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CA IPCC : Question Paper (with Answers) - COST ACCOUNTING & FINANCIAL MANAGEMENT May 2011

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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 (a) You are given two financial plans of a company which has two financial situations. The detailed information are as under: Installed capacity 10,000 units Actual production and sales 60% of installed capacity Selling price per unit ` 30 Variable cost per unit ` 20 Fixed cost: Situation A = ` 20,000 Situation B = ` 25,000 Capital structure of the company is as follows: Financial Plans XY ` ` 12,000 40,000 35,000 10,000 52,000 Equity Debt (cost of debt 12%) XM 45,000 You are required to calculate operating leverage and financial leverage of both the plans. (b) You are given the following information of a worker: (i) Name of worker : X (ii) Ticket No. : 002 (iii) Work started : 1-4-11 at 8 a.m. (iv) Work finished : 5-4-11 at 12 noon (v) Work allotted : Production of 2,160 units (vi) Work done and approved : 2000 units (vii) Time and units allowed : 40 units per hour (viii) Wage rate : ` 25 per hour The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (ix) Bonus : 40% of time saved (x) Worker X worked 9 hours a day. You are required to calculate the remuneration of the worker on the following basis: (i) (ii) (c) Halsey plan and Rowan plan Prepare a Store Ledger Account from the following transactions of XY Company Ltd. April, 2011 1 Opening balance 200 units @ ` 10 per unit. 5 Receipt 250 units costing ` 2,000 8 Receipt 150 units costing ` 1,275 10 Issue 100 units 15 Receipt 50 units costing ` 500 20 Shortage 10 units 21 Receipt 60 units costing ` 540 22 Issue 400 units The issues upto 10-4-11 will be priced at LIFO and from 11-4-11 issues will be priced at FIFO. Shortage will be charged as overhead. (d) What is factoring? Enumerate the main advantages of factoring. (4 5 = 20 Marks) Answer (a) Computation of Operating and Financial Leverage Actual Production and Sales: 60% of 10,000 = 6,000 units Contribution per unit: ` 30 ` 20 = ` 10 Total Contribution: 6,000 ` 10 = ` 60,000 Financial Plan Situation XY XM A B A B ` ` ` ` Contribution (C) Less: Fixed Cost 60,000 20,000 60,000 25,000 60,000 20,000 60,000 25,000 Operating Profit or EBIT 40,000 35,000 40,000 35,000 4,800 4,800 1,200 1,200 Less: Interest 41 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 Earnings before tax (EBT) 35,200 30,200 38,800 33,800 Operating Leverage C = EBIT 60,000 40,000 60,000 35,000 60,000 40,000 60,000 35,000 = 1.5 Financial Leverage = EBIT EBT 40,000 35,200 = 1.71 = 1.5 40,000 38,800 35,000 30,200 = 1.14 = 1.16 (b) No. of units produced and approved = 2,000 = 1.71 = 1.03 35,000 33,800 = 1.04 Standard time = 40 units per hour Hourly Wage Rate = ` 25 Time allowed = 40 units per hour Time allowed for 2,000 units (i) 2,000 = 50 hours 40 Calculation of Remuneration under Halsey Plan: Standard time allowed for 2,000 units : 50 hours Actual time taken for 2,000 units : 40 hours Time saved 10 hours Basic wages for time taken 40 hours @ ` 25 Bonus: 40% of time saved 40 10 25 100 Total = ` 1,000 =` 100 ` 1,100 (ii) Calculation of Remuneration Under Rowan Plan: Wages for time taken 40 hours @ ` 25 Bonus = = = ` 1,000 Time saved x (Time Taken x Hourly Rate) Time allowed 40 10 25 50 = ` 200 Total ` 1,200 42 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (c) Name :Code No. :Description:Date Store Ledger Account Max. Stock Level Min. Stock Level Re-order level Re-order quantityReceipts Issues Qty. Rate Amount Qty. Rate Units Units ` ` Amount Qty. 250 8 150 8.50 10 15 100 50 10 10 (shortage) 60 9 8.50 500 20 21 8.50 10 100 540 22 190 210 43 The Institute of Chartered Accountants of India 10 8 3,580 ` 10 10 8 10 8 8.50 2,000 4,000 200 250 50 200 250 50 50 190 10 8 8.50 10 8 8.50 10 10 4,425 250 50 50 190 1,275 ` 200 200 250 200 250 150 2,000 8 ` Balance Rate Amount 8 8.50 10 10 250 April 1 5 ` Bin No.Location Code- 8 50 50 60 40 50 50 60 8.50 10 9 8 8.50 10 9 5,275 4,925 4,825 5,365 1,785 (Closing