The University of Technology, Jamaica

Advanced Costing and Management AccountingSemester 2

Course ProjectWednesday April 16, 2014

Group Members:Kacia Scott 1000412Jheanelle Brown 1001093Stephen Waite 1007565Chantelle Richards 1000148Jody Warren 1001585Nastassia Nash 1000657

Table of Contents

Question 1

Question 2

Question 3

Question 4

Question 5

ReferencesAppendix

QUESTION 1a. Products target costTarget cost= Anticipated Selling price Desired Profit x= 590 -.25x = 1.25x=590 =590/1.25= $472b. Projected Total cost per unit$Direct Material56Purchased parts 37Manufact. Labour (4.5*14)63Assembly Labour Rate (15*5.2)78Overhead Cost: Materials Handling (10%*93)9.3Engineering 13.5Product Delivery24Marketing6 Production (8.2*26)213.2Total500I. Direct material cost reduced by 20% and Purchases parts by 15% $Direct Material (80%*56)44.80Purchased parts (85%*37)31.45Manufact. Labour (4.5*14)63Assembly Labour Rate (15*5.2)78Overhead Cost: Materials Handling (10%*76.25)7.63 Engineering 13.5Product Delivery24Marketing6 Production (8.2*26)213.2Total481.58

II. Increase Direct material cost by 20%, reduce machine hours by 10%,manufacturing labour hours by 16%, assembly hours by 20%. $Direct Material (1.20*56) 67.20Purchased parts 37Manufact. Labour (.84*4.5*14)52.92Assembly Labour Rate (.80*5.2*15)62.40Overhead Cost: Materials Handling (10%*104.20)10.42Engineering 13.5Product Delivery24Marketing6 Production (8.2*26*90%)191.88Total465.32

c. When decided on the new product, management should choose the second alternative offered by the design engineers which will result in a projected cost of $465.32 per unit that is below the target cost established by the company. This will in turn increase the quantity level and later satisfy the customers.

d. The considerations that should go into pricing a product that will increase market share is setting prices:1. that are competitive2. Acceptable to customer which will increase loyalty3. One that recovers all costs incurred in bringing the product to the market4. That will return a profit on goods.

e. Four possible pricing strategies:1. Price skimming- marketers sets relatively high prices for products at first and lowers the price overtime.2. Price penetration- sets low prices in order to avoid encouraging competitors into entering a market.3. Mark-up pricing -the price of adding a constant percentage to the cost price of an item to arrive at its selling price.4. Cost-plus pricing- this is the cost of production adding a fixed rate of profit.

QUESTION 22A Profit CentresA Profit Centre is an organizational unit in which a manager has control over and is held accountable for both cost and revenue performance. Profit centers cost overruns are expected if they are coupled with proportionate gains in revenue and profitability.The main characteristics and objectives of profit centres are: Profit centres are units within an organisation where managers are accountable for both revenue and costs. Cost centre managers are accountable only for managing inputs of their centres. Both cost and revenue centre managers have limited decision making authority. Profit centre managers are free to set selling prices, choose which markets to sell in make product mix and output decisions and select suppliers. Profit centre managers are held accountable for both the revenue and expenses attributed to their subunits.Investment CentresInvestment Centres is an organizational unit in which a manager has control over and is held accountable for cost, revenue, and asset performance.At higher levels within an organization, unit managers will be held accountable not only for cost control and profit outcomes, but also for the amount of investment capital that is deployed to achieve those outcomes. In other words, the manager is responsible for adopting strategies that generate solid returns on the capital he or she is entrusted to deploy. Evaluation models forinvestment centersbecome more complex and diverse. They usually revolve around calculated rates of return.The main characteristics and objectives of profit centres are: Profit centres are units within an organisation where managers are accountable for both revenue and costs. Cost centre managers are accountable only for managing inputs of their centres. Both cost and revenue centre managers have limited decision making authority. Profit centre managers are free to set selling prices, choose which markets to sell in make product mix and output decisions and select suppliers. Profit centre managers are held accountable for both the revenue and expenses attributed to their subunitsa) Explain what conditions are necessary for the successful introduction of such centres. The concept of profit centers enables a company's executives and management to determine how best to focus its resources to maximize profitability. In order to optimize profits, management may decide to allocate more resources to highly profitable areas, while reducing allocations to less profitable or loss-making units.

