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CA IPCC : Sample / Mock Test Paper (with Model Answers) - COST ACCOUNTING & FINANCIAL MANAGEMENT Oct 2014

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Test Series: October, 2014 MOCK TEST PAPER 2 INTERMEDIATE (IPC): GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART I : COST ACCOUNTING Question No. 1 is compulsory. Attempt any five questions from the remaining six questions. Working notes should form part of the answer. Time Allowed 1 Hours 1. Maximum Marks 50 Answer the followings: (a) A, B and C are three industrial workers working in sports industry and are experts in making cricket pads. A, B and C are working in Mahi Sports, Virat Sports and Sikhar Sports companies respectively. Workers are paid under different incentive schemes. Company wise incentive schemes are as follows: Company Incentive scheme Mahi Sports Virat Sports Sikhar Sports Emerson s efficiency system Merrick differential piece rate system Taylor s differential piece work system The relevant information for the industry is as under: Standard working hours Standard output per hour (in units) Daily wages rate No. of working days in a week 8 hours a day 2 ` 360 6 days Actual outputs for the week are as follows: A B C 132 units 108 units 96 units You are required to calculate effective wages rate and weekly earnings of all the three workers. (b) Frontiers Ltd. has furnished the following standard cost data per unit of production: Material 10 kg @ ` 10 per kg. Labour 6 hours @ ` 5.50 per hour Variable overhead 6 hours @ ` 10 per hour. Fixed overhead ` 4,50,000 per month (Based on a normal volume of 30,000 labour hours.) The Institute of Chartered Accountants of India The actual cost data for the month of August 2014 are as follows: Material used 50,000 kg at a cost of ` 5,25,000. Labour paid ` 1,55,000 for 31,000 hours worked Variable overheads ` 2,93,000 Fixed overheads ` 4,70,000 Actual production 4,800 units. Calculate: (i) Material Cost Variance. (ii) Labour Cost Variance. (iii) Fixed Overhead Cost Variance. (iv) Variable Overhead Cost Variance. 2. (2 x 5 Marks = 10 Marks) Aditya Ltd. manufactures two products K596 and H852. The sales director has anticipated to sale 8,000 units of Product K596 and 4,200 units of Product H852. The Standard cost data for the products for next year are as follows: Product- K596 Per unit Product- H852 Per unit 12 kg. 15 kg. 8 ltr. 15 kg. 6 kg. 14 ltr. 12 hour 8 hour 10 hour 5 hour Product- K596 (Units) Product- H852 (Units) 800 1,000 1,600 2,100 Material-X (kg) Material-Y (kg) Material-Z (ltr) 25,000 30,000 30,000 18,000 14,000 7,500 Direct materials: - Material X @ ` 15 per kg. - Material Y@ ` 16 per kg. - Material Z @ ` 5 per ltr. Direct wages: - Unskilled @ ` 40 per hour - Skilled @ ` 75 per hour Budgeted stocks for next year are as follows: 1st January, 2015 31st December, 2015 1st January, 2015 31st December, 2015 Prepare the following budgets for next year: (a) Production budget, in units; The Institute of Chartered Accountants of India (b) Material purchase budget, in quantity and in value; (c) Direct labour budget, in hours and in value. 3. (8 Marks) Reddy Ltd. manufactures a single product and absorbs the production overheads at a pre-determined rate of `15 per machine hour. At the end of financial year 2013-14, it has been found that actual production overheads incurred were ` 7,20,000. It included ` 15,000 on account of 'written off' obsolete stores and ` 12,000 being the wages paid for the strike period under an award. The production and sales data for the year 2013-14 is as under: Production: Finished goods Work-in-progress (50% complete in all respects) Sales: Finished goods 25,000 units 6,000 units 20,000 units The actual machine hours worked during the period were 52,000. It has been found that one-third of the under/ over