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CA IPCC : Question Paper (with Answers) - COST ACCOUNTING & FINANCIAL MANAGEMENT Nov 2014

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PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT Question No. 1 is compulsory. Answer any five questions from the remaining six questions. Working notes should form part of the answers. Question 1 Answer the following: (a) Following details are related to a manufacturing concern: Re-order Level Economic Order Quantity Minimum Stock Level Maximum Stock Level 1,60,000 units 90,000 units 1,00,000 units 1,90,000 units Average Lead Time Difference between minimum lead time and Maximum lead time 6 days 4 days Calculate: (i) Maximum consumption per day (ii) Minimum consumption per day (b) Zed Limited sells its product at ` 30 per unit. During the quarter ending on 31st March, 2014, it produced and sold 16,000 units and suffered a loss of ` 10 per unit. If the volume of sales is raised to 40,000 units, it can earn a profit of ` 8 per unit. You are required to calculate: (i) Break Even Point in Rupees. (ii) Profit if the sale volume is 50,000 units. (iii) Minimum level of production where the company needs not to close the production if unavoidable fixed cost is ` 1,50,000. (c) Alpha Limited requires funds amounting to ` 80 lakhs for its new project. To raise the funds, the company has following two alternatives: (i) to issue Equity Shares (at par) amounting to ` 60 lakhs and borrow the balance amount at the interest of 12% p.a.; or (ii) to issue Equity Shares (at par) and 12% Debentures in equal proportion. The Income-tax rate is 30%. Find out the point of indifference between the available two modes of financing and state which option will be beneficial in different situations. The Institute of Chartered Accountants of India (d) 'A' Ltd. and 'B' Ltd. are identical in every respect except capital structure. 'A' Ltd. does not employ debts in its capital structure whereas 'B' Ltd. employs 12% Debentures amounting to ` 10 lakhs. Assuming that : (i) All assumptions of M-M model are met; (ii) Income-tax rate is 30%; (iii) EBIT is ` 2,50,000 and (iv) The Equity capitalization rate of A' Ltd. is 20%. Calculate the value of both the companies and also find out the Weighted Average Cost of Capital for both the companies. (4 x 5 = 20 Marks) Answer (a) Difference between Minimum lead time Maximum lead time = 4 days Max. lead time Min. lead time = 4 days Or, Max. lead time = Min. lead time + 4 days.............................................(i) Average lead time is given as 6 days i.e. Max.lead time + Min.lead time = 6 days.......................................................(ii) 2 Putting the value of (i) in (ii), Min. lead time + 4 days + Min.lead time 2 = 6 days Or, Min. lead time + 4 days + Min. lead time = 12 days Or, 2 Min. lead time = 8 days Or, Minimum lead time = 8days 2 = 4 days Putting this Minimum lead time value in (i), we get Maximum lead time = 4 days + 4 days = 8 days (i) Maximum consumption per day: Re-order level = Max. Re-order period Maximum Consumption per day 1,60,000 units = 8 days Maximum Consumption per day Or, Maximum Consumption per day = (ii) Minimum Consumption per day: Maximum Stock Level = The Institute of Chartered Accountants of India 1,60,000units = 20,000 units 8days Re-order level + Re-order Quantity (Min. lead time Min. Consumption per day) Or, 1,90,000 units = 1,60,000 units + 90,000 units (4 days Min. Consumption per day) Or, 4 days Min. Consumption per day = 2,50,000 units 1,90,000 units Or, Minimum Consumption per day = 60,000 units = 15,000 units 4 days (b) Units sold Sales value (`) Profit/ (loss) (`) 16,000 units 4,80,000 (1,60,000) 40,000 units 12,00,000 3,20,000 P/V Ratio = = (` 30 16,000 units) (` 10 16,000 units) (` 30 40,000 units) (` 8 40,000 units) Change inprofit ` 3,20,000 ( ` 1,60,000) 100 = 100 Change insales value ` 12,00,000 ` 4,80,000 ` 4,80,000 100 = 66.67% ` 7,20,000 Total Contribution in case of 40,000 units = Sales Value P/V Ratio = ` 12,00,000 66.67% = ` 8,00,000 So, Fixed cost = Contribution Profit = ` 8,00,000 ` 3,20,000 = ` 4,80,000 Break-even Point in Rupees = FixedCost P / V Ratio = (i) ` 4,80,000 = ` 7,20,000 66.67% (ii) If sales volume is 50,000 units, then profit = Sales Value P/V Ratio Fixed Cost = (50,000 units ` 30 66.67% - ` 4,80,000) = ` 5,20,000 (iii) Minimum level of production where the company needs not to close the production, if unavoidable fixed cost is ` 1,50,000: The Institute of Chartered Accountants of India = Avoidable fixedcos t Contributionper unit = Totalfixedcos t Unavoidable fixedcos t Contributionper unit = ` 4,80,000 ` 1,50,000 ` 30 66.67% = ` 3,30,000 = 16,500 units. ` 20 At production level of 16,500 units, company needs not to close the production. (c) (i) (Note: The par value of equity share is assumed to be `100) Amount = ` 80 Lakhs Plan I = Equity of ` 60 lakhs + Debt of ` 20 lakhs Plan II = Equity of ` 40 lakhs + Debentures of ` 40 Lakhs. Plan I: Interest Payable on Loan = 0.12 x 20,00,000 = 2,40,000 Plan II: Interest Payable on Debentures = 0.12 x 40,00,000 = 4,80,000 Computation of Point of Indifference (EBIT - I) (I - t ) = E 1 (EBIT - (EBIT - I ) (I - t ) 2 E 2 2,40,000 ) (1- 0.3 ) (EBIT - 4,80,000 ) (I - 0.3 ) = 60,000 40,000 2 (EBIT 2,40,000) = 3(EBIT 4,80,000) 2 EBIT 4,80,000 = 3 EBIT 14,40,000 2 EBIT 3 EBIT = -14,40,000 + 4,80,000 EBIT = 9,60,000 The Institute of Chartered Accountants of India (ii) Earnings per share (EPS) under Two Situations for both the Plans Situation A (EBIT is assumed to be ` 9,50,000) Particulars Plan I Plan II EBIT 9,50,000 9,50,000 Less: Interest @ 12% 2,40,000 4,80,000 EBT 7,10,000 4,70,000 Less: Taxes @ 30% EAT 2,13,000 4,97,000 1,41,000 3,29,000 No. of Equity Shares EPS 60,000 8.28 40,000 8.23 Comment: In Situation A, when expected EBIT is less than the EBIT at indifference point then, Plan I is more viable as it has higher EPS. The advantage of EPS would be available from the use of equity capital and not debt capital. Situation B (EBIT is assumed to be ` 9,70,000) Particulars Plan I EBIT 9,70,000 Less: Interest @ 12% 2,40,000 EBT 7,30,000 Less: Taxes @ 30% 2,19,000 EAT 5,11,000 No. of Equity Shares 60,000 EPS 8.52 Plan II 9,70,000 4,80,000 4,90,000 1,47,000 3,43,000 40,000 8.58 Comment: In Situation B, when expected EBIT is more than the EBIT at indifference point then, Plan II is more viable as it has higher EPS. The use of fixed-cost source of funds would be beneficial from the EPS viewpoint. In this case, financial leverage would be favourable. (Note: The problem can also be worked out assuming any other figure of EBIT which is more than 9,60,000 and any other figure less than 9,60,000. Alternatively, the answer may also be based on the factors/governing the capital structure like the cost, risk, control, etc. Principles). (d) (i) Calculation of Value of Firms A Ltd. and B Ltd according to MM Hypothesis Market Value of A Ltd (Unlevered) Vu = EBIT (1 - t ) K e The Institute of Chartered Accountants of India = = 2,50,000 (1 - 0.30 ) 20% 1,75,000 20% = ` 8,75,000 Market Value of B Ltd. (Levered) V E = V u + DT = 8,75,000 + (10,00,000 x 0.30) = 8,75,000 + 3,00,000 = ` 11,75,000 (ii) Computation of Weighted Average Cost of Capital (WACC) WACC of A Ltd. = 20% (Ke =Ko) WACC of B Ltd. B Ltd. EBIT Interest to Debt holders 2,50,000 (1,20,000) EBT Taxes @ 30% 1,30,000 (39,000) Income available to Equity Shareholders Total Value of Firm 91,000 11,75,000 Less: Market Value of Debt Market Value of Equity (10,00,000) 1,75,000 Ke = 91,000 / 1,75,000 0.52 For Computation of WACC B. Ltd Component of Costs Amount Equity 1,75,000 0.149 0.52 0.0775 Debt 10,00,000 0.851 0.084* 0.0715 WACC 0.1490 11,75,000 Weight Cost of Capital WACC Kd= 12% (1- 0.3) = 12% x 0.7 = 8.4% WACC = 14.90% Question 2 (a) Z Limited obtained a contract No. 999 for ` 50 lacs. The following details are available in respect of this contract for the year ended March 31, 2014: The Institute of Chartered Accountants of India ` Materials purchased 1,60,000 Materials issued from stores 5,00,000 Wages and salaries paid 7,00,000 Drawing and maps Sundry expenses 60,000 15,000 Electricity charges 25,000 Plant hire expenses 60,000 Sub-contract cost Materials returned to stores 20,000 30,000 Materials returned to suppliers 20,000 The following balances relating to the contract No. 999 for the year ended on March 31, 2013 and