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RTP for IPCC Nov 2015 paper 3

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Shubhangi Jain
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PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PART I: COST ACCOUNTING QUESTIONS Material 1. Aditya Brothers supplies surgical gloves to nursing homes and polyclinics in the city. These surgical gloves are sold in pack of 10 pairs at price of ` 250 per pack. For the month of November 2015, it has been anticipated that a demand for 60,000 packs of surgical gloves will arise. Aditya Brothers purchases these gloves from the manufacturer at ` 228 per pack within a 4 to 6 days lead time. The ordering and related cost is ` 240 per order. The storage cost is 10% p.a. of average inventory investment. Required: (i) Calculated the Economic Order Quantity (EOQ) (ii) Calculate the number of orders needed every year (iii) Calculate the total cost of ordering and storage of the surgical gloves. (iv) Determine when should the next order to be placed. (Assuming that the company does maintain a safety stock and that the present inventory level is 10,033 packs with a year of 360 working days). Labour 2. Arnav Limited manufactures and sales plastic chairs. It pays wages under the differential piece rate system by following F.W. Taylor s System with a standard piece rate of ` 12.50 per unit of chair produced by the workers. Standard production per hour is 4 chairs. Each worker is supposed to work 8 hours a day from Monday to Friday and 5 hours on Saturday. Presently, there are 118 workers who are entitled for this plan. The plant and machinery used to manufacture the chairs was purchased long back and does not match with the efficiency of the workers. Workers appraised their concerns to the management and demanded wages on the time rate basis i.e. ` 50 per hour and the incentive under the Halsey Premium plan. The following production estimates has been made for the month of November, 2015 under the three scenarios: Scenario Production (in units) Worst case Optimal case Best case 42,400 84,960 1,27,400 Required: (a) Calculate total wages and average wages per worker per month, under the each scenario, when The Institute of Chartered Accountants of India 70 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 (i) Current system of wages and incentive payment system is followed (ii) Workers demand for time rate wages and Halsey premium plan is accepted. (b) Mr. K, during the month of October 2015, has produced 1,050 units. What will be impact on his earning if he will be able to produce the same number of units in next month also. Should he support the workers demand? (Take 4 working weeks in a month) Overheads 3. PQR manufacturers a small scale enterprise, produces a single product and has adopted a policy to recover the production overheads of the factory by adopting a single blanket rate based on machine hours. The annual budgeted production overheads for the year 2015-16 are ` 44,00,000 and budgeted annual machine hours are 2,20,000. For a period of first six months of the financial year 2015 -2016, following information were extracted from the books: Actual production overheads ` 24,88,200 Amount included in the production overheads: Paid as per court s order ` 1,28,000 Expenses of previous year booked in current year ` 1,200 Paid to workers for strike period under an award ` 44,000 Obsolete stores written off ` 6,700 Production and sales data of the concern for the first six months are as under: Production: Finished goods 24,000 units Works-in-progress (50% complete in every respect) 18,000 units Finished goods 21,600 units Sale: The actual machine hours worked during the period were 1,16,000 hours. It is revealed from the analysis of information that of the under/ over absorption was due to defective production policies and the balance was attributable to increase/decrease in costs. Required: (i) Determine the amount of under/over absorption of production overheads for the six months period of 2015-16. (ii) Show the accounting treatment of under/ over absorption of production overheads, and The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 71 (iii) Apportion the under/ over absorbed overheads over the items. Non-integrated Accounting 4. As of 31st March, 2015, the following balances existed in a firm s cost ledger, which is maintained separately on a double entry basis: Debit( (`) Credit( (`) Stores Ledger Control A/c 3,20,000 Work-in-progress Control A/c 1,52,000 Finished Goods Control A/c 2,56,000 Manufacturing Overhead Control A/c 28,000 Cost Ledger Control A/c 7,00,000 7,28,000 7,28,000 During the next quarter, the following items arose: (`) Finished Product (at cost) Manufacturing overhead incurred Raw material purchased 2,35,500 91,000 1,36,000 Factory wages 48,000 Indirect labour 20,600 Cost of sales 1,68,000 Materials issued to production 1,26,000 Sales returned (at cost) 8,000 Materials returned to suppliers 11,000 Manufacturing overhead charged to production 86,000 You are required to prepare the Cost Ledger Control A/c, Stores Ledger Control A/c, Work-in-progress Control A/c, Finished Stock Ledger Control A/c, Manufacturing Overhead Control A/c, Wages Control A/c, Cost of Sales A/c and the Trial Balance at the end of the quarter as per costing records. Contract Costing 5. Get Homes Constructions has undertaken three separate building contracts. Information relating to these contracts for the year 2014-15 are as under: The Institute of Chartered Accountants of India 72 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Contract I (Amount in ` 000) Value of contract Contract II (Amount in ` 000) Contract IIII (Amount in ` 000) 17,500 14,500 24,500 Work completed and certified -- 4,100 8,150 Materials at site -- 220 310 Plant & Machinery (WDV) -- 770 3,760 Wages outstanding -- 48 104 Profit transferred to Costing P/L A/c. -- -- 350 Materials issued to the sites 870 2,150 4,020 Wages paid to workers 450 1,160 2,180 Salary to site staffs 90 85 135 Travelling and other expenses 18 24 32 910 240 680 110 90 126 Materials at site 215 152 12 Plant & Machinery (WDV) 728 808 3,552 52 98 146 2,000 8,600 24,000 800 452 560 Balance as on 01-04-2014: Transaction during the year: Plants issued to sites Apportionment expenses of Head office Balance as on 31-03-2015: Wages outstanding Value of work certified Cost of work not certified As per the contract agreement 15% of the certified value of the contract is kept by the contractees as retention money. The Contact-III is scheduled to be completed in the coming months, however, this contract required a further estimated cost of ` 7,20,000 to get it completed. Required: (a) Prepare Contract Statement for each of the three contracts and calculate the notional/ estimated profit/ loss (b) Calculate the profit/ loss to be transferred to Costing Profit & Loss Account for internal managerial purpose. The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 73 Process Costing 6. Star Ltd. manufactures chemical solutions for the food processing industry. The manufacturing takes place in a number of processes and the company uses a FIFO process costing system to value work-in-process and finished goods. At the end of the last month, a