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CA IPCC : Question Paper (with Answers) - COST ACCOUNTING & FINANCIAL MANAGEMENT Nov 2013

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DISCLAIMER The Suggested Answers hosted in the website do not constitute the basis for evaluation of the students answers in the examination. The answers are prepared by the Faculty of the Board of Studies with a view to assist the students in their education. While due care is taken in preparation of the answers, if any errors or omissions are noticed, the same may be brought to the attention of the Director of Studies. The Council of the Institute is not in anyway responsible for the correctness or otherwise of the answers published herein. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Question No. 1 is compulsory. Attempt any five questions from the remaining six questions. Working notes should form part of the answers. Question 1 Answer the following: (a) Primex Limited produces product 'P'. It uses annually 60,000 units of a material 'Rex' costing ` 10 per unit. Other relevant information are: Cost of placing an order : ` 800 per order Carrying cost : 15% per annum of average inventory Re-order period : 10 days Safety stock : 600 units The company operates 300 days in a year. You are required to calculated: (i) Economic Order Quantity for material 'Rex'. (ii) Re-order Level (ill) Maximum Stock Level (iv) Average Stock Level (b) Journalise the following transactions assuming cost and financial accounts are integrated : ` (i) Materials issued : Direct 3,25,000 Indirect 1,15,000 (ii) Allocation of wages (25% indirect) 6,50,000 (iii) Under/Over absorbed overheads: Factory (Over) 2,50,000 Administration (Under) 1,75,000 (iv) Payment to Sundry Creditors 1,50,000 (v) Collection from Sundry Debtors 2,00,000 The Institute of Chartered Accountants of India 42 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 (c) Calculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage for the following firms : N 17,500 Production (in units) S 6,700 D 31,800 Fixed costs ` 4,00,000 3,50,000 2,50,000 Interest on loan ` 1,25,000 75,000 Nil Selling price per unit ` 85 130 37 Variable cost per unit ` 38.00 42.50 12.00 (d) X Ltd. is considering the following two alternative financing plans: Plan - I Plan - II ` ` Equity shares of ` 10 each 4,00,000 4,00,000 12% Debentures 2,00,000 - - 2,00,000 6,00,000 6,00,000 Preference Shares of ` 100 each ` The indifference point between the plans is ` 2,40,000. Corporate tax rate is 30%. Calculate the rate of dividend on preference shares. (4 x 5 = 20 Marks) Answer (a) (i) Economic Order Quantity (E.O.Q) = = 2 Annual requirement of 'Rex' Ordering cost per order Annual carrying cost per unit per annum 2 60,000units ` 800 = ` 10 15% 9,60,00,000 ` 1.5 = 8,000 units (ii) Re-order Level = Safety Stock + (Normal daily Usage Re-order period) = 600 + ( 60,000units 300days = 600 + 2,000 = 2,600 units The Institute of Chartered Accountants of India 10 days) PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 43 (iii) Maximum Stock Level = E.O.Q (Re-order Quantity) + Safety Stock = 8,000 units + 600 units = 8,600 units (iv) Average Stock Level = Minimum Stock level + = 600* + 1 1 2 Re-order Quantity 8,000 units 2 = 4,600 units OR Average Stock Level = = MaximumStock level + MinimumStock level 2 8,600units + 600units 2 = 4,600 units * Minimum Stock Level = Re-order level (Normal daily usage Re-order period) = 2,600 ( 60,000units 300days 10 days) = 2,600 2,000 = 600 units OR Minimum Stock Level = Safety Stock level = 600 units Note: Various levels can be calculated in different other ways. However answers will be the same. (b) Journal Entries under Integrated system of accounting Particulars (i) ` Work-in-Progress Ledger Control A/c Dr. 3,25,000 Factory Overhead Control A/c Dr. ` 1,15,000 To Stores Ledger Control A/c (Being issue of Direct and Indirect materials) The Institute of Chartered Accountants of India 4,40,000 44 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 (ii) Work-in Progress Ledger Control A/c Dr. 4,87,500 Factory Overhead control A/c Dr. 1,62,500 To Wages Control A/c 6,50,000 (Being allocation of Direct and Indirect wages) (iii) Factory