March 31, 2014 are available: as on 31st March, 2013 as on 31st March, 2014 12,00,000 20,000 35,00,000 40,000 15,000 10,000 30,000 20,000 Work certified Work uncertified Materials at site Wages outstanding The contractor receives 75% of work certified in cash. Prepare Contract Account and Contractee's Account. (8 Marks) (b) Balance Sheets of Star Ltd. are as under: Balance Sheet Liabilities Share Capital Reserve 31/03/13 31/03/1 Assets 4` ` (in lakh `) 31/03/13 31/03/14 ` ` 24.00 4.50 30.00 Plant & Machinery 6.00 Buildings 15.00 12.00 21.00 18.00 Profit & Loss A/c Debentures 1.80 - 3.00 Investments 6.00 Sundry Debtors 21.00 3.00 15.00 Provision for Taxation Proposed Dividend 2.10 3.00 3.00 Stock 6.00 Cash in hand/Bank 6.00 6.00 12.00 6.00 60.00 75.00 Sundry Creditors 24.60 21.00 Total 60.00 75.00 The Institute of Chartered Accountants of India With the help of following additional information, prepare Cash Flow Statement: (i) Depreciation on plant and machinery was charged @ 25% on its opening balance and on building @ 10% on its opening balance. (ii) During the year an old machine costing ` 1,50,000 (written down value ` 60,000) was sold for ` 1,05,000. (iii) ` 1,50,000 was paid towards Income-tax, during the year. (8 Marks) Answer (a) Contract No. 999 Account for the year ended 31st March, 2014 Dr. Cr. Particulars Amount (`) Particulars To Work in progress b/d: Work certified - By Material returned to store 12,00,000 By Material returned to suppliers 30,000 20,000 20,000 By Stock (Material) c/d 30,000 Work uncertified To Stock (Materials) b/d To Material purchased 15,000 By Work in progress c/d: 1,60,000 Work certified To Material issued 5,00,000 To Wages paid (10,000) 20,000 - Work uncertified 35,00,000 40,000 7,00,000 Less: Opening O/s Add: Closing O/s Amount (`) 7,10,000 To Drawing and maps* To Sundry expenses 60,000 15,000 To Electricity charges To Plant hire expenses 25,000 60,000 To Sub- contract cost To Notional profit c/d 20,000 8,35,000 (balancing figure) 36,20,000 To Costing P& L A/c (W.N.-1) To WIP Reserve (balancing figure) 36,20,000 4,17,500 By Notional profit b/d 4,17,500 8,35,000 8,35,000 8,35,000 *Assumed that expenses incurred for drawing and maps are used exclusively for this contract only. The Institute of Chartered Accountants of India Contractee s Account Dr. Particulars To Balance c/d (` 35,00,000 75%) Amount (`) Cr. Particulars Amount (`) 26,25,000 By Balance b/d 9,00,000 (75% of ` 12,00,000) By Bank A/c 17,25,000 26,25,000 26,25,000 Working Note: 1. Profit to be Transferred to Costing Profit & Loss account: (a) Percentage of completion = = Work certfied x100 Value of contract ` 35,00,000 x100 = 70% ` 50,00,000 (b) Profit to be transferred to Costing Profit & Loss Account = Cash received 2 Notional profit Work certified 3 = 2 75 ` 8,35,000 = ` 4,17,500 100 3 (b) Cash Flow Statement for the year ending on March 31, 2014 ` in lakhs I. Cash flows from Operating Activities Net profit made during the year (W.N.1) Provision for taxation made during the year Profit on sale of machinery Adjustment for depreciation on Machinery (W.N.2) Adjustment for depreciation on Land & Building Operating profit before change in Working Capital Increase in inventory Decrease in Debtors Decrease in Creditors Cash generated from operations Income-tax paid Net cash from operating activities The Institute of Chartered Accountants of India ` in lakhs 8.70 2.40 (0.60) 3.75 1.20 15.45 (6.00) 6.00 (3.60) 11.85 (1.50) 10.35 II. Cash flows from Investing Activities Purchase of Machinery Sale of Machinery Purchase of Building Purchase of investments (10.20) 1.05 (7.20) (3.00) (19.35) III. Cash flows from Financing Activities Issue of shares Issue of debentures Dividend paid Net increase in cash and cash equivalent Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period 6.00 6.00 (3.00) 9.00 Nil 6.00 6.00 Working Notes: (i) Net Profit made during the year ended 31.3.2014 ` in lakhs Increase in P & L (Cr.) Balance Add: Add: 1.20 Transfer to general reserve Provided for proposed dividend during the year 1.50 6.00 8.70 (ii) Plant & Machinery Account ` in lakhs To Balance b/d To P& L A/c [1.05 less 0.45 (0.60 less depreciation 0.15)] To Cash/Bank (balancing fig.) 15.00 By 0.60 By 10.20 By 25.80 The Institute of Chartered Accountants of India ` in lakhs Depreciation (Bal. Fig.) [25% of 15 ] 3.75 Cash/Bank A/c 1.05 Balance c/d 21.00 25.80 (iii) Provision for Taxation Account ` in lakhs ` in lakhs To Cash/Bank (Bal. Fig.) 1.50 By Balance b/d 2.10 To Balance c/d 3.00 4.50 By P & L A/c 2.40 4.50 (iv) Proposed Dividend Account ` in lakhs To Bank To Balance c/d ` in lakhs 3.00* By Balance b/d 3.00 6.00 9.00 By P & L A/c (Bal. Fig.) 6.00 9.00 * last year proposed dividend assumed to be paid this year. (v) Building Account ` in lakhs To Balance b/d To Bank A/c (Purchase) ` in lakhs 12.00 By Depreciation 1.20 Balance c/d 18.00 7.20 By 19.20 19.20 Question 3 (a) RST Limited is presently operating at 50% capacity and producing 30,000 units. The entire output is sold at a price of ` 200 per unit. The cost structure at the 50% level of activity is as under: ` Direct Material Direct Wages 75 per unit 25 per unit Variable Overheads Direct Expenses 25 per unit 15 per unit Factory Expenses (25% fixed) 20 per unit Selling and Distribution Exp. (80% variable) 10 per unit Office and Administrative Exp. (100% fixed) 5 per unit The company anticipates that the variable costs will go up by 10% and fixed costs will go up by 15%. The Institute of Chartered Accountants of India You are required to prepare an Expense budget, on the basis of marginal cost for the company at 50% and 60% level of activity and find out the profits at respective levels. (8 Marks) (b) From the following information, prepare Balance Sheet of a firm: Stock Turnover Ratio (based on cost of goods sold) - 7 times Rate of Gross Profit to Sales - 25% Sales to Fixed Assets - 2 times Average debt collection period - 1.5 months Current Ratio - 2 Liquidity Ratio - 1.25 Net Working Capital - ` 8,00,000 Net Worth to Fixed Assets - 0.9 times Reserve and Surplus to Capital - 0.25 times Long Term Debts - Nil All Sales are on credit basis. (8 Marks) Answer (a) Expense Budget of RST Ltd. for the period Per unit (`) 30,000 units 36,000 units Amount (`) Amount (`) 200.00 60,00,000 72,00,000 82.50 27.50 24,75,000 8,25,000 29,70,000 9,90,000 - Variable Overheads 27.50 8,25,000 9,90,000 - Direct Expenses 16.50 4,95,000 5,94,000 - Variable factory expenses 16.50 4,95,000 5,94,000 8.80 2,64,000 3,16,800 (B) 179.30 53,79,000 64,54,800 (C) = (A B) 20.70 6,21,000 7,45,200 Sales (A) Less: Variable Costs: - Direct Material - Direct Wages (75% of ` 20 p.u.) - Variable Selling & Dist. exp. (80% of ` 10 p.u.) Total Variable Cost Contribution The Institute of Chartered Accountants of India Less: Fixed Costs: - Office and Admin. exp. (100%) -- 1,72,500 1,72,500 - Fixed factory exp. (25%) -- 1,72,500 1,72,500 - Fixed Selling & Dist. exp. (20%) -- 69,000 69,000 (D) -- 4,14,000 4,14,000 (C D) -- 2,07,000 3,31,200 Total Fixed Costs Profit (b) Working Notes; 1. Net Working Capital = Current Assets Current Liabilities =2-1=1 Current Assets = = Net Working Capital 2 1 8,00,000 2 1 Current Assets =16,00,000 Current Liabilities = 16,00,000 8,00,000 = 8,00,000 2. Liquid Ratio = 1.25 = 1.25 = Liquid Assets Current Liabilities Current Assets - Stock Current Liabilities 16,00,000 - Stock 8,00,000 1.25 x 8,00,000 = 16,00,000 Stock 10,00,000 = 16,00,000 Stock Stock = 6,00,000 Liquid Assets = 1.25 x 8,00,000 = 10,00,000 3. Stock Turnover Ratio = 7= COGS Stock COGS 6,00,000 COGS = 42,00,000 The Institute of Chartered Accountants of India 4. Sales Gross Profit = COGS Gross Profit Sales = 25% Gross Profit = 25% Sales Sales 25% Sales = COGS Sales = 5. 42,00,000 = = 12 1.5 =8 Credit Sales Debtors Turnover 56,00,000 = 7,00,000 8 Sales Fixed Assets =2 Fixed Assets = 7. = 56,00,000 Debtors turnover Ratio = Debtors 6. 