PRACTICE TEST PAPER - 1 INTERMEDIATE (IPC): GROUP I PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT

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1 PRACTICE TEST PAPER - 1 INTERMEDIATE (IPC): GROUP I 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. Time Allowed 3 Hours Maximum Marks 100 Solution 1(a): (i) Calculation of Economic Order Quantity: EOQ = x A x O = x (60,000 packs x 1 months) x `40 = 3,893.3 packs or 3,893 packs C `8 x 10% (ii) Number of orders per year Annual requirements = 7,0,000 packs = or 185 orders a year EOQ 3,893 packs (iii) Ordering and storage costs: x A x O x C = x 7,0,000 x `40 x `.8 = `88,768 (iv) Timing of next order: Average delivery period = Maximum lead time + Minimum lead time = 6 Days + 4 Days = 5 Days Average usage per day = Annual Requirement 360 Days = 7,0,000 Packs =,000 Packs 360 Days Days requirement covered by Present inventory = Present Inventory. Average usage per unit = 10,000 Packs = 5 Days 000 Packs Timing for the next order = Average Delivery Period Days Requirement covered by Present Inventory = 5 Days 5 Days = 0 Days This means that next order for the replenishment of supplies has to be placed immediately. Solution 1(b): Sales Volume (Units) 16,000 40,000.. Sales Value (`) 4,80,000 1,00,000 Profit/Loss (1,60,000) 3,0,000 P/V Ratio = Change in profit 100 = `3,0,000 (- `1,60,000) 100 Change in sales value `1,00,000 - `4,80,000 = `4,80, = 66 /3% `7,0,000 Sales Volume (Units) 16,000 40,000 Contribution (66 /3% of Sales) (`) 3,0,000 8,00,000 + loss/(-) Profit (`) 1,60,000 (3,0,000) Fixed Cost (`) 4,80,000 4,80,000 (i) Break-even Point in Rupees = Fixed Cost P/V Ratio = `4,80,000 = `7,0, /3% (ii) If sales volume is 50,000 units, then profit = Sales Value P/V Ratio Fixed Cost = (50,000 units `30 66 /3% - `4,80,000) = `5,0,000 (iii) Minimum level of production where the company needs not to close the production, if unavoidable fixed cost is `1,50,000 = Avoidable fixed cost Contribution per unit = Total fixed cost Unavoidable fixed cost Contribution per unit = `4,80,000 - `1,50,000 `30 66 /3% = `3,30,000 = 16,500 units. `0 Advise: At production level of > 16,500 units, company needs not to close the production.

2 Solution 1(c): (i) Computation of Costs of Different Components of Capital Equity Shares Ke = D1 + g = D0 (1 + g) + g P0 P0 = `3.60 (1.09) `54 = = 16.7% Preference Shares Kp = D = `11 = 11.58% NP `95 Debt Post tax Kd = I (1 -t) = 1 (1 0.4) = 7.% P 100 (ii) Weighted Average Cost of Capital (WACC) WACC = (Post tax Kd x Wd) + (Ke x We) + (Kp x Wp) WACC = (7.