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CA IPCC : Question Paper (with Answers) - COST ACCOUNTING & FINANCIAL MANAGEMENT May 2012

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DISCLAIMER The Suggested Answers hosted on 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 any way 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 answer. Question 1 Answer the following: (a) AK Limited produces and sells a single product. Sales budget for calendar year 2012 by a quarters is as under: Quarters I II III IV No. of units to be sold 18,000 22,000 25,000 27,000 The year is expected to open with an inventory of 6,000 units of finished products and close with inventory of 8,000 units. Production is customarily scheduled to provide for 70% of the current quarter s sales demand plus 30% of the following quarter demand. The budgeted selling price per unit is ` 40 . The standard cost details for one unit of the product are as follows: Variable Cost` 34.50 per unit Fixed Overheads `2 hours 30 minutes @` 2 per hour based on a budgeted production volume of 1,10,000 direct labour hours for the year. Fixed overheads are evenly distributed through-out the year. You are required to: (i) Prepare Quarterly Production Budget for the year. (ii) In which quarter of the year, company expected to achieve bread-even point. (b) A Machine costing `10 lacs was purchased on 1-4-2011. the expected life of the machine is 10 years. At the end of this period its scrap value is likely to be `10,000. the total cost of all the machines including new one was `90 lacs. The other information is given as follows: (i) Working hours of the machine for the year was 4,200 including 200 non-productive hours. (ii) Repairs and maintenance for the new machine during the year was ` 5,000. (iii) Insurance Premium was paid for all the machine ` 9,000. (iv) New machine consumes 8 units of electricity per hour, the rate per unit being ` 3.75 (v) The new machine occupies area of the department. Rent of the department is 2,400 per month. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 45 (vi) Depreciation is charged on straight line basis Compute machine hour rate for the new machine. (c) RES Ltd. is an all equity financed company with a market value of ` 25,00,000 and cost of equity Ke = 21%. The company wants to buyback equity shares worth ` 5,00,000 by issuing and raising 15% perpetual debt of the same amount. Rate of tax may be taken as 30%. After the capital restructuring and applying MM Model (with taxes), you are required to calculate: (i) Market value of RES Ltd. (ii) Cost of Equity Ke (iii) Weighted average cost of capital and comment on it. (d) A company is presently having credit sales of ` 12 lakh. The existing credit terms are 1/10, net 45 days and average collection period is 30 days. The current bad debts loss is 1.5%. In order to accelerate the collection process further as also to increase sales, the company is contemplating liberalization of its existing credit terms to 2/10, net 45 days. It is expected that sales are likely to increase by 1/3 of existing sales, bad debts increase to 2% of sales and average collection period to decline to 20 days. The contribution to sales ratio of the company is 22% and opportunity cost of investment in receivables is 15 percent (pre-tax). 50 per cent and 80 percent of customers in terms of sales revenue are expected to avail cash discount under existing and liberalization scheme respectively. The tax rate is 30%. Should the company change its credit terms? (Assume 360 days in a year). (4 5 = 20 Marks) Answer (a) (i) Production Budget for the year 2012 by Quarters I II III IV Total Sales demand(Unit) 18,000 22,000 25,000 27,000 92,000 I Opening Stock 6,000 7,200 8,100 8,700 30,000 II 70% of Current Quarter s Demand 12,600 15,400 17,500 18,900 64,400 III 30% of Following Quarter s Demand 6,600 7,500 8,100 7,400* 29,600 IV Total Production(II &III) 19,200 22,900 25,600 26,300 94,000 Closing Stock (I+IVSales) *Balancing Figure 7,200 8,100 8,700 8,000 32,000 V The Institute of Chartered Accountants of India 46 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (ii) Break Even Point = Fixed Cost/ PV Ratio =220000/13.75% = 1600000 or 40000 units. P/V Ratio = (40 - 34.50 = 5.50)/40 100 =13.75% (Or, Break Even Point= Fixed Cost/ Contribution = 2,20,000/5.50 = 40,000 Units) Total sales in the quarter II is 40000 equal to BEP means BEP achieved in II quarter. (b) Computation of machine hour rate of new Machine Total