Stock) INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 (d) Concept of Factoring and its Main Advantages: Factoring involves provision of specialized services relating to credit investigation, sales ledger management purchase and collection of debts, credit protection as well as provision of finance against receivables and risk bearing. In factoring, accounts receivables are generally sold to a financial institution (a subsidiary of commercial bank called factor ), who charges commission and bears the credit risks associated with the accounts receivables purchased by it. Advantages of Factoring The main advantages of factoring are: (i) The firm can convert accounts receivables into cash without bothering about repayment. (ii) Factoring ensures a definite pattern of cash inflows. (iii) Continuous factoring virtually eliminates the need for the credit department. Factoring is gaining popularity as useful source of financing short-term funds requirement of business enterprises because of the inherent advantage of flexibility it affords to the borrowing firm. The seller firm may continue to finance its receivables on a more or less automatic basis. If sales expand or contract it can vary the financing proportionally. (iv) Unlike an unsecured loan, compensating balances are not required in this case. Another advantage consists of relieving the borrowing firm of substantially credit and collection costs and from a considerable part of cash management. Question 2 (a) You are given the following information of the three machines of a manufacturing department of X Ltd.: Preliminary estimates of expenses (per annum) Total Machines A B C (`) (`) (`) (`) Depreciation 20,000 7,500 7,500 5,000 Spare parts 10,000 4,000 4,000 2,000 Power 40,000 3,000 2,500 2,500 Consumable stores 8,000 Insurance of machinery Indirect labour 8,000 20,000 Building maintenance expenses 20,000 44 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Annual interest on capital outlay 50,000 Monthly charge for rent and rates 10,000 Salary of foreman (per month) 20,000 20,000 10,000 20,000 Salary of Attendant (per month) 5,000 (The foreman and the attendant control all the three machines and spend equal time on them.) The following additional information is also available: Machines A C 1,00,000 Estimated Direct Labour Hours B 1,50,000 1,50,000 Ratio of K.W. Rating 3 2 3 Floor space (sq. ft.) 40,000 40,000 20,000 There are 12 holidays besides Sundays in the year, of which two were on Saturdays. The manufacturing department works 8 hours in a day but Saturdays are half days. All machines work at 90% capacity throughout the year and 2% is reasonable for breakdown. You are required to : Calculate predetermined machine hour rates for the above machines after taking into consideration the following factors: An increase of 15% in the price of spare parts. An increase of 25% in the consumption of spare parts for machine B & C only. 20% general increase in wages rates. (b) The Marketing Manager of XY Ltd. is giving a proposal to the Board of Directors of the company that an increase in credit period allowed to customers from the present one month to two months will bring a 25% increase in sales volume in the next year. The following operational data of the company for the current year are taken from the records of the company: ` Selling price Variable cost Total cost Sales value 21 p.u. 14 p.u. 18 p.u. 18,90,000 45 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 The Board, by forwarding the above proposal and data requests you to give your expert opinion on the adoption of the new credit policy in next year subject to a condition that the company s required rate of return on investments is 40%. (8 + 8 = 16 Marks) Answer (a) Computation of Machine Hour Rate Basis of Total apportionment (A) Machines A B C ` ` ` ` Standing Charges Insurance Depreciation Basis 8,000 3,000 3,000 2,000 Indirect Labour Direct Labour 24,000 6,000 9,000 9,000 Building Maintenance expenses Floor Space 20,000 8,000 8,000 4,000 Rent and Rates Floor Space 1,20,000 48,000 48,000 24,000 Salary foreman of Equal 2,40,000 80,000 80,000 80,000 