absorption of production overheads was due to faulty production planning and the rest was attributable to normal increase/ decrease in costs. You are required to: (i) Calculate the amount of under/ over absorption of production overheads during the year 2013-14; and (ii) Show the accounting treatment of under/ over absorption of production overheads. (8 Marks) 4. Honourable Ltd. produces a product which a quarterly demand of 30,000 units. Each unit of the product requires 1.5 kg. of raw material. The cost of placing one order for raw material is ` 1,000 and the inventory carrying cost per kg. per annum is ` 2. The lead time for procurement of raw material is 24 days and a safety stock of 8,000 kg. of raw materials is maintained by the company. The company has been able to negotiate the following discount structure with the raw material supplier. Order quantity (kg.) Upto 60,000 60,001 80,000 80,001 1,60,000 1,60,001 3,00,000 3,00,001 4,50,000 You are required to The Institute of Chartered Accountants of India Discount NIL 4,000 20,000 32,000 40,000 (i) Calculate the re-order point taking 30 days in a month. (ii) Prepare a statement showing the total cost of procurement and storage of raw material after considering the discount of the company elects to place one, two, four or six orders in the year. (iii) State the number of orders which the company should place to minimise the costs after taking EOQ also into consideration. (8 Marks) 5. (a) What is inter-process profit? State its advantages and disadvantages. (b) Elaborate the practical application of Marginal costing. 6. (4 x 2 = 8 Marks) Commercial Ltd. manufactures one main product G 1 and two by-products R1 and L1. For the month of September 2014, following details are available: Total cost upto separation Point ` 4,28,000 Cost after separation No. of units produced Selling price per unit Estimated net profit as percentage to sales value Estimated selling expenses as percentage to sales value G1 4,000 ` 150 - R1 ` 38,000 2,000 ` 60 25% L1 ` 26,000 3,000 ` 70 30% 20% 10% 15% There is no beginning or closing inventories. Prepare statement showing: (i) Allocation of joint cost; and (ii) Product-wise and overall profitability of the Commercial Ltd. for September 2014. (8 Marks) 7. (a) What do you mean by time and motion study? Why is it so important to management? (b) Define explicit costs. How is it different from implicit costs? The Institute of Chartered Accountants of India (4 x 2 =8 Marks) Test Series: October, 2014 MOCK TEST - 2 INTERMEDIATE (IPC) Group I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART II : FINANCIAL MANAGEMENT All questions are compulsory. Working notes should form part of the answer. Time Allowed 1 Hours 1. Maximum Marks 50 (a) Mr. Raman has asked for your advice regarding investment in a bond for Rs. 995 which will make one payment of Rs. 1,200 five years from today or invest in a local bank account. You are required to compute: (i) The internal rate of return on the bond s cash flows? What additional information do you need to make a choice? (ii) Your advice to Mr. Raman if the bank is paying 3.5% per year for five years (compounded annually). (iii) Will your advice change if the bank was paying 5% annually for five years? If the price of the bond was Rs. 900 and the bank pays 5% annually? (b) You are a pension manager and are considering investing in a preferred stock which pays Rs. 50,00,000 per year forever beginning one year from now. Another investment option is yielding 10% per year; you are required to compute the present value of this investment? What is the highest price you would be willing to pay for this investment? (6 + 2 = 8 Marks) 2. (a) Alpha Limited issued 10,000, 10% Debentures of Rs. 100 each on 1st April. The cost of issue was Rs. 25,000. The tax rate is 35%. You are required to determine the cost of debentures