Accounting for Business
The key purpose of this report is to analyses the accounting practices of Pooma Sports Ltd to suggest better ways of accounting to the Board of Directors of the firm. From this report, it is analyzed that it is challenging for the firm to develop budgets as it is important for it to consider strategic planning for budget development.
Apart from this, it is also identified from the report that it is also challenging for the firm to make decisions whether it should manufacture trough in-house production or outsourcing. From analysis, it is suggested to the firm that it will better to outsource manufacturing as it is less risky option with providing high returns.
At the same time, there are differences between the net cash flows and the operating profit due to depreciation and non-cash expenses affecting income statement. The firm is facing negative cash flows due to making higher payment. There is also dilemma for the company to make use of direct costing or costing allocation to the departments.
Both methods provide own benefits and challenges but cost apportionment based on departments can be more beneficial for the company to reduce overheads for the departments which are facing low revenues for longer period.
Apart from this, it is also identified from report that there are differences in results obtained from different investment appraisal methods named as NPV, ARR, IRR and payback period. However, the use of NPV method provides more reliable results due to considering time value of money and assumption of reinvestment based on cost of capital.
Need for budgets and strategic planning
The need for budget along with a strategic plan is a part of strategic planning. The strategic planning provides guideline to achieve organisational goals and budget provides the funds support to achieve these goals.
The document highlights the need for budget as a tool of strategic planning, to promote co-ordination and control among business units, for optimal resource allocation and evaluation of performance.
However, the article emphasise on changing the process of budgeting and dispensing the budget. This outlook can be supported as in recent volatile business environment it is better to dispense budget and reinstate with a more dynamic system of key performance indicator (KPI) and method of rolling forecast.
This will be useful for the organisation to reallocate strategic decisions towards more customers oriented. The traditional budgets are no longer capable to flexible to allow creativity and sufficient tool to cope with external uncertainties.
As per the document, budgets should be dispensed as budgets have turn out to be inexact as behavioural problem are associated with it (Pingle, 2013). Hence, any dysfunctional behaviour from the workers or managers or its acceptance issue can lead to hostile actions and dishonesty and reduce allocation of resources.
Thus, the budget are required to transform to replace its control and command designs and required to give authority to front line managers for enhancing creativity, better resource allocation and to take decisions and actions to satisfy the customers. Thus, this indicates that transformation of budgeting process of the companies to achieve its alignment with the strategic goals.
a. Types of cost behaviour and why all fixed costs are in reality stepped fixed costs
As per cost behavior, fixed costs do not change with the activity level within the relevant range. At the same time, variable cost such as direct labour cost and direct materials cost change in direct proportion to the production level. Stepped fixed costs are the costs which do not change within certain high and low thresholds of activity.
As Pooma Sports Ltd wants to introduce a new style of Rugby boot to the market, so it is intended to increase activity by starting up a new production shift, which includes utilities and the salaries of shift supervisors or existing resources (Harris, 2014).
b. Risk and return offered by the two manufacturing options
Higher margin of safety in outsourcing production reduces the chances of risk of loss. It can be said better decision to outsource the manufacturing process as it reduces the risk of loss to which a business is subjected by changes in sales.
There may be possibility of changes in sales as larger margin of safety is suitable for well protection of business from sales variations. At the same time, company will need to sell less pairs of boots to achieve the breakeven point if it outsources manufacturing process rather than in-house production.
It means the company will need to sell less number of products to reach in the situation where the profit is zero. at the same time, it is more effective for the firm to outsource the manufacturing to get returns earlier as compared to the in-house manufacturing (Vanderbeck, 2012).
However, if the firm wants to achieve the budgeted profit of £250,000, it will need to sell more pairs of boots in outsourcing option. It means it will take more time to get sufficient returns through outsourcing option. But overall, it can be recommended that it will be better option for the firm to outsource the manufacturing process because it will enable the firm to reduce the risk that is major factor in the condition of sales variations.
Reasons for the differences between the net cash flows and the operating profit
Form the information of this cash budget, it can be identified that the net cash flow is different from operating profit because it includes some specific items that impact on the income statement. These items are depreciation and non-cash expenses that are included in this cash budget.
These kinds of expenses influence the net income of the budget but not effects on the cash flow. At the same time, the credit sales also created the different value of the net cash flow and the operating profit includes the amount of the profit (Faulkender et al., 2012).
Moreover, this statement also includes some credit sales and credit purchase that effect on the profit of the company but not effect on the cash flow. So it can be said that the net cash flows of the cash budget are different from operating profit.
On the other hand, form this cash budget statement, it can also be identified that the net cash flow is negative in each month, while the company is providing profits in the return of each six month period.
The main reason behind it is that the organization has many high expenses then income and also the payments are high then cash inflow. This cash budget has more payments than cash receipts in each month. In addition to this, the credit sales of the company are also very high that impact on the cash inflow (Dickinson, 2011).
These are the main reasons for the negative cash flow but at the same time, it can be seen that the negative cash flow is reducing constantly. It shows that the negative cash flow will not remain negative during the next six-month budget preparation. It is because now the operating profit is positive and the negative net cash flow is also reduced after the six-month budget.