0.75 56,00,000 2 = 28,00,000 Net worth = Fixed Assets + Current Assets Long-term Debt Current Liabilities = 28,00,000 + 16,00,000 0 8,00,000 = 36,00,000 8. Reserves & Surplus Capital = 0.25 Net worth = Reserves and Surplus + Capital Capital = 36,00,000 1.25 = 28,80,000 Reserves and Surplus = 0.25 x 28,80,000 = 7,20,000 9. Cash = Liquid Assets Debtors = 10,00,000 7,00,000 = 3,00,000 10. Long Term Debts = Nil The Institute of Chartered Accountants of India Draft Balance Sheet Liabilities Share Capital Reserves and Surplus Long Term Debts Current Liabilities ` 28,80,000 7,20,000 8,00,000 44,00,000 Assets Fixed Assets Current Assets: Stock Debtors Cash ` 28,00,000 6,00,000 7,00,000 3,00,000 44,00,000 (Note: The above solution has been worked out by ignoring the Net worth to Fixed assets ratio given in the question in order to match the total of assets and liabilities in the Balance Sheet). Question 4 (a) Following information have been extracted from the cost records of XYZ Pvt. Ltd: ` Stores: Opening balance 54,000 Purchases Transfer from WIP 2,88,000 1,44,000 Issue to WIP Issue for repairs 2,88,000 36,000 Deficiency found in stock Work-in-progress: 10,800 ` Opening balance Direct wages applied 1,08,000 1,08,000 Overheads charged Closing balance 4,32,000 72,000 Finished Production: ` Entire production is sold at a profit of 15% on cost at WIP Wages paid Overheads incurred 1,26,000 4,50,000 Draw the Stores Ledger Control Account, Work-in-Progress Control Account, Overheads Control Account and Costing Profit and Loss Account. (8 Marks) The Institute of Chartered Accountants of India (b) The Capital structure of RST Ltd. is as follows: ` Equity Share of ` 10 each 8,00,000 10% Preference Share of ` 100 each 5,00,000 12% Debentures of ` 100 each 7,00,000 20,00,000 Additional Information: - Profit after tax (Tax Rate 30%) are ` 2,80,000 - Operating Expenses (including Depreciation ` 96,800) are 1.5 times of EBIT - Equity Dividend paid is 15% - Market price of Equity Share is ` 23 Calculate: (i) Operating and Financial Leverage (ii) Cover for preference and equity dividend (iii) The Earning Yield Ratio and Price Earning Ratio (iv) The Net Fund Flow Note: All operating expenses (excluding depreciation) are variable. (8 Marks) Answer (a) Stores Ledger Control A/c Particulars To Balance b/d To General Ledger Adjustment A/c To Work in Process A/c (`) Particulars (`) 54,000 By Work in Process A/c 2,88,000 By Overhead Control A/c By Overhead Control A/c (Deficiency) 1,44,000 By Balance c/d 2,88,000 36,000 10,800* 4,86,000 4,86,000 *Deficiency assumed as normal (alternatively can be treated as abnormal loss) The Institute of Chartered Accountants of India 1,51,200 Work in Progress Control A/c Particulars (`) Particulars To Balance b/d To Stores Ledger Control A/c To Wages Control A/c To Overheads Control a/c 1,08,000 2,88,000 1,08,000 4,32,000 By Stores Ledger Control a/c By Costing P/L A/c (Balancing figures being Cost of finished goods) By Balance c/d 9,36,000 (`) 1,44,000 7,20,000 72,000 9,36,000 Overheads Control A/c Particulars (`) Particulars To Stores Ledger Control A/c To Stores Ledger Control A/c To Wages Control A/c (`1,26,000- `1,08,000) To Gen. Ledger Adjust. A/c 36,000 10,800 18,000 By Work in Process A/c By Balance c/d (Under absorption) (`) 4,32,000 82,800 4,50,000 5,14,800 5,14,800 Costing Profit & Loss A/c Particulars To Work in progress To Gen. Ledger Adjust. A/c (Profit) (`) Particulars 7,20,000 By Gen. Ledger Adjust. A/c 1,08,000 (Sales) (` 7,20,000 115%) (`) 8,28,000 8,28,000 8,28,000 (b) Working Notes: ` Net Profit after Tax Tax @ 30% 2,80,000 1,20,000 EBT Interest on Debentures 4,00,000 84,000 EBIT 4,84,000 Operating Expenses (1.5 times of EBIT) 7,26,000 Sales The Institute of Chartered Accountants of India 12,10,000 (i) Operating Leverage Contribution = EBIT (12,10,000 - 6,29,200) = 4,84,000 = 5,80,800 4,84,000 =1.2 times EBIT Financial Leverage = = EBT 4,84,000 4,00,000 = 1.21 times OR EBIT Preference Dividend Financial Leverage = EBT - 1- t = = = 4,84,000 50,000 4,00,000 - 1- 0.30 4,84,000 4,00,000 - 71,428.57 4,84,000 3,28,571 (ii) Cover for Preference Dividend PAT = Preference Share Dividend = 2,80,000 50,000 = 5.6 times The Institute of Chartered Accountants of India =1.47 times Cover for Equity Dividend = = = (PAT - Preference Dividend) Equity Share Dividend (2,80,000 - 50,000) 1,20,000 2,30,000 1,20,000 = 1.92 times (iii) Earning Yield Ratio = EPS Market Price 100 2,30,000 = 100 80,000 23 = 2.875 23 100 =12.5% Price Earnings Ratio (PE Ratio) = Market Price EPS = 23 2.875 = 8 times (iv) Net Funds Flow = Net PAT + Depreciation-Total Dividend = 2,80,000 + 96,800 (50,000 + 1,20,000) = 3,76,800 1,70,000 Net Funds Flow = 2,06,800 