Overhead Control A/c Dr. 2,50,000 To Costing Profit & Loss A/c 2,50,000 (Being transfer of over absorption of Factory overhead) Costing Profit & Loss A/c Dr. 1,75,000 To Administration Overhead Control A/c (Being transfer of under Administration overhead) absorption 1,75,000 of (iv) Sundry Creditors A/c Dr. 1,50,000 To Cash/ Bank A/c 1,50,000 (Being payment made to creditors) (v) Cash/ Bank A/c Dr. To Sundry Debtors A/c 2,00,000 2,00,000 (Being payment received from debtors) (c) Computation of Degree of Operating Leverage (DOL), Degree of Financial Leverage (DFL) and Degree of Combined Leverage (DCL) Firm N Output (Units) Firm S Firm D 17,500 6,700 31,800 85 130 37 Sales Revenue (A) 14,87,500 8,71,000 11,76,600 Variable Cost/Unit 38.00 42.50 12.00 Less: Variable Cost (B) 6,65,000 2,84,750 3,81,600 Contribution (A-B) 8,22,500 5,86,250 7,95,000 Less: Fixed Cost 4,00,000 3,50,000 2,50,000 EBIT 4,22,500 2,36,250 5,45,000 Less: Interest on Loan 1,25,000 75,000 - PBT 2,97,500 1,61,250 5,45,000 Selling Price/Unit The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT C EBIT 45 DFL= 8,22,500 5,86,250 7,95,000 4,22,500 2,36,250 5,45,000 = 1.95 DOL = = 2.48 = 1.46 EBIT 4,22,500 2,36,250 5,45,000 PBT 2,97,500 1,61,250 5,45,000 = 1.42 = 1.47 = 1.00 1.95 x 1.42 2.48 x 1.47 1.46 x 1 OR = 2.77 = 3.65 = 1.46 Contribution PBT 8,22,500 = 2.76 2,97,500 5,86,250 = 3.64 1,61,250 7,95,000 = 1.46 5,45,000 DCL = OL x FL DCL = (d) Computation of Rate of Preference Dividend EBIT = 2,40,000 Tax rate = 30% (EBIT Interest) (1 Tax rate) EBIT (1 Tax rate) Preference Dividend = No. of Equity Shares (N1 ) No. of Equity Shares (N2 ) (2,40,000 - 24,000) (1- 0.30) 2,40,000 (1- 0.30) - Preference Dividend = 40,000 40,000 2,16,000 (1- 0.30) 1,68,000 - Preference Dividend = 40,000 40,000 1,51,200 = 1,68,000 Preference Dividend Preference Dividend = 1,68,000 1,51,200 Preference Dividend = 16,800 Rate of Dividend = Preference Dividend 16,800 x 100 = 8.4% x 100 = Preference Share Capital 2,00,000 Question 2 (a) The following information relates to a bus operator: Cost of the bus Insurance charges Manager-cum accountant's salary The Institute of Chartered Accountants of India ` 18,00,000 ` 3% p.a. 8,000 p.m. 46 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 Annual Tax ` ` ` Garage Rent Annual repair & maintenance Expected life of the bus Scrap value at the end of 15 years ` ` ` ` ` ` Driver's salary Conductor's salary Stationery Engine oil, lubricants (for 1200 kms.) Diesel and oil (for 10 kms.) 50,000 2,500 p.m. 1,50,000 15 years 1,20,000 15,000 p.m. 12,000 p.m. 500 p.m. 2,500 52 Commission to driver and conductor (shared equally) 10% of collections Route distance 20 km long The bus will make 3 round trips for carrying on the average 40 passengers in each trip. Assume 15% profit on collections. The bus will work on the average 25 days in a month. Calculate fare for passenger-km. (8 Marks) (b) The assets of SONA Ltd. consist of fixed assets and current assets, while its current liabilities comprise bank credit in the ratio of 2 : 1. You are required to prepare the Balance Sheet of the company as on 31st March 2013 with the help of following information: Share Capital ` 5,75,000 Working Capital (CA-CL) ` 1,50,000 Gross Margin 25% Inventory Turnover 5 times Average Collection Period 1.5 months Current Ratio 1.5:1 Quick Ratio 0.8: 1 Reserves & Surplus to Bank & Cash 4 times The Institute of Chartered Accountants of India (8 Marks) PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 47 Answer (a) Working Notes: (i) Calculation of Depreciation of Bus (Per month) = = Cost of the bus Scrap value at the endof the15 years Expectedlife of the bus ` 18,00,000 ` 1,20,000 15 years = ` 1,12,000 p.a. Depreciation per month = ` 1,12,000 12months = ` 9,333.33 (ii) Calculation of total distance travelled and Passenger-km. per month Total distance = 3 trips 2 20 k.m. 25 days = 3,000 k.m. Total Passenger-km. = 3 trips 2 20 k.m. 25 days 40 passengers = 1,20,000 Passenger-k.m. (iii) Cost of Engine oil, Lubricants and Diesel & oil (Per month) Engine oil & lubricants = = Totaldistance travelled 1,200 K.m. 3,000K.m. 1,200 K.m. ` 2,500 ` 2,500 = ` 6,250 Diesel and Oil = = Totaldistance travelled 10 K.m. 3,000K.m. 