Upload
angelina-preston
View
237
Download
0
Tags:
Embed Size (px)
Citation preview
1
More Standard Costing & Variance Analysis
Week 10
2
Fixed Overhead Variances With Fixed Overheads we use BUDGETED
fixed overheads Fixed Overheads are absorbed into units of
output Total variance : Difference between actual
fixed o’h and absorbed fixed o’h (ie under- or over- absorbed fixed o’h)
Expenditure variance : difference between budgeted fixed o’h and actual fixed o’h
Volume variance : difference between budgeted production volume and actual production volume X std absorption rate per UNIT
3
Fixed Overhead VariancesScenario
Product “X” Budgeted output = 1,000 Std time to produce a unit = 2
hours Budgeted fixed o’h (FO) = £20,000 Therefore: fixed o’h absorption
rate (FOAR) per unit = 20,000 = £20 1,000
4
Fixed Overhead VariancesScenario
Actual Data Fixed Overhead = £20,450 Actual Output = 1,100 units Actual hours worked = 2,300
5
Total Variance
Actual fixed o’h = 20,450 Absorbed fixed o’h (1,100 units X FOAR £20) =
22,000 Variance 1,550
(F) (ie £1,550 of fixed o’h
OVERabsorbed)
6
Expenditure Variance
(this is the easy one) Budgeted fixed o’h = 20,000 Actual fixed o’h =
20,450 Variance 450 (A)
7
Volume Variance (Budgeted output – Act output) X
FOAR (1,000 – 1,100) X 20 = 2,000 (F)
Summary Expenditure 450 (A) Volume 2,000 (F) Total 1,550 (F) BUT……..
8
Fixed Overhead Volume Variance – Sub Variances
Volume Variance can be split into Efficiency variance Capacity variance We have FOAR per UNIT, need to
calculate FOAR per HOUR FOAR per hour = Budgeted Fixed
O’H Budgeted hours (1,000 X2)
= 20,000/2,000 = £10
9
Fixed Overhead Volume Variance – Sub Variances
Efficiency (Std hrs – Act hrs) X FOAR per hr = (2,200 – 2,300) X 10 = 1,000 (A) Capacity (Budgeted hrs – Actual hrs) X FOAR
= (2,000 – 2,300) X 10 = 3,000 (F) Volume 2,000 (F)
10
Fixed Overhead Volume Variance – Sub Variances
NOTES
Notes 1 Std hrs : Std time per unit = 2 hrs 1,100 units actually made Therefore Std hrs = 2 X 1,100 = 2,200 Notes 2 Budgeted hours = capacity Here 2,000 hrs were budgeted for but
actual hours exceeded that so effectively exceeded capacity
11
Back to Acme Blocks Fixed & Variable overheads Budgeted production = 1,000 units (blocks) Budgeted fixed o’heads = £0.30 per unit Budgeted variable o’heads = £0.10 per unit Budgeted fixed o’h absorption rate (hourly) 50 hours @ £6.00 per hour = 300 Budgeted variable o’h absorption rate (hourly) 50 hours @ £2.00 per hour = 100
12
Acme Blocks – Actual Data
Fixed overheads 68 hours @ £6.20 = £421.60
Variable overheads 68 hours @ £1.80
= £122.40
Note 10 hours “idle”
13
Acme Block - Analysis Total Variance 1,200 units should cost (1,200 X 10p) = 120.00 Actual cost = 122.40 Variance 2.40 (A)
14
Sub Variances Expenditure variance Productive hours (68-10) = 58 58 hrs should incur (58 X 2) = 116.00 Actual overheads = 122.40 Variance 6.40 (A) Efficiency Variance (Std hrs – Productive hrs) X VOAR If 1,000 units budgeted to take 50 hrs, Then 1,200 units should take 60 hrs (60 – 58) X 2 = 4.00 (F) Summary 6.40 (A) + 4.00 (F) = 2.40 (A)
15
Capital Investment Appraisal
If a company is going to invest in a project it need to ensure
The project will be financially viable
It will be successful Risk levels will be minimised
16
Discount or not? We will consider 4 methods of
decision making for capital projects Each method can be used to Make comparisons between projects
competing for scarce resources Make comparisons between a project
and a company benchmark 2 methods employ discounting 2 do not
17
Company scenarioVerminous Ltd (cost of capital 10%)
Verminous Ltd are contemplating the purchase of a new machine. They have a choice of either the "Weasel" or the "Stoat". The company has made some estimates of costs and expected cash inflows and this
is rovided below: WeaselStoat
£,000 £,000 Cost of Machine -400 -600 Cash inflows Year 1 80 -20 Year 2 90 260 Year 3 90 185 Year 4 120 200 Year 5 120 215 Year 6 60 Profit 160 240
18
Payback Period (PP) The payback period Is the period of time required for the
cumulative expected cash flows from an investment project to equal the initial cash outflow
This method computes the amount of time required to recover the initial investment
The acceptance criterion is dependent upon the maximum cutoff period established by management for projects of a similar type
19
Pros and Cons of PP Advantages
Easy to use and understand Can be used as a measure of liquidity Easier to forecast short term than long
term cashflows Disadvantages
Does not account for time value of money***
Does not consider cashflows beyond the payback period
The cutoff period is subjective
20
Weasel & Stoat cumulative cumulative -400 -400 -600 -600
Year 1 80 -320 -20 -620 Year 2 90 -230 260 -360 Year 3 90 -140 185 -175 Year 4 120 -20 200 25 Year 5 120 100 215 Year 6 60 Weasel = 4yrs 1/6th (4 yrs 2 months) Stoat = 3 yrs 7/8th (3 yrs 10.5 months)
21
A PP conundrum
M1 M2 M3Cost of machine -100 -100 -100Yr 1 cashflow 20 5 40Yr 2 cashflow 40 10 50Yr 3 cashflow 40 85 10Yr 4 cashflow 30 -20 200Yr 5 cashflow 20 -10 500What is PP? PP = 3 years for each
22
Accounting Rate of Return (ARR)
This technique is similar to ROCE ratio you are familiar with
Remember, ROCE can be used as a measure of management efficiency
How effectively can management make profit (return) from capital in the business (capital employed)
23
Accounting Rate of Return (ARR)
All other appraisal techniques are concerned with NET cashflows
ie cash generated less cash costs ARR considers Accounting Profit as
the measurement Accounting Profit = Income less all costs incurred in
generating that income, therefore includes depreciation
24
Accounting Rate of Return (ARR)
ARR = Average annual profit X 100 Average Investment
Average annual profit = total profit for project / number of years
Average Investment = (Capital cost + residual value) / 2
25
So, applying it toWeasel & Stoat
Weasel Stoat Total dep'n -400 -600
Year 1 80 -20 Year 2 90 260 Year 3 90 185 Year 4 120 200 Year 5 120 215 Year 6 60
Total profit 160 240
26
Which means..