fire occurred in the factory and destroyed some of the paper files containing records of the process operations for the month. Star Ltd. needs your help to prepare the process accounts for the month during which the fire occurred. You have been able to gather some information about the month s operating activities but some of the information could not be retrieved due to the damage. The following information was salvaged: Opening work-in-process at the beginning of the month was 800 litres, 70% complete for labour and 60% complete for overheads. Opening work-in-process was valued at ` 26,640. Closing work-in-process at the end of the month was 160 litres, 30% complete for labour and 20% complete for overheads. Normal loss is 10% of input and total losses during the month were 1,800 litres partly due to the fire damage. Output sent to finished goods warehouse was 4,200 litres. Losses have a scrap value of `15 per litre. All raw materials are added at the commencement of the process. The cost per equivalent unit (litre) is `39 for the month made up as follows: (` `) Raw Material 23 Labour 7 Overheads 9 39 Required: (a) Calculate the quantity (in litres) of raw material inputs during the month. (b) Calculate the quantity (in litres) of normal loss expected from the process and the quantity (in litres) of abnormal loss / gain experienced in the month. (c) Calculate the values of raw material, labour and overheads added to the process during the month. (d) Prepare the process account for the month. The Institute of Chartered Accountants of India 74 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Standard Costing 7. Jigyasa Pharmaceuticals Ltd. is engaged in producing dietary supplement Funkids for growing children. It produces Funkids in a batch of 10 kgs. Standard material inputs required for 10 kgs. of Funkids are as below: Material Quantity (in kgs.) Rate per kg. (in ` ) Vita-X 5 110 Proto-D 3 320 Mine-L 3 460 During the month of March, 2015, actual production was 5,000 kgs. of Funkids for which the actual quantities of material used for a batch and the prices paid thereof are as under: Material Quantity (in kgs.) Rate per kg. (in ` ) Vita-X 6 115 Proto-D 2.5 330 Mine-L 2 405 You are required to calculate the following variances based on the above given information for the month of March, 2015 for Jigyasa Pharmaceuticals Ltd.: (i) Material Cost Variance; (ii) Material Price Variance; (iii) Material Usage Variance; (iv) Material Mix Variance; (v) Material Yield Variance. Marginal Costing 8. T Ltd produces a single product T-10 and sells it at a fixed price of ` 2,050 per unit. The production and sales data for first quarter of the year 2014-15 are as follows: April May June Sales in units 4,200 4,500 5,200 Production in units 4,600 4,400 5,500 Actual/budget information for each month was as follows: Direct materials 4 kilograms at `120 per kilogram Direct labour 6 hours at `60 per hour The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT Variable production overheads 150% of direct labour Sales commission 15% of sales value Fixed production overheads ` 5,00,000 Fixed selling overheads 75 ` 95,000 There was no opening inventory at the start of the quarter. Fixed production overheads are budgeted at ` 60,00,000 per annum and are absorbed into products based on a budgeted normal output of 60,000 units per annum. Required: (a) Prepare a profit statement for each of the three months using absorption costing principles. (b) Prepare a profit statement for each of the three months using marginal costing principles. (c) Present a reconciliation of the profit or loss figures given in your answer to (a) and (b). Budget and Budgetary Control 9. G Ltd. manufactures two products called M and N . Both products use a common raw material Z. The raw material Z is purchased @ ` 36 per kg from the market. The company has decided to review inventory management policies for the forthcoming year. The following forecast information has been extracted from departmental estimates for the year ended 31st March 2016 (the budget period): Product M Sales (units) Finished goods stock increase by year-end Post-production rejection rate (%) Material Z usage (per completed unit, net of wastage) Material Z wastage (%) Product N 28,000 320 13,000 160 4 5 kg 6 6 kg 10 5 Additional information: - Usage of raw material Z is expected to be at a constant rate over the period. - Annual cost of holding one unit of raw material in stock is 11% of the material cost. - The cost of placing an orders is ` 320 per order. - The management of G Ltd. has decided that there should not be more than 40 orders in a year for the raw material Z. The Institute of Chartered Accountants of India 76 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Required: (a) Prepare functional budgets for the year ended 31st March 2016 under the following headings: (i) Production budget for Products M and N (in units). (ii) Purchases budget for Material Z (in kgs and value). (b) Calculate the Economic Order Quantity for Material Z (in kgs). (c) If there is a sole supplier for the raw material Z in the market and the supplier do not sale more than 4,000 kg. of material Z at a time. Keeping the management purchase policy and production quantity mix into consideration, calculate the maximum number of units of Product M and N that could be produced. Miscellaneous 10. (a) Define Product costs. Describe three different purposes for computing product costs. (b) What do you understand by Operating Costs? Describe its essential features and state where it can be usefully implemented? (c) How apportionment of joint costs upto the point of separation amongst the joint products using market value at the point of separation and net realizable value method is done? Discuss. (d) Explain: (i) Pre-production Costs (ii) Research and Development Costs (iii) Training Costs SUGGESTED HINTS/ANSWERS 1. (i) Calculation of Economic Order Quantity: EOQ = 2 A O = Ci 2 (60,000 packs 12 months) ` 240 ` 228 10% = 3,893.3 packs or 3,893 packs. (ii) Number of orders per year Annual requirements = E.O.Q 7,20,000 packs =184.9or185orders a year 3,893 packs The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 77 (iii) Ordering and storage costs (`) Ordering costs : 185 orders ` 240 44,400.00 Storage cost : (3,893 packs 10% of `228) 44,380.20 Total cost of ordering & storage 88,780.20 (iv) Timing of next order (a) Day s requirement served by each order. Number of days requirements = 360days No. of working days = = 1.94 days No. of order in a year 185orders supply. This implies that each order of 3,893 packs supplies for requirements of 1.94 days only. (b) Days requirement covered by inventory = Units in inventory (Day's requirement served by an order) Economic order quantity 10,033 packs 1.94 days = 5 days requirement 3,893 packs (c) Time interval for placing next order Inventory left for day s requirement Average lead time of delivery 5 days 5 days = 0 days This means that next order for the replenishment of supplies has to be placed immediately. 