The Institute of Chartered Accountants of Nepal. Compilation of Suggested Answers. Cost Accounting. CAP II Examination

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1 Compilation of Suggested s

2 Compiler of Suggested s Table of Content Chapter Head Page No Chapter 1 Cost Concept and Costing Methods 3 Chapter 2 Material Control 7 Chapter 3 Labor Control 25 Chapter 4 Overhead Control 40 Chapter 5 Unit Costing 57 Chapter 6 Cost Account System and Cost Control 66 Chapter 7 Method Of Costing 74 Chapter 8 Cost Concept for Decision Making 124 Chapter 9 Costing and Inter Firm Comparision 178 Chapter 10 Control and Cost Reduction 181 2

3 Compiler of Suggested s Chapter 1: Cost Concepts and Costing Methods 3

4 Compiler of Suggested s Question No 1 Distinguish between a. Product costs and period costs (June 2010)(2.5 Marks) Product costs are costs which can be identified with goods produced for resale. They vary with production because these costs are directly affected by the production volume. If there is no production, these costs will not be incurred. Raw materials and direct labour costs are the examples of product costs. Period costs are costs which are matched against the revenue of the current period. These costs vary with the passage of time and not with the volume of production. Therefore, even if there is no production, these costs have to be incurred. Rent, insurance, salary etc are the examples of period costs. b. Controllable Cost and Uncontrollable Cost (December 2012) (December, 2014)(2.5 Marks) Controllable cost and uncontrollable cost Controllable cost Uncontrollable cost Controllable cost are the costs which can be influenced by action Controllable cost are influenced by specified member of an undertaking Can be influenced by the action of executive of each responsibility centers Can be minimized for cost control purpose Generally variable cost and semi variable cost are in the nature of controllable cost Uncontrollable cost are the costs which can not be influenced by action Uncontrollable cost are not influenced by specified member of an undertaking Can not be influenced by the action of executive of each responsibility but could avoid with initial decision Can not be minimized for cost control purpose Generally Fixed cost are in the nature of uncontrollable cost c. Running Charges and Maintenance Charges (December 2012)(2.5 Marks) Running charges and maintenance charges both are the parts of total costs in operating costing. These are used to prepare a cost statement in an industry where services are rendered and goods are not produced. Running charges are variable costs relating to rendering of services, where as maintenance charges are generally in the nature of semi-variable or semi-fixed costs. The items to be included in running charges and maintenance charges depend on the nature of the operation. For example, cost of fuel in transport sector, cost of food items in restaurant are running charges; besides the cost of repairs and spares in transport sector and the cost of lighting, consumable stores etc. in hotels are maintenance charges. To find out per unit cost of services rendered, the costs are required to be segregated into variable and fixed costs. Therefore, the maintenance charges require to be segregated into variable and fixed costs 4

5 Compiler of Suggested s Question No 2: Write short note on a. Functions of management accounting system (June 2011)(2.5 Marks) Management accounting systems provide information to assist managