Chapter 1

IAS 1 — Presentation of Financial Statements

IAS 1 Presentation of Financial Statements sets out the overall requirements for financial statements,
including how they should be structured, the minimum requirements for their content and overriding
concepts such as going concern, the accrual basis of accounting and the current/non-current distinction.
The standard requires a complete set of financial statements to comprise a statement of financial
position, a statement of profit or loss and other comprehensive income, a statement of changes in
equity and a statement of cash flows.

Components of financial statements / A complete set of financial statements includes:

1. A statement of financial position (balance sheet) at the end of the period

2. A statement of profit or loss and other comprehensive income for the period (presented as a
single statement, or by presenting the profit or loss section in a separate statement of profit or
loss, immediately followed by a statement presenting comprehensive income beginning with
profit or loss)
3. A statement of changes in equity for the period
4. A statement of cash flows for the period
5. Notes, comprising a summary of significant accounting policies and other explanatory notes

A statement of profit or loss and other comprehensive income for the period.

The income statement is a historical record of the trading of a business over a specific
period (normally one year). It shows the profit or loss made by the business – which is
the difference between the firm's total income and its total costs.

The income statement serves several important purposes:

 Allows shareholders/owners to see how the business has performed and whether it has
made an acceptable profit (return)
 Helps identify whether the profit earned by the business is sustainable ("profit quality")
 Enables comparison with other similar businesses (e.g. competitors) and the industry as a
whole
 Allows providers of finance to see whether the business is able to generate sufficient
profits to remain viable (in conjunction with the cash flow statement)
 Allows the directors of a company to satisfy their legal requirements to report on the
financial record of the business

The structure and format of a typical income statement is illustrated below:

Cost of sales/Cost of goods sold
Cost of goods sold (COGS) refers to the direct costs attributable to the
production of the goods sold in a company. This amount includes the cost of the
materials used in creating the good along with the direct labor costs used to
produce the good. It excludes indirect expenses, such as distribution costs and
sales force costs.
Only forms of direct expense which is used in the business for producing the
product or service is Cost of sales
Other Income= This income received from other activities not from primary
business is known as other income. Examples include Interest received,
Exchange gains. The other income will be added to gross profit.

Administration Expense
Administrative expenses are the expenses that an organization incurs not directly
tied to a specific function such as manufacturing, production or sales. These
expenses are related to the organization as a whole as opposed to an individual
department. Salaries of senior executives and costs of general services such as
accounting are examples of administrative expenses.
Administrative expenses are typically fixed in nature as they incurred to be the
foundation of business operations. These expenses would exist regardless of the
level of sales that occur. Therefore, not many administrative expenses are
variable. Because they are fixed, they are often hard to reduce.

Selling and distribution expense

Any expense linked with selling the goods after producing the product is known
as selling and distribution expense,
Selling expenses are part of the operating expenses (along with administrative
expenses). Selling expenses include sales commissions, advertising,
promotional materials distributed, rent of the sales showroom, rent of the sales
offices, salaries and fringe benefits of sales personnel, utilities and telephone
usage in the sales department, etc.
Finance cost
The is the cost of interest charge from long term lenders the interest they charge
or the bank overdraft interest amount. Any type of interest cost would be included
here.
also known as the cost of finances (COF), is the cost, interest, and other charges
involved in the borrowing of money to build or purchase assets. This can range
from the cost it takes to finance a mortgage on a house, to finance a car loan
through a bank.

Chapter 2 Limited Companies

What is Limited company?

A limited company differs from other organizations as it is a separate legal entity.
Its existence is separate from that of shareholders.
Accounting concept of entity is followed.
Limited liabilities rules were formed in the act of 1985 and 1989.
Two major rules of the act were:
1. Shareholders will not participate in the act of managing or running the
business. Will have to appoint directors.
2. If the company is bankrupt creditors would not be able to claim
shareholders individual assets. Only company assets and capital as per
article of association.
Formation of limited liability company
A company is formed when certain documents are registered by people, known
as its founders, with the registrar of companies and various fees and duties are
paid to the Registrar.
Two documents are mandatory to be filled in registrar of companies?
 1. Memorandum= Defines relationship to rest of the company to rest of the
world. It contains following information.
 Name of company
 Statement of limited liability
 The amount of authorized capital
2. Article of association= Is a document that defines the rights and duties of a
company shareholders and directors.
 Regulations on calling shareholders for meeting
 Members voting rights
 Appointment of directors
 Maximum number of shares directors might hold.

There are 2 types of Limited

1) Public companies= can offer shares to public and can be traded in stock
exchange. Share capital minimum should 50,000pounds
2) Private companies=authorized share capital less than 50,000pounds.
Cannot trade shares in stock exchange. Special arrangements for sale of
shares are required.
Share capitals
 Authorized share capital= is the maximum amount of capital which the
company can raise by issuing shares. This amount is fixed by registrar of
companies by estimating the value of a company.
 Issued share capital= is the total shares which have been issued to the
shareholders. It can be less than authorized capital but can never be more
than the authorized capital.
What is Application of shares and allotment of shares?
 Application of shares= This is when the initial request for interested
shareholders to invest in business is advertised. They would have to pay
small percentage value of the share. This is known as application. However
the issue with application of shares is it may exceed the authorized capital.
Thereafter allotment must take place.
  Allotment of shares is when the application of share has exceeded the
authorized capital. The proceeds (application of shares) should be allotted
on a predetermined basis. Which should have been mentioned in
prospectus. The excess proceeds from application is transferred back.

Classes of shares
Ordinary shares= These shares purchased by the shareholders (Owners) of the
company. Profit remaining after paying out all expenses, Interest and dividend to
preference shares will belong to Ordinary shareholders, they will most probable
receive dividence every year. If the company is bankrupt and run out of business
ordinary shareholders will be settled last.
Preference shares= They are preferential shareholders unlike O/D shareholders.
They receive fixed dividence yearly. They are entitled to assets before O/D
shareholders if the company is wounded up.
There are 2 types of Preference shares
1) Redeemable preference shareholders= They are known as non-current
liability and the dividence expense is deducted from Income statement.
These redeemable preference shareholders should be settled on a
predetermined future date.
2) Irredeemable Preference shareholders= They are known as a part of the
equity as the investment made by irredeemable preference shareholders
will never be paid back. The dividence paid will be fixed and will be
deducted from the retain earnings in the equity section.
*Assumption if the question is silent on the types of preference shares
consider it to be irredeemable preference shareholder
Nominal value and share premium
Nominal value of a share is fixed does not change is constant.
Share premium occurs when an ordinary share has been sold at value exceeding
nominal value.
Example 1: The directors X company issued ordinary shares 60,000 which has a
nominal value of 1RS. The shares were issued for 1.50RS. Prepare journal entries?
Bonus issues
The company act gives companies the power to use their reserves to issue shares
to ordinary shareholders as fully paid up shares. These shares are known as bonus
shares because the shareholders do not have to pay for them as the own it.
These bonus shares are a motivator as shareholders could sell them in open
market or receive dividends.
Example 2 A company decided to issue bonus share to its existing shareholders 4
shares is to 1. The issued share capital is 10,000, Share premium is 2,000 and
retain earnings is 5,000. Prepare journal Entries?