2. (a) Calculation of Total wages and average wages per worker per month. (i) When Current system of wages and incentive payment system is followed: Worst case Optimal case Best case I Standard Production (in units) (45 hours 4 units 4 weeks 118 workers) 84,960 84,960 84,960 II No. of units to be produced 42,400 84,960 1,27,400 III Efficiency {(II I) 100} 49.91% 100% 149.95% The Institute of Chartered Accountants of India 78 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 IV Differential piece rate* V Total Wages (II IV) `4,24,000 `12,74,400 `19,11,000 VI Average wages per worker (V 118) `3,593.22 `10,800 `16,194.92 `10 (`12.5 0.8) `15 `15 (`12.5 1.2) (`12.5 1.2) *For efficiency less than 100%, 83% of piece rate and for efficiency more than or equals to 100%, 125% of piece rate may also be taken. (ii) When workers demand for time rate wages and Halsey premium plan is accepted: Worst case Optimal case Best case I No. of units expected to be produced (units) 42,400 84,960 1,27,400 II Standard no. units in an hour (units) 4 4 4 III Standard Hours (I II) 10,600 21,240 31,850 IV Expected working hours (45 hours 4 weeks 118 workers) 21,240 21,240 21,240 V Hours to be saved (III IV) -- -- 10,610 VI Time wages (IV `50) VII Incentive under Premium Plan `10,62,000 `10,62,000 `10,62,000 -- Halsey -- `2,65,250 1 Time saved ` 50 2 VIII Total Wages (VI +VII) IX Average wages per worker (VIII 118) `10,62,000 `10,62,000 `13,27,250 `9,000 `9,000 `11,247.88 (b) Calculation of gain or loss in the current monthly income of Mr. K: Wages earned in October 2015: Standard production unit (45 hours 4 weeks 4 units) No. of units produced Efficiency Differential piece rate (refer the above part) I Total wages (1,050 units `15) The Institute of Chartered Accountants of India 720 units 1,050 units 145.83% `15 `15,750 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 79 Expected wages under the new scheme Standard hours (1,050 units 4 units) 262.50 hours Expected hours to be taken 180 hours (45 hours 4 weeks) Time saved 82.50 hours Time wages (180 hours `50) `9,000 `2,062.50 1 Incentive Time saved `50 2 II Total expected wages `11,062.50 Loss from the proposed scheme (II I) `4,687.50 Supporting the demand of colleague workers will cost `4,687.50 in the next month to Mr. K. 3. (i) Amount of under/ over absorption of production overheads during the period of first six months of the year 2015-2016: Amount (`) Total production overheads actually incurred during the period Amount (`) 24,88,200 Less: Amount paid to worker as per court order 1,28,000 Expenses of previous year booked in the current year 1,200 Wages paid for the strike period under an award 44,000 Obsolete stores written off 6,700 (1,79,900) 23,08,300 Less: Production overheads absorbed as per machine hour rate (1,16,000 hours `20*) Amount of overheads over absorbed production *Budgeted Machine hour rate (Blanket rate) = 23,20,000 11,700 ` 44,00,000 = ` 20 per hour 2,20,000 hours (ii) Accounting treatment of over absorbed production overheads: As, one fourth of the over absorbed overheads were due to defective production policies, this being abnormal, hence should be transferred to Costing Profit and Loss Account. The Institute of Chartered Accountants of India 80 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Amount to be transferred to Costing Profit and Loss Account = (11,700 * ) ` 2,925 Balance of over absorbed production overheads should be distributed over Works in progress, Finished goods and Cost of sales by applying supplementary rate*. Amount to be distributed = (11,700 * ) ` 8,775 Supplementary rate = ` 8,875 = ` 0.2689 per unit 33,000 units (iii) Apportionment of under absorbed production overheads over WIP, Finished goods and Cost of sales: Equivalent completed units Amount (`) Work-in-Progress (18,000 units 50% ` 0.2689) 9,000 2,420 Finished goods (2,400 units ` 0.2689) 2,400 646 Cost of sales (21,600 units ` 0.2689) 21,600 5,809 Total 33,000 8,875 4. Cost Ledger Control Account (`) To Store Ledger Control A/c To Balance c/d (`) 11,000 By Opening Balance 9,84,600 By Store ledger control A/c 7,00,000 1,36,000 By Manufacturing Overhead Control A/c 91,000 By Wages Control A/c 68,600 9,95,600 9,95,600 Stores Ledger Control Account (`) (`) To Opening Balance 3,20,000 By WIP Control A/c To Cost ledger control A/c 1,36,000 By Cost ledger control A/c (Returns) By Balance c/d 4,56,000 The Institute of Chartered Accountants of India 1,26,000 11,000 3,19,000 4,56,000 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 81 WIP Control Account (`) To Opening Balance (`) 1,52,000 By Finished Stock Ledger Control A/c To Wages Control A/c 48,000 By Balance c/d To Stores Ledger Control A/c To Manufacturing Overhead Control A/c 2,35,500 1,76,500 1,26,000 86,000 4,12,000 4,12,000 Finished Stock Ledger Control Account (`) (`) To Opening Balance 2,56,000 By Cost of Sales 1,68,000 To WIP Control A/c 2,35,500 By Balance c/d 3,31,500 To Cost of Sales A/c (Sales Return) 8,000 4,99,500 4,99,500 Manufacturing Overhead Control Account (`) (`) To Cost Ledger Control A/c 91,000 By Opening Balance 28,000 To Wages Control A/c 20,600 By WIP Control A/c 86,000 To Over recovery c/d 2,400 1,14,000 1,14,000 Wages Control Account (`) To Transfer to Cost Ledger Control A/c (`) 68,600 By WIP Control A/c By Manufacturing Control A/c 68,600 The Institute of Chartered Accountants of India 48,000 Overhead 20,600 68,600 82 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Cost of Sales Account (`) To Finished Stock Ledger Control A/c (`) 1,68,000 By Finished Stock Ledger Control A/c (Sales return) 8,000 By Balance c/d 1,60,000 1,68,000 1,68,000 Trial Balance (`) Stores Ledger Control A/c 3,19,000 WIP Control A/c 1,76,500 Finished Stock Ledger Control A/c (`) 3,31,500 Manufacturing Overhead Control A/c -- Cost of Sales A/c 2,400 1,60,000 Cost ledger control A/c (a) Contract Statement The Institute of Chartered Accountants of India 9,87,000 (Amount in ` 000) Contract-I (`) Balance as on 01-04-2014: - Work completed and certified - Materials at site - Plant & Machinery Transaction during the year: Materials issued Wages paid to workers Less: Outstanding at beginning Add: Outstanding at closing Salary to site staffs Travelling and other expenses Plant issued to sites Apportionment of Head office expenses Total (A) 9,84,600 9,87,000 5. -- Contract-II (`) ContractIII (`) ---- 4,100 220 770 8,150 310 3,760 870 450 -52 90 18 910 110 2,150 1,160 (48) 98 85 24 240 90 4,020 2,180 (104) 146 135 32 680 126 2,500 8,889 19,435 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 83 Balance as on 31-03-2015 - Materials at site 215 152 12 - Plant & Machinery 728 808 3,552 - Work in progress: 2,000 8,600 24,000 800 452 560 -- -- 720 Total (B) 3,743 10,012 28,844 Notional/ estimated profit {(B) (A)} 1,243 1,123 9,409 - Value of work certified - Cost of work not certified Estimated additional cost (b) Profit to be transferred to Costing Profit and Loss Account for internal purpose: Contract-I Value of Contract 17,500 Value of work certified 2,000 Percentage of completion (%) 11.43 Contract-II 14,500 8,600 59.31 Contract-III 24,500 24,000 97.96 1,123 636.37 9,409 7,484.50 {(9,409 97.96% 85%) - 350} Work certified 100 Value of contract Notional/ Estimated profit Profit to be transferred to Costing Profit & loss A/c 6. 