Per hour(`) (`) A. Standing Charges I. Insurance Premium 9000 x II. Rent 1,000 1 9 1 x2400x12 10 2,880 3,880 B. Machine expenses I. Repairs and Maintenance [5,000/4,000] 0.97* 1.25 10,00,000 - 10,000 II. Depreciation 10 4,000 24.75 III. Electricity 8 units x ` 3.75 30.00 Machine hour rate 56.97 Working Note 1 Calculation of productive Machine hour rate Total hours 4,200 Less: Non-Productive hours 200 4,000 * 3,880/ 4000 = 0.97 (c) Computation of Market Value, Cost of Equity and WACC of RES Ltd. Market Value of Equity = 25,00,000 Ke =21% Net income (NI) for equity - holders = Market Value of Equity Ke The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 47 Net income (NI) for equity holders = 25,00,000 0.21 Net income for equity holders = 5,25,000 EBIT= 5,25,000/0.7= 7,50,000 All Equity Debt and Equity 7,50,000 7,50,000 - 75,000 EBT 7,50,000 6,75,000 Taxes (30%) 2,25,000 2,02,500 Income available to equity shareholders 5,25,000 4,72,500 Income to debt holders plus income available to shareholders 5,25,000 5,47,500 EBIT Interest to debt-holders Present value of tax-shield benefits = ` 5,00,000 x 0.30 = 1,50,000 (i) Value of Restructured firm = 25,00,000 + 1,50,000 = 26,50,000 (ii) Cost of Equity (Ke) Total Value = 26,50,000 Less: Value of Debt = 5,00,000 Value of Equity = 21,50,000 4,72,500 =0.219 = 22% Ke = 21,50,000 (iii) WACC Cost of Debt (after tax)= 15% (1- 0.3)= 0.15 (0.70) = 0.105= 10.5% Components of Costs Amount Cost of Capital Weight Weighted COC Equity 21,50,000 0.22 0.81 0.178 Debt 5,00,000 0.105 0.19 0.020 26,50,000 WACC = 19.8% The Institute of Chartered Accountants of India 0.198 48 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 Comment: At present the company is all equity financed. So, Ke = Ko i.e. 21%. However after restructuring, the Ko would be reduced to 19.81% and Ke would increase from 21% to 21.98%. Reduction in Ko and increase in Ke is good for the health of the company. (d) Evaluation of Credit Policy Working Notes: (i) Calculation of Cash Discount Cash Discount = Total credit sales % of customers who take up discount Rate Present Policy = 12,00,000 50 .01 = ` 6,000 100 Proposed Policy = 16,00,000 0.80 0.02 = ` 25,600 (Ii) Opportunity Cost of Investment in Receivables Present Policy = 9,36,000 (30/360) (70% of 15)/100 = 78,000 10.5/100 = ` 8,190 Proposed Policy = 12,48,000 (20/360) 10.50/100 = ` 7,280 Statement showing Evaluation of Credit Policies Particulars Present Policy Proposed Policy Credit Sales 12,00,000 16,00,000 9,36,000 12,48,000 18,000 32,000 6,000 25,600 2,40,000 2,94,400 72,000 88,320 1,68,000 2,06,080 8,190 7,280 1,59,810 1,98,800 Variable Cost @ 78% of sales Bad Debts @ 1.5% and 2% Cash Discount Profit before tax Tax @ 30% Profit after Tax Opportunity Cost of Investment in Receivables Net Profit Advise: Proposed policy should be adopted since the net benefit is increased by (` 1,98,800 - 1,59,810) ` 38,990. [Note: Opportunity cost of investment in receivables can be computed alternatively taking contribution @ 22 percent into consideration. The net benefit then would change accordingly to ` 1,95,137.] The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49 Question 2 (a) A contractor commenced a contract on 1-7-2011. The costing records concerning the said contract reveal the following information as on 31-32012. Amount (`) Material sent to site 7,74,300 Labour paid 10,79,000 Labour outstanding as on 31-3-2012 1,02,500 Salary to Engineer Cost of plant sent to site (1-7-2011) 20,500 per month 7,71,000 Salary to Supervisor (3/4 time devoted to contract) 9,000 per month Administration & other expenses 4,60,600 Prepaid Administration expenses Material in hand at site as on 31-3-2012 10,000 75,800 Plant used for the contract has an estimated life of 7 years with residual value at the end of life ` 50,000. Some of material costing ` 13,500 was found unsuitable and sold for ` 10,000. Contract price was ` 45,00,000. On 31-3-2012 two third of the contract was completed. The architect issued certificate covering 50% of the contract price and contractor has been paid ` 20,00,000 on account. Depreciation on plant is charged on straight line basis. Prepare Contract Account. (8 Marks) (b) The Balance Sheet of X Ltd. as on 31-3-2011 and 31-3-2012 are as under: Liabilities 2011 2012 Assets Equity Share 18,00,000 22,00,000 Fixed Assets capital (` 10 each) (Including machine) General Reserve 7,50,000 Security premium 50,000 6,00,000 Stock 45,000 Debtors Profit & Loss A/c 4,50,000 5,30,000 Cash