Question 5 (a) Identify the methods of costing for the following: (i) Where all costs are directly charged to a specific job. (ii) Where all costs are directly charged to a group of products. The Institute of Chartered Accountants of India (iii) Where cost is ascertained for a single product. (iv) Where the nature of the product is complex and method can not be ascertained. (b) Explain the treatment of over and under absorption of overheads in cost accounts. (c) Explain four kinds of float with reference to management of cash. (d) Distinguish between Operating Lease and Financial Lease . (4 x 4 = 16 Marks) Answer (a) Sl. No. Method of Costing (i) Job Costing (ii) Batch Costing (iii) Unit Costing or Single or Output Costing (iv) Multiple Costing (b) Treatment of over and under absorption of overheads are:(i) Writing off to costing P&L A/c: Small difference between the actual and absorbed amount should simply be transferred to costing P&L A/c, if difference is large then investigate the causes and after that abnormal loss/ gain shall be transferred to costing P&L A/c. (ii) Use of supplementary Rate: Under this method the balance of under and over absorbed overheads may be charged to cost of W.I.P., finished stock and cost of sales proportionately with the help of supplementary rate of overhead. (iii) Carry Forward to Subsequent Year: Difference should be carried forward in the expectation that next year the position will be automatically corrected. (c) Four Kinds of Float with reference to Management of Cash The four kinds of float are: (i) Billing Float: The time between the sale and the mailing of the invoice is the billing float. (ii) Mail Float: This is the time when a cheque is being processed by post office, messenger service or other means of delivery. (iii) Cheque processing float: This is the time required for the seller to sort, record and deposit the cheque after it has been received by the company. (iv) Bank processing float: This is the time from the deposit of the cheque to the crediting of funds in the seller s account. The Institute of Chartered Accountants of India (d) Difference between Financial Lease and Operating Lease S.No. Finance Lease Operating Lease 1. The risk and reward incident to ownership are passed on the lessee. The lessor only remains the legal owner of the asset. The lessee is only provided the use of the asset for a certain time. Risk incident to ownership belongs only to the lessor. 2. The lessee bears the risk of The lessor bears obsolescence. obsolescence. 3. The lease is non-cancellable by The lease is kept cancellable by the either party under it. lessor. 4. The lessor does not bear the cost of Usually, the lessor bears the cost of repairs, maintenance or operations. repairs, maintenance or operations. 5. The lease is usually full payout. the risk of The lease is usually non-payout. (Note: Students may answer any four of the above differences) Question 6 (a) PQR Ltd. having an annual sales of ` 30 lakhs, is re-considering its present collection policy. At present, the average collection period is 50 days and the bad debt losses are 5% of sales. The company is incurring an expenditure of ` 30,000 on account of collection of receivables. The alternative policies are as under: Alternative I Average Collection Period Bad Debt Losses Collection Expenses Alternative II 40 days 30 days 4% of sales 3% of sales ` 60,000 ` 95,000 Evaluate the alternatives on the basis of incremental approach and state which alternative is more beneficial. (8 Marks) (b) The following information relate to Process A: (i) Opening Work-in-Progress 8,000 units at ` 75,000 Degree of Completion: Material Labour and Overhead (ii) Input 1,82,000 units at (iii) Wages paid (iv) Overheads paid The Institute of Chartered Accountants of India 100% 60% ` 7,37,500 ` 3,40,600 ` 1,70,300 (v) Units scrapped 14,000 Degree of Completion: Material 100 % Wages and Overheads Closing Work - in- Progress (vi) 80% 18,000 units Degree of Completion: Material 100% Wages and Overheads Units completed and transferred 1,58,000 to next process (vii) (viii) (ix) 70% Normal loss 5% of total input including opening WIP Scrap value is ` 5 per unit to be adjusted out of