earned
to go into a monthly draw during which the forfeited interest was pooled together, and
where one lucky winner would walk away with R1 million. Of course, launching such a
product could only have been done after careful consideration and costing had been
done. Quite often such service products are only launched after modelling the risks and
potential rewards for the bank on a custom-made actuarial model.
Probably the most prolific users of costing in business today are the insurance
companies. The price one pays for life insurance depends largely on a series of risk
factors, which include, but is not limited to:
 The expected mortality of an average potential client.

 The age of the client. The older a client, the bigger the chance of dying soon.
Older clients will pay more for life cover than younger clients.
 The occupation of the client. The riskier the working environments of a client the
higher the premium for life cover. A mine worker will pay much more for life cover
(all other variables being constant, of course) than a secretary because the chance
of being killed in his / her working environment is much higher than that of the office
worker.
 The health of the client. Most insurance companies will send a prospective client
wishing to take out life cover for a blood test. A standard blood test for life insurance
will test the HIV status of the client, whether the client has high cholesterol, sugar
or cotinine levels (a test for smoking), and whether their liver function is normal. If

the blood tests reveal dangerously high levels on any of the above, premium
loadings may be imposed (i.e. premiums will be raised accordingly).
Period costs (R) Product costs (R)

Marketing,
Adminis- Manufac-
distribution Direct Direct
trative turing
or selling materials labour
cost overhead
cost
Polyethylene purchased per week,
100 000
R25 000
Wages of the machine operators:
R1 200 per operator per week. There
144 000
are 30 machine operators on duty in
the factory at any point in time.
Monthly salary of the factory
supervisor, 13 000
R13 000.
Depreciation on plastic extruding
machines,: R246 900 per machine per 82 300
annum.
Depreciation on office equipment,
4 000
R48 000 per annum
Depreciation on delivery vehicle,
1 300
R5 600 per annum.
CEO’s travelling costs, R5 500 per
5 500
month.

Period costs (R) Product costs (R)

Marketing,
Adminis- Manufac-
distribution Direct Direct
trative turing
or selling materials labour
cost overhead
cost
Rates and taxes amount to R14 000
per month, and must be apportioned in
relation to floor space (the factory 3 500 10 500
takes up 75% of the total floor space of
the entire premises).
Advertising and distribution costs,
6 000
R1 500 per week.
Indirect materials used in production,
29 440
R23 per ton of RX 007 manufactured.
Wages of the factory cleaning staff,
12 200
R3 050 per week.
Fees paid to security company for the
security guard positioned at the front 800
entrance to the factory, R800 p.m.
Fees paid to the security company for
the security guard positioned at the
800
main entrance to the administrative
building, R800.
Monthly insurance premium, R3 400
(R2 400 of which relates to the 1 000 2 400
factory).
Import tariffs and customs duties paid
on polyethylene imported from abroad, 19 200
R1 500 per 100 tons imported.
Telephone, stationery and general
2 700
office expenses, R2 700 p.m.
Railage and carriage on sales, R2 200
7 040
per consignment of 400 tons sold.
TOTALS: 14 340 17 500 119 200 144 000 150 640
Note: Total cost = R445 680

Semi-variable costs
These are cost items which are partly fixed and partly variable. In managerial accounting
the costs are usually dealt with by dividing them into their fixed and variable components.
A good example of such a cost is a telephone account. The line rental is the fixed
component and it must be paid, even if no calls are made. The moment any calls are
made, the variable component comes into play. The more calls you make, the more the
variable cost will be and this cost rises in direct relationship to the usage (the number of
calls × the cost per call). The total cost of using a telephone will be the sum of the fixed
cost and the variable cost. It is important to note that the total cost can never be below
the fixed cost.
Semi-fixed costs
These are costs which will stay fixed for a given level of production, but will increase in
increments once production has passed the maximum level applicable to the cost. An
example of this type of cost is a transport contractor who has one truck for which he pays
R5 000 per month according to a lease agreement. This truck can carry a maximum load
of 10 tons. If the contractor should sign a contract for the transportation of five tons, the
cost of leasing the truck will be R5 000. If he should sign an additional agreement for a
further four tons, his lease cost will still be R5 000, because he has not reached the
maximum carrying capacity of the truck yet. Should he be offered a third contract to
transport a further two tons, he will have to consider the situation closely. Transportation
of the first 10 tons will mean a leasing cost of R5 000. Should he accept the third contract,
he will have to transport 11 tons and he will have to lease a second truck. This means
that his total cost will be R10 000. Leasing the second truck will enable him to transport
loads of up to 20 tons. If he would sign more contracts and he exceeds 20 tons (but not
30 tons) he will have to lease a third truck and his cost will increase to R15 000.
Loads of 0 to 10 tons total cost of leasing = R5 000

Loads between 10 and 20 tons total cost of leasing = R10 000

(i)
Fixed costs Variable
per month costs per
(R) month (R)
Polyethylene purchased per week, R25 000 100 000
Wages of the machine operators: R1 200 per operator per week.
There are 30 machine operators on duty in the factory at any point 144 000
in time.
Monthly salary of the factory supervisor, R13 000. 13 000
Depreciation on plastic extruding machines, R246 900 per machine
82 300
per annum.
Fixed costs Variable
per month costs per
(R) month (R)
Depreciation on office equipment, R48 000 per annum 4 000
Depreciation on delivery vehicle, R15 600 per annum. 1 300
CEO’s travelling costs, R5 500 per month. 5 500
Rates and taxes amount to R14 000 per month, and must be
apportioned in relation to floor space (the factory takes up 75+% of 14 000
the total floor space of the entire premises).
Advertising and distribution costs, R1 500 per week. 6 000
Indirect materials used in production, R23 per ton of RX 007
29 440
manufactured.
Wages of the factory cleaning staff, R3 050 per week. 12 200
Fees paid to security company for the security guard positioned at
800
the front entrance to the factory, R800 p.m.
Fees paid to the security company for the security guard positioned
800
at the main entrance to the administrative building, R800.
Monthly insurance premium, R3 400 (R2 400 of which relates to the
3 400
factory).
Import tariffs and customs duties paid on polyethylene imported
19 200
from abroad, R1 500 per 100 tons imported.
Telephone, stationery and general office expenses, R2 700 p.m. 2 700
Railage and carriage on sales, R2 200 per consignment of 400 tons
7 040
sold.
TOTALS: 146 000 299 680
Note: Total cost = R445 680

(ii) Variable cost: R299 680/ (4 × 320) = R234.13 per ton
(iii) Selling price per ton: R234.13 + 150% = R585.33 per ton
(iv) Marginal income ratio: (585.33 – 234.13)/ 585.33 × 100 = 60%

Or: 150/ 250 × 100 = 60%
(v) Break-even point in units: Fixed costs/ marginal income per unit:
R146 000/ (R585.33 – R234.13) = 415.72 tons, rounded to 416 tons
(vi) Break-even point in Rand value: Fixed costs/ Marginal income ratio:
R146 000/ 0.6 = R243 333.33
(vii) Units to be sold to achieve a net profit of R10 000 000 per annum:
Fixed costs per annum + profit target per annum/ marginal income per unit:
(R1 752 000 + 10 000 000)/ R351.20 = 33 462.41 tons, rounded up to 33 463 tons.
(viii) The direct material, called polyethylene, is the main ingredient in the business’
production costs. Renegade Dealers should constantly benchmark the prices
charged by their preferred supplier(s) against alternative suppliers. Suppliers often
attract customers with very low prices, only to increase these prices considerably
in due course – to such an extent that an alternative suppler might have been a
better bet in the long run.
Wages is a very contentious issue. The wages paid should always be relative to
the output provided. If the labourers produce twice as much as the competitors of
a certain product in a week, but the wage rate offered is 50% higher than that of
the competitors, then the real wage is actually quite low. Adding 50% to cost, but
100% to productivity is a winning recipe. Ways in which this can be done is to
introduce incentive schemes as part of every employee’s pay package.
Carriage on sales is a difficult cost item. It is not only price that is important, but
also the timeliness of deliveries, the safeguarding of the cargo and the
roadworthiness of the vehicles used. When volumes produced become enormous,
companies often negotiate substantial rebates with cartage contractors. Due to the
high maintenance on these vehicles, most companies prefer to outsource the
function, so that they can concentrate on what they do best: Production.

(i) When costing the operations of a business, the cost per hour to deliver the product
or service should be averaged. To explain this concept, let us focus on the
operations of a vehicle maintenance workshop. Sometimes workers will be very
efficient in their jobs, i.e. when there are no power outages, everyone is motivated,
and equipment and operations are streamlined to perfection. At other times,
outputs will be less than favourable, i.e. downtime is rife; systems, staff and
processes are slow. Let us say the business pays a motor mechanic R100 per
hour, and the average car service takes two hours to complete. If the business
wants to earn double the income than the cost it has incurred, it will quote the
client two hours on the job-card for a service @ R200 p/ h = R400 for the labour
to complete a standard service. This does not mean that it will necessarily take
two hours to complete the service. It might take one hour, or it might take three
hours, but the business needs to create a benchmark on which it can base its
costing and charge rates and hours that are fair to customers and to staff. Let us
say a mechanic dropped a washer in the carburettor of a car he/ she was
servicing. This could mean that the time spent on completing that service could
end up being five or six hours long. It would be unfair to charge the client for six
hours of work, though, since the reason for the extended number of hours spent
was due to an error on the part of the supplier. If the service took one hour to
complete, because there was a second mechanic available to help with the
service, the business would still charge the two hours, essentially partially
recouping the ‘loss’ they incurred on the previous client (this ‘loss’ is called an
‘opportunity cost’, i.e. the income forfeited due to the man hours lost in searching
for the washer in the carburettor).
(ii) ‘Gross’ means before deductions. When we speak of ‘gross profit’, we refer to the
profit before the deduction of overheads/ operating expenses. Net profit refers to
the ‘bottom line’ or the profit after the deduction of overheads / operating
expenses. Gross profit is the difference between the sales revenue and the cost
of sales (also called the cost of goods manufactured). From a costing perspective,
the cost of sales equals the direct materials + direct labour + manufacturing
overheads.

It is easy to explain a mark-up percentage. The term explains itself. A

manufacturer produces a product for R100 and ‘marks it up’ by 50%, thus adding
50% of R100 to the R100 to arrive at R150.
When explaining a mark-up percentage, use the following equation:
Cost price + Gross Profit = Selling price
R100 + R50 = R150
The mark-up percentage can be calculated as follows:
50
× 100 = 50%
100
The gross margin is a bit harder to explain. In board meetings, directors often
speak of gross margins. This is easier to use in strategic decision-making than
mark-up percentages. A gross margin of 25% basically means that 25 cents of
each R1 in sales revenue becomes available to cover overheads with. The reason
why directors and managers use this ratio is that it now becomes relatively easy
to calculate breakeven points. One could divide fixed costs by the gross profit per
unit to obtain a breakeven point. In the costing sphere, this could be misleading,
though, since the cost of sales could include manufacturing overheads that are
fixed, not variable in nature. Therefore, in costing circles, one would rather speak
of a contribution margin, and a marginal income ratio. Such a figure will exclude
all forms of fixed costs, and will only focus on the marginal cost or marginal profit
of every additional unit produced and sold.
When explaining a gross margin, use the following equation:
Cost price + Gross Profit = Selling price
R100 + R50 = R150
The gross margin can be calculated as follows:
50
× 100 = 331/ 3%
150
When products are marked up on cost, the particular cost could either be the cost
of sales or the total variable cost. Per definition, cost of sales is the total cost
incurred to get a product in the condition and location ready for sale (this cost
could include fixed and variable components). The total variable cost includes
only the variable cost components of production. Most accountants will use the
cost of sales as the basis for mark-ups and margins, not the variable cost.

The advantages of using a mark-up instead of a gross margin as a basis for

costing, is that the denominator in all interpretations of results will be the cost, not
the revenue. This makes it easier to think like a cost accountant, not like a
strategic manager. Strategic planners speak of gross margins, since the main
focus is revenue and revenue-generating activities.
The advantages and disadvantages of using a gross margin instead of a mark-up

on cost are converse to the above.
(i)
Manufac- Adminis- Direct Indirect
Variable Fixed Direct Indirect
Cost item turing trative mate- mate-
cost cost labour labour
overhead overhead rials rials
Factory
supervisor’s X X X
salary
Executive
training X X
programme
Lubricants for
X X X
machines
Manufac- Adminis- Direct Indirect
Cost item turing trative mate- mate-
cost cost labour labour
overhead overhead rials rials
Top
management X X
salaries
Product
X X
advertising
Assembly-line
workers’ X X
wages
Headquarters
secretarial X X
salaries
Rent on
factory X X
building
Salesmen’s
X X
commissions
Raw materials X X

(ii)
In relation to units of
Cost behaviour
Cost item production
Paper used in producing a text book X X
Lubricants for machines X X
Glue used in producing a text book X X
Depreciation of equipment in the staff room X
Cloth used in producing women’s clothing X X
A supervisor’s salary X X
Screws used in manufacturing furniture X X
Wood used in producing skateboards X X
Rent on a factory building X X
Clay used in manufacturing bricks X X
Salaries of the cleaning staff in the factory X X
Wages of the workers that assemble the product X X
Workings:
To calculate the breakeven point for each investment opportunity, the following analysis
of cost, distinguishing between fixed and variable cost, is required
Opportunity 1 Opportunity 2
Type of cost Variable Total Variable Total

Fixed Fixed
cost per variable cost per variable
cost cost
unit cost unit cost
R 240
Direct manufacturing cost R128 R256 000 R80 000 R4 R80 000
000
Indirect manufacturing cost 60 120 000 4 80 000
Selling and administrative
20 40 000 144 000 4 80 000 160 000
costs
R208 R416 000 R224 000 R12 R240 000 R400 000

(i) The breakeven point in units can be calculated as follows:
Fixed cost/ Marginal income per unit Fixed cost/ Marginal income per unit
224 000/ (400 – 208) = 1 167 units 400 000/ (40 – 12) = 14 286 units
Note: breakeven amounts must be rounded upwards, as rounding downwards will not
ensure complete recovery of fixed cost.
(ii) The breakeven point in sales revenue can be calculated as follows:
Fixed cost/ Marginal income ratio Fixed cost/ Marginal income per unit
224 000/ [(400 - 208)/ 400] = R466 667 400 000/ [(40 – 12)/ 40] = R571 429
OR: OR:
1 167 × R400 = R466 800 14 286 × R40 = R571 440
CVP graphs – See the following pages:
Opportunity 1

Opportunity 2

(a)
 TR = 875Q
 TC = 11 250 + 500Q
 VC = 500Q
 Net profit is the total revenue minus the total cost
o NP = 875Q – (11 250 + 500Q)
o NP = 375Q – 11 250
 Gross profit or marginal income is the total revenue minus the variable cost
o MI = 875Q – 500Q
o MI = 375Q
(b) NP = 375(450) – 11 250 = R157 500
(c) MI = 375(66) = R24 750
(d) Yes, the functions are indeed parallel. The gradient for both functions is 500. By
matching slope for slope at each quantity, there’s an equal distance of R
11 250, being the total fixed costs.
(e) (875Q)( 1 – x/100) – 500Q = 17 531.25

48 125 – 481.25x – 27 500 = 17 531.25
Percentage discount: = 6.43 % discount
(a) Variable cost per unit:
Raw materials R 620

Direct labour 310
Sales representatives’ commission 465
Glue and nails 31
Carriage on sales 93
1 519

(b) Fixed cost per month:
Factory foreman’s wages R 1 860

Rental of factory 2 480
Rates and taxes 930
Advertising costs 1 085
Short-term insurance on factory 248
Quality controller 186
6 789
(c) R2 367.63 – 1 519.00 = R848.63 per unit
(d) R6 789 ÷ 848.63 = 8 units
(e) [6 789 + (10 260.74/ 0.71)]/848.63 = 25.029 units (Answer: 26 – rounded up)
(f)

Learning Unit 5: Controlling Inventory and Overhead

Costs
 Identify appropriate cost centres and elements of Unit:
cost.
 Explain how inventory costs can be controlled in
the most efficient way.
 Demonstrate how inventory can be valued
according to the FIFO method or weighted average
method of valuation.
 Illustrate how the most economical ordering
quantity for items of inventory can be ascertained.
 Record and analyse information with respect to
allocation, apportionment and absorption of
overhead costs.
 Establish overhead costs in accordance with the
organisation’s procedures.
o What are the three different inventory items?
o Why is it necessary to perform stock takes?
o What are the two different methods of
inventory valuation?
o What are the categories of costs associated
with trading inventories?
o What is the definition of economic order
quantity (EOQ)?
o What are the three methods used to re-
assign service department costs?
o What are the steps to be followed in activity-
based costing?
1 Recommended Additional Reading Resources needed:

A calculator.
Vigario, F. 2007. Managerial Accounting. 4th edition. Durban: LexisNexis. Chapter 2

Visit the following links and answer the questions that are posed on the website:
Accounting Coach. 2012. Manufacturing overhead. [Online]. Available at:

http://blog.accountingcoach.com/category/36/ [Accessed 25 November 2016].
Accounting Coach. 2012. Nonmanufacturing overhead. [Online]. Available at:

http://blog.accountingcoach.com/category/37/ [Accessed 25 November 2016].
3 Activities
As with most formulas and theorems, the EOQ model has a number of underlying
assumptions. An understanding of these assumptions will be of assistance in making the
necessary adjustments when these assumptions are relaxed.
Discuss in groups the underlying assumptions of the EOQ model.

in the textbook.
Purpose:
The purpose of this activity is to explore some important concepts that you have to
understand when it comes to controlling inventory and overhead costs.
Task:
This activity is designed to introduce you to the concept of opportunity cost, as well as to
revise the difference between the two inventory systems.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge of valuing inventory,
by calculating inventory according to the FIFO and the weighted average cost methods.
Task:

This activity is designed to introduce you to the concept of inventory valuation, by
providing very simple information to give you an opportunity to practise these
calculations.

in the textbook.
Purpose:
The purpose of this activity is to integrate your knowledge of stock valuation, profit
calculation and the different inventory systems.
Task:

This activity is designed to integrate various different aspects that have been covered in
this book, thereby preparing you for typical test and exam questions. Furthermore, this
activity requires of you to reflect on the ethical aspects relating to stock valuation, which
is an important concern for financial managers.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on calculating the
economic order quantity.
Task:

This activity is designed to enhance your understanding of the economic ordering
quantity, by applying its use to different scenarios.

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on calculating the
economic order quantity.
Task:


in the textbook.
Purpose:
The purpose of this activity is to embed your knowledge on calculating the economic
order quantity.
Task:


in the textbook.
Purpose:
The purpose of this activity is to embed your knowledge on calculating the economic
order quantity.
Task:

in the textbook.
Purpose:
The purpose of this activity is to test your newly-acquired knowledge on the
apportionment of overheads.
Task:

This activity is designed to use all three methods of apportionment of overheads, thereby
providing you with an opportunity to practise using all three methods, as well as enabling
you to compare the three methods.

in the textbook.
Purpose:
Task:

This activity is designed to focus on using the linear algebraic method of apportioning
overhead costs, which is often difficult for students to grasp.
3.11 Activity 10 – Question 5.10 For Activity 10 consult

p.138 in the textbook.
Purpose:
Task:

This activity is designed to allow you to compare the results you get when using the direct
method and using the linear algebraic method, and to reflect on why this difference
occurs.

Purpose:
Task:

This activity is designed to introduce the concept of over- or under absorption of
overheads.

Purpose:
Task:

This activity is designed to embed the concept of over- or under absorption of overheads.

For Activity 13 consult
Purpose:
The purpose of this activity is to identify activities that can be used as cost drivers when
calculating costs.
Task:

This activity is designed to make you think ‘out of the box’ and let you realise that a
financial manager can use any one of a variety of different activities as cost drivers,
depending on the nature of the enterprise and the processes involved in manufacturing
a product.

For Activity 14 consult
Purpose: p.154 in the textbook.
The purpose of this activity is to test your newly-
acquired knowledge of the ABC system to calculate overhead costs.
Task:

This activity is designed to introduce you to the calculation of overheads using the ABC
system, by providing you with very basic information.

Purpose:
The purpose of this activity is to embed your knowledge on the ABC system to calculate
overhead costs.
Task:

This activity is designed to embed your knowledge on the ABC system by providing you
with information that you have to interpret in order to perform the correct calculations.
Tretstor CC has three production departments (X, Y and Z) and one service department
in its factory. A predetermined overhead absorption rate has been established for each
of the production departments on the basis of machine hours at normal capacity. The
overheads of each production department comprise directly allocated expenses and a
share of the overheads of the service department, apportioned in the ratio 6:5:4 to
departments X, Y and Z respectively. All overheads are classified as fixed n nature. The
actual overhead incurred in each department was in line with the budget.
The following table of incomplete information is available concerning the apportionment

and absorption of production overheads foe a period.
Required:
Calculate the missing figures for (i) – (viii).
Production departments
X Y Z
Budgeted allocated expenses R600 000.00 R305 000.00 R320 000.00
Budgeted service department
(i) (ii) R225 000.00
apportionment
Normal machine hours capacity 15 500 hours (iii) (v)
Predetermined absorption rate (vi) R 53.30 (iv)
Actual machine utilisation (vii) 11 600 hours 13 200 hours
Over/ (under) absorption of
(R6 048.00) (viii) (R48 867.00)
overheads
 The unit price or production cost is constant and does not vary with changes in
the order size;
 The demand rate is known with certainty and is a constant rate over the year;
 The ordering cost per unit is constant and is measured in currency (for example
Rand value). Carrying costs remain constant over the same time period as that
of demand;
 Stock-out cost is so exorbitantly high that inventory is replenished before stock-
outs occur;
 Order quantity is constant per order and the whole batch is delivered at once;
 Replenishment of inventory occurs before the inventory level reaches zero (0)
and not when the safety stock level is reached;
 The lead time for placing and receiving an order is known with certainty and
remains constant.
(i) Opportunity costs could be defined as being “the value of the next best
alternative forfeited by choosing to engage in a particular activity or venture”. It
is therefore the potential benefit that is given up when one alternative is selected
over another. Almost every decision in life has an inherent opportunity cost.
Choosing to study full time has the opportunity cost of losing out on a salary that
you could have earned had you started working immediately upon leaving
school. For a business owner there is an opportunity cost in starting the business.
Had the owner invested the money in a government bond or in a fixed deposit
(at virtually no risk), interest would have been earned. However, there would also
be other benefits had he/ she taken this route instead. Such benefits would
include time with family and friends, a less stressful life, etc. When a managerial
accountant has to make a judgement call about the viability of a project, the
opportunity cost of this project should be central in his/ her thought process.
Although opportunity cost is not usually entered in the accounting records of an
organisation, it is a cost that must be explicitly considered in every decision a
manager makes. The benefits of engaging in a project must always outweigh the
opportunity cost thereof, or else the project is fundamentally flawed. Another

example to highlight this point would be that of a baker. A baker can try to save
costs by postponing the purchases of flour at regular re-order levels has major
repercussions – loss in sales, late delivery, poor rapport with customers and
suppliers – all being opportunity costs.
(ii) If a business uses a perpetual inventory system, the cost of inventory or raw
materials purchased is debited to an inventory account. This system allows the
firm to charge inventory costs to production or to cost of goods sold, as inventory
is used. Each acquisition of raw materials and each transfer of inventory to work
in process is recorded in the inventory account as it takes place.
With the periodic inventory system, acquisitions and reductions of inventory are
not recorded in the inventory account. Instead, all inventory acquisitions are
recorded in a purchases account. When inventory is sold, the cost thereof is
usually unknown, and will only be calculated at the end of the trading period when
a physical count of inventory is made.
FIFO method
Day Purchases Issues Balance