10 K.m. ` 52 ` 52 = ` 15,600 Statement showing the Operating Cost per Passenger-km. ` (i) Standing Charges: Depreciation {Working Note- (i)} The Institute of Chartered Accountants of India 9,333.33 ` 48 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 ` 18,00,000 Insurance Charge 3% 4,500 Manager-cum-accountant s salary 8,000 12 4,166.67 ` 50,000 Annual Tax (p.m.) 12 Garage Rent 2,500 28,500 (ii) Maintenance Charges: 12,500 ` 1,50,000 Repair & Maintenance per month 12 (iii) Running Cost: Driver s Salary 15,000 Conductor s Salary 12,000 Stationery 500 Engine oil & Lubricants {Working Note- (iii)} 6,250 Diesel and oil {Working Note- (iii)} 15,600 Total running cost before deducting commission to driver and conductor 49,350 Total cost excluding commission to driver and conductor 49,350 90,350 Driver s commission on collection* 6,023.34 Conductor s commission on collection* 6,023.33 Total Cost (i) +(ii) + (iii) 1,02,396.67 Add: Profit** 18,070 Total Collection 1,20,466.67 Working note: Total costs before commission on collection and net profit is ` 90,350. Commission on collection to driver and conductor is 10% of collection and Profit is 15% of collection means 100% - (10% + 15%) i.e. 75% = ` 90,350 So, Total collection = ` 90,350 75 100 = ` 1,20,466.67 *Total Commission on collection = 10% ` 1,20,466.67 = ` 12,046.67 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Driver s share = 50% ` 12,046.67 = 6,023.34 Conductor s share = 50% ` 12,046.67 = 6,023.33 ** Profit on collection = ` 1,20,466.67 15% = ` 18,070 Fare per Passenger-km. = = Total Collection Total Passenger - km. {Working Note (ii)} ` 1,20,466.67 1,20,000 = ` 1.004 (appx.) (b) Working Notes: (1) Computation of Current Assets (CA) and Current Liabilities (CL) Current Assets = Current Ratio Current Liabilities CA CL = 1.5 1 CA = 1.5CL CA - CL = 1,50,000 1.5 CL- CL = 1,50,000 0.5 CL CL = CA 2. = 1,50,000 = 1.5 x 3,00,000 = 4,50,000 1,50,000 = 3,00,000 0.5 Computation of Bank Credit (BC) and Other Current Liabilities (OCL) Bank Credit Other CL = 2 1 BC = 2 OCL BC + OCL = CL 2 OCL + OCL = 3,00,000 3 OCL = 3,00,000 OCL = 1,00,000 Bank Credit = 2 1,00,000 = 2,00,000 The Institute of Chartered Accountants of India 49 50 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 3. Computation of Inventory Quick Ratio = = Quick Assets Current Liabilities Current Assets - Inventories Current Liabilities 4,50,000 - Inventories 3,00,000 0.8 0.8 3,00,000 = 4,50,000 Inventories Inventories 4. = = 4,50,000 2,40,000 = 2,10,000 Computation of Debtors Inventory Turnover = 5 times Average Inventory COGS COGS Inventory Turnover = = 2,10,000 5 = 10,50,000 Average Collection Period (ACP) Debtors Turnover = 360 ACP = 360 45 = 1.5 months = 45 days =8 Sales - COGS 100 = 25% Sales 25 Sales Sales - COGS = 100 Sales 0.25 Sales = COGS 0.75 Sales = 10,50,000 Sales = 10,50,000 = 14,00,000 0.75 Debtors = Sales Debtors Turnover = 5. 14,00,000 = 1,75,000 8 Computation of Bank and Cash Bank & Cash = CA - (Debtors + Inventory) = 4,50,000 (1,75,000 + 2,10,000)= 4,50,000 3,85,000 = 65,000 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 6. 51 Computation of Reserves & Surplus Reserves & Surplus Bank & Cash =4 Reserves & Surplus = 4 65,000 = 2,60,000 Balance Sheet of SONA Ltd. as on March 31, 2013 Liabilities ` Assets Share Capital 5,75,000 Fixed Assets Reserves & Surplus ` 2,60,000 Current Assets: Current Liabilities: Bank Credit Other Current Liabilities 2,00,000 Inventories Debtors 1,00,000 Bank & Cash 11,35,000 6,85,000 2,10,000 1,75,000 65,000 11,35,000 Question 3 (a) The rate of change of labour force in a company during the year ending 31st March, 2013 was calculated as 13%,8% and 5% respectively under 'Flux Method', 'Replacement method' and 'Separation method'. The number of workers separated during the year is 40. You are required to calculate: (i) Average number of workers on roll. (ii) Number of workers replaced during the year. (iii) Number of new accessions i.e. new recruitment. (iv) Number of workers at the beginning of the year. (8 Marks) (b) APZ Limited is considering to select a machine between two machines 'A' and 'B'. The two machines have identical capacity, do exactly the same job, but designed differently. Machine 