if they were issued (a) at par (b) at a premium of 10% and (c) at a discount of 10%. (b) You are provided with the following data relating to four firms: Firm EBIT in Rs. Interest in Rs. Equity Capitalization Rate The Institute of Chartered Accountants of India A B C D 2,00,000 3,00,000 5,00,000 6,00,000 20,000 12% 60,000 16% 2,00,000 15% 2,40,000 18% Assuming that there are no taxes and rate of debt is 10%, you are required to determine the value of each firm using the Net Income approach. Also determine the Overall Cost of Capital of each firm. (6 + 6 = 12 Marks) 3. (a) Balance Sheets of Beta Limited as on March 31, 2013 and March 31, 2014 are as under: Liabilities 31.3.2013 31.3.2014 Assets 31.3.2013 31.3.2014 Rs. Rs. Rs. Rs. Equity Share Land & Building 6,00,000 7,00,000 Capital (Rs.10 face value per 10,00,000 12,00,000 share) General Reserve 3,50,000 2,00,000 Plant & Machinery 9,00,000 11,00,000 9% Preference Investments 2,50,000 2,50,000 Share Capital 3,00,000 5,00,000 (Long-term) Share Premium 25,000 4,000 Stock 3,60,000 3,50,000 A/c Profit & Loss A/c 2,00,000 3,00,000 Debtors 3,00,000 3,90,000 8% Debentures 3,00,000 1,00,000 Cash & Bank 1,00,000 95,000 Creditors 2,05,000 3,00,000 Prepaid Expenses 15,000 20,000 Bills Payable 45,000 81,000 Advance Tax 80,000 1,05,000 Payment Provision for Tax 70,000 1,00,000 Preliminary 40,000 35,000 Expenses Proposed 1,50,000 2,60,000 ________ ________ Dividend 26,45,000 30,45,000 26,45,000 30,45,000 Additional information: (i) Depreciation charged on building and plant and machinery during the year 2013-14 were Rs. 50,000 and Rs. 1,20,000 respectively. (ii) During the year an old machine costing Rs. 1,50,000 was sold for Rs. 32,000. Its written down value was Rs. 40,000 on date of sale. (iii) During the year, income tax for the year 2012-13 was assessed at Rs. 76,000. A cheque of Rs. 4,000 was received along with the assessment order towards refund of income tax paid in excess, by way of advance tax in earlier years. (iv) Proposed dividend for 2012-13 was paid during the year 2013-14. (v) 9% Preference shares of Rs. 3,00,000, which were due for redemption, were redeemed during the year 2013-14 at a premium of 5%, out of the proceeds of fresh issue of 9% Preference shares. The Institute of Chartered Accountants of India (vi) Bonus shares were issued to the existing equity shareholders at the rate of one share for every five shares held on 31.3.2013 out of general reserves. (vii) Debentures were redeemed at the beginning of the year at a premium of 3%. (viii) Interim dividend paid during the year 2013-14 was Rs. 50,000. You are required to prepare: (A) Schedule of Changes in Working Capital; and (B) Fund Flow Statement for the year ended March 31, 2014. (b) A proforma cost sheet of Theta Limited provides the following particulars: Amount per unit (Rs.) Raw materials cost Direct labour cost Overheads cost Total cost Profit Selling Price 100 37.50 75 212.50 37.50 250 Theta Limited keeps raw material in stock, on an average for one month; work-inprogress, on an average for one week; and finished goods in stock, on an average for two weeks. The credit allowed by suppliers is three weeks and company allows four weeks credit to its debtors. The lag in payment of wages is one week and lag in payment of overhead expenses is two weeks. It sells one-fifth of the output against cash and maintains cash-in-hand and at bank put together at Rs.37,500. You are required to prepare a statement showing estimate of Working Capital needed to finance an activity level of 1,30,000 units of production. Assume that production is carried on evenly throughout the year, and wages and overheads accrue similarly. Work-in-progress stock is 80% complete in all respects. For calculation purposes, consider 4 weeks as equivalent to a month. (4+12+8= 24 Marks) 4. (a) How is Debt service coverage ratio