1,243 Nil 2 `1,123 85% 3 (a) Calculation of Raw Material inputs during the month: Quantities Entering Process Opening WIP Raw material input (balancing figure) Litres Quantities Process 800 Transfer Goods Leaving Litres to 5,360 Process Losses Closing WIP 6,160 The Institute of Chartered Accountants of India Finished 4,200 1,800 160 6,160 84 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 (b) Calculation of Normal Loss and Abnormal Loss/Gain Litres Total process losses for month 1,800 Normal Loss (10% input) 536 Abnormal Loss (balancing figure) 1,264 (c) Calculation of values of Raw Material, Labour and Overheads added to the process: Material Labour Overheads Cost per equivalent unit `23.00 `7.00 `9.00 Equivalent units (litre) (refer the working note) 4,824 4,952 5,016 Cost of equivalent units `1,10,952 `34,664 `45,144 `8,040 -- -- `1,18,992 `34,664 `45,144 Add: Scrap value of normal loss (536 units ` 15) Total value added Workings: Statement of Equivalent Units (litre): Input Details Opening WIP Equivalent Production Units Output details Units Material Labour Overheads Units (%) Units (%) Units (%) 800 Units completed: Units 5,360 introduced - Opening WIP 800 -- -- 240 30 320 40 - Fresh inputs 3,400 3,400 100 3,400 100 3,400 100 Normal loss Abnormal loss Closing WIP 6,160 The Institute of Chartered Accountants of India 536 -- -- -- -- -- -- 1,264 1,264 100 1,264 100 1,264 100 160 160 100 6,160 4,824 48 4,952 30 32 5,016 20 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT (d) 85 Process Account for Month Litres To Opening WIP 800 To Raw Materials 5,360 Amount (`) Litres Amount (`) 26,640 By Finished goods 1,18,992 By Normal loss To Wages -- 34,664 By Abnormal loss To Overheads -- 45,144 By Closing WIP 6,160 2,25,440 4,200 1,63,800 536 8,040 1,264 49,296 160 4,304 6,160 2,25,440 7. Material SQ* SP AQ** SP AQ** AP RSQ*** SP Vita-X ` 2,75,000 (2,500 kg. ` 110) ` 3,30,000 (3,000 kg. ` 110) ` 3,45,000 (3,000 kg. ` 115) ` 2,62,460 (2,386 kg. ` 110) Proto-D ` 4,80,000 (1,500 kg. ` 320) ` 4,00,000 (1,250 kg. ` 320) ` 4,12,500 (1,250 kg. ` 330) ` 4,58,240 (1,432 kg. ` 320) Mine-L ` 6,90,000 (1,500 kg. ` 460) ` 4,60,000 (1,000 kg. ` 460) ` 4,05,000 (1,000 kg. ` 405) ` 6,58,720 (1,432 kg. ` 460) ` 14,45,000 ` 11,90,000 ` 11,62,500 ` 13,79,420 Total * Standard Quantity of materials for actual output : Vita-X = Proto-D = Mine-L = 5kgs. 5,000kgs. = 2,500kgs. 10kgs 3kgs. 5,000kgs. = 1,500kgs. 10kgs 3kgs. 5,000kgs. = 1,500kgs. 10kgs ** Actual Quantity of Material used for actual output: Vita-X = Proto-D = Mine-L = 6kgs. 10kgs 5,000kgs. = 3,000kgs. 2.5kgs. 10kgs 2kgs. 10kgs 5,000kgs. = 1,250kgs. 5,000kgs. = 1,000kgs. The Institute of Chartered Accountants of India 86 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 ***Revised Standard Quantity (RSQ): Vita-X = Proto-D = Mine-L = (i) 5kgs. 5,250kgs. = 2,386kgs. 11 kgs 3kgs. 11kgs 3kgs. 11kgs 5,250kgs. = 1,432kgs. 5,250kgs. = 1,432kgs. Material Cost Variance = (Std. Qty. Std. Price) (Actual Qty. Actual Price) Or Vita-X = (SQ SP) (AQ AP) = ` 2,75,000 - ` 3,45,000 = ` 70,000 (A) Proto-D = ` 4,80,000 - ` 4,12,500 = ` 67,500 (F) Mine-L = ` 6,90,000 - ` 4,05,000 = ` 2,85,000 (F) ` 2,82,500 (F) (ii) Material Price Variance Vita-X Proto-D Mine-L = Actual Quantity (Std. Price Actual Price) = (AQ SP) (AQ AP) = ` 3,30,000 - ` 3,45,000 = ` 4,00,000 - ` 4,12,500 = ` 4,60,000 - ` 4,05,000 = ` 15,000 = ` 12,500 = ` 55,000 ` 27,500 (A) (A) (F) (F) (iii) Material Usage Variance = Std. Price (Std. Qty. Actual Qty.) Or Vita-X = (SQ SP) (AQ SP) = ` 2,75,000 - ` 3,30,000 = ` 55,000 (A) Proto-D = ` 4,80,000 - ` 4,00,000 = ` 80,000 (F) Mine-L = ` 6,90,000 - ` 4,60,000 = ` 2,30,000 (F) ` 2,55,000 (F) (iv) Material Mix Variance Or Vita-X = Std. Price (Revised Std. Qty. Actual Qty.) = (RSQ SP) (AQ SP) = ` 2,62,460 - ` 3,30,000 = ` 67,540 (A) Proto-D = ` 4,58,240 - ` 4,00,000 = ` 58,240 (F) Mine-L = ` 6,58,720 - ` 4,60,000 = ` 1,98,720 (F) = ` 1,89,420 (F) The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 87 (v) Material Yield Variance = Std. Price (Std. Qty. Revised Std. Qty.) Or Vita-X = ` 12,540 (F) Proto-D = ` 4,80,000 - ` 4,58,240 = ` 21,760 (F) Mine-L = ` 6,90,000 - ` 6,58,720 = ` 31,280 (F) = ` 65,580 8. = (SQ SP) (RSQ SP) = ` 2,75,000 - ` 2,62,460 (F) (a) Statement of Profit under Absorption Costing April (`) Particulars May (`) June (`) Sales (units) 4,200 4,500 5,200 Selling price per unit 2,050 2,050 2,050 86,10,000 92,25,000 1,06,60,000 0 5,92,000 4,44,000 Sales value (A) Cost of Goods Sold: - Opening Stock @ `1,480 - Production cost @ `1,480 68,08,000 65,12,000 81,40,000 - Closing Stock @ `1,480 (5,92,000) (4,44,000) (8,88,000) - Under/ (Over) absorption 40,000 60,000 (50,000) Add: Fixed Selling Overheads 95,000 95,000 95,000 (B) 63,51,000 68,15,000 77,41,000 (A B) 22,59,000 24,10,000 29,19,000 Cost of Sales Profit Workings: 1. Calculation of full production cost (`) Direct Materials (4 kg. ` 120) 480 Direct labour (6 hours ` 60) 360 Variable production Overhead (150% of ` 360) 540 Total Variable cost `60,00,000 Fixed production overhead 60,000units 1,380 100 1,480 The Institute of Chartered Accountants of India 88 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 2. Calculation of Opening and Closing stock April May June Opening Stock 0 400 300 Add: Production 4,600 4,400 5,500 Less: Sales 4,200 4,500 5,200 400 300 600 Closing Stock 3. Calculation of Under/Over absorption of fixed production overhead April (` `) Overhead absorbed June (` `) 5,00,000 Actual Overhead May (` `) 5,00,000 5,00,000 4,60,000 4,40,000 5,50,000 (4,600 units `100) (4,600 units `100) (4,600 units `100) 40,000 60,000 (50,000) Under/(Over) absorption (b) Statement of Profit under Marginal Costing Particulars April (`) May (`) June (`) Sales (units) 4,200 4,500 5,200 Selling price per unit 2,050 2,050 2,050 Sales value 86,10,000 92,25,000 1,06,60,000 Less: Variable production cost 57,96,000 62,10,000 71,76,000 Contribution 28,14,000 30,15,000 34,84,000 5,00,000 5,00,000 5,00,000 95,000 95,000 95,000 22,19,000 24,20,000 28,89,000 Less: Fixed Production Overheads Less: Fixed Selling Overheads Profit (c) Reconciliation of profit under Absorption costing to Marginal Costing Particulars Profit under Absorption Costing Add: Opening Stock Less: Closing Stock Profit under Marginal Costing The Institute of Chartered Accountants of India April (` `) 22,59,000 0 40,000 May (` `) 24,10,000 40,000 (400 ` 100) 30,000 June (` `) 29,19,000 30,000 (300 ` 100) 60,000 (400 ` 100) (300 ` 100) (600 ` 100) 22,19,000 24,20,000 28,89,000 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 9. (a) (i) 89 Production Budget (in units) for the year ended 31st March 2016 Product M Product N 28,000 13,000 Add: Increase in closing stock 320 160 No. good units to be produced 28,320 13,160 Post production rejection rate 4% 6% 29,500 14,000 28,320 0.96 13,160 0.94 Budgeted sales (units) No. of units to be produced (ii) Purchase budget (in kgs and value) for Material Z Product M Product N 29,500 14,000 5 kg. 6 kg. Material needed for production 1,47,500 kg. 84,000 kg. Materials to be purchased 1,63,889 kg. 88,421 kg. 1,47,500 0.90 84,000 0.95 No. of units to be produced Usage of Material Z per unit of production Total quantity to be purchased 2,52,310 kg. Rate per kg. of Material Z `36 Total purchase price `90,83,160 (b) Calculation of Economic Order Quantity for Material Z EOQ = 2 2,52,310kg. `320 = `36 11% 16,14,78,400 = 6,385.72 kg. `3.96 (c) Since, the maximum