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

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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 answer. Question 1 Answer the following: (4 x 4=20 Marks) (a) X Limited has estimated that for a new product its break-even point is 20,000 units if the item is sold for 14 per unit and variable cost ` 9 per unit. Calculate the degree of operating leverage for sales volume 25,000 units and 30,000 units. (b) Accountant of your company had computed labour turnover rates for the quarter ended 30th September, 2012 as 14%, 8% and 6% under Flux method, Replacement method and Separation method respectively. If the number of workers replaced during 2nd quarter of the financial year 2012-13 is 36, find the following: (i) The number of workers recruited and joined; and (ii) The number of workers left and discharged. (c) X is invested ` 2,40,000 at annual rate of interest of 10 percent. What is the amount after 3 years if the compounding is done? (i) Annually (ii) Semi-annually. (d) KL Limited produces product 'M' which has a quarterly demand of 8,000 units. The product requires 3 kgs quantity of material 'X' for every finished unit of product. The other information are follows: Cost of material 'X' : Cost of placing an order Carrying Cost : : ` 20 per kg. ` 1000 per order 15% per annum of average inventory You are required: (i) Calculate the Economic Order Quantity for material 'X'. (ii) Should the' company accept an offer of 2 percent discount by the supplier, if he wants to supply the annual requirement of material 'X' in 4 equal quarterly instalments ? Answer (a) Computation of Degree of Operating Leverage (DOL) Selling Price = ` 14 per unit The Institute of Chartered Accountants of India 42 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 Variable Cost = ` 9 per unit Fixed Cost = BEP x ( Selling price Variable cost) = 20,000 x (14 - 9) = 20,000 x 5 = 1,00,000 ` (For 25,000 units) ` (For 30,000 units) Sales ( @ `14 /unit) 3,50,000 4,20,000 Less: Variable Cost (@ 9 unit ) 2,25,000 2,70,000 Contribution 1,25,000 1,50,000 Less: Fixed Cost 1,00,000 1,00,000 25,000 50,000 1,25,000 25,000 1,50,000 50,000 EBIT Contribution DOL EBIT DOL 5 times No. of wor ker s replaced (b) Labour Turnover Rate (Replacement method) = Average No. of wor ker s 8 36 = 100 Average No. of wor ker s or, or, Average No. of workers = 450 Labour Turnover Rate (Separation method) = or, 6 100 or, No. of workers separated Average No. of workers No. of workers separated = 27 = No. of workers separated 450 Labour Turnover Rate (Flux Method) = or, No. of Separations + No. of accession (Joinings) Average No. of wor ker s 14 27 + No. of accessions (Joinings) = 100 450 or, 100 (27 + No. of Accessions) = 6300 or, (i) 3 times No. of Accessions = 36 The No. of workers recruited and Joined = 36 (ii) The No. of workers left and discharged = 27 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 43 (c) Computation of Future Value Principal (P) = ` 2,40,000 Rate of Interest ( ) = 10% p.a. Time period (n)= 3 years Amount if compounding is done: (i) Annually Future Value = P (1 + )n 10 = 2,40,000 (1 + 1 + 100 = 2,40,000 ( 1 + 0.1) 3 3 = 2,40,000 x 1.331 = ` 3,19,440 (ii) Semi-Annually 10 Future Value = 2,40,000 1 + 100x 2 3x 2 = 2,40,000 ( 1 + 0.05) 6 = 2,40,000 x ( 1 .05) 6 = 2,40,000 x 1.3401 = ` 3,21,624 (d) Annual demand of material X = 8000 units (per quarter) x 4 (No. of Quarter in a year) x 3 kgs (for every finished product) = 96,000 kgs. (i) Calculation of Economic Order Quantity (EOQ) for material X EOQ = = 2 x Annual demand x ordering cost Carrying cost per unit per annum 2 96,000 kg ` 1000 ` 20 15% = 8,000 kg. The Institute of Chartered Accountants of India 44 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (ii) Evaluation of Cost under different options of order quantity . Particulars When EOQ is ordered When discount of 2% is accepted and supply is in 4 equal installments Order size 8000 kgs 96,000Kgs = 24,000 kgs 4 No. of order 96000 kgs 8000 kgs Purchase Cost per kg. 96000 kgs = 12 24,000 kgs ` 20 Total Purchase Cost (A) (20-2% ` 20) = ` 19.60 (96,000 kgs x 19.6)= `18,81,600 (96,000 kgs x ` 20) =`19,20,000 Ordering Cost (B) 12 orders x ` 1000 =`12,000 Carrying Cost (C) 8000 kgs 2 =4 4 orders x ` 1000 = ` 4,000 24000 kgs 15% x 20 = ` x 15% 19.6 = ` 2 35,280 ` 19,44,000 Total Cost (A+B+C) 12,000 `19,20,880 Advice The total Cost is lower if Company accept an offer of 2 percent discount by