Mode E and Q Regulations

Assessment Information – This assignment is an individual assignment.

Criteria for Assessment

This assignment is designed to assess the following Learning Outcomes:

1. Analyse and interpret core financial statements for sole traders and limited companies, in line with prescribed international accounting standards.  Focus will be put on the use of annual reports of international real-world public companies.
   
   
2. Evaluate appropriate management accounting techniques and use management accounting information to support business decision-making.
   
   
3. Understand apply and evaluate management accounting concepts and techniques in decision making.

As set out on page 2 and generally, this assignment requires you to write a draft business report to address the following issues within the case study.

You are the Personal Assistant to Chris Smith[1].  3 months ago, Chris was appointed by ABCD Plc, the parent company of BB Ltd, as General Manager of BB Ltd to turn it around. 
In his/her late 30’s, after a business degree, Chris qualified as an accountant before joining ABCD as part of a trouble-shooting team.  BB Ltd is his/her first independent command, so to speak.  You are part of the turnaround team.  It’s ABCD that pays both your salaries.

The last few years have been very difficult for BB Ltd, a UK-based company whose principal activity is the manufacture of digital video equipment, which it distributes to retailers.  It has only survived through the support of its parent company, ABCD plc, to whom it currently owes a significant debt.  ABCD has reached the point where it is prepared to take drastic action, including closing down BB Ltd.  So BB Ltd needs rapidly to improve its financial performance, advancing on all fronts; as appropriate increasing revenue and reducing costs and capital employed.  Cash is available from ABCD if the case is strong.

Below is the brief you have received from Chris Smith:

Please draft a report to go out in my name as follows:

• Highest level of confidentiality
• Readership – ABCD’s BB Steering Committee + BB’s top tier managers
• 2,500 words, though you can add appendices to that limit.  Remember that clarity (e.g. from headings and bullet points) is the cardinal virtue in this organisation.  Brevity is a bonus, so if it’s less than 2,500 words that’s great. 
  
  But never cut corners or mislead – if something is complex or you just don’t know (or cannot say) then make that clear, why, and ideally, how and when you can get back to clarity.  Repetition kills credibility because it tells the reader that you don’t know what you’ve already said.  Spell-checks are there to make everyone look literate.  And as my time is more valuable than yours, you must do the proofreading.
  
  

You have a few leads with which to start but I need from you elaboration, exploration and in some cases a recommendation.  Specifically, in the draft report I’m looking for the following:

1. As per normal for ABCD, an Executive Summary of the report to follow (250-300 words)
   
   
2. The Cash budget – the finance department have passed me some alarming figures.  What’s going on – we all need to know.  Recommendations would be welcome including recommendations as to where we need to investigate (300-400 words).
   
   
3. New product line – a recommendation – and don’t forget to draw attention to the limitations of this sort of Cost-Volume-Profit analysis (200-250 words).
4. Capital investment – an intelligent discussion of the options.  Give recommendation but be aware that the final decision rests with ABCD who may choose differently.  
   I know that the BB managers are used to the Accounting Rate of Return (ARR) as one of the investment appraisal methods.  ABCD rejected ARR some years ago but can you include a few soothing words to justify its non-use.  (350-450 words).

• Selecting the builder – It’s all very well to decide to build an extension to modernise the works but you need a builder.  Can you cast your eye over the summarised accounts of the final shortlisted two?  Does that information suggest choosing one over the others?  Ratios will be part but not all of your justification, so you’ll need to choose and explain your selection of ratios – but not too many please (650 – 800 words).
  
  
• Budgeting.  I feel I’d like to know how BB Ltd got into the state they are in.  I believe that their current way of budgeting is both traditional and not especially rigorous.  I know that ABCD have been looking at the Beyond Budgeting approach, but they have not come to any conclusions so far.  Can you report on how and why traditional budgeting tends to go wrong and the modern ways in which small manufacturing firms like ours can budget effectively?  Be gentle if you start to criticise the current BB managers – we don’t want to alienate them.  On the other hand, they may need to be educated in best modern practice.  Changes here will only show medium term gains, which is why it’s the last item in the report.  I’ve a few leads but you’ll need to do your own research here. (450 – 600 words).