number of order per year can not be more than 40 orders and the maximum quantity per order that can be purchased is 4,000 kg. Hence, the total quantity of Material Z that can be available for production: = 4,000 kg. 40 orders = 1,60,000 kg. Product M Material needed for production to maintain the same production mix The Institute of Chartered Accountants of India Product N 1,03,929 kg. 56,071 kg. 1,63,889 1,60,000 2,52,310 88,421 1,60,000 2,52,310 90 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Less: Process wastage 10,393 kg. 2,804 kg. Net Material available for production 93,536 kg. 53,267 kg. 18,707 units 8,878 units 53,267kg. 6kg. Units to be produced 93,536kg. 5kg. 10. (a) Definition of product costs: Product costs are inventoriable costs. These are the costs, which are assigned to the product. Under marginal costing variable manufacturing costs and under absorption costing, total manufacturing costs constitute product costs. Purposes for computing product costs: The three different purposes for computing product costs are as follows: (i) Preparation of financial statements: Here focus is on inventoriable costs. (ii) Product pricing: It is an important purpose for which product costs are used. For this purpose, the cost of the areas along with the value chain should be included to make the product available to the customer. (iii) Contracting with government agencies: For this purpose government agencies may not allow the contractors to recover research and development and marketing costs under cost plus contracts. (b) Operating Costs are the costs incurred by undertakings which do not manufacture any product but provide a service. Such undertakings for example are Transport concerns, Gas agencies; Electricity Undertakings; Hospitals; Theatres etc. Because of the varied nature of activities carried out by the service undertakings, the cost system used is obviously different from that followed in manufacturing concerns. The essential features of operating costs are as follows: (1) The operating costs can be classified under three categories. For example in the case of transport undertaking these three categories are as follows: (a) Operating and running charges: It includes expenses of variable nature. For example expenses on petrol, diesel, lubricating oil, and grease etc. (b) Maintenance charges: These expenses are of semi-variable nature and includes the cost of tyres and tubes, repairs and maintenance, spares and accessories, overhaul, etc. (c) Fixed or standing charges: These includes garage rent, insurance, road licence, depreciation, interest on capital, salary of operating manager, etc. (2) The cost unit used is composite like passenger-mile; Kilowatt-hour, etc. The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 91 It can be implemented in all firms of transport, airlines, bus-service, etc., and by all firms of distribution undertakings. (c) Apportionment of Joint Cost amongst Joint Products using: Market value at the point of separation This method is used for apportionment of joint costs to joint products upto the split off point. It is difficult to apply if the market value of the product at the point of separation is not available. It is useful method where further processing costs are incurred disproportionately. Net realizable value Method From the sales value of joint products (at finished stage) the followings are deducted: Estimated profit margins Selling & distribution expenses, if any Post split off costs. The resultant figure so obtained is known as net realizable value of joint products. Joint costs are apportioned in the ratio of net realizable value. (d) (i) Pre-production Costs: These costs forms the part of development cost, incurred in making a trial production run, preliminary to formal production. These costs are incurred when a new factory is in the process of establishment or a new project is undertaken or a new product line or product is taken up, but there is no established or formal production to which such costs may be charged. (ii) Research and Development Costs: Research costs are the costs incurred for the original and planned investigation undertaken with a prospect of gaining new scientific or technical knowledge and understanding. Development costs are the cost incurred in applying research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services prior to the commencement of commercial production or use. (iii) Training Costs: Costs which are incurred in and in relation to providing training to the workers, apprentices, executives etc. Training cost consists of wages and salaries paid to new trainees, fees paid to trainers, cost of materials and properties used to train the trainees, costs associated with training centre, loss suffered due to lower production and extra spoilage etc. The total cost of training section is thereafter apportioned to production centers. The Institute of Chartered Accountants of India 92 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 PART II: FINANCIAL MANAGEMENT QUESTIONS Time Value of Money 1. You need a sum of ` 1,00,000 at the end of 10 years. You know that the best you can do is to deposit some lump sum amount today at 6% rate of interest or to make equal payments into a bank account, starting a year from now on which you can earn 6% interest. Find out (i) What amount to be deposited today or (ii) What amount must be deposited annually? Ratio Analysis 2. Based on the following particulars show various assets and liabilities of Tirupati Ltd. Fixed assets turnover ratio 8 times Capital turnover ratio Inventory Turnover 2 times 8 times Receivable turnover Payable turnover 4 times 6 times GP Ratio 25% Gross profit during the year amounts to ` 8,00,000. There is no long-term loan or overdraft. Reserve and surplus amount to ` 2,00,000. Ending inventory of the year is ` 20,000 above the beginning inventory. Cash Flow Analysis 3. Balance Sheets of RIO Ltd. as on 31st March, 2014 and 2015 were as follows: Liabilities Equity Share Capital 31.3.14 (` `) 31.3.15 (` `) Assets 10,00,000 10,00,000 Goodwill 31.3.14 (` `) 31.3.15 (` `) 1,00,000 80,000 8% Preference Share Capital 2,00,000 3,00,000 Land and Building 7,00,000 6,50,000 General Reserve 1,20,000 1,45,000 Plant & Machinery 6,00,000 6,60,000 2,40,000 2,20,000 Securities Premium -- Profit and Loss A/c 2,10,000 3,00,000 Stock 4,00,000 3,85,000 11% Debentures 5,00,000 3,00,000 Debtors 2,88,000 4,15,000 Creditors 1,85,000 2,15,000 Cash and Bank 88,000 93,000 The Institute of Chartered Accountants of India 25,000 Investments (non-trading) PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT Provision for tax 80,000 Proposed Dividend 1,36,000 1,05,000 Prepaid Expenses 1,44,000 Premium Redemption Debentures on of 24,31,000 25,34,000 15,000 -- 93 11,000 20,000 24,31,000 25,34,000 Additional Information: 1. Investments were sold during the year at a profit of ` 15,000. 2. During the year an old machine costing ` 80,000 was sold for ` 36,000. Its written down value was ` 45,000. 3. Depreciation charged on Plants and Machinery @ 20 per cent on the opening balance. 4. There was no purchase or sale of Land and Building. 5. Provision for tax made during the year was ` 96,000. 