B203B – Accounting

and Finance [Part B]

TOPIC 1- STATEMENT OF CASH FLOWS
Statement of Cash Flows
 The statement of cash flow is a financial statement that shows all the cash inflows that
the business receives from its operations, investing activities and financing activities,
as well as all cash outflows that is paid for operations and investment activities
during a given period. The net total of the statement is the net increase or decrease of
the cash (and cash equivalents) of the business over the period.
1. Cash flow from operating activities
 this is the net inflow and outflow from trading operations, after tax payments (or receipts) and cash
paid to meet financing costs.

2. Cash flow from investing activities

 This section of the statement is concerned with cash payments made to buy non-current assets and
with cash receipts from the disposal of non-current assets.

3. Cash flow from financing activities

 This part is concerned with the long-term financing of the business. It considers borrowings and
finance from share issues. This category is concerned with repayment/redemption of finance as well as
with the raising of it.
Methods in Preparing the Cash Flow
Statement
 Deducing net cash flows from operating activities:
 Direct method: it involves an analysis of the cash records of the business for the period,
picking out all payments and receipts relating to operating activities. This is a simple
method, but hardly any business adopt the direct method.
 Indirect method: this is a much more popular method.
 The statement of financial position (balance sheet) will tell us how much was owed
in respect of credit sales at the beginning and end of the reporting period (trade
receivables). The income statement tells us the sales revenue figure. If we adjust the
sales revenue figure by the increase or decrease in trade receivables over the
period, we deduce the cash from sales for the period.
CASH FLOW STATEMENT – STANDARD LAYOUT
CASH FLOW FROM OPERATING
ACTIVITIES
• PLUS / MINUS

CASH FLOW FROM INVESTING

ACTIVITIES
• PLUS / MINUS

CASH FLOW FROM FINANCING

ACTIVITIES
• EQUALS

Net Cash Increase (Decrease) in

cash and cash equivalents over a
period of time
STATEMENT OF CASH FLOWS – Using the INDIRECT Method
Profit BEFORE Taxation

+ Depreciation Expense

+ Interest Expense

(- / +) Increase (minus) or Decrease (plus) in Inventories

(- / +) Increase (minus) or decrease (plus) in receivables

(+ / -) Increase (plus) or decrease (minus) in trade payables

- Interest paid

- Taxation paid

- Dividend paid

Net cash flows from operating activities

 ITEM SOURCE USE

Increase in Accounts Payable

Decrease in Accruals
Increase in Accounts Receivables
Sale of a Machine
Increase in Inventory
Increase in Notes Payable
Company paid cash dividends
Increase in Prepaid Expense
Depreciation on Fixed Assets
Payment of Loan Installments
Decrease in Cash
Purchase of Equipment
 ITEM SOURCE USE
Increase in Accounts Payable X  
Decrease in Accruals   X
Increase in Accounts Receivables   X
Sale of a Machine X  
Increase in Inventory   X
Increase in Notes Payable X  
Company paid cash dividends   X
Increase in Prepaid Expense X  
Depreciation on Fixed Assets X  
Payment of Loan Installments   X
Decrease in Cash X  
Purchase of Equipment   X
EXAMPLE ONE
ITEM AMOUNT (K.D.)
Profit before taxation 122
Depreciation charged 34
Interest expense 6
At the beginning of the year
Inventories 15
Trade receivables 24
Trade payables 18
At the end of the year
Inventories 17
Trade receivables 21
Trade payables 19
Further information
Taxation paid 32
Interest paid 5
Dividends paid 9
EXAMPLE ONE – Continued..
STATEMENT OF CASH FLOW for XYZ Co. as of 31/12/20XX
Profit before tax 122

+ Depreciation 34

+ Interest expense 6

(+ / -) Increase in inventories (17-15) (2)

(+ / -) Decrease in trade receivables (21-24) 3

(+ / -) Increase in trade payables (19-18) 1

Cash generated from operating activities 164

- Interest paid (5)

- Taxation paid (32)

- Dividends paid (9)

Net cash from operating activities 118

 EXAMPLE TWO
ITEM AMOUNT (K.D.)
Profit before taxation (after Interest) 125,000
Depreciation charged 35,000