Salary attendant of Equal 60,000 20,000 20,000 20,000 4,72,000 1,65,000 1,68,000 1,39,000 84.75 86.29 71.40 Total standing charges Hourly rate for standing charges (B) Machine Expenses: Depreciation Direct 20,000 7,500 7,500 5,000 Spare parts Final estimates 13,225 4,600 5,750 2,875 Power K.W. rating 40,000 15,000 10,000 15,000 Consumable Stores Direct 8,000 3,000 2,500 2,500 46 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Total Machine expenses 81,225 30,100 25,750 25,375 15.46 13.23 13.03 1,95,100 1,93,750 1,64,375 100.21 99.52 84.43 Hourly Rate for Machine expenses Total (A + B) Machine rate 553,225 Hour Working Notes: (i) Calculation of effective working hours: No. of holidays 52 (Sundays) + 12 (other holidays) = 64 Saturday (52 2) = 50 No. of days (Work full time) = 365 64 50 = 251 Hours Full days work 251 8 = 2,008 Half days work 50 4 = 200 2,208 Hours Effective capacity 90% of 2,208 1,987 (Rounded off) Less: Normal loss of time (Breakdown) 2% Effective running hour 40 (Rounded off) 1,947 (ii) Amount of spare parts is calculated as under: A B C ` ` ` Preliminary estimates 4,000 4,000 2,000 Add: Increase in price @ 15% 600 4,600 600 4,600 300 2,300 - 1,150 575 4,600 5,750 2,875 Add: Increase in consumption @ 25% Estimated cost 47 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 (iii) Amount of Indirect Labour is calculated as under: ` Preliminary estimates 20,000 Add: Increase in wages @ 20% 4,000 24,000 (iv) Interest on capital outlay is a financial matter and, therefore it has been excluded from the cost accounts. (b) Advise regarding Change in Credit Policy Working Notes: (1) Present Sales Value ` 18,90,000 Present Selling Price per unit ` 21 \ Present Sales Volume = 18,90,000 = 90,000 units 21 Expected increase in Sales Volume = 25% \ Expected Sales Volume in next year = 90,000 + 25% = 90,000 + 22,500 = 1,12,500 units (2) ` 16,20,000 Present total cost (90,000 18) Add: Variable cost on additional Sales (22,500 14) 3,15,000 \ Total cost of future sales 19,35,000 \ Average cost per unit 19,35,000 = ` 17.2 1,12,500 (3) ` Cost of Sale (1,12,500 17.2) 19,35,000 Average collection period = 2 months \ Average Investment in receivables in the proposed credit policy = 48 The Institute of Chartered Accountants of India 19,35,000 2 = 3,22,500 12 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (4) ` Additional Investment in receivables 90,000 18 = 3,22,500 - 12 = 3,22,500 1,35,000 = ` 1,87,500 (5) Contribution from additional sales = (21 14) 22,500 = ` 1,57,500 (6) Return on receivables additional investments in = 1,57,500 100 1,87,500 = 84% Advise: Since the expected rate of return on additional investment in receivables (84%) is more than the required rate of return (40%), the proposed increase in credit period from one month to two months should be accepted and implemented in the next year. Question 3 The management of MNP Company Ltd. is planning to expand its business and consults you to prepare an estimated working capital statement. The records of the company reveal the following annual information: ` Sales Domestic at one month s credit 24,00,000 Export at three month s credit (sales price 10% below domestic price) Materials used (suppliers extend two months credit) 10,80,000 9,00,000 Lag in payment of wages month 7,20,000 Lag in payment of manufacturing expenses (cash) 1 month 10,80,000 Lag in payment of Adm. Expenses 1 month 2,40,000 Sales promotion expenses payable quarterly in advance 1,50,000 Income tax payable in four instalments of which one falls in the next financial year Rate of gross profit is 20%. 