Saturday, 23 June 2012

Activity-Based Costing Vs Traditional Absorption Costing (Critical Review)

By Jackie, Researcher
Topic: Education
Area of discussion: Cost & Management Accounting

The objectives of this research are to find out which method is considered the best method to allocate indirect costs (i.e to generate relevant cost information for decision making purposes), the correct ways on how to calculate it (steps by steps guide is given below plus an additional real question taken from LCCI as an extra revision purposes), to explain what are the differences between activity-based costing and traditional absorption costing system and how to use a “quick check” method of which I designed myself (to check whether the computed answers are correct or not?).

Generally, both methods are used to calculate the cost of production. There are no differences between these two methods in finding material costs and labour costs. Their major concern is how to allocate the overhead costs to the cost of production. Ideally, using Activity-Based Costing is better than Traditional Absorption Costing as it is more accurate, reasonable and appropriate. This is because Activity Based Costing system uses both volume-based and non-volume-based cost drivers, while Traditional Absorption Costing system uses only volume-based cost drivers. Examples of volume-based cost drivers include: units of output, direct labour hours and machine hours while examples of non-volume-based cost drivers include:  numbers of production inspection, number of machine set-up, number of stock requisition and etc.

Let’s take a look at this example:

Based on the question above, single-stage traditional absorption costing system applies, whereby we need to total up all the overheads cost and then divide it by the total level of activity.  For this question the level of activity will be the total number of machine hours. After dividing it, we will get the overheads cost per one unit of activity (i.e. production overhead absorption rate). Then, the final step is to allocate this rate to the products by multiplying it with the number of machine hours used by a particular product. See below.

For Activity-Based Costing, since the separate cost activities are already given, then we only need to divide the cost of each activity with their respective cost drivers in order to find the activity rates. Cost driver is the factor that causes a change in an activity cost. For example: number of inspections and number of set ups. See below.

Then, the final step is to allocate those rates to products by multiplying them with the amount of cost drivers which will be used by them. For example, if product Alpha requires 20 inspections, then, 20 inspections x £800/inspection = £ 16,000 will be allocated to product Alpha. In order to find the product inspection overhead per unit, we have to further divide the amount by the Alpha’s total production output (units) which is 500 units. Then, £32 will be allocated to each unit of Alpha. Same method of calculation applies for the rest. See below.

A “quick check” method:
Although the cost of production per unit for each product is different in Traditional Absorption Costing and Activity-Based Costing, both methods will have the same total cost of production and because of this we can use this “quick check” method to check the answers.

References, additional readings and related links:

Gain an understanding of the basic concept of activity based costing

The basic concept of activity based costing

Activity Based Costing versus Traditional Costing

Activity Based Costing with worked example to compare with Traditional Costing

Saturday, 16 June 2012

Unemployment in Malaysia [Updated, June 2012]

By Jackie, Researcher
Topic: Society (employability)

The objectives of this research are to find out the latest unemployment rate in Malaysia,to determine which is the worst affected sector, the reasons behind all these problems, suggestions to tackle those problems, discussion on the effectiveness of certain government’s plans and actions to cope with these problems so far, the employers' views regarding this issue and what should the fresh graduates do to secure a better job in the future.

Research Essay
INTI International College Subang

            Normally unemployment rate in developed countries is higher than developing countries due to higher competition. For example, in the last three quarters of 2011, United Kingdom’s unemployment rate has rose from 7.8% to 7.9% and followed by 8.3% respectively. At the same time, Malaysia’s unemployment rate has went up from 3% to 3.2% and followed by 3.3%, and was ranked at 170th place (see note 1) out of 198 countries based on their degree of severity (The Human Resource Ministry of Malaysia and CIA World Factbook, 2012). Observation reveals that youth unemployment rate (see note 2) is even greater than the overall unemployment rate for both of the countries suggesting that youngsters are facing more difficulties in finding jobs as compared to adults. In Malaysia, one of the badly affected sector is the nursing field (see note 3) whereby in 2010, more than 54% of the private nursing graduates were unemployed three to four months after graduating, compared to only 21.7% in 2008 (The Star, 2012). It is a worry situation as fresh graduates find themselves difficult to get employed despite having a solid academic qualification.

Comparison of Malaysia unemployment rate with United Kingdom unemployment rate in 2011.