the supplier, when supply of the annual requirement of material X is made in 4 equal instalments. Question 2 (a) The following account balances and distribution of indirect charges are taken from the accounts of a manufacturing concern for the year ending on 31st March, 2012: (8 Marks) Item Total Production Departments Amount Service Departments (`) X (`) Y (`) Z (`) A (`) B (`) Indirect Material 1,25,000 20,000 30,000 45,000 25,000 5,000 Indirect Labour 2,60,000 45,000 50,000 70,000 60,000 35,000 Superintendent's Salary 96,000 - - 96,000 - - Fuel & Heat 15,000 Power 1,80,000 Rent & Rates 1,50,000 Insurance 18,000 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Meal Charges 45 60,000 Depreciation 2,70,000 The following departmental data are also available: Production Departments Service Departments X Area (Sq. ft.) Capital Value of Assets (`) Kilowatt Hours Radiator Sections Y Z A B 4,400 4,000 3,000 2,400 1,200 4,00,000 3,500 20 6,00,000 4,000 40 5,00,000 3,000 60 1,00,000 1,500 50 2,00,000 30 No. of Employees 60 70 120 30 20 Expenses charged to the service departments are to be distributed to other departments by the following percentages: X Y Z A B Department A 30 30 20 20 Department B 25 40 25 10 Prepare an overhead distribution statement to show the total overheads of production departments after re-apportioning service departments' overhead by using simultaneous equation method. Show all the calculations to the nearest rupee. (b) The following accounting information and financial ratios of M Limited relate to the year ended 31st March, 2012 : Inventory Turnover Ratio 6 Times Creditors Turnover Ratio 10 Times Debtors Turnover Ratio 8 Times Current Ratio 2.4 Gross Profit Ratio 25% Total sales ` 30,00,000; cash sales 25% of credit sales; cash purchases ` 2,30,000; working capital ` 2,80,000; closing inventory is ` 80,000 more than opening inventory. You are required to calculate: (i) Average Inventory (ii) Purchases (iii) Average Debtors (iv) Average Creditors The Institute of Chartered Accountants of India 46 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (v) Average Payment Period (vi) Average Collection Period (vii) Current Assets (viii) Current Liabilities. (8 Marks) Answer (a) Primary Distribution of Overheads Item Basis Total Amount (`) Production Departments Service Departments X (`) Y (`) Z (`) A (`) B (`) Indirect Material Actual 1,25,000 20,000 30,000 45,000 25,000 5,000 Indirect Labour Actual 2,60,000 45,000 50,000 70,000 60,000 35,000 Superintendent s Actual Salary 96,000 - - 96,000 - - Fuel & Heat Radiator Sections {2:4:6:5:3} 15,000 1,500 3,000 4,500 3,750 2,250 Power Kilowatt Hours {7:8:6:3:0} 1,80,000 52,500 60,000 45,000 22,500 - Rent & Rates Area (Sq. ft.) {22:20:15:12:6} 1,50,000 44,000 40,000 30,000 24,000 12,000 Insurance Capital Value of Assets {4:6:5:1:2} 18,000 4,000 6,000 5,000 1,000 2,000 Meal Charges No. Employees {6:7:12:3:2} of 60,000 12,000 14,000 24,000 6,000 4,000 Depreciation Capital Value of Assets {4:6:5:1:2} 2,70,000 60,000 90,000 75,000 15,000 30,000 11,74,000 2,39,000 2,93,000 3,94,500 1,57,250 90,250 Total overheads Re-distribution of Overheads of Service Department A and B Total overheads of Service Departments may be distributed using simultaneous equation method Let, the total overheads of A = a and the total overheads of B= b a = 1,57,250 + 0.10 b The Institute of Chartered Accountants of India (i) PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT or, 10a - b = 15,72,500 [(i) x10] b = 90,250 + 0.20 a or, -0.20a + b = 47 (ii) 90,250 10a - b = 15,72,500 -0.20a + b = 9.8a a 90,250 = 16,62,750 = 1,69,668 Putting the value of a in equation (ii), we get b = 90,250 + 0.20 x 1,69,668 b = 1,24,184 Secondary Distribution of Overheads Production Departments Total overhead as per primary distribution Service Department A (80% of 1,69,668) Service Department B (90% of 1,24,184) Total (b) (i) X (`) 2,39,000 50,900 31,046 3,20,946 2,93,000 50,900 49,674 3,93,574 Computation of Average Inventory Gross Profit = 25% of 30,00,000 Gross Profit = 7,50,000 Cost of goods sold (COGS) = 30,00,000 7,50,000 COGS = 22,50,000 Inventory Turnover Ratio = 6= COGS Average Inventory 22,50,000 Average inventory Average inventory = 3,75,000 (ii) Computation of Purchases Purchases = COGS + Increase in Stock = 22,50,000 + 80,000 Purchases = 23,30,000 The Institute of Chartered Accountants of India Y (`) Z (`) 3,94,500 33,934 31,046 4,59,480 48 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (iii) Computation