200 @ R23.15
1
400 @ R24.27
200 @ R23.15
2 100 @ R25.65 400 @ R24.27
100 @ R25.65
-
200 @ R23.15
15 250 @ R24.27
150 @ R24.27
100 @ R25.65
250 @ R24.27
20 200 @ R26.05 100 @ R25.65
200 @ R26.05
250 @ R24.27
100 @ R25.65
25 120 @ R26.47
200 @ R26.05
120 @ R26.47
-
250 @ R24.27
-
28 100 @ R25.65
70 @ R26.05
130 @ R26.05
120 @ R26.47
Thus: Value as at 31 July 20.8 according to FIFO:
(70 × R26.05) + (120 × R26.47) = R4 999.90
Weighted average cost method
Day Purchases Issues Balance

1 600 @ R23.90
2 100 @ R25.65 700 @ R24.15
15 350 @ R24.15 350 @ R24.15
20 200 @ R26.05 550 @ R24.84
25 120 @ R26.47 670 @ R25.13
28 480 @ R25.13 190 @ R25.13
Alternative layout:
Day Type Units Unit cost Value

1 Open 200 23.15 4 630
Open 400 24.27 9 708
2 Purchase 100 25.65 2 565
700 24.15 16 903
15 Sale (350) 24.15 -8 452
350 24.15 8 452
20 Purchase 200 26.05 5 210
25 Purchase 120 26.47 3 176
670 25.13 16 838
28 Sale -480 25.13 -12 063
Closing value 190 25.13 4 775
Thus: value as at 31 July 20.8 according to weighted average method:
190 × R25.13 = R 4 774.70.
Note the rounding differences in the calculation of weighted average cost. Should no
rounding have occurred throughout, the answer would be R4 774.93.
(i)
(a) Opening stock
= 500 diaries × R60 = R30 000
Bought on 30 April 20.8
= (100 diaries × R 64 = R 6 400) + R 280 = R 6 680, thus landed cost = R 66.80 each
Bought on 31 August 20.8
= (180 diaries × R72 = R12 960) + R680 = R13 640, thus landed cost = R 75.78
each
Bought on 31 January 20.9
= (200 diaries × R 82 = R16 400) + R1 000 = R17 400, thus landed cost = R 87
each.
Thus, value of inventory on 28 February 20.9:
200 @ R87.00 each = R17 400

180 @ R75.78 each = 13 640
80 @ R66.80 each = 5 344
R36 384
(b) Calculate the cost of sales
500 @ R60.00 each = R30 000

20 @ R66.80 each = 1 336
R31 336
(c) Calculate the gross profit
Sales = 520 @ R100 each = R52 000

Cost of sales = R31 336
Gross profit = R52 000 – 31 336 = R20 664
(d) Calculate the mark-up % for the year:
20 664/ 31 336 × 100 = 65.9%
(e)
Perpetual inventory system

Trading account F1
20.9 20.9
Feb. 28 Cost of sales GJ# 31 336 00 Feb. 28 Sales GJ# 52 000 00
Profit and loss GJ# 20 664 00
52 000 00 52 000 00
(f)
Periodic inventory system
Trading account F1
20.9 20.9
Trading
inventory
Feb. 28 Feb. 28 Sales 52 000 00
(opening GJ# 30 000 00 GJ#
stock)
Trading
Purchases 35 760 00 inventory
GJ# GJ# 36 384 00
(Closing stock)
Carriage on
purchases GJ# 1 960 00
00
Profit and loss GJ# 20 664
88 384 00 88 384 00
(ii)
(a) Opening stock
= 500 diaries × R60 = R30 000 (This is the weighted average cost).
Bought on 30 April 20.8
= (100 diaries × R64 = R6 400) + R280 = R6 680, thus landed cost

= R66.80 each
Bought on 31 August 20.8
= (180 diaries × R72 = R12 960) + R680 = R13 640, thus landed cost
= R75.78 each
Bought on 31 January 20.9
= (200 diaries × R82 = R16 400) + R1 000 = R17 400, thus landed cost
= R87.00 each
Thus, value of inventory available for sale
Date No of Units Value

Open 500 30 000
20.8/ 04/ 30 100 6 680
20.8/ 08/ 31 180 13 640
20.9/ 01/ 31 200 17 400
980 67 720
980 diaries at a total landed cost of R67 720 = R69.10 each
Stock value for the 460 diaries on hand at the year-end:
460 at R69.10 = R31 786
(b) Calculate the cost of sales
520 at R69.10 = R35 932

Note: the assumption is that 520 stock items were disposed of on 28 February
20.9.
(c) Calculate the gross profit
Sales = 520 @ R100 = R52 000

Cost of sales = R35 932
Gross profit = R16 068
(d) Calculate the mark-up % for the year
16 068/ 35 932 × 100 = 44.72%
(e)
Perpetual inventory system
Trading account F1
20.9 20.9
Feb. 28 Cost of sales GJ# 35 932 00 Feb. 28 Sales GJ# 52 000 00
52 000 00 52 000 00
(f)
Periodic inventory system
Trading account F1
20.9 20.9
Trading inventory
Feb. 28 Feb. 28 Sales 52 000 00
(opening stock) GJ# 30 000 00 GJ#
Trading
Purchases 35 760 00 inventory 31 786 00
GJ# GJ#
(Closing stock)
Carriage on
purchases GJ# 1 960 00
Profit and loss GJ# *16 066 00

83 786 00 83 786 00
* Note: The gross profit is R2 out due to rounding.
(iii)
(a) No, manipulating valuation methods could lead to serious misrepresentation of
company results. A business should stick to one acceptable and legal method of
valuation.
(b) The Companies Act requires that the method that has been chosen by the
business be disclosed in their financial statements.
(c) The advantage of the perpetual system is that the trading inventory account
reflects the balance of what should be on hand in the event of a stock take being
done. In this way, obsolete stock and theft can easily be detected. This is difficult
to do under a periodic system, where there is no benchmark figure or balance to
compare actual stock take values against. Stock losses automatically defaults to
cost of sales, and the business owner might be under the wrong impression, i.e.
that these goods were in fact sold to customers.
(i)
(ii)
(a) EOQ:
No of orders = 6 250/ 500 = 12.5
Cost of orders = 12.5 × 200 = 2 500.00
Average quantity of inventory = 500 ÷ 2 = 250
Cost of holding stock = 250 × 10 2 500.00
Total cost R 5 000.00
(b) Order 1 250:

No of orders = 6 250/ 1 250 = 5
Cost of orders = 5 × 200 = 1 000.00
Average quantity of inventory = 1 250/ 2 = 625
Cost of holding stock = 625 × 10 = 6 250.00
Total cost R7 250.00
Saving = R7 250 – R5 000 = R2 250.00
(iii) Discount @ R2 per unit @ 6 250 units per annum = R12 500
Assume order size of 625 units
6 250/ 625 = 10 orders × R200 = R2 000
Stock holding = 625/ 2
= 312.5 units × R10 = R3 125
R5 125
EOQ as in (ii) = R5 000
Additional cost (Order size 625) = R125
Saving by taking discount of R2:
(6 250 x R2) – R125 = R12 375
It is recommended that Dubega Ltd takes up the offer.
(i)
(ii)
The high cost of capital means that the organisation has to pay for borrowed
funds which increase the cost of holding the inventory. Smaller quantities
purchased more often will decrease this cost as the units are likely to be sold
(turned into cash) and the borrowed funds paid off more quickly, thereby reducing
the interest expense.
(i)
(ii)
Maximum expected usage per week 75 parts

Average usage per week 54 parts
Excess: 21 parts
X4
Lead time
weeks
Safety stock 84 parts
(iii)
Average weekly usage 54 parts

X4
Lead time
weeks
Normal usage 216 parts
Safety stock 84 parts
Reorder point 300 parts
(iv) An order for 450 parts will be placed when the stock on hand drops to 300 parts.
(i)
*0.10 + (0.5 × 10%) = 0.15

(ii) Number of orders per year = Annual demand ÷ Quantity per order
= 320 000/ 8 000
= 40
(iii) Total annual ordering costs = Number of orders × Cost per order
= 40 × R15
= R600
(iv) Total annual carrying costs = Holding cost × Average ordered inventory
= R0.15 × (8 000 ÷ 2)
= R600
(v)
Total cost @ EOQ Total cost @ 32 000 units

Annual discounted
a
Annual purchase cost + 160 000.00 purchase cost + 153 600.00
freight freight
b
Ordering cost 600.00 Ordering cost 150.00
c
Carrying cost 600.00 Carrying cost 2 400.00
161 200.00 156 150.00
a
320 000 × 0.50 × (1 - 0.04) = R153 600.00
b
320 000 ÷ 32 000 × 15 = R150.00
c
32 000÷ 2 = R16 000 units to hold @ R0.15 per unit = R2 400.00
I.e., since the cost of ordering at the discount is cheaper than the standard set by
the EOQ, the business should accept the discount offer (the net benefit of taking the
discount is R5 050.00).
(vi) Reorder point = 320 000 ÷ 360 × 9 days = 8 000
(vii) One order @ R15 plus holding cost (320 000 ÷ 2 × 15 cents)
= R15 + R24 000
= R24 015
Note: When ordering at EOQ, the ordering costs are R600 and the carrying cost is
R600, therefore the total cost difference between ordering once and ordering at the
EOQ is an increase is costs of: R24 015 - R1 200 = R22 815.
(i) Direct method:
Admin:
Women’s clothing: 15/24 × 90 000 = 56 250
Men’s clothing: 9/24 × 90 000 = 33 750
Facilities:
Women’s clothing: 150/225 × 60 000 = 40 000
Men’s clothing: 75/225 × 60 000 = 20 000
Total: Direct cost Admin Facilities Total

Women’s clothing: 300 000 56 250 40 000 396 250
Men’s clothing: 250 000 33 750 20 000 303 750
(ii) Step method:
Facilities:
Women’s clothing 150/250× 60 000 = 36 000
Men’s clothing 75/250× 60 000 = 18 000
Admin 25/250× 60 000 = 6 000_
60 000
Admin:
Admin + Facilities 90 000 + 6 000 = 96 000
Women’s clothing 15/24 × 96 000 = 60 000

Men’s clothing 9/24 × 96 000 = 36 000
96 000
Total: Direct cost Admin Facilities Total

Women’s clothing: 300 000 60 000 36 000 396 000
Men’s clothing: 250 000 36 000 18 000 304 000
(iii) Linear algebraic method:
The following algebraic equations will be used:
(Where: A = Admin; W = Women’s clothing; F = Facilities; M = Men’s clothing)
A = 90 000 + 0.1F F = 60 000 + 0.2A

W = 300 000 + 0.4A + 0.6F M = 250 000 + 0.4A + 0.3F
Step 1: Substitute A into F

F = 60 000 + 0.2(90 000 + 0.1F)
F = 60 000 + 18 000 + 0.02F
0.98F = 78 000
F = R79 591.84
Step 2: Substitute the solution of F into A

A = 90 000 + 0.1(79 591.84)
A = R97 959.18
Step 3: Substitute the solution of A and F into W

W = 300 000 + 0.4(97 959.18) + 0.6(79 591.84)
W = 300 000 + 39 183.67 + 47 755.10
W = 386 938.77
Step 4: Substitute the solution of A and F into M

M = 250 000 + 0.4(97 959.18) + 0.3(79 591.84)
M = 250 000 + 39 183.67 + 23 877.55
M = R313 061.22
(i) Algebraic equation
X = 1 080 950 + 0.40A + 0.55B

Y = 1 560 250 + 0.50A + 0.25B
A = 267 800 + 0.2B
B = 180 000 + 0.1A
(ii) A = R310 000,

B = R211 000,
X = R1 321 000,
Y = R1 768 000
(iii) R73 200 [(310 000 – 267 800) + (211 000 – 180 000)]
(iv) R447 800 (267 800 + 180 000)
(i)
Distribution
Admin
factor
Cutting 35 β 470 000
Assembly 35 Ω 470 000
70 940 000
β(35 ÷ 70) × 940 000

Ω(35 ÷ 70) × 940 000
Distribution factor Maintenance
Cutting 60 β 319 579
Assembly 35 Ω 186 421
95 506 000
β(60 ÷ 95) × 506 000

