Management Accounting Theory

Question 1

What are the objectives of a company listed on a stock exchange?

Answer 1

1. Increase sales revenue
2. Lower costs
3. Increase share price
4. Increase dividends
5. Produce good quality products
6. Have an extended & improved product range
7. Good customer service & reputation
8. Good relations with local community
9. Behave in a socially & environmentally responsible manner
10. Growth/defence of market share
11. Expand into new geographical markets

Question 2

What are the objectives of a company not listed on a stock exchange? (Shares owned by members of family)

Answer 2

1. Provide high salaries
2. Provide other forms of remuneration (cars, trips abroad) for family members that are directors or employed by company
3. Employee welfare
4. Good relations with local community

Question 3

What is a budget?

Answer 3

Forward-looking formal plan that states what’s expected (or planned) to happen in the business over the next budget period

Question 4

What are the main purposes of budgeting?

Answer 4

1. Planning & anticipation for future eventualities to ensure organisation decisions align with its goals
2. Communication btwn different parts of organistion and different levels of management & coordination of activities (e.g. production and sales department)
3. Motivation as a target to work towards
4. Authorisation of budgeted expenditure & responsibility to meet said budgets
5. Evaluation & control of whether budgets are fulfilled

Question 5

What are the limitations of budgets?

Answer 5

1. Badly set budgets may result in dysfunctional behaviour
2. Must assign resposbilities fairly
3. Subject to error and revision is frequently required bc based on FUTURE expectations
4. Takes time -> costly
5. Doesn’t replace need for managerial decision-making
6. Some important factors may not be quantifiable (e.g. customer relations) -> won’t be included in budget

Question 6

What is a cash budget?

Answer 6

Forward-looking document that shows cash inflows & outflows and net cash position of business on weekly/monthly/quarterly basis

Question 7

Why is a cash budget important?

Answer 7

Helps business identify any shortfalls of cash such that it can mitigate it by arranging additional finance (issuing shares, leasing/selling NCA, taking loans, bank overdraft)

Question 8

Why is cash vital for business survival?

Answer 8

Because if a business lacks cash, it won’t be able to pay its employees, suppliers, tax & other government charges, loan repayments or loan interests

Question 9

What is the limiting factor for a business?

Answer 9

Usually sales -> sets level of all other business activities

Question 10

Cash Payment for Purchases

Answer 10

If Gross Profit Margin given: x%
COS: remainder of x% x Sales Budget

Question 11

What is working capital?

Answer 11

Inventory, receivables and payables
If cash is invested in working capital -> can’t be used to invest in new business projects or pay employees, finance providers or tax authorities
Benefits: (1) hold sufficient inventory supply to avoid unexpected shortages, (2) maintain good relations with customers and suppliers

Question 12

What does working capital represent?

Answer 12

Cash tied up in day-to-day business operations

Question 13

Cash operating cycle (Working capital investment)

Answer 13

Period it takes to recover cash tied up in working capital
Cash Operating Cycle:
Inventory Holding Period + Receivables Collection Period - Payables Payment Period

Question 14

Shorter Cash Operating Cycle implies

Answer 14

Less money tied up in working capital

Question 15

What can firms do to keep investment in working capital to a minimum?

Answer 15

1. Hold only bare minimum level of inventory to meet expected short-term needs -> but may be impossible to get inventory at short notice in case of sudden business opportunities/spoilage -> customers go elsewhere -> loss in sales & customer goodwill damage
2. Offer short credit terms to customers or only make sales for cash -> customers can buy from other stores that sell on credit and more favourable terms
3. Delay payment to suppliers as long as possible -> supplier can refuse to sell business more goods or insist on immediate cash payment

Question 16

Investment in working capital example

Answer 16

Sales: 60,000 @ $6.50 = $390,000
Receivables: 3 months
Receivables outstanding: 390k x 3/12 = $97,500
GPM: 40%
COS: 60% x 390k = $234,000
Inventory holding: 2 months
Average inventory holding: 234k x 2/12 = $39,000
Payables: 1.5 months
Average payables outstanding: 234k x 1.5/12 = $29,250
Working Capital Investment: Receivables Outstanding + Payables Outstanding - Inventory Held
$97,500 + $39,000 - $29,250 = $107,250

Question 17

What is credit control?

Answer 17

Way to manage receivables by (1) checking creditworthiness of prospective customers to mitigate bad and doubtful debts, (2) regularly checking if there are overdue debts and (3) contacting customers via telephone or mailing to remind them to pay
If customers continuously fail to pay -> business should stop selling to tem and take legal action against them using up-to-date and accurate records of customer transactions

Question 18

Credit discount example

Answer 18

Allow 3 months credit to customers. Bank charges overdraft at 1.25% per month. Should firm offer 2.5% discount for payment within 2 months?
= assume $100 sale. If discount applies: $97.50 after 2 months vs $100 after 3 months
Effect: 100-97.5 = 2.5 ‘interest’. Interest from borrowing $100 from bnk: $1.25
2.5 > 1.25 -> costlier to offer discount than wait another month and incur bank overdraft interest charges

Question 19

What should firms do if they anticipate cash deficit?

Answer 19

1. Negotiate to collect money from customers earlier (using discounts as incentive)
2. Negotiate paying suppliers later
3. Renegotiate loan repayment
4. Buy new inventory later (if it won’t cause any issues)
5. Lease/Sell NCA to other companies