University of KwaZulu-Natal

School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
SUGGESTED SOLUTION QUESTION 1

1. Budgeted break even point in kilograms and Rands

R
Sales 240 1
Variable costs
Materials (R60 x 1.4 kgs) 84 1
Labour (R20 x 2 hrs) 40 1
Variable overhead (R30 x 2 hrs) 60 1
Standard contribution per kg 56

Budgeted breakeven point:

Fixed costs/ contribution per kg

= R210 000/R56 1
= 3 750 kgs x R240 = R900 000 2
7

2. Actual profit statement, month one

R
Sales 1 800 000 0.5
Variable costs
Materials 660 000 0.5
Labour 303 360 0.5
Variable overhead 480 000 0.5
Contribution 356 640 1
Fixed costs 200 000 0.5
Actual profit 156 640 0.5
4

3. Reconciliation of budget and actual profit

R
Budgeted contribution (R56 x 8 400 kgs) 470 400 1
Budgeted fixed costs 210 000 1
Budgeted profit 260 400 1

R
Budgeted profit 260 400
Sales volume (BS – AS) x std contribution
(8 400 – 8 000) x R56 (22 400) 2
Standard profit 238 000 1
Adverse Favourable
Sales price (BSP – ASP) x AS (R) (R)
(R240 – R225) x 8 000 120 000 2
Material price (SP – AP) x AQ
(R60 – R55) x 12 000 60 000 2
Material usage (SQ – AQ) x SP
[(1.4 kgs x 8 000) – 12 000] x R60 48 000 2.5

1
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
Labour rate (SR – AR) x AH
(R20 – R19.20) x 15 800 hrs 12 640 2
Labour efficiency (SH – AH) x SR
[(2 hrs x 8 000) – 15 800 hrs) x R20 4 000 2.5
Variable overhead rate (SR – AR) x AH
(R30 x 15 800 hrs) – R480 000 6 000 2
Variable overhead efficiency (SH – AH) x SR
(16 000 hrs – 15 800 hrs) x R30 6 000 2
Fixed overhead expenditure (BFO –AFO)
R210 000 – R200 000 10 000 2
174 000 92 640 (81 360)
Actual Profit 156 640 1

4. Discussion of performance

Purchasing manager

The favourable material price variance indicates that the purchasing manager has
clearly bought a cheaper product. 1

The variance is not likely due to a change in market conditions as we are told that the
market for the purchase of unprocessed nuts is stable. 1

The variance is attributable either to the purchase of an inferior quality product or the
good buying/negotiation skills of the purchasing manager. 1

The adverse material usage variance suggests that it is more likely that the purchasing
manager purchased an inferior quality product. 1

The adverse sales price variance is significant. 1

The market for the sale of roasted nuts is stable and therefore the reduction in selling
price is not due to market conditions. 1

The adverse sales price variance is probably due to the sale of an inferior quality
product. 1

There appears to be no problem with the roasting process as the maintenance manager
has indicated that the ovens have been working well. 1

The poor quality of the final product is probably due to the poor quality of nuts
purchased. 1

This may have also led to a fall in the volume of sales resulting in an adverse sales
volume variance. 1

Thus overall the purchasing manager is responsible for a loss of R220 000 calculated
as follows:

2
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
Material price 96 000
Material usage (104 000)
Sales price (170 000)
Sales volume (42 000)
(220 000) 2

Production manager

The increase in wage rates has resulted in an adverse labour rate variance. 1

The higher wages do appear to have boosted the morale of the workers resulting in
them working harder and producing a favourable efficiency variance. 1

Overall the production manager is responsible for an increase in profit of R15 000
calculated as follows:

Labour rate (30 000)

Labour efficiency 40 000
10 000 1

Maintenance manager

The maintenance manager appears to have saved R16 000 by delaying the annual
maintenance of the ovens. 1

The maintenance manager has only delayed the spend and not prevented it. Therefore
it is not a real saving. 1