% x 0.5) + (16.7% x 0.60) + (11.58% x 0.15) = 13.30% Solution 1(d): Computation of EPS Sales 0,000 Less: Variable Cost of Production (14,000) Contribution 6,000 Less: Fixed Cost (1,000) Earnings Before Tax and Interest (EBIT) 5,000 Less: (1,000) Earnings Before Tax (EBT) 4,000 Less: Tax (50%) (,000) Earnings After Tax (EAT),000 No. of Equity Shares,000 Earnings Per Share (EPS) 1 DCL = Contribution = `6,000 = 1.5 times EBT `4000 DCL = % change in EPS. % change in Sales 1.5 = % change in EP 0% % change in EPS = 30% EPS (revised) = `1 + ( ) = `1.30. Solution (a): (i) Statement of Equivalent Production Input Output Equivalent Production Material - A Consumables Labour & Overheads % Units % Units % Units Nil Opening WIP Nil ,000 Put & Processed 51, , , ,000 Normal Loss (4% of 55,000), Closing W-I-P, , , ,00 Abnormal Gain (00) 100 (00) 100 (00) 100 (00) 55,000 5,8800 5,400 5,000 *Material A represent transferred in units from process I (ii) Determination of Cost per Unit Amount in (`) Equivalent Units Per Unit (`) (i) Direct Material (Consumables): Value of units transferred from Process I 3,7,800 Less: Vale of normal Loss (,00 units x `5) (11,000) 3,16,800 5, (ii) consumables added in Process II 1,57,00 5, (iii) (a) Labour 1,04,000 5, (b) Overhead 5,000 5, Total Cost per equivalent unit 1.00

3 (iii) Determination of value of Work in Progress and units transferred to Process III Equivalent Units Rate (`) Total Cost (`) (1) Value of Closing W-I-P, ,000 Material from Process I 1, ,800 Labour 1,00.00,400 Overhead 1, ,00 0,400 () Value of units transferred to Process - III 51, ,1,000 Solution (b): Statement showing Calculation of Existing Capital Employed Equity Share Capital (5,00,000 shares x `10) 50,00,000 Reserves & Surplus 0,00,000 8% Debentures (`80,000/8%) 10,00,000 11% Long Term Loan (`,0,000/11%) 0,00,000 Existing Capital Employed 1,00,00,000 Return on Capital Employed (%) = EBIT or Net Operating Profit x 100 Existing Capital Employed = `3,00,000 x 100 = 3% `1,00,00,000 Expected Return on Capital Employed as a result of modernisation = 3% + % = 5% Statement showing Computation of Expected EBIT Post modernisation Existing Capital Employed 1,00,00,000 Add: Additional Capital Raised 30,00,000 Less: 8% paid off (10,00,000) Revised Capital Employed 1,0,00,000 Revised Rate of Return (%) 5% Expected EBIT post modernisation 30,00,000 Alternative 1: Raise Entire amount as Term Loan: EBIT on Revised Capital Employed 30,00,000 Less: Interest on Term Loan Existing Term Loan (11% x `0,00,000) (,0,000) New Term Loan (1% x `30,00,000) (3,60,000) EBT 4,0,000 Less: Income Tax (@ 50%) (1,10,000) EAT 1,10,000 No. of Equity Shares 5,00,000 EPS.4 P/E Ratio (Revised) 8 times MPS (P/E Ratio x EPS) `19.36 Alternative : Raising Part by Issue of Equity Shares and rest by Term Loan: EBIT on Revised Capital Employed 30,00,000 Less: Interest on Term Loan Existing Term Loan (11% x `0,00,000) (,0,000) New Term Loan [1% x (`30,00,000 `0,00,000)] (1,0,000) EBT 6,60,000 Less: Income Tax (@ 50%) (13,30,000) EAT 13,30,000 No. of Equity Shares (5,00, ,00,000) 6,00,000 EPS `.17 P/E Ratio 10 MPS (P/E Ratio x EPS) `.17 (i) Advise: Alternative should be chosen as it gives maximum MPS. (ii) If P/E ratio remains constant at 10, Revised MPS (under alternative 1) = 10 x `.4 = `4.0, then, Alternative 1 should be chosen as it will give higher MPS.