At the beginning of the year

Inventories 1,500
Trade receivables 2,400
Trade payables 1,800
At the end of the year
Inventories 2,800
Trade receivables 1,400
Trade payables 2,200
Further information
Taxation paid 31,000
Interest paid 6,000
Dividends paid 8,000
EXAMPLE TWO - Continued
STATEMENT OF CASH FLOW for ABC Co. as of 31/12/20XX
Profit before tax 125,000
+ Depreciation 35,000
(+ / -) Increase in inventories (2,800 – 1,500) (1,300)
(+ / -) Decrease in trade receivables (1,400 – 2,400) 1,000
(+ / -) Increase in trade payables (2,200 – 1,800) 400
Cash generated from operating activities
- Interest paid (31,000)
- Taxation paid (6,000)
- Dividends paid (8,000)
Net cash from operating activities 115,100
B203B – Accounting
and Finance [Part B]
TOPIC 2 – RELEVANT COSTS
Relevant Costs
 Cost represents the amount sacrificed to achieve a particular business objective.
 But when measuring cost for decision-making purposes, things are not quite
simple. These are RELEVANT COSTS.
 To be relevant to a particular decision, a cost must have three attributes. What are
these attributes?
 It must relate to the objectives of the business: most businesses have enhancing owners’
wealth as their key strategic objective. Thus, to be relevant to a particular decision, a cost
must have an effect on the wealth of the business.
 It must be a future cost: past costs cannot be relevant to decisions being made about the
future.
 It must vary with the decision: only costs (and revenues) that are different between
outcomes can be used to distinguish between them.
Relevant costs: opportunity, outlay, committed and sunk costs
 An opportunity cost is the value, in monetary terms, of being deprived of the next
best opportunity in order to pursue the particular objective.
 An outlay cost is an amount of money that will have to be spent to achieve that
objective.
 A sunk cost is another way of referring to a past cost and so the terms ‘sunk
cost’ and ‘past cost’ can be used interchangeably.
 A committed cost arises where an irrevocable decision has been made to incur
the cost because, for example, a business has entered into a binding contract. As a
result, it is more or less a past cost despite the fact that the cash may not be paid until
some point in the future.
 Since the business must eventually pay, a committed cost can never be a relevant cost
for decision making.
RELEVANT COSTS – Example ONE
 A garage buys a lorry for £10,000.
It requires a new engine costing £2,500 that will take 20 hrs to fit.
The technicians will be paid £15 per hour to fit the engine.
The technicians are short of work but the garage wishes to retain
their services.
The lorry could be sold immediately for £9,000.
 Solution:
 Initial cost of lorry = £ 10,000 [Irrelevant cost, sunk cost]
 New engine cost = £ 2,500 [Future outlay cost – Relevant Cost]
 Labour cost = 20 hr x £ 15 = £ 300 [Irrelevant cost, the same cost will be incurred whether the business undertakes
the engine-replacement work or not]
 Market price of the lorry = £ 9,000 [Opportunity cost – Relevant Cost]
 So the the minimum price the garage should charge for the lorry after the engine has been fitted is
 £
 Opportunity cost of lorry 9,000
 Cost of new engine 2,500
 11,500
Relevant Costs – Example TWO
 Follows the same information as in example 1 EXCEPT that;
 If a mechanic is to be put on the engine-replacement job, it will mean that other work that the
mechanic could have done during the 20hours, all of which could be charged to a customer, will not
be undertaken. The garage’s labor charge is £50 an hour. The mechanic is only paid £15 an hour.
 Solution:
 Initial cost of lorry = £ 10,000 [Irrelevant cost, sunk cost]
 New engine cost = £ 2,500 [Future outlay cost – Relevant Cost]
 Labour cost = 20 hr x £ 50 = £ 1,000 [Relevant cost]
 Market price of the lorry = £ 9,000 [Opportunity cost – Relevant Cost]
 So, in this case, the the minimum price the garage should charge for the lorry after the engine has
been fitted is;
 £
 Opportunity cost of lorry 9,000
 Opportunity cost of technicians’ time 1,000
 Cost of new engine 2,500
 12,500
RELEVANT COSTS – Example TWO
Jay Ltd is bidding for a contract that will require 800 units of Alpha. This material is
currently held and information is as follows:

Historic cost Re-sale value Replacement cost

K.D./unit K.D. /unit K.D./unit
10 12 14

Scenario 1: Alpha is no longer used by the business.

