Answers to 3 Finance and accounts

Answers are given below to the student workpoints, toolkits and practice questions in the book. Answers are
not exhaustive but give guidance to students on the key points to cover.

3.1 INTRODUCTION TO FINANCE

Student workpoint 3.1 (p150)
Relevant company examples should be provided that show the distinction between capital expenditure and
revenue expenditure. Company capital expenditure items could include buildings, vehicles and machinery.
Company revenue expenditure items could include wages, rent and insurance.

Practice question (p151)

a) Capital expenditure involves spending money to acquire fixed assets. These are items that will last in a
business for more than a year and can be used over and over again. For the South-East Asian farmers,
examples of fixed assets include farm machinery like tractors, farming land, and lorries or pick-up trucks
to help transport goods to the market. These fixed assets would be beneficial to the farmers over a
longer period as they are a means of generating income for their businesses. The farmers can also use
these assets as collateral for loans from the banks to acquire even more farm inputs to help their farm
operations succeed and grow.
Revenue expenditure is where money is spent on the day-to-day running of a business or venture. For
the South-East Asian farmers, examples of such expenses include wages, fertilizer costs, and fuel for
their farm vehicles. The farmers need to understand that keeping track of their revenue expenditure
is important, and that funds for this need to be available immediately or in the short term to keep
their farms or businesses operational. On the other hand, the farmers need to be careful not to have
consistently high revenue expenditure as this makes it difficult for them to build sufficient capital
required to make long-term investments, for example in more land or farm vehicles.
Accept any other relevant response.
Mark as 2+2. Award [1] for each correct and relevant explanation of why understanding capital
expenditure would be beneficial to the South-East Asian farmers, up to [2]. Award [1] for each correct
and relevant explanation of why understanding revenue expenditure would be beneficial to the South-
East Asian farmers, up to [2]. Maximum award: [4].

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3.2 SOURCES OF FINANCE

Student workpoint 3.2 (p153)
Internal sources of finance could include personal funds, sale of assets, and retained profit.

Student workpoint 3.3 (p160)

Examples of sources of finance available to private sector organizations include bank loans, crowdfunding
and business angels. A key source of finance for public sector organizations is with the help of the
government through tax provision.

Student workpoint 3.4 (p161)

Source of finance Short-term Long-term
Retained profit ✓
Trade credit ✓
Leasing ✓ ✓
Sale of assets ✓ ✓
Crowdfunding ✓
Share capital ✓
Overdrafts ✓
Loan capital ✓
Microfinance providers ✓ ✓

Practice question (p165)

a) A business angel is a very affluent individual who provides financial capital to a small start-up or
entrepreneur in return for ownership equity in their business. Also known as an angel investor, they
invest in high-risk businesses that show good potential for high returns or future growth.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above
(candidates are not expected to word their definition exactly as above).

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b) Despite taking a long time to save the funds, Maria has control over THDS’s finances. She does not
need to pay the funds back or rely on outside investors or lenders, who could decide to withdraw their
support at any time.
Maria knows exactly how much money is available to run her business. This includes knowing how
much she received after selling her household items.
Accept any other relevant response.
Mark as [2+2]. Award [2] for each correct and relevant explanation, up to a maximum of [4].
c) A bank overdraft would allow Maria to withdraw more money than she currently has in the THDS
business bank account. As she has a reasonable amount of money in her account already, there is a
good possibility that she will get even more funds. In this case, interest is only charged on the amount
overdrawn. However, should Maria exceed the limit that the bank set, she may attract higher additional
bank costs.
For a long-term loan, interest is charged on the full loan to be repaid; however, these repayments
(installments) are usually spread evenly until the full loan amount (principal plus interest) is paid.
Benefits to Maria of taking up a long-term loan compared to a bank overdraft:
➔ Its repayment is spread out over a predetermined period of time, reducing the burden to THDS of
having to pay it in a lump sum (as may be the case with a bank overdraft).
➔ Having been in business for at least two years, Maria can negotiate for lower interest charges
depending on the amount she wishes to borrow, which may not be the case with a bank overdraft.
Drawbacks to Maria of taking up a long-term loan compared to a bank overdraft:
➔ Maria may need to provide collateral (security) before the loan is approved, which is not a
requirement when obtaining a bank overdraft.
➔ If Maria takes up a long-term loan with variable interest rates, should these rates increase then she
will be faced with a higher debt repayment burden over the long term. Even though bank overdraft
interest rates may be high, they are paid off in the short term.
➔ Paying interest only on the amount overdrawn, as in the case of a bank overdraft, can make it a
cheaper option than a long-term loan.
Accept any other relevant response.
Limitations of the stimulus material:
➔ What type of business organization is THDS?
➔ How large is THDS in terms of its organizational structure?
➔ How much exactly does Maria have in her account?
In deciding which of the two options is best, Maria will also need to think about: the cost of the source
of finance, the specific amount required, and the state of the external environment. These factors could
seriously influence her choice.

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Marks should be allocated according to the following level descriptors:

Marks Level descriptor

0 The work does not reach a standard described by the descriptor.
1–2 • Little understanding of the demands of the question.
• Little use of business management tools and theories; any tools and theories that are used are irrelevant or
used inaccurately.
• Little or no reference to the stimulus material.
• No arguments are made.
3–4 • Some understanding of the demands of the question.
• Some use of business management tools and theories, but these are mostly lacking in accuracy and relevance.
• Superficial use of information from the stimulus material, often not going beyond the name of the person(s) or
name of the organization.
• Any arguments made are mostly unsubstantiated.
5–6 • The response indicates an understanding of the demands of the question, but these demands are only
partially addressed.
• Some relevant and accurate use of business management tools and theories.
• Some relevant use of information from the stimulus material that goes beyond the name of the person(s) or
name of the organization but does not effectively support the argument.
• Arguments are substantiated but are mostly one-sided.
7–8 • Mostly addresses the demands of the question.
• Mostly relevant and accurate use of business management tools and theories.
• Information from the stimulus material is generally used to support the argument, although there is some lack
of clarity or relevance in some places.
• Arguments are substantiated and have some balance.
9–10 • Clear focus on addressing the demands of the question.
• Relevant and accurate use of business management tools and theories.
• Relevant information from the stimulus material is integrated effectively to support the argument.
• Arguments are substantiated and balanced, with an explanation of the limitations of the case study or
stimulus material.

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3.3 COSTS AND REVENUES

Student workpoint 3.5 (p167)
In classifying and categorizing the costs, it is important to note that unlike variable costs that change with
the number of goods or services produced, fixed costs do not change with the amount of goods or services
produced. In addition, direct costs are clearly attributed to the production of specific goods or services, while
indirect costs are not clearly identified with the production of specific goods or services.