Ω(35 ÷ 95) × 506 000
Therefore:
Direct costs 2 160 000 1 440 000
Allocated costs
Admin 470 000 319 579
Maintenance 470 000 186 421
3 100 000 1 946 000
(ii)
M = 506 000 + 0.3(940 000 + 0.05m)
= 506 000 + 282 000 + 0.015m
0.985m = 788 000
m = 800 000
ad = 940 000 + (0.05 * 800 000)

= 940 000 + 40 000
= 980 000
c = 2 160 000 + (0.35 * 980 000) + (0.6 * 800 000)

= 2 983 000
as = 1 440 000 + (0.35 * 980 000) + (0.35 * 800 000)

= 2 063 000
(iii) In the direct method there is no recognition of interdepartmental servicing while

this type of servicing is recognised in the linear algebraic method.
(i) R39 780 [(R66 300 ÷ 5/ 10) × 3/ 10]
(ii) R26 520 [(R66 300 ÷ 5/ 10) × 2/ 10]
(iii) 18 500 hrs. [(R125 180 + 26 520) ÷ R8.20]
(iv) R14 per hr. [(R213 700 + R66 300) – R6 720] ÷ 19 520 hrs.
(v) 20 000 hrs. [(19 520 hrs.) + (R6 720 ÷ R14)]
(vi) R12.20 per hr. [(R143 220 + R39 780) ÷ 15 000 hrs.]
(vii) 14 700 hrs. [15 000 hrs. – (R3 660 ÷ R12.20)]
(viii) R4 510 (over-applied) [(R19 050 × R8.20) – (125 180 + 26 520)]
Company X:
Allocation rate:
Labour costs = Budgeted overheads/ budgeted labour costs × 100/ 1

= 380 000/ 95 000 × 100/ 1
= 400%
Total manufacturing costs as determined during the year:
Direct material cost R184 000

Direct labour cost R96 000
Applied manufacturing overhead cost (R96 000 × 400%) R384 000
Total manufacturing cost R664 000
Under- or over-allocation:
Applied manufacturing overheads – Actual manufacturing overheads

= R384 000 – R412 000
= (R28 000) Under-allocated.
Company Y:
Allocation rate:
Labour hours = Budgeted overheads/ budgeted labour hours

= 310 000/ 31 000
= R10 per labour hour

Applied manufacturing overhead cost (32 100 × R10) R321 000
Applied manufacturing overheads – Actual manufacturing overheads

= R321 000 – R296 000
= R25 000 Over-allocated.
Company Z:
Allocation rate:
Labour hours = Budgeted overheads/ budgeted units of production

= R300 000/ 150 000
= R2 per unit produced

Applied manufacturing overhead cost (143 800 × R2) R287 600
Actual manufacturing overheads – Allocated manufacturing overheads

= R290 000 – R287 600
= (R2 400) Under-allocated.
Calculation of activity relates:
Overhead cost Cost driver value

Overhead Cost driver Cost driver rate
R (total)
Machine 44 900 Machine hours 17 9641 hours R2.5 per hour
Set-ups 5 300 No. of set-ups 20 set-ups R265 per set up
Materials – R191.66
2 300 No. of material orders 12 material orders
ordering per order
Materials – R284.375
9 100 No. of times handled 32 times
handling per time
R735.71428
Spare parts 10 300 No. of spare parts 14 spare parts
per part
J K L M
R R R R
Machine (180, 1 800, 864, 15 120) 450 4 500 2 160 37 800
Set-ups (1, 7, 2, 10) 265 1 855 530 2 650
Materials – ordering (1, 5, 1, 5) 192 958 192 958
Materials – handling (2, 12, 4, 14) 569 3 413 1 138 3 981
Spare parts (2, 6, 1, 5) 1 471 4 414 736 3 679
Overhead costs per product 2 947 15 140 4 756 49 068
Units 600 6 000 720 8 400
Overhead costs per unit R4.91/ u R2.52/ u R6.61/ u R5.84/ u
1
Machine hours: J: 600 units × 0.3 = 180 hours
K: 6 000 units × 0.3 = 1 800 hours
L: 720 units × 1.2 = 864 hours
M: 8 400 units × 1.8 = 15 120 hours
17 964 hours
There are alternative ways in which you can answer this question. What follows below
is one such alternative.
Alternative solution:
Machine-related costs
Product Units Hrs./ unit Total
J 600 0.30 180
K 6 000 0.30 1 800
L 720 1.20 864
M 8 400 1.80 15 120
17 964
Machine department overhead cost 44 900
Cost driver rate (44 900 ÷ 17 964) 2.50
Set-up costs
Cost per set-up = R265.00 [5 300/ 20]
Product # set-ups Units Cost driver rate Workings

J 1 600 0.44 1 × 265/ 600
K 7 6 000 0.31 7 × 265/ 6 000
L 2 720 0.74 2 × 265/ 720
M 10 8 400 0.32 10 × 265/ 8 400
Material ordering costs
Cost per material order = R191.67 [2 300/ 12]
Product # orders Units Cost driver rate Workings

J 1 600 0.32 1 × 191.67/ 600
K 5 6 000 0.16 5 × 191.67/ 6 000
L 1 720 0.27 1 × 191.67/ 720
M 5 8 400 0.11 5 × 191.67/ 8 400
Material handling costs
Cost per material handling = R284.38 [9 100/ 32]
Product # handling Units Cost driver rate Workings

J 2 600 0.95 2 × 284.38/ 600
12 × 284.38/
K 12 6 000 0.57
6 000
L 4 720 1.58 4 × 284.38/ 720
14 × 284.38/
M 14 8 400 0.47
8 400
Spare parts
Cost per spare part = R735.71 [10 300/ 14]
Product # spare parts Units Cost driver rate Workings

J 2 600 2.45 2 × 735.71/ 600
K 6 6 000 0.74 6 × 735.71/ 6 000
L 1 720 1.02 1 × 735.71/ 720
M 5 8 400 0.44 5 × 735.71/ 8 400
Cost per unit of output using ABC is as follows:
Product J K L M
Machine overheads 0.75 0.75 3.00 4.50
Set-ups 0.44 0.31 0.74 0.32
Material ordering 0.32 0.16 0.27 0.11
Material handling 0.95 0.57 1.58 0.47
Spare parts 2.45 0.74 1.02 0.44
Overhead cost per unit 4.91 2.53 6.61 5.84
Calculation of product costs using traditional costing system
Under the traditional costing system, overhead costs will be absorbed on a machine
hour basis, as follows:
R
Total overheads 28 598
Total machine hours [(132 × 5) + (110 × 3) + (88 × 2) + (132 × 3)] 1 562
Machine overhead rate 18.31
Product cost:
Product A B C D
Direct materials 44 55 33 66
Direct labour 31 23 16 23
Overheads @ R18.31/ hour 92 55 37 55
Cost per unit 167 133 86 144
Units of output 132 110 88 132
Total cost 22 044 14 630 7 568 19 008
Calculation of product costs using ABC
Cost driver
Cost R Cost driver Activity rate
transactions
Machine department 11 473 # machine hours 1 562 7.35
Set-up costs 5 775 # production runs 21 275.00
Stores receiving 3 960 # requisitions raised 22 180.00
Quality control 2 310 # production runs 21 110.00
Materials handling and dispatch 5 080 # orders executed 46 110.43
Product A B C D
Direct materials 5 808 6 050 2 904 8 712
Direct labour 4 092 2 530 1 408 3 036
Machine department 4 848 2 424 1 293 2 909
Set-up costs 1 650 1 375 1 100 1 650
Stores receiving 990 990 990 990
Quality control 660 550 440 660
Materials handling and dispatch 1 451 1 210 968 1 451
Total cost 19 499 15 129 9 103 19 408
Comparison of costs: Traditional v ABC
Product A B C D
Traditional 22 044 14 630 7 568 19 008
ABC 19 499 15 129 9 103 19 408
Over-cost/ (under-cost) 2 545 (499) (1 535) (400)
Per unit 19.28 (4.54) (17.44) (3.03)
Product A is over-costed using the traditional costing method, whereas B, C and D are
under-costed.
Traditional costing
Product X Y Z
Prime cost/ unit 38.00 101.00 78.00
Machine department 2.88 8.64 7.20
Assembly department 7.92 3.96 1.98
Cost per unit 48.80 113.60 87.18
# units produced 60 000 48 000 36 000
Total cost 2 928 000 5 452 800 3 138 480
ABC
Machining Assembly Set-up Order
Purchasing
services services costs processing
Overhead
428 400 381 600 31 200 187 200 100 800
cost
636 000 38 400
Cost driver 504 000 624 13 440
direct labour customer
units machine hrs. set-ups supplier orders
hrs. orders
Cost driver
0.85 0.60 50.00 4.875 7.50
rate
Product X Y Z
Prime cost 2 280 000 4 848 000 2 808 000
Overheads:
Machine department 102 000 244 800 153 000
Assembly department 288 000 115 200 43 200
Set-ups 7 200 12 000 12 000
Order processing 46 800 46 800 93 600
Purchasing 27 000 36 000 37 800
Total cost 2 751 000 5 302 800 3 147 600
Comparison of costs: Traditional v ABC
Product X Y Z
Traditional 2 928 000 5 452 800 3 138 480
ABC 2 751 000 5 302 800 3 147 600
Over-cost / (under-cost) 177 000 150 000 (9 120)
Per unit 2.95 3.13 (0.25)
Product X and Y are over-costed using the traditional costing method, whereas Z is
slightly under-costed.
Production Departments
X Y Z
Budgeted allocated expenses R600 000.00 R305 000.00 R320 000.00
Budgeted service department apportionment R337 500.00 R281 250.00 R225 000.00
14 500
Normal machine hours capacity 15 500 hours 11 000 hours
hours
Predetermined absorption rate R60.48 R53.30 R37.59
13 200
Actual machine utilisation 15 400 hours 11 600 hours
hours
(R48 867.00
Over / (under) absorption of overheads (R6 048.00) R31 980.00
)
Note: Approximate answers should also be accepted due to rounding.
Calculations:
(i) R225 000.00 ÷ 4/15 × 6/15
(ii) R225 000.00 ÷ 4/15 × 5/15
(iii) (R305 000.00 + R281 250.00) ÷ R53.30
(iv) (R320 000.00 + R225 000.00 - R48 867.00) ÷ 13 200 hours
(v) 13 200 hours - (-R48 867.00 ÷ R37.59)
(vi) (R600 000.00 + R337 500.00) ÷ 15 500 hours
(vii) 15 500 hours + (-R6 048.00 ÷ R60.48)
(viii) (11 600 hours - 11 000 hours) × R53.30
Learning Unit 6: Accounting for a Manufacturing

Enterprise
 Demonstrate knowledge of the business and Learning Unit:
accounting environment.
 Identify and describe accounting methods in line
with organisational requirements and GAAP /
GRAP.
 Make the necessary double entries in the
general ledger of a manufacturing concern.
 Prepare a production cost statement for a
manufacturing concern.
 Prepare a trading statement for a manufacturing
concern.
 Set up the notes to the production cost and
trading statements for a manufacturing concern.
Prepare a business plan suitable for sub-mission
to a financial institution.
o What are the terminologies one would find
in a manufacturer’s dictionary?
o Which general ledger accounts are
peculiar to manufacturing concerns, and
how are they administered?
o How does one combine manufacturing
records with administrative records in the
books of account?
o How is a production cost statement
prepared?