6. Preference shares were issued for consideration of cash during the year. You are required to prepare: (i) Cash flow statement as per AS- 3. (ii) Schedule of Changes in Working Capital. Cost of Capital 4. Navya Limited wishes to raise additional capital of `10 lakhs for meeting its modernisation plans. It has ` 3,00,000 in the form of retained earnings available for investments purposes. The following are the further details: Debt/equity mix 40%/60% Cost of debt (before tax) Upto ` 1,80,000 10% Beyond ` 1,80,000 16% Earnings per share `4 Dividend pay out `2 Expected growth rate in dividend 10% Current market price per share ` 44 Tax rate 50% You are required: (a) To ascertain the pattern for raising the additional finance. The Institute of Chartered Accountants of India 94 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 (b) To calculate the post-tax average cost of additional debt. (c) To calculate the cost of retained earnings and cost of equity, and (d) Find out the overall weighted average cost of capital (after tax). Capital Structure Decisions 5. Company P and Q are identical in all respects including risk factors except for debt/equity, company P having issued 10% debentures of ` 18 lakhs while company Q is unlevered. Both the companies earn 20% before interest and taxes on their total assets of ` 30 lakhs. Assuming a tax rate of 50% and capitalization rate of 15% from an all-equity company. Compute the value of companies P and Q using (i) Net Income Approach and (ii) Net Operating Income Approach. Leverage 6. A firm has sales of ` 75,00,000 variable cost is 56% and fixed cost is ` 6,00,000. It has a debt of ` 45,00,000 at 9% and equity of ` 55,00,000. (i) What is the firm s ROI? (ii) Does it have favourable financial leverage? (iii) If the firm belongs to an industry whose capital turnover is 3, does it have a high or low capital turnover? (iv) What are the operating, financial and combined leverages of the firm? (v) If the sales is increased by 10% by what percentage EBIT will increase? (vi) At what level of sales the EBT of the firm will be equal to zero? (vii) If EBIT increases by 20%, by what percentage EBT will increase? Capital Budgeting 7. BT Pathology Lab Ltd. is using a X-ray machines which reached at the end of their useful lives. Following new X-ray machines of two different brands with same features are available for the purchase. Maintenance Cost Brand Cost of Machine Life of Machine Year 1-5 Year 6-10 Year 1115 XYZ `6,00,000 15 years ` 20,000 ` 28,000 ` 39,000 Rate of Depreciation 4% ABC `4,50,000 10 years -6% ` 31,000 ` 53,000 Residual Value of both of above machines shall be dropped by 1/3 of Purchase price in the first year and thereafter shall be depreciated at the rate mentioned above. The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 95 Alternatively, the machine of Brand ABC can also be taken on rent to be returned back to the owner after use on the following terms and conditions: Annual Rent shall be paid in the beginning of each year and for first year it shall be ` 1,02,000. Annual Rent for the subsequent 4 years shall be ` 1,02,500. Annual Rent for the final 5 years shall be ` 1,09,950. The Rent Agreement can be terminated by BT Labs by making a payment of ` 1,00,000 as penalty. This penalty would be reduced by ` 10,000 each year of the period of rental agreement. You are required to: (a) Advise which brand of X-ray machine should be acquired assuming that the use of machine shall be continued for a period of 20 years. (b) Which of the option is most economical if machine is likely to be used for a period of 5 years? The cost of capital of BT Labs is 12%. Management of Payables (Creditors) 8. A Ltd. is in the manufacturing business and it acquires raw material from X Ltd. on a regular basis. As per the terms of agreement the payment must be made within 40 days of purchase. However A Ltd. has a choice of paying ` 98.50 per ` 100 it owes to X Ltd. on or before 10th day of purchase. Should A Ltd. accept the offer of discount assuming average billing of A Ltd. with X Ltd. is ` 10,00,000 and an alternative investment yield a return of 15% and company pays the invoice. Financing of Working Capital 9. Following information is forecasted by the Puja Limited for the year ending 31st March, 2015: Balance as at 1st April, 2014 Balance as at 31st March, 2015 (`) (`) Raw Material 45,000 65,356 Work-in-progress 35,000 51,300 Finished goods 60,181 70,175 1,12,123 1,35,000 50,079 70,469 Debtors Creditors Annual purchases of raw material (all credit) The Institute of Chartered Accountants of India 4,00,000 96 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Annual cost of production 7,50,000 Annual cost of goods sold 9,15,000 Annual operating cost 9,50,000 Annual sales (all credit) 11,00,000 You may take one year as equal to 365 days. You are required to calculate: (i) Net operating cycle period. (ii) Number of operating cycles in the year. (iii) Amount of working capital requirement using operating cycles. Miscellaneous 10. (a) The profit maximization is not an operationally feasible criterion. Comment on it. (b) Write short notes on the following: (i) Bridge Finance (ii) Floating Rate Bonds (iii) Packing Credit. (c) Financial Leverage is a double edged sword Comment. SUGGESTED HINTS/ANSWERS 1. (i) PV = FV (1+ k)n or, PV = `1,00,000 (1+ 0.06)10 = ` 55,839.48 (ii) (1+ k )n -1 FVA (k,n) = A k A= 2. (a) FVA (k,n) (1+ k ) -1 k G.P. ratio = n = `1,00,000 = ` 7,586.68 13.181 Gross Profit Sales = 25% The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT Sales = Gross Profit 25 100 = (b) Cost of Sales ` 8,00,000 25 100 = ` 32,00,000 ` 32,00,000 - ` 8,00,000 = Receivable turnover Sales Gross profit = (c) = ` 24,00,000 Sales =4 Debtors = Sales `32,00,000 = = ` 8,00,000 4 4 = Debtors = = Cost of Sales =8 Fixed Assets Fixed assets = Cost of Sales ` 24,00,000 = ` 3,00,000 = 8 8 (e) Inventory turnover = Cost of Sales = 8 Average Stock Average Stock = Cost of Sales ` 24,00,000 = ` 3,00,000 = 8 8 Average Stock = Opening Stock + Closing Stock 2 Average Stock = Opening Stock + Opening Stock + 20,000 2 Average Stock = Opening Stock + ` 10,000 Opening Stock = Average Stock - ` 10,000 = ` 3,00,000 - `10,000 = ` 2,90,000 = Opening Stock + ` 20,000 = ` 2,90,000 + ` 20,000 = ` 3,10,000 Payable turnover = Purchase =6 Creditors Purchases = Cost of Sales + Increase in Stock = ` 24,00,000 + ` 20,000 = ` 24,20,000 (d) Fixed assets turnover Closing Stock (f) The Institute of Chartered Accountants of India 97 98 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Purchase ` 24,20,000 = = ` 4,03,333 6 6 Creditors = (g) Capital turnover = Cost of Sales = 2 Capital Employed = Cost of Sales ` 24,00,000 = = ` 12,00,000 2 2 Capital Employed (h) Capital = Capital Employed Reserves & Surplus = ` 12,00,000 ` 2,00,000 = ` 10,00,000 Balance Sheet of Tirupati Ltd as on Liabilities Assets Amount (`) Capital 10,00,000 Amount (`) Fixed Assets 3,00,000 Reserve & Surplus 2,00,000 Stock 3,10,000 Creditors 4,03,333 Debtors 8,00,000 Other Current Assets 1,93,333 16,03,333 3. (i) 16,03,333 Cash Flow Statement for the year ending 31st Mach, 2015 (`) (`) A. Cash flow from Operating Activities Profit and Loss A/c as on 31.3.2015 3,00,000 Less: Profit and Loss A/c as on 31.3.2014 2,10,000 90,000 Add: Transfer to General Reserve Provision for Tax