                 Firstly, graduates lack of working experience and generic competencies. For instance, “jobless nurse” which is the most popular unemployment topic in Malaysia recently, Khoo and Liow (2012) agree that this is due to minimal qualification and zero practical training experience (see note 4). Ideally, organisations prefer to hire people with relevant experience as they can spend lesser time and money to train them (Chong, 2005). Meanwhile, in a survey conducted by Ranjit (2005), 258 Malaysian private sector managers have identified certain soft skills which were lacking in Malaysian graduates such as planning, organizing, problem-solving, decision-making, leadership, creativity, critical thinking, conceptual and networking skills. According to his observation of job advertisements in two leading English newspapers in 2004, he found that the generic skills which are most sought-after by employers are interpersonal skills, oral and written communication, leadership skills, teamwork, problem-solving, creativity and computer literacy. As a solution, Malaysian government has allocated RM10.5 million to launch Graduate Employability Programme (GEP) in 2010 to enhance the skills and competencies of unemployed graduates. 

Generic competencies which are most sought-after by employers

                Secondly, poor command of English. In 2009, has conducted an English Language Assessment (ELA) test whereby it had ranked Singaporeans first, Filipino second and Malaysians third. This has proven that Malaysian command of English is not up to standard. The survey revealed that 65% of employers have turned down job seekers due to poor command of English, which is the official business language for 91% of Malaysian companies. Chook (2009) states that ‘Proficiency in English influences one’s ability to communicate effectively, and to articulate ideas and solutions well. It also affects self-confidence, the ability to work in team and excel.’ As a solution, in 2003, English was readopted as the medium of instruction for Science and Mathematics in primary and secondary school but sadly, in 2009 government has made decision to revert back to Bahasa Malaysia starting from 2012 onwards, claiming that the step is ineffective as only 19.2% of secondary teachers and 9.96% of primary teachers were sufficiently proficient in English. Fortunately, 89 American educators were invited to teach English in Terengganu under English Teaching Assistantship (ETA) programme since 2009. This programme received positive outcome and therefore, ETA has been spreaded to Pahang and Johor while Education Ministry look forward to hire teachers from Britain and Australia also (The Star, 2012).

              Thirdly, graduates lack of positive attributes. In October 2011,’s survey taken by 571 human resource practitioners reveals that unrealistically high salary or benefits demand is the top reason why fresh graduates were not hired. According to Siti (2011), many candidates were caught unprepared during interview and she elaborates further that ‘They attend interview without even basic knowledge about their potential employers. It makes a very bad first impression.’ In addition, some of the poor attitudes from the employers’ point of view are choosy about jobs, unwilling to learn, reluctant to serve beyond their own comfort zone, job-hopping (see note 5) and lack of self-confidence (see note 6) in finding a job.

Comparison of the expected salary with the actual salary received for the diploma and degree holders in 2011.

                Fourthly, there is a mismatch between the type of graduation degree and the requirements for the available jobs in the labour market. Naroden (2010) highlights that colleges and universities should provide their students with proper career guidance and information, ensure that their syllabus were relevant to the current industrial needs as well as conduct researches on the market needs to prevent students from taking irrelevant courses. It is better if they could identify the job available in the market before they start the students enrolment. Jeyakumar (2012) has pin point this situation where a freeze was made on the intake of new students in private institution until existing graduates secure jobs as the need for new nurses is only about 1,500 a year in private sector but on average 12,000 students will graduate annually.

                In addition, some external factors give negative impacts towards employment. For instance, the retirement age (see note 7) of private sector has raised from 55 to 60, with an option of four-year extension while for civil servants, it has raised from 55 to 58 (Manimaran, 2011). This will eventually diminish the needs for new recruitment to replace the senior employees. Besides, the extension of maternity leave (see note 8) from 60 days to 90 days seems unfavourable to some employers. They voice out that this will affect work operations and productivity whereby they have to find other people to replace their jobs temporarily, and have to pay additional costs for extra 30 days maternity leave. This may cripple business and cause losses (Indramalar, 2010).

                  In conclusion, fresh graduates must keep upgrading themselves from time to time with a mixture set of skills and lower down their expectation as well as change their negative attitude as competition is becoming stiffer plus the existing of external factors.  

Funny cartoon      
1.Unemployment rate (%) comparison and ranking between countries.
2.Youth unemployment rate in United Kingdom and Malaysia.
3.The Star Newspaper (3th February 2012), “Nursing job woes cut deep”.
4.The Star Newspaper (8th February 2012), “Attitude the biggest hindrance”; also please take note that   
   ‘Khoo’ is referring to Jeannie Khoo, Kelly Services marketing director for Singapore and Malaysia while 
   ‘Liow’ is referring to Malaysia’s Health Minister Datuk Seri Liow Tiong Lai.
5.The Star Newspaper (10th February 2012), “Youths with an attitude”: 12% of workers job-hop every year  
    especially in lower-rank jobs in factories, restaurants or hotels. The Star Newspaper (19th February 2012),  
    “Costly job hopping”: Employers had to spend an average RM25,000 to RM30,000 to replace each   
     employee who quit.
6. Employee Confidence Index, a measure of a jobseeker’s confidence in finding a job.
7.The Malaysian Insider (26th September 2011), “Private sector retirement age to go up”.
8.The Star Newspaper (12th July 2010), “Demands of motherhood”.