Toolkit: Contribution: absorption costing (p168)

How does absorption costing differ from variable costing?
Variable costing (also called marginal costing or direct costing) is a managerial accounting method in which all
variable costs – including direct material, direct labour, and variable overhead costs – are assigned to a given
product, and the fixed overhead costs are expensed (deducted as expenses) in the period in which they are
incurred.
“Variable overhead costs” are defined as costs that change as the volume of production changes or the number
of services provided changes. Variable overhead costs increase as production output increases and decrease
when production output decreases. If there is no production output, then there will be no variable overhead
costs. Variable overhead cost examples include sales commissions, supplies, and raw materials used in
production.
“Fixed overhead costs” are costs that do not change even when the volume of production activity changes.
Fixed overhead costs are necessary to keep a company operating smoothly. Fixed overhead cost examples
include insurance, salaries of plant managers, and rent of the office.
Under the variable costing method, fixed overhead costs are not included in the cost of sales. In contrast,
absorption costing applies all direct costs, fixed overhead costs, and variable overhead costs to the cost
of the product. The cost of sales under absorption costing includes direct material, direct labour, and all
overheads.
Absorption costing hence includes all of the direct costs associated with manufacturing a product. Variable
costing includes all of the variable costs in the cost of sales but excludes the fixed overhead costs.
What are the advantages and disadvantages of using absorption costing in accounting?
Advantages of absorption costing:
➔ It is compliant with generally accepted accounting principles (GAAP). A key advantage of choosing to
use absorption costing is that it is the most suitable method for the purposes of preparing accounts as it
is GAAP compliant. A major reason for this is that stock is not undervalued when using this method.
➔ It considers all production costs. Absorption costing considers all of the costs of production, unlike
variable costing that just considers direct costs. Absorption costing includes a company’s fixed costs of
operation, such as salaries, rental facilities and utility bills. With absorption costing, the management
of a company has a more complete picture of the cost per unit for a product, and can easily evaluate
profitability and determine the prices of products.

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➔ It tracks profits accurately. Absorption costing provides a company with a more accurate picture of
profitability than variable costing, especially if all of its products are not sold during the same accounting
period that they were manufactured. This is important if a company increases production in advance of
an anticipated seasonal increase in sales.
Disadvantages of absorption costing:
➔ Skewed profit and loss statement (also known as the income statement). Absorption costing can make
a company’s profit amount appear much better than it actually is during a given accounting period. This
is because all fixed costs are not deducted from revenues unless all of the company’s manufactured
products are sold. This skewing of profit and loss statements can potentially mislead both company
management and investors.
➔ It has no influence on operational efficiency. Absorption costing does not provide as good an analysis
of cost and volume as variable costing. If fixed costs are a large part of total production costs, it is
difficult to determine differences in costs that occur at various production levels. This makes it more
difficult for company management to make the best decisions for operational efficiency. (Note that
operational efficiency measures how much cost is incurred during a given financial period, where lower
costs equals greater efficiency.)
➔ It is not suited to product line comparisons. Variable costing (unlike absorption costing) is more useful
if a company wishes to compare different product lines’ potential profitability. It is easier to recognize the
differences in profits from producing one good over another by looking only at the variable costs directly
related to production of that good.
Find two company examples that use this method.
Examples could include Coca-Cola and Tesla.

Toolkit: Descriptive statistics (p168)

To what extent would the use of mean, mode and median be useful when analysing financial data
for businesses?
In descriptive statistics, a measure of central tendency is a single number or value that attempts to describe
or represent a set of data by identifying the central position within that set of data. In finance for example,
single values can be used to describe or represent a set of financial data because most data tends to cluster
around central points.
The three most common measures of central tendency that are applicable in finance are the mean, median,
and mode. Each of these measures calculates the location of the central point using a different method. The
choice of which type of measure of central tendency to use depends on the type of data in hand.
Mean: this is the most popular and familiar measure of central tendency. Often called the average, it is the
sum of all the data points divided by the number of data points.
The main advantage of the mean is that it is the only measure of central tendency where the sum of the
deviations of each value from the mean is always zero. However, the one main disadvantage of the mean is
that it is susceptible to the influence of outliers. As the data becomes skewed, the mean loses its ability to
provide the best central location for the data because the skewed data is dragging it away from the typical
value.

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Median: this is the middle number in an arranged list of numbers. It is the value that separates the higher
half from the lower half of a data sample. In a data set, it may be thought of as the “middle” value. For
example, in the data set [11, 12, 13, 16, 17, 18, 19], the median is 16: the fourth largest, and also the fourth
smallest, number in the sample.
The advantage of the median is that it is less affected by outliers and skewed data. This aspect makes it a
better option than the mean as a measure of central tendency.
Mode: this is the number that appears most frequently in a data set. A set of numbers may have one mode,
more than one mode (bimodal), or no mode at all. To find the mode, the numbers should be arranged in order
of magnitude (from least to greatest), then the number of times each number occurs should be counted.
The number that occurs the most is the mode. For example, the data set below gives the age of 11 finance
students in a graduate class, in whole years:
24, 24, 24, 25, 26, 27, 27, 28, 28, 30, 30
The following table shows a simple frequency distribution of the finance students’ age data. Such a table
is known as a frequency table. The frequency table is created by arranging collected data values and their
corresponding frequencies. The purpose of constructing this table is to show the number of times a value
occurs.

Age Frequency
24 3
25 1
26 1
27 2
28 2
30 2

The most commonly occurring value is 24; therefore, the mode of this distribution is 24 years.
The advantage of the mode over the median and the mean is that it can be found for both numerical and
non-numerical data. However, the mode does have some limitations. In some distributions, the mode may
not reflect the centre of the distribution very well. The presence of more than one mode can limit its ability in
describing the centre or typical value of the distribution. This is because a single value cannot be identified
to describe the centre.
In some cases, particularly where the data are continuous, the distribution may have no mode at all, such as
if all values are different. In this case, it may be better to consider using the median or mean.
How would this information be visually presented?
The graphical representation of a frequency table is called a histogram. On a histogram, the mode is
represented by the highest bar.
The mean and median can be visually presented using bar charts or line graphs.

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Practice question (p169)

a) (i) Fixed costs are costs that do not vary with the amount of goods or services produced by a
business. They are expenses that should be paid regardless of any business activity the firm
engages in. Examples of fixed costs include insurance, salaries, and rent.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer
above (candidates are not expected to word their definition exactly as above).
(ii)  Revenue is the income earned from the sale of goods and services. Revenue includes all income
received, whether the goods or services were sold on credit or for cash.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer
above (candidates are not expected to word their definition exactly as above).
(iii) Profit is the amount earned after subtracting the costs or expenses from revenue. It is the financial
gain obtained when the total revenue generated exceeds the total costs incurred.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer
above (candidates are not expected to word their definition exactly as above).
b) Direct costs are costs that can be identified with the production of specific goods or services. They are
expenses that can be traced directly to a particular product or department. An example for TAK could
be labour costs, which is tied to the number of trips a TAK driver makes while driving the tourist van.
Another example is the fuel cost tied to the number of tourist trips made.
Accept any other relevant response.
Mark as [2+2]. Award [2] for each correct and relevant explanation that uses examples, up to a
maximum of [4].
c) The financial consultant could advise Tom to increase his revenue streams in the following ways:
➔ Sale of fixed assets – Tom could sell the two five-year-old vehicles to generate more revenue and
just keep the three that are newly acquired.
➔ Rental income – Tom could hire out his office space during the low seasons when there are fewer
tourists.
➔ Sale of company shares – Tom could sell more shares from the company he is a shareholder in and
plough this back into TAK.
Accept any other relevant response.
Mark as [3+3]. Award [1] for each correct and relevant revenue stream identified, up to [3]. Award an
additional [1] each for a relevant explanation, up to [3]. Maximum award: [6].