Balance 7% Debentures 3,00,000 2,00,000 Preliminary Expense Creditors 1,50,000 1,45,000 2012 20,50,000 18,75,000 7,10,000 8,95,000 7,25,000 9,80,000 1,25,000 1,80,000 35,000 25,000 2,15,000 Provision for tax 2011 1,65,000 36,45,000 39,55,000 36,45,000 39,55,000 Additional Information: (i) Depreciation charged on fixed assets during the year was ` 2,05,000. An old machine costing ` 2,00,000 (WDV` 80,000) was sold for ` 65,000 during the year. The Institute of Chartered Accountants of India 50 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (ii) Provisions for tax made during the year for ` 1,78,000. (iii) On 1-4-2011 company redeemed debentures of ` 1,00,000 at a premium of 5%. (iv) Company has issued fully paid bonus shares of ` 2,00,000 by capitalization of profit. Prepare Cash Flow Statement. (8 Marks) Answer (a) Contract Account (For the period 1.7.11 to 31.3.12) Particulars Amount Particulars ` To Material Issued To Labour ` 7,74,300 By Material (Sold) By P&L A/c (Loss) 10,000 11,81,500 (13,500-10,000) 1,84,500 By Material in hand 3,500 75,800 10,79,000 Add: Outstanding 1,02,500 To Salary to engineer (20,500 x 9) Amount To Salary to Supervisor 60,750 3 9000 9 4 By Cost of Contract c/d 26,39,600 To Administration & other expenses Less: Prepaid 4,60,600 10,000 4,50,600 To Depreciation on Plant (Working Note 1) 77,250 27,28,900 To Cost of Contract b/d To Notional Profit c/d 27,28,900 26,39,600 By work-in Progress: 2,70,300 -Work certified 50% of 45,00,000 -Work uncertified (W.N.-2) (26,39,600-19,79,700) 29,09,900 To P&L A/c(W.N.3) To Reserve 22,50,000 6,59,900 29,09,900 2,70,300 2,70,300 The Institute of Chartered Accountants of India 1,60,178 By Notional Profit b/d 1,10,122 2,70,300 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51 Working Note 1. Calculation of depreciation on Plant Cost of the Plant 7,71,000 Less: Residual Value 50,000 7,21,000 Estimated life 7 Years Depreciation per annum 1,03,000 Depreciation for 9 months = 2. 1,03,000 9 = 77,250 12 Cost of work uncertified = Cost incurred to date minus 50% of the total cost of contract = `26,39,600(figure already shown in the contract A/c) - `19,79,700 = `6,59,900 3. Calculation of Profit to be transferred 2 20,00,000 2,70,300 = 1,60,178 3 22,50,000 (b) Cash flow Statement of X Ltd. for the year ending 31.03.2012 (A) Cash flow from Operating Activities : (`) Net Profit before Tax (80,000 + 50,000 + 1,78,000) 3,08,000 Add : Depreciation Loss on Sale of Machine 2,05,000 15,000 Interest Paid on Debentures Preliminary Expenses written off Cash flow before working capital adjustments 14,000 10,000 5,52,000 (-) Increase in Stock (1,85,000) (-) Increase in Debtors (2,55,000) (+) Increase in Creditors Cash flow from Operating Activities The Institute of Chartered Accountants of India 65,000 1,77,000 (`) 52 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 Less : Tax paid (1,58,000) (B) Cash flow from Investing Activities Sale of Machine 19,000 65,000 Purchase of Fixed Assets (1,10,000) Net cash used in Investing activities (45,000) (C) Cash flow from Financing activities Issue of Equity Shares 2,00,000 Redemption of Debentures Interest paid on Debentures (1,05,000) (14,000) Net cash used in Financing Activities 81,000 Net Increase in Cash and Cash Equivalent during year Add : Opening Balance of Cash 55,000 1,25,000 Closing Balance of Cash 1,80,000 Working Notes : Fixed Assets Account To Balance b/d To Bank 20,50,000 By Bank 1,10,000 By P&L a/c By Depreciation a/c By Balance c/d 21,60,000 65,000 15,000 2,05,000 18,75,000 21,60,000 Provision for Tax To Balance b/d 1,58,000 By balance c/d 1,45,000 To Bank 1,65,000 By P & L a/c 1,78,000 3,23,000 3,23,000 General Reserve A/c To Equity share capital a/c 2,00,000 By Balance b/d To Balance c/d 6,00,000 By P & L a/c 8,00,000 The Institute of Chartered Accountants of India 7,50,000 50,000 8,00,000 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53 Question 3 (a) The management of a company wants to formulate an incentive plan for the workers with a view to increase productivity. The following particulars have been extracted from the books of company: Piece Wage rate ` 10 Weekly working hours 40 Hourly wages rate ` 40 (guaranteed) Standard/normal time per unit 15 minutes. Actual output for a week: Worker A 176 pieces Worker B 140 pieces Differential piece rate: 80% of piece rate when output below normal and 120% of piece rate when output above normal. Under Halsey scheme, worker gets a bonus equal to 50% of Wages of time