The sales of the company are also increasing that will also be helpful to provide positive net cash flow. So, it can say that the more payment is the reason for negative cash flow.
a. Original costing method & revised costing method
In original costing method, cost apportionment based on cost centres is done on an equitable basis. This base allows to the allotment of expenses which cannot recognize completely with a specific department. These expanses need division and apportionment over two or more cost centres or units. Direct method is the easiest method computationally but this factor is less significant by the use of computers.
At the same time, it is easy to explain to managers and other users. But it does not consider the interactions among support departments. It also increases the overhead costs for the departments which are not performing well over the time (Anderson and Sollenberger, 2011). So, it can be stated that it does not focus on department while allocating the costs that causes high overhead costs for the departments which are not performing better.
In revise costing method, the firm can reduce the overheads to the Sports Clothing and Sports Equipment profit centres. It can be helpful for the company to increase sales and profits. Apart from this, the reduction in overhead costs to these departments will be support to enhance sales through price reduction and profit maintenance at the same time.
Allocation to the department allows for reapportioning the cost on the basis of material consumed by different department. It is also effective to allocate overhead costs to different departments based on the benefits obtained from thee departments (DRURY, 2013). This method provides a broader consideration than marginal costs. At the same time, it also shows relevant cost in the long run. But it uses past costs and also restricts future costs to outlays only.
b. Critical appraisal of the Sales Director’s view
The sales director says that the proposed costing method is superior as it helps in reduction of the overheads chargeable to the Sports Clothing and Sports Equipment cost centres. This method is appropriate to allocate cost to different departments as per their sales level and benefit the firm to overcome the adverse situations for those departments which are facing losses for longer period.
In addition, this method is quite effective for the firm to allocate costs to the departments to bring in profitable situation by reducing the amount of overheads for thee departments. But at the same time, it also causes inequality in allocation of costs that may reduce the reliability of the cost allocation.
It is considered that basis for distribution should be equitable and practicable. Apart from this, this method may be time consuming that as compared to direct method that may cause complexity in cost allocation (Matz et al., 2011). Apart from this, it is allocated based on area of departments, but it should allocate the cost among different departments based on benefits obtained by departments.
a. Reasons for the apparent conflicts
In the given case, it is identified that NPV suggests that there is need for the Sports Equipment department to invest in the Superstitcher due to high NPV showing high returns. Similarly, accounting rate of return is also high for the investment in the Superstitcher indicating more feasibility for the investment.
But at the same time, payback period shows that the firm will enable to recover its investment in equipment earlier if it invests in purchasing of the Gluemaster. In addition, internal rate of return shows that the firm should invest in the Gluemaster to get higher internal rate of return.
There are differences between the results obtained from NPV and IRR because NPV is an absolute measure presenting the amount of value added or lost in a project while IRR is a relative measure showing the rate of returns in a project over its lifespan. However, both are discounting methods and consider the time value of money (Anderson and Sollenberger, 2011).
The NPV and IRR conflict is dependent on whether the projects are independent or mutually exclusive. Independent projects are projects in which decision for selecting one project does not influence decision related to others. In such projects, NPV and IRR conflict does not arise as the firm can select any project with positive NPV. But mutually exclusive projects are the projects in which selection of one projects excludes the consideration of others. For this, best project is chosen.
In the given case, the given project is mutually exclusive as there is need to select only one option (Graham and Smart, 2011). In such scenario, NPV and IRR conflict arises because of the relative size of the project or different cash flow distribution of the projects. IRR method assumes that there is possible to reinvest any cash flows at the IRR that is unrealistic as there is no guarantee of achieving reinvestment at IRR.
On the other hand, NPV is based on assumption of reinvestment at the cost of capital that is realistic. At the same time, payback period also provides contradictory results than NPV and ARR because this method just provides information about the time period to cover the startup costs. The payback period method doesn’t consider inflation and the cost of capital (Shepherd, 2015). It is also not based on time value of money as purchasing power of money declines over time.
However, ARR and NPV both suggest same results but ARR is different from NPV as it considers operating profit rather than cash flows and does not take into account time value of money.
b. Risk and return presented by each option
Higher NPV shows higher returns for the investors on investment in a specific project. At the same time, less risky project may be beneficial for the firm to invest. Low payback period shows that the cost of an investment can be recovered the sooner indicating the less risky investment.
From return perspective, it can be recommended to the firm that it should invest in the Superstitcher due to high NPV showing high returns. From risk perspective, the firm can recover its initial investment cost sooner from the investment in the Gluemaster as it is less risky project. Both results are contradictory to each other (Pingle, 2013).
But at the same time, the NPV method is considered more realistic and believable investment appraisal method due to its consideration for time value of money and assumption of reinvesting at cost of capital that make it more reliable method. Therefore, it can be suggested to the Sports Equipment department for purchasing the Superstitcher.
At the same time, if the firm does not have sufficient investment capital available, then it will be better to purchase the Superstitcher requiring only £ 1,000,000 that is lower amount than £ 1,300,000 required for purchasing the Gluemaster.
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