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3.4 FINAL ACCOUNTS

Student workpoint 3.6 (p175)
a) Answers shown in bold in the table below.
$000
Sales revenue 950
Cost of goods sold 300
Gross profit 650
Expenses 300
Profit before interest and tax 350
Interest 10
Profit before tax 340
Tax 40
Profit for period 300
Dividends 50
Retained profit 250

b) The stakeholders include shareholders, employees, customers, and suppliers.

c) 
Shareholders: shareholders are keen to establish how profitable BTW Ltd is in order to assess the safety
of their investment. They are interested in knowing how valuable the business is becoming throughout
its financial year. They can check how efficiently BTW Ltd is investing capital in an attempt to make a
worthwhile return on their investment.
Employees: if BTW Ltd is a profitable business, it could signal to employees that their jobs are secure.
This can also indicate that they may get pay increases. They can also see the potential for business
growth, further strengthening these two aspects of job security and salary increases.
Customers: customers are keen to know whether there will be a constant supply of BTW Ltd’s products in
the future. This can influence how dependent they should be on BTW Ltd and how secure they feel it is.
If BTW Ltd lacks security, perhaps due to low profitability, customers will go elsewhere where supply is
reliable and guaranteed.
Suppliers: suppliers can use the final accounts from BTW Ltd to negotiate better cash or credit terms.
They can either extend the trade credit period or demand immediate cash payments. The security of BTW
Ltd, and thus its ability to pay off its debts, will be a key concern for suppliers.

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Student workpoint 3.7 (p180)

1. Figure changes and answers shown in bold.
XYZ Ltd (profit-making entity)
Statement of financial position as at 30 June 2022
$m $m
Non-current assets
Property, plant and equipment 600
Accumulated depreciation (30)
Non-current assets 570

Current assets
Cash 30
Debtors 20
Stock 50
Current assets 100
Total assets 670

Current liabilities
Bank overdraft 6
Trade creditors 35
Short-term loans 15
Current liabilities 56

Non-current liabilities
Borrowings – long term 275
Non-current liabilities 275

Total liabilities 331

Net assets 339

Equity
Share capital 220
Retained earnings 119
Total equity 339

2. Uses of the balance sheet:

➔ To determine the net worth of a business. The net worth helps a business to ascertain its true value.
This can be calculated by working out the difference between the total assets and total liabilities.
➔ To check how sustainable the business is for future operations. One way of doing this is by looking at
the value of non-current assets compared to the value of current assets. If the non-current assets have
a higher value than the current assets, it means the business has a good chance of sustaining future
operations.

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➔ To check on the possibility of dividend issuance. Shareholders would like to know if they will get a
return on their investment. If a business has a sufficient amount of retained earnings, that is a good
indication it is profitable and the likelihood of dividend issuance is high. These dividends are a form
of return on the shareholders’ investment.
Limitations of the balance sheet:
➔ Non-current assets are usually recorded at historical cost. Historical cost is often criticized for its
inaccuracy since it may not reflect the current market valuation. Because of this, the balance sheet
does not show the true value of such assets.
➔ Use of estimates. Since some current asset values are based on estimations, the balance sheet
does not reflect the true financial position of the business.
➔ Omission of valuable non-monetary assets. The balance sheet does not reflect assets that cannot
be expressed in monetary terms, such as honesty, skill, and employee loyalty.

Student workpoint 3.8 (p184)

orignal cost - residual value
1. annual depreciation =
expected useful life of asset

$2,000 - $200
annual depreciation expense = = $360
5

2. [ (cost basis of asset - salvage value)

]
(estimated total units to be produced over estimated useful life)
= units of production rate

[ ($2,000 - $200)
100,000 ]
= 0.018

units of production rate = 0.018

estimated total units produced over estimated useful life
= actual units produced
useful life
100,000
= 20,000
5
actual units produced per period = 20,000

units of production rate × actual units produced = depreciation expense

0.018 × 20,000 = $360

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Practice question (p186)

a) 
Copyright provides a creator with the exclusive right to protect the production of their work. Hence,
the original creators of products and anyone provided with authorization are the only ones with the
exclusive right to reproduce the created work. Anyone wishing to use a copyright holder’s work must
seek permission from them to do so.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above
(candidates are not expected to word their definition exactly as above).
b) (i) X is US$10,500 (total equity), Y is US$48,000 (creditors). Missing figures are in bold in the balance
sheet below.
Award [2] each for the calculation of (X) total equity and (Y) creditors. Maximum award: [4].
(ii) BPT Ltd
Statement of financial position as at 31 October 2021
US$ US$
Non-current assets 30,000
Depreciation (1,500)
Non-current assets 28,500

Current assets
Cash 2,000
Debtors 28,000
Stock 0
Current assets 30,000
Total assets 58,500

Current liabilities
Creditors 48,000
Short-term borrowing 0
Current liabilities 48,000

Non-current liabilities
Long-term loan 0
Non-current liabilities 0

Total liabilities 48,000

Net assets 10,500

Equity
Share capital 2,000
Retained earnings 8,500
Total equity 10,500

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In terms of layout, award [4] for a fully accurate and fully labelled balance sheet that conforms to
the layout in the IB Business Management Guide.
If the balance sheet balances but the order of the assets or liabilities is slightly inaccurate
(according to the generally accepted method the candidate has chosen), award [3].
If the balance sheet balances but the order of the assets or liabilities is significantly inaccurate,
such as placing share capital and retained earnings as a liability, award [2].
Award [1] if the candidate conveys some understanding of a balance sheet and some sense that
total assets equal total liabilities + total equity.
Do not penalize a response more than once for errors that are carried forward.
Apply the Own Figure Rule (OFR). The Own Figure Rule means that if students give an incorrect
answer (figure), then provided they show their workings, they will be rewarded for what is correct.
Marks are not deducted for mistakes.
c) Benefits to Mary of using the units of production method include:
➔ The units of production method writes down an asset based on its usage as opposed to time,
because the depreciation expense is directly tied to the wear and tear on the asset. For Mary, this
would be a more accurate reflection of the declining physical value of her computer hardware.
➔ The units of production method would accurately match revenues and expenses for Mary’s online
education business. As it is based on asset usage, Mary will realize that her increasing expenses
fluctuate with customer demand. This allows revenues generated by her online education business
to be matched to her high expenses when producing financial statements, hence providing a more
realistic view of what is taking place in BPT Ltd.
Accept any other relevant response.
Mark as [2+2]. Award [2] for each correct and relevant explanation of the benefits of units of
production to Mary, up to a maximum of [4].