2,25,000 Ignore work-in-progress and depreciation. The company keeps one month s stock of raw materials and finished goods (each) and believes in keeping ` 2,50,000 available to it including the overdraft limit of ` 75,000 not yet utilized by the company. The management is also of the opinion to make 12% margin for contingencies on computed figure. You are required to prepare the estimated working capital statement for the next year. (16 Marks) 49 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 Answer Preparation of Statement of Working Capital Requirement for MNP Company Ltd. Estimated Working Capital Statement (A) Current Assets in terms of Cash Costs Export Sales 1,60,000 1 19,20,000 12 Debtors: Domestic Sales 2,40,000 3 9,60,000 12 Prepaid Sales promotion expenses Stock of Raw materials 37,500 75,000 1 9,00,000 12 Stock of finished goods ` 1 28,80,000 12 2,40,000 Cash at Bank and in Hand Total Current Assets (B) 1,75,000 9,27,500 Current Liabilities in terms of Cash Costs ` Creditors for: Material 2 9,00,000 12 1,50,000 Wages 1 7,20,000 24 30,000 Manufacturing expenses 1 10,80,000 12 90,000 Administrative expenses 1 2,40,000 12 20,000 Income Tax Payable 56,250 Total Current Liabilities 3,46,250 (C) ` Net Current Assets (A B) 5,81,250 Add: 12% margin for contingencies 69,750 Required Working Capital 6,51,000 50 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Working Notes: Cash cost of sales is calculated as under: Domestic Sales Less: Gross profit @ 20% ` 24,00,000 4,80,000 Export Sales 10,80,000 100 ` = 12,00,000@10% 90 10,80,000 ` 19,20,000 1,20,000 9,60,000 28,80,000 Question 4 The summarized Balance Sheets of XYZ Limited as at 31st March, 2010 and 2011 are given below: Liabilities 2010 2011 Assets (`) Preference capital share Equity share capital Share premium A/c Capital redemption reserve 2010 (`) (`) 2011 (`) 4,00,000 2,00,000 Plant Machinery and 7,00,000 8,20,000 4,00,000 6,60,000 Long term investment 3,20,000 4,00,000 30,000 Goodwill 1,00,000 Current Assets 30,000 9,10,000 11,41,000 40,000 - General reserve 2,00,000 1,20,000 Short term investment (less than 2 months) P & L A/c Current liabilities 1,30,000 6,40,000 1,75,000 Cash and Bank 9,00,000 Preliminary expenses Proposed dividend 1,60,000 2,10,000 Provision for tax 1,50,000 1,80,000 21,20,000 25,75,000 50,000 84,000 1,00,000 40,000 80,000 20,000 21,20,000 25,75,000 Additional information: During the year 2011 the company: (i) Preference share capital was redeemed at a premium of 10% partly out of proceeds issue of 10,000 equity shares of ` 10 each issued at 10% premium and partly out of profits otherwise available for dividends. 51 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 (ii) The company purchased plant and machinery for ` 95,000. It also acquired another company stock ` 25,000 and plant and machinery ` 1,05,000 and paid ` 1,60,000 in Equity share capital for the acquisition. (iii) Foreign exchange loss of ` 1,600 represents loss in value of short-term investment. (iv) The company paid tax of ` 1,40,000. You are required to prepare cash flow statement. (16 Marks) Answer Preparation of Statement of Cash Flow for XYZ Limited Cash flow statement as per AS 3 for the year ending 31st March, 2011 (a) Cash flow from Operating Activities ` Profit before tax (2,75,000 + 1,70,000) 4,45,000 Add: Depreciation on machinery Foreign exchange loss 80,000 1,600 Preliminary expenses written off 20,000 Cash flow before working capital adjustment Add: Stock obtained on acquire 5,46,600 25,000 Increase in Current Liabilities Less: Increase in current assets 2,60,000 (2,31,000) Cash flow before tax paid Less: Tax paid (b) 6,00,600 (1,40,000) Cash flow from operating activities Cash flow from Investing Activities 4,60,600 Purchase of Machinery Purchase of investment (c) ` (95,000) (80,000) Cash flow from Financing Activities Issue of shares at premium 1,10,000 Payment of dividend Redemption of preference shares at premium Net increase/decrease in cash and cash equivalent (a+b+c) (1,60,000) (2,20,000) (1,75,000) (2,70,000) 15,600 Cash and cash equivalent at the beginning of the year 1,50,000 Cash and cash equivalent at the end of the year 1,65,600 52 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Working Notes: Plant and Machinery Account 1. ` To balance b/d 7,00,000 By depreciation To bank ` 80,000 95,000 To acquired from other 1,05,000 By balance c/f 8,20,000 9,00,000 9,00,000 Provision for Tax Account 2. ` ` To bank 1,40,000 By balance b/d 1,50,000 To balance c/f 1,80,000 By P & L 1,70,000 3,20,000 3,20,000 Profit for the year 2011 3. ` P&L Account (1,75,000-1,30,000) 45,000 Transfer to general reserve (1,20,000+1,00,000 for redemption-opening 2,00,000) 20,000 Proposed dividend Net Profit 4. 