direct material cost You are required to compute on the basis of FIFO basis: (i) Equivalent Production (ii) Cost Per Unit (iii) Value of Units transferred to next process. (8 Marks) Answer (a) Evaluation of Alternative Collection Programmes Present Policy Alternative I Alternative II ` ` ` 30,00,000 30,00,000 30,00,000 50 4,16,667 40 3,33,333 30 2,50,000 Reduction in Receivables from Present Level (`) 83,334 1,66,667 (A) 5% ` 8,333 4% ` 16,667 3% 1,50,000 1,20,000 90,000 30,000 60,000 Sales Revenues Average Collection Period (ACP) (days) Receivables (`) Sales ACP 360 Savings in Interest @ 10% p.a. % of Bad Debt Loss Amount (`) Reduction in Bad Debts from Present Level (B) The Institute of Chartered Accountants of India Incremental Level Benefits from Present (C) = (A) + (B) 38,333 76,667 30,000 60,000 95,000 Incremental Collection Expenses from Present Level (D) 30,000 65,000 (C D) ` 8,333 ` 11,667 Collection Expenses (`) Incremental Net Benefit Conclusion: From the analysis it is apparent that Alternative I has a benefit of ` 8,333 and Alternative II has a benefit of ` 11,667 over present level. Alternative II has a benefit of ` 3,334 more than Alternative I. Hence Alternative II is more viable. (Note: In absence of Cost of Sales, sales has been taken for purpose of calculating investment in receivables. Cost of Funds has been assumed to be 10%. 1 year = 360 days.) (b) (i) Statement of Equivalent Production (FIFO Method) Input Particulars Units Opening WIP Introduced Output Particulars Units 8,000 Transfer to next Process : 1,82,000 Opening WIP completed 8,000 Introduced & completed 1,50,000 Normal loss 9,500 5% (8,000 + 182,000) Abnormal loss 4,500 Closing WIP 18,000 1,90,000 1,90,000 Equivalent Production Material Labour & Overheads (%) Units (%) Units -100 -- -1,50,000 -- 40 100 -- 3,200 1,50,000 -- 100 100 4,500 18,000 1,72,500 80 70 3,600 12,600 1,69,400 (ii) Computation of Cost per unit Particulars Materials (`) Labour (`) Overhead (`) Input of Materials Expenses Total Less : Sale of Scrap (9,500 units x ` 5 ) Net cost Equivalent Units Cost Per Unit 7,37,500 -7,37,500 (47,500) 6,90,000 1,72,500 4.0000 -3,40,600 3,40,600 -3,40,600 1,69,400 2.0106 -1,70,300 1,70,300 -1,70,300 1,69,400 1.0053 Total cost per unit = ` (4.0000 + 2.0106 + 1.0053) = ` 7.0159 The Institute of Chartered Accountants of India (iii) Value of units transferred to next process: Amount (`) Opening W-I-P Add: Labour (3,200 units ` 2.0106) Overhead (3,200 units ` 1.0053) Amount (`) 75,000 6,434 3,217 New introduced (1,50,000 units ` 7.0159) 84,651 10,52,385 11,37,036 Question 7 Answer any four of the following: (a) Why money in the future is worth less than similar money today? Give the reasons and explain. (b) Distinguish between 'Business Risk' and 'Financial Risk'. (c) What is 'Internal Rate of Return'? Explain. (d) State the different types of Packing Credit. (e) Define Labour Turnover . How is it measured? Explain. (4 x 4 = 16 Marks) Answer (a) Money in the Future is worth less than the Similar Money Today due to several reasons: Risk There is uncertainty about the receipt of money in future. Preference For Present Consumption Most of the persons and companies in general, prefer current consumption over future consumption. Inflation In an inflationary period a rupee today represents a greater real purchasing power than a rupee a year hence. Investment Opportunities Most of the persons and companies have a preference for present money because of availabilities of opportunities of investment for earning additional cash flow. (b) Business Risk and Financial Risk: Business risk refers to the risk associated with the firm s operations. It is an unavoidable risk because of the environment in which the firm has to operate and the business risk is represented by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by revenues and expenses. Revenues and expenses are affected by demand of firm s products, variations in prices and proportion of fixed cost in total cost. Whereas, Financial risk refers to the additional risk placed on firm s shareholders as a result of debt use in financing. Companies that issue more debt instruments would have The Institute of Chartered Accountants