What is the minimum price for Alpha for inclusion in the contract bid?
Solution: 800 × £12 = £9,600
Scenario 2: Alpha is in regular use.
Solution: 800 × £14 = £11,200
RELEVANT COSTS – Example THREE
 A business is considering making a bid to undertake a contract. Fulfilment of the contract
will require the use of two types of material. Quantities of both of these materials are held
by the business. If it chose to, the business could sell the raw materials in their present
state. All of the inventories of these two raw materials will need to be used on the
contract. Information on the raw materials concerned is as follows:

Inventories Quantity Historic cost Sales value Replacement

item (units) (K.D./unit) (K.D./unit) cost
  (K.D./unit)
A1 600 6 5 8

B2 400 7 10 11

 1) Identify all the relevant and the irrelevant costs of the problem above.
 2) How much should be included in the minimum price in respect of the two
inventories items detailed above?
RELEVANT COSTS – Example THREE

Inventories item Quantity Historic cost Sales value Replacement

  (units) ($/unit) ($/unit) cost
($/unit)
A1 600 6 5 8
B2 400 7 10 11

 USE THE FOLLOWING INFORMATION:

 Inventories of item A1 is in frequent use in the business on a variety of work.
 The inventories of item B2 were bought a year ago for a contract that was abandoned.
It is a surplus that will not be used by the business again, unless the contract currently
being considered proceeds.
 The assembly of the product is a highly skilled operation and it will take 100 hours for the
whole contract to be complete. The workforce is currently underutilized. It is the
business’s policy to retain this workplace on full pay in anticipation of high demand next
year. There is sufficient available skilled labor to undertake the contract now under
consideration. Skilled workers are paid $25 an hour.
RELEVANT COSTS – Example THREE
 Solutions
 If the company does not take on the project, the minimum price in respect of the two
inventories items detailed above is;
 Cost of Material A1 = K.D. 4,800 (600 x 8) [Future outlay cost – Relevant Cost]
 Cost of Material B2 = K.D. 4,000 (400 x 10) [Relevant Cost]
 Labour cost = 100 hrs x K.D. 25 = K.D. 2,500 [Irrelevant Cost]
 If the company does take on the project, the minimum price in respect of the two
inventories items detailed above is;
 Cost of Material A1 = K.D. 4,800 (600 x 8) [Future outlay cost – Relevant Cost]
 Cost of Material B2 = K.D. 4,400 (400 x 11) [Relevant Cost]
 Labour cost = 100 hrs x K.D. 25 = K.D. 2,500 [Relevant Cost]
 SO, in the first case: Total Price = K.D. 8,800
 And in the Second Case: Total Price = K.D. 11,700
B203B – Accounting
and Finance [Part B]
TOPIC 2 – COST-PROFIT-ANALYSIS
TYPES of Costs Behavior
 Fixed cost: remain constant when changes occur to the volume of activity (rent, insurance,
cleaning cost, etc..)
 Variable: vary according to the volume of activity (raw material, labor)
 Stepped Fixed Cost: It remains constant up to a certain volume of activity and then will
increase and remain constant again up to a certain volume of activity.
 Example: As the volume of activity increases from zero, the rent (a fixed cost) is unaffected. At a
particular point, the volume of activity cannot increase further without additional space being
rented. The cost of renting the additional space will cause a ‘step’ in the rent cost.

C Co R
st e
o (£) nt
st
c
(£ o
) st
F (£
)
R
0 Volume of activity (units of
output) 0 Volume of activity 0 Volume of activity
Cost Behavior – Semi-Fixed Costs
 Semi-Fixed Costs are costs that have an element of both fixed and variable cost.
 An example might be the electricity cost, or the phone cost.
 We can estimate the fixed and variable elements by using the HIGH-LOW METHOD
 This method involves taking the highest and lowest total activity cost figures from the
range of past quarterly data available.
 Example:

Lowest quarterly activity Highest quarterly activity

Volume of activity 100,000 units 180,000 units
Total electricity cost $80,000 $120,000
Example – High-low Method
 STEP 1: Calculate the variable Cost per Unit
 The variable cost per unit is : $(120,000 – 80,000)/(180,000 – 100,000) = $0.5 per unit
 STEP 2: Multiply variable cost per unit by the low and high volume of activity