saved. Calculate: (i) Earning of workers under Halsey s and Rowan s premium scheme. (ii) Earning of workers under Taylor s differential piece rate system and Emerson s efficiency plan. (8 Marks) (b) STN Ltd. is a readymade garment manufacturing company. Its production cycle indicates that materials are introduced in the beginning of the production phase; wages and overhead accrue evenly throughout the period of cycle. The following figures for the 12 months ending 31st December 2011 are given. Production of shirts 54,000 units Selling price per unit ` 200 Duration of the production cycle 1 month Raw material inventory held 2 month s consumption Finished goods stock held for 1 month Credit allowed to debtors is 1.5 months and credit allowed by creditors is 1 month. Wages are paid in the next month following the month of accrual. In the work-in-progress 50% of wages and overheads are supposed to be conversion costs. The ratios of cost to sales price are-raw materials 60% direct wages 10% and overheads 20%. Cash is to be held to the extent of 40% of current liabilities and safety margin of 15% will be maintained. Calculate amount of working capital required for the company on a cash cost basis. (8 Marks) The Institute of Chartered Accountants of India 54 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 Answer (a) Calculation of earnings for workers under different incentive plans: (i) Halsey s Premium Plan: Worker A 40 hours Actual time taken Standard time Production for actual Worker B 40 hours 176 Pcs 15 Min. 60 Min. = 44 hours Minimum Wages Bonus Earning 140 Pcs 15 Min. 60 Min. = 35 hours 40 hours x ` 40 = ` 1600 40 hours x ` 40 = ` 1600 50% (44-40) x `40 = ` 80 No bonus ` 1680 ` 1600 ` 1600 ` 1600 4 40 ` 40 44 No bonus Rowan s Premium Plan: Minimum Wages (as above) Bonus = ` 145.45 Earning ` 1745.45 ` 1600 176 100 160 = 110% 140 100 160 = 87.5% `10x120%x176 Pcs = ` 2112 `10x80%x140Pcs ` 1120 ` 40x40 hours = 1600 ` 40x40 hours = 1600 (20%+10%) of (40x40) = 480 20% of 1600 = 320 ` 2080 ` 1920 (ii) Taylor s differential Piece rate Efficiency Earning Emerson s efficiency Plan Time Wages Bonus Earning The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55 (b) Computation of Amount of Working Capital required on a Cash Cost basis Working Notes: 1. Raw material inventory: The cost of materials for the whole year is 60% of the Sales value. 60 = ` 64,80,000 . The monthly consumption of 100 raw material would be ` 5,40,000. Raw material requirements would be for two months; hence raw materials in stock would be ` 10,80,000. Hence it is 54,000 units x ` 200 x 1.5 = ` 12,15,000 12 2. Debtors: Total Cash Cost of Sales = 97,20,000 x 3. Work-in-process: (Each unit of production is expected to be in process for one month). ` (a) Raw materials in work-in-process (being one month s raw material requirements) 5,40,000 (b) Labour costs in work-in-process (It is stated that it accrues evenly during the month. Thus, on the first day of each month it would be zero and on the last day of month the work-in-process would include one month s labour costs. On an average therefore, it would be equivalent to of the month s labour costs) 45,000 (c) 4. Overheads (For month as explained above) Total work-in-process Finished goods inventory: _90,000 6,75,000 (1 month s cost of production) Raw materials Labour Overheads 5. 6. 5,40,000 90,000 1,80,000 8,10,000 Creditors: Suppliers allow a one month s credit period. Hence, the average amount of creditors would be ` 5,40,000 being one month s purchase of raw materials. Direct Wages payable: The direct wages for the whole year is 54,000 units ` 200 x 10% = 10,80,000. The monthly direct wages would be 90,000 (10,80,000 12). Hence, wages payable would be ` 90,000. The Institute of Chartered Accountants of India 56 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 Statement of Working Capital Required ` ` Current Assets Raw materials inventory (Refer to working note 1) 10,80,000 Debtors (Refer to working note 2) 12,15,000 Working in-process (Refer to working note 3) 6,75,000 Finished goods inventory (Refer to working note 4) 8,10,000 Cash 2,52,000 Current Liabilities Creditors (Refer to working note 5) 5,40,000 Direct wages payable (Refer to working note 6) Estimated working capital requirements (before safety margin of 15%) 90,000 40,32,000 6,30,000 34,02,000 5,10,300 39,12,300 Add: Safety margin of 15% Estimated Working Capital Requirements Question 4 (a) SJ Ltd. has furnished the following information: Standard