Make sure that you
complete Revision
Faul, MA, Du Plessis, PC and Van Vuuren SJ. 2001.
Fundamentals of cost and management accounting. 3rd edition.
have worked through
Durban: Butterworths/ LexisNexis. Chapter 4.
2 Recommended Digital Engagement Notes on Learning Unit 6

and Activities in the textbook:
Visit the following links and answer the questions that are posed overview of the most
on the website: important manufacturing
accounts. The most
Accounting Coach. 2012. Is there a difference between work-in- important concept to grasp
process and work-in-progress? [Online]. Available at: is the sequential move of
http://blog.accountingcoach.com/work-in-process-work-in- inventories via the work-in-
progress/ [Accessed 25 November 2016]. progress account. Ensure
that students understand
Accounting Coach. 2012. Manufacturing overhead. [Online]. how incomplete goods
Available at: http://blog.accountingcoach.com/category/36/ make up a significant part
[Accessed 25 November 2016]. of total stock values at the
accounting date.
have access to a wide variety of conceptual videos on business topics such as
bookkeeping, accounting, economics, financial management, income tax, cost and
management accounting, financial management and business law. Visit:
3 Activities
The business and accounting environment has a distinct influence on how a cost
accountant will disclose the results of any costing exercise.
Discuss the business and accounting environment with specific reference to the
following:
 Define the business environment in relation to generally accepted accounting

practice. Make special reference to cost centres, profit centres and investments
centres and the costs that are found in this environment;
 Describe generally recognised accounting methods suitable for different
organisations;
 Explain organisational policies and procedures related to accounting and
administrative systems in terms of GAAP/ GRAP.

in the textbook.
Purpose:
The purpose of this activity is to apply your newly-acquired knowledge on
manufacturing accounts.
Task:

This activity is designed to provide a framework whereby the manufacturing accounts
in the general ledger can be constructed. The particular manner in which a
manufacturer reports on goods in stages, this being direct materials, to work-in-
process, to finished goods, are of particular importance here.

in the textbook.
Purpose:
The purpose of this activity is to apply your newly-acquired knowledge on
manufacturing accounts.
Task:

This activity provides more practice on the same topics assessed in Question 6.1.

The purpose of this activity is to apply your newly-
acquired knowledge on manufacturing accounts.
Task:

This activity provides more practice on the same topics assessed in Question 6.1 and
6.2, but with the addition of administrative records and accounts.

in the textbook.
Purpose:
The purpose of this activity is to illustrate that, in relation to the production cost
statement, some of the materials, labour and overhead costs incurred during the period
relate to goods that have not yet been completed.
Task:

This activity is designed to show that the cost of goods manufactured cannot be
ascertained merely by summing the direct material, direct labour and manufacturing
overhead.

in the textbook.
Purpose:
The purpose of this activity is to embed your knowledge of the production cost
statement of a manufacturer.
Task:

This activity is designed to formalise your acquired knowledge in drawing up a
production cost statement and the notes thereto.

in the textbook.
Purpose:
Task:


in the textbook.
Purpose:
Task:


in the textbook.
Purpose:
Task:

The following information relates to Partridge Suppliers for the year ended 31 January
20.9:
Balances on 1 February 20.8:
Raw materials inventory R74 250.65

Work-in-process inventory R17 643.55
Finished goods inventory R89 866.99
Indirect material inventory R22 161.81
Transaction totals for the year ended 31 January 20.9:
Credit purchases of raw materials R368 813.73

Freight on raw material purchases (on credit) R59 613.55
Indirect material purchased on credit R93 320.12
Sales of finished products R5 986 608.98
Direct labour: Factory wages R442 892.59
Pension fund contributions paid by
R82 840.50
employer
Medical aid contributions paid by employer R119 811.21
UIF contributions paid by employer R4 429.00
Indirect labour R247 198.66
Electricity: Factory R148 501.30
Administrative offices R129 758.25
Rent expense: Factory R31 851.16
Telephone and fax: Factory R150 837.74
Insurance: Factory R120 257.88
Selling and administrative costs R201 431.70
Stationery R21 938.47
Salaries of administrative staff R305 890.49
Sales returns of finished products R34 382.09
Consumable stores (Indirect materials) issued to the factory R77 308.64
Depreciation on factory machinery R59 098.16
Balances on 31 January 20.9
Unfinished goods on hand R228 112.03

Raw materials on hand R54 098.87
Finished products on hand R269 704.05
Required:
Prepare the following general ledger accounts of Partridge Suppliers:

 Direct material (B4);
 Work-in-process (B5);
 Finished goods (B6);
 Indirect material (B7);
 Direct labour (C1);
 Factory overhead costs (C2);
 Cost of sales (N2);
 Trading account (F1);
 Profit and loss account (F2).
The following information relates to Pemberton CC for the year ended 31 March 20.8:
Balances on 1 April 20.7:

Raw materials inventory R79 850.25
Work-in-process inventory R18 974.13
Finished goods inventory R96 644.30
Indirect material inventory R23 833.14
Transaction totals for the year ended 31 March 20.8:

Credit purchases of raw materials R396 627.76
Freight on raw material purchases (on credit) R64 109.29
Indirect material purchased on credit R100 357.84
Sales of finished products R6 438 088.07
Direct labour: Factory wages R476 293.25
Pension fund contributions paid by employer R89 087.90
Medical aid contributions paid by employer R128 846.75
UIF contributions paid by employer R4 763.00
Indirect labour R265 841.10
Electricity: Factory R159 700.50
Rent expense: Factory R34 253.21
Telephone and fax: Factory R162 213.14
Insurance: Factory R129 327.11
Selling and administrative costs R216 622.64
Stationery R23 592.96
Salaries of administrative staff R328 959.16
Sales returns of finished products R36 975.01
Consumable stores (Indirect materials) issued to the factory R83 138.86
Depreciation on factory machinery R63 555.03
Balances on 31 March 20.8:

Work-in-process goods on hand R245 314.99
Raw materials on hand R58 178.72
Finished products on hand R290 043.75
Required:
Prepare the production cost statement, the trading statement and the notes to the
financial statements of Pemberton CC for the year ended 31 March 20.8.
The three types of cost centres are: profit centres, cost centres and investment centres:
Cost centre
A cost centre can be defined as a segment that has control over the incurrence of cost.
A very important feature of a cost centre is that it has no control over generating
revenue or the use of investment funds.
Profit centre
A profit centre differs from a cost centre in that it has control over both cost and
revenue. If, for example, a subsidiary of a large company is concerned with marketing
as well as producing the company’s goods, then this subsidiary will be regarded as a
profit centre of the larger entity. However, like a cost centre, a profit centre generally
does not have control over how investment funds are used.
Investment centre
An investment centre is any segment of an organisation that has control over cost and
revenue and also over the use of investment funds. The head office of a large
organisation may well be regarded as an investment centre, since they have the
ultimate responsibility of ensuring that production and marketing goals are met. In
addition, they have the responsibility for seeing that adequate facilities are available to
carry out the production and marketing functions, and for seeing that adequate working
capital is available to ensure the smooth running of operations. Whenever a segment
of an organisation has control over investment in areas such as plant and equipment,
receivables, inventory and entry into new markets, then it is referred to as an
investment centre (© EDGE Learning Media CC).
4.2 Activity 1 – Question 6. 1
General ledger of Tatterson’s Designer Products

(Extract only)
Direct material B#
20.8 20.9
Work-in-
Mar. 1 Balance b/d 134 850 00 Feb. 28 GJ# 205 350 00
process
31 Bank CPJ# 176 350 00 Balance c/d 125 000 00
Petty cash PCJ# 19 150 00
330 350 00 330 350 00
20.9
Mar. 1 Balance b/d 125 000 00
Direct labour C#
20.9 20.9
Creditors for Work-in-
Feb. 28 GJ# 89 130 00 Feb. 28 GJ# 89 130 00
wages process
Manufacturing overheads C#
20.9 20.9
Indirect Work-in-
Feb. 28 GJ# 35 000 00 Feb. 28 GJ# 276 140 00
labour process
Indirect
GJ# 27 040 00
material
Maintenance
GJ# 13 600 00
: factory
Sundry
GJ# 16 300 00
manuf. o/ h
Electricity GJ# *72 000 00
Depreciation GJ# 81 200 00
Rent
GJ# **31 000 00
expense
276 140 00 276 140 00
*R120 000 × 60% = R72 000
**R62 000 × 50% = R31 000
Work-in-process B#
20.8 20.9
Finished
goods
20.9 Balance c/d 163 200 00
Direct
Feb. 28 GJ# 205 350 00
material
Direct labour GJ# 89 130 00
Manufacturing GJ# 276 140 00

overheads
713 320 00 713 320 00
20.9
Finished goods B#
Date Details Fol. Amount Date Details Fol. Amount,
20.8 20.9
Cost of
sales
2009 Balance c/d 195 000 00
Work-in-
Feb. 28 GJ# 550 120 00
process
720 120 00 720 120 00
20.9
General ledger of Balesteros International (Extract only)

Direct material B#
20.8 20.9
Work-in-
Oct. 1 Balance b/d 42 816 00 Sep. 30 GJ# *79 500 00
process
20.9 Balance c/d 54 030 00
Creditors
Sep. 30 CJ# 79 425 00
control
Creditors
CJ# 11 289 00
control
133 530 00 133 530 00
20.9
Oct 1 Balance b/d 54 030 00
*R79 500 constitutes the raw materials issued to the factory.
Work-in-process B#
20.8 20.9
Finished
Oct. 1 Balance b/d 11 928 00 Sep. 30 GJ# 270 036 00
goods
20.9 Balance c/d 18 363 00
Sep. 30 Direct material GJ# 79 500 00
Manufacturing
GJ# 130 671 00
overheads
288 399 00 288 399 00
20.9
Oct. 1 Balance b/d 18 363 00
Finished goods B#
20.8 20.9
Oct. 1 Balance b/d 74 475 00 Sep. 30 Cost of sales GJ# 321 900 00
20.9 Balance c/d 22 611 00
Work-in-
Sep. 30 GJ# 270 036 00
process
344 511 00 344 511 00
20.9
Indirect material B#
20.8 20.9
Manufacturing
Oct. 1 Balance b/d 3 579 00 Sep. 30 GJ# 10 560 00
overheads
20.9 Balance c/d 2 379 00
Sep. 30 Bank CBP# 9 360 00
12 939 00 12 939 00
20.9
Manufacturing overheads C#
20.9 20.9
Indirect Work-in-
Sep. 30 GJ# 29 340 00 Sep. 30 GJ# 130 671 00
labour process
Electricity GJ# 17 100 00
Maintenance GJ# 12 027 00
Insurance GJ# 15 390 00
Indirect
GJ# 10 560 00
materials
Rent
GJ# 30 000 00
expense
130 671 00 130 671 00
Cost of sales N#
20.9 20.9
Finished Trading
Sep. 30 GJ# 321 900 00 Sep. 30 GJ# 321 900 00
goods account
Trading account F1
20.9 20.9
321
Sep. 30 Cost of sales GJ# 00 Sep. 30 Sales GJ# 600 000 00
900 (631 800 - 31 800)
278
Profit and loss GJ# 00
100
600
00 600 000 00
000
Only expenses relating to the administrative side of

the business are closed off against profit and loss.
Profit and loss F2

20.9 20.9
Trading
Apr. 30 Electricity GJ# 14 433 00 Apr. 30 GJ# 278 100 00
account
Maintenance GJ# 11 154 00
Distribution
GJ# 5 637 00
costs
Advertising GJ# 11 775 00
Salaries GJ# 56 271 00
Rent expense GJ# 15 000 00
Capital (net 156
GJ# 00
profit) 930
278
00 278 100 00
100
General ledger of Fetherline Manufacturers
Direct material B#
20.3 20.4
Work-in-
May 1 Balance b/d 8 644 00 Apr. 30 GJ# 52 222 00
process (x)
20.4
Creditors
Apr. 30 CJ# 42 936 00 Balance c/d 6 298 00
control
Creditors
CJ# 6 940 00
control
58 520 00 58 520 00
20.4
May 1 Balance b/d 6 298 00
Direct labour C#
20.4 20.4
Creditors for Work-in- 0
Apr. 30 GJ# 51 560 00 Apr. 30 GJ# 75 668
wages process 0
Pension fund
GJ# 9 644 00
contributions
Medical aid
GJ# 13 948 00
contributions
UIF
GJ# 516 00
contributions
0
75 668 00 75 668
0
Work-in-process B#
20.3 20.4
Finished
goods
20.4 Balance c/d 26 556 00
Apr. 30 Direct material GJ# 52 222 00
Factory
GJ# 106 598 00
overhead costs
236 542 00 236 542 00
20.4
Finished goods B#
20.3 20.4
Cost of
sales
20.4 Balance c/d 31 398 00
Work-in-
Apr. 30 CJ# 209 986 00
process
220 448 00 220 448 00
20.4
Indirect material B#
20.3 20.4
Factory
overheads
20.4 Balance c/d 4 444 00
Creditors
Apr. 30 CJ# 10 864 00
control
13 444 00 13 444 00
20.4
Factory overhead costs C#