Right issue
When a company needs to raise more capital, it may do by issuing new shares. In
invitation for general public is an expensive process because the company must
issue a prospectus which gives the past history of the company. Its present
situation and other details of annual report.
A right issue is where existing shareholders are invited to purchase new shares at
lower rate than the market value of shares. Usually the market rate would be
higher than the nominal value.
Eg: a share is traded at 1.8 in open market a right issue of 1.5 for share is issued.
This reduction of 0.3 will be a motivator for shareholders to purchase it.
Example 3 Zee LTD has 50,000 ordinary shares at a nominal value of 1 per share
and retain earning of 100,000. The market value of a share is 2. Zee Limited made
a right issue of 10,000 shares to existing shareholders at price of 1.20. Prepare the
Journal entries?
Right issue and Bonus issue compared
Right issue Bonus issue
Shareholders pay for shares Shareholders do not pay for shares
The company net assets are increased The net assets are unchanged
by cash received

There are two classes of reserves(Equity)

 Revenues reserve= are created by transferring profits from appropriation
section to Income statement account to reserve accounts. Revenue reserves
maybe created for specific purposes
replacement of fixed assets or planned expansion of the business or generally to
strengthen the financial position of the company. Revenue reserves is another
name for retain earnings. It solely includes profit from operations .
 Capital reserves= This reserve is created with one off events. They represent
gains arise from particular circumstances and mostly represent gains which have
not yet been realized.

Types of revenue Reserve Types of capital reserve

1. Retain Earnings 1. Ordinary shares
2. General reserve 2. Share premium reserve
3. Capital Replacement Reserve 3. Revaluation reserve
4. Foreign exchange reserve 4. Capital redemption reserve

Dividence = This is the amount paid to shareholder as a return for their investment.
Interim dividence = This is the dividence paid before a year end.
Final dividence= This is the dividence paid at the end of the year.
Total dividence is addition of interim and final dividence.

The condition for dividence payment is the dividence payment cannot exceed the total
of revenue reserves.
 Statement of changes in equity is the equity section of statement of financial position
with changes shown in detail. Below is the format and a exercise.

2019 May Q6
2018 Jan Q2
2017 May Q5
2016 Oct Q3
Capital Redemption Reserve= This reserve is created when a company redeems
its shares back. The companies act 1985 permits companies to issue redeemable
shares provided it has issued other shares which are not redeemable.
Redeemable shares can be bought back by company. The act also permits
companies to purchase their own shares although they are not redeemable.
Example 5
The following balances were in the books of Zee Holdings plc on 1 January 2019, at the start of the
financial year

£1 Ordinary shares 15,000

Share premium reserve 27,000
Retain Earnings 30,000

On 1 March 2019, the directors of Zee Holdings plc decided to redeem one ordinary share for every 10
shares held. The redemption was at the market price of £3.00 per share.

(A) Prepare the Journal entries to show the redemption of shares on 1 March 2019.

Revaluation of Reserve= A company may revalue its fixed asset any gain must be
transferred to this account.
Example 6
On 20 April 2016 property with a book value of £80 million was revalued upwards by 10% to reflect the
market value.

(A) Prepare the Journal entries to show the revaluation on 20 April 2016?

What is debenture?
A debenture is a document by a company to someone who has lent money. It
states the amount of loan. The annual interest payable. Dates on which interest is
paid. Debentures are usually secured on all or some of the asset. If company gets
into financial difficulty the assets will be sold and debentures will be first settled.
Chapter 3 Merger and Acquisition

What is difference between the purchase of a business and purchase of assets

of business?
 If a company only takes over one asset and uses it in another facility is
known as purchase of assets, however the company taking over a
combination of assets and liabilities and running the business is known as
purchase of business.
 In a purchase of a business there will be goodwill arising whereas purchase
of asset there is no goodwill.
 The company may a issue a combination of shares and cash in a take over
of the business where as there is no share issue in sale of a asset.

What is Goodwill?
Goodwill is the amount paid for acquisition of a business in excess of the fair
value of its separate net assets.
A company acquiring the business will normally be purchasing the business above
the net assets. The payment would normally be with issue of shares or cash for
acquisition. It usually is a combination of both ways. The goodwill is paid for
several reasons.
 It’s a value paid for acquiring an established trade. The company does not
have to be built up a new business from nothing the business has been
built.
 The brand name of the company. The brand name could be very famous
therefore they purchasing company will pay a heavy goodwill.
 The customer base would be very strong. As there is a steady foreseeable
income the goodwill will also be high.
The difference between purchased goodwill and inherent goodwill?
Purchased goodwill has been paid for. Inherent goodwill has not been paid for
and will arise.
Which type of Goodwill can be shown in statement of financial position and
why?
Only purchased goodwill can be shown in statement of financial position as
goodwill under intangible assets.
Inherent goodwill cannot be shown as per standard IFRS 10. IFRS 10 states only
purchased goodwill to be shown as there is actually cash inflow to the business.
If the purchase value of the business is less than the net assets?
Its known as a negative goodwill and must be shown as a negative amount in the
in intangible assets.
What is Realization account?
When a business is merged or sold the need for realization account arises. It
shows how much individual business have made profits on their net assets.
The objective of preparing Realization account is to close the books of accounts of
the dissolved firm and to determine profit or loss on the Realization of assets and
payment of liabilities. It is prepared by:

 Transferring all the assets to the debit side of the realization account.
 Transferring all the liabilities to the credit side of the realization account
 Crediting the Receipt on the sale of business to the realization account.
 Balancing the account and identifying how much has to be transferred to
sundry shareholder account.
What is the purpose of realization account?
 To close all books of accounts.
 To record transactions relating to sale of assets and discharge liabilities.
 To determine profit and loss account due to realization of assets and
liabilities.

Sundry shareholders account?

The sundry shareholder account deals with the changes in statement of changes
in equity. The sundry shareholder account is created to close down the ledger of
statement of changes in equity. The profit on realization account will be credited
in sundry shareholders account. The purchase consideration will be debited.
What are Net assets?
Net assets can be calculated in two specific ways
1. Total assets minus Total Liabilities is equal to Net Assets.
2. Total of statement of changes in equity is equal to Net assets
In the examination if revaluation is requested and identify the new net assets is
the question its better to use method one. The purchase of a business if it is a
above net asset it is known as goodwill if it is less than net assets its known as
Negative goodwill.

How to pass journal entries, Ledger accounts, Purchaser of limited companies

and merger of 2 companies, Acquistion account All these we will practice
directly doing questions.