overhead absorption rate per unit Standard rate per hour ` 20 `4 Budgeted production 15,000 units Actual production 15,560 units Actual overheads were ` 2,95,000 out of which ` 62,500 fixed . Actual hours 74,000 Overheads are based on the following flexible budget Production (units) 8,000 10,000 14,000 Total Overheads (`) 1,80,000 2,10,000 2,70,000 You are required to calculate the following overhead variances (on hour s basis) with appropriate workings: (i) Variable overhead efficiency and expenditure variance (ii) Fixed overhead efficiency and capacity variance. The Institute of Chartered Accountants of India (8 Marks) PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57 (b) ANP Ltd. is providing the following information: Annual cost of saving ` 96,000 Useful life 5 years Salvage value Internal rate of return zero 15% Profitability index 1.05 Table of discount factor: Discount factor Years 1 2 3 4 5 Total 15% 0.870 0.756 0.658 0.572 0.497 3.353 14% 0.877 0.769 0.675 0.592 0.519 3.432 13% 0.886 0.783 0.693 0.614 0.544 3.52 You are required to calculate: (i) Cost of the project (ii) Payback period (iii) Net present value of cash inflow (iv) Cost of capital. (8 Marks) Answer (a) Workings: (a) Variable overhead rate per unit = Difference in total overheads at two levels/ Difference in out- put at two level = (2,70,000 - 2,10,000) /(14,000-10,000) = 60,000/ 4,000 = ` 15 per unit (b) Fixed overhead = 2,70,000 - (14000 15) = `60,000 (c) Standard Fixed Overhead Rate Per Hour = 4-3 = 1 (d) Standard Hour Per Unit = Standard hours rate per unit / standard overhead rate per hour = 20/4 = 5 hours (e) Actual Variable Overhead = 2,95,000 62,500= 2,32,000 (f) Actual Variable Overhead Per Hour = 2,32,500/74,000= 3.1419 (g) Budgeted hours = 15,000 5 = 75,000 hours (h) Standard variable overhead rate per hour = Variable overheads/budgeted hours =15,000 15 / 75,000 = `3.00 per hour The Institute of Chartered Accountants of India 58 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (i) Standard Hours for Actual Production= 15,560 5 = 77,800 hours (i) Variable Overhead efficiency and expenditure Variance: Variable overhead efficiency variance Hours Actual Hours) = Standard Rate Per Hour (Std. = 3 (77,800 - 74,000)= 11,400 (F) Variable overhead expenditure variance = Actual Hours (Std.Rate Per HourActual Rate Per Hour) = 74,000 (3-3.1419)= 10,500 (A) (ii) Fixed overhead efficiency and expenditure variance: Fixed overhead efficiency variance = Std.Rate Per Hour (Std.Hours-Actual Hours) = 1(77,800-74,000)= 3800(F) Fixed overheads Capacity variance = Std. Rate Per Hour(Actual HoursBudgeted Hours) = 1(74,000 75,000 ) = 74,000 - 75,000 = 1000 A Standard Fixed overhead rate per hour is calculated with the help of budgeted hours and the Fixed overhead efficiency and expenditure variance is calculated as follows: Standard fixed overhead rate per hour = Fixed overheads/budgeted hours= 60,000 / 75,000 = `0.80 per hour (ii) Fixed overhead efficiency and capacity variance Fixed overhead efficiency Variance*= Std. Rate per hour (Std. hours - Actual hours) = `0.80 (15,560 x5 - 74,000) = `3,040 (F) Fixed overhead capacity variance*= Std. Rate per hour (Actual hours- Budgeted hours) = `0.80 (74,000-15000 x 5) = `800 (A) (b) (i) Cost of Project At 15% internal rate of return (IRR), the sum of total cash inflows = cost of the project i.e initial cash outlay Annual cost savings = ` 96,000 Useful life = 5 years Considering the discount factor table @ 15%, cumulative present value of cash inflows for 5 years is 3.353 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59 Hence, Total Cash inflows for 5 years for the Project is 96,000 x 3.353 = ` 3,21,888 Hence, Cost of the Project = ` 3,21,888 (ii) Payback Period Payback period = Cost of the Project ` 3,21,888 = 96,000 Annual Cost Savings Payback Period = 3.353 years (iii) Net Present Value (NPV) NPV = Sum of Present Values of Cash inflows Cost of the Project = ` 3,37,982.40 3,21,888 = ` 16,094.40 Net Present Value = ` 16,094.40 (iv) Cost of Capital Profitability index = 1.05 = Sum of Discounted Cash inflows Cost of the Project Sum of Discounted Cash inf lows 3,21,888 \ Sum of Discounted Cash inflows = ` 3,37,982.40 Since, Annual Cost Saving = ` 96,000 Hence, cumulative discount factor for 5 years = ` 3,37,982.40 96,000 From the discount factor table, at discount rate of 13%, the cumulative discount factor for 5 years is 3.52 Hence, Cost of Capital = 13% Question 5 (a) What is an Integrated Accounting System? State its