Friday, 1 June 2012

Share Repurchase Theory/ Stock Buyback Theory (Critical Review)

By Jackie, Researcher
Topic: Education
Area of discussion: Finance
Chapter: Dividend policy
Subchapter: Alternatives to cash dividends - Share repurchases

The objectives of this research are to find out is there any effects on the stock price when a company purchases its own shares, what are the effects of stock buyback on certain financial ratios, and what are the reasons or motives for share repurchases. By the way, this topic is very popular as questions are often set out from this chapter in finance examination. Therefore, it is good to actually understand and gain some knowledge about the basic concept of share repurchases although we might not be playing shares in real-life.

Share repurchase is a programme by which a company buybacks its own shares in the open market. Ideally, there are three general ways of doing it: tender offer (shareholders are invited to offer their shares to be sold back at the price set by the company), stock market purchase (repurchases of own stock in the open market at current market prices), and agency buy back/ arrangement (brokers are employed as agents to organize the repurchases of its shares from institutional shareholders).

Let’s look at this example: 

If INTI Corp Bhd uses RM15 million of its cash to repurchase its shares at RM5.00 per share, what is the new return on assets (ROA), earnings per share (EPS) and price per share?

Solution (Effects):

Cash = RM20 million – RM15 million = RM5 million

Total assets = RM50 million – RM15 million = RM35 million

Total number of shares repurchased = RM15million ÷ RM5 per share = 3 million shares

No of ordinary shares outstanding = 10million shares – 3million shares = 7million shares

New return on assets (ROA)
= (Earnings ÷ Total assets) x 100%
= (RM2 million ÷ RM35 million) x 100%
= 5.71%

New earnings per share (EPS)
= Earnings ÷ No of ordinary shares outstanding
= RM2 million ÷ 7 million shares
= RM0.29 per share

New price per share
= (Total assets – Cash spent on repurchasing) ÷ No of ordinary shares outstanding
= (RM50 million – RM15 million) ÷ 7 million shares
= RM5.00 per share

Critical explanation:
Is it 100% confirm that, ROA and EPS will rise when a company purchased its own shares?
Theoretically and practically, yes! This is because both ROA and EPS’s numerators (the number on the top of a fraction) i.e. earnings remain unchanged in stock repurchase. However, their denominators (the number on the bottom of a fraction) decrease where total assets decreased due to cash used in repurchasing (in ROA) and total number of ordinary shares declined due to stock buybacks (in EPS). Therefore, when the numerator remains while the denominator declined, the two financial ratios (ROA and EPS) will obviously increase.

Is there any effect of stock buyback on the share price?
Nope. Remember, finance theory already mentioned clearly: “Repurchases do not change stock price”. Although, based on my researches there are actually different arguments exist in this theory due to its theory’s limitations and assumptions. That’s why at the beginning of this example when I created this question, I clearly put there INTI Corp Bhd purchases its own shares at RM5.00 per share which is its market price in the open market. In short, repurchases at market price will not affect stock price. However, stock price will be affected if a company repurchases its shares at apremium (a price higher than the market) or at a discount (a price lower than the market).

The motives of share repurchase (or stock buyback)
  • To improve financial ratios by reducing the number of shares outstanding. Buybacks reduce the assets on the balance sheet (cash was used in buybacks), and thus increases the return on assets (ROA) while earnings per share (EPS) increases as the numbers of shares outstanding decreases after the buyback.
  • To avoid or eliminate excessive dilution which has the opposite effect of repurchase as it weakens the financial ratios of the company by increasing the number of shares outstanding.
  • To avoid or reducing the likelihood from becoming takeover targets/ to ward off any sort of hostile activity.

Some of the past year examination question related to this topic, directly extracted from my college past year exam paper. The sample answer was provided by the examiner. Ideally, this ‘share repurchases’ question is quite famous in examination as it can easily be tested in two ways: theory and calculation. Somehow, I have seen some question which requires students to compare the advantages and disadvantages of stock buyback with other alternatives to cash dividends such as stock dividends and stock splits.

This sharing is not considered as leaking of information, but to increase the diffusion of finance knowledge. Hopefully, this information will be helpful to some students especially for those who are currently taking finance examination.

Related links, additional readings and references:

Stock Market Tips & Facts: What is the stock buyback theory?

Stock Market : How Do Stock Buybacks Work?

Don’t trust stock buybacks:

The best way for companies to avoid becoming takeover targets is to engage in regular stock buy-backs on the open market.

Stock markets: The buy-back delusion, The Economist