SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY of 7 STRATEGIC MANAGEMENT ACCOUNTING SEMESTER-6

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1 Question No. 1 (a) SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 1 of 7 Years Total Budgeted sales in units 42,000 43,000 51,000 58,000 61,000 Purchases minus variable cost of production 31,416,000 32,164,000 38,148,000 43,384,000 45,628,000 Cost of supervisor (2,400,000) (2,400,000) (2,400,000) (2,400,000) (2,400,000) Rs. (½ for each year figure 2.5 Cash flow from operation 29,6,000 29,764,000 35,748,000 40,984,000 43,228,000 before tax [CFBT] (1 for 1 st year Less: Tax depreciation 33,253,938 8,772,159 7,456,335 6,337,885 5,387,202 and ½ for year 2-5) 3 Taxable income / (loss) (4,237,938) 20,991,841 28,291,665 34,646,115 37,840,798 Tax saving / (expense) [T] 1,440,899 (7,137,226) (9,619,166) (11,779,679) (12,865,871) Cash flow from operation after tax [CFAT] = CFBT + T 30,456,899 22,626,774 26,128,834 29,204,321 30,362,129 Cost of machine (91,735,000) 1 Working Capital 250, Sale Proceed of Machines 200,000 12,000,000 1 Tax impact of disposal (34,000) 6,299,344 (0.5 for 26 t year and 1 for 2021) 1.5 Total Cash outflow (91,319,000) 30,456,899 22,626,774 26,128,834 29,204,321 48,661,472 PV factor Present Value [PV] (91,319,000) 26,710,700 17,399,989 17,636,963 17,288,958 25,255,304 12,972, In-house production with buying machine is recommended due to + ve NPV associated with this Assumption: (1) There will be no change in working capital if outside purchase is opted. (2) Existing machine will not be sold if outside purchase is opted. WORKINGS: Cost of automatic machine Purchase Price 91,200,000 Discount (2,736,000) Freight Inward 1,061,000 Installation cost 2,210,000 91,735,000 Tax depreciation: Year Cost / Opening WDV Initial Normal Total Ending WDV 1 91,735,000 22,933,750 10,320,188 33,253,938 58,481, ,481,062 8,772,159 8,772,159 49,708, ,708,903 7,456,335 7,456,335 42,252, ,252,568 6,337,885 6,337,885 35,914, ,914,683 5,387,202 5,387,202 30,527,481

2 SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 2 of 7 Rupees per Unit Outside purchase cost 2,700 Less : Variable Cost Existing Reduction Reduced Direct Material Direct Labour 1, Variable overhead Total 1,952 Net difference ,416,000 Machine Tax Gain / (Loss) Old New Sale Proceed 200,000 12,000,000 Tax WDV (100,000) (30,527,481) Tax Gain / (Loss) 100,000 (18,527,481) Tax Impact 34,000 (6,299,344) (b) Many companies use the payback method, in addition to determine the present value, because the payback method provides a preliminary screening of projects. It indicates how fast an original can be recovered from the cash flows, which is of particular interest when a project is considered risky. 03 (c) Year Cumulative PV (Rs.) 0 (91,319,000) (64,608,300) (47,208,311) (29,571,348) (12,282,390) ,972, As cumulative PV is positive (+ ve) in 5th year from negative in 4th year; the DPP is between 4 years and 5 years. (d) Schedule of net after tax, annual, real cash flows: Cost saving of wages and benefits , , , ,000 (0.25 Cost of additional supplies (9,000) (9,000) (9,000) (9,000) (0.25 Cost of additional power (13,000) (13,000) (13,000) (13,000) (0.25 Net cost savings 146, , , ,000 (0.25 Net of Tax saving rate After tax cost savings (A) 96,360 96,360 96,360 96,360 (0.25

3 SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 3 of 7 Annual depreciation 76,850 20,273 17,232 14,647 02(0.5 Tax rate Tax shield on depreciation 26,129 6,893 5,859 4,980 02(0.5 Sale proceeds from machine , Tax gain on sale of machine , Nominal cash flows (B) 26,129 6,893 5,859 86,000 Price index Real rupees cash flows (C) 24,194 5,891 4,650 63,235 (0.25 Cost of machine (212,000) Total after tax real cash flows (A+C) (212,000) 120, ,251 1,0 159,595 (0.25 WORKINGS: Tax depreciation Year Cost / Opening WDV Initial Normal Total Ending WDV ,000 53,000 23,850 76, , ,150 20,273 20, , ,877 17,232 17,232 97, ,645 14,647 14,647 83,000 (round off) Equipment Sale proceed 80,000 Tax WDV (83,000) Gain / (loss) (3,000) Tax shield (34%) 1,020 (e) Since the Division B, bases its analysis on real after tax cash flows, it should use the real discount rate, computed as follows: (1 n) (1 r) (1 i) 1 14 r r = 6.54%

4 SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 4 of 7 Question No. 2 Minimum price to be quoted for construction of shed work: Rs. 000 Direct materials: Prime quality steel 160 Rs.96 per kg. 15,360 Galvanized steel 140 Rs.130 per kg. 18,200 Other materials at purchase price 1,500 Direct Labor: Adeeb s time 125 Skilled labor 28,100 Rs.200 per hour 5,620 Unskilled labor 15,200 Rs.50 per hour (W-1) 760 Other costs: Scaffolding, excavator, crane and lifter rent - incremental 900 of general purpose machinery - General over-heads - Opportunity cost of using yard (80,000 25) 2,000 Feasibility reports, plans and drawing cost - Total cost 44,465 30% 13,339.5 Minimum price 57,804.5 Minimum price that must be quoted is Rs.57,804,500 to earn a desired mark up 30% on relevant cost. (W-1) Unskilled Labor hours: =4,800 hrs ,000 hrs-4,800 hrs= 15,200 hrs 0.5