advantages. (b) State the types of cost in the following cases: (i) Interest paid on own capital not involving any cash outflow. (ii) Withdrawing money from bank deposit for the purpose of purchasing new machine for expansion purpose. (iii) Rent paid for the factory building which is temporarily closed The Institute of Chartered Accountants of India 60 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (iv) Cost associated with the acquisition and conversion of material into finished product. (c) Discuss factors that a venture capitalist should consider before financing any risky project. (d) What is Net Operating income theory of capital structure? Explain the assumptions on which the NOI theory is based. (4 4 = 16 Marks) Answer Integrated Accounts is the name given to a system of accounting, whereby cost and financial accounts are kept in the same set of books. There will be no separate sets of books for Costing and Financial records. Integrated accounts provide or meet out fully the information requirement for Costing as well as for Financial Accounts. Advantages: The main advantages of Integrated Accounts are as follows: (a) No need for Reconciliation- The question of reconciling costing profit and financial profit does not arise, as there is one figure of profit only. (b) Less efforts- Due to use of one set of books, there is a significant extent of saving in efforts made. (c) Less Time consuming- No delay is caused in obtaining information as it is provided from books of original entry. (d) Economical process- It is economical also as it is based on the concept of Centralisation of Accounting function . (b) Type of costs (i) Imputed Cost (ii) Opportunity Cost (iii) Shut Down Cost (iv) Product Cost (c) Factors to be considered by a Venture Capitalist before Financing any Risky Project (i) Quality of the management team is a very important factor to be considered. They are required to show a high level of commitment to the project. (ii) The technical ability of the team is also vital. They should be able to develop and produce a new product / service. (iii) Technical feasibility of the new product / service should be considered. (iv) Since the risk involved in investing in the company is quite high, venture capitalists should ensure that the prospects for future profits compensate for the risk. (v) A research must be carried out to ensure that there is a market for the new product. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61 (vi) The venture capitalist himself should have the capacity to bear risk or loss, if the project fails. (vii) The venture capitalist should try to establish a number of exist routes. (viii) In case of companies, venture capitalist can seek for a place on the Board of Directors to have a say on all significant matters affecting the business. (Note: Students may answer any four of the above factors) (d) Net Operating Income (NOI) Theory of Capital Structure According to this approach, there is no relationship between the cost of capital and value of the firm. The value of the firm is independent of the capital structure of the firm. Assumptions of NOI Approach (a) There are no taxes. (b) The market capitalizes the value of the firm as a whole. Thus the split between debt and equity is not important. (c) The increase in proportion of debt in capital structure leads to change in risk perception of the shareholders i.e. increase in cost of equity (Ke). The increase in cost of equity is such as completely offset the benefits of using cheaper debt. (d) The overall cost of capital remains same for all degrees of debt equity mix. Question 6 (a) A product passes through two processes A and B. During the year 2011, the input to process A of basic raw material was 8,000 units @ ` 9 per unit. Other information for the year is a s follows: Process A Output units Normal loss (% to input) Scrap value per unit (` ) Direct wages (` ) Direct expenses (` ) Selling price per unit (`) Process B 7,500 4,800 5% 2 10% 10 12,000 24,000 6,000 5,000 15 25 Total overheads `17,400 were recovered as percentage of direct wages. Selling expenses were `5,000. There are not allocate to the processes. 