2,10,000 2,75,000 Cash and Cash Equivalent Opening balance + short term investment =1,00,000 + 50,000 = ` 1,50,000 Closing balance = Closing cash + short term investment + foreign exchange loss = 80,000+84,000+1,600=` 1,65,600 Question 5 (a) You are given the following information of the cost department of a manufacturing company: ` Stores: Opening Balance 12,60,000 Purchases 67,20,000 53 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 Transfer from work-in-progress 33,60,000 Issue to work-in-progress 67,20,000 Issue to repairs and maintenance 8,40,000 Shortage found in stock taking 2,52,000 Work-in-progress: Opening Balance Direct wages applied 25,20,000 25,20,000 Overhead applied 90,08,000 Closing Balance Finished products: 15,20,000 Entire output is sold at a profit of 12% on actual cost from work-in-progress. Other information: ` Wages incurred 29,40,000 Overhead incurred 95,50,000 Income from Investment Loss on sale of fixed assets Shortage in stock taking is treated as normal loss. 4,00,000 8,40,000 You are require to prepare: (i) Stores control account; (ii) Work-in-progress control account; (iii) Costing Profit and Loss account; (iv) Profit and Loss account and (v) Reconciliation statement (b) What is debt securitization? Explain the basic debt securitization process. (12 + 4 = 16 Marks) Answer (a) Stores Leger Control Account Dr. Cr. ` To Balance b/d ` 12,60,000 By Work-in-progress control A/c 54 The Institute of Chartered Accountants of India 67,20,000 PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT To General adjustment A/C To Work-in Control A/c ledger progress 67,20,000 By Overhead control A/c 33,60,000 By Overhead (Shortage) control 8,40,000 A/c 2,52,000 By Balance c/d 35,28,000 1,13,40,000 1,13,40,000 W.I.P Control A/c Dr. Cr. ` ` To Balance b/d 25,20,000 By Stores ledger control A/c To Stores ledger control A/c To Direct wages Control A/c 67,20,000 By Costing P&L A/c (Cost of 25,20,000 Sales) (Balancing figure) To Overhead control A/c 33,60,000 90,08,000 BY Balance c/d 1,58,88,000 15,20,000 2,07,68,000 2,07,68,000 Costing Profit and Loss A/c Dr. Cr. ` To W.I.P Control A/c To General ledger Adj. A/c (Profit) ` 1,58,88,000 By General Ledger 19,06,560 Adj. A/c Cost of sales Add 12%Profit ` 1,58,88,000 19,06,560 1,77,94,560 1,77,94,560 1,77,94,560 Financial Profit and Loss A/c Dr. Cr. ` To opening stock : Stores 12,60,000 W.I.P 25,20,000 ` ` By Sales 1,77,94,560 37,80,000 By Income from investment To Purchases 67,20,000 By stock: To Wages 29,40,000 4,00,000 Closing Stores 35,28,000 W.I.P 15,20,000 55 The Institute of Chartered Accountants of India ` 50,48,000 INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 To Overhead 95,50,000 By loss To Loss on sale of fixed assets 5,87,440 8,40,000 2,38,30,000 2,38,30,000 Reconciliation Statement Dr. Cr. ` Profit as per Cost Accounts ` 19,06,560 Add: Income from investments 4,00,000 23,06,560 Less : Loss on sale of fixed assets 8,40,000 Under absorption of overheads (working note) Loss as per Financial Accounts 20,54,000 28,94,000 5,87,440 Working Notes: Overhead Control Account Dr. Cr. ` To General Ledger Adj. A/c 9550000 By W.I.P control A/c To stores Ledger Control A/c 252000 By balance c/d (under absorption of overheads) To stores ledger control A/c 90,08,000 20,54,000 8,40,000 To wages control A/c Indirect wages (` 29,40,000-25,20,000) ` 4,20,000 1,10,62,000 1,10,62,000 (b) Debt Securitisation and its Basic Process: It is a method of recyling of funds. It is especially beneficial to financial intermediaries to support the lending volumes. Assets generating steady cash flows are packaged together and against this asset pool, market securities can be issued e.g., housing finance, auto loans, and credit card receivable. Process of Debt securitization (i) The Origination Function: A borrower seeks a loan from finance company, bank, etc., the credit worthiness of borrower is evaluated and contract is entered into with repayment schedule structured over the life of the