Questions to practice
 2017 October Question 2
 2017 January question 3
 2018 may question 3
 Chapter 4 Project Appraisal

Capital investment
When a business spends money on new non-current assets it is known as capital investment or
capital expenditure. It is expected to generate long-term benefits.

Capital investment decisions normally represent the most important decisions that an organisation
makes, since they commit a substantial proportion of a firm’s resources to actions that are likely to
be irreversible.

Many different investment projects exist including:

 replacement of assets
 cost-reduction schemes
 new product/service developments
 product/service expansions
The distinction between capital expenditure and revenue expenditure is important

Capital expenditure is expenditure incurred in

 The acquisition of non-current assets required for use in the business and not for resale
 The alteration or significant improvement of non-current assets for the purpose of increasing
their revenue-earning capacity.

Capital expenditure is initially shown in the statement of financial position as non-current assets. It is
then charged to the statement of profit or loss over a number of periods, via the depreciation charge

Revenue expenditure is expenditure incurred in

a) The purchase of assets acquired for conversion into cash (e.g. goods for resale)
b) The manufacturing, selling and distribution of goods and the day-to-day administration of the
business
c) The maintenance of the revenue-earning capacity of the non current assets (i.e. repairs, etc)

Revenue expenditure is generally charged to the statement of profit or loss for the period in which
the expenditure was incurred.
The Payback Period = is the time a project will take to pay back the money spent on it. It is
based on expected cash flows and provides a measure of liquidity. Cashflows could occur evenly
or unevenly make sure you calculate the cashflows.
Decision Criteria

 Compare the payback period to the companys maximum return time allowed and if the
payback is quicker the project should be accepted.
 Faced with mutually exclusive projects choose the project with the quickest payback.
Calculating payback if it is constant Net cashflows.

Payback period= Initial Investment

Annual Net Cashflow
To convert the payback period in months you could multiply by 12.

Example 1:
An expenditure of 2million is expected to generate net cash inflows of 500,000 each year for
the next seven years.
Calculate the Payback period for the project?

Example 2: A project will involve spending 1.8million. Annual net cash flows from the project
would be 350,000.
Calculate the payback period?

Example 3: Project A:
Initial Investment: 450,000
Scrap Value in year 5: 20,000
Year 1 2 3 4 5
Annual net 200,000 150,000 100,000 100,000 100,000
Cashflows

Project B
Initial Investment: 100,000
Scrap value in year 5:10,000
Year 1 2 3 4 5
Annual net 50,000 40,000 30,000 20,000 20,000
Cashflows
Required: Calculate which project the company should select if the objective is to minimize the
payback period?
Discounted Payback= It’s a advance project evaluation method considering time value of
money Or else considering the inflation. The cash flows are discounted using cost of capital
percentage.

Example 4: Project A:
Initial Investment: 450,000
Scrap Value in year 5: 20,000
Year 1 2 3 4 5
Annual net 200,000 150,000 100,000 100,000 100,000
Cashflows
Discount 0.909 0.826 0.751 0.683 0.621
Factor 10%

Project B
Initial Investment: 100,000
Scrap value in year 5:10,000
Year 1 2 3 4 5
Annual net 50,000 40,000 30,000 20,000 20,000
Cashflows
Discount 0.909 0.826 0.751 0.683 0.621
Factor 10%
Required: Calculate the discounted payback period for both projects if the relevant cost of
capital is 10%?

Advantages Disadvantages
Simple to understand Is not a measure of absolute profits
Decision criteria is simple Does not consider cashflows after payback
period
Uses cashflows less subjective than
accounting profits
May help in avoiding liquidity problems

Net Present Values

The NPV of an investment represents the net benefit or loss of benefit in present value terms
for an investment opportunity.

A positive NPV represents the surplus funds earned on a project. This means that it tells us the
impact of shareholder wealth.
Net present value (NPV) is the difference between the present value of cash inflows and the
present value of cash outflows over a period of time. NPV is used in capital budgeting and
investment planning to analyze the profitability of a projected investment or project.

Decision Criteria
 Any project with positive NPV is viable.
 Projects with negative NPV is not Viable
 Faced with mutually-exclusive projects, choose the project with the highest NPV.

Example 5:
Year 0 1 2 3 4 5
Net Cashflow (240,000) 80,000 120,000 70,000 40,000 20,000
Discount 1 0.917 0.842 0.772 0.708 0.650
factor 9%

The companys cost of capital is 9%

Calculate the NPV of the project to assess whether it should be undertaken?

Example 6: Project A:
Initial Investment: 450,000
Scrap Value in year 5: 20,000
Year 1 2 3 4 5
Annual Net 200,000 150,000 100,000 100,000 100,000
Cashflows
Discount 0.909 0.826 0.751 0.683 0.621
Factor 10%

Project B
Initial Investment: 100,000
Scrap value in year 5:10,000
Year 1 2 3 4 5
Annual net 50,0000 40,000 30,000 20,000 20,000
Cashflows
Discount 0.909 0.826 0.751 0.683 0.621
Factor 10%
Required: Calculate the Net Present Values to nearest for project A and B if the relevant cost of
capital is 10%?
 Advantages Disadvantages
Considers time value of money Fairly complex
It is measure of absolute profits Not well understood by non financial persons
Whole life of project considered It may be difficult to determine cost of capital
Maximizes shareholder wealth

Internal rate of return

This is the rate of return, or discount rate, at which a project has a NPV of zero.

The internal rate of return (IRR) is a metric used in capital budgeting to estimate the
profitability of potential investments. The internal rate of return is a discount rate that makes
the net present value (NPV) of all cash flows from a particular project equal to zero. IRR
calculations rely on the same formula as NPV does.

Decision criteria
 If IRR is greater than the company’s cost of capital the project should be accepted.
 Faced with mutually exclusive projects choose the project with higher IRR.

How to Find IRR?

 Calculate TWO NPVs for the project one positive and other negative with different cost
of capitals
 Use the following formula to find IRR
IRR=L+ _NL__ ×(H-L)
NL-NH
Where L= Lower rate of interest
H= Higher rate of interest
NL= NPV at lower rate of interest
NH=NPV at higher rate of interest
N= NPV at higher rate of interest
Example 6
Net cashflows of Project A are as follows
Year 1 2 3 4 5 6
Net Cashflows(000S) (450) 200 150 100 100 120

The NPV of the Project A discount rate at 10% is 73620

The NPV of the Project A discount rate at 20% is (25000)
Calculate the IRR of project A?
Example 7
You are give the following:
At 20% the NPV is 8,510
At 30% the NPV is -9,150
Calculate the IRR?
Advantages Disadvantages
Does consider time value of money It does not measure absolute profits
Its percentage could be understood by non IRR may conflict with NPV
financial personel
Consider cashflows Fairly complicated to calculate

What is Accounting rate of return?

The accounting rate of return (ARR) is the percentage rate of return expected on an investment
or asset as compared to the initial investment cost.
ARR does not consider the time value of money or cash flows, which can be an integral part of
maintaining a business.