2/3 of the output of Process A was passed on to the next process and the balance was sold.The entire output of Process B was sold. Prepare Process A an B Accounts. The Institute of Chartered Accountants of India (8 Marks) 62 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (b) The capital structure of JCPL Ltd. is as follows: ` Equity share capital of ` 10 each 8,00,000 8% Preferences share capital of ` 10 each 6,25,000 10% Debenture of ` 100 each 4,00,000 18,25,000 Additional Information: Profit after tax (tax rate 30%) ` 1,82,000 Operating expenses (including depreciation ` 90,000) being 1.50 times of EBIT Equity share dividend paid 15%. Market price per equity share` 20. Require to calculate: (i) Operating and financial leverage. (ii) Cover for the preference and equity share of dividends. (iii) The earning yield and price earnings ratio. (iv) The net fund flow. (8 Marks) Answer (a) Process A Account Units To Input To Direct Wages 8000 To Direct Exp. To overheads Units Amount(`) Amount(`) 72000 By Normal Loss (5%) 12000 By Abnormal loss 6000 @ 12.50 5800 By Process B A/C (1:2) By Profit and Loss A/C 400 100 800 1250 5000 62500 2500 31250 8000 95800 (2500 @ 12.50) 8000 95800 Cost of abnormal Loss in process A = The Institute of Chartered Accountants of India 95800 - 800 95000 = = 12.50 per unit 8000 - 400 7600 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63 Process B A/C Units To Process A A/C 5000 To Direct Wages Units 62500 By Normal Loss 24000 By Finished stock A/C To Direct Exp. Amount(`) 500 5000 4800 104640 5300 Amount(`) 109640 5000 or Profit & loss A/C To overheads To Abnormal gain 300 11600 6540 5300 109640 Cost of Abnormal gain = 103100 - 5000 98100 = = 21.80 5000 - 500 4500 Working Profit & Loss A/c Particulars To Cost of Sales: Process A (2,500@12.50) 31,250 Process B (4,800@21.80) 1,04,640 To Abnormal Loss: Process A [(100 units @(12.50-2)] To Selling expenses To Net Profit Amount(`) Particulars By Sales: Process A (2500 x 15) - 37,500 Process B 1,35,890 (4800 x 25) - 1,20,000 By Abnormal gain: Process B 1050 [(300 units @ (21.80-10)] 5,000 19,100 1,61,040 Amount(`) 1,57,500 3540 1,61,040 Note: 1. As mentioned selling expenses are not allocable to process which is debited directly to the P/L A/c. 2. It is assumed that Process A and Process B are not responsibility centres and hence, Process A and Process B have not been credited to direct sales. P/L A/c is prepared to arriving at profit/loss. The Institute of Chartered Accountants of India 64 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (b) [Assumption: All operating expenses (excluding depreciation) are variable] Working Notes ` Net profit after tax 1,82,000 Tax @ 30% 78,000 EBT 2,60,000 Interest on debenture 40,000 EBIT 3,00,000 Operating Expenses 1.50 times 4,50,000 Sales 7,50,000 (i) Operating Leverage = Contribution/EBIT = (7,50,000 - 3,60,000) / 3,00,000 = 3,90,000 / 3,00,000 = 1.30 times. Financial Leverage = EBIT / EBT = 3,00,000 / 2,60,000 = 1.15 times OR Pr ef Dividend FL = EBIT + EBT - 1- t = = 3,00,000 3,00,000 = 50,000 2,60,000 - (7,14,29) 2,60,000 - ( ) 1 - 0.3 3,00,000 = 1.59 = 1.6 1,88,571 (ii) Preference Dividend Cover = PAT / Preference share Dividend = 1,82,000 / 50,000 = 3.64 times Equity dividend cover = PAT - Pref. div / Equity dividend = 1,82,000 - 50,000/1,20,000= 1.10 times (iii) Earning yield = EPS / Market price 100 i.e. = 1,32,000 / 80,000 = 1.65 / 20 = 8.25% Price Earnings Ratio = Market price / EPS = 20 / 1.65 = 12.1 Times The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65 (iv) Net Funds Flow Net Funds flow = Net profit after tax + depreciation Total dividend = 1,82,000 + 90,000 (50,000 + 1,20,000) = 2,72,000 1,70,000 Net funds flow = 1,02,000 Question 7 Answer any four of the following: (a) The profit maximization is not an operationally feasible criterion. Comment on it. (b) Explain the important ratios that would be used in each of the following situations: (i) A bank is approached by a company for a loan of ` 50 lakh for working capital purposes. (ii) A long term creditor interested in determining whether his claim is adequately secured. (iii) A shareholder who is examining his portfolio and who is to decide whether he should hold or sell his holding in the company. (iv) A finance manager interested to know the effectiveness with which a firm uses its available resources. (c) Write short notes on the following: (i) Deep Discount Bonds (ii) Angle of Incidence (d) Discuss basic assumptions of Cost Volume Profit analysis. (e) Distinguish between bill of material and material requisition note. (4 4 = 16 Marks) Answer (a) The profit maximisation is not an operationally feasible criterion. The above statement is true because Profit maximisation can be a short-term objective for any organisation and cannot be its sole objective. Profit maximization