Direct Labour Rate And Efficiency Standards Accounting Essay


Gross profit margin gives a good indication of the financial health of a company. It shows if a company will be able to meet its operating and other expenses after paying for the cost of goods sold. It tells us that Tesco made a gross profit of 7.56p per £1 of turnover of the business. Net profit margin excludes cost of goods sold and other selling expenses. A net profit margin ratio of 5.59% means that for each pound of sales that Tesco generates it is contributing 5.59p to its net income.


Current Ratio

Current Assets:Current Liabilities

2053:4809 = 0.43:1

Acid Test Ratio or Quick Ratio

Current Assets - Stocks: Current Liabilities

2053 - 929:4809 = 0.23:1

Current ratio shows the ability of a company to meet its short term maturing obligations (short-term creditors) from realisation of its current assets. If hasn't enough cash and lines of credit available to the business at all times, it is most likely to cease to operate. Ideally the figure should always be greater than 1, which would indicate that there are sufficient assets available to pay liabilities, should the need arise. Acid test ratio shows if a company sufficient short-term assets (without selling inventory) to meet its immediate liabilities. Tesco's current and acid ratios are 0.43 and 0.23 respectively. Supermarkets can easily survive on these low ratios with cash being received for goods sold, before the goods are actually paid for.

Assets Management

Total Asset Turnover

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Total Asset Turnover = Turnover/Total Assets

23653/13556 = 1.74

The total asset turnover shows us how efficient the company has been in using the assets at the disposal of the business to generate its turnover. A low figure would suggest either poor trading performance or an over investment in costly fixed assets.

In Tesco financial statement under consideration we can see that its turnover was 1.74 times bigger than total assets. It was able to generate sales of £1.74 for every £1 of assets it owned and used.


Earnings per share: EPS

Net Income - Dividend on Preferred Stock/Average Outstanding Shares

830/350 = 2.37

It is the average amount of profits earned per ordinary share issued. It compares the benefits derived from owning a share with the cost of purchasing the share. Investors use this ratio to assess the relative merits of different investment opportunities. Investors in Tesco earned £2.37 per ordinary share they own.

Price/Earnings or P/E ratio

Current market share price (2002)/Earnings per share

15.8/2.37 = 6.66

The P/E ratio is an important ratio for investors. Basically, it gives us an indication of the confidence that investors have in the future prosperity of the business. In the case of Tesco above it means that investors are paying the 6.66 years worth of earning to own a Tesco share. In other words the investor will recover their investment in a share after 6.66 years.

Dividends per Share: DPS

Dividends paid to equity shareholders/Average number of issued equity shares

390/350 = 1.11

DPS shows how much the shareholders were actually paid by way of dividends.

Having a growing dividend per share can be a sign that the company's management believes that the growth can be sustained.

Dividend Yield

Latest annual dividends/ Current market share price

390/15.8 = 24.68

The dividend yield ratio allows investors to compare the latest dividend they received with the current market value of the share as an indictor of the return they are earning on their shares.

Dividend Cover

Dividend cover = Net profit available to equity shareholders/

Dividends paid to equity shareholders

390/390 = 1

The dividend cover ratio tells us how easily a business can pay its dividend from profits. A high dividend cover means that the company can easily afford to pay the dividend and a low value means that the business might have difficulty paying a dividend. In the case of Tesco, it paid 100% of net profit available to shareholders as dividend.

2. Variance Analysis

A variance is the difference between an expected or planned amount and an actual amount. For example, there can be a variation from planned amount in a department's expense report. Variance analysis helps us to identify and explain why there is a difference between a budgeted amount and an actual amount.

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The standard costing uses all elements of product cost, that is, Direct Materials, Direct Labour, and Manufacturing Overhead.

Direct Materials Price and Quantity Standards:

Standard price per unit of direct materials is the price that should be paid for a single unit of materials, including allowances for quality, quantity purchased, shipping, receiving, and other such costs, net of any discounts allowed.

Direct Materials Price Variance:

Direct materials price variance is the difference between the actual purchase price and standard purchase price of materials. Direct materials price variance is calculated either at the time of purchase of direct materials or at the time when the direct materials are used.

Direct Materials Quantity Variance:

Direct materials quantity variance or Direct materials usage variance measures the difference between the quantity of materials used in production and the quantity that should have been used according to the standard that has been set. Although the variance is concerned with the physical usage of materials, it is generally stated in pounds terms to help gauge its importance.

Direct Labour Rate and Efficiency Standards:

Direct labour price and quantity standards are usually expressed in terms of a labour rate and labour hours. The standard rate per hour for direct labour includes not only wages earned but also fringe benefit and other labour costs.

Direct Labour Rate | Price Variance:

Direct Labour price variance is also termed as direct labor rate variance. This variance measures any deviation from standard in the average hourly rate paid to direct labor workers.

Direct Labour Efficiency | Usage | Quantity Variance:

The quantity variance for direct labour is generally called direct labour efficiency variance or direct labour usage variance.

Factory Overhead Variances:

Jobs or processes are charged with cost on the basis of standard hours allowed multiplied by the standard factory over head rate. The standard overhead rate or predetermined overhead rate is discussed in detail at our job order costing system page. The standard hours allowed figure is determined by multiplying the labour hours required to produce one unit (the standard labour hours per unit) times the actual number of units produced during the period. The units produced are the equivalent units of production for the departmental factory overhead cost being analysed. At the end of the month, overhead actually incurred is compared with the expenses charged into process using the standard factory overhead rate. The difference between these figures is called the overall or net factory overhead variance.

To control operations, managers compute and analyze variance for whole cost categories, such as total direct material cost, as well as variances for elements of those categories such as the price and quantity of each direct material.

Variance analysis, for example in a manufacturing setting variance analysis will attempt to identify why there is a difference between a manufacturer's standard costs of the inputs that has been used for the actual products it manufactured, and the actual costs of the inputs it incurred in the manufacturing of the same products. To illustrate, if a company manufactured 5000 of shirts and lets assume its projected standard cost was £20,000 (input) but it actually used £28,000 of materials. There is a variation of £8,000. Using a variance analysis we will divide the £8,000 into a price variance and a quantity variance. The price variance will tell us if the company paid more for the inputs than it had planned. The quantity variance will tell us if the company had used too much of the input for the products manufactured than it had planned for.

Variance analysis for manufacturing overhead costs is more complicated than the variance analysis for materials. However, the variance analysis of manufacturing overhead costs is very important, as manufacturing overhead costs have become a very large percentage of a product's costs.

Performance measurement serves a vital function in organizations. Performance measurement can provide feedback concerning what works and what does not work, and it can help motivate people to sustain their efforts.

Managers use standard costs to help control costs. Companies in highly competitive sectors like Nokia must strive all the time to produce high quality mobile phones and services at low cost. If they do not, they will be out of business in no time. To stay competitive managers must source their inputs such as raw materials at the lowest possible prices and still produce high quality output. If the raw materials and ancillary inputs are not sourced at the lowest possible prices or more inputs are used than is necessary, higher costs will result.

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The key in meeting corporate goals is to get feedback from the appropriate managers. Having their buy-in into what the standards should be and other company policies would be, it would ensure a most accurate performance.

Management should establish policies and procedures to:

preparing operational plans

assigning responsibility for performance

communicating operations plans to key personnel

identifying the causes of significant variances

taking corrective action to eliminate problems

A variance provides the yardstick to measure the fairness of the standard, allowing management to redirect its effort and to make reasonable adjustments.


Question 3

Departmental overhead rates are based on a department's direct and indirect overhead costs and some measure of the department's activity, such as the department's machine hours. Departmental rates are more accurate than plant-wide rates when a company manufactures diverse products requiring a variety of processes.

The departmentalizing of manufacturing overhead costs allows for better planning and control if the head of each department is held responsible for the costs and productivity of his or her department.

The departmentalizing of manufacturing overhead costs also allows for the computation and application of several departmental overhead cost rates instead of having a single, plant-wide overhead rate. This is important when there are a variety of products and some require many operations in a department with high overhead rates, while other products require very few operations in the high cost department.

There may also be products, which require many hours of processing, but they occur in low cost departments. For instance, the assembly and packing departments of a manufacturer are likely to have very low overhead cost rates. On the other hand, the fabricating and milling departments will likely have much higher overhead cost rates.

Under activity-based costing (ABC) overhead costs are allocated to products on the basis of the resources consumed in each activity relating to the design, production, and distribution of particular products. Costs are assigned to homogeneous cost pools that represent specific activities. The allocation of these costs to products is accomplished through appropriate cost drivers. Cost drivers are transaction-related and volume-related, which represent the causes of costs incurred in specific activities

To answer the question if I will introduce ABC in an organisations which are incrurring high amout of overheads, I will say yes for the following reasons

It accurately predict costs, profits, and resources requirements associated with changes in production volumes, organisational structure and costs of resources. It easily identifies the root causes of poor financial performance. Track costs of activities and work processes. It equips managers with cost intelligence to stimulate improvements.

The implementation of ABC can make the employee understand the various costs involved. This will then enable them to analyze the cost and to identify the activities that add value and those that do not add value. Based on this, improvements can be implemented and the benefits can be realised. This continuous improvement process in terms of analysing the cost, to reduce or eliminate the non value added activities and to achieve an overall efficiency.

ABC can help enterprise in answering the market need for better quality products at competitive prices. Analysing the product profitability and customer profitablility, the ABC method can contribute effectively for the top management's decision making process. With ABC, enterprises are able to improve their efficiency and reduce the cost without sacrificing the value for the customer. It also enables enterprises to model the impact of cost reduction and subsequently confirm the savings achieved.

Overall, ABC is a dynamic method for continuos improvement. With ABC any enterprise can have a built-in-competitive cost advantage, so it can continuously add value to both its stakeholders and customers.

Question 4

Budgeting is a management planning and control system and consists of deciding the objectives of an organization for a defined period; say one year and breaking them down into detailed objectives and activities required to meet them.

In conventional budgeting departments prepare their budgets based on the previous year's budgets. Departments justify only the increases in the expenses required for the current year.

In contrast to conventional budgeting, zero based budgeting system is not formulated by just incrementing the previous year's expenditure for the current year. It starts with zero base. The expenditures can be controlled and profits as predicted realized with lot more surety.

Zero Based Budgeting is better for the following reasons:

It questions the current budgets/expense levels, the effectiveness and efficiency of current processes. Thus, overall cost management/control is in-built.

It focuses on corporate or organizational objectives and within them, the departmental objectives. Thus budget supports their achievements; it supports the overall business very effectively.

It drives the departments' plans and so, the planning process starts right away with the formulation of the budgets right at the beginning of the year.

It is based on current market and business realities and therefore, more realistic.