Activity-Based Costing (ABC) is designed to address the limitations of traditional overhead absorption, particularly in automated environments. It assigns overhead costs to products based on the activities they require and the resources those activities consume, leading to more accurate product cost information when direct labour is a poor proxy for overhead consumption.

The Accruals Concept (or matching concept) states that transactions are recorded when they occur, not when cash is received or paid. Profit includes sales made on credit and expenses incurred but not yet paid, while the bank balance only reflects actual cash movements. This is why profit and cash flow are different.

The payback period is the time it takes for the cumulative cash inflows to equal the initial investment. After 2 years, £140,000 is recovered (£70,000 x 2). £60,000 is needed to reach £200,000. In year 3, the monthly cash inflow is £70,000/12 = £5,833.33. £60,000 / £5,833.33 ≈ 10.3 months. Therefore, the payback period is 2 years and approximately 10.3 months, which rounds to 2 years and 11 months from the options given.

Zero-Based Budgeting (ZBB) requires managers to justify all budgeted expenditures, not just changes from the previous year. Each budget cycle starts from a ‘zero base,’ and every function within the organization is analyzed for its needs and costs. This contrasts with incremental budgeting, which takes the previous period’s budget as a starting point.

Gearing (or leverage) ratio measures the relationship between a company’s debt (long-term borrowing) and its equity (shareholders’ funds). A ratio of 60% means that for every £100 of equity, the company has £60 of debt. It is a key indicator of financial risk and capital structure.

A favourable rate variance suggests labour was paid less per hour than budgeted (e.g., using lower-grade, cheaper staff). An adverse efficiency variance suggests more labour hours were used than budgeted for the output achieved. This combination is classic: cheaper workers are often less experienced or skilled, leading to slower work and higher hours, which hurts efficiency.

The net profit (or loss) calculated in the Statement of Profit or Loss is a key component in determining the change in retained earnings, which feeds into the equity section of the Statement of Financial Position. The cash flow statement uses information from both the profit or loss and the statement of financial position to explain changes in cash. Therefore, the logical preparation order is Profit or Loss first, then Financial Position, then Cash Flows.

The key factor here is that the company is at full capacity. Accepting the special order would mean diverting resources from normal sales that generate £10 contribution per unit (£25 – £15) to sales that generate only £3 contribution (£18 – £15). This would lead to an opportunity cost. The financial loss would be the lost contribution on the displaced units, making the order unprofitable unless capacity can be increased.

The current ratio includes all current assets (inventory, receivables, cash, etc.). The quick ratio excludes inventory as it is less liquid. A current ratio of 2:1 is healthy, but a quick ratio of 0.8:1 (below 1:1) indicates potential liquidity issues if inventory cannot be sold quickly. The large drop from 2.0 to 0.8 is primarily caused by inventory making up a large portion of current assets.

Activity-Based Costing (ABC) is designed to address the limitations of traditional overhead absorption, particularly in automated environments. It assigns overhead costs to products based on the activities they require and the resources those activities consume, leading to more accurate product cost information when direct labour is a poor proxy for overhead consumption.0