fails to serve as an operational criterion for maximizing the owner's economic welfare. It fails to provide an operationally feasible measure for ranking alternative courses of action in terms of their economic efficiency. It suffers from the following limitations: (i) Vague term: The definition of the term profit is ambiguous. Does it mean short term or long term profit? Does it refer to profit before or after tax? Total profit or profit per share? The Institute of Chartered Accountants of India 66 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2012 (ii) Timing of Return: The profit maximization objective does not make distinction between returns received in different time periods. It gives no consideration to the time value of money, and values benefits received today and benefits received after a period as the same. (iii) It ignores the risk factor. (iv) The term maximization is also vague. (b) Important Ratios used in different situations (i) Liquidity Ratios- Here Liquidity or short-term solvency ratios would be used by the bank to check the ability of the company to pay its short-term liabilities. A bank may use Current ratio and Quick ratio to judge short terms solvency of the firm. (ii) Capital Structure/Leverage Ratios- Here the long-term creditor would use the capital structure/leverage ratios to ensure the long term stability and structure of the firm. A long term creditors interested in the determining whether his claim is adequately secured may use Debt-service coverage and interest coverage ratio. (iii) Profitability Ratios- The shareholder would use the profitability ratios to measure the profitability or the operational efficiency of the firm to see the final results of business operations. A shareholder may use return on equity, earning per share and dividend per share. (iv) Activity Ratios- The finance manager would use these ratios to evaluate the efficiency with which the firm manages and utilises its assets. Some important ratios are (a) Capital turnover ratio (b) Current and fixed assets turnover ratio (c) Stock, Debtors and Creditors turnover ratio. (c) (i) Short Note on Deep Discount Bonds Deep Discount Bonds is a form of zero-interest bonds. These bonds are sold at a discounted value and on maturity face value is paid to the investors. In such bonds, there is no interest payout during lock in period. IDBI was the first to issue a deep discount bond in India in January, 1992. The investor could hold the bond for 26 years or seek redemption at the end of every five years with a specified maturity value. (ii) Angle of incidence This angle is formed by the intersection of sales line and total cost line at the breakeven point. This angle shows the rate at which profits are being earned once the break-even point has been reached. The wider the angle the greater is the rate of earning profits. A large angle of incidence with a high margin of safety indicates extremely favourable position. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67 (d) CVP Analysis:-Assumptions (i) Changes in the levels of revenues and costs arise only because of changes in the number of products (or service) units produced and sold. (ii) Total cost can be separated into two components: Fixed and variable (iii) Graphically, the behaviour of total revenues and total cost are linear in relation to output level within a relevant range. (iv) Selling price, variable cost per unit and total fixed costs are known and constant. (v) All revenues and costs can be added, sub traded and compared without taking into account the time value of money. (e) Bills of material Material Requisition Note 1. It is document by the drawing office 1. It is prepared by the foreman of the consuming department. 2. It is a complete schedule of 2. component parts and raw materials required for a particular job or work order. It is a document authorizing StoreKeeper to issue Material to the consuming department. 3. It often serves the purpose of a Store 3. Requisition as it shown the complete schedule of materials required for a particular job i.e. it can replace stores requisition. It cannot replace a bill of material. 4. It can be used for the purpose of 4. quotation It is useful in arriving historical cost only. 5. It helps in keeping a quantitative 5. control on materials draw through stores Requisition. It shows the material actually drawn from stores. The Institute of Chartered Accountants of India

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