of Average Debtors Let Credit Sales be ` 100 Cash sales = 25 x 100 =` 25 100 Total Sales = 100 +25= 125 Total sales is ` 125 credit sales is ` 100 If total sales is 30,00,000, then credit sales is = 30,00,000x100 125 Credit Sales = 24,00,000 Cash Sales = 6,00,000 Debtors Turnover Ratio = = Average Debtors = Net Credit Sales =8 Average debtors 24,00,000 =8 Average debtors 24,00,000 8 Average Debtors = 3,00,000 (iv) Computation of Average Creditors Credit Purchases = Purchases Cash Purchases = 23,30,000 2,30,000 = 21,00,000 Creditors Turnover Ratio = 10 = Credit Purchases Average Creditors 21,00,000 Average Creditors Average Creditors = 2,10,000 (v) Computation of Average Payment Period Average Payment Period = Average Creditors Average Daily Credit Purchases The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 2,10,000 2,10,000 = Credit Purchases 21,00,000 365 365 = 2,10,000 x 365 21,00,000 = = 36.5 days OR Average Payment Period = 365/Creditors Turnover Ratio = 365 = 36.5 days 10 (vi) Computation of Average Collection Period Average Collection Period = = Average Debtors 365 Net Credit Sales 3,00,000 365 24,00,000 = 45.625 days OR Average collection period = 365/ Debtors Turnover Ratio = 365 = 45.625 days 8 (vii) Computation of Current Assets Current Ratio = Current Assets (CA) Current Liabilities (CL) 2.4 Current Liabilities = Current Assets or CL = CA/2.4 Working capital = Current Assets Current liabilities 2,80,000 = CA-CA/2.4 2,80,000 = 1.4 CA/2.4 CA = 4,80,000 (viii) Computation of Current Liabilities Current liabilities = 4,80,000 = 2,00,000 2.4 The Institute of Chartered Accountants of India 49 50 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 Question 3 (a) Following are the summarized Balance Sheets of JKM Limited as on 31st March, 2011 and 2012 : (12 Marks) (` in lakhs) Liabilities 31st March 2011 2012 ` ` Equity Share Capital Capital Reserve General Reserve Profit & Loss Account Proposed Dividend Bills Payable Sundry Creditors Provision for Tax 50.00 4.00 5.30 8.00 2.00 3.50 4.00 55.00 2.50 6.00 6.70 11.00 1.80 4.60 5.00 76.80 92.60 Assets 31st March 2011 2012 ` Goodwill Land & Building Plant & Machinery Investment Stock Sundry Debtors Bills Receivables Cash in hand & Bank Share Issue Exp. ` 5.00 20.00 22.00 2.00 8.60 10.20 1.00 7.20 0.80 76.80 4.20 18.00 31.00 3.50 12.70 13.00 0.70 8.90 0.60 92.60 Additional Information: (i) A machine (original cost ` 2,80,000; Book Value ` 1,70,000) was sold during the year for ` 1,50,000. (ii) Depreciation for 2011-12 was amounted to ` 3,00,000 on plant and machinery and ` 50,000 on land and building. (iii) A piece of land had been sold out on 01-11-2011 and the profit on the sale has been credited in capital reserve. (iv) ` 40,000 is received as dividend including ` 15,000 pre-acquisition profit, which is credited to investment account. (v) An interim dividend of ` 2,50,000 has been paid during the year 2011-12. (vi) Income tax paid during the year 2011-12, amounted to ` 3,80,000. Required: (A) Prepare a schedule of changes in the working capital. (B) Prepare funds flow statement as on 31st March, 2012. (b) From the following particulars compute a conservative estimate of profit by 4 methods on a contract which has 80 percent complete: (4 Marks) ` Total expenditure to date Estimate further expenditure to complete the contract The Institute of Chartered Accountants of India 8,50,000 1,70,000 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Contract Price Work Certified Work not certified Cash received 51 15,30,000 10,00,000 85,000 8,16,000 Answer (a) (A) Schedule of Changes in the Working Capital 31st March Particulars Changes in Working Capital (in lakhs) 2011 (`) 2012 (`) Increase (`) Current Assets Stock Sundry Debtors Bills Receivables Cash in Hand & Bank 8.60 10.20 1.00 7.20 12.70 13.00 0.70 8.90 4.10 2.80 Total (A) 27.00 35.3 3.50 2.00 4.60 1.80 5.5 6.4 21.5 7.4 28.9 (B) Preparation of Funds Flow Statement 28.9 A. B. Current Liabilities Sundry Creditors Bills Payable Total (B) C. D. Working Capital (A-B) Increase in Working Capital 28.9 Decrease (`) 0.30 1.70 1.10 0.20 8.8 7.4 8.8 Working Notes: Plant & Machinery A/c Particulars To Balance b/d To Bank (Purchase ) (Balancing figure) Particulars ` 22.00 By Depreciation 13.7 By Bank (Sale) By Loss on Sale By Balance c/d 3.00 1.50 0.20 31.00 ` 35.7 The Institute of Chartered Accountants of India 35.7 52 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 Provision for