Item 2 – Cash budget

BB Ltd’s Finance Department has prepared the following cash budget and budgeted income statement for the first 3 months of the 2021/22 budget year, a period in which the company is expected to return to profit.

Budgeted cash flow	January	February	March
	£	£	£
Opening balance	10,056	(13,860)	(58,499)
RECEIPTS:
Cash sales	544,855	554,580	569,415
Credit sales	1,260,000	1,273,145	1,297,722
Total receipts	1,804,855	1,827,725	1,867,137
PAYMENTS:
Materials cash purchases	(571,699)	(598,922)	(626,529)
Materials credit purchases	(235,668)	(229,000)	(223,457)
Operating expenses	(288,368)	(299,903)	(310,339)
Fixed overheads	(243,700)	(243,700)	(243,700)
Production labour	(313,955)	(321,952)	(330,808)
Administration costs	(175,380)	(178,888)	(176,991)
Total payments:	(1,828,770)	(1,872,365)	(1,911,824)
Net cash flow	(23,916)	(44,640)	(44,687)
Balance c/f	(13,860)	(58,499)	(103,187)
Budgeted income statement	January	February	March
	£	£	£
Sales	1,818,000	1,852,302	1,903,755
Cost of sales	(1,060,500)	(1,080,509)	(1,110,524)
Gross profit	757,500	771,792	793,231
Operating expenses	(299,903)	(310,339)	(319,533)
Fixed overheads	(285,873)	(285,873)	(285,873)
Administration costs	(175,380)	(178,888)	(176,991)
Total expenses	(761,156)	(775,100)	(782,398)
Operating profit/(loss)	(3,656)	(3,307)	10,833

The following information is relevant to the cash budget:

1. Credit customers are allowed one month’s credit on sales;
2. Credit suppliers allow one-month credit on raw materials purchases;
3. Materials and production labour costs are included in the cost of sales in the budgeted income statement.

The following information from the budgeted Statement of Financial Position is also available.

	January	February	March
	£	£	£
Trade receivables	1,273,145	1,297,722	1,334,340
Trade payables	229,000	223,457	216,888
Finished goods inventory	221,845	239,345	255,742
Raw materials inventory	385,126	431,448	478,752

Item 3 – New product line

The Production Department has come to me with an idea to increase automation in one of their main production processes – see the table below for the relevant information.  

If implemented, it will significantly impact the cost structure of one of their most popular lines of virtual reality headsets.  Current annual sales are steady around 12.000 units. 

Can you advise – and don’t forget to list any additional questions we should be asking them?

	Current process	New process
Sales price (per headset)	£350.00	£350.00
Direct materials cost (per headset)	£225.00	£225.00
Direct labour cost (per headset)	£90.00	£70.00
Fixed manufacturing overheads	£100,000	£370,000
Fixed administrative overheads	£100,000	£80,000
Fixed selling and distribution overheads	£55,000	£55,000
Break-even point (headsets)	7,788	9,181
Profit at current sales levels (12.000 units)	£165,000	£155,000
Margin of safety at budgeted profit level	44.5%	28.4%
Unit sales (headsets) required to achieve the budgeted profit of £200,000	13,000	12,818

Item 4 – Capital investment appraisal

BB Ltd is planning some new building to allow the re-organisation of certain production processes.  There are two building options using the same land within the current factory perimeter, Medium Build (MB) and Small Build (SB).  Big build was rejected at an earlier stage.  Both will bring a wide range of benefits but, as many are hard to estimate, the figures needed to be treated with even more caution than usual.  Not included in the calculations is that MB allows for future expansion in a way that SB does not.  10% of the initial cost is to be paid in year 3 as part of the retention process.  After year 5, indicated by the infinity symbol, ∞,  the gains flow in perpetuity (i.e. every year and in principle forever,).

The perpetuity has been turned into a capital value by the application of the I/r factor.  The information below about the cash flows and capital investment appraisal measures has been collected so far.  ABCD applies a cost of capital of 6%.for such projects, this being irrelevant to the Accounting Rate of Return (ARR) which ABCD does not use.  As the BB managers are most familiar with ARR, you need to identify why ARR is inferior to other appraisal methods.