5 Question No. 3 (a) SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 5 of 7 Return on Divisional Investment (ROI): Before After Divisional profit 240, ,360 Divisional 1,200,000 1,320,000 Divisional ROI 20% 19.8% The ROI will fall in the short term if the new is undertaken. This is a problem which often arises with ROI. (b) Divisional Residual Income (RI): Before After Divisional profit 240, ,360 Less: imputed interest 1,200,000 * 17% 204, ,320,000 * 17% - 224, Residual income 36,000 36,960 The residual income will increase if the new is undertaken. The use of residual income has highlighted the fact that the new project returns more than the cost of capital (17.8% (21,360/120,000) compared with 17%). 02 Question No. 4 (a) Plug Pin Total (i) A Current selling price (S.P.) (Rs.) B Reduction in S.P. 10% 15% C Reduced S.P. [ A (A x B)] (Rs.) D Budgeted sales (Rs.) 2,700,000 1,870,000 E Budgeted sales in units [D C] 100,000 55,000 F Planned breakeven sales in units (70%) 70,000 38, ,500 (ii) G Planned breakeven sales (Rs.) 1,890,000 1,309,000 H Margin of safety [D - G] (Rs.) 810, ,000 I Planned profit (Rs.) 259,200 93,500 J PV ratio [I H] 32.0% 16.7% K Fixed cost at breakeven [G x J] (Rs.) 604, ,167 L Current fixed expenses (Rs.) 632, ,940 M Reduction in fixed expenses [L - K] (Rs.) 27,260 4,773 (0.5 for each product and 1 for total)=2 ( (

6 (b) SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 6 of 7 Weighted average contribution per unit: A per unit B per unit C per unit Selling price per unit Variable cost per unit Contribution per unit Contribution from 3 units of A Contribution from 2 units of B Contribution from 3 units of C Total contribution from sale of 8 units Rs. Weighted average contribution per unit = Rs.68/ 8 = Rs.8.50 The required number of sales units: = (Fixed costs + Required profit)/weighted average contribution per unit = (Rs.130,000 + Rs.108,000) / Rs.8.50 = 28,000 units 0.5 The required sales in terms of the number of units of the products and sales revenue of each product: Product Units Selling price per unit Sales revenue required. A 28,000 3/8 10, Rs.346, B 28,000 2/8 7, Rs.196, C 28,000 3/8 10, Rs.325, Total 28,000 Rs.868,000 The sales revenue of Rs.868,000 will generate a profit of Rs.108,000 if the products are sold in the mix 3:2: Question No. 5 (a) [Any four (04)] It may be difficult to identify which resources are likely to be in short supply and what amount of their availability will be. Management may not make product mix decisions which are profit maximizing. They may be more concerned to develop a production/sales plan. The assumptions of linearity may be totally invalid except over smaller ranges. The linear programming model is essentially static and is therefore not really suitable for analyzing in detail the effects of changes in the various parameters, for example over time. The shadow price of a scarce resource only applies up to a certain limit. In some circumstances, a practical solution derived from a linear programming model may be of limited use as, for example, where the variables may only take on integer values. A solution must then be found by a combination of rounding up and trial and error. 04

7 SUGGESTED SOLUTIONS/ ANSWERS EXTRA ATTEMPT EXAMINATIONS, MAY 26 7 of 7 (b) (i) Since the Division A has idle capacity, it does not have to give up any outside sales to take on the Division B s business. Applying the formula for the lowest acceptable transfer from the viewpoint of the selling division, we get: Transfer price Variable Cost per unit + (Total Contribution margin on the lost sale/ Number of units transferred) Transfer Price Rs (Rs. 0 / 25,000) = Rs. 65 per unit 02 Division B would be unwilling to pay more than Rs. 116 per unit, the price it is currently paying an outside supplier for its batteries. Therefore, the transfer price must fall within the range: Rs. 65 Transfer price Rs (ii) Since the Division is A selling all of its production to the outside customers, it would have to give up some of these outside sales to take on the Division A s business. Thus, Division A has an opportunity cost, which is the total contribution margin on lost sales: Transfer price Veritable Cost per unit + Total Contribution margin on the lost sale..number of Units Transferred Transfer price Rs (Rs Rs. 65) 25,000 = Rs 65 + Rs. 55= Rs , Since the Division B can purchase batteries from outside supplier at only Rs. 116 per unit, no transfers will be made between the two divisions. 02 (iii) Applying the formula for the lowest acceptable price from the viewpoint of the selling division, we get: Transfer price Veritable Cost per unit + Total Contribution margin on the lost sales Number of Units Transferred Transfer price (Rs.65 - Rs.7) + (Rs Rs.65) 25,000 = Rs , In this case, the transfer price must fall within the range: Rs. 113 Transfer price Rs (iv) [Any three (03)] Potential benefits of operating a transfer pricing system within a divisionalised company It can lead to goal congruence by motivating divisional managers to make decisions, which improve divisional profit and improve profit of the organisation as a whole. It can prevent dysfunctional decision making so that decisions taken by a divisional manager are in the best interests of his own part of the business, other divisions and the organisation as a whole. Transfer prices can be set at a level that enables divisional performance to be measured commercially'. A transfer pricing system should therefore report a level of divisional profit that is a reasonable measure of the managerial performance of the division. It should ensure that divisional autonomy is not undermined. A well-run transfer pricing system helps to ensure that a balance is kept between divisional autonomy to provide incentives and motivation, and centralised authority to ensure that the divisions are all working towards the same target, the benefit of the organisation as a whole. THE END 03