There is no residual value, so full cost is depreciated.
Average Annual Profit = (Total Net cashflows – Full cost of asset) / years of project
Again, as no RV average investment = Cost/2
Weasel (160/6)/200*100 = 13% Stoat (240/5)/300*100 = 16%
27
ARR and ROCE Assume Verminous Ltd’s ROCE is 14% If Weasel were chosen it would reduce
(if only marginally) the company’s ROCE
If Stoat were chosen it would, of course, increase ROCE
In this case higher ARR = project with higher profit
But what is most important Profits or ROCE? Assume Verminous has ROCE of 12%...
28
ARR a conundrum Weasel Stoat Total depreciation -400 -600
Year 1 80 -20 Year 2 90 260 Year 3 90 185 Year 4 120 200 Year 5 120 145 Year 6 60
Total profit 160 170 ARR Av profit (160/6) 27 (170/5) 34 13% (W) Av Investment 200 300 11% (S)
29
Pros & Cons of ARR Advantages
generally accepted provides index of performance encourages managers to improve ARR can be used to gauge performance & make
comparisons Disadvantages
lack of consensus on definitions of capital or profit
can be manipulated can distort overall allocation of resources noncash items included ignores the timing of cash flows
30
Discounting methods Both PP and ARR assume absolute
values in cashflows The value of a cashflow today = the
same as its value in 5 or 6 years time There is no consideration of risk
involved (cashflows are estimates!) They assume the capital used is
costless Apart from the projects they assume
there is no alternative use for the capital (ie invest it)
31
A question..
Let us suppose you were given the choice of receiving £10,000 today or £10,000 in 3 years time.
Which would you choose?
32
Discounting cashflows The value of that £10,000 today can be
measured as £10,000 plus the potential value of interest earned.
If you were to receive your cash in 3 years time, then, you would expect to receive not just £10,000 but an additional sum for the interest receivable over that time period.
Conversely the value today of that £10,000 plus interest received in 3 years, would simply be £10,000.
33
Graphically represented
34
The use of PV tables
To discount cashflows use PV tables
Example (Also found in textbook)
35
Net Present Value
The essence of a business is to maximise shareholder wealth
If “raw” cashflows are considered it is possible that an apparent increase in wealth could actually result in a diminution
36
Application to Weasel & Stoat
Weasel Stoat DF @ 10% PV DF @ 10% PV
-400 1.000 -400.0-600 1.000 -600.0
Year 180 0.909 72.7 -20 0.909 -18.2 Year 290 0.826 74.3 260 0.826 214.8 Year 390 0.751 67.6 185 0.751 138.9 Year 4120 0.683 82.0 200 0.683 136.6 Year 5120 0.621 74.5 215 0.621 133.5 Year 660 0.564 33.8
NPV = 4.97 NPV = 5.63
37
Comparison of results
The 2 machines both have POSITIVE NPVs
But only just… It is up to management to
decide if the factors incorporated in the Discount Rate are sufficient to accept the project with the higher NPV
38
Internal Rate of Return (IRR)
The application of Present Values to the cashflows shows that the actual rate of return must be >10%
In some instances management would want to know the exact rate of return
We can find this by formula
39
Internal Rate of Return (IRR)
Ideal Scenario By “trial & error” calculate
Negative NPV As 10% gives Positive NPV Choose a higher Discount Rate In this case 11% should do Apply DF to cashflows &
determine NPV Then apply formula
40
IRR Formula IRR = A + C (B – A) C – D Where: A = discount rate of low trial B = discount rate of high trial C = NPV of low trial cashflow D = NPV of high trial cashflow
41
Weasel & Stoat Weasel Stoat
DF @ 11% DF @ 11%
-400 1.000 -400.0 -600 1.000 -600.0
Year 1 80 0.901 72.1 -20 0.901 -18.0 Year 2 90 0.812 73.1 260 0.812 211.1 Year 3 90 0.731 65.8 185 0.731 135.2 Year 4 120 0.659 79.1 200 0.659 131.8 Year 5 120 0.593 71.2 215 0.593 127.5 Year 6 60 0.535 32.1
NPV = -6.71 NPV = -12.37
42
Weasel & StoatOutcomes
Weasel IRR = 10 + [4.97/(4.97+6.71)]*1 10 +0.425514 = 10.43% Stoat IRR = 10 + [5.63/(5.63+12.37)]*1 10 +0.3128 = 10.31%