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3.5 P ROFITABILITY AND LIQUIDITY RATIO

ANALYSIS
Student workpoint 3.9 (p191)
1. a) Gross profit margin:
gross profit
gross profit margin = × 100
sales revenue
US$500 million
gross profit margin = × 100 = 62.5%
US$800 million
XYZ Ltd generates a gross profit margin of 62.5%. This is interpreted to mean that for every $100 of
sales it makes $62.5 as its gross profit. That is, every $1 of sales revenue brings in about 63 cents as
gross profit.
Profit margin:
profit before interest and tax
profit margin = × 100
sales revenue
US$250 million
profit margin = × 100 = 31.25%
US$800 million
XYZ Ltd makes a profit margin of 31.25%. This means that for every $100 of sales revenue made,
it generates a profit margin of $31.25. That is, every $1 of sales brings in about 31 cents as profit
margin.
ROCE (return on capital employed):
capital employed = non-current liabilities + equity
= US$250 million + US$365 million = US$615 million
profit before interest and tax
ROCE = × 100
capital employed
US$250 million
ROCE = × 100 = 40.65%
US$615 million
The business is making an ROCE of 40.65%. This means that for every $100 of capital invested,
XYZ Ltd generates $40.65 as its profit before interest and tax. As the ROCE is high, this acts as an
incentive for XYZ Ltd owners to inject more money into their businesses for higher returns.
b) Current ratio:
current assets
current ratio =
current liabilities
$90 million
current ratio = =2
$45 million

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XYZ Ltd’s current ratio is 2, which can also be expressed as 2:1. This is interpreted to mean that for
every $1 of current liabilities, the business has $2 of current assets. This means that XYZ Ltd has
sufficient working capital to pay off its short-term debts.
Acid test ratio:
current assets - stock
acid test ratio =
current liabilities
$90 million - $55 million
acid test ratio = = 0.78
$45 million
For every $1 of current liabilities, XYZ Ltd has $0.78 of current assets less stock. By removing stock,
the business gets rid of the least liquid of current assets to focus on the most liquid of them. In this
case, the acid test ratio is less than 1:1 which means that XYZ Ltd is not in sound financial health.
It may be facing a liquidity crisis (the inability to pay its short-term debts) and should therefore be
scrutinized with extreme caution by financial institutions.
2. The acid test ratio (as part of the liquidity ratios) is in the most need of improvement. The profit margin,
a profitability ratio, also has room for some improvement.
Strategies to improve the acid test ratio:
➔ XYZ Ltd could sell off stock at a discount for cash. This will help to improve its liquidity position and
provide more working capital to pay off its short-term debts. However, selling stock at a discount
could reduce the revenue generated from the sold stock, thereby reducing its profits.
➔ XYZ Ltd could increase the credit period for debtors to enable them to purchase more stock on credit.
The problem here is that it may lead to increased bad debts if the debtors do not pay.
Strategies to improve the profit margin:
➔ XYZ Ltd can carefully check on the indirect costs to see where unnecessary expenses may be
avoided, for example reducing expenditure on high pay packages for senior managers. This could,
however, demoralize the managers who have been used to high pay packages.
➔ XYZ Ltd could negotiate with key stakeholders with the aim of cutting costs, for example with
landlords for cheaper rent or with suppliers for product discounts. However, negotiating for cheaper
rent could lead to the firm moving to another location that is less than ideal. Customers might see
the move as detrimental and the firm could lose some of its prestige.

Practice question (p193)

a) (i) The long-term loan (X):
net assets = total assets − (current liabilities + long-term loan)
1,600 = 3,200 − (800 + X)
X = 2,400 − 1,600
X = 800 or $800,000
Award [1] if the candidate has correctly calculated the long-term loan.

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(ii) The current ratio:

current assets
current ratio =
current liabilities
$1,400
current ratio = = 1.75
$800
 Award [1] for correct working (do not credit the formula, which is given in the exam) and [1] for the
correct answer. Maximum award: [2].
(iii) The acid test (quick) ratio:
current assets - stock
acid test ratio =
current liabilities
$1400 - $400
acid test ratio = = 1.25
$800
Award [1] for correct working (do not credit the formula, which is given in the exam) and [1] for the
correct answer. Maximum award: [2].
b) (i) The profit before interest and tax:
Sales revenue $6,895
Cost of sales ($4,700)
Gross profit $2,195
Expenses ($2,150)
Profit before interest and tax $45

Award [1] for correct working and [1] for the correct answer. Maximum award: [2].
(ii) The gross profit margin:
gross profit
gross profit margin = × 100
sales revenue
$2,195
gross profit margin = × 100 = 31.8%
$6,895
NB If a candidate rounds to 32%, accept for [1]. If a candidate rounds to 31%, award [0].
Award [1] for correct working and answer (do not credit the formula, which is given in the exam).
(iii) The profit margin:
profit before interest and tax
profit margin = × 100
sales revenue
$45
profit margin = × 100 = 0.652%
$6,895

Award [1] for correct working and answer (do not credit the formula, which is given in the exam).

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c) Return on capital employed (ROCE):

capital employed = non-current liabilities + equity
= $800 + $1,600 = $2,400
profit before interest and tax
ROCE = × 100
capital employed
$45
ROCE = × 100 = 1.875%
$2,400
 Award [1] for correct working (do not credit the formula, which is given in the exam) and [1] for the
correct answer. Maximum award: [2].
d) Producing the special order windows would have both advantages and disadvantages for the company.
The financial position of WAW is precarious. Although the gross profit margin is 31.83%, the profit margin
is extremely slim at 0.652%, so any further deterioration in the company’s position may place it in a
loss-making position.
The cash flow position of the business is adequate at the moment. Its acid test ratio of 1.25 means that
the business has $1.25 of liquid funds for every $1 of current liabilities, which is acceptable given a rule
of thumb of 1:1 for this ratio. Its stock levels are also acceptable and it seems to be in a good position to
borrow money to fund any additional finance associated with the new special orders.
As the break-even point for each order is only 100 units, this suggests that the company will not be
risking too much financially to take this option if this order level is achievable. It will be up to the
marketing department to make this judgment. The 50 % deposit at the order stage should also ensure
that the company’s cash flow is adequate during the production process and before the units are
delivered.
There would be additional costs associated with recruiting an extra member of staff and this would
need to be factored into the issue, but the business should be able to fund this. Given that the present
profit margin is so low, producing special orders could be a good idea if these generate a higher profit
margin for the business. Given that WAW is considering making special order windows because it
has underutilized capacity, the business will not have to borrow additional money to purchase new
equipment.
Limitations of the stimulus:
➔ By how much have the sales of WAW fallen due to the housing crisis?
➔ Are the Canadian suppliers of building materials the only customers for WAW?
Accept any other relevant examination.
If the response is one-sided and includes only profitability ratios or only liquidity ratios, award a
maximum of [3–4]; to achieve the top level descriptor, candidates need to refer to both.