Taxation A/c Particulars To Balance c/d To Bank A/c Particulars ` ` 5.00 By Balance b/d 3.80 By P&L A/c (balancing figure) 4.00 8.80 8.80 8.80 Investment A/c Particulars To Balance b/d To Bank (purchase b/d) Particulars ` ` 2.00 By Dividend A/c 1.65 By Balance c/d 0.15 3.65 3.65 3.50 Land & Building A/c Particulars ` To Balance b/d To Capital Reserve (Profit on Sale) Particulars ` 20.00 By Bank A/c (Sale) 2.50 By Depreciation By Balance c/d 4.00 0.50 18.00 22.50 22.50 Adjusted Profit & Loss A/c Particulars ` To Depreciation on: Particulars By Net Profit for 2011 ` 5.30 Plant & Machinery 3.00 By Dividend on Investment 0.25 Land & Building 0.50 By Funds from Operation 26.15 To Loss on Sale of Machinery 0.20 To Goodwill Written Off 0.80 To Share Issue Up Written Off 0.20 To Provision for Taxation 4.80 To Transfer to General Reserves 2.00 To Interim Dividend 2.50 To Proposed Dividend 11.00 By Net Profit for 2012 6.70 31.70 The Institute of Chartered Accountants of India 31.70 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53 Funds Flow Statement as on 31st March 2012 Sources of Fund Rs. Application of Fund Funds from Operation Dividend on Investment Sale of Machinery Issue of Shares Sale of Land 26.15 0.40 1.50 5.00 4.00 Increase in Working Capital Tax paid Interim Dividend Dividend Purchase of Investments Purchase of Plant Rs. 7.40 3.80 2.50 8.00 1.65 13.70 37.05 37.05 (Note: Schedule of changes in the working capital may be computed alternatively by taking provision for tax as a current liability.) (b) Working Notes: (i) Calculation of Notional Profit = (Work certified + work not certified) Total expenditure to date = ` (10,00,000+85,000) ` 8,50,000 = ` 2,35,000 (ii) Calculation of Estimated Profit Contract Price (Expenditure to date + Further expenditure to be incurred) = `15,30,000 ` (8,50,000 + 1,70,000) = ` 5,10,000 Computation of Conservative Estimate of Profit by following methods: 1. Notional Profit x 2 Cash received x work certified 3 = = 2. ` 2,35,000 x 2 ` 8,16,000 x 3 ` 10,00,000 ` 1,27,840 Estimated Profit x = ` 5,10,000 = Cost of work done Cash received Estimated total Cost work certified x 8,50,000 8,16,000 (8,50,000 + 1,70,000) 10,00,000 ` 3,46,800 The Institute of Chartered Accountants of India 54 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 3. Estimated Profit x = = 4. ` 5,10,000 Cash received Contract Price 8,16,000 15,30,000 ` 2,72,000 Notional Profit x x Work Certified Cash Received x Contract Price Work Certified = ` 2,35,000 x = 10,00,000 8,16,000 x 15,30,000 10,00,000 ` 1,25,333 Estimated Profit x Work Certified Contract Price = ` 5,10,000 x 10,00,000 15,30,000 = 5. ` 3,33,333 Cost of work done Estimated total Cost ` 5,10,000 x 8,50,000 10,20,000 = 7. Estimated Profit x = 6. ` 4,25,000 Notional Profit x Work Certified Contract Price = ` 2,35,000 x = 10,00,000 15,30,000 ` 1,53,595 Most conservative Profit is ` 1,25,333, therefore profit to be transferred to Profit and Loss a/c is ` 1,25,333. Question 4 (a) The standard labour employment and the actual labour engaged in a 40 hours week for a job are as under: (6 Marks) The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Category of Workers Skilled Semi-skilled Standard No. of Wage Rate per workers hour (`) 65 45 20 30 Unskilled 15 Standard output: 2000 units; No. of workers 50 30 15 55 Actual Wage Rate per hour (`) 50 35 20 10 Actual output: 1800 units Abnormal Idle time 2 hours in the week Calculate: (i) Labour Cost Variance (ii) Labour Efficiency Variance (iii) Labour Idle Time Variance. (b) SS Limited is considering the purchase of a new automatic machine which will carry out some operations which are at present performed by manual labour. NM-A1 and NM-A2, two alternative models are available in the market. The following details are collected : (10 Marks) Machine NM-A1 NM-A2 20,00,000 25,00,000 5 Years 5 Years Cost of Machine Estimated working life (`) Estimated saving in direct wages per annum (`) 7,00,000 9,00,000 Estimated saving in scrap per annum (`) 60,000 1,00,000 Estimated additional cost of indirect material per annum (`) 30,000 90,000 Estimated additional cost of indirect labour per annum (`) 40,000 50,000 (`) 45,000 85,000 Estimated additional cost of repairs and maintenance per annum Depreciation will be charged on a straight line method. Corporate tax rate is 30 percent and expected rate of return may be 12 percent. You are required to evaluate the alternatives by calculating the: (i) Pay-back Period (ii) Accounting (Average) Rate of Return; and The Institute of Chartered Accountants of India 56 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (iii) Profitability Index or P.V. Index (P.V. factor for ` 1 @ 12% 0.893; 0.797; 0.712; 0.636; 0.567; 0.507) Answer (a) Working Note: Table Showing Standard & Actual Cost Worker Standard Hours (a) Standard Rate per Hour (b) Standard Actual Hours Cost for Paid Actual Output (d ) (c) = (a x b) Actual Actual Cost Idle time Rate per hour (e) (f) = (d) x (e) (f) Actual hours worked (g)=(d)-(f) Skilled 2,340 hrs. [(65 Workers x 40 hrs.)