loan. 56 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (ii) The Pooling Function: Similar loans or receivables are clubbed together to create an underlying pool of assets. The pool is transferred in favour of special purpose vehicle (SPV), which acts as a trustee for investors. (iii) The Securitization Function: SPV will structure and issue securities on the basis of assets pool. The securities carry a coupon and expected maturity, which can be asset based/mortgage based. These are generally sold to investors through merchant bankers. Investors are pension funds, mutual funds and insurance funds. The process of securitization is without resource i.e. investors bear the credit risk or risk of default. Credit enhancement facilities like insurance, letter of credit and guarantees are provided. Question 6 (a) The management of Z Company Ltd. wants to raise its funds from market to meet out the financial demands of its long-term projects. The company has various combination of proposals to raise its funds. You are given the following proposals of the company: (i) Proposals % of Equity % of Debts % of Preference shares P 100 - - Q 50 50 - 50 - 50 R (ii) Cost of debt 10% Cost of preference shares 10% (iii) Tax rate 50% (iv) Equity shares of the face value of ` 10 each will be issued at a premium of ` 10 per share. (v) Total investment to be raised ` 40,00,000. (vi) Expected earnings before interest and tax ` 18,00,000. From the above proposals the management wants to take advice from you for appropriate plan after computing the following: Earnings per share Financial break-even-point Compute the EBIT range among the plans for indifference. Also indicate if any of the plans dominate. (b) Distinguish between cost units and cost centres. 57 The Institute of Chartered Accountants of India (12 + 4 = 16 Marks) INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 Answer (a) (i) Computation of Earnings per Share (EPS) Plans P Q R ` ` ` 18,00,000 18,00,000 18,00,000 - 2,00,000 - 18,00,000 16,00,000 18,00,000 Less : Tax @ 50% 9,00,000 8,00,000 9,00,000 Earnings after tax (EAT) 9,00,000 8,00,000 9,00,000 - - 2,00,000 Earnings available for equity shareholders 9,00,000 8,00,000 7,00,000 No. of shares 2,00,000 1,00,000 1,00,000 4.5 8 7 Earnings before interest & tax (EBIT) Less: Interest charges Earnings before tax (EBT) Less : Preference share dividend E.P.S (Rs.) (ii) Computation of Financial Break-even Points Proposal P =0 Proposal Q = ` 2,00,000 (Interest charges) Proposal R = Earnings required for payment of preference share dividend i.e. ` 2,00,000 0.5 (Tax Rate) = ` 4,00,000 (iii) Computation of Indifference Point between the Proposals The indifference point (EBIT - 11 )(1 - T ) (EBIT - 12 )(1 - T ) = E1 E2 Where, EBIT = Earnings before interest and tax 11 = Fixed Charges (Interest) under Proposal P 12 = Fixed charges (Interest) under Proposal Q T = Tax Rate E1 = Number of Equity shares in Proposal P E2 = Number of Equity shares in Proposal Q 58 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT Combination of Proposals (A) Indifference point where EBIT of proposal P and proposal Q is equal (EBIT - 0)(1 - .5) (EBIT - 2,00,000)(1 - 0.5) = 2,00,000 1,00,000 .5 EBIT (1,00,000) = (.5 EBIT -1,00,000) 2,00,000 .5 EBIT = EBIT 2,00,000 EBIT = ` 4,00,000 (b) Indifference point where EBIT of proposal P and Proposal R is equal: (EBIT - 1)(1 - T ) = E1 EBIT - 12)(1 - T ) - Preference share dividend E2 (EBIT - 0)(1 - .5) (EBIT - 0)(1 - .5) - 2,00,000 = 1,00,000 2,00,000 .5EBIT .5EBIT - 2,00,000 = 2,00,000 1,00,000 .25 EBIT = 0.5 EBIT -2,00,000 EBIT = 2,00,000 0.25 = ` 8,00,000 (c) Indifference point where EBIT of proposal Q and proposal R are equal (EBIT - 2,00,000)(1 - 0.5) (EBIT - 0)(1 - 0.5) - 2,00,000 = 1,00,000 1,00,000 .5 EBIT -1,00,000 = .5 EBIT 2,00,000 There is no indifference point between proposal Q and proposal R Analysis: It can be seen that Financial proposal Q dominates proposal R , since the financial break-even-point of the former is only ` 2,00,000 but in case of latter, it is ` 4,00,000. (b) Cost units: It is a unit of product, service or time (or combination of these) in relation to which costs may be ascertained or express. A batch which consists of a group of identical items and maintain its identity through one or more stages of production may also be considered as a cost unit. Cost units are usually the units of physical measurement like number, weight, area, volume, length, time and value. 