4 Solution 3(a): (i) Production Budget (in Litres) June July Aug Sept Budgeted sales for the month 6,000 7,500 8,500 7,000 Add: Closing stock (40% of next month s sale) Less: opening stock (750) (750) (850) (700) Fruit Juices to be Produced 6,000 7,600 8,350 6,950 (ii) Preparation of fruits purchase budget June July Aug Budgeted Production for the month (in Litres) 6,000 7,600 8,350 Add: Closing stock (50% of next month s Production) (in Litres) 3,800 (7,600 x 50%) 4,175 (8,350 x 50%) 3,475 (6,950 x 50%) (In Litres) 9,800 11,775 11,85 Fruits Required for Production (in Kg) 34,300 (9,800 x 3.5 kg) 41,1.5 (11,775 x 3.5 kg) Less: Opening Stock (in kg) (5,800) (13,300) (3,800 x 3.5 kg) 41,387.5 (11,85 x 3.5 kg) (14,61.5) (4,175 x 3.5 kg) Fruits to be Purchased (in kg) 8,500 7,91.5 6,.775 (iii) Budgeted Gross Profit for quarter June to August June July Aug Total Budgeted sales (in Litres) 6,000 7,500 8,500 Selling price per unit (`) Sales revenue (`) 6,30,000 7,87,500 8,9,500 3,10,000 Less: Cost of Sales (`) (Sales unit x Cost Per Unit) 4,50,000 5,6,500 6,37,500 16,50,000 Gross Profit (`) 1,80,000,5,000,55,000 6,60,000. Solution 3(b): (i) Statement showing Evaluation of Buy Proposal: () Time PVIFA/PVF Brand XYZ Brand ABC Amount PV Amount PV Cash Outflows: Initial Cost 0 1 6,00,000 6,00,000 4,50,000 4,50,000 Add: Operating Cost ,000 7,096 31,000 1,11, ,000 57,71 53,000 1,08, ,000 45,63 NIL Less: Scrap Value at the end of life of machine (64,000) (11,693) (See WN 1) (57,000) (18,354) PVCO (Net) 7,6,937 6,51,801 EAPVCO = PVCO PVIFA(r,n) 7,6, = 1,1,015 6,51, = 1,15,359 Statement showing Computation of Cash Outflows if machine of Brand ABC is taken on rent Time PVF Cash Outflows (`) PVCO (`) Annual Rent 0 1 1,0,000 1,0, ,0,500 3,11, ,09,950,51,884 PVCO 6,65,07 PVIFA (1%, 10 years) EAPVCO = PVCO. 1,17,73 PVIFA Advice: The Company should purchase machine of Brand XYZ as it gives the lowest Equivalent Annual Present Value of Cash Outflows. Working Notes: (1) Scrap Value at the end of Machine s Life: XYZ = (`6,00,000 x /3) (`6,00,000 x 4% x 14) = `4,00,000 `3,36,000 = `64,000 ABC = (4,50,000 x /3) (`4,50,000 x 6% x 9) = `3,00,000 `,43,000 = `57,000

5 (ii) If machine is used for only 5 Years Statement showing Evaluation of Buy Proposal: () Time PVF Brand XYZ Brand ABC Amount PV Amount PV Cash Outflows: Initial Cost 0 1 6,00,000 6,00,000 4,50,000 4,50,000 Add: Operating Cost ,000 7,096 31,000 1,11,749 Less: Scrap Value at the end of 5 years (WN ) (3,04,000) (1,7,489) (1,9,000) (1,08,941) PVCO 4,99,607 4,5,808 Statement showing Computation of Cash Outflow if machine ABC is taken on rent for 5 years Time PVF Cash Outflows (`) PVCO (`) Annual Rent 0 1 1,0,000 1,0, ,0,500 3,11,33 Penalty for Terminating Rent Agreement ,000 8,370 4,41,693. Advice: The Company should take machine ABC on rent as it gives the lowest Present Value of Cash Outflows. () Scrap Value at the end of 5 Years: XYZ = (`6,00,000 x /3) (`6,00,000 x 4% x 4) = `4,00,000 `96,000 = `3,04,000 ABC = (`4,50,000 x /3) (`4,50,000 x 60% x 4) = `3,00,000 `1,08,000 = `1,9,000 Solution 4(a): Dr. Contract Account for the year ended 31 st March, 014 Cr. HP-1 (`) HP- (`) HP-1 (`) HP- (`) To Balance b/d: W-I-P 7,80,000,80,000 Bu Closing material at site 47,000 5,000 To Material purchased 6,0,000 8,10,000 By W-I-P: To Wages: (`85,000 + `1,000) 97,000 Value of work certified 0,50,000 16,10,000 (`6,000 + `8,400) 70,400 Cost of work not certified 1,90,000 1,40,000 To Donation to local club* 5,000,500 To Plant hire charges: (`7,000 x 1/3) 4,000 (`57,000 x 1/3) 19,000 To Depreciation on concrete mixture**: (`8,0,000 x 15% x 180/365) 60,658 (`8,0,000 x 15% x 100/365) 33,699 To Notional profit (balance c/d) 7,00,34 5,86,401,87,000 18,0,000,87,000 18,0,000 To Costing P & L A/c (WN-) 1,86,758 1,56,374 By Notional profit (balance 7,00,34 5,86,401 