Not all units within an organization can be tracked as profit centers. This is especially applicable to departments that provide an essential service within an organization, but do not generate their own revenues. Some examples of these include the research department within a broker-dealer, the administration arm of a company, and a unit that provides after-sales support in an organization.An investment center is different in that it indirectly adds profit and is evaluated according to the money it takes to operate. Moreover, unlike a profit center, investment centers can utilize capital in order to purchase other assets. Because of this complexity, companies have to use a variety of metrics, includingreturn on investment(ROI), residual income and economic value added (EVA) to evaluate performance. There must be divisionalization of dissimilar activities in the organization. It is difficult for top management to be acquainted with all the different activities of various segments of the business The activities of each division must be independent as possible of other activities Divisions should be regulated so that no one division should seek its own profit, which might lead to reduction of the company profit as a whole.b) Profit centers are valid for a specific time period. This has advantages in that: No complications arise when a new fiscal year begins. You can enter future changes to the master data in advance.Profit centers are time-dependent in two ways: First, you can enter a period during which actual or plan data can be posted to the profit center. Second, you can define time-based fields when you customize Profit Center.

c) Compare two performance appraisal measures that might be used if investment centres are introduced. The two performance measures that might be used if investment centres are introduced are Return on Investment and Profit Margin (Operating Performance) Ratio. Return on Investment is a measure of operating performance and efficiency in utilizing assets; computed in its simplest for by dividing operating profit by average total assets while Profit Margin Ratio is an overall measure of the profitability of operations during a period; computed by dividing operating profit by revenue. Consequences which may arise include scenarios where decisions might be taken by a divisional manager in the best interest of his division, but does not necessarily match the best interest of the organization on a whole2B (i) Return on capital employed The traditional approach to investment appraisal isreturn on capitalemployed (ROCE). In its basic form, it is calculated as the ratio of the accounting profit generated by an investment project to the required capital outlay, expressed as a percentage. An advantage is that by evaluating a project on the basis of apercentage rate of return it is using a concept with which all management is familiar. For example, being told that a project has a four year payback would not immediately convey whether that was good or bad; but being told that a project is expected to produce a 30% return on capital would appear obviously desirable given that we know the going rate of return on the overall company.

The second advantage is connected to the first. It is the fact that the method evaluates the project on the basis of its profitability, which many managers believe should be the focus of the appraisal. A disadvantage is that there are so many variants that no general agreement exists on how capital employed should be calculated, on whether initial or average capital employed should be used or on how profit should be defined. As a result, the method lays itself open to abuse as a technique of investment appraisal by allowing the decision maker to select a definition of ROCE that best suits their preconception of a project's desirability.(i) Residual incomeThis is the amount of profit that remains (as a residual) after subtracting an imputed interest charge.Residual incomewill increase when investment earning above thecost of capitalare undertaken and investments earning below the cost of capital are eliminated. Also, residual incomeis more flexible since a different cost of capital can be applied to investments with different risk characteristics.Residual income has a serious drawback; it should not be used to compare the performances of different-sized businesses, because as a dollar measure it incorporates a bias in favour of larger businesses.(ii) Discounted future earningsA method within theincome approach whereby the present value of future expected economic benefits is calculated using a discount rate.The value of the firm is based on projected future results, rather than assets and it can be used with either net earnings or net cash flow. It is also useful when future results are expected to be different (up or down) from recent history.It May understate the value of balance sheet assets. It may also discount the valuation based on the level of risk. A business perceived as riskier typically receives a lower valuation than a more stable business. Projections are not guaranteed; unforeseen future events can cause income or earnings projections to be completely invalid.

b)The existing ROCE is 20% and the estimated ROCE on the additional investment is 15% ($9000/$60000) the divisional manager will therefore reject the additional investment, since adding this to the existing investments will result as a decline in the existing ROCE as 20%.The residual income on the additional investment is $600 ($9000 average profit for the year less an inputted interest charge of 14% x $6000= $8400). The manager will accept the additional investment since it results in an increase in residual income.If the discounted future earnings method is used, the investment would be accepted, since it will yield a positive figure for the year (i.e $9000 x 3.889 discount factor). Note that the annual future cash flows are $19000 ($9000 net profit plus $10000 depreciation provision). The project has a 6 year life. The annual cash inflow must be in excess of $15,428 ($60000/ 3.889 annuity factor- 6 years at 14%) if the investment is to yield a positive NPV. If annual cash flows are $19000 each year for the next 6 years, the project should be accepted.The residual income and discounted future earnings methods of evaluation will induce the manager to accept the investment. These methods are consistent with the correct economic evaluation using the NPV method. If ROCE is used to evaluate performance, the manager will incorrectly reject he investment .This is because the manager will only accept projects that yield a return in excess of the current ROCE OF 20%.

