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ACC00724 Financial Analysis of the Company Assessment 2 Answer

Accounting for Managers (ACC00724) S3, 2019

Assessment 2 (20 Marks)

QUESTION 1 (10 Marks)

Several potential investors have been studying the affairs Grafton Pty Ltd to decide whether to invest in the company by purchasing unsecured notes with the company was proposing to issue. The statements of financial position at 30 June 2018 and 2019 follow:

GRAFTON PTY LTD

Statement of Financial Position

As at 30 June

20192018

CURRENT ASSETS$$

Cash at bank3,2642,832

Marketable securities1,5191,775

Accounts receivable1,178930

Inventories2,6191,848

Other current assets3,0943,605

Total Current Assets11,67410,990

Non-Current Assets19,96016,276

TOTAL ASSETS31,63427,266

CURRENT LIABILITIES

Accounts payable4,8804,300

Bills payable1,5742,555

Current maturities of long-term debt978450

Accrued expense720728

Provisions3,4202,345

Total Current liabilities11,57210,378

NON-CURRENT LIABILITIES

Long-term debt5,8004,160

2019201

$$

Accrued expenses (payroll)5,4254,730

Other non-current liabilities2,3902,055

Total Non-current Liabilities13,61510,945

TOTAL LIABILITIES25,18721,323

TOTAL EQUITY6,4475,943

TOTAL LIABILITIES AND EQUITY31,63427,266

Required:

  1. Calculate appropriate liquidity and financial stability ratios for the years ended 30 June 2018 and 2019. Research reveals that typical ratios in the industry for the current and quick ratios are 1.7:1 and 1.0:1 respectively. For financial stability ratios the Debt ratio (total liability/total assets) and the Leverage ratio (total assets/total equity), industry averages are 2.5:1 for the leverage ratio and 60% for the debt ratio. (must show your workings/calculations) (5 marks)
  2. Comment on the liquidity and financial stability of the company, given the information available. (3 marks)
  3. Would you, as one of the potential investors in unsecured notes, lend money to the company? Explain why or why not (2 marks)

QUESTION 2 (5 Marks)

Dunning Ltd. manufactures a popular power nail gun suitable for the home renovator. Financial and other data for this product for the last twelve months are as follows:

Sales20,000 units

Selling price $130 per unit

Variable manufacturing cost$50 per unit

Fixed manufacturing costs$400,000

Variable selling and administrative costs $30 per unit

Fixed selling and administrative costs$300,000.

The directors of Dunning Ltd. want to try to increase the profitability of this product and invited senior staff to suggest how this might be done. Three suggestions have been received.

The accountant, Jim Jackson, believes that a price increase of $10 per unit is the best way to boost profits. He would spend an additional $125000 on national advertising and contends, that if this is done, sales volume would not drop appreciably from last year.

The production manager, Tim Walter, thinks that an improved quality product could increase sales volume by 25% if accompanied by an advertising campaign costing $50000 aimed at tradespeople as well as home renovators. The improved quality would add $5 per unit to the variable cost. Mr Walter believes that the price should not be increased.

The sales manager, Sandy Smith, wants to undertake a promotion campaign where a $10 rebate is offered on all nail guns sold during the three months beginning 1 April. Normally 6000 units are sold during that period and Ms Smith believes that this could be boosted to 10,000 units if an advertising campaign costing $40,000 were launched late in March.

You have been asked by the Dunning board to comment on each of these three proposals. Draft a report in response to this request. You are not asked to make an outright choice, but rather to analyse the potential strengths and weaknesses of each proposal by calculating break-even point. The sales volumes forecast by each staff member should be treated as estimates only and your report should examine the effects of variations in actual sales from these forecasts and its respective break-even point. Show your calculations to support your comments and mention qualitative factors that may also be involved.

QUESTION 3 (5 Marks)

ABC Ltd makes trailers. It receives a special order to produce 350 trailers for a local retail outlet. The order will take 2,100 kg of material that costs $16.10 per kg and will require 1,400 direct labour hours and 525 machine hours. The following are the expected/budgeted annual costs for ABC Ltd:

Direct labour$327,600

Direct labour hours25,795

Direct materials$193,200

Indirect costs$98,400

Machine hours9,840

Required: (must show your calculations/workings)

  1. Calculate the overhead allocation rate: note that the process is labour-intensive (1/2 mark)
  2. Calculate the total costs of the special order (1 mark)
  3. Calculate the cost of the special order if ABC Ltd uses machine time as the basis for allocating overheads (1/2 mark)
  4. Calculate the minimum price per trailer that ABC Ltd could accept. (1 mark)
  5. Write around 200 words explaining how segmenting the overheads can help in allocating overhead costs to individual jobs or services. You must support your discussion by readings and research and acknowledge the source of your information (referencing). (2 marks)

Answer

Introduction

In this report, implication of the financial analysis of the company has been done. The profitability, liquidity and financial stability of the company has been assessed. Afterward, the implication of the costing method and computation of the break-even point analysis have been done. The assessment of the budget variance have also been made to assess the financial data of the company. 