Further, the delay in maintenance could have disastrous consequences if the ovens
were to break down before the maintenance occurs, resulting in lost production and
sales. 1

It is also possible that the adverse variable overhead expenditure variance was partly
caused by poor oven maintenance. 1
1 mark per valid point. Maximum 15

3
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
SUGGESTED SOLUTION QUESTION 2

1. Budgeted break even point at 160 000 units

Total fixed costs:

Production W1 1 120
Selling etc W2 800
1 920 1

Contribution per unit:

Selling price 6 400 000/160 000 40 1
Variable cost per unit: 25
Production W1 16
Selling etc W2 9
Contribution per unit: 15 1

BEP = 1 920 000

15
= 128 000 units 1

Budgeted margin of safety

Budgeted sales 160 000

BEP 128 000
MOS 32 000 1
MOS % 20.00% 1

If sales decline by more than 20% losses will be incurred 1

W1: Analysis of production costs

Difference
Units 160 200 40
Production costs 3,680 4,320 640

Variable production cost per unit 640 / 40 16 2

Fixed production costs per annum:
Variable costs for 160 000 units 2,560
Total costs for 160 000 units 3,680
Fixed costs balance 1,120 2

W2: Analysis of selling etc costs

Difference
Units 160 200 40
Selling etc costs 2,240 2,700
Less: Additional fixed costs (25 000 x 4) 100 2
Net selling etc costs 2,240 2,600 360

Variable production cost per unit 9 1

4
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
Fixed production costs pa at 160000 units
Variable costs for 160 000 units 1,440
Total costs for 160 000 units 2,240
Fixed costs balance 800 1
15

2.1 Absorption costing income statement for 1st Quarter

R
Sales 38000 x 40 1 520 000 0.5
Less: Cost of sales 874 000
Opening stock 5000 x 23 W1 115 000 0.5
Production cost 33000 x 23 759 000 0.5
Closing stock 0 0
Gross profit 646 000 0.5
Less: under absorbed fixed production costs W2 -69 000
Adjusted gross profit 577 000
Less: Selling, admin & distribution costs: 542 000
Variable 38000 x 9 342 000 0.5
Fixed 800 / 4 200 000 0.5
Net profit 35 000

W1: Product cost

Variable production cost 16 1.0
Fixed production cost W1.1 7 2.0
23

W1.1: Fixed production costs rate per unit

Budgeted costs 1 120 000
Budgeted volume 160 000

W2: Under absorbed fixed production costs

Budgeted for the year 1 120
Per quarter ÷4 280 1.0
Add: increase 20 1.0
Actual for 1st quarter 300
Absorbed 33000 x 7 231 1.0
Under absorbed 69 1.0
10.0

2.2 Variable costing income statement for 1st Quarter

R
Sales 1 520 000 0.5
Less: Variable Costs 950 000
Opening stock 5000 x 16 W1 80 000 0.5
Production cost 33000 x 16 528 000 0.5
Closing stock 0 0
Variable cost of sales 608 000

5
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
Variable selling, admin & distribution costs 342 000 0.5
Contribution 570 000 1.0
Less: fixed costs: 500 000
Production 300 000 0.5
Selling, admin, distribution 200 000 0.5
Net profit 70 000 4.0

2.3 Profit reconciliation

Absorption costing net profit 35 000 0.5
Add: Fixed production overhead included
in stock decrease 5000 x 7 35 000 2
Variable costing net profit 70 000 0.5
3.0

3. Absorption or variable costing for reporting results internally?

Advantages of variable costing:

1. Results are not distorted by the effect of stock movements on fixed costs and hence profit.
In this example, absorption profit was understated by R35 000 as a result of the stock decrease.

2. Profits are primarily a function of sales and hence are more believable whereas using
absorption costing production and sales determine profit. This can distort profit as is the case
here where an under absorption of R69 000 has been reported, primarily because production was
7 000 units below budget.