'A' costs ` 8,00,000, having useful life of three years. It costs ` 1,30,000 per year to run. Machine 'B' is an economy model costing ` 6,00,000, having useful life of two years. It costs ` 2,50,000 per year to run. The cash flows of machine 'A' and 'B' are real cash flows. The costs are forecasted in rupees of constant purchasing power. Ignore taxes. The opportunity cost of capital is 10%. The Institute of Chartered Accountants of India 52 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 The present value factors at 10% are : Year PVIF0.10,t PVIFA0.10,2 = 1.7355 PVIFA0.10,3 = 2.4868 t1 0.9091 t2 0.8264 t3 0.7513 Which machine would you recommend the company to buy? (8 Marks) Answer (a) (i) Labour Turnover Rate (Separation method) = No. of workers separated Average no. of workers onroll = 40 Average no. of workers on roll Or, 5 100 Or, Average no. of workers on roll = 800 (ii) Labour Turnover Rate (Replacement method) = No. of workers replaced Average no. of workers on roll No. of workers replaced Or, 8 100 Or, No. of workers replaced = 64 = 800 (iii) Labour Turnover Rate (Flux Method) = No. of Separations + No. of accession (new recruitments) Average No. of workers on roll = 40 + No. of accessions (New recruitments) 800 Or, 13 100 Or, 100 (40 + No. of Accessions) = 10,400 Or, No. of new accessions = 64 (iv) No. of workers at the beginning of the year Let workers at the beginning of the year were X Average no. of workers on roll = The Institute of Chartered Accountants of India Wor ker s at the begining + Wor ker s at the end 2 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 800 = X + ( X + New accessions Separations) 2 800 = X + ( X + 64 40) 2 800 = X + ( X + 24 ) 2 2X = 1,600 24 X 53 = 788 workers (b) Statement Showing Evaluation of Two Machines Particulars Machine A Machine B 8,00,000 6,00,000 3 2 Running Cost of Machine per year (`) : (ii) 1,30,000 2,50,000 Cumulative PVF for 1-3 years @ 10% : (iii) 2.4868 - Cumulative PVF for 1-2 years @ 10% : (iv) - 1.7355 3,23,284 4,33,875 11,23,284 10,33,875 4,51,698.57 Or 4,51,699 5,95,721.69 Or 5,95,722 Purchase Cost (`) : (i) Life of Machines (in years) Present Value of Running Cost of Machines (`): (v) = [(ii) x (iii)] Cash Outflow of Machines (`) : (vi) = (i) + (v) Equivalent Present Value of Annual Cash Outflow [(vi) (iii)] Recommendation: APZ Limited should consider buying Machine A since its equivalent Cash outflow is less than Machine B. Question 4 (a) SP Limited produces a product 'Tempex' which is sold in a 10 Kg. packet. The standard cost card per packet of 'Tempex' are as follows: ` Direct materials 10 kg @ ` 45 per kg 450 Direct labour 8 hours @ ` 50 per hour 400 Variable Overhead 8 hours @ ` 10 per hour Fixed Overhead 80 200 1,130 Budgeted output for the third quarter of a year was 10,000 Kg. Actual output is 9,000 Kg. The Institute of Chartered Accountants of India 54 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 Actual cost for this quarter are as follows : ` Direct Materials 8,900 Kg @ ` 46 per Kg. 4,09,400 Direct Labour 7,000 hours @ ` 52 per hour 3,64,000 Variable Overhead incurred 72,500 Fixed Overhead incurred 1,92,000 You are required to calculate : (i) Material Usage Variance (ii) Material Price Variance (iii) Material Cost Variance (iv) Labour Efficiency Variance (v) Labour Rate Variance (vi) Labour Cost Variance (vii) Variable Overhead Cost Variance (viii) Fixed Overhead Cost Variance (8 Marks) (b) The following are the summarized Balance Sheet of Flexon Limited as on 31st March 2012 and 2013 : Liabilities 31.3.12 31.3.13 Assets ` 31.3.13 ` ` 31.3.12 ` Share Capital 8,00,000 8,00,000 Goodwill 15,000 15,000 General Reserve 1,40,000 1,80,000 Building 4,00,000 3,60,000 Profit & Loss A/c. 1,60,000 2,70,000 Plant 3,70,000 5,20,000 Sundry Creditors 1,71,000 1,67,000 Investment (Long-term) 1,20,000 1,50,000 30,000 Stock 3,00,000 2,30,000 1,80,000 Debtors 1,80,000 2,00,000 66,000 1,52,000 Bills Payable Provision for Tax 20,000 1,60,000 Cash & Bank 14,51,000 16,27,000 Additional Information: (1) Depreciation charged during the year 2012-13: The Institute of Chartered Accountants of India 14,51,000 16,27,000 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55 On Plant - ` 40,000 On