20.4 20.4
Work-in- 0
Apr. 30 Indirect labour GJ# 28 778 00 Apr. 30 GJ# 106 598
process 0
Indirect
GJ# 9 000 00
material
Electricity GJ# 26 672 00
Telephone GJ# 3 708 00
Rent expense GJ# 14 000 00
106 0
00 106 598
598 0
Cost of sales N#
20.4 20.4
Finished Trading
Apr. 30 GJ# 189 050 00 Apr. 30 GJ# 189 050 00
goods account
Trading account F1
20.4 20.4
Sales
Apr. 30 Cost of sales GJ# 189 050 00 Apr. 30 (696 480 – GJ# 692 480 00
4 000)
692 480 00 692 480 00
Only expenses relating to the administrative side of

the business are closed off against profit and loss
Profit and loss F2

20.4 20.4
Trading
Apr. 30 Electricity GJ# 15 106 00 Apr. 30 GJ# 503 430 00
account
Telephone GJ# 9 422 00
Rent
GJ# 8 000 00
expense
Selling and
GJ# 42 440 00
admin. costs
Stationery GJ# 2 554 00
Salaries GJ# 49 424 00
Capital (net
GJ# 371 784 00
profit)
503 430 00 503 430 00
The reason is that some of the materials, labour and overhead costs incurred during
the period relate to goods that have not yet been completed. The costs that relate to
the goods that are not yet completed are shown in the work-in-process inventory
figures shown at the bottom of the production cost statement. The opening work-in-
process inventory must be added to the manufacturing costs for the period, and the
closing work-in-process must be deducted, to arrive at the cost of goods manufactured.
The logic underlying the production cost statement is laid out in the illustration that
follows. To calculate the cost of goods sold, start at the top of the schedule and work
your way down using the following steps:
Steps:
1. Calculate the raw materials used in production in the top section of the
illustration.
2. Insert the total raw materials used in production in the second section of the
illustration, and calculate the total manufacturing cost.
3. Insert the total manufacturing cost into the third section of the illustration, and
calculate the cost of goods manufactured.
4. Insert the cost of goods manufactured into the bottom section of the illustration,
and calculate the cost of goods sold.
The schedule appears below:
Amount (R)
Calculation of raw materials used in production:
Opening raw materials inventory XXX
Add: Purchases of raw materials during the period XXX
Less: Closing raw materials inventory (XXX)
Raw materials used in production A
Calculation of total manufacturing costs:

Raw materials used in production A
Add: Direct labour XXX
Add: Total manufacturing overhead costs XXX
Total manufacturing cost B
Calculation of cost of goods manufactured:
Opening work-in-process inventory XXX
Add: Total manufacturing cost B
Less: Closing work-in-process inventory (XXX)
Cost of goods manufactured C
Calculation of cost of goods sold:

Opening finished goods inventory XXX
Add: Cost of goods manufactured C
Less: Closing finished goods inventory XXX
Cost of goods sold XXX
Ubuntu Manufacturers
Production cost statement for the year ended 31 March 20.7

Notes R
Direct costs 217 431
Direct material costs 1 134 481
Direct labour costs 2 82 950
Factory overhead costs 3 235 881
Total manufacturing costs 453 312
Plus: Opening Work-in-process (1 April 20.6) 18 051
Less: Closing Work-in-process (31 March 20.7) (8 901)
Cost of production of finished goods 462 462
Trading statement for the year ended 31 March 20.7

Notes R
Sales 739 200
Cost of finished goods sold 4 (493 626)
Notes to the financial statements
1. Direct material costs
Opening inventory 22 683

Net purchases (150 000 – 35 445) 114 555
Freight on raw material purchases 13 530
Customs duties -
150 768
Closing inventory (16 287)
Direct material cost 134 481
2. Direct labour costs
Factory wages 60 000

Pension fund contributions by employer 10 380
Medical aid contributions by employer 11 970
UIF contributions by employer 600
Direct labour cost 82 950
3. Factory overhead costs
Indirect material 18 000

Indirect labour 45 042
Rent paid (96 000 × 9/ 12) 72 000
Depreciation 43 200
Insurance (35 580 × 9/ 12) 26 685
235 881
4. Cost of finished goods sold
Opening stock of finished goods (1 April 20.6) 13 980

Plus: Cost of finished goods produced during the year 497 907
Less: Closing stock of finished goods (31 March 20.7) 18 261
493 626
Leningrad Manufacturers
Production cost statement for the year ended 31 August 20.8

Notes R
Plus: Opening Work-in-process (1 September 20.7) 9 350
Less: Closing Work-in-process (31 August 20.8) (27 000)
Trading statement for the year ended 31 August 20.8

Notes R
Sales 955 000

Net purchases 228 150
Import tariffs on direct material purchases 22 400
Customs duties -
286 250
Direct material cost 277 650

Pension fund contributions by employer 15 600
Medical aid contributions by employer 13 700
UIF contributions by employer 700

Indirect material (10 000 + 44 000 – 6 550) 47 450

Depreciation 21 000
Insurance 10 050
Repairs and maintenance 13 000
Salaries 125 000
Rent paid 112 500
446 600
Opening stock of finished goods (1 September 20.7) 15 250

Less: Closing stock of finished goods (31 August 20.8) (17 000)
804 850
Jaypeg Industrial Ltd.
Production cost statement for the month ended 31 August 20.5

Notes R
Plus: Opening Work-in-process (1 August 20.5) 31 230
Less: Closing Work-in-process (31 August 20.5) (52 300)
Trading statement for the month ended 31 August 20.5

Sales 1 884 350

Net purchases 252 130
Railage on direct material purchases 24 320
Customs duties -
407 680
Direct material cost (*given) 242 140

Pension fund contributions by employer -
Medical aid contributions by employer -
UIF contributions by employer -
Indirect material (given) 42 000

Depreciation 75 000
Insurance 52 130
Electricity 63 240
Maintenance 41 230
Rent paid 100 000
454 830
Opening stock of finished goods (1 August 20.5) 32 130

Less: Closing stock of finished goods (31 August 20.5) (53 670)
(* Given) 887 600
Iconic Products Ltd
(i)
Production cost statement for the month ended 28 February 20.9

Notes R
Plus: Opening Work-in-process (1 March 20.8) 46 500
Less: Closing Work-in-process (28 February 20.9) (63 270)
(ii)
Trading statement for the month ended 28 February 20.9

Notes R
Sales 737 100
(iii)
Opening stock 36 000

Net purchases (85 005 – 2 625) 82 380
Import duty on direct material purchases 10 920
Customs duties -
129 300
Closing stock (58 380)
Direct material cost (*given) 70 920
Factory wages [(178 500 × 90%) – 1 500] 159 150

Pension fund contributions by employer -
Medical aid contributions by employer -
UIF contributions by employer -
Indirect labour [(178 500 × 10%) + 12 600 + 9 300] 39 750

General expenses: factory 2 400
Repairs and maintenance: factory 5 100
Insurance (18 000 × 2/ 3) 12 000
Water and electricity (36 000 × 75%] 27 000
Depreciation: factory equipment (690 000 × 15%) 103 500
Rent expense (9 600 × 75%) 10 800
200 550
Opening stock of finished goods (1 March 20.8) 137 040

Less: Closing stock of finished goods (28 February 20.9) (159 651)
391 239
General ledger of Partridge Suppliers
Direct material B4
20.8 20.9
Work-in-
Feb. 1 Balance b/d 74 250.65 Jan. 31 448 579.06
process
20.9 Balance c/d 54 098.87
Jan. 31 Creditors control 368 813.73
Creditors control 59 613.55
502 677.93 502 677.93
20.9
Feb. 1 Balance b/d 54 098.87
Work-in-process B5
20.8 20.9
Finished
Feb. 1 Balance b/d 17 643.55 Jan. 31 1 723 137.42
goods
20.9 Balance c/d 228 112.03
Jan. 31 Direct material 448 579.06
Direct labour 649 973.30
Factory overhead
835 053.54
costs
1 951 249.45 1 951 249.45
20.9
Finished goods B6
20.8 20.9
Cost of
Feb. 1 Balance b/d 89 866.99 Jan. 31 1 543 300.36
sales
20.9 Balance c/d 269 704.05
Jan. 31 Work-in-process 1 723 137.42
1 813 004.41 1 813 004.41
20.9
Indirect materials B7
20.8 20.9
Factory
Feb. 1 Balance b/d 22 161.81 Jan. 31 overhead 77 308.64
costs
20.9 Balance c/d 38 173.29
Jan. 31 Creditors control 93 320.12
115 481.93 115 481.93
20.9
Direct labour C1
20.9 20.9
Factory
Jan. 31 Creditors for wages 442 892.59 Jan. 31 649 973.30
overheads
Pension fund
82 840.50
contributions
Medical aid
119 811.21
contributions
UIF contributions 4 429.00
649 973.30 649 973.30
20.9
Factory overhead costs C2

20.9 20.9
Work-in-
Jan. 31 Indirect materials 77 308.64 Jan. 31 835 053.54
process
Indirect labour 247 198.66
Electricity expense 148 501.30
Rent expense 31 851.16
Telephone and fax
150 837.74
expense
Insurance 120 257.88
Depreciation 59 098.16
835 053.54 835 053.54
Cost of sales C3
20.9 20.9
Trading
Jan. 31 Finished goods 1 543 300.36 Jan. 31 1 543 300.36
account
Trading account F1
20.9 20.9
Jan. 31 Cost of sales 1 543 300.36 Jan. 31 Sales 5 952 226.89
Profit and loss 4 408 926.53
5 952 226.89 5 952 226.89
F2
Profit and loss
20.9 20.9
Electricity Trading
Jan. 31 129 758.25 Jan. 31 4 408 926.53
expense account
Telephone and
40 372.29
fax expense
Insurance 68 718.79
Salaries and
305 890.49
wages
Stationery 21 938.47
Selling and admin
201 431.70
costs
Capital (net profit) 3 559 882.99
4 408 926.53 4 408 926.53
Production cost statement of Pemberton CC for the year ended 31 March 20.8
Notes R
Direct costs 1181 399.48
Direct material costs 1 482 408.58
Direct labour costs 2 698 990.90
Factory overhead costs 3 898 028.95
Total manufacturing costs 2 079 428.43
Plus: Opening work-in-process (1 April 20.7) 18 974.13
Less: Closing work-in-process (31 March 20.8) (245 314.99)
Cost of production of finished goods 1 853 087.57
Trading statement of Pemberton CC for the year ended 31 March 20.8

Notes R
Sales 6 401 113.06
Cost of finished goods sold (1 659 688.12)
Gross profit 4 741 424.94
Notes to the financial statements:
Opening inventory 79 850.25

Net purchases 396 627.76
Freight on raw material purchases 64 109.29
Custom duties -
540 587.30
Less Closing inventory (58 178.72)
482 408.58
Factory wages 476 293.25

Pension fund contributions by employer 89 087.90
Medical aid contributions by employer 128 846.75
UIF contributions by employer 4 763.00
698 990.90
Indirect material 83 138.86

Indirect labour 265 841.10
Depreciation: Factory machinery and equipment 63 555.03
Electricity 159 700.50
Telephone and fax 162 213.14
Insurance 129 327.11
898 028.95
Opening stock of finished goods sold (1 April 20.7) 96 644.30

Plus: Cost of finished goods produced during the year 1853 087.57
Less: Closing stock of finished goods (31 March 20.8) (290 043.75)
1 659 688.12
Learning Unit 7: Job Costing

 Explain the steps involved in job costing. Learning Unit:
 Identify overhead application rates.
 Calculate the cost of a job.
 Calculate the profit or loss of a job.
 Identify and calculate over- or under-absorbed
overheads.
 Calculate the cost of a job taking into account
work-in-process and finished goods.
 Identify and complete a job order cost sheet.
 Account for normal and abnormal wastage.
 Prepare relevant ledger accounts for a job
costing system.
 Prescribed text pp.183–206
o What are the steps involved in job costing?
o How should the work-in-process account
be administered?
o What is the purpose of job cost sheets and
how are they prepared?
o How does one account for spoilage under
a job costing system?
o How are the ledger accounts under a job
costing system prepared?