/ 2,000 units)] x1,800 units ` 45 `1,05,300 2,000 hrs. (50 Workers x 40 hrs.) ` 50 `1,00,000 100 hrs. 1,900 hrs. (50 (2,000 hrs.-100 Workers x hrs.) 2 hrs.) Semiskilled 720 hrs. [(20 Workers x 40 hrs.)/ 2,000 units)] x1,800 units `30 `21,600 1,200 hrs. (30 Workers x 40 hrs.) `35 1,140 hrs. `42,000 60 hrs. (30 (1,200 hrs.-60 Workers x hrs.) 2 hrs.) Unskilled 540 hrs. [(15 Workers x 40 hrs.)/ 2,000 units)] x1,800 units `15 `8,100 800 hrs. (20 Workers x 40 hrs.) `10 760 hrs. `8,000 40 hrs. (800 hrs.-40 (20 Workers x hrs.) 2 hrs.) Total 3,600 hrs. `1,35,000 4,000 hrs. `1,50,000 200 hrs. 3,800 hrs. Calculation of Variances (i) Labour Cost Variance = Standard Cost for actual output Actual cost Skilled worker = `1,05,300 - `1,00,000 = ` 5,300 (F) Semi-skilled worker = ` 21,600 - ` 42,000 = ` 20,400 (A) Unskilled Worker = ` 8,100 - ` 8,000 = `100 (F) Total = `5,300 (F) + `20,400 (A) + `100 (F) = `15,000 (A) The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57 (ii) Labour Efficiency Variance = Std. Rate x (Standard hours Actual hours worked) Skilled worker = ` 45 x (2,340 hrs. - 1,900 hrs.) = `19,800 (F) Semi-skilled worker = ` 30 x (720 hrs. - 1,140 hrs.) = ` 12,600 (A) Unskilled Worker = ` 15 x (540 hrs. - 760 hrs.) = ` 3,300 (A) Total = `19,800 (F) + `12,600 (A) + `3,300 (A) = `3,900 (F) (iii) Labour Idle Time Variance = Std. Rate x Idle Time (Hrs.) Skilled worker = ` 45 x 100 = ` 4,500 (A) Semi-skilled worker = ` 30 x 60 hrs. = ` 1,800 (A) Unskilled worker = ` 15 x 40 hrs. = ` 600 (A) Total = ` 4,500 (A) + ` 1,800 (A) + ` 600 (A) = ` 6,900 (A) (b) Evaluation of Alternatives Working Notes: Depreciation on Machine NM-A1 = 20,00,000 5 = 4,00,000 Depreciation on Machine NM-A2 = 25,00,000 = 5,00,000 5 Particulars Annual Savings: Direct Wages Scraps Total Savings (A) The Institute of Chartered Accountants of India Machine NM-A1 (`) Machine NM-A2 (`) 7,00,000 9,00,000 60,000 1,00,000 7,60,000 10,00,000 58 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 Annual Estimated Cash Cost : Indirect Material Indirect Labour 30,000 40,000 90,000 50,000 Repairs and Maintenance 45,000 85,000 Total Cost (B) 1,15,000 2,25,000 Annual Cash Savings (A-B) 6,45,000 7,75,000 Less: Depreciation 4,00,000 5,00,000 Annual Savings before Tax 2,45,000 2,75,000 73,500 82,500 Annual Savings /Profits after tax 1,71,500 1,92,500 Add: Depreciation 4,00,000 5,00,000 Annual Cash Inflows 5,71,500 6,92,500 Less: Tax @ 30% (i) Payback Period Machine NM-A1 = = Machine NM- A2 = Total Initial Capital Investment Annual expected after tax net cashflow 20,00,000 = 3.50 Years 5,71,500 25,00,000 = 3.61 Years 6,92,500 Decision: Machine NM-A1 is better. (ii) Accounting (Average) Rate of Return (ARR) ARR = Average Annual Net Savings x 100 Average investment Machine NM-A1 = 1,71,500 x 100 10,00,000 Machine NM-A2 = 1,92,500 x 100 = 15.4% 12,50,000 = 17.15% Decision: Machine NM-A1 is better. (Note: ARR may be computed alternatively by taking initial investment in the denominator.) The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59 (iii) Profitability Index or P V Index Present Value Cash Inflow = Annual Cash Inflow x PV factor at 12% Machine NM-A1 = 5, 71,500 x 3.605 = ` 20, 60,258 Machine NM-A2 = 6, 92,500 x 3.605 = ` 24, 96,463 PV Index = Present Value of Cash Inflow Investment Machine NM-A1 = 20,60,258 = 1.03 20,00,000 Machine NM-A2 = 24,96,463 = 0.9 25,00,000 Decision: Machine NM-A1 is better. Question 5 (a) Briefly explain the essential features of a good cost accounting system. (4 x 4 = 16 Marks) (b) What is inter-process profit? State its advantages and disadvantages. (c) What do you understand by operating costing? How are composite units computed? (d) List the fundamental principles governing capital structure. Answer (a) Essentials of a good Cost Accounting System: The essential features, which a good Cost Accounting System should possess, are as follows: (a) Informative and Simple: Cost Accounting System should be tailor-made, practical, simple and capable of meeting the requirements of a business concern. (b) Accuracy: The data to be used by the Cost Accounting System should be accurate; otherwise it may distort the output of the system. (c) Support from Management: Necessary cooperation and participation of executives from various departments of the concern is essential for developing a good system of Cost Accounting. (d) Cost- Benefit: The Cost of installing and operating the system should justify the results. (e) Precise Information: The system of costing should not sacrifice the utility by introducing meticulous and unnecessary details. (f) Procedure: A carefully phased programme should be prepared by using network analysis for the introduction of the system. The Institute of Chartered Accountants of India 60 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (g) Trust: Management should have faith in the Costing System and should also provide a helping hand for its development and success. (b) Definition of Inter-Process Profit and Its advantages and disadvantages In some process industries the output of one process is transferred to the next process not at cost but at market value or cost plus a percentage of profit. The difference between cost and the transfer price is known as inter-process profits. The advantages and disadvantages of using inter-process profit, in the case of process type industries are as follows: Advantages: 1. Comparison between the cost of output and its market price at the stage of completion is facilitated. 2. Each process is made to stand by itself as to the profitability. Disadvantages: 1. The use of inter-process profits involves complication. 2. The system shows profits which are not realised because of stock not sold out (c) Meaning of Operating Costing: Operating Costing is a method of ascertaining costs of providing or operating a service. This method of costing is applied by those undertakings which provide services rather than production of commodities. This costing method is usually made use of by transport companies, gas and water works departments, electricity supply companies, canteens, hospitals, theatres, schools etc. Computation of composite units: When two units are merged into one it is called Composite units. It is explained with example as follows. Composite units i.e. tonnes kms., quintal kms. etc. may be computed in two ways. (i) Absolute (weighted average) tonnes-kms. Absolute tonnes-kms., are the sum total of tonnes-kms., arrived at by multiplying various distances by respective load quantities carried. (ii) Commercial (simple average) tonnes-kms. Commercial tonnes-kms., are arrived at by multiplying total distance kms., by average load quantity. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61 (d) Fundamental Principles Governing Capital Structure The fundamental principles are: (i) Cost Principle: According to this principle, an ideal pattern or capital structure is one that minimises cost of capital structure and maximises earnings per share (EPS). (ii) Risk Principle: According to this principle, reliance is placed more on common equity for financing capital requirements than excessive use of debt. Use of more and more debt means higher commitment in form of interest payout. This would lead to erosion of shareholders value in unfavourable business situation. (iii) Control Principle: While designing a capital structure, the finance manager may also keep in mind that existing management control and ownership remains undisturbed. (iv) Flexibility Principle: It means that the management chooses such a combination of sources of financing which it finds easier to adjust according to changes in need of funds in future too. (v) Other Considerations: Besides above principles, other factors such as nature of industry, timing of issue and competition in the industry should also be considered. (Note: Students may answer any four of the above principles.) Question 6 (a) The following figures are related to LM Limited for the year ending 31st March, 2012 : Sales - 24,000 units @ ` 200 per unit; P/V Ratio 25% and Break-even Point 50% of sales. You are required to calculate: (i) Fixed cost for the year (ii) Profit earned for the year (iii) Units to be sold to earn a target net profit of ` 11,00,000 for a year. (iv) Number of units to be sold to earn a net income of 25% on cost. (v) Selling price per unit if Break-even Point is to be brought