59 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 Cost centre: It is defined as a location, person or an stress of equipment (or group of these) for which cost may be ascertained and used for the purpose of cost control. Cost centres are of two types, viz., personal and impersonal. A personal cost centre consists of a person or group of persons and an impersonal cost centre consists of a location or an item of equipment (or group of these). Question 7 Answer any four of the following: (a) How do you deal with the following in cost account? (i) Packing Expenses (ii) Fringe benefits (b) Explain the following ratios: (i) Operating ratio (ii) Price earnings ratio (c) Enumerate the causes of labour turnover. (d) Write short note on William J. Baumal Vs. Miller-Orr cash management model. (e) Discuss the process of estimating profit/loss on incomplete contracts. (4 4 = 16 Marks) Answer (a) Packing expenses: Cost of primary packing necessary for protecting the product or for convenient handling, should become a part of the prime cost. The cost of packing to facilitate the transportation of the product from the factory to the customer should become a part of the distribution cost. If the cost of special packing is at the request of the customer, the same should be charged to the specific work order or the job. The cost of fancy packing necessary to attract customers is an advertising expenditure. Hence, it is to be treated as a selling overhead. Fringe benefits: These are the additional payments or facilities provided to the workers apart from their salary and direct cost-allowances like house rent and city compensatory allowances. If the amount of fringe benefit is considerably large, it may be recovered as direct charge by means of a supplementary wage or labour rate; otherwise these may be collected as part of production overheads. (b) (i) Concept of Operating Ratio Operating ratio= Cost of goods sold + operating expenses 100 Net sales This is the test of the operational efficiency with which the business is being carried; the operating ratio should be low enough to leave a portion of sales to give a fair return to the investors. 60 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (ii) Concept of Price-Earning ratio Price Earning Ratio = Market price per equity share Earning per share This ratio indicates the number of times the earnings per share is covered by its market price. It indicates the expectation of equity investors about the earnings of the firm. (c) Causes of Labour Turnover : The main causes of labour turnover in an organisation/industry can be broadly classified under the following three heads : (a) Personal Causes; (b) Unavoidable Causes; and (c) Avoidable Causes. Personal causes are those which induce or compel workers to leave their jobs; such causes include the following : (i) Change of jobs for betterment. (ii) Premature retirement due to ill health or old age. (iii) Domestic problems and family responsibilities. (iv) Discontent over the jobs and working environment. Unavoidable causes are those under which it becomes obligatory on the part of management to ask one or more of their employees to leave the organisation; such causes are summed up as listed below: (i) Seasonal nature of the business; (ii) Shortage of raw material, power, slack market for the product etc.; (iii) Change in the plant location; (iv) Disability, making a worker unfit for work; (v) Disciplinary measures; (vi) Marriage (generally in the case of women). Avoidable causes are those which require the attention of management on a continuous basis so as to keep the labour turnover ratio as low as possible. The main causes under this case are indicated below : (i) Dissatisfaction with job, remuneration, hours