Building - ` 40,000 (2) Provision for tax of ` 1,90,000 was made during the year 2012-13. (3) Interim dividend paid during the year 2012-13: Interim Dividend - ` 80,000 Corporate Dividend Tax - ` 13,596 Prepare: (i) Statement of changes in working capital (ii) Funds flow statement for the year ended 31st March, 2013. (8 Marks) Answer (a) (i) Material Usage Variance = Std. Price (Std. Quantity Actual Quantity) = ` 45 (9,000 kgs. 8,900 kgs.) = ` 4,500 (Favourable) (ii) Material Price Variance = Actual Quantity (Std. Price Actual Price) = 8,900 kgs. (` 45 ` 46) = ` 8,900 (Adverse) (iii) Material Cost Variance = Std. Material Cost Actual Material Cost = (SQ SP) (AQ AP) = (9,000 kgs. ` 45) (8,900 kgs. ` 46) = ` 4,05,000 ` 4,09,400 = `4,400 (Adverse) (iv) Labour Efficiency Variance = Std. Rate (Std. Hours Actual Hours) = ` 50 ( 9,000 10 8hours 7,000 hrs.) = ` 50 (7,200 hrs. 7,000 hrs.) = ` 10,000 (Favourable) (v) Labour Rate Variance = Actual Hours (Std. Rate Actual Rate) = 7,000 hrs. (` 50 `52) = ` 14,000 (Adverse) (vi) Labour Cost Variance = Std. Labour Cost Actual Labour Cost = (SH SR) (AH AR) The Institute of Chartered Accountants of India 56 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 = (7,200 hrs. ` 50) (7,000 hrs. ` 52) = ` 3,60,000 ` 3,64,000 = `4,000 (Adverse) (vii) Variable Cost Variance = Std. Variable Cost Actual Variable Cost = (7,200 hrs. ` 10) ` 72,500 = ` 500 (Adverse) (viii) Fixed Overhead Cost Variance = Absorbed Fixed Overhead Actual Fixed Overhead = ` 200 9,000kgs. ` 1,92,000 10 kgs. = ` 1,80,000 ` 1,92,000 = ` 12,000 (Adverse) (b) (i) Schedule of Changes in Working Capital Particulars 31st March 2012 (`) Working Capital 2013 Increase (`) (`) Decrease (`) (A) Current Assets Stock 3,00,000 2,30,000 - 70,000 Debtors 1,80,000 2,00,000 20,000 - 66,000 1,52,000 86,000 - 5,46,000 5,82,000 1,71,000 1,67,000 4,000 - 20,000 30,000 - 10,000 Total (B) 1,91,000 1,97,000 Working Capital (A-B) 3,55,000 3,85,000 1,10,000 80,000 Cash & Bank Total (A) (B) Current Liabilities Sundry Creditors Bills Payable Increase in Working Capital Total 30,000 3,85,000 - - 30,000 3,85,000 1,10,000 1,10,000 Funds Flow Statement as on 31st March, 2013 Sources of Fund Funds from Operation ` Application of Fund 5,13,596 ` 30,000 Interim Dividend The Institute of Chartered Accountants of India Increase in Working Capital 80,000 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57 Purchase of Investment 30,000 Corporate Dividend Tax 13,596 Purchase of Plant 1,90,000 Payment of Income Tax 1,70,000 5,13,596 5,13,596 Working Notes: Adjusted Profit and Loss A/c Particulars ` Particulars To General Reserve 40,000 By Net Profit for 2012 ` 1,60,000 To Depreciation: Plant 40,000 Building 40,000 To Goodwill By Funds from Operations 5,13,596 80,000 - To Interim Dividend 80,000 To Corporate Dividend Tax 13,596 To Provision for Tax To Net Profit for 2013 1,90,000 2,70,000 6,73,596 6,73,596 Provision for Tax A/c Particulars To Bank A/c (Tax Paid) To Balance b/d ` Particulars 1,70,000 By Bal. b/d 1,80,000 By P&L A/c 3,50,000 ` 1,60,000 1,90,000 3,50,000 Plant & Machinery A/c Particulars To Bal. b/d To Bank ` Particulars ` 3,70,000 By Depreciation 40,000 1,90,000 By Bal. c/d 5,20,000 5,60,000 5,60,000 (Note: Schedule of changes in the working capital maybe computed alternatively by taking provision for tax as current liability and working out the problem accordingly.) The Institute of Chartered Accountants of India 58 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 Question 5 (a) Explain the following terms in relation to process costing: (i) Equivalent Production (ii) Inter-process profit (b) Elaborate the practical application of Marginal Costing. (c) What is Virtual Banking? State its advantages. (d) What is Over capitalisation? State its causes and consequences. (4 x 4 = 16 Marks) Answer (a) (i) Equivalent Production: When opening and closing stocks of work-in-process exist, unit costs cannot be computed by simply dividing the total cost by total number of units still in process. We can convert the work-in-process units into finished units called equivalent production units so that the unit cost of these uncompleted (W-I-P) units can be obtained. Equivalent Production units = Actual number of units in production Percentage of work completed. It consists of balance of work done on opening work-in-process, current production done fully and part of work done on closing WIP with regard to different elements of costs viz., material, labour and overhead. (ii) Inter-Process Profit: 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 interprocess profits. (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 break-even analysis which shows the effect of increasing or decreasing production activity on the profitability of the company. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59 (c) Virtual Banking and its Advantages Virtual banking refers to the provision of banking and related services through the use of information technology without direct recourse to the bank by the customer. The advantages of virtual banking services are as follows: Lower cost of handling a transaction. The increased speed of response to customer requirements. The lower cost of operating branch network along with reduced staff costs leads to cost efficiency. Virtual banking allows the possibility of improved and a range of services being made available to the customer rapidly, accurately and at his convenience. (Note: Students may answer any two of the above advantages) (d) Overcapitalization and its Causes and Consequences It is a situation where a firm has more capital than it needs or in other words assets are worth less than its issued share capital, and earnings are insufficient to pay dividend and interest. Causes of Over Capitalization Over-capitalisation arises due to following reasons: (i) Raising more money through issue of shares or debentures than company can employ profitably. (ii) Borrowing huge amount at higher rate than rate at which company can earn. (iii) Excessive payment for the acquisition of fictitious assets such as goodwill etc. (iv) Improper provision for depreciation, replacement of assets and distribution of dividends at a higher rate. (v) Wrong estimation of earnings and capitalization. (Note: Students may answer any two of the above reasons) Consequences of Over-Capitalisation Over-capitalisation results in the following consequences: (i) Considerable reduction in the rate of dividend and interest payments. (ii) Reduction in the market price of shares. (iii) Resorting to window dressing . The Institute of Chartered Accountants of India 60 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 (iv) Some companies may opt for reorganization. However, sometimes the matter gets worse and the company may go into liquidation. (Note: Students may answer any two of the above consequences) Question 6 (a) Calculate Machine Hour Rate from the following particulars: Cost of Machine - ` 25,00,000 Salvage Value - ` 1,25,000 Estimated life of the machine - 25,000 Hours Working Hours (per annum) - 3,000 Hours Hours required for maintenance - 400 Hours Setting-up time required - 8% of actual working hours Additional Information: (i) Power 25 units @ ` 5 per unit per hour. (ii) Cost of repairs and maintenance ` 26,000 per annum. (iii) Chemicals required for operating the machine ` 2,600 per month. (iv) Overheads chargeable to the machine ` 18,000 per month. (v) Insurance Premium (per annum) 2% of the cost of machine (vi) No. of operators - 02 (looking after three other machines also) (vii) Salary per operator per month ` 18,500 (8 Marks) (b) PTX Limited is considering a change in its present credit policy. Currently it is evaluating two policies. The company is required to give a return of 20% on the investment in new accounts receivables. The company's variable costs are 70% of the selling price. Information regarding present and proposed policies is as follows: Present Policy Policy Policy Option 1 Option 2 30,00,000 42,00,000 45,00,000 Debtors turnover ratio 4 times 3 times 2.4 times Loss due to bad debts 3% of sales 5% of sales 6% of sales Annual Credit Sales (`) Note: Return on investment in new accounts receivable is based on cost of investment in debtors. Which option would you recommend? The Institute of Chartered Accountants of India (8 Marks) PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61 Answer (a) Computation of Machine Hour Rate