Question 1 Financial Analysis

a) Calculation of liquidity and financial stability ratio

Details20192018Industry average ratio
Liquidity ratio   
Current ratio 1.01 t1.06 t1.70 t
Liquidity ratio0.78 t0.88 t1.00 t
Stability (financial stability ratio   
Debt ratio80%78%60%
Leverage ratio4.91 t4.59 t2.5
Debt to Equity ratio90%70%not given

(Please check the excel file for the computation of the data)

b) Position of the company’s stability and financial leverage 

The current ratio of company has been decreased by .5 times which reflects that company has decreased current assets. However, some changes in the current liabilities have also been ensured. The liquidity of the company is stable and showing to .78 times in 2019 which is .10 times lower due to the high blockage of the funds in its inventory.  The debt ratio of company has also been maintained to 80% in 2019 which reflects that company has kept higher debt capital in its business. The leverage ratio has also been increased to 4.91 times in 2019 by .30 times (Mookdee, & Bellamy, 2017).The current assets of the company has decreased by 14$ which may negatively impact the business and resulted to negative outcomes. In addition to this, higher debt capital may also impact the business stability (Peter, 2016).

c) Option to lend money

This has revealed that the company has been facing issue in the paying of its lending with the available liquidity. The decreased liquidity ratio may result to the low cash inflows in its business operation. Therefore, on the basis of the debt capital structure and liquidity, it could be inferred that if company is having unsecured debts in the company then it would be wise not to invest in this company (Hogan, Hutson, & Drnevich, 2017). The high financial leverage, low profitability and reduction in the financial leverage are the major negative factors which may negatively impact the business growth. Therefore, investing in this company is not viable decision for the return making purpose. 

Question 2 Break even sales

This is the point at which company would have no profit and no loss. This point is usually expected when a company is newly set up and new business in set up for the business. 

This case has revealed that with the advertisement costing of $125000 will result to the stable sales in the process.  In addition to this, advertisement costing will reduce the overall profit by $125000. The break-even point will be same and sales will increased to 25000 with the increased variable cost by $5 accompanied with the additional advertisement costing to $50000.  The suggestion given by manger would result to the increased sales volume to 10,000 units and increased the costing to $740000 (Song, et al. 2017).

The break-even point in the give case would be 18500 units 

Workings:-

Computation of the net effect
Incremental profit statement1st option2nd option3rd option
Increment in the costing
Advertisement$125,000 $50,000 $40,000 
Variable cost0250000
Total cost$125,000 $75,000 $40,000 
Contribution increased0$225,000 $160,000 
Net effect($125,000)$150,000 $120,000 


Contribution computation
DetailsSituation existingoption-1option-2option-3
sales volume (units)20000200002500024000
Sales price130140130120
less : variable cost     
        manufacturing cost50505050
       selling and distribution    cost30303030
         other variable cost 0050
Total variable cost80808080
Contribution50605040


Computation of the Break-Even sales
DetailsExisting situation of the companyoption-1option-2option-3
Fixed costing (Manufacturing$400,000 $400,000 $400,000 $400,000 
Fixed selling costing$300,000 $300,000 $300,000 $300,000 
Advertisement expenses$0 $125,000 $50,000$40,000
Total fixed costing$700,000 $825,000 $750,000 $740,000 
Contribution per unit$50604540
BEP14000137501666718500
sales volume data200002000025000$24,000 

Answer to question no-3

Costing and analysis 

a) Overhead allocation rate 

Details  Total amount
Direct materials$193,200 
Direct labour$327,600 
Indirect costs$98,400 
Total overhead$619,200 
Total labor hour25,795
Total overhead rate$24.00 

b) Calculation of total cost of the special order

Computation of the total cost of the given special order
DetailsPer unitTotal amount
Total quantity350 
2100 kg of raw material$16.10 
1400 hour of direct Labour$12.70 
525 hour of machine hour$10.00 
Total costing of the orders$38.80$13,580.00

c) Computation of the overhead rate based on the labor hour

Total costing of the special orders
Particulars Amount
Total overhead rate$62.93 
Total machine hour525
Total cost of the project$33,037 

d) Calculation of minimum price of special order for ABC ltd.

Minimum price computation data
Details Total amount Total amount
Total quantity  350
2100 kg of raw material$16.10 
1400 hour of direct Labour$12.70$28.80
Total variable cost $10,080.00

e) Segment overhead costing

To understand the segmental analysis, concepts related to cost, nature of products is considered. There are many types of cost to identify the product specific cost and segment costing is the best costing method for evaluating the actual cost of the product. Organization having the complexities in the process distribute the work according to the work and operation. Activity based costing is another costing method which helpful to identify the actual cost of product in the process an operations (Peter, 2016).  According to the activity based costing, it is based on the operation, or the cost distribution is depending on the correct method which offer the exact cost specifically assigned to specific job and service. For the awareness of allocated overheads and expenses factor, make expensive and non-value added operation provides more visibility for the proper absorption of the costing in the method (Mrdutt, et al. 2018).

On the other side if Business employ is follow  the traditional costing approach is more simplistic and less accurate than actual based costing  so that the organization not identify the actual cost and income aspects to the specific products. Under traditional costing strategy, the company charges all costs to the commodity, be it connected or not, and lose little benefit value (Lumpkin, & Ireland, 2018).

However, by using the strategy and proper costing methods company could easily absorb the costing in the different work segments.  If company follows the segment costing approach then it distribute the direct and indirect cost for the particular work and operation and absorb the costing in the particular process to determine actual costing associated with the particular segment process (Lin, Liang, & Chen, 2011). The segment costing approach is used for the particular section which is helpful in determining the right cost associated with the process, and also assist in evaluating the cost of the product associated with the process. Any product that is not making profit is kept separate in the costing and cost center and product that is not profit making and cost center should then take appropriate action to make this profit center of the product. The organization uses multiple cost drivers based on the transaction-specific or product-specific for the allocation of cost to a particular products and process (Lee, 2019).

Conclusion

After analysis the undertaken computation in the given case study, it is inferred that the company has increased the financial leverage of the company which has negatively impacted the business sustainability. It could be concluded that the company's higher financial leverage may result in the capital's lower cost but it also negatively impacts the investment decision of the investors. The costing of the absorption is also useful in determining the correct costing associated with the operation for the better absorption of the costing in different process.

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