of work, working conditions, etc., (ii) Strained relationship with management, supervisors or fellow workers; 61 The Institute of Chartered Accountants of India INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011 (iii) Lack of training facilities and promotional avenues; (iv) Lack of recreational and medical facilities; (v) Low wages and allowances. (d) William J Baumal vs Miller- Orr Cash Management Model: According to William J Baumal s Economic order quantity model optimum cash level is that level of cash where the carrying costs and transactions costs are the minimum. The carrying costs refer to the cost of holding cash, namely, the interest foregone on marketable securities. The transaction costs refer to the cost involved in getting the marketable securities converted into cash. This happens when the firm falls short of cash and has to sell the securities resulting in clerical, brokerage, registration and other costs. The optimim cash balance according to this model will be that point where these two costs are equal. The formula for determining optimum cash balance is : 2U P C = S , Where, C U = Optimum cash balance = Annual (monthly) cash disbursements P S = Fixed cost per transaction = Opportunity cost of one rupee p.a. (or p.m) Miller-Orr cash management model is a net cash flow stochastic model. This model is designed to determine the time and size of transfers between an investment account and cash account. In this model control limits are set for cash balances. These limits may consist of h as upper limit, z as the return point, and zero as the lower limit. When the cash balances reach the upper limit, the transfer of cash equal to h-z is invested in marketable securities account. When it touches the lower limit, a transfer from marketable securities account to cash account is made. During the period when cash balance stays between (h,z) and (z, o ) i.e high and low limits no transactions between cash and marketable securities account is made. The high and low limits of cash balance are set up on the basis of fixed cost associated with the securities transactions, the opportunity cost of holding cash and the degree of likely fluctuations in cash balances. These limits satisfy the demands for cash at the lowest possible total costs. (e) Process of Estimating Profit/Loss on Incomplete Contracts: To determine the profit to be taken to Profit and Loss Account, in the case of incomplete contracts, the following process is followed: (i) Completion of contract is less than 25 per cent: In this case no profit should be taken to profit and loss account. 62 The Institute of Chartered Accountants of India PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT (ii) Completion of contract is upto 25 per cent or more than 25 per cent but less than 50 per cent: In this case one-third of the notional profit, reduced in the ratio of cash received to work certified, should be transferred to the Profit and Loss Account. Mathematically: 1 Cash received Notional Profit 3 Work received (iii) Completion of contract is upto 50 per cent or more than 50 per cent but less than 90 per cent: In this case, two-third of the notional profit, reduced by proportion of cash received to work certified, is transferred to the Profit and Loss Account. Mathematically : 2 Cash received Notional Profit 3 Work received (iv) Completion of contract is upto 90 per cent or more than 90 per cent i.e. it is nearing completion: In this case the profit to be taken to Profit and Loss Account is determined by determining the estimated Profit and using any one of the following formulas : (a) Estimated Profit Work certified Contract price (b) Estimated Profit Work certified Cash received Contract price Work certified OR Estimated Profit Cash received Contract price (c) Estimated Profit Cost of work to date Estimated total cost (d) Estimated Profit Cost of work to date Cash received Estimated total cost Work certified (e) Notional Profit Work certified Contract price 63 The Institute of Chartered Accountants of India

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