QUESTION3Pagoda Enterprise ReportTO: The Directors, Pagoda Enterprise FROM: Michael Bacchas, Chief Executive Officer (CEO)DATE: March 20, 2014SUBJECT: FEASIBILITY OF PROJECTPagoda Enterprise is planning to replace an old machine that was bought seventeen years ago for a new more efficient one. This report serves to introduce to you the feasibility of replacing the machine as well as an outline of the strengths and weaknesses of the methods employed by Pagoda Enterprise to determine the projects feasibility. The following methods were used to prepare a detailed analysis of the conclusion: Net Present Value, Internal Rate of Return, Average Rate of Return, payback period and Profitability Index.One method implemented was the Net Present Value (NPV). This is the difference between the present value of cash inflows and the present value of cash outflows. The NPV is used to analyze the profitability of an investment or project. Because of the time value of money, a dollar earned in the future wont be worth as much as one earned today. In order to facilitate this discount rate in the NPV formula is used. Strengths of the NPV method include: The consideration of the time value of money by allowing the consideration of the cost of capital, interest rates and investment opportunity. The value of todays dollar and the risk associated with future cash flow is recognized. It is the wide scale acceptance of the measure in the financial community and is based on discounted cash flows.Weaknesses include: Ranking Investments by NPV does not compare absolute levels of investment because NPV looks at cash flows and not at profits and losses. NPV is highly sensitive to the discount percentage which makes it tricky to determine. Assumes that capital is abundant meaning no capital rationing exists.Another alternative method that the company could utilize in measuring performance is that of the Internal Rate of Return (IRR) method which is stated as the discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. A project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth. Strengths of the IRR method include: IRR method provides a simple hurdle rate for investment decision making This method implements capital rationingWeaknesses of IRR method include: It is not as easy to understand and compute as other methods. It ignores the size of the projectThe Average Rate of Return (ARR) is defined as the amount of profit, or return, that an individual can expect based on an investment made. It divides the average profit by the initial investment in order to get the ratio or return that can be expected. This allows an investor or business owner to easily compare the profit potential for projects, products and investments.Strengths of the ARR method include: Good for internal purposes: for public companies trying to manage their reported Earnings per Share. Can also be used to measure the performance of projects and subsidiaries within an organization.Weaknesses of the ARR method include: ARR does not consider the time value of money, which means that returns taken in during later years may be worth less than those taken in now. Does not consider cash flows, which can be an integral part of maintaining a business.The Payback Period is defined as the length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions.Strengths of the Payback Period include: Certain time requirements are available in terms of how long a project will take to pay for itself. It's easy to compute, easy to understand and provides some indication of risk by separating long-term projects from short-term projects.Weaknesses of the Payback Period include: It ignores any benefits that occur after the payback period and, therefore, does not measure profitability. It ignores the time value of money.The Profitability Index (PI) was the final method used. This is defined as the index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio. As values on the profitability index increase, so does the financial attractiveness of the proposed project.Strengths of the Profitability Index include: PI considers analysis all cash flows of entire life. PI considers the time value of money and ascertains the exact rate of return of the project. PI makes the right in the case of different amount of cash outlay of different project.Weaknesses of the Profitability Index include: It is difficult to understand interest rate or discount rate. It is difficult to calculate profitability index if two projects having different useful life.

QUESTION 4

QUESTION 5A. VARIANCESContribution margin Selling price 250Direct material 40Direct Labour 100CM 110Material Prices Actual 49,500,000/1000000 = 49.5Budgeted = 40Material usage 9.51000000KG = 1100000X = 1unit Actual 1000000\1100000 = 0.9090909 kgBudgeted = 1kg 0.09090909

Sales Volume Variance:Actual Sales1,100,000 unitsPlanned Sales1,000,000 units 100,000 units (F)X standard profit $110 $11,000,000

Sales Price Variance: Actual Sales (1,100,000*$200)$220,000,000Planned Sales (1,100,000*$250)$275,000,000 $55,000,000 (A)

Material Prices Variance:Actual price paid 1000,000*49.5 $49,500,000Budgeted price to paid (1,00,000*$40)$40,000,000 $9,500,000 (A)

Material Usage Variance:Actual material used (1000,000/1,100000)*1100000 =1,000,000 kilogramsBudgeted material to be used1kg*1,100000 =1,100,000 kilograms 100,000 Kilograms (f)X direct material per unit $40 4,000,000 (F)