Make sure that you
Faul, MA, Du Plessis, PC and Van Vuuren SJ. 2001. Fundamentals
complete Revision
of cost and management accounting. 3rd edition. Durban:
Butterworths/ LexisNexis. Chapter 5.
have worked through

Visit the following links and answer the questions that are posed on the website:
Accounting Coach. 2012. Is there a difference between work-

in-process and work-in-progress? [Online]. Available at:
in the textbook:
http://blog.accountingcoach.com/work-in-process-work-in-
progress/[Accessed 25 November 2016)
overview of job cost sheets
and general ledger
Accounting Coach. 2012. Manufacturing overhead. [Online].
accounts used in job
Available at: http://blog.accountingcoach.com/category/36/
costing. The applied
principles in this Learning
Unit are almost identical to
Accounting Coach. 2012. What is job order costing? [Online].
those discovered in
Available at: http://blog.accountingcoach.com/what-is-job-
Learning Unit 6.
order-costing/ [Accessed 25 November 2016)
media.com/channels/bc [Accessed 25 November 2016)
3 Activities
A cost accounting system requires five parts, namely:
 An input measurement basis;

 An inventory valuation method;
 A cost accumulation method;
 A cost flow assumption; and
 A capability of recording inventory cost flows at certain intervals.
Required:
Do some research on each of the five parts; refer back to your notes and provide a
brief summary of each part to assist you both with putting this learning module or Job
costing into perspective.

in the textbook.
Purpose:
The purpose of this activity is to apply your newly-acquired knowledge of
manufacturing overhead application rates in job costing.
Task:

This activity is designed to provide a framework whereby manufacturing overhead
application rates can be calculated.

in the textbook.
Purpose:
The purpose of this activity is to apply your newly-acquired knowledge of absorption
rates in job costing.
Task:

This activity provides insight with respect to absorption rates in job costing.

The purpose of this activity is to apply your newly-
acquired knowledge on manufacturing accounts.
Task:

This activity provides more practice on the same topics assessed in Question 7.1 and
7.2.

in the textbook.
Purpose:
The purpose of this activity is to illustrate how jobs are costed on job cost cards/ sheets.
Task:

This activity is designed to show how the costs of a job are outlined and summarised
on a job card/ sheet.
Purpose: For Activity 5 consult p.200

The purpose of this activity is to embed your knowledge in the textbook.
of the ledger accounts used to cost a job.
Task:

This activity is designed to formalise your acquired knowledge in drawing up the
general ledger accounts used to cost a job.

in the textbook.
Purpose:
The purpose of this activity is to embed your knowledge of the total cost of a batch, the
unit cost and the profit per unit for a specified job in production.
Task:

This activity is designed to formalise your acquired knowledge in calculating the total
cost of a batch, the unit cost and the profit per unit for a job.

in the textbook.
Purpose:
The purpose of this activity is to embed your knowledge of job costing.
Task:

This activity is designed to formalise your acquired knowledge in job costing.

in the textbook.
Purpose:
The purpose of this activity is to embed your knowledge of job costing.
Task:

This activity is designed to formalise your acquired knowledge of job costing, with
specific reference to the statement of comprehensive income and the calculation of
closing inventory levels for specified jobs.
A summary of the budget data for the Saber Manufacturing Group for the year 20.8 is
given below:
Manufacturing overhead cost R684 500.00

Direct material costs R343 469.00
Direct labour costs R502 607.00
Direct labour hours 97 500 hours
Machine hours 37 690 hours
Required:
(a) Use each of the following bases to determine the manufacturing overhead
application rate. Round off to two decimal places:
 Direct materials cost;
 Direct labour costs;
 Direct labour hours;
 Machine hours.
(b) Prepare a schedule showing the amount of overhead that would be applied to
Job 87 using each application rate. Assume the following data for the job.
Direct material costs R3 803.00

Direct labour costs R5 234.00
Direct labour hours 1 568 hours
Machine hours 461 hours
(c) Calculate the total cost of Job 87 using the various bases.
Part 1: Input measurement basis
The foundation of every cost accounting system is the input measurement basis. This
has to do with the types of costs that will flow into and through the inventory accounts.
There are three alternatives here, namely pure historical costing, normal historical
costing and standard costing.
Pure historical costing
In a pure historical costing system, only historical costs flow through the inventory
accounts. With a ‘historical cost’ we mean an actual cost that has been recorded.
Normal historical costing
Normal historical costing uses historical costs for direct material and labour, but
overhead is charged or applied to the inventory using a predetermined overhead rate
per activity measure. Typical activity measures include direct labour hours, or direct
labour costs. The amount of factory overhead charged to the inventory is determined
by multiplying the predetermined overhead rate by the actual quantity of the activity
measure. The difference between the applied overhead and the actual overhead costs
represents an overhead variance.
Standard costing
In a standard costing system, all manufacturing costs are applied, or charged to the
inventory accounts using standard or predetermined prices and quantities. The
differences between the applied costs are charged to variance accounts. The
variances provide the basis for the concept of accounting control.
Part 2: Inventory valuation methods
The four inventory valuation methods are arranged in the order of the amount of cost
that is traced to the inventory. When the throughput methods are used, the least
amount of cost is traced to inventory, while the ABC model involves tracing the greatest
amount of costs to inventory. The inventory valuation methods are very important,
because they control the manner in which net profit is determined.
The throughput method
According to this method, only direct material costs are charged to the inventory
accounts. All other costs are expensed during the period. The throughput method is
problematic, since it does not adhere to the matching principle of accounting, because
all manufacturing cost, other that direct material are expensed when they are paid for,
rather than capitalised in the inventory accounts.
The direct or variable method
According to this method, only the variable manufacturing costs are capitalised, or
charged to the inventory accounts. Fixed manufacturing costs are recorded as
expenses in the period in which they were incurred. However, it does not adhere to the
matching principle either, because the current fixed costs associated with producing
the inventory are expensed regardless of whether the output is sold during the period.
For this reason, direct costing is usually not accepted for external reporting purposes.
The full absorption method
Full absorption costing ensures that all manufacturing costs are capitalised in the
inventory accounts. These costs will therefore not be expensed, but rather be treated
as assets. This means that these costs do not become expenses until the inventory is
sold. In this way, the matching principle is adhered to. Full absorption costing may be
used for internal and external reporting purposes.
Activity based method
The ABC model attempts to provide more accurate product costs by tracing costs to
products through activities. In other words, costs are traced to activities (activity
costing) and then these costs are traced, in a second stage, to the products that use
those activities. Another way to express this concept is to say that activities consume
resources and products consume activities. With this idea an attempt is made to treat
all costs as variable, recognising that all costs vary due to some sort of activity. Under
the ABC system, both manufacturing costs and selling and administrative costs are
traced to products. However, treating selling and administrative products in this way is
not acceptable for external reporting purposes.
In traditional full absorption costing and direct (or variable) costing systems, indirect
manufacturing costs are allocated to products on the basis of a production volume-
related measurement such as direct labour hours. Hence, the basic differences
between traditional systems and activity-based systems are two-fold:
 The manner in which the indirect costs are assigned (ABC uses both production
and volume and non-production volume related bases);
 The choice of which costs are assigned to products (in ABC systems, all costs
are assigned to products, including engineering, marketing, distribution and
administrative costs, although some seriously unrelated costs may not be
assigned).
Part 3: four cost accumulation methods
Cost accumulation refers to the manner in which costs are collected and identified with
specific customers, jobs, batches, order, departments and processes. The four
accumulation methods are as follows:
Job order costing
In job order costing, costs are accumulated by jobs, orders, contracts or lots. The key
is that the work is done to the customer’s specifications. As a result, each job is
different. For example, job order costing is used for construction projects, government
contracts, shipbuilding, automobile repair, job printing, textbooks, toys, wood furniture,
etc. Even professional services such as lawyers and doctors can be costed in this way.
Process costing
In process costing, costs are accumulated by departments, operations or processes.

The work performed on each unit is standardised or uniform where a continuous mass
production or assembly operation is involved. Process costing is particularly used by
companies that produce appliances, alcoholic beverages, tires, sugar, breakfast
cereals, leather, paint, etc.
Just-in-time (back flush)
Back flush costing is a simplified cost accumulation method that is sometimes used by
companies that adopt just-in-time (JIT) production systems. However, JIT is not just a
technique, or collection of techniques. Just-in-time is a very broad philosophy that
emphasises simplification and continuously reducing waste in all areas of business
activity. JIT systems were developed in Japan and depend on the communitarian
concepts of teamwork and continuous improvement. In fact, many of the assumptions,
attitudes and practices of communitarian capitalism are included in the JIT philosophy.
One of the many goals of JIT systems is zero-ending inventory. In a back flush cost
system, manufacturing costs are accumulated in fewer inventory accounts than when
using the job order or process cost methods. In fact, in extreme back flush systems,
most of the accounting records are eliminated. The production facilities are also
arranged in self-contained manufacturing cells that are dedicated to the production of

a single, or similar products. In this way more of the manufacturing costs become direct
product costs and fewer cost allocations are necessary. Thus, more accurate costing
is obtained in spite of the fact that the cost accumulation method is simplified.
Hybrid or mixed methods
Hybrid or mixed systems are used in situations where more than one cost accumulation
method is required. For example, in some cases process costing is used for direct
materials and job order costing is used for conversion costs, (i.e., direct labour and
factory overhead). In other cases, job order costing might be used for direct materials,
and process costing for conversion costs. The different departments or operations
within a company might require different cost accumulation methods. For this reason,
hybrid or mixed cost accumulation methods are sometime referred to as operational
costing methods.
Part 4: four cost flow assumptions
A cost flow assumption refers to how costs flow through the inventory accounts, not
the flow of work or products on a production line. This distinction is important, because
the flow of costs is not always the same as the flow of work. The various types of cost
flow assumptions include: specific identification (e.g., by job), first-in, first-out, last-in-
first-out and weighted average.
Costs flow through the inventory accounts by the job in a job order cost system which
represents an example of specific identification. The requirements of the various jobs
determine the timing of the cost flows. Simple jobs tend to move through the system
faster than more complex jobs. The first-in-first-out (FIFO) and weighted average cost
flow assumptions are used in process costing. Since costs are accumulated by the
process or department in a process cost environment, a cost flow assumption is
needed to determine the treatment of the beginning inventory. When FIFO is used, it
is assumed that the units of product in the beginning inventory are finished first and
transferred to the next department before any of the units that are started during the
period. The group of units in the beginning inventory maintain their separate identity
and prior period costs. However, when the weighted average cost flow assumption is
used, the beginning inventory units lose their separate identity because they are
lumped together with the units of product started during the period. Process costing
tends to be fairly challenging, therefore you may find these introductory concepts to be
confusing.
Part 5: Recording interval capability
Inventory records can be maintained on a perpetual or a periodic basis. Conceptually,

the perpetual inventory method provides a company with the capability of maintaining
continuous records of the quantities of inventory and the costs flowing through the
inventory accounts. The periodic method, on the other hand, requires counting the
quantity of inventory before inventory records can be updated. In the past,
manufacturers tended to keep perpetual inventories, while retailers used the periodic
method. However, today a variety of modern point of sale devices and dedicated
microcomputer software are readily available to provide any company with perpetual
inventory capability.
Application basis Overhead cost Divided by Overhead rate

(i) Units of production R936 840 450 000 units R2.08 per unit
(ii) Direct material cost R936 840 R738 540 126.85%
R11.09 per machine
(iii) Machine hours R936 840 84 500 hours
hour
(iv) Direct labour hours R936 840 220 000 hours R4.26 labour hour
(v) Direct labour cost R936 840 R845 920 110.75%
(i) Calculate the overhead absorption rate for 20.9.
Overhead
= Budgeted overheads ÷ Budgeted machine hours
absorption rate
= R79 800 ÷ 14 000
= R5.70
(ii) Overheads to be absorbed by each job.
Dr Pillay 2 200 machine hrs. × R5.70 per hour = R12 540