of India higher financial risk than companies financed mostly by equity. Financial risk can be measured by ratios such as firm s financial leverage multiplier, total debt to assets ratio etc. (c) Internal Rate of Return: It is that rate at which discounted cash inflows are equal to the discounted cash outflows. It can be stated in the form of a ratio as follows: Cash inflows =1 Cash Outflows This rate is to be found by trial and error method. This rate is used in the evaluation of investment proposals. In this method, the discount rate is not known but the cash outflows and cash inflows are known. In evaluating investment proposals, internal rate of return is compared with a required rate of return, known as cut-off rate. If it is more than cut-off rate the project is treated as acceptable; otherwise project is rejected. (d) Different Types of Packing Credit Packing credit may be of the following types: (i) Clean Packing credit: This is an advance made available to an exporter only on production of a firm export order or a letter of credit without exercising any charge or control over raw material or finished goods. It is a clean type of export advance. Each proposal is weighted according to particular requirements of the trade and credit worthiness of the exporter. A suitable margin has to be maintained. Also, Export Credit Guarantee Corporation (ECGC) cover should be obtained by the bank. (ii) Packing credit against hypothecation of goods: Export finance is made available on certain terms and conditions where the exporter has pledgeable interest and the goods are hypothecated to the bank as security with stipulated margin. At the time of utilising the advance, the exporter is required to submit alongwith the firm export order or letter of credit, relative stock statements and thereafter continue submitting them every fortnight and whenever there is any movement in stocks. (iii) Packing credit against pledge of goods: Export finance is made available on certain terms and conditions where the exportable finished goods are pledged to the banks with approved clearing agents who will ship the same from time to time as required by the exporter. The possession of the goods so pledged lies with the bank and is kept under its lock and key. (iv) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture, processing, purchasing, or packing of goods meant for export against a firm order qualifies for the packing credit guarantee issued by Export Credit Guarantee Corporation. The Institute of Chartered Accountants of India (v) Forward exchange contract: Another requirement of packing credit facility is that if the export bill is to be drawn in a foreign currency, the exporter should enter into a forward exchange contact with the bank, thereby avoiding risk involved in a possible change in the rate of exchange. (Note: Students may answer any four of the above packing credits). (e) Labour turnover in an organisation is the rate of change in the composition of labour force during a specified period measured against a suitable index. The standard of usual labour turnover in the industry or labour turnover rate for a past period may be taken as the index or norm against which actual turnover rate should be compared. The methods for measuring labour turnover are: Replacement method: This method takes into consideration actual replacement of labour irrespective of no. of workers leaving. Replacement method = Number of employees replaced during the year 100 Average number of employees on roll during the year Separation method: In this method labour turnover is measured by dividing the total no. of separations during the period by average no. of workers on payroll during the same period. Separation method = Number of employees separated during the year 100 Average number of employees on roll during the year Flux method: This method takes into account both the replacements as well as no. of separations during the period. Flux method No.of employeesreplaced No.of employees separated + duringthe year duringthe year 100 = Average number of employees on roll during the year The Institute of Chartered Accountants of India

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