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Marks should be allocated according to the following level descriptors:

Marks Level descriptor

0 The work does not reach a standard described by the descriptor.
1–2 • Little understanding of the demands of the question.
• Little use of business management tools and theories; any tools and theories that are used are irrelevant or
used inaccurately.
• Little or no reference to the stimulus material.
• No arguments are made.
3–4 • Some understanding of the demands of the question.
• Some use of business management tools and theories, but these are mostly lacking in accuracy and relevance.
• Superficial use of information from the stimulus material, often not going beyond the name of the person(s) or
name of the organization.
• Any arguments made are mostly unsubstantiated.
5–6 • The response indicates an understanding of the demands of the question, but these demands are only
partially addressed.
• Some relevant and accurate use of business management tools and theories.
• Some relevant use of information from the stimulus material that goes beyond the name of the person(s) or
name of the organization but does not effectively support the argument.
• Arguments are substantiated but are mostly one-sided.
7–8 • Mostly addresses the demands of the question.
• Mostly relevant and accurate use of business management tools and theories.
• Information from the stimulus material is generally used to support the argument, although there is some lack
of clarity or relevance in some places.
• Arguments are substantiated and have some balance.
9–10 • Clear focus on addressing the demands of the question.
• Relevant and accurate use of business management tools and theories.
• Relevant information from the stimulus material is integrated effectively to support the argument.
• Arguments are substantiated and balanced, with an explanation of the limitations of the case study or
stimulus material.

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3.6 EFFICIENCY RATIO ANALYSIS (HL ONLY)

Student workpoint 3.10 (p198)
a) Stock turnover:
cost of sales
stock turnover ratio (number of times) =
average stock
$250 million
stock turnover ratio (number of times) = = 4.5 times
$55 million
XYZ Ltd turns over its stock 4.5 times a year. This is a high stock turnover ratio which means that it sells
stock quickly, thereby earning more profit from its sales. This also means that goods do not become
obsolete quickly and perishable goods do not expire, showing that the firm has good control over its
purchasing decisions.
b) Debtor days:
debtors
debtor days ratio (number of days) = × 365
total sales revenue
$15 million
debtor days ratio (number of days) = × 365 = 6.84 days
$800 million
It takes XYZ Ltd an average of 6.84 days to collect debts. These are short debtor days which is good for
the business because it has sufficient working capital to run its day-to-day operations and it can also
invest this money in other projects.
c) Creditor days:
creditors
creditor days ratio (number of days) = × 365
cost of sales
$20 million
creditor days ratio (number of days) = × 365 = 29.2 days
$250 million
This means that XYZ Ltd has about 29 days to pay its creditors. This is a relatively high creditor days
ratio, which enables the business to use available cash to fulfil its short-term obligations.
d) Gearing ratio:
loan capital
gearing ratio = × 100
capital employed
capital employed = non-current liabilities + equity
$250 million
gearing ratio = × 100 = 40.65%
$615 million
XYZ Ltd has a gearing ratio of 40.65%, which means that about two fifths of the capital requirements
of the business come from long-term loans. It is hence low-geared as this ratio is below 50%. This is a
good position to be in as the business has the potential to get more funding from financiers to expand
their operations.

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Practice question (p200)

a) Insolvency is a financial state where a person or firm cannot meet their debt payments on time. The
person or firm no longer has the money to pay off debt obligations. This is where their debts exceed their
assets.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above
(candidates are not expected to word their definition exactly as above).
b) Candidates should calculate appropriate efficiency ratios to support their analysis. These ratios may
include:

2020 2021
Debtor days (days) 34.91 38.89
Creditor days (days) 26.22 19.21
Stock turnover (days) 79.56 93.75
Gearing ratio (%) 75.43 76.47

NB Candidates should also be credited for the use of different formulae in the calculation of these ratios.
For example, the stock turnover may be expressed as number of times rather than in days or may use
cost of sales as the basis for calculation.
When looking at the financial performance of the company, candidates should be analysing it from the
perspective of whether the financial manager should declare for bankruptcy. They may raise a number
of issues and these may include:
➔ There is evidence of poor credit control. The number of debtor days has risen (indicating poor
collection of debts) and creditors seem to have been paid even quicker. There may be some scope
for renegotiating terms with many suppliers or delaying payment wherever possible. This would help
restore the cash position.
➔ There is a clear problem with excess stock and the stock turnover (in days) has risen, fast indicating
deteriorating stock control.
➔ Gearing has risen slightly and is quite high. This will leave the firm vulnerable to external shocks and
changes in interest rates. A rise in interest rates could hit margins quite hard.
➔ Their overdraft has grown considerably, perhaps due to poor credit and stock control.
Accept any other relevant point.
Limitations of the stimulus material:
➔ What caused the slowing down of the sales growth?
➔ Is the company still only producing web cameras after ten years of being in existence?
Candidates should not necessarily be wholly negative in their analysis. The firm appears to have grown
consistently and has a good reputation for quality and reliability. Given that many of the issues raised
can be solved with improved management, CB Ltd may still be a potentially good investment. However,
the financial manager may want to look closely at what the other management ratios show, including
how all these ratios compare with other similar firms in the industry, before deciding on whether the
business should declare for bankruptcy.

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Marks should be allocated according to the following level descriptors:

Marks Level descriptor

0 The work does not reach a standard described by the descriptor.
1–2 • Little understanding of the demands of the question.
• Little use of business management tools and theories; any tools and theories that are used are irrelevant or
used inaccurately.
• Little or no reference to the stimulus material.
• No arguments are made.
3–4 • Some understanding of the demands of the question.
• Some use of business management tools and theories, but these are mostly lacking in accuracy
and relevance.
• Superficial use of information from the stimulus material, often not going beyond the name of the person(s) or
name of the organization.
• Any arguments made are mostly unsubstantiated.
5–6 • The response indicates an understanding of the demands of the question, but these demands are only
partially addressed.
• Some relevant and accurate use of business management tools and theories.
• Some relevant use of information from the stimulus material that goes beyond the name of the person(s) or
name of the organization but does not effectively support the argument.
• Arguments are substantiated but are mostly one-sided.
7–8 • Mostly addresses the demands of the question.
• Mostly relevant and accurate use of business management tools and theories.
• Information from the stimulus material is generally used to support the argument, although there is some lack
of clarity or relevance in some places.
• Arguments are substantiated and have some balance.
9–10 • Clear focus on addressing the demands of the question.
• Relevant and accurate use of business management tools and theories.
• Relevant information from the stimulus material is integrated effectively to support the argument.
• Arguments are substantiated and balanced, with an explanation of the limitations of the case study or
stimulus material.