b/d) To Costing P & L Reserve A/c. 5,13,584 4,30,07 7,00,34 5,86,401 7,00,34 5,86,401 * Assuming donation paid to local club was exclusively for the above projects, hence included in the contract account. ** Depreciation on concrete mixture machine is charged on the basis of number of days used for the projects, as it is clearly mentioned in the question that this machine can be used for other projects also. Working Notes: 1. Computation of Stage of completion of the projects: Value of work certified x 100 Value of contract HP 1 = `0,50,000 x 100 = 4.71% `48,00,000 HP = `16,10,000 x 100 = 44.7% `36,00,000. Computation of profit to be recognized in the Costing profit & loss A/c. 1 x Notional profit x Cash Received 3 Value of work certified HP 1 = 1 x `7,00,34 x 80% = `1,86,758 3 HP = 1 x `5,86,401 x 80% = `1,56,374 3 (Land purchased and brokerage and registration fee paid for this purpose cannot be charged to contract account, hence not included in the contract account).

6 Solution 4(b): (a) Gross Profit = `4,00,000 5% of Sales = `4,00,000 Sales = `16,00,000 (b) Debtors Velocity = 3 months (Sundry Debtors + Bills Receivable) x 1 = 3 Net Credit Sales Sundry Debtors + `5,000 = 3 `16,00,000 1 Sundry Debtors = `4,00,000 `5,000 = `3,75,000 (c) Stock Velocity = 8 months Average Stock x 1 months = 8 months Cost of Goods Sold Average Stock = 8 Sales Gross Profit 1 Average Stock = 8 (`16,00,000 `4,00,000) = `8,00,000 1 Average Stock = `8,00,000 Opening Stock + Closing Stock = `8,00,000 Opening Stock + (Opening Stock + `10,000) = `8,00,000 Opening Stock + `10,000 = `16,00,000 Opening Stock = `16,00,000 `10,000 Opening Stock = `7,95,000 Closing Stock = `7,95,000 + `10,000 = `8,05,000 (d) Creditors Velocity = months (Sundry Creditors + Bills Payable) x 1 months = months Credit Purchases Sundry Creditors + `10,000 = `1,10,000* 1 * Purchases = Cost of Goods Sold + Closing Stock - Opening Stock = `1,00,000 + `8,05,000 `7,95,000 = `1,10,000 Sundry Creditors = `,01,667 `10,000 = `1,91,667 Note: It s assumed that all sales given are credit sales and all purchases given are credit purchases. Solution 5: (a) It is defined as a location, person or an item 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, Personal Cost Centre: It consists of a person or group of persons e.g. Mr. X, supervisor, foreman, accountant, engineer, process staffs, mining staffs, doctors etc. Impersonal Cost Centre: It consists of a location or an item of equipment (or group of these) e.g. Ludhiana branch, boiler house, cooling tower, weighing machine, canteen, and generator set etc. In a manufacturing concern there are two types of cost centres viz., Production and Service cost centres. (b) The main advantages of Integrated Accounting are as follows: No need for Reconcilation: The question of reconciling costing profit and financial profit does not arise, as there is only one figure of profit. Less efforts: Due to use of one set of books, there is significant saving in efforts made. Less time consuming: No delay is caused in obtaining information provided in books of original entry. Economical Process: It is economical also as it is based on the concept of Centralization of Accounting Function (c) Differentiation between Factoring and Bills Discounting The differences between Factoring and Bills discounting are: (i) Factoring is called as Invoice Factoring whereas Bills discounting is known as Invoice discounting. (ii) In Factoring, the parties are known as the client, factor and debtor whereas in Bills discounting, they are known as drawer, drawee and payee. (iii) Factoring is a sort of management of book debts whereas bills discounting is a sort of borrowing from commercial banks. (iv) For factoring there is no specific Act, whereas in the case of bills discounting, the Negotiable Instruments Act is applicable.