3. Separation of costs into variable and fixed facilitates decision making using CVP analysis.

Advantages of absorption costing:

1. Internal results are reported on the same basis as is done externally so management are always
aware of what will be presented to external users, e.g. shareholders and bankers.

2. Fixed costs are not underestimated when pricing products as they are treated as product costs.

3. For seasonal businesses variable costing may distort results by treating fixed production costs
as period costs. However this does not apply here since we are told sales and production are
evenly spread during the year. 7 max
4. CVP analysis

1st quarter contribution per unit (a) (i) 15.00

Selling price reduction 2.5% on 40 -1.00 1
Sales commission (40 -1.00) x 5% -1.95 1
Revised contribution per unit 12.05

Fixed costs for 2nd quarter 500 000

Required profit 70,000 1.05 73 500 1
Required contribution 573 500

Required volume 573 500 / 12.05 47 593.36 2

Required volume growth from 38 000 to 47 593.36 25.2% 1

6
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
Comments:
1. How feasible is it to achieve sales growth of 25% with such a small discount?
Being a competitive market, competitors are likely to reduce prices too. 

2. On the other hand, incentivising salesman with a commission is likely to result in

increased sales. But is the incentive strong enough to achieve this sales growth?

3. Break even point will increase by approximately 25%, thus increasing business risk:
Quarter 1 Quarter 2
Fixed costs 500 000 500 000
Contribution per unit 15.00 12.05
BEP 33333.33 41493.78 24.5% 

4. Increased capacity utilisation may result in economies of scale which could lower unit
variable cost. 5 max
Total 11

7
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
SUGGESTED SOLUTION QUESTION 3

1.
 Management Expertise: The board should consider whether they have the
expertise to manage a company that is involved in a different sector to their
current operations
 Legality of transaction: It is important that the necessary approval be sought
before the transaction is processed. Shareholder approval and approval from
Competition Commission may be required
 Morale of workers in Steel (Pty) Ltd: The proposed buyout could negatively
effect the morale of the workforce and may lead to low productivity
 Reliability: Problems at Steel (Pty) Ltd will have an adverse impact on our
production process
 Quality of raw material: As the steel is being imported, we need to ensure that
it is of a satisfactory quality for our production requirements
 Further investments required in the company: We need to ascertain the extent
of the investment required to buy the company and thereafter to maintain the
operations
 Existing supply contracts that may be in place: Management should determine
if a contract is in place with the existing supplier and the consequences of
cancelling the contract
 Effect of forex on business: As Steel (Pty) Ltd is an importer, the additional
risk of a volatile foreign exchange rate must be considered on the business
 Business outlook for the steel market: A market assessment should be
conducted to determine the outlook for the future sales of Steel (Pty) Ltd
 Business synergies that can be obtained: Investigation of cost savings that can
be achieved e.g., common administration

ANY OTHER VALID POINT,

2 MARKS PER VALID ITEM, MAXIMUM 10

2
2.1
20.8 20.7

Current ratio 127/125 130/111

(Current asets/current liabilities) 1.10:1 1,17:1
1 1

 This ratio indicates the extent to which the claims of short term creditors are
covered by assets that can be translated into cash in the short term
 The norm for this ratio is 2:1
 The ratio has fallen slightly from 20.7 to 20.8 and is below the accepted norm in
both years
 Of further concern is the R10m decrease in the bank balance from 20.7 to 20.8
1 MARK PER VAILD POINT, MAX 3

8
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
20.8 20.7
Quick Ratio 72/125 55/111
(current assets-stock)/current liabilities .58:1 .50:1
1 1

 This ratio indicates the extent to which current liabilities are covered by current
assets after excluding inventories
 The general norm is 1:1
 The ratio has improved in the current year, indicating that the stock is better
managed, as evidenced by a decrease in stock by R 20m
1 MARK PER VAILD POINT, MAX 3
MAXIMUM 10