		Small Build	–	Medium Build
Year	6% DCF Factor	Cash flow (£)	Present value (£)	–	Cash flow (£)	Present value (£)
0	1.0000	-1,500,000	-1,500,000	–	(1,900,000)	(1,900,000)
1	0.9434	100,000	94,340	–	120,000	113,208
2	0.8900	100,000	89,000	–	120,000	106,800
3	0.8396	-60,000	-50,376	–	-70,000	(58,772)
4	0.7921	120,000	95,052	–	130,000	102,973
5	0.7473	130,000	97,149	–	140,000	104,622
∞		130,000		–	160,000
5+	0.7016	2,167,000	1,520,367	–	2,666,666	1,870,933
NPV		345,532	–		339,764
Payback period	14 years 3 months	–	14 years 10 months
Internal rate of return	7.33%	–	7.07%

Item 5 – Selecting the Builder

The technical and marketing staff have got together to get us to two options, two companies we can go with.  That’s good, but what worries me is the risk that whoever we pick might either go bust or get into such trouble that they go slow or leave the job half-finished or to try to squeeze more money from us.  I recall building companies being more likely than average to get into financial trouble.

ABCD subscribes to FAME, a financial database.  Attached are documents for you to use:
1. FAME reports on Novus and Harper (Appendices to this brief)

2. Companies House links to their public details:
– Harpers https://find-and-update.company-information.service.gov.uk/company/06892284 – Novus https://find-and-update.company-information.service.gov.uk/company/02403551 .

What I’d like you to do in 650 – 800 words are the following:

1. Report on and explain what accounting ratios we can use to inform ourselves as part of guarding ourselves against the failure of those with whom we choose to work.  There is gearing, the current and the quick ratios, but what else?  I don’t think people can cope with more than 10 ratios – anything up to another half dozen on top of these 3 should be fine.  And again, brevity/economy is good!
   
   
2. Using all the ratios arising from Task 1 above, report on Novus and Harpers.  Do they both pass the financial tests?  Please also comment on anything you find that needs to be drawn to the attention of senior management.

Item 6 Budgeting

As changes here will only show medium term gains, it’s the last item in the report.

I’d like to know how BB Ltd got into the state they are in.  I believe that their current way of budgeting is both traditional and not especially rigorous.  ABCD have been looking at the Beyond Budgeting approach but they have not come to any conclusions so far.  Can you report on how and why traditional budgeting tends to go wrong and the modern ways in which small manufacturing firms like ours can budget effectively?

In my research on budgeting, I got as far as a 2018 literature review which looked pretty good – Beyond budgeting: review and research agenda Nguyen, Weigel and Hiebl.

(Nguyen, Weigel and Hiebl) Abstract

Purpose – Beyond budgeting has received an increased amount of scholarly attention in recent years. However, because most of the published research is discrete and unconnected, an overall picture of what is known about beyond budgeting has not evolved. Therefore, the purpose of this paper is to provide an overview of the available research on beyond budgeting. In particular, the authors compare conceptual papers that mostly stress the benefits of beyond budgeting with empirical evidence on beyond budgeting implementation and offer ideas for future research on beyond budgeting.

Design/methodology/approach – This paper uses systematic literature review methods. After an extensive database search and examination of references/citations, 32 papers were analysed with regard to bibliographical information, research design and findings.

Findings – Although proponents of beyond budgeting have put substantial effort into developing and promoting this concept, numerous empirical studies demonstrate that many organizations being investigated would still rather improve traditional budgeting than abandon it completely. This review also highlights the main criticisms of traditional budgeting, development of management control systems under beyond budgeting and factors hindering the implementation of beyond budgeting.

Research limitations/implication – This paper suggests that further research is needed on the scaling of beyond budgeting, organizational changes under beyond budgeting and challenges resulting from the implementation of beyond budgeting.

Originality/value – The paper is the first comprehensive literature review on beyond budgeting.

Keywords Beyond budgeting, Budget, Abandoning budgeting, Removing budgeting, Traditional budgeting

What I’d like you to do is to pick out the main points relevant to our situation that we want the BB managers and the ABCD committee to appreciate, along with recommendations for the future.  (400 – 600 words)

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[1] If you need to you, you can decide if your Chris Smith is female (Christine/Christina) or male (Christopher/Christian).  In this text, when appropriate, I’m writing him/her.