The formula = (Average annual profit/Initial Investment)*100

or
(Average annual profit/Average investment)*100

How to Calculate the Accounting Rate of Return – ARR

1. Calculate the annual net profit from the investment, which could include revenue minus
any annual costs or expenses of implementing the project or investment.
2. If the investment is a fixed asset such as property, plant, or equipment, subtract any
depreciation expense from the annual revenue to achieve the annual net profit.
3. Divide the annual net profit by the initial cost of the asset, or investment. The result of
the calculation will yield a decimal. Multiply the result by 100 to show the percentage
return as a whole number.

Example 8
A project is being considered that has an initial investment of $250,000 and it's forecasted to
generate revenue for the next five years. Below are the details:

 Initial investment: $250,000

 expected profit per year: $70,000
 time frame: 5 years
Example 9
A project has a investment of 500,000 initial investment.
Its forecasted revenue for first year is 80,000
Direct cost is 35,000 and depreciation is 15,000 for first year.

Its forecasted revenue for the second year is 90,000

Direct cost is 40,000, Indirect cost is 10,000 and depreciation is 15,000

Its forecasted revenue for the Third year is 120,000

Direct cost is 50,000, Indirect cost is 20,000 and depreciation is 15,000, Administration cost is
12,000
Calculate the ARR of the project?

Weighted average cost of capital

The weighted average cost of capital (WACC) is basically the average rate of interest or returns
expected by the investors (shareholders or lenders). The WACC is generally useful in identifying
how much company will have to pay the owners and lenders to satisfy them. Therefore its always
better for potential investors to see the WACC before investing.
What is interest? Long term creditors would lend money to a business the rate of money they would
want back at a fixed percentage is known as interest.
What is return? The shareholders or owners would want profits or dividence from the business as
they are taking a risk.
WACC is also known as cost of capital(Inflation/Discount rate) as all long term borrowing and capital
invested by shareholders are considered to be financing the capital needs of a business.

Example 10 A restaurant chain wanted to invest on a new store they estimated the total fixed cost be
350million.The owners were willing to invest 300 million at 5% return and the balance would be
financed by a bank Loan for 7%. Calculate the weighted average cost of capital?

Example 11 A engineering plc wanted to invest in new heating technology which would require
100million. The shareholders invested 25million at a rate of 3%, The bank provided 50million with
8% interest, Debentures 25 million at 10% interest. Calculate the WACC?
Example 12 A football stadium wanted to build it own stadium at a value of 500million. The owners
did not have sufficient funds to invest therefore intend to use most 60% through external sources.
The 40% funded by owners would be at a return of 4%, The balance is funded as follows.
100 million bank loan 7% mortgage a building
100 million Debentures at 12% no security
100 million Preference shares 8% half of the investment there was a personally guarantee by
owners.
Calculate

A, The weighted average cost of capital?

B, The reasons why different rates of interest is paid for the same amount?

2019 May Q5
2019 Jan Q3
2017 May Q4

Chapter 5 Marginal Costing and Absorption Costing

Marginal and absorption costing are two different ways of valuing the cost of goods sold and
finished goods in inventory. With absorption costing production overheads are treated as a
product cost and an amount is assigned to each unit. In marginal costing all fixed overheads are
treated as period costs and are charged in full against the profit for the period

Marginal Costing= cost of a unit of inventory is the total of the variable costs required to
produce the unit (the marginal cost). This includes direct materials, direct labour, direct
expenses and variable production Overheads.
No fixed overheads are included in the inventory valuation; they are treated as a period cost and
deducted in full lower down the statement of profit or loss.

Marginal costing is the principal costing technique used in decision making. The key reason for
this is that the marginal costing approach allows management’s attention to be focused on the
changes which result from the decision under consideration.

The contribution concept lies at the heart of marginal costing. Contribution

can be calculated as follows: Contribution= Sales price – Varaible costs

Absorption Costing=values each unit of inventory at the cost incurred to produce the unit. This
includes an amount added to the cost of each unit to represent the production overheads incurred
by that product. The amount added to each unit is based on estimates made at the start of the
period.
Absorption costing is a method of building up a full product cost which adds direct costs and a
proportion of production overhead costs by means of one or a number of overhead absorption
rates.

Absorption costing statement of profit or loss account

Revenue XX
Less: cost of sales:
Opening inventory X
Variable cost of production X
Fixed overhead absorbed X
Closing Inventory (X)
(XX)
Gross profit XX

Non-production cost (X)

Profit or Loss XX

 Valuation of inventory–opening and closing inventory are valued at full production cost
under absorption costing.
 Absorption costing statements are split into production costs in the cost of sales and
non-production costs after gross profit.
 Non-production cost is any cost not incurred in the factory or producing the product. The
question will specifically state if there is non-production cost

Marginal costing statement of profit or loss account

Revenue XX
Less: cost of sales:
Opening inventory X
Variable cost of production X
Closing Inventory (X)
(XX)
XX
Less:Non-production variable cost (X)
Contribution XX
Fixed cost (X)
Profit or Loss XX

 Valuation of inventory–opening and closing inventory are valued at marginal (variable)

cost under marginal costing.
 The fixed costs incurred are deducted from contribution earned in order to determine the
profit for the period.
  Marginal costing statements are split into all variable costs before contribution and all
fixed costs after contribution.
 Note: Only the production variable costs are included in the cost of sales and valuation
of inventory. If there are variable non production costs (i.e. selling costs) these would be
deducted before contribution but not included in the cost of sales

Example 1

The fixed production overhead cost for the month is 10,000.

Example 2

Fixed production overheads for period 3 is 75,000

2020 Jan Q6
 Chapter 6 Break Even analysis

The contribution concept

the contribution concept lies at the heart of marginal costing. Contribution can be calculated
as follows.
Contribution = Selling price – Variable costs

State the Variable cost per unit, Total Variable cost, Contribution per unit, Total contribution,
Profit per unit and total profits. Assuming 1,200 Lamps have been produced and sold using the
following data?

Contribution analysis

 Contribution gives an idea of how much ‘money’ there is available to ‘contribute’

towards paying for the overheads of the organisation.
 At varying levels of output and sales, contribution per unit is constant.
 At varying levels of output and sales, profit per unit varies.
 Total contribution = Contribution per unit x Sales volume.
 Profit = Total contribution – Fixed overheads.
Example 2
Buhner LTD makes only one product, the cost information is as follows

Description $
Direct Materials 3
Direct Labours 6
Variable cost 2
Variable selling cost 5
Selling Price 21

Sales during the period were 3,000 units and actual fixed production overheads incurred were
$25,000.
A) Calculate the total contribution earned during the period?
B) Calculate the total profit or loss for the period?

Breakeven point
The breakeven point is the point at which neither a profit nor a loss is made.
At the breakeven point the following situations occur.