calculated? What is its significance? (b) Discuss conflict in profit versus wealth maximization objective. The Institute of Chartered Accountants of India (3 +3 = 6 Marks) Test Series: October, 2014 MOCK TEST PAPER 2 INTERMEDIATE (IPC): GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART I : COST ACCOUNTING Suggested Answers/ Hints 1. (a) Calculation of effective wages rate and weekly earnings of the workers A, B and C Workers A B C Standard Output 96 units 96 units 96 units (8 hrs. 2 units 6 days) Actual Output Efficiency (%) 132 units 132units 96units Daily wages Rate (8 hrs. 2 units 6 days) (8 hrs. 2 units 6 days) 108 units 100= 137.5 ` 360 108units 96units 96 units 96units 100= 112.5 96units ` 360 100= 100 ` 360 Incentive system Emerson s Efficiency System Merrick differential piece rate system Taylor s differential piece work system Rate of Bonus 20% of ordinary piece rate 25% of ordinary piece rate 57.5% of time rate (20% + 37.5%) Effective Wage Rate Total weekly earnings (b) ` 70.875 per hour ` 360 8hours 157.5% ` 27 per piece ` 28.125 per piece ` 360 16units 120% ` 360 16units 125% ` 3,402 ` 2,916 ` 2,700 (8 hours 6 days ` 70.875) (108 units ` 27) (96 units ` 28.125) Budgeted Production 30,000 hours 6 hours per unit Budgeted Fixed Overhead Rate = 5,000 units = ` 4,50,000 5,000 units = ` 90 per unit Or = ` 4,50,000 30,000 hours = ` 15 per hour. (i) Material Cost Variance = (Std. Qty. Std. Price) (Actual Qty. Actual Price) = (4,800 units 10 kg. `10) - ` 5,25,000 = ` 4.80,000 ` 5,25,000 The Institute of Chartered Accountants of India = ` 45,000 (A) (ii) Labour Cost Variance = (Std. Hours Std. Rate) (Actual Hours Actual rate) = (4,800 units 6 hours ` 5.50) `1,55,000 = ` 1,58,400 ` 1,55,000 = ` 3,400 (F) (iii) Fixed Overhead Cost Variance = (Budgeted Rate Actual Qty) Actual Overhead = (` 90 x 4,800 units) ` 4,70,000 = ` 38,000 (A) OR = (Budgeted Rate Std. Hours) Actual Overhead = (` 15 x 4,800 units 6 hours) ` 4,70,000 = ` 38,000 (A) (iv) Variable Overhead Cost Variance= (Std. Rate Std. Hours) Actual Overhead = (4,800 units 6 hours ` 10) - ` 2,93,000 = ` 2,88,000 - ` 2,93,000 = ` 5,000 (A) 2. (a) Production Budget (in units) Product- K596 (units) Expected sales Add: Closing stock Less: Opening stock Units to be produced Product- H852 (units) 8,000 1,000 (800) 8,200 4,200 2,100 (1,600) 4,700 (b) Material Purchase Budget Material-X (kg.) Materials required: - Product-K596 Material-Y (kg.) Material-Z (ltr.) - Product- H852 98,400 1,23,000 65,600 (8,200 units 12 kg.) (8,200 units 15 kg.) (8,200 units 8 ltr.) Total 70,500 28,200 65,800 (4,700 units 15 kg.) (4,700 units 6 kg.) (4,700 units 14ltr.) 1,68,900 1,51,200 1,31,400 The Institute of Chartered Accountants of India Add: Closing stock Less: Opening stock Quantity to be purchased Rate Purchase cost 30,000 (25,000) 18,000 (30,000) 7,500 (14,000) 1,73,900 1,39,200 1,24,900 `15 per kg. ` 26,08,500 `16 per kg. ` 22,27,200 `5 per ltr. ` 6,24,500 (c) Direct Labour Budget Unskilled (hours) For Product K596 Skilled (hours) 98,400 65,600 (8,200 units 12 hours) (8,200 units 8 hours) For Product H852 3. 23,500 (4,700 units 10 hours) Labour hours required Rate Wages to be paid 47,000 (4,700 units 5 hours) 1,45,400 ` 40 per hour ` 58,16,000 89,100 ` 75 per hour ` 66,82,500 (i) Amount of under/ over absorption of production overheads during the year 2013-14 Total production overheads actually incurred during the year 2013-14 Less: 'Written off' obsolete stores Wages paid for strike period 7,20,000 ` 15,000 ` 12,000 (27,000) Net production overheads actually incurred: (A) 6,93,000 Production overheads absorbed by 52,000 machines hours @ `15 per hour: (B) 7,80,000 Amount of over-absorption of production overheads: [(B) (A)] 87,000 (ii) Accounting treatment of over absorption of production overheads: It is given in the statement of the question that 25,000 units were