Proposed Dividend 25,000 96,000 1,44,000 Profit before Tax 2,65,000 3,55,000 Adjustment for Depreciation: Land and Building (on building) Plant and Machinery Profit on Sale of Investments Loss on Sale of Plant and Machinery The Institute of Chartered Accountants of India 50,000 1,20,000 1,70,000 (15,000) 9,000 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 99 Goodwill written off 20,000 Interest on 11% Debentures (see the note) 33,000 Operating Profit before Working Capital Changes 5,72,000 Adjustment for Working Capital Changes: Decrease in Prepaid Expenses Decrease in Stock Increase in Debtors Increase in Creditors 4,000 15,000 (1,27,000) 30,000 Cash generated from Operations 4,94,000 Income tax paid (71,000) Net Cash Inflow from Operating Activities (a) 4,23,000 B. Cash flow from Investing Activities Sale of Investment 35,000 Sale of Plant and Machinery 36,000 Purchase of Plant and Machinery (2,25,000) Net Cash Outflow from Investing Activities (b) (1,54,000) C. Cash Flow from Financing Activities Issue of Preference Shares Securities Premium received on Issue of Pref. Shares 1,00,000 25,000 Redemption of Debentures at premium (2,20,000) Dividend paid (1,36,000) Interest paid to Debenture holders Net Cash Outflow from Financing Activities (c) (33,000) (2,64,000) Net increase in Cash and Cash Equivalents during the year (a + b + c) 5,000 Cash and Cash Equivalents at the beginning of the year 88,000 Cash and Cash Equivalents at the end of the year 93,000 The Institute of Chartered Accountants of India 100 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Working Notes: 1. Provision for the Tax Account (`) (`) To Bank (paid) 71,000 By To Balance c/d 1,05,000 By Balance b/d 80,000 Profit and Loss A/c 96,000 1,76,000 2. 1,76,000 Investment Account (`) To Balance b/d To Profit and Loss (Profit on sale) (`) 2,40,000 By Bank A/c (bal. figure) 35,000 15,000 By Balance c/d 2,20,000 2,55,000 3. 2,55,000 Plant and Machinery Account (`) (`) To Balance b/d 6,00,000 By Bank (sale) 36,000 To Bank A/c (Purchase bal. figure) 2,25,000 By Profit and Loss A/c (Loss on sale) 9,000 By Depreciation 1,20,000 By Balance c/d 6,60,000 8,25,000 8,25,000 Note: It is assumed that the debentures are redeemed at the beginning of the year. (ii) Schedule of Changes in Working Capital Particulars 31st March Change in Working Capital 2014 2015 Increase Decrease (` `) (` `) (` `) (` `) Current Assets Stock 4,00,000 3,85,000 -- 15,000 Debtors 2,88,000 4,15,000 1,27,000 -- Prepaid Expenses 15,000 11,000 -- 4,000 Cash and Bank 88,000 93,000 5,000 -- 7,91,000 9,04,000 Total (A) The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 101 Current Liabilities Creditors 1,85,000 2,15,000 Total (B) 1,85,000 2,15,000 6,06,000 6,89,000 83,000 6,89,000 Working Capital (A B) Increase in Working Capital 4. -- 30,000 -- -- 83,000 6,89,000 1,32,000 1,32,000 (a) Pattern of Raising Additional Finance Equity = 10,00,000 60/100 = ` 6,00,000 Debt = 10,00,000 40/100 = ` 4,00,000 Capital structure after Raising Additional Finance Sources of fund Amount (`) Shareholder s funds Equity capital (6,00,000 3,00,000) Retained earnings 3,00,000 3,00,000 Debt at 10% p.a. 1,80,000 Debt at 16% p.a. (4,00,000 1,80,000) Total funds 2,20,000 10,00,000 (b) Post-tax Average Cost of Additional Debt K d = I(1 t), where K d is cost of debt, I is interest and t is tax. On ` 1,80,000 = 10% (1 - 0.5) = 5% or 0.05 On ` 2,20,000 = 16% (1 0.5) = 8% or 0.08 Average Cost of Debt (Post tax ) i.e. Kd = 1,80,000 0.05 + 2,20,000 0.08 4,00,000 100 = 6.65% (approx) (c) Cost of Retained Earnings and Cost of Equity applying Dividend Growth Model Ke = D1 +g P0 or D0 1+ g P0 +g The Institute of Chartered Accountants of India 102 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Then, Ke = 2 1.1 44 + 0.10 = 2.2 + 0.10 = 0.15 or 15% 44 (d) Overall Weighted Average Cost of Capital (WACC) (After Tax) Particulars Amount (`) Weights Cost of WACC Capital Equity (including retained earnings) 15% 9.00 4,00,000 0.40 6.65% 2.66 Total (i) 0.60 Debt 5. 6,00,000 10,00,000 1.00 11.66 Valuation under Net Income Approach Particulars P Amount (`) Q Amount (`) Earnings before Interest & Tax (EBIT) (20% of ` 30,00,000) 6,00,000 Less: Interest (10% of ` 18,00,000) 1,80,000 Earnings before Tax (EBT) 4,20,000 6,00,000 Less: Tax @ 50% 2,10,000 3,00,000 Earnings after Tax (EAT) (available to equity holders) 2,10,000 3,00,000 14,00,000 (2,10,000 100/15) 20,00,000 (3,00,000 100/15) Add: Total Value of debt 18,00,000 Nil Total Value of Company 32,00,000 20,00,000 Value of equity (capitalized @ 15%) 6,00,000 (ii) Valuation of Companies under Net Operating Income Approach Particulars Capitalisation of earnings at 15% `6,00,000(1- 0.5) 0.15 Less: Value of debt {18,00,000 (1 0.5)} The Institute of Chartered Accountants of India P Amount (`) Q Amount (`) 20,00,000 20,00,000 9,00,000 Nil PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 103 Value of equity 20,00,000 Add: Total Value of debt 18,00,000 Nil Total Value of Company 6. 11,00,000 29,00,000 20,00,000 Income Statement Particulars Amount (`) Sales 75,00,000 Less: Variable cost (56% of 75,00,000) 42,00,000 Contribution 33,00,000 Less: Fixed costs 6,00,000 Earnings before interest and tax (EBIT) 27,00,000 4,05,000 Less: Interest on debt (@ 9% on ` 45 lakhs) Earnings before tax (EBT) (i) ROI = = 22,95,000 EBIT 100 Capital employed = EBIT 100 Equity + Debt 27,00,000 100 = 27% 55,00,000 + 45,00,000 (ROI is calculated on Capital Employed) (ii) ROI = 27% and Interest on debt is 9%, hence, it has a favourable financial leverage. (iii) Capital Turnover = Net Sales Capital Net Sales 75,00,000 = = 0.75 Capital 1,00,00,000 Which is very low as compared to industry average of 3. Or = (iv) Calculation of Operating, Financial and Combined leverages (a) Operating Leverage = (b) Financial Leverage = (c) Combined Leverage = Contribution EBIT EBIT EBT Contribution EBT = 33,00,000 27,00,000 = 27,00,000 = 1.18 (approx) 22,95,000 = 33,00,000 = 1.44 (approx) 22,95,000 = 1.22 (approx) Or = Operating Leverage Financial Leverage = 1.22 1.18 = 1.44 (approx) The Institute of Chartered Accountants of India 104 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 (v) Operating leverage is 1.22. So if sales is increased by 10%. EBIT will be increased by 1.22 10 i.e. 12.20% (approx) (vi) Since the combined Leverage is 1.44, sales have to drop by 100/1.44 i.e. 69.44% to bring EBT to Zero Accordingly, New Sales = ` 75,00,000 (1 - 0.6944) = ` 75,00,000 0.3056 = ` 22,92,000 (approx) Hence at ` 22,92,000 sales level EBT of the firm will be equal to Zero. (vii) Financial leverage is 1.18. So, if EBIT increases by 20% then EBT will increase by 1.18 20 = 23.6% (approx) 7. Since the life span of each machine is different and time span exceeds the useful lives of each model, we shall use Equivalent Annual Cost method to decide which brand should be chosen. (i) If machine is used for 20 years Present Value (PV) of cost if machine of Brand XYZ is purchased Period Cash Outflow (`) 0 PVF@12% Present Value 6,00,000 1.000 6,00,000 1-5 20,000 3.605 72,100 6-10 28,000 2.045 57,260 11-15 39,000 1.161 45,279 15 (64,000) 0.183 (11,712) 7,62,927 PVAF for 1-15 years 6.811 Equivalent Annual Cost = `7,62,927 = ` 1,12,014 6.811 Present Value (PV) of cost if machine of Brand ABC is