 Total sales revenue = Total costs, i.e. Profit = 0

 or Total contribution = Fixed costs, i.e. Profit = 0

The following formula is used to calculate the breakeven point in terms of numbers of units
sold. Breakeven point = (Fixed costs /Contribution per unit)

Example 3

A) Calculate the breakeven point in terms of number of units and sales revenue
Target Profit
This is the target level of profit which company wants to achieve after covering all variable and
fixed cost. To achieve target profit the company should be able to sell target profit level of
units.
The units is calculated using the formula:
(Fixed cost +Target profit)/ Contribution per unit= Level of units to produce to achieve target
profit
Margin of safety
The margin of safety is the amount by which anticipated sales (in units) can fall below budget
before a business makes a loss. It can be calculated in terms of numbers of units
The following formulae are used to calculate the margin of safety(in terms of units)
=Budgeted sales – Breakeven point sales
Example 4

The angle of Incidence (Could be illustrated using a diagram)

The angle of incidence illustrates the relationship between total costs and sales revenue. The
greater the angle, the greater the difference per unit between total costs and sales revenue. A
business would like the angle of incidence to be large, as the contribution and profit per unit
sold will be large.
Graphical representation of break-even analysis:

The High/Low method used for separating a semi variable cost

A number of methods exist for analysing semi-variable costs into their fixed and
variable elements. The main methods is:
 High/low method

High/low method
Total costs=Total fixed costs+(variable cost per unit* activity level)

Once the fixed cost and unit cost for an activity level has been identified. This
could be used to identify total cost at different activity levels.
Example 5
Outputs(units) Total costs($)
200 7,000
300 8,000
400 9,000
Required
A)Find the variable cost per unit
B) Find the total fixed cost
C)Estimate the total cost if output is 350units
D) Estimate the total cost if output is 600units

Limiting Factor
A limiting factor is a factor of production which restricts the level of activity / quantity of output.
Restricts meaning there is a shortage is usually labour hours or material therefore the production is
limited.

Order of Production

The process of ranking the product to be produced first based on highest contribution per limiting
factor. The process of ranking when the company has to choose the order of production.

1. Find the contribution per each product

2. Find contribution per limiting factor(By dividing the contribution by the limiting factor per unit)
3. Rank the product which gives highest contribution per limiting factor.

Contract to supply goods

A contract is legal binding agreement to sell a fixed number of goods for a fixed rate. The contract
should be given prominence and the sales should be made even though the contract might end up in a
loss. A contract could be drawn up for set period with lawyers registering the contract. Contracts could
never be verbal.
 Chapter 7 Investment ratios

There are several ratios which would be calculated by the Investors before purchasing the
shares of a company. These ratios are known as Investor ratios. It is necessary that you not only
memories the ratios but also learn to interpret them.

Earnings per share= Profit left for ordinary shareholder after interest, Tax, and preference
dividends have been provided for in the Income statement Account. Ordinary dividends are
paid out of earnings. Any balance not paid increase the retain earnings reserve.

Earnings per ordinary share = (Net profit after tax – preference dividend)/
Number of Issued ordinary shares
Having a higher EPS from previous years or compared to competitors Shows Company is
performing well.
Comment on the share if requested in the question. If it has increased from previous year. Why
has it increase. Reason for increase in Earnings per share is as follows and Vice Versa.

 If profits have increased from previous years earnings increase.

 If banks loans have been reduced.
 If preference Dividence has reduced.
Price Earnings Ratio= calculates the number of times the price being paid for the shares on the
market exceeds the earnings per share. The price-to-earnings ratio (P/E ratio) is the ratio for
valuing a company that measures its current share price relative to its per-share earnings (EPS).
P/E ratios are used by investors and analysts to determine the relative value of a company's
shares price against the Earnings done by a share.
Price/earnings ratio = Market price of share/ Earnings per share
Dividence Per share= This basically a calculation on how much a ordinary share holder has been
paid dividend.
Dividend paid per share = Total ordinary dividend/Number of Issued ordinary shares

Note: its number of ordinary shares not the value of ordinary shares .

Dividend Yield= The dividend yield is the ratio of a company's annual dividend per
share compared to its share price. The dividend yield is represented as a
percentage and is calculated as follows:
Dividend yield = (Dividend per share/Market price of share) x100
Comparing the dividend yield of different companies' stock allows you to see which company is
paying the best dividend relative to share price. Compute the dividend yield by dividing the
annual dividends per share by the current share price.
Dividend cover= The Dividend Coverage Ratio, also known as dividend cover, is a financial
metric that measures the number of times that a company can pay dividends to its
shareholders. The dividend coverage ratio is the ratio of the company’s net income divided by
the dividend paid to shareholders.
A lower dividend cover is preferred by investors as it states most dividend has been given out as
dividence.
Dividend cover = (Net profit after tax – preference dividend)/Total ordinary dividend
Return On capital Employed= ROCE is a profitability ratio that measures how efficiently a
company can generate profits from its capital employed by comparing net operating profit to
capital employed. In other words, return on capital employed shows investors how many
dollars in profits each dollar of capital employed generates.
ROCE is a long-term profitability ratio because it shows how effectively assets are performing
while taking into consideration long-term financing
Return on Capital employed = (Net profit before interest and tax /Capital employed) x 100
Net profit before interest adnd tax could also be known as operating profit(Earnings before
interest and tax).
Capital employed is addition of total capital plus Long term liabilities.

Gearing ratio could be of two types. It will be specific mentioned in question what ratio to
use.
Debt/Equity Ratio= The debt to equity ratio is a financial, liquidity ratio that compares a
company’s total debt to total equity. The debt to equity ratio shows the percentage of company
financing that comes from creditors and investors. A higher debt to equity ratio indicates that
more creditor financing (bank loans) is used than investor financing (shareholders).

DEBT/Equity= Total Long term Liabilities/(Ordinary shares +Reserves)

Debt/ Capital Employed= Debt-to-capital ratio is a financial, liquidity ratio that measures the
proportion of interest-bearing debt to the sum of interest-bearing debt and shareholders'
equity.
Debt/ Capital Employed= Total Long term Liabilities/(Ordinary shares +Reserves+ Total Long
term Liabilities)

Interest Cover= The interest coverage ratio is a financial ratio that measures a company’s
ability to make interest payments on its debt in a timely manner. Unlike the debt service
coverage ratio, this liquidity ratio really has nothing to do with being able to make principle
payments on the debt itself. Instead, it calculates the firm’s ability to afford the interest on the
debt.
Interest cover Ratio= Earnings before interest and tax(PBIT)/Interest expense.
What is the importance of Investment ratios?

 Being able to compare investor ratios can mean the difference between investing in a
good company or a bad company.
 Ratios are snapshots of financial statements than going through each and every
statement line by line. Before making an investment decision maybe the investor has
around 10 companies to choose.
 To compare performance from previous years or other companies.
 The ordinary shareholders should identify risk as if company closes down they would
not be able to claim money of long-term debts are high.
 The debenture holders to verify if the company is able to be pay interest monthly.