Setting-up time is Unproductive (Machine hour2,407*) Particulars ` Setting-up time is Productive (Machine hour- 2,600) ` Fixed Charges (Standing Charges): 89.74 83.08 46.12 42.69 20.77 19.23 156.63 145.00 95.00 95.00 125.00 125.00 10.80 Overhead Chargeable ` 18,000 12 = ` 2,16,000 ` 2,16,000 Rs ` 2,16,000 Rs 2,407 hours ; 2,600 hours 10.00 12.96 12.00 400.39 387.00 Operator s Salary: R ` 18,500 12 2 Operators = ` 1,11,000 4 machines ` 1,11,000 R ` 1,11,000 R 2,407 hours ; 2,600 hours Insurance: 2% of `25,00,000 = `50,000 Variable Expenses (Machine Expenses) per hour Depreciation : Power: ` 25,00,000 ` 1,25,000 25,000 hours ( 25 units ` 5) Repairs and Maintenance : ` 26,000 2,407 hours ; ` 26,000 2,600 hours ` 2,600 12 Rs ` 2,600 12 Rs Chemical : ; 2,600 hours 2,407 hours Machine Hour Rate The Institute of Chartered Accountants of India 62 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 * (Hours) Working Hours 3,000 Less: Maintenance hours 400 2,600 Less: Setting-up hours Actual working hours ( 193 2,600hours 100) 108 2,407 Assumptions: 1. Working hours (i.e. 3,000 hours) are inclusive of maintenance and setting-up time. 2. It is assumed that no power is consumed by the machine during unproductive hours i.e. during maintenance and unproductive setting-up hours. 3. Depreciation is calculated on the basis of estimated life of the machine hours. Hence per unit machine hour rate of depreciation will be same. Note: As this numerical problem does not specifically mention about the nature of settingup time; means whether setting-up time is unproductive or productive is not clear. The problem can be solved assuming setting-up time either as productive or as unproductive. The question may be solved based on logical assumption regarding the nature of settingup time (i.e. unproductive or productive) and for furnishing any one or both the situation. (b) Statement of Evaluation of Credit Policies of PTX Limited (based on Total Cost Approach) Present Policy Sales Revenue Less: Variable Cost @70% Contribution Policy Option I Policy Option II 30,00,000 21,00,000 42,00,000 29,40,000 4,50,0000 31,50,000 9,00,000 12,60,000 13,50,000 (90,000) (2,10,000) (2,70,000) (1,05,000) (1,96,000) (2,62,500) 7,05,000 8,54,000 8,17,500 Less: Other Relevant Costs Bad Debt Losses Investment Cost (VC DTR) 20% Profit Recommendation: PTX Limited is advised to adopt Policy Option I. (Note: In the above solution, investment in accounts receivable is based on total cost of goods sold on credit. Since fixed costs are not given in the problem, therefore, it is assumed The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63 that there are no fixed costs and investment in receivables is determined with reference to variable costs only. The above solution may alternatively be worked out on the basis of incremental approach. However, the recommendation would remain the same.) Question 7 Answer any four of the following: (a) What is the meaning of Margin of Safety (MOS)? State the relationship between Operating Leverage and Margin of Safety Ratio. (b) Describe the steps involved in the budgetary control technique. (c) 'Management of marketable securities is an integral part of investment of cash.' Comment. (d) What do you mean by capital structure? State its significance in financing decision. (e) (i) State the main elements of leveraged lease. (ii) State the escalation clause in contract costing. (4 x 4 = 16 Marks) Answer (a) Margin of Safety (MoS) is the excess of total sales over the Break even sales. MoS defines the amount upto which level sales can decline before occurring loss. Therefore MoS = Total Sales - Break even sales Sales Break even sales and MoS ratio = Break even sales Sales (BE sales) will depend on contribution margin (BE sales = Fixed Cost Contribution margin). Contribution margin is related to operating leverage also. Operating leverage is calculated as Contribution Operating profit and contribution margin plays an important role in it. If sales are expected to increase, higher operating leverage will result in higher profit. When sales are expected to decrease, lower operating leverage will result in higher profit. Higher variable cost and lower fixed cost will result into higher