Dr Green 2 050 machine hrs. × R5.70 per hour = R11 685
Dr Ndlovu 800 machine hrs. × R5.70 per hour = R4 560
(iii) The cost of goods sold and the value of the closing inventory.
Dentists
Cost item
Dr Pillay Dr Green Dr Ndlovu
Direct material used R9 200 R18 550 R5 400
Direct labour cost R30 550 R29 800 R9 325
Manufacturing overheads absorbed R12 540 R11 685 R4 560
Normal cost of goods sold R52 290

Value of ending inventory R60 035 R19 285
(iv) Calculation of under-absorbed and over-absorbed overheads for August 20.9.
Actual overheads R35 325

Overheads applied * R28 785
Under-absorbed overheads for the month R6 540
*R28 785 = (R12 540 + R11 685 + R4 560)
(i)
Application basis Overhead cost Divided by Overhead rate

Direct materials cost R651 260 R326 790 199.29%
Direct labour costs R651 260 R478 200 136.19%
Direct labour hours R651 260 98 250 R6.63
Machine hours R651 260 37 980 R17.15
(ii)
Application basis Job 78 Data Overhead rate Overhead cost

Direct materials cost R3 618 199.29% R7 210.31
Direct labour costs R4 980 136.19% R6 782.26
Direct labour hours 1 580 hours 6.63 R10 475.40
Machine hours 465 hours 17.15 R7 974.75
(iii)
Job 78
Material cost Labour cost Overhead cost Total cost
R3 618 R4 980 R7 210.31 R15 808.31
R3 618 R4 980 R6 782.26 R15 380.26
R3 618 R4 980 R10 475.40 R19 073.40
R3 618 R4 980 R7 974.75 R16 572.75
(i) Calculation of overhead absorption rates
Budgeted manufacturing overheads

Overhead absorption rate=
Budgeted direct labour hours
Department Assembling: R54 000 ÷ 13 500 = R4.00 per direct labour hour
Department Polishing: R82 500 ÷ 15 000 = R5.50 per direct labour hour
(ii)
JOB ORDER COST SHEET
Job order no.: 20.9/ 08

Customer: Kiki Limited
Date ordered: 14/ 08/ 20.9.
Product: TT321
Date started: 15/ 08/ 20.9
Quantity: 45
Date requested: 14/ 09/ 20.9
Specification: As per order
Date completed: 12/ 09/ 20.9
DEPARTMENT: ASSEMBLING
FACTORY
DIRECT MATERIALS DIRECT LABOUR
OVERHEADS
Date Description Qty Amt Hours Rate Amt Hours Rate Amt
R141.7
45kg R1 080 27 R5.25 27 R4.00 R108.00
5
R141.7
Sub-total R1 080 R108.00
5
DEPARTMENT: POLISHING
FACTORY
DIRECT MATERIALS DIRECT LABOUR
OVERHEADS
Date Description Qty Amt Hours Rate Amt Hours Rate Amt
R331.2
48 R6.90 48 R5.50 R264.00
0
R331.2
Sub-total R264.00
0
Total – Dept. Assembling and Dept. R472.9
R372.00
Polishing 5
Selling Price 2 309.94
Less: Costs 1 924.95
Materials 1 080.00
Direct Labour 472.95
Factory
372.00
Overheads
Gross Profit 384.991
1R1
924.95 × 20% = R384.99
General ledger of Goodwood Company
Material control B#
20.11 20.11
Jul. 1 Balance b/d 0 00 Sep. 30 Production GJ# 8 540 00
Factory
Sep. 30 Purchases GJ# 13 000 00 GJ# 350 00
overheads
Balance c/d 4 110 00
13 000 00 13 000 00
20.11
Production control B#
20.11 20.11
Jul. 1 Balance b/d 4 180 00 Sep. 30 Finished goods GJ# 17 010 00
Material
Sep. 30 GJ# 8 540 00 Balance c/d 5 000 00
control
Labour
GJ# 5 450 00
control
Factory
overheads GJ# 3 840 00
control
22 010 00 22 010 00
20.11
Finished goods control B#

20.11 20.11
Jul. 1 Balance b/d 0 00 Sep. 30 Cost of sales GJ# 16 872 50
Production
Sep. 30 GJ# 17 010 00 Balance c/d 137 50
control
17 010 00 17 010 00
20.11
Oct. 1 Balance b/d 137 50
Labour control C#
20.11 20.11
Wages Production
Sep. 30 GJ# 7 950 00 Sep. 30 GJ# 5 450 00
payable control
Factory
GJ# 2 500 00
overheads
7 950 00 7 950 00
Factory overheads control C#

20.11 20.11
Material control Production
Sep. 30 GJ# 350 00 Sep. 30 GJ# 3 840 00
(indirect) control
Labour control
GJ# 2 500 00 Cost of sales GJ# 400 00
(indirect)
Depreciation GJ# 1 200 00 (underapplied)
Sundry
GJ# 190 00
overheads
4 240 00 4 240 00
Cost of sales C#

20.11 20.11
Finished
Trading
Sep. 30 goods GJ# 16 872 50 Sep. 30 GJ# 17 272 50
account
control
Factory
GJ# 400 00
overheads
17 272 50 17272 50
(i)
Job 775 Cost Dir Lab Hrs. Mach Hrs. Rate Cost
Direct materials R630
Direct labour- Blanking 80 R5.50 R440
Direct labour – Assembly 140 R4.00 R560
Direct labour – Finishing 60 R4.50 R270
Production Overhead – Blanking 40 R20.00 R800
Production Overhead – Assembly 140 R9.00 R1 260
Production Overhead - Finishing 60 R12.00 R720
Total product cost R4 680
General overheads Total product cost x 10% R468
Total cost of batch R5 148
(ii) Unit cost R5 148/ 150 =R34.32

Selling price per unit =R50.00
(iii) Profit per unit =R15.68
4.8 Activity 7– Question 7.7
(i) Costs of completed jobs and (iii) Net income
L1670 J1901 H702 G901 TOTAL

Material cost @
R1 500 R5 000 0 0 R6 500
beginning
Material cost this year 0 0 R16 872 R10 980 R27 852
Total material cost R1 500 R5 000 R16 872 R10 980 R34 352
Labour cost @ beginning R6 000 R8 000 0 0 R14 000
Labour cost this year R800 R9 600 R1 575 R1 200 R13 175
Total labour costs R6 800 R17 600 R1 575 R1 200 R27 175
Overheads @ beginning R8 000 R4 000 0 0 R12 000
Overheads this year R400 R6 000 R1 000 R1 200 R8 600
Total overheads R8 400 R10 000 R1 000 R1 200 R20 600
Total cost R16 700 R32 600 R19 447 R13 380 R82 127
Selling Price R18 000 R45 000 R28 000 R25 000 R116 000
Profit per Job R1 300 R12 400 R8 553 R11 620 R33 873
Selling and Admin
R25 510
expenses
Net Income R8 363
(ii)
Ending Work-in-process B168

Material cost this year R5 670
Labour cost this year R180
Overhead this year 90 × R2 = R180
Total cost R6 030
TT201 TT202 TT203 Total

Work-in-process: 1 March R4 940 R4 940
Direct material used R6 000 R5 092 R3 458 R14 550
Opening Stock R2 850
Add: Purchases R14 516
R17 366
Less: Indirect Material R798
R16 568
Less: Closing Stock (Materials) R2 018
Direct Labour R6 080 R4 560 R3 420 R14 060
Apportioned overheads R3 040* R2 280 R1 710 R7 030
Indirect Material R798
Indirect labour R2 090
Lease of machinery and equipment R2 280
Power R1 140
Fire and liability insurance R722
R20 060 R11 932 R8 588 R40 580
Less: Closing stock work-in-process R11 932 R11 932
Cost of Sales R20 060 R8 588 R28 648
Sales R23 788 R10 336 R34 124
Gross Profit R3 728 R1 748 R5 476
*R6 080/ R14 060 × R7030 =R3 040
(a)
Application Basis Overhead Cost Divided by Overhead Rate
Direct materials cost R684 500.00 R343 469 199.29%

Direct labour cost R684 500.00 R502 607 136.19%
Direct labour hours R684 500.00 97 500 R7.02
Machine hours R684 500.00 37 690 R18.16
(b)
Application Basis Job 87 Data Overhead Rate Overhead Cost
Direct materials cost R3 803.00 199.29% R7 579.00
Direct labour cost R5 234.00 136.19% R7 128.18
Direct labour hours 1 568 hours R7.02 R11 007.36
Machine hours 461 hours R18.16 R8 371.76
(c)
Job 87
Material Cost Labour Cost Overhead Cost Total Cost
R3 803.00 R5 234.00 R7 579.00 R16 616.00
R3 803.00 R5 234.00 R7 128.18 R16 165.18
R3 803.00 R5 234.00 R11 007.36 R20 044.36
R3 803.00 R5 234.00 R8 371.76 R17 408.76

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IIE Workbook FINM6211

The Independent Institute of Education (Pty) Ltd is registered

©The Independent Institute of Education (Pty) Ltd 2017 Page 1 of 175

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Glossary of Key Terms for this Module

Term Definition My Notes

Abnormal The waste or wrecking of inventory

©The Independent Institute of Education (Pty) Ltd 2017 Page 3 of 175

Term Definition My Notes

Allocated or Overhead costs allocated to the

©The Independent Institute of Education (Pty) Ltd 2017 Page 4 of 175

Term Definition My Notes

Business plan A sales document that conveys the

©The Independent Institute of Education (Pty) Ltd 2017 Page 5 of 175

Term Definition My Notes

Current liabilities Debts that have to be settled within a

©The Independent Institute of Education (Pty) Ltd 2017 Page 6 of 175

Term Definition My Notes

Finished goods The product which becomes available

©The Independent Institute of Education (Pty) Ltd 2017 Page 7 of 175

Term Definition My Notes

Inventory The process of assigning cost to

©The Independent Institute of Education (Pty) Ltd 2017 Page 8 of 175

Term Definition My Notes

Master budget The comprehensive, all-encompassing

©The Independent Institute of Education (Pty) Ltd 2017 Page 9 of 175

Term Definition My Notes

Operating budget Consists of the sales budget, the

©The Independent Institute of Education (Pty) Ltd 2017 Page 10 of 175

Term Definition My Notes

Profit The amount by which the total sales

©The Independent Institute of Education (Pty) Ltd 2017 Page 11 of 175

Term Definition My Notes

Short-term loan A loan that has to be repaid within the

©The Independent Institute of Education (Pty) Ltd 2017 Page 12 of 175

Term Definition My Notes

Understocking The amount of stock held is too low with

©The Independent Institute of Education (Pty) Ltd 2017 Page 13 of 175

Learning Unit 1: The Role of the Financial Manager

1 Recommended Additional Reading Make sure that you

©The Independent Institute of Education (Pty) Ltd 2017 Page 14 of 175

2 Recommended Digital Engagement and Activities

Accounting Coach. 2012. Accounting careers. [Online]. Available at:

©The Independent Institute of Education (Pty) Ltd 2017 Page 15 of 175

3.2 Izimvo Exchange 2

It is the task of the financial manager to ensure proper management of creditors,

Consider the following scenario:

©The Independent Institute of Education (Pty) Ltd 2017 Page 16 of 175

3.3 Activity 1 – Question 1.1 For Activity 1 consult p.7 in

Commentary Related to Activity Design:

3.4 Activity 2 – Question 1.2 For Activity 2 consult p.8 in

Commentary Related to Activity Design:

©The Independent Institute of Education (Pty) Ltd 2017 Page 17 of 175

3.5 Activity 3 – Question 1.3 For Activity 3 consult p.8 in

Commentary Related to Activity Design:

3.6 Activity 4 – Question 1.4

Commentary Related to Activity Design:

3.7 Revision Exercise 1

Answer the following questions: