ACCA F2 Management Accounting Technical Articles
ACCA F2 Management Accounting Technical Articles : Founded in 1904, the Association of Chartered Certified Accountants (ACCA) is the global professional accounting body offering the Chartered Certified Accountant qualification (ACCA or FCCA). From June 2016, ACCA recorded that it has 188,000 members and 480,000 students in 178 countries. ACCA’s headquarters are in London with principal administrative office in Glasgow. ACCA works through a network of 100 offices and centres and more than 7,100 Approved Employers worldwide, who provide employee development.
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ACCA F2 Management Accounting Technical Articles
ACCA F2 Management Accounting Technical Articles : Ratio analysis
The ability to analyse financial statements using ratios and percentages to assess the performance of organisations is a skill that will be tested in many of ACCA’s exam papers. It will also be regularly used by successful candidates in their future careers.
The Paper F2/FMA syllabus introduces candidates to performance measurement and requires candidates to be able to ‘Discuss and calculate measures of financial performance (profitability, liquidity, activity and gearing) and non-financial measures’. This article will focus on measures of financial performance and will detail the skills and knowledge expected from candidates in the Paper F2/FMA exam.
Paper F2/FMA candidates are expected to be able to calculate key accounting ratios, to know what they measure, and to explain what particular values mean. The syllabus categorises ratios into four headings: profitability, liquidity, activity and gearing.
ACCA F2 Management Accounting Technical Articles : Profitability ratios, as their name suggests, measure the organisation’s ability to deliver profits. Profit is necessary to give investors the return they require, and to provide funds for reinvestment in the business. Three ratios are commonly used.
1. Return on capital employed (ROCE): operating profit ÷ (non current liabilities +
total equity) %
2. Return on sales (ROS): operating profit÷ revenue %
3. Gross margin: gross profit÷ revenue %
Return on capital employed
Return on capital employed (sometimes known as return on investment or ROI) measures the return that is being earned on the capital invested in the business. Candidates are sometimes confused about which profit and capital figures to use. What is important is to compare like with like. Operating profit (profit before interest) represents the profit available to pay interest to debt investors and dividends to shareholders. It is therefore compared with the long-term debt and equity capital invested in the business (non current liabilities + total equity). By similar logic, if we wished to calculate return on ordinary shareholders funds (the return to equity holders), we would use profit after interest and tax divided by total equity).
A return on capital is necessary to reward investors for the risks they are taking by investing in the company. Generally, the higher the ROCE figure, the better it is for investors. It should be compared with returns on offer to investors on alternative investments of a similar risk.
Return on sales
Return on sales (sometimes known as operating margin) looks at operating profit earned as a percentage of revenue. Again, in simple terms, the higher the better. Poor performance is often explained by prices being too low or costs being too high.
The ROCE and ROS ratios are often considered in conjunction with the asset turnover ratio. (The asset turnover ratio is discussed later). They are considered at the same time because:
ROCE = ROS x asset turnover
operating profit = operating profit x revenue
capital employed revenue capital employed
This relationship can be useful in exam calculations. For example, if you are told that a business has a return on sales of 5% and an asset turnover of 2, then its ROCE will be 10% (5% x 2). This is more than a mathematical trick. It means that any change in ROCE can be explained by either a change in ROS, or a change in asset turnover, or both.
Return on sales looks at profits after charging non-production overheads. Gross margin on the other hand focuses on the organisation’s trading activities. Once again, in simple terms, the higher the better, with poor performance often being explained by prices being too low or costs being too high.
This measures the ability of the organisation to meet its short-term financial obligations.
Two ratios are commonly used:
4. Current ratio current assets ÷ current liabilities
5. Acid test (current assets – inventory) ÷ current liabilities
The current ratio compares liabilities that fall due within the year with cash balances, and assets that should turn into cash within the year. It assesses the company’s ability to meet its short-term liabilities. Traditionally textbooks tell us that this ratio should exceed 2.0:1 for a company to be able to safely meet its liabilities. However, acceptable current ratios vary between industrial sectors, and many companies operate safely at below the 2:1 level.
A very high current ratio is not necessarily good. It could indicate that a company is too liquid. Cash is often described as an ’idle asset‘ because it earns no return, and carrying too much cash is considered wasteful. A high ratio could also indicate that the company is not making sufficient use of cheap short-term finance.
The acid test (or quick ratio) recognises that inventory often takes a long time to convert into cash. It therefore excludes inventory values from liquid assets. Traditionally textbooks tell us that this ratio should exceed 1:1 but once again many successful companies operate below this level.
In practice a company’s current ratio and acid test should be considered alongside the company’s operating cashflow. A healthy cashflow will often compensate for weak liquidity ratios.
Fixed overhead absorption
Objective testing questions involving the under or over absorption of overhead and fixed overhead volume variances commonly cause difficulties for F2/FMA candidates.
Effective presentation and communication of information using charts
ACCA F2 Management Accounting Technical Articles : Accounting data is often presented in the form of tables of numbers, sometimes simply as a print out from a spreadsheet or reports from an accounting software package. While this style of presentation provides detailed figures, it may not always be the most effective way to present and communicate information. It may be that some key information should be highlighted, perhaps relationships between certain figures should be emphasised, or trends identified. Appropriate presentation of data in the form of graphs or charts can be a useful analysis tool and if the data is then effectively interpreted this can facilitate the decision-making process. The syllabus for Papers MA2 and F2/FMA require that candidates should be able to describe the key features of different charts, identify suitable charts in particular situations and interpret data presented in charts. The material in this article is also relevant for candidates sitting Paper MA1.
There are many software packages that allow the user to create charts that look very professional but it is important to consider the different types of charts available and select an appropriate chart type for the data being presented. Presenting data in an inappropriate chart can convey information which may be misleading. The term ‘chart’ is generally considered to include all types of graphs and any other type of chart used to give a pictorial presentation of the data. Some types of charts tend to be described as graphs while others use the term chart, eg it is more common to hear the term line graphbut the term bar chart. The words ‘chart’ and ‘graph’ are considered to be interchangeable for the purposes of this article.
A variety of chart types will be reviewed in this article, and the features that make a particular chart type appropriate for the type of data being presented will be highlighted. Some useful tips on presentation will also be provided, together with guidance on interpreting the data presented in the charts. To illustrate the point of ensuring that an appropriate chart type is selected, some data has been presented using an inappropriate chart type resulting in ineffective communication of information.