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3.7 CASH FLOW

Student workpoint 3.11 (p207)
1. Cash flow forecast for the first five months of trading:

All figures in $ January February March April May

Opening balance 0 (500) (13,000) (22,500) (34,250)
Cash inflows
Owner’s savings 4,000 0 0 0 0
Bank loan 6,000 0 0 0 0
Cash sales revenue 2,000 4,000 5,000 5,500 6,000
Total cash inflows 12,000 4,000 5,000 5,500 6,000

Cash outflows
Materials 1,000 2,000 2,500 2,750 3,000
Wages and salaries 5,000 5,000 5,000 5,000 5,000
Advertising costs 3,000 3,000
Loan repayment 500 500 500 500 500
Rent 6,000 6,000 6,000 6,000 6,000
Total cash outflows 12,500 16,500 14,000 17,250 14,500

Net cash flow (500) (12,500) (9,000) (11,750) (8,500)

Closing balance (500) (13,000) (22,500) (34,250) (42,750)

2. Juma’s cash flow forecast shows a negative closing balance in all five months up to May. Despite Juma
injecting his own savings and getting a bank loan, the forecast shows negative net cash flows. He will
require key strategies to improve this unfortunate position. Some recommendations include:
Reducing cash outflow:
➔ Juma could negotiate with suppliers or creditors to delay payment for materials. This will help him
to have working capital for his short-term needs in the business. However, he should note that
negotiations may be time-consuming, and delaying payment to suppliers could affect his future
business relationships.
➔ Juma can decrease specific expenses that will not affect production capacity, such as advertising
costs. However, if not well checked, this may reduce future demand for his restaurant.
➔ Juma could look into sourcing cheaper suppliers. This will help to reduce costs on materials,
decreasing the outflow of funds. A possible danger of this is that the quality of his restaurant meals
may be compromised, affecting future customer relationships.

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Improving cash inflows:

➔ Juma can continue to insist that customers pay with cash only when buying meals. This avoids the
problem of delayed payments from potential debtors, which ties up cash. The disadvantage is that
the business may lose customers who prefer to pay for their meals using a credit card.
➔ Juma can diversify his meal offering. This will widen the variety of meal choices on offer to
customers, potentially increasing sales. However, diversification may come with higher costs and
with no clear guarantee of sales.

Practice question (p209)

a) 
Investment refers to the act or state of investing. In business, investing is spending money on
purchasing an asset with the expectation of future earnings. Investing involves wealth creation,
including hoping that the bought asset appreciates in value over time.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above
(candidates are not expected to word their definition exactly as above).
b) (i) Cash flow forecast for NPF June 2020–September 2020

Item (figures in millions of US$) June July August September

Opening balance 1 (8.25) (17) (16.25)
Cash inflows
Donations received 40 30 30 20
Total cash inflows 40 30 30 20
Cash outflows
Payments (donation transfers) 47.5 38 28.5 28.5
Internet usage fee 1 1
Maintenance fee for servers and computers 0.25 0.25 0.25 0.25
Web designer’s fee 0.5 0.5 0.5 0.5
Concert sponsoring fee 5
Total cash outflows 49.25 38.75 29.25 35.25
Net cash flow (9.25) (8.75) 0.75 (15.25)
Closing balance (8.25) (17) (16.25) (31.5)

Award [6] if the cash flow forecast is drawn accurately and neatly in a generally accepted format and
is error free. If the candidate provides a heading of total cash inflow/total cash outflow without using
another heading above of cash inflow or cash outflow, do not penalize as an omission.
Award [4–5] if the cash flow forecast is drawn essentially correctly and neatly in a generally accepted
format, but there is one error for [5] or two errors for [4].
Award [2–3] if a cash flow forecast is drawn, but either it is not in a generally accepted format or it is
untidy, and/or the forecast contains three or more errors. The errors could include, in addition to number
placement problems and mathematical errors, conceptual errors (using the word “profit” rather than
“net cash flow”) or omissions, such as not having a line like “closing balance” or totals.

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Award [1] if the candidate conveys some understanding of what a cash flow forecast is, but
otherwise the forecast is largely inaccurate, incomplete, or illegible.
NB Allow the Own Figure Rule (OFR): if a candidate makes an error in one row and carries it through
the remainder of the forecast, that is only one error. This provision includes both mathematical
errors and conceptual errors.
If the candidate omitted both headings of cash outflow/cash inflow, [1] should be deducted. Using
the term “net profit in the cash flow forecast” instead of “net cash flow” is inaccurate and [1]
should be deducted. If the candidate has only one row for all cash outflows, deduct [1] from the
total mark awarded.
Full working is not expected.
(ii) The cash flow forecast reveals a worrying deterioration in the cash flow position of NPF. Although
the organization was set up with a generous contribution, we must assume that cash reserves are
running low.
There are forecast to be very marginal improvements in August (the negative is slightly smaller
than in the previous month), but the sponsorship of the concert in September will impose a
significant drain on cash resourcing at a time of dwindling donations.
Allow discretion when Own Figure Rule (OFR) applies to the comments.
Award [1] for overall deterioration, [1] for generous contribution inflow, [1] for marginal
improvements in August, [1] for September outflow.
Award [1] for each correct and appropriate comment based on the forecast, such as the
breakdown above. Maximum award: [4].
(iii) NPF can either reduce the outflow or increase the inflow, or elements of both. NPF could:
➔ Try to secure a bank overdraft to increase cash inflow. It may be difficult to obtain this with no
assets to be used as collateral but NPF has no debt in 2020.
➔ Seek a fresh injection of capital from the retired businessman or find another investor who
holds a similar view and vision about educational opportunities for children in developing
countries. The fresh injection will increase cash inflow.
➔ Try to co-sponsor the concert with another charity through a joint venture or strategic alliance
in order to reduce the cash outflow.
➔ Fundraise through e-commerce or other merchandising opportunities to increase the cash
inflow.
➔ Negotiate lower fees for web design and maintenance or find more socially responsible
providers in order to reduce cash outflow.
Accept any other relevant solution.
Mark as [3+3]. Award [3] for a clear and detailed explanation of the possible solution to the
liquidity problems highlighted in parts (i) and (ii). Reference is made to the stimulus material.
Award [2] for an adequate explanation of the possible solution to the liquidity problems
highlighted in parts (i) and (ii), though the response may be lacking in clarity or detail.
Award [1] for a brief and general answer (possibly just a list) with no development/explanation.

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3.8 INVESTMENT APPRAISAL

Toolkit: BCG matrix (p215)
How can the knowledge of this tool help businesses to improve their financial decision-making?
The BCG matrix works on the premise that every business should have a portfolio containing both high-
growth products requiring cash investment and low-growth products that provide extra cash. Having both
types of products can ensure long-term business success.
The BCG is important in financial decision-making because:
➔ It provides a high-level overview for the finance department to see the opportunities that each product
in the organization’s product portfolio presents.
➔ It enables the finance department to think of ways to allocate its financial resources to the
organization’s product portfolio so that profits are maximized over the long term.
➔ The finance department can see the extent to which the organization’s product portfolio is balanced.
For example, an organization with very few products in its portfolio could be in a risky position if
competition increases for similar products. This will have financial implications for the business.
➔ It is very simple to use and can be used across the other business departments, providing a chance to
collaborate and compare department outcomes.