What are the Limitations of ratios?

 The ratios need to be accurate. The information to create ratios are taken from
financials statements in annual report. If the annual reports are wrong or if any
significant items are not entered. Window dressing takes place.
 Information’s needs to be on time. As audited statements are produced after 3 months
of financial year previous year accounts may have been used. Previous year and this
year records would be significantly different.
 Ratios can be interpreted in several ways.
 Ratios do not include PESTEL factors.
 Ratios are backward looking does not give information on future
The ratios of AS level should also be very familiar, there is less chances of you getting a full
question on this topic but there would be included as 5marks with other topics in your syllabus.
Thereby following ratios are all important and make sure you are familiar with it.
Profitability ratios Efficency ratios Financial ratios Investment ratios
Return on capital Capital employed to Current ratio
employed (ROCE) Turnover (Sales as a The above ratios
percentage to capital
discussed.
employed)
Net profit Margin Total asset turnover Liquid ratio
Gross Profit Margin Fixed asset turnover Stock turnover ratio
Current asset Debtor days
turnover
Creditors days
 Chapter 8

Budgets
What is budget? A quantitative expression of a plan of action prepared in advance
of the period to which it relates.
Budgets set out the costs and revenue that are expected to be incurred or earned
in future periods.
The difference between a forecasted and a budget?
Forecast is an estimate of the likely position of the business in future based on
past experience or present conditions
Budget is a statement of planned future results which are expected to follow from
actions taken by management to change the present circumstances.
Purpose of budgets?
 Planning for future
 Controling cost= by comparing planned budget with actual cost
 Co-ordinating= making sure managers are working towards same common
goal
 Communication= Targets to individual
 Evaluavation=Performance of managers judged by comparing to budget

The budget you should be familiar with end of this lesson are
1. Revenue budget
2. Production budget
3. Purchases budget
4. Inventory budget
5. Trade receivables
6. Trade Payables
7. Capital
8. Cash
How is budget helpful in planning?
Planning= Managers are responsible for planning and control of a business for the
benefit of owners, and budgets are essential tools for planning and controlling.
Business could plan for short term which is within one year and long term for
periods above one year. Limited companies should always have a strategic plan
for at least 5 years.

The budgets can be prepared using following ways.

 Top down budgets= The top management prepares budget and handed
down to departmental managers. Who are responsible of putting them to
effect.
 Bottom Up budgets= Are prepared by departmental management and
reviewed by top management.
Revenue Budgets = We identify the future revenue of the business using market
conditions, past and present experience. Sales budget is starting point in
preparing budgets.
Example 1 A company makes two products- A and B. The products are sold in the
ratio 1:1. Planned selling prices are 100 and 200 per unit respectively. The
company needs to earn 900,000 revenue in the coming year.
Prepare sales budget for the year.
Production budget= The production budget anticipates the number of products
to produce. The production budget anticipates finished goods.
Budgeted production levels can be calculated as follows
forecasted sales
Closing inventory
(opening Inventory)
Budgeted production
Example 2 A company makes two products, PS and TG. Forecasted sales for the
coming year are 5,000 and 1,000 units respectively.
The company has the following opening and required closing inventory levels.
PS units TG units
Opening inventory 100 50
Required closed inventory 1,100 50
Required: Prepare the production budget for the coming year?

Material budgets= There are two types of material budget you need to be able to calculate the usage
budget and purchase budget.

1. Material usage budget calculates the amount of material required to produce the production
budget. The calculation is done by simply by multiplying the production budget into the quantity
required to produce each product.
2. Material Purchase budget is made up the following elements
Material usage budget
Closing material Inventory
(opening material inventory)
Material Purchase budget
Example 3.
A company produces product PS and TG and has budgeted to produce 6,000 units of PS and 1000 units
of product TG in the coming year.
The data about the materials required to produce products PS and TG is given as follows.

PS TG
Finished Products: Per unit Per unit
KG of raw materials X 12 12
KG of raw materials Y 6 8

Direct materials Raw materials

X (KG) Y (KG)
Desired closing inventory 6,000 1,000
Opening Inventory 5,000 5,000

Standard rates and prices

Raw material X 0.72$ per KG
Raw material Y 1.52$ per KG
Required
A) The material usage budget
B) The material purchase budgets in units and values
Labour Budgets= Is the number of labour hours required to complete a unit. This
could simply be calculated by identify how much labour hours are required and
multiplied by the labour rate.
Example 4.
A company produces products PS and TG and has budgeted to produce 6,000
units of products PS and 1000 units of product TG in the coming year.
The data about the labor hours required to produce product PS and TG is given as
follows.
Finished Products:
PS per unit TG per unit
Direct Labour Hours 8 12
Standard rate for direct labour hours is =5.20 per hour
Required:
Prepare the labour budget for coming year?
Overhead Budgets include overheads a company would usually incur.
Example 5.
A company produces products PS and TG and has budgeted to produce 6,000
units of products PS and 1000 units of product TG in the coming year.
The following data about the machine hours required to produce product PS and
TG and the standard production overhead per machine hour is relevant to the
coming year.
PS per unit TG per unit
Machine hours 8 12
Production overheads per machine hour
Variable 1.54 per machine hour
Fixed 0.54 per machine hour
Required calculated the overhead budget for coming year
Reciepts from recievables
If a business offers credit sale these will be recorded in the income statement at
the point when sale is made. This does not reflect the actual cash received by the
business.
To calculate cash received from the credit sale there are two things to consider:
 The value of receipt- How much value of cash will be received from credit
sale.
 The timing of receipts- when will cash be received from the credit sale

Example 6
The forecasted sales for organization are as follows
Month January February March April
Sales 6,000 8,000 4,000 5,000
All sales are made on credit and receivable tend to pay in the following pattern.
In month of sale 10%
In month after sale 40%
Two month after sale 45%
Irrecoverable debts 5%

Calculate the forecasted cash receipts from receivable in April?

Payments to payables
If a business purchases on credit these will be recorded in the income statement
at the point when purchase is made. This does not reflect the actual cash paid by
the business.
To calculate cash payments from the credit purchase there are two things to
consider:
• The value of payment- How much cash will be paid to payable.
• The timing of payment - when will cash be paid to payable.
Example 7
A manufacturing business makes and sells widgets. Each widget requires two
units of raw materials, which cost 3$ each. Production and sales quantities of
widget each month are as follows.
Month Sales and production units
December(actual) 50,000
January(budget) 55,000
February(Budget) 60,000
March(Budget) 65,000

In the past, the business has maintained its inventories of raw materials at
100,000 units. However it plans to increase raw materials inventories to 110,000
units at end of January and 120,000 units at the end of February. The business
takes one month credit from suppliers.
Calculate the forecasted payments to suppliers for month of January, February,
March, for raw materials purchases.