purchased Period 0 Cash Outflow (`) PVF@12% Present Value 4,50,000 1.000 4,50,000 1-5 31,000 3.605 1,11,755 6 -10 53,000 2.045 1,08,385 10 (57,000) 0.322 (18,354) 6,51,786 The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT PVAF for 1-10 years 105 5.65 Equivalent Annual Cost = `6,51,786 = ` 1,15,360 5.65 Present Value (PV) of cost if machine of Brand ABC is taken on Rent Period Cash Outflow (`) PVF@12% Present Value 0 1,02,000 1.000 1,02,000 1-4 1,02,500 3.037 3,11,293 5-9 1,09,950 2.291 2,51,895 6,65,188 PVAF for 1-10 years 5.65 Equivalent Annual Cost = `6,65,188 = ` 1,17,732 5.65 Decision: Since Equivalent Annual Cash Outflow is least in case of purchase of Machine of brand XYZ the same should be purchased. (ii) If machine is used for 5 years (a) Scrap Value of Machine of Brand XYZ = ` 6,00,000 ` 2,00,000 ` 6,00,000 0.04 4 = ` 3,04,000 (b) Scrap Value of Machine of Brand ABC = ` 4,50,000 ` 1,50,000 ` 4,50,000 0.06 4 = ` 1,92,000 Present Value (PV) of cost if machine of Brand XYZ is purchased Period 0 Cash Outflow (`) Present Value 6,00,000 1.000 6,00,000 20,000 3.605 72,100 (3,04,000) 0.567 (1,72,368) 1-5 5 PVF@12% 4,99,732 Present Value (PV) of cost if machine of Brand ABC is purchased Period Cash Outflow (`) 0 Present Value 4,50,000 1.000 4,50,000 31,000 3.605 1,11,755 (1,92,000) 0.567 (1,08,864) 1-5 5 PVF@12% 4,52,891 The Institute of Chartered Accountants of India 106 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 Present Value (PV) of cost if machine of Brand ABC is taken on Rent Period Cash Outflow (`) PVF@12% Present Value 0 1,02,000 1.000 1,02,000 1-4 1,02,500 3.037 3,11,293 50,000 0.567 28,350 5 4,41,643 Decision: Since Cash Outflow is least in case of lease of Machine of brand ABC the same should be taken on rent. 8. Annual Benefit of accepting the Discount 1.5 365 100 -1.50 40 -10 =18.53% Annual Cost = Opportunity Cost of foregoing interest on investment = 15% If average invoice amount is ` 10,00,000 If discount is Accepted Payment to Supplier 98,500 Not Accepted 1,00,000 (1,214) Return on investment of ` 98,500 for 30 days {` 98,500 (30/365) 15%} 98,500 98,786 Thus, from above table it can be seen that it is cheaper to accept the discount. 9. Working Notes: 1. Raw Material Storage Period (R) = = = Average Stock of Raw Material q 365 Annual Consumption of Raw Material ` 45,000 + ` 65,356 2 365 ` 3,79,644 53 days. Annual Consumption of Raw Material = Opening Stock + Purchases- Closing Stock = ` 45,000 + ` 4,00,000 ` 65,356 = ` 3,79,644 The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 2. Work-in-Progress (WIP) Conversion Period (W) WIP Conversion Period = Average Stock of WIP q365 Annual Cost of Pr oduction = ` 35,000 + ` 51,300 2 365 ` 7,50,000 = 21 days 3. Finished Stock Storage Period (F) Average Stock of Finished Goods = Cost of Goods Sold ` 65,178 q365 ` 9,15,000 = Average Stock = = 26 days. ` 60,181 + ` 70,175 = 4. 365 2 ` 65,178. Debtors Collection Period (D) = = Average Debtors Annual Credit Sales 365 ` 1,23,561.50 q365 ` 11,00,000 = 41 days Average debtors = 5. ` 1,12,123 + ` 1,35,000 ` 1,23,561.50 2 Creditors Payment Period (C) = Average Creditors Annual Net Credit Purchases 365 `50,079 + `70,469 2 365= 55 days = ` 4,00,000 (i) Operating Cycle Period = R + W + F+ D C = 53 + 21 + 26 + 41 55 = 86 days The Institute of Chartered Accountants of India 107 108 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015 (ii) Number of Operating Cycles in the Year = 365 365 = = 4.244 Operating Cycle Period 86 (iii) Amount of Working Capital Required = Annual Operating Cost = Number of Operating Cycles ` 9,50,000 = ` 2, 23,845.42 4.244 10. (a) The profit maximisation is not an operationally feasible criterion. This statement is true because Profit maximisation can be a short-term objective for any organisation and cannot be its sole objective. Profit maximization fails to serve as an operational criterion for maximizing the owner's economic welfare. It fails to provide an operationally feasible measure for ranking alternative courses of action in terms of their economic efficiency. It suffers from the following limitations: (i) Vague term: The definition of the term profit is ambiguous. Does it mean short term or long term profit? Does it refer to profit before or after tax? Total profit or profit per share? (ii) Timing of Return: The profit maximization objective does not make distinction between returns received in different time periods. It gives no consideration to the time value of money, and values benefits received today and benefits received after a period as the same. (iii) It ignores the risk factor. (iv) The term maximization is also vague (b) (i) Bridge Finance: Bridge finance refers, normally, to loans taken by the business, usually from commercial banks for a short period, pending disbursement of term loans by financial institutions. Normally it takes time for the financial institution to finalise procedures of creation of security, tie-up participation with other institutions etc. even though a positive appraisal of the project has been made. However, once the loans are approved in principle, firms in order not to lose further time in starting their projects arrange for bridge finance. Such temporary loan is normally repaid out of the proceeds of the principal term loans. It is secured by hypothecation of moveable assets, personal guarantees and demand promissory notes. Generally rate of interest on bridge finance is higher as compared with that on term loans. (ii) Floating Rate Bonds: These are the bonds where the interest rate is not fixed and is allowed to float depending upon the market conditions. These are ideal instruments which can be resorted to by the issuers to hedge themselves against the volatility in the interest rates. They have become more popular as a money market instrument and have been successfully issued by financial institutions like IDBI, ICICI etc. The Institute of Chartered Accountants of India PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 109 (iii) Packing Credit: Packing credit is an advance made available by banks to an exporter. Any exporter, having at hand a firm export order placed with him by his foreign buyer on an irrevocable letter of credit opened in his favour, can approach a bank for availing of packing credit. An advance so taken by an exporter is required to be liquidated within 180 days from the date of its commencement by negotiation of export bills or receipt of export proceeds in an approved manner. Thus Packing Credit is essentially a short-term advance. (c) On one hand when cost of fixed cost fund is less than the return on investment financial leverage will help to increase return on equity and EPS. The firm will also benefit from the saving of tax on interest on debts etc. However, when cost of debt will be more than the return it will affect return of equity and EPS unfavourably and as a result firm can be under financial distress. This is why financial leverage is known as double edged sword . Effect on EPS and ROE: When Effect Result ROI > Interest Favourable Advantage ROI < Interest Unfavourable Disadvantage ROI = Interest Neutral Neither advantage nor disadvantage The Institute of Chartered Accountants of India

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