Student workpoint 3.12 (p215)

1. Payback period:

Year Net cash flows ($) Cumulative cash flows ($)

0 (40,000) (40,000)
1 15,000 (25,000)
2 30,000 5,000
3 10,000 15,000
4 5,000 20,000

The initial investment outlay will be paid back sometime in year 2 – but in which month exactly? This
can be calculated using the following formula:
extra cash inflow required
× 12 months
annual cash flow in year 2
The extra cash inflow in year 2 is $5,000, as shown in the table above. This is because in year 1 it has
been calculated that only $5,000 needs to be paid in year 2 to pay off the initial investment. The annual
cash flow in year 2 is $30,000. Applying this information to the formula we get:
$5,000
× 12 months = 2 months
$30,000
It therefore takes one year and two months to pay back the initial investment of $40,000.

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2. Average rate of return (ARR):

(total returns - capital cost)

years of usage
ARR = × 100
capital cost
total returns = $15,000 + $30,000 + $10,000 + $5000 = $60,000
($60,000 - $40,000)
net return per annun = = $5,000
4
$5,000
ARR = × 100 = 12.5%
$40,000
The retail business expects an ARR of 12.5% on its investment.
3. Net present value (NPV):

Year Annual net cash flows ($) Discount factor at 6% Present value in $
0 (40,000) 1 (40,000)
1 15,000 0.9434 14,151
2 30,000 0.8900 26,700
3 10,000 0.8396 8,396
4 5,000 0.7921 3,960.50

NPV = total present values − original cost

NPV = $53,207.50 − $40,000 = $13,207.50
The NPV is a positive value of $13,207.50, signifying that this is a viable project that should go ahead.

Practice question (p218)

a) Investment appraisal refers to the quantitative techniques used in evaluating the viability or
attractiveness of an investment proposal. It assesses and justifies the capital expenditure allocated
to a particular project. It therefore aims to establish whether a particular business venture is worth
pursuing and whether it will be profitable.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above
(candidates are not expected to word their definition exactly as above).
b) Payback period for Option A:
Cost of Option A: $20,000
Net return: $1,000 − $500 for insurance = $9,500
$20,000 − $9500 (1 year) = $10,500
10,500
× 365 = 333.26 days
11,500
Accept 1 year and 33.26 days, or 1 year and 10.9 months, or 1 year and 11 months.

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Award [1] for correct working and [1] for the correct answer. Maximum award: [2].
Award up to a maximum of [1] if the net annual return is not calculated.
c) ARR for Option B:
In order to calculate the ARR, the net annual return has to be calculated.

Year Expected revenue/return in $

1 14,000 − 12,000 − 2,000 = 0

2 16,800 − 15,000 − 2,000 = −200

3 23,800 − 2,000 = 21,800

4 28,000 − 2,000 = 26,000

7,600
$47,000 - $40,000 = = $1,900
4
$1,900
× 100 = 4.75%
$40,000
Award [1] for correct working and [1] for the correct answer. Maximum award: [2].
Award up to a maximum of [1] if the net annual return is not calculated and the candidate used the
raw figures.
d) NPV for Option A:

Years DCF/return in $
1 9,500 × 0.9615 = 9,134.25
2 11,500 × 0.9246 = 10,632.9
3 16,500 × 0.8890 = 14,668.5
4 19,500 × 0.8548 = 16,668.6
Total DCF 51,104.25
NPV 51,104.25 – 20,000 = 31,104.25

NPV for Option B:

Years DCF/return in $
1 0 × 0.9615 = 0
2 −200 × 0.9246 = −184.92
3 21,800 × 0.8890 = 19,380.2
4 26,000 × 0.8548 = 22,224.8
Total DCF 41,420.08
NPV 41,420.08 – 40,000 = 1,420.08

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Allow candidate Own Figure Rule (OFR) from calculations in part (c).
Award [3–4] for correct calculations of both options. The figures and the calculations are shown and are
clearly presented. For full marks, candidates should have calculated the net annual return per option to
start with. If the net annual return is not calculated, award up to [3].
Award [2–3] for mostly correct calculations (workings) and clear presentation of the NPV method for
both years. Allow for one mistake per option. Award [2] for correct calculations (workings) and clear
presentation of one option.
Award [1–2] for some relevant calculations which may include more than two mistakes. The
calculations (workings) may not be clear. Award [1] if only the final answer is presented per option and
the answer is correct.
e) Possible advantages of the NPV method could include:
➔ Maia will incorporate future earnings into today’s value.
➔ It is a more accurate method, as the decision is made in the present while the return is predicted for
the future.
➔ Normally money in the future is worth less than the current value, so Maia can calculate the present
value of the return on investment taking into account the effect of interest rates and time.
➔ If the NPV is positive, the investment should be taken on a financial basis.
➔ The other methods do not incorporate discounted cash flow.
➔ When comparing two or more options, as in this case, Maia can clearly see that Option A gives the
highest NPV.
➔ Maia can also compare the effects of different discount rates.
Possible disadvantages of the NPV method could include:
➔ It might be difficult for Maia to decide on the most accurate discount factor, especially if the inflation
rate and interest rate fluctuate considerably.
➔ An accurate rate is crucial for EEB. The discount rate of 4 % might not be accurate, which may lead to
the wrong decision.
➔ As with the other methods, Maia relies on estimated data on the return generated by the investment.
➔ Given changes in the external environment, especially technological changes, the figures are likely
to be overestimated.
➔ The predicted/estimated figures are likely to make the decision taken in the present more favourable.
Accept any other relevant advantage or disadvantage and explanation.
Mark as [2+2]. Award [1] for a relevant and correct advantage/disadvantage identified, up to [2].
Award [1] each for a relevant and correct explanation with application to EEB, up to [2]. Maximum
award: [4].
Do not credit responses that are generic and refer to the advantages of investment appraisal rather than
to the use of the NPV method.