down by 4,000 units. (8 Marks) (b) R Limited showed a net loss of ` 35,400 as per their cost accounts for the year ended 31st March, 2012. However, the financial accounts disclosed a net profit of ` 67,800 for the same period. The following information were revealed as a result of scrutiny of the figures of cost accounts and financial accounts: (8 Marks) The Institute of Chartered Accountants of India 62 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (i) Administrative overhead under recovered (ii) Factory overhead over recovered (iii) Depreciation under charged in Cost Accounts (`) 25,500 1,35,000 26,000 (iv) Dividend received (v) Loss due to obsolescence charged in Financial Accounts 20,000 16,800 (vi) Income tax provided (vii) Bank interest credited in Financial Accounts 43,600 13,600 (viii) Value of opening stock: In Cost Accounts 1,65,000 In Financial Accounts 1,45,000 (ix) Value of closing stock: In Cost Accounts 1,25,500 In Financial Accounts (x) Goodwill written-off in Financial Accounts (xi) Notional rent of own premises charged in Cost Accounts (xii) Provision for doubtful debts in Financial Accounts 1,32,000 25,000 60,000 15,000 Prepare a reconciliation statement by taking costing net loss as base. Answer (a) Break even point (in units) is 50% of sales i.e. 12,000 units Hence, Break even point (in sales value) is 12,000 units x ` 200 = ` 24,00,000 (i) We know that Break even sales = Fixed Cost P/V ratio or ` 24,00,000 = Fixed Cost 25% or Fixed Cost = ` 24,00,000 x 25% = ` 6,00,000 So Fixed Cost for the year is ` 6,00,000 (ii) Contribution for the year =(24,000 units x ` 200) x 25% = ` 12,00,000 Profit for the year = Contribution Fixed Cost = ` 12,00,000 - ` 6,00,000 = ` 6,00,000 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63 (iii) Target net profit is ` 11,00,000 Hence, Target contribution = Target Profit + Fixed Cost = ` 11,00,000 + ` 6,00,000 = ` 17,00,000 Contribution per unit = 25% of ` 200 = ` 50 per unit No. of units = `17,00,000 = 34,000 unit ` 50 per unit So, 34,000 units to be sold to earn a target net profit of ` 11,00,000 for a year. (iv) Net desired total Sales (Number of unit x Selling price) be , then desired profit is 25% on Cost or 20% on Sales i.e. 0.2 Desired Sales = = Fixed Cost + Desired Profit P/V ratio 6,00,000 + 0.2 25% or, 0.25 = 6,00,000 + 0.2 or, 0.05 = 6,00,000 or, = ` 1,20,00,000 No. of units to be sold - 1,20,00,000 = 60,000 units 200 (v) If Break even point is to be brought down by 4,000 units then Breakeven point will be 12000 units 4000 units = 8000 units Fixed Cost = ` 6,00,000 Required Contribution per unit Selling Price = 6,00,000 = ` 75 8,000unit Contribution per unit ` 75 = ` 300 per unit 25% P / V ratio (assuming PV ratio will remain as 25%) Hence, selling price per unit shall be ` 300 if Breakeven point is to be brought down by 4000 units. The Institute of Chartered Accountants of India 64 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 [Note: This part also can be solved assuming variable cost proportion as constant. In that case Selling price will be, Existing variable cost (` 150) + New contribution per unit (` 75) i.e. ` 225 per unit.] (b) Statement of Reconciliation Sl. No. 1. 2. 3. 4. 5. 6. 1. 2. 3. 4. 5. 6. Particulars Net loss as per Cost Accounts Additions Factory O/H over recovered Dividend Received Bank Interest received Difference in Value of Opening Stock (1,65,000 1,45,000) Difference in Value of Closing Stock (1,32,000 1,25,500) Notional Rent of own Premises Deductions Administration O/H under recovered Depreciation under charged Loss due to obsolescence Income tax Provided Goodwill written-off Provision for doubtful debts Net Profit as per Financial A/cs Amount (`) Amount (`) (35,400) 1,35,000 20,000 13,600 20,000 6,500 60,000 2,55,100 25,500 26,000 16,800 43,600 25,000 15,000 (1,51,900) 67,800 Question 7 Answer any four of the following: (4 x 4 = 16 Marks) (a) Discuss the conflicts in profit verses wealth maximization principle of the firm. (b) State the considerations on which capital expenditure budget is prepared. (c) Distinguish between business risk and financial risk. (d) What are the forms of bank credit? (e) "Financing a business through borrowing is cheaper than using equity." Briefly explain. The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65 Answer (a) Conflict in Profit versus Wealth Maximization Principle of the Firm Profit maximisation is a short-term objective and cannot be the sole objective of a