Flexible budget is where the budget initially prepared does not match with
quantities sold. Therefore, the budget initially prepared must be changed
according to sales this is known as flexed budget. Thereafter the actual
performance could be matched with flexed budget. The reason for flexed budget
is its inappropriate to match budget and actual with different sales figures.
 Chapter 9
Statement of Cashflows

What is statement of cashflows?

A cashflow statement is one that lists the cashflow of a business over period of
time, Usually the same period as that covered by profit and loss account.
A cashflow is any increase or decrease in cash in a business. Cash includes cash in
hand and deposits repayable on demand, less overdrafts that are repayable on
demand.
Demand means fast or within 24 hours.
Why cashflows statements are important?
1. To Identify how much liquid cash is available to match immediate
payments. To identify if business can survive in short term.
2. To make decision making on increase capital, investment or prolong
payments which are possible and follow up on credit sale give cash
discounts encourage early payments.
3. Cashflows opening balance and closing balance will show the difference
due to running the business.
4. It will act as a controlling indicator.
Cashflows is a mandatory requirement by companies act and accounting standard
IFRS 1 to provide statement of cashflows. The preparation of cashflow statement
is guided by the standard IAS 07.
Drawbacks of statement of cashflows?
1. Statement of cashflows use historic information. We do not predict the
future
2. No interpretation is required by standard. Users will have to conclude
themselves. How cash would be brought in future
 The statement of cashflow is divided into following sections
 Operating Activities are principal revenue producing activities of the
business.

 Investing activities are cash spent on noncurrent assets, proceeds of sale of

non-current assets and income from investments.

 Financing activities include the proceeds of issue of shares and long term
borrowings made or repaid.

 Net increase or decrease in cash and cash equivalence is the overall

increase or decrease in cash during the period. This can be calculated by
comparing the level of cash on statement of financial position for current
and previous years.

 Cash means cash in hand and bank accounts balances, including overdrafts.

There are two methods to calculated cash generated from operations.

1. Indirect method= cashflow format has been prepared using this method.
2. Direct method= The method has been provided below.
Format For statements Cashflow
Cashflows from operating activities $ $
Profit before Tax XX
Add: Finance cost X
Profit before interest and tax/Operating profit XXX
Investment income (X)
Depreciation charge X
Loss/Profit on disposal of non-current asset X/(X)
(Increase)/Decrease in inventories (X)/X
(Increase)/ Decrease in trade receivable or Other (X)/X
Receivables
Increase/(Decrease) in trade payables or other X/(X)
payables
Cash generated from operations XXXX
Interest Paid (X)
Income Tax Paid (X)
Net cashflow from operating activities XXXXX

Cashflows from Investing activities

Purchase of PPE (X)
Proceeds of sale of equipment X
Interest received X
Dividence received X
Net cash used in investing activities X/(X)
Cashflows from Financing activities
Proceeds of issue of shares X
Repayment of Loans (X)
Dividence paid (X)
Net cash used in financing activities X/(X)
Net Increase in cash and cash equivalence XX/(XX)

Cash equivalence at end of the period. XX/(XX)

-Cash and cash equivalent at beginning of the (XXX)
period
Net Increase in cash and cash equivalence XX/(XX)

Example 1
Statement of financial Position of Geronimo at 31 December 2006 and 2005
2005 2006
Non-Current Assets $000 $000
Property Plant and Equipment 750 1048
Accumulated Depreciation (120) (190)
630 858

Current Asset
Inventory 105 98
Trade Recievable 86 102
Dividend recievable 50 57
Cash 18 42
259 299

Total Asset 889 1157

Capital and Reserve

Share capital 120 200
Share premium 80 106
Revaluavation Reserve 12 212
Retain Earnings 226 283
438 801
Non Current Liabilities
Loan 300 200

Current Liabilities
Trade Payables 79 77
Interest Accrual 5 3
Tax 67 76
151 156
Total capital and Liabilities 889 1157

Income statement of Geronimo at 31 December 2006

$000
Revenue 1,100
Cost of sales (678)
Gross profit 422
Investment Income(Other Income)
-Interest 15
-Dividence 57
Operating Expenses (309)
(Administration+Distribution)
Operating Profit 185
Finance cost(Interest) (22)
Profit Before tax 163
Tax (71)
Profit after tax 92

Additional Information
 Operating Expenses include a loss on disposal of Non-Current Asset of
$5,000.
 During the year plant which originally cost 80,000 and with depreciation
of $15,000 was disposed.
Required
A) Calculate cash generated from operations using indirect methods?
B) Calculate how much was paid for Interest Expense, Income Tax Paid and
find out the net cashflow from operations?
C) Calculate how much was received for Interest income and Dividence
recievable?
D) Calculate how much assets are Disposed and Purchased?
 E) Calculate cash inflows and Cash Outflows from financing activities?

Direct method

Cash sales XX
Cash received from recievables XX
Less:
Cash purchasers (X)
Cash Paid to credit suppliers (X)
Cash expense (X) (XX)
Cash generated from operations XXX

Note: Its always preferable to use Indirect method in Edexcel AL exams. Most of
the details provided would be to start the some in indirect method.
 Chapter 10

Standard Costing
The purposes of standard costing?
A standard cost is the planned unit cost of a product or service. It is an
indication of what a unit of product or service should cost.

Standard costs represent ‘target’costs and they are therefore useful for
planning, control and motivation. They are also commonly used to simplify inventory
valuation.

There are four main types of cost standards

 Basic standards.
 Ideal standards.
 Attainable standards.
 Current standards

Basic standards=these are long-term standards which remain unchanged over a

period of years. Their sole use is to show trends over time for items such as material
prices, labour rates, and labour efficiency. They are also used to show the effect of
using different methods over time. Basic standards are the least used and the
least useful type of standard.

Ideal standards= these standards are based upon perfect operating conditions.
Perfect operating conditions include: no wastage; no scrap; no breakdowns; no
stoppages; no idle time. In search for perfect quality, companies can use ideal
standards for pinpointing areas where close examination may result in large cost
savings. Ideal standards may have an adverse motivational impact because they are
unlikely to be achieved.

Attainable standards=these standards are the most frequently Encountered type of

standard. They are based on efficient (but not perfect) operating conditions. These
standards include allowances for the following: normal or expected material losses;
fatigue; machine breakdowns. Attainable standards must be based on a high
performance level so that with a certain amount of hard work they are achievable (unlike
ideal standards).
Current standards=these standards are based on Current levels of efficiency in terms
of allowances for breakdowns, wastage, losses and so on. The main disadvantage of
using current standards is that they do not provide any incentive to improve on the
current level of performance.
Variance we are going to look into are

 Material variances
 Labour variances
 Variable overhead variances

Material Variance= There are two causes of material cost variances

 A difference in purchase price is known as material price variance

 A difference in quantity used is known as material usage variance

Material Price variance is calculated as follows

Material price variance = (actual quantity brought × actual price) –
(actual quantity bought × standard price)

Material Usage variance is calculated as follows

Material usage variance = (actual quantity used × standard price) –
(standard quantity used for actual production × standard price)

Total material variance is the addition of Material price variance and material
usage variance.