completely finished and 6,000 units were 50% complete, one third of the over-absorbed overheads were due to faulty production planning and the rest were attributable to normal increase/ decrease in costs. The Institute of Chartered Accountants of India 1. (33-1/3% of `87,000) i.e. `29,000 of over absorbed overheads were due to faulty production planning. This being abnormal, should be credited to the Profit and Loss A/c 29,000 2 Balance (66-2/3% of `87,000) i.e. `58,000 of over absorbed overheads should be distributed over work-in-progress, finished goods and cost of sales by using supplementary rate 58,000 Total over-absorbed overheads 87,000 Apportionment of over-absorbed overhead of `58,000 over work-in-progress, finished goods and cost of sales. Equivalent Completed units 3,000 6,215 Finished goods (5,000 units `2.0714) 5,000 10,357 Cost of sales (20,000 units `2.0714) 20,000 41,428 28,000 58,000 Work-in-progress (3,000 units `2.0714) (Refer to Working Note) Accounting treatment: Dr. Overhead control A/c Dr. Cr. (`) 87,000 To Work-in-progress A/c 6,215 To Finished goods control A/c 10,357 To Cost of sales A/c 41428 To Cost Profit & Loss A/c 29,000 Working Note: Supplementary overhead absorption rate 4. = ` 58,000 28,000 units = `2.0714per unit Working notes 1. Annual demand (30,000 units per quarter 4 quarters) = 1,20,000 units 2. Raw material required for 1,20,000 units (1,20,000 units 1.5 kg.) = 1,80,000 kg. 3. EOQ = 2 1,80,000 kgs. ` 1,000 = 13,416 kgs.(appx) `2 4.Total cost of procurement and storage when the order size is equal to EOQ or 13,416 kg. The Institute of Chartered Accountants of India No. of orders (1,80,000 kg. 13,416 kg.) = 13.42 times or 14 times Ordering cost (14 orders `1,000) = ` 14,000 Carrying cost ( 13,416 kg. ` 2) = ` 13,416 Total cost = ` 27,416 (i) Re-order point = Safety stock + Lead time consumption = 8,000 kg. + = 8,000 kg. + 12,000 kg. 1,80,000kg. 24 days 360days = 20,000 kg. (ii) Statement showing the total cost of procurement and storage of raw materials (after considering the discount) Order size No. of orders Total cost of procurement Average stock Kg. Discount Total cost (5)=(4) `2 (6) (7)=[(3)+(5) (6)] 1,80,000 90,000 45,000 30,000 32,000 20,000 - 1,49,000 72,000 49,000 36,000 Kg. (1) (2) 1,80,000 90,000 45,000 30,000 5. Total cost of storage of raw materials 1 2 4 6 (3)=(2) `1,000 (4)= (1) 1,000 2,000 4,000 6,000 90,000 45,000 22,500 15,000 (iii) Number of orders which the company should place to minimize the costs after taking EOQ also into consideration is 14 orders. Total cost of procurement and storage in this case comes to ` 27,416 (please refer working note-4 above), which is minimum. (a) In some process industries the output of one process is transferred to the next process not at cost but at market value or cost plus a percentage of profit. The difference between cost and the transfer price is known as inter-process profits. The advantages and disadvantages of using inter-process profit, in the case of process type industries are as follows: Advantages: 1. Comparison between the cost of output and its market price at the stage of completion is facilitated. 2. Each process is made to stand by itself as to the profitability. Disadvantages: 1. The use of inter-process profits involves complication. The Institute of Chartered Accountants of India 2. The system shows profits which are not realised because of stock not sold out (b) Practical applications of Marginal costing: (i) Pricing Policy: Since marginal cost per unit is constant from period to period, firm decisions on pricing policy can be taken particularly in short term. (ii) Decision Making: Marginal costing helps the management in taking a number of business decisions like make or buy, discontinuance of a particular product, replacement of machines, etc. (iii) Ascertaining Realistic Profit: Under the marginal costing technique, the stock of finished goods and work-in-progress are carried on marginal cost basis and the fixed expenses are written off to profit and loss account as period cost. This shows the true profit of the period. (iv) Determination of production level: Marginal costing helps in the preparation of breakeven analysis which shows the effect of increasing or decreasing production activity on the profitability of the company. 