company. It is at best a limited objective. If profit is given undue importance, a number of problems can arise like the term profit is vague, profit maximisation has to be attempted with a realisation of risks involved, it does not take into account the time pattern of returns and as an objective it is too narrow. Whereas, on the other hand, wealth maximisation, as an objective, means that the company is using its resources in a good manner. If the share value is to stay high, the company has to reduce its costs and use the resources properly. If the company follows the goal of wealth maximisation, it means that the company will promote only those policies that will lead to an efficient allocation of resources. (b) The preparation of Capital Expenditure Budget is based on the following considerations: 1. Overhead on production facilities of certain departments as indicated by the plant utilisation budget. 2. Future development plans to increase output by expansion of plant facilities. 3. Replacement requests from the concerned departments 4. Factors like sales potential to absorb the increased output, possibility of price reductions, increased costs of advertising and sales promotion to absorb increased output, etc. (c) 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 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. (d) Forms of Bank Credit Some of the forms of bank credit are: (i) Short Term Loans: In a loan account, the entire advance is disbursed at one time either in cash or by transfer to the current account of the borrower. It is a single advance and given against securities like shares, government securities, life insurance policies and fixed deposit receipts, etc. The Institute of Chartered Accountants of India 66 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2012 (ii) Overdraft: Under this facility, customers are allowed to withdraw in excess of credit balance standing in their Current Account. A fixed limit is therefore granted to the borrower within which the borrower is allowed to overdraw his account. (iii) Clean Overdrafts: Request for clean advances are entertained only from parties which are financially sound and reputed for their integrity. The bank has to rely upon the personal security of the borrowers. (iv) Cash Credits: Cash Credit is an arrangement under which a customer is allowed an advance up to certain limit against credit granted by bank. Interest is not charged on the full amount of the advance but on the amount actually availed of by him. (v) Advances against goods: Goods are charged to the bank either by way of pledge or by way of hypothecation. Goods include all forms of movables which are offered to the bank as security. (vi) Bills Purchased/Discounted: These advances are allowed against the security of bills which may be clean or documentary. Usance bills maturing at a future date or sight are discounted by the banks for approved parties. The borrower is paid the present worth and the bank collects the full amount on maturity. (vii) Advance against documents of title to goods: A document becomes a document of title to goods when its possession is recognised by law or business custom as possession of the goods like bill of lading, dock warehouse keeper's certificate, railway receipt, etc. An advance against the pledge of such documents is an advance against the pledge of goods themselves. (viii) Advance against supply of bills: Advances against bills for supply of goods to government or semi-government departments against firm orders after acceptance of tender fall under this category. It is this debt that is assigned to the bank by endorsement of supply bills and executing irrevocable power of attorney in favour of the banks for receiving the amount of supply bills from the Government departments. (Note: Students may answer any four of the above forms of bank credit.) (e) Financing a business through borrowing is cheaper than using equity (i) Debt capital is cheaper than equity capital from the point of its cost and interest being deductible for income tax purpose, whereas no such deduction is allowed for dividends. (ii) Issue of new equity dilutes existing control pattern while borrowing does not result in dilution of control. (iii) In a period of rising prices, borrowing is advantageous. The fixed monetary outgo decreases in real terms as the price level increases. The Institute of Chartered Accountants of India

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