7 (d) Conflict in Profit versus Wealth Maximization Principle of the Firm: Profit maximisation is a short-term objective and cannot be the sole objective of a company. It is at best a limited objective. If profit is given undue importance, a number of problems can arise like the term profit is vague, profit maximisation has to be attempted with a realisation of risks involved, it does not take into account the time pattern of returns and as an objective it is too narrow. Whereas, on the other hand, wealth maximisation, as an objective, means that the company is using its resources in a good manner. If the share value is to stay high, the company has to reduce its costs and use the resources properly. If the company follows the goal of wealth maximisation, it means that the company will promote only those policies that will lead to an efficient allocation of resources. (e) Present Value: Present Value is the current value of a Future Amount. It can also be defined as the amount to be invested today (Present Value) at a given rate over specified period to equal the Future Amount. Perpetuity: Perpetuity is an annuity in which the periodic payments or receipts begin on a fixed date and continue indefinitely or perpetually. Fixed coupon payments on permanently invested (irredeemable) sums of money are prime examples of perpetuities. Solution 6(a): Raw Materials SQ for Actual Output (tonnes) SP per tonne (`) SC for Actual Output (`) RSQ (tonnes) Actual Consumption (tonnes) AP per tonnes (`) Actual Cost (`) A 13.3 (18 tonnes x 0.74) 1,000 1,59, , ,6,000 B 7.0 (18 tonnes x 0.4) 3,500 1,69, , ,65,00 C 11.5 (18 tonnes x 0.64) 18,000,07, ,000,07, ,36, ,34,00 (i) Material Cost Variance = Standard Cost for Actual Output Actual Cost = `5,36,400 `5,34,00 = `,00 (F) (ii) Material Price Variance = Actual Quantity (Std. Price Actual Price) A = 13.1 tonnes (`1,000 `1,347.56) B = 7.10 tonnes (`3,500 `3,67.606) C = tonnes (`18,000 `18,000) (iii) Material Usage Variance = Std Price (Std. Quantity for Actual Output Actual Quantity) A = `1,000 (13.3 tonnes 13.1) tonnes = `,400 (F) B = `3,500 (7.0 tonnes 7.10) tonnes = `,350 (F) C = `18,000 (11.5 tonnes 11.50) tonnes = `360 (F) = `5,110 (F) (iv) Material Mix Variance = Std. Price (Revised Std. Quantity Actual Quantity) A = `1,000 ( tonnes 13.1) tonnes = (F) B = `3,500 ( tonnes 7.10) tonnes = (F) C = `18,000 ( tonnes 11.50) tonnes = `4,560 (A) = `1,650 (F) = Nil = `,910 (A) = (A) = 47.3 (A) Standard Cost per unit of Output = `5,36, tonnes = `9,800 Standard Output for Total Actual mix = 18 tonnes x 31.7 tonnes 3.04 tonnes = tonnes Material Yield Variance = (Actual Output Standard Output for Total Actual mix) x Standard Cost per unit of Output = (18 tonnes tonnes) x `9,800 = `5, (F) (v) Material Yield Variance = Std. Price (Std. Quantity for Actual Output Revised Std. Quantity) A = `1,000 (13.3 tonnes tonnes) = `1, (F) B = `3,500 (7.0 tonnes tonnes) = `1, (F) C = `18,000 (11.5 tonnes tonnes) = `, (F) = `5, (F) Solution 6(b): Monthly Cash Budget for Six Months, January to June, 013 () Jan Feb March April May June Opening Cash Balance 1,500 3,50 1,500 (11,91) (15,04) 576 Receipts: Collection From Debtors One Month After Sale (40%) 6,000 6,000 7,500 9,000 1,000 11,400