Direct Labour Rate Variance:Actual labour Cost$93,600,000Budgeted Labour Cost (1,950,000*$50)$97,500,000 $3,900,000 (F)

Direct Labour Usage Variance:Actual Labour used 1,950,000 hrsBudgeted hrs to be used (1,100,000*2)2,200,000 hrs 250,000 hrs (F)X labour rate $50 per hour $12,500,000 (F)

Fixed Overhead Expenditure Variance Actual amount$45,000,000Budgeted amount to be used (1,000,000*2*20)$40,000,000 $5,000,000 (A)

Fixed Overhead Volume VarianceActual volume1,100,000 unitsBudgeted volume to be used1,000,000 units 100,000 units (A)X hours per unit *2 200,000 hoursX fixed overhead per hour $20 $4,000,000

B. ACTUAL INCOME STATEMENT$ $Sales (i) 220,000,000Less Production cost:Direct Materials 49,500,000Direct Labour93,600,000(143,100,000)Contribution margin769,000,000Fixed overhead ( 45,000,000)EBIT 31,900,000

1. Sales= 1,100,000*$200 = $220,000,000

C. STANDARD INCOME STATEMENT

Sales 250,000,000

Less Production cost:

Direct Materials 40,000,000Direct labour 100,000,000 (140,000,000)Contribution margin 110,000,000Fixed overhead (40,000,000)EBIT 70,000,000

D Reconciliation of profit Sale Price Variance (55,000,000)Sales Volume Variance 11,000,000Material usage Variance 4,000,000Material Price Variance (9,500,000)Labour Rate Variance 3,900,000Labour Efficiency Variance 12,500,000Expenditure Variance (5,000,000)Actual profit 31,900,000ReferencesAnonymous. (NA) Responsibility Accounting and Management by exception Retrieved from e http://www.principlesofaccounting.com/chapter22/chapter22.htmlAverage Rate of Return definition. Retrieved from: http://www.investopedia.com/terms/a/arr.aspInternal Rate of Return definition. Retrieved from: http://www.investopedia.com/terms/i/irr.aspMyler, Larry (February 14,2013) Be A Hero: Turn A Cost Center Into A ProfitCenter Retrieved from http://www.forbes.com/sites/larrymyler/2013/02/14/be-a-hero-turn-a-cost-center-into-a-profit-center/eNet Present Value definition. Retrieved from: http://www.investopedia.com/terms/n/npv.aspPayback Period definition. Retrieved from: http://www.investopedia.com/terms/p/paybackperiod.asp Profitability Index definition. Retrieved from: http://www.investopedia.com/terms/p/profitability.asp

APPENDIX

Old Machine $Purchase Price of Old Machine2,000,000

Less Accumulated Depreciation (W1)(1,700,000)

Net Book Value300,000

Sales Proceed from Old Machine200,000

Loss100,000

Tax @ 30%30,000

Cash Inflows from Old Machine230,000

New Machine $Purchase Price of New Machine1,200,000

Add Other Costs Costs:

Shipping100000

Site Preparation Cost100000

Inspection300000

500,000

Total Capitalized Costs1,700,000

Opening Inventory50,000

Initial Investment 1,750,000

Cash Flow from Old Machine230,000

Net Initial Investment1,520,000

Workings:1. Depreciation = Cost of Machine/ Useful Life = 2,000,000/20 = 100,000

Therefore Accumulated Depreciation = 100,000* useful life of 17 years = 1,700,0002. Net DepreciationDepreciation on New Machine = 382,500Depreciation on Old Machine = (100,000) 282,5003. Salvage Value = 10% of Capitalized Costs =10% * $1,700,000 =$170,000YEAR 1YEAR 2YEAR 3YEAR 4

Savings700,000650,000600,000 750,000

Less Capitalization Costs(100,000)(100,000)(100,000)(100,000)

Upkeep(20,000)(20,000)(20,000)(20,000)

Net Savings580,000530,000480,000630,000

Net Depreciation282,500282,500282,500(382,500)

Taxable Profit297,500247,500197,500247,500

Tax @ 30%(89,250)(74,250)(59,250)(74,250)

Net Income208,250173,250138,250173,250

Net Depreciation282,500282,500282,500382,500

Operating Cash Flows490,750455,750420,750555,750

Opening Inventory50,000

Salvage Value 170,000

Net Operating Cash Flows490,750455,750420,750775,750

PVIF @ 12.5%0.8890.7900.70200.624

DCF435,222.22360,098.77295,506.17484,296.91

Total DCF1,576,124.07

Less Net Initial Investment-1,520,000.00

Net Present Value56,124.07

= =