2.2
2.2.1
20.8 20.7
COS (2/3*sales) 200 160
1/2 1/2
(COS/inventory) 200/55 160/75
Inventory turnover ratio 3.64 times 2.13 times
1 1

 This ratio measures how quickly inventory is sold, he higher the ratio, the better
the entity is performing with regard to stock management
 In the current year, the ratio has improved from 2.13 to 3.64 indicating that there
has been a considerable improvement in the management of inventory
 An analysis of the financial statements indicate that the sales has increased by
R60m, whilst the inventory level has decreased by R20m

1 MARK PER VAILD POINT, MAXIMUM 3

2.2.2
20.8 20.7
Average collection period 67*365/300 42*365/240
(Acc Rec*365/sales) 81.52 days 63.88 days
1 1

 This ratio measures the average number of days that it would take for the
outstanding debtors to be collected
 There has been a considerable increase in the ratio indicating that the debtors book
is not being well managed
 Consideration should also be given to the adequacy of the provision for bad debts
due to the worsening of the ratio

1 MARK PER VAILD POINT, MAXIMUM 3

9
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
2.2.3
20.8 20.7

Fixed Asset turnover ratio 300/60 240/40

(sales/operating fixed assets) 5 times 6 times
1 1

 This ratio indicates the efficiency with which operating assets are used to generate
sales
 The greater the ratio, the better the asset utilisation
 The ratio is marginally lower than the previous year and this could be attributable
to the 50 % increase in fixed assets.
 Given the increase in turnover of 25 %, the business appears to be utilising its
fixed assets effectively

1 MARK PER VAILD POINT, MAXIMUM 3

2.3
20.8 20.7

Debt Ratio 157/192 146/178

(Total debt/Total assets) 82% 82%
1 1

 This ratio measures the percentage of total funds provided by creditors and is an
indicator of the financial risk of the company
 Although the ratio is high, it is fairly similar to the previous year
 It may be necessary to undertake a comparison with companies in the steel sector
to determine the reasonableness of the ratio
 Most of the funds borrowed are from its trade creditors for which there is no
borrowing cost, therefore the higher ratio may be representative of better working
capital management rather than a higher financial risk

1 MARK PER VAILD POINT, MAXIMUM 4

3.
 Multi-industry firms: Many firms are diversified into different industries, and
it is misleading to compare such firms against one set of industry averages.

 Use of industry averages: Most firms want to be better than average so merely
attaining performance is not necessarily good. To achieve high-level
performance it is better to target the industry leader’s ratios.

 Inflation: As financial statements are prepared on a historic basis, ratio

analysis over a period of time is less reliable due to the effects of inflation.
Since inflation affects inventory costs, profits are also affected.

 Seasonal factors: It is important that the year-ends of firms being compared

are considered as the ratios could be affected by seasonality.

10
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
 Window dressing: It is possible for a firm to window dress its financial
statements to reflect an improved financial position

 Different operating and accounting practices: These can distort comparisons as

firms which employ differing methods will have different results for their
respective ratios even if they are in reality extremely similar.

 Conflicting results: A firm may have some ratios which look good and others
which look bad making it difficult on balance to tell whether the company is in
a strong or a weak position.

2 MARKS PER VALID ITEM, MAXIMUM 10

MAXIMUM 50 MARKS

11
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
SUGGESTED SOLUTION QUESTION 4

Purpose of Valuation

Trim (Pty) Ltd is to be valued for the purpose of setting a purchase price for 60% of
Ted Trim’s shareholding in Trim (Pty) Ltd.

Methods of Valuation

This is a majority valuation and hence it is appropriate to use either an earnings

based or free cash flow method of valuation. The latter method is the preferred and
chosen method as we have access to all the required information. The free cash flows
will be determined for each year of the planning period (2009 to 2011) and the
terminal value at 2011, all discounted at the required rate of return, which is Trim
(Pty) Ltd’s weighted average cost of capital (WACC). This will give the value of the
entire company. To obtain the value of the equity, the market value of Trim’s (Pty)
Ltd’s long-term debt will be deducted from the company value. 