Example 1 :The following information relates to the production of Product X.

Extract from the standard cost card of Product X one unit .
Direct materials (40 square metres × $5.30 per square metre) $212.

Actual results for direct materials in the period: 1,000 units were
produced and 39,000 square metres of material costing $210,600 in total
were purchased and used.

Required: Calculate the materials total, price and usage variances for Product X in the
period.

Example 2
James Marshall Ltd makes a single product with the following budgeted
material costs per unit:
2 kg of material A at $10/kg
Actual details:
Output 1,000 units
Material purchased and used 2,200 kg
Material cost $20,900
Calculate Total material variance, materials price and usage variances
Material Inventory and its impact on Variance

 The materials price variance is calculated on the total of all the materials
purchased in the period, whether they are used or not. Therefore a closing
inventory would not have a impact on material price variance
 The materials usage variance is based on the quantity of materials used.
Therefore make sure to account for material inventory in closing stock and
calculate the variance for usage.

Example 3
X Ltd purchases 4,000 kg of material at a cost of $8,400. It uses 3,300 kg to produce
600 units of product A.
Product A's standard cost card for material is as follows:
Material 5Kg @ $2 per Kg
Required: Calculate the price variance, the usage variance

Example 4
Blossom Ltd manufactures and sells garden statues.
The budget and actual results for materials in November are as follows:
Budget production of 7,500 units using 22,500 kg costing $90,000.

Actual production 6,500 units, 20,800 kg of material purchased costing

$91,520.
There was no opening inventory of raw materials at the start of November
but there were 500 kg of closing inventory at the end of November.
Required:
Calculate the material price variance, and the material usage variance

Labour variances= There are two causes of labour cost variances

 A difference in rate paid is known as labour rate variance
 A difference in hours worked is known as labour efficiency Variance

Labour rate variance is calculated as follows

Labour rate Variance=
(Actual Hours × Actual Rate)-(Actual Hours × Standard rate)

Labour Efficency Variance is calculated as follows

Labour effiency Variance=
(Actual hours × Standard rate)-(Standard hours for actual production × Standard rate)

Example 5
The following information relates to the production of Product X.
Extract from the standard cost card of Product X
Direct labour: Bonding (24 hrs @ $5 per hour) 120

Actual results for wages:

Production 1,000 units produced
Bonding 23,900 hours costing $131,450 in total
Required:
Calculate the labour total, rate and efficiency variances in the Bonding
department for Product X in the period.
Example 6

Variable overhead variances

Variable overhead variances are very similar to those for materials and labour because,
like these direct costs, the variable overhead cost also changes when activity levels
change.

Variable Overhead= There are two causes of variable overhead variances

  The variable overhead cost per hour was different to that expected an
expenditure variance
 working more or less hours than expected for the actual production an efficiency
variance
Variable Expenditure Variance=
(Actual Hours × Actual Rate) – (Actual hours × Standard rate)
Variable Efficency Variance=
(Actual hours × Standard Rate)- (Standard hours for actual production× Standard rate)

Example 7
The budgeted output for Carr Ltd for May was 1,000 units of product A.
Each unit requires two direct labour hours. Variable overheads are
budgeted at $3/labour hour.
Actual results:
Output : 900 units
Labour hours worked: 1,980 hours
Variable overheads: $5,544
Required:Calculate variable overhead total, expenditure and efficiency variances.

Example 8
The causes of variances can be classified under four headings?

 Planning errors lead to the setting of inappropriate standards or budgets. This may be
due to carelessness on the part of the standard setter.
 Measurement errors include errors caused by inaccurate completion of timesheets or job
cards and inaccurate measurement of quantities issued from stores.
 Random factors are by definition uncontrollable, although they need careful monitoring
to ensure that they are not, in fact, one of the other types of variance
 Operational factors occur during the production of the product or the provision of the
service. Factors could include less efficient staff being employed and material spillages.
 Chapter 11

Directors report
The companies act requires directors to prepare report for each year. The report
should include the following
1. A review of the business during the year
2. Any significant changes taken place, principle activities taking place
3. Any events which affect financial statement which is material taking place
after the year.
4. Recommended Dividence.
5. Name of directors and companies
6. Donation given to political parties or charities
7. Arrangements for health safety at work, social responsibilities.
8. Information on research and development.
Importance of directors’ report= The company is operated through his ideas, the
ideas should have a plan and resources. He would mention how he is going to
perform in the future. How his performance for the year has been. How is he
going to improve. The SWOT analysis briefed. These mentioned facts would not
be available anywhere else in the annual report.
 The importance of auditors’ report?
The shareholders are owners of the company. They appoint directors to run the
business on their behalf as per companies act. As directors will be preparing
financial statements they could manipulate the accounts to show higher figures to
get better bonuses or make interrelated transactions un favorable to
shareholders. Due to the above-mentioned reasoned auditors are appointed to
check if the directors reports give a true and fair view. Is there any errors,
misstatements or fraud being identified?
Auditors being appointed for the following
1. To check if proper books are maintained
2. Financial statement are matching with the books of prime entry and ledger
3. Auditors opinion true and far view
4. The accounts prepared in accordance with standards
The auditor’s responsibility extends reporting on directors report and stating
whether the statement in are consistent with financial statement. To verify if the
statement contains misleading information.
Auditors must be independent, qualified accountants and report to shareholders
not directors as a objective

Role of auditors with corporate governance

Corporate governance has 5 key area= Auditors are supposed to check each area on the following
manner.

Leadership – lead by an effective board, who are responsible for success of company, clear division of
responsibilities, with non-executive directors who should challenge. The Chairman is responsible for the
Board. No individual should be able to make all the decisions. An auditor could note in the Audit Report,
or enquire about division of responsibilities. For example, is the Chief Executive Officer also the
Chairman?

Effectiveness – board should have an appropriate balance of skills, experience, independence, and
knowledge to carry out duties effectively. Appointment to the board should be formal, rigorous and
transparent. There should be induction, self-evaluation, and re-election. An auditor could note in the
Audit Report (or ask) to check that re-election of board members at regular intervals does take place.
Accountability The board should present a balanced and understandable assessment of the company’s
position and prospects. The board is responsible for risk and internal controls, and should have sound
risk management. The board should maintain an appropriate relationship with the company’s auditor.

Remuneration Levels of remuneration should attract, retain and motivate directors of the required
quality. However, a company should avoid paying more than is necessary. Director’s remuneration
should be partly linked to individual and corporate performance. No director should be involved in
deciding their own remuneration.

Relations with shareholders The board is responsible for ensuring a satisfactory dialogue with
shareholders takes place, based on mutual understanding of objectives. Investors should be encouraged
to participate at the AGM. An auditor could note in the Audit Report (or ask) about sufficient notice
being given concerning the date of the AGM.