Lowest quarterly activity Highest quarterly activity

Volume of activity 100,000 units ($) 180,000 units ($)

Variable cost:
100,000 x $0.5 50,000 90,000
180,000 x $0.5
Fixed cost (balancing 30,000 30,000
figure)
Total Electricity cost 80,000 120,000
TOTAL COSTS
 Total cost diagram

Cost
(£) Total cost

Variable
costs

Fixed costs

0
Volume of activity (units of output)
Break-Even Analysis
 The profit or loss, which is the difference between sales revenue line and the total costs
line.
 Where there’s no difference between the two, we have what we call BEP: Break-even
point.
 At this point, Total sales
Cost revenue
there’s neither a profit nor a loss. (£) Break-
f i
 If the volume of activity even Pro
point t
is below the BEP, there’s a loss. Total cost
Variable
 If the volume of activity
cost
Los
is above the BEP, there’s a profit. F s
Fixed cost

0
Volume of activity (units of output)
Break-Even Point Calculation
 We use the following Equation:

BEP _______________Fixed cost_________________

= (Sales revenue per unit − Variable cost per unit)

 Example 1:
 Cottage industries makes baskets
 Fixed cost = $500
 Material cost/basket = $2
 Labor cost /basket = $10
 It takes one hour for employees to make a basket.
 The basket makers are all on contracts such that if they do not work for any reason, they are not paid.
 Selling price/basket = $14
 What is the BEP?
 BEP = Fixed cost / (Sales revenue per unit – variable cost per unit)
 = 500/(14-12) = 250 baskets
Break-Even Calculation
 Example 2:
 Cottage industries expects to sell 500 baskets a month.
 The business has the opportunity to rent a basket-making machine.
 Doing so will increase the fixed costs = $3,000
 Using the machine will reduce the labor time = ½ hr / basket
 Labor cost = $10/hr
 How much profit would the business make each month from selling baskets:
 Without the machine?
 With the machine?
 What is the BEP if the machine is rented? = 3,000/(14- (2+5)) = 429 baskets
 Without the machine

$ $
Sales revenue 7,000
Materials (1,000)
Labor (5,000)
Fixed costs (500)
Total costs (6,500)
Profit 500

With the Machine

$ $
Sales revenue 7,000
Materials (1,000)
Labor (2,500)
Fixed costs (3,000)
Total costs (6,500)
Profit 500
Interpretation of Results
 The two scenarios led to the same profit ($500).
 So based on the profit, we cannot make a decision whether the machine should be
used or not.
 There’s a distinct difference between the two strategies in regards to their BEP.
 Without the machine, BEP = 250 baskets. It means that without the machine, the
business will start making a profit after selling 250 baskets.
 With the machine, BEP = 429 baskets. It means that with the machine, the business
will start making a profit after selling 429 baskets.
 The knowledge of BEP and the planned volume of activity gives some basis for
assessing the riskiness of the activity.
Break-Even – Example Two
 Americana Company they are producing meals. They are expecting to sell 50,000
meals per month. Their total fixed cost per months is 10,000 K.D, and the total
variable cost is 25,000 K.D, they are selling each meal for 1.5 K.D.
 Calculate the profit and breakeven point:
 Solution:
 Variable Cost Per Unit: 25,000 / 50,000 = $0.5 per unit
 BEP = 10,000 / (1.5 – 0.5) = 10,000 units
 Profit = Sales – (Fixed Cost + Variable Cost) = (50,000 x 1.5) – (10,000 + 25,000) =
75,000 – 35,000 = $40,000
Break-Even – Example Three
 A project under consideration costs $75,000, has a five-year life, and has no salvage
value. Depreciation is straight line to zero. Sales are projected at 500 units per year.
Price per unit is $2500, variable cost per unit is $1500, and fixed costs are $200,000
per year. What is the accounting break-even point?
 Solution:
 BEP = 200,000 / (2,500 – 1,500) = 200,000 units
 Total Variable Cost = 500 units x $1,500 per unit = $750,000
 Sales = 500 units x $2,500 per unit = $1,250,000
 Profit = Sales – (Fixed Cost + Variable Cost) = $1,250,000 – (200,000 + 750,000) =
$300,000