8 Two Months After Sale (60%) 9,000 9,000 9,000 11,50 13,500 18,000 Proceeds from Sale of Freehold Properties ,000 - Total Cash Available (A) 16,500 18,50 18,000 8,338 35,476 9,976 Payments: Payment to Suppliers 5,000 6,50 7,500 10,000 9,500 11,000 Payment for Overheads,500 3,000 4,000 3,800 5,500 5,500 Wages Paid in month of Production (75%) 4,500 6,000 6,41 7,45 7,45 7,76 Paid one month later (5%) 1,50 1,500,000,137,475,475 Purchase of new machine ,000 - Corporation Tax paid , Total Payments (B) 13,50 16,750 9,91 3,36 34,900 6,737 Closing Cash Balance (A) (B) 3,50 1,500 (11,91) (15,04) 576 3,39 Working Notes: (1) Sale Receipts () Nov Dec Jan Feb March April May June Forecast Sales 1,000 1,000 1,000 1,50 1,500,000 1,900,00 Sale Proceeds 15,000 15,000 15,000 18,750,500 30,000 8,500 33,000 Debtors Pay: 1 Month 40% - 6,000 6,000 6,000 7,500 9,000 1,000 11,400 Month 60% - - 9,000 9,000 9,000 11,50 13,500 18,000 15,000 15,000 16,500 0,50 5,500 9,400 () Payment of Materials Nov Dec Jan Feb March April May June Quantity Produced 1,000 1,50 1,500,000 1,900,00,00,300 Materials (`) 5,000 6,50 5,000 6,50 7,500 10,000 9,500 11,000 Paid ( Months after) (`) - - 5,000 6,50 7,500 10,000 9,500 11,000 (3) Variable Overheads Nov Dec Jan Feb March April May June Quantity Produced 1,000 1,50 1,500,000 1,900,00,00,300 Variable Overheads (Quantity x `),000,500 3,000 4,000 3, (Quantity x `.50) ,500 5,500 5,750 Paid one month Later (`) -,000,500 3,000 4,000 3,800 5,500 5,500 (4) Wages Payable Dec Jan Feb March April May June Quantity Produced 1,50 1,500,000 1,900,00,00,300 Wages (Quantity x `4) 5,000 6,000 8, (Quantity x `4.50) ,550 9,900 9,900 10,350 Paid 75% this month(`) 3,750 4,500 6,000 6,41 7,45 7,45 7,76 5% Next month(`) - 1,50 1,500,000,137,475,475 5,750 7,500 8,41 9,56 9,900 10,37 Solution 7: (a) Sl. No. Method of Costing (i) Job Costing (ii) Batch Costing (iii) Unit Costing or Single or Output Costing (iv) Multiple Costing (b) Treatment of over and under absorption of overheads are: (i) Writing off to Costing P&L A/c: Small difference between the actual and absorbed amount should simply be transferred to costing P&L A/c, if difference is large then investingare the carses and after that avnormal loss/gain shall be transferred to costing P&L A/c. (ii) Use of supplementary Rate: Under the method the balance of under and over absorbed overheads may be charged to cost of W.I.P., finished stock and cost of sales proportionately with the help of supplementary rate of overhead. (iii) Carry Forward to Subsequent Year: Difference should be carried forward in the expectation that next year the position will be automatically corrected. (c) Four Kinds of Float with reference to Management of Cash The four kinds of float are: (i) Billing Float: The time between the sale and the mailing of the invoice is the billing float. (ii) Mail Float: This is the time when a cheque is being processed by post office, messenger service or other means of delivery.

9 (iii) Cheque processing float: This is the time required for the seller to sort, record and deposit the cheque after it has been received by the company. (iv) Bank processing float: This is the time from the deposit of the cheque to the crediting of funds in the seller s account. (d) Difference between Financial Lease and Operating Lease S.No. Financial Lease Operating Lease 1. The risk and reward incident to ownership are passed on the lessee. The lessor only remains the legal owner of the asset. The lessee is only provided the use of the asset for a certain time. Risk incident to ownership belongs only to the lessor.. The lessee bears the risk of obsolescence. The lessor bears the risk of obsolescence. 3. The lease is non-cancellable by either party under it. The lease is kept cancellable by the lessor. 4. The lessor does not bear the cost of repairs, maintenance or operations. Usually, the lessor bears the cost of repairs, maintenance or operations. 5. The lease is usually full payout. The lease is usually non-payout. (Note: Students may answer any four of the above differences).

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