If Tim Trim purchases the 60% shareholding, Ted Trim will be a minority shareholder
(40%) hence a minority valuation is necessary.

A reasonableness test will be undertaken using the Net Asset Value (NAV) based on
market values to confirm the reasonableness of the free cash flow valuation.

FCF calculation
2009 2010 2011
R’000 R’000 R’000
Cash flow from operations 2 370 3 730 5 006
Add: depreciation 750 900 1 100
Add: long-term interest 300 300 300
Less: tax on interest (120) (120) (120)
Changes in working capital (570) (1 480) (830)
Cash from operations 2 730 3 330 5 456
Investment in fixed assets (1 460) (1 048) (3 000)
Free Cash Flows 1 270 2 282 2 456

Changes in Working Capital

2008 2009 2010 2011
R’000 R’000 R’000 R’000
Inventory 2 800 3 000 3 840 4 560
Accounts receivable 2 000 2 500 3 200 3 800
Current liabilities (1 420) (1 550) (1 610) (2 100)
3 380 3 950 5 430 6 260
Changes in working capital 570 1 480 830

12
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
Investment in Fixed Assets
2009 2010 2011
R’000 R’000 R’000
Opening balance 7 960 8 670 8 818
Less: depreciation (750) (900) 1 100
7 210 7 770 7 718
Closing balance 8 670 8 818 10 718
Difference = Acquisitions 1 460 1 048 3 000

WACC calculation
WACC = (0.8 x 17%) + (0.2 x 0.2(1 – 0.4)) = 16% 

Terminal value at the end of the planning period (end of year 2011)

FCF (1+g) = 2 456 (1 + 0.08) = R33 156

WACC – g 0.16 - 0.08

Value of equity in the company

Vequity = Σ FCFt + Terminal value - Debt

(1+ WACC)t (1 + WACC) t

= 1 270 + 2 282 + (2 456 + 33 156) - 1 500

1.16 (1.16)² (1.16)³
= 1 095 + 1 696 + 22 815 – 1 500
= R24 106 ÷ 700 shares 
= R34.44 per share = R14 464 (60%)

Minority Valuation

The expected dividends for the next 3 years are given as R1.06, R2.20 and R2.77 per
share. Thereafter the company is expected to maintain a constant dividend growth
rate of 8% in the foreseeable future.

A conventional formula for the calculation of the value of the shares is the dividend
discount model:

P0 = D0 (1 + g)
ke – g

In this case, the dividends for the first 3 years have to discounted separately, together
with the price of a share at the end of year 3. The price in year 3 will be based on the
model shown above. The appropriate cost of equity is 17% (given) and g = 8%.

P3 = 2.77 (1 + 0.08) = R33.33

0.17- 0.08

13
 University of KwaZulu-Natal
School of Accounting
Managerial Accounting and Finance III, MAFM300WY and MAFM300PY
_____________________________________________________________________
P0 = 1.06 + 2.20 + 2.77 + 33.33
1.17 (1.17)² (1.17)³
= 0.91 + 1.61 + 23.13
= R25.65 per share

Reasonableness Test

To test the reasonableness of the calculations, a net asset valuation at market values of
the assets must be performed.
R
Fixed assets 7 960
Inventory 2 800
Accounts receivable 2 000
Current liabilities (1 420)
Long-term debt (1 500)
NAV 9 840

R9 840 ÷ 700 shares = R14.06 per share or R5 904 (60%)

Conclusion
Given the company’s growth prospects, the Free Cash Flow valuation of R24 106
000, which constitutes the going concern value, versus the liquidation NAV of R9
840 000 seems fair. The maximum Tim Trim is therefore likely to pay for Trim
(Pty) Ltd’s shares is 60% x R24 106 000 = R14 464 000. However, as Tim will
obtain a clear majority shareholding, Ted Trim may want to receive a premium for
control.

 correct set out

14