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f) Arguments in support of Maia’s decision to opt for Option B:

Financial considerations:
➔ Although the ARR is considerably lower than Option A, 4.75 % is still higher than the current discount
factor of 4 %, assuming that it is based on the current interest or inflation rate in the economy. It is
therefore still financially viable.
➔ The NPV for Option B is positive, hence the investment is viable. However, the figure is not very
high and is significantly lower than the NPV of Option A. But Maia might have realized that the best
investment appraisal method should have been the payback period given the rapid change in
technology. Hence, the favourable financial result of investing in Option A might not have impressed
Maia that much.
Non-financial considerations:
➔ EEB may gain a competitive advantage in the market. The new system can potentially be used to
develop a USP for EEB. It will enable the company to reach a larger volume of customers and to
compete globally.
➔ EEB is currently profitable and has the cash to invest. The significant higher costs of Option B are not
seen by Maia as a hindrance for EEB.
➔ Option B is a secure one – a very important advantage for an online operator. Other operators
reported some security issues with Option A. EEB will not have to face frequent breakdowns of the
software that might endanger its reputation and reduce efficiency and quality of service.
Possible arguments against:
➔ Option B will last for 4 years only. EEB will have to update the computer system at a further
considerable cost in 4 years’ time anyway. This is the same replacement time if Option A is chosen.
➔ Given the fact that EEB operates in the service sector, employees’ effort and performance is of vital
importance. A 15 % reduction in employees is a significant one. EEB is known for its service quality,
but this USP may be eroded. The remaining employees might also be unmotivated due to a fear of
further redundancy.
Accept any other relevant issue for and against.
Limitations of the stimulus material:
➔ How long has EEB been in the online hotel reservation business in order to be regarded as well-
known and reputable?
➔ What specific problems does the “Book-Fast” software present?
It is not expected that the candidates will reach a final judgment. However, it does look like the Finance
Director paid more attention to the non-financial issues given the comfortable financial situation that
EEB is in.
To achieve the top level descriptor, candidates must give a balanced examination of two possible
arguments for and two possible arguments against Maia’s choice.

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Marks should be allocated according to the following level descriptors:

Marks Level descriptor

0 The work does not reach a standard described by the descriptor.
1–2 • Little understanding of the demands of the question.
• Little use of business management tools and theories; any tools and theories that are used are irrelevant or
used inaccurately.
• Little or no reference to the stimulus material.
• No arguments are made.
3–4 • Some understanding of the demands of the question.
• Some use of business management tools and theories, but these are mostly lacking in accuracy and
relevance.
• Superficial use of information from the stimulus material, often not going beyond the name of the person(s) or
name of the organization.
• Any arguments made are mostly unsubstantiated.
5–6 • The response indicates an understanding of the demands of the question, but these demands are only
partially addressed.
• Some relevant and accurate use of business management tools and theories.
• Some relevant use of information from the stimulus material that goes beyond the name of the person(s) or
name of the organization but does not effectively support the argument.
• Arguments are substantiated but are mostly one-sided.
7–8 • Mostly addresses the demands of the question.
• Mostly relevant and accurate use of business management tools and theories.
• Information from the stimulus material is generally used to support the argument, although there is some lack
of clarity or relevance in some places.
• Arguments are substantiated and have some balance.
9–10 • Clear focus on addressing the demands of the question.
• Relevant and accurate use of business management tools and theories.
• Relevant information from the stimulus material is integrated effectively to support the argument.
• Arguments are substantiated and balanced, with an explanation of the limitations of the case study or
stimulus material.

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 IB Business Management Answers: 3 Finance and accounts

3.9 BUDGETS (HL ONLY)

Student workpoint 3.13 (p225)
1. Particulars Budgeted figure ($) Actual figure ($) Variance ($)
Material costs 12,000 18,500 6,500 [A]
Direct labour costs 9,000 7,800 1,200 [F]
Sales of radios 25,000 25,600 600 [F]
Sales of Apple iPad 15,000 12,750 2,250 [A]
Advertising costs 6,000 7,100 1,100 [A]

2. An adverse variance of $6,500 is experienced in the material costs. This could be a result of
unexpected changes in the economy, such as inflation that drove the material costs higher. In addition,
XAV Ltd could have underestimated how much material was needed for production.
3. XAV Ltd has three adverse variance figures and two favourable variance figures. Overall, it does not
seem to be in a good position financially as its budgeted figure for material costs and advertising costs
are much lower than the actual figures. Even though it makes a favourable variance on sales of radios,
this is quite insignificant compared to the larger adverse variances it experiences on its costs overall.

Practice question (p226)

a) A cost centre is a section of a business where costs are incurred and recorded. This can help managers
to collect and use cost data effectively. A cost centre can be divided according to department, product
or geographical location.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above
(candidates are not expected to word their definition exactly as above).
b) Complete budget for KJC Ltd:
All figures in $000 Budgeted figures Actual figures Variance
Revenue
Sales revenue 500 400 100 [A]
Interest earned 100 80 20 [A]
Total revenues 600 480 120 [A]

Costs
Direct labour costs 90 75 15 [F]
Direct material costs 80 90 10 [A]
Advertising 20 10 10 [F]
Rent 15 15 0
Electricity 30 40 10 [A]
Total costs 235 230 5 [F]

Excess of revenues over 365 250 115 [A]

(under) costs

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 IB Business Management Answers: 3 Finance and accounts

[6] The budget is drawn accurately and neatly in a generally accepted format, and is error free.
[4–5] The budget is drawn essentially correctly and neatly in a generally accepted format. Award
[5] if there is one error, [4] if there are two errors. If the candidate produces an accurate budget (that
is, the final excess of revenues over (under) costs is correct and the means by which the candidate
arrived at that figure is clear and logical) but does not use a generally accepted format, award [5].
[2–3] A budget is drawn, but either it is not in a generally accepted format or it is untidy, and the
forecast contains two or more errors.
[1] The candidate conveys some understanding of what a budget is, but otherwise the budget is
largely inaccurate, incomplete, or illegible.
c) Favourable variances in KJC Ltd were experienced in the direct labour costs and advertising. Here, both
presented a financial benefit to the business, the former with a lower cost figure of $15,000 and the
latter with a reduced cost of $10,000.
Adverse variances were experienced in the sales revenue figures ($100,000), interest earned
($20,000), direct material costs ($10,000), and electricity ($10,000) which proves financially costly
for KJC Ltd.
Overall, KJC Ltd has an adverse variance of $115,000 which is quite significant, placing it in an
unfavourable position financially.
Accept any other relevant response.
Mark as [2+2]. Award [1] for relevant favourable variance(s) identified and award an additional
[1] for a relevant explanation, up to a maximum of [2]. Award [1] for relevant adverse variance(s)
identified and award an additional [1] for a relevant explanation, up to a maximum of [2]. Maximum
award: [4].
d) Roles of profit centres to KJC Ltd include:
➔ Aiding decision-making: by monitoring the profit centres, Mr Liu can help KJC Ltd with financial
information about the different parts of the pot business. This information can assist KJC Ltd’s
management in deciding whether to continue or discontinue producing all the pots or just specific
types of pots. With such information, the production of high-cost and least profitable pots can be
stopped to make way for new, lower-cost but more profitable pots (especially given the decline in
sales in the second half of the year).
➔ Better accountability: profit centres will help to hold KJC Ltd’s specific business sections
accountable. For example, Mr Liu will be able to identify the managers who performed poorly in
their department, including what may have caused the sales of pots for the second half of the year
to decrease. This will hold them accountable due to their inefficiency.
Accept any other relevant response.
Mark as [2+2]. Award [1] for each correct and relevant role of profit centres identified, up to [2]. Award
an additional [1] each for a relevant explanation, up to [2]. Maximum award: [4].

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