6. (i) Statement showing allocation of Joint Cost Particulars R1 No. of units Produced Selling Price Per unit (`) Sales Value (`) Less: Estimated Profit (R1 -25% & L1 -30%) Cost of Sales Less: Estimated Selling Expenses (R1 -10% & L1 -15%) Cost of Production Less: Cost after separation Joint Cost allocated (ii) 2,000 60 1,20,000 (30,000) 90,000 (12,000) 78,000 (38,000) 40,000 L1 3,000 70 2,10,000 (63,000) 1,47,000 (31,500) 1,15,500 (26,000) 89,500 Statement of Profitability G1 (`) Particulars Sales Value (A) R1 (`) L1 (`) 6,00,000 1,20,000 2,10,000 40,000 89,500 (4,000 `150) Less: - Joint Cost The Institute of Chartered Accountants of India 2,98,500 (4,28,000 -40,000 - 89,500) - Cost after separation Selling Expenses - 38,000 26,000 1,20,000 12,000 31,500 4,18,500 90,000 1,47,000 30,000 63,000 (G1- 20%, R1-10% & L1-15%) (B) Profit (A B) 1,81,500 Overall Profit = `1,81,500 + `30,000 + `63,000 = ` 2,74,500 7. (a) Time and motions study: It is the study of time taken and motions (movements) performed by workers while performing their jobs at the place of their work. Time and motion study has played a significant role in controlling and reducing labour cost. Time Study is concerned with the determination of standard time required by a person of average ability to perform a job. Motion study, on the other hand, is concerned with determining the proper method of performing a job so that there are no wasteful movements, hiring the worker unnecessarily. However, both the studies are conducted simultaneously. Since materials, tools, equipment and general arrangement of work, all have vital bearing on the method and time required for its completion. Therefore, their study would be incomplete and would not yield its full benefit without a proper consideration of these factors. Time and motion study is important to management because of the following features: 1. Improved methods, layout, and design of work ensure effective use of men, material and resources. 2. Unnecessary and wasteful methods are pin-pointed with a view to either improving them or eliminating them altogether. This leads to reduction in the work content of an operation, economy in human efforts and reduction of fatigue. 3. Highest possible level of efficiency is achieved in all respect. 4. Provides information for setting labour standards - a step towards labour cost control and cost reduction. 5. Useful for fixing wage rates and introducing effective incentive scheme. (b) Explicit costs: These costs are also known as out of pocket costs. They refer to those costs which involves immediate payment of cash. Salaries, wages, postage and telegram, interest on loan etc. are some examples of explicit costs because they involve immediate cash payment. These payments are recorded in the books of account and can be easily measured. Main points of difference: The following are the main points of difference between Explicit and Implicit costs. The Institute of Chartered Accountants of India (i) Implicit costs do not involve any immediate cash payment. As such they are also known as imputed costs or economic costs. (ii) Implicit costs are not recorded in the books of account but yet, they are important for certain types of managerial decisions such as equipment replacement and relative profitability of two alternative courses of action. The Institute of Chartered Accountants of India Test Series: October, 2014 MOCK TEST 2 INTERMEDIATE (IPC) GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART II : FINANCIAL MANAGEMENT SUGGESTED ANSWERS/HINTS 1. (a) (i) Computation of Internal Rate of Return 995 x (1+i)5 = 1,200. (1+i)5 = 1,200 995 Taking 5th root of both sides: (1+i) =1.0382 Internal rate of return i.e. i = 0.0382 = 3.82% In order to make a choice, you need to know what interest rate is being offered by the local bank. (ii) Advice: If the bank is paying 3.5%, Mr. Raman should choose the bond because it is earning a higher rate of return i.e. 3.82%. (iii) Advice: If the bank is paying 5% per year, Mr. Raman should deposit his money in the bank. He would earn a higher rate of return. If the price of the bond was Rs. 900, its IRR would be as following: 900 x (1+i)5 = 1,200. (1+i)5 = 1,200 900 Internal rate of return i.e. i =5.92% Since the internal rate of return i.e. 5.92% is higher than the bank rate i.e. 5%; hence, Mr. Raman should choose to buy the bond. (b) Present Value of Investment PV = Rs. 50,00,000 = Rs. 5,00,00,000 0.10 Highest price you would be willing to pay = Rs. 5,00,00,000. The Institute of Chartered Accountants of India 2. (a) Particulars Par Discount 10,000 100 10,000 110 =10,00,000 =11,00,000 Gross Proceeds Premium 10,000 90 = 9,00,000 Less : Cost of Issue Net Proceeds 25,000 9,75,000 25,000 10,75,000 25,000 8,75,000 Interest at 10% 1,00,000 1,00,000 1,00,000 Less : Tax at 35% 35,000 35,000 35,000 Net Outflow Kd=Interest (after tax)/Net Proceeds 65,000 6.67% 65,000 6.05% 65,000 7.43% (b) Firm A B C D 2,00,000 3,00,000 5,00,000 6,00,000 20,000 60,000 2,00,000 2,40,000 1,80,000 2,40,000 3,00,000 3,60,000 12% 16% 15% 18% 15,00,000 15,00,000 20,00,000 20,00,000 Value of Debt (D)=Interest Kd of 10% 2,00,000 6,00,000 20,00,000 24,00,000 Value of Firm (V) = (E+D) 17,00,000 21,00,000 40,00,000 44,00,000 11.76% 14.29% 12.5% 13.64% EBIT Less: Interest EBT = Net Income Ke (given) Value of Equity (E)=Net Income Ke K0 3. (a) = WACC = EBIT V (A) Schedule of Changes in Working Capital Particulars Current Assets: Stock Debtors Cash and Bank Prepaid Expenses Total (A) The Institute of Chartered Accountants of India 31.3.2013 31.3.2014 Effect on Working Capital Increase Decrease Rs. Rs. Rs. Rs. 3,60,000 3,00,000 1,00,000 15,000 7,75,000 3,50,000 3,90,000 95,000 20,000 8,55,000 90,000 5,000 10,000 5,000 - Current Liabilities: Creditors Bills Payable Total (B) Net Working Capital (A-B) Net Decrease in Working Capital 2,05,000 45,000 2,50,000 5,25,000 - 3,00,000 81,000 3,81,000 4,74,000 51,000 - 95,000 36,000 51,000 - 5,25,000 5,25,000 1,46,000 1,46,000 (B) Funds Flow Statement for the year ended 31st March, 2014 Rs. Sources of Fund Funds from Operation 7,49,000 Issue of 9% Preference Shares 5,00,000 Sales of Plant & Machinery 32,000 Refund of Income Tax 4,000 Financial Resources Provided (A) 12,85,000 Applications of Fund Purchase of Land and Building 1,50,000 Purchase of Plant and Machinery 3,60,000 Redemption of Debentures 2,06,000 Redemption of Preference Shares 3,15,000 Payment of Tax 1,05,000 Payment of Interim Dividend 50,000 Payment of Dividend (2012-13) 1,50,000 Financial Resources Applied (B) 13,36,000 Net Decrease in Working Capital (A - B) 51,000 Working Notes: Estimation of Funds from Operation Profit and Loss A/c Balance on 31.3.2014 Add: Depreciation on Land and Building Depreciation on Plant and Machinery Loss on Sale of Plant and Machinery (40,000 32,000) The Institute of Chartered Accountants of India Rs. 3,00,000 50,000 1,20,000 8,000 Preliminary Expenses written off Transfer to General Reserve Proposed Dividend Provision for Taxation Interim Dividend paid (40,000 35,000) 5,000 50,000 2,60,000 1,06,000 50,000 Less: Profit and Loss A/c balance on 31.3.13 Funds from Operation 6,49,000 9,49,000 2,00,000 7,49,000 Plant & Machinery A/c Rs. 9,00,000 By Depreciation 3,60,000 By Bank (Sale) By P/L A/c (Loss on Sale) _______ By Balance c/d 12,60,000 To Balance b/d To Bank [Purchase (Bal. Fig.)] Rs. 1,20,000 32,000 8,000 11,00,000 12,60,000 Provision for Taxation A/c Rs. 76,000 By Balance b/d Rs. 70,000 To Advance tax payment A/c To Balance c/d 1,00,000 By P/L A/c (additional provision for 6,000 2012-13) By P/L A/c (Provision for _______ 13-14) 1,00,000 1,76,000 1,76,000 Advance Tax Payment A/c Rs. To Balance b/d To Bank (paid for 13-14) 80,000 By Provision for taxation A/c 1,05,000 By Bank (Refund of tax) Rs. 76,000 4,000 _______ By Balance c/d 1,05,000 1,85000 1,85,000 The Institute of Chartered Accountants of India To Bank (2,00,000 (redemption) To Balance c/d 8% Debentures A/c Rs. x 103%) 2,06,000 By Balance b/d By Premium redemption 1,00,000 of Debentures A/c 3,06,000 Rs. 3,00,000 on 6,000 3,06,000 9% Preference Share Capital A/c Rs. Rs. To Bank A/c (3,00,000 x 105%) 3,15,000 By Balance b/d (redemption) By Premium on redemption To Balance c/d 5,00,000 of Preference shares A/c 3,00,000 15,000 _______ By Bank (Issue) 5,00,000 8,15,000 8,15,000 Securities Premium A/c Rs. To Premium on redemption of debentures A/c 6,000 By Balance b/d Rs. 25,000 To Premium on redemption of preference shares A/c 15,000 To Balance c/d 4,000 25,000 _____ 25,000 General Reserve A/c Rs. Rs. To Bonus to Shareholders A/c 2,00,000 By Balance b/d 3,50,000 To Balance c/d 2,00,000 By P/L A/c (transfer) b/f 4,00,000 50,000 4,00,000 Land and Building A/c Rs. Rs. To Balance b/d 6,00,000 By Depreciation To Bank (Purchase) (Bal. Fig.) 1,50,000 By Balance c/d 7,00,000 7,50,000 7,50,000 The Institute of Chartered Accountants of India 50,000 (b) A. Activity level: 1,30,000 units Statement showing Estimate of Working Capital Needs Investment in Inventory: Raw material inventory: 1 month 4 1,30,000 52 ` 100 B. C. D. E. 4. * 1 WIP Inventory : 1 week 1,30,000 0.80 212.50 52 Finished goods inventory: 2 weeks 2 1,30,000 212.50 52 Investment in Debtors: 4 weeks at cost 4 4 1,30,000 212.50 5 52 Cash balance Investment in Current Assets (A + B + C) Current Liabilities: Creditors : 3 weeks 7,50,000 3 1,30,000 100 52 Deferred wages : 1 week 93,750 1 1,30,000 37.50 52 Deferred overheads : 2 weeks 2 1,30,000 75 3,75,000 52 Net Working Capital Needs 10,00,000 4,25,000 10,62,500 17,00,000 37,500 42,25,000 12,18,750 30,06,250 (a) Calculation of Debt Service Coverage Ratio (DSCR) and its Significance The debt service coverage ratio can be calculated as under: Debt Service Coverage Ratio = Earnings available for debt service Interest + Installments Debt service coverage ratio indicates the capacity of a firm to service a particular level of debt. High credit rating firms target DSCR to be greater than 2 in its entire loan life. High DSCR facilitates the firm to borrow at the most competitive rates. The Institute of Chartered Accountants of India (b) Conflict in Profit versus Wealth Maximization Objective The company may pursue profit maximisation goal but that may not result into creation of shareholder value. However, profit maximisation cannot be the sole objective of a company. It is at best a limited objective. If profit is given undue importance, a number of problems can arise like the term profit is vague, profit maximisation has to be attempted with a realisation of risks involved, it does not take into account the time pattern of returns and as an objective it is too narrow. Whereas, on the other hand, wealth maximisation, as an objective, means that the company is using its resources in a good manner. If the share value is to stay high, the company has to reduce its costs and use the resources properly. If the company follows the goal of wealth maximisation, it means that the company will promote only those policies that will lead to an efficient allocation of resources. The Institute of Chartered Accountants of India

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