MoS and risk will be lower and vice versa. So like Operating leverage, MoS is a measure of risk as to what extent an organisation is exposed to change in sales volume. (b) There are certain steps involved in the budgetary control technique. They are as follows: (i) Definition of objectives: A budget being a plan for the achievement of certain operational objectives, it is desirable that the same are defined precisely. The objectives should be written out; the areas of control demarcated; and items of revenue and expenditure to be covered by the budget stated. (ii) Location of the key (or budget) factor: There is usually one factor (sometimes there may be more than one) which sets a limit to the total activity. Such a factor is known as key factor. For proper budgeting, it must be located and estimated properly. The Institute of Chartered Accountants of India 64 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013 (iii) Appointment of controller: Formulation of a budget usually required whole time services of a senior executive known as budget controller; he must be assisted in this work by a Budget Committee, consisting of all the heads of department along with the Managing Director as the Chairman. (iv) Budget Manual: Effective budgetary planning relies on the provision of adequate information which are contained in the budget manual. A budget manual is a collection of documents that contains key information for those involved in the planning process. (v) Budget period: The period covered by a budget is known as budget period. The Budget Committee determines the length of the budget period suitable for the business. It may be months or quarters or such periods as coincide with period of trading activity. (vi) Standard of activity or output: For preparing budgets for the future, past statistics cannot be completely relied upon, for the past usually represents a combination of good and bad factors. Therefore, though results of the past should be studied but these should only be applied when there is a likelihood of similar conditions repeating in the future. (c) Management of Marketable Securities is an Integral Part of Investment of Cash Management of marketable securities is an integral part of investment of cash as it serves both the purposes of liquidity and cash, provided choice of investment is made correctly. As the working capital needs are fluctuating, it is possible to invest excess funds in some short term securities, which can be liquidated when need for cash is felt. The selection of securities should be guided by three principles namely safety, maturity and marketability. (d) Concept of Capital Structure and its Significance in Financing Decision Capital structure refers to the mix of a firm s capitalisation i.e. mix of long-term sources of funds such as debentures, preference share capital, equity share capital and retained earnings for meeting its total capital requirement. Significance in Financing Decision The capital structure decisions are very important in financial management as they influence debt equity mix which ultimately affects shareholders return and risk. These decisions help in deciding the forms of financing (which sources to be tapped), their actual requirements (amount to be funded) and their relative proportions (mix) in total capitalisation. Therefore, such a pattern of capital structure must be chosen which minimises cost of capital and maximises the owners return. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (e) (i) 65 Main Elements of Leveraged Lease Under this lease, a third party is involved beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third party i.e., lender. The asset so purchased is held as security against the loan. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor. The lessor is entitled to claim depreciation allowance. (ii) Escalation Clause - If during the period of execution of a contract, the prices of materials, or labour etc., rise beyond a certain limit, the contract price will be increased by an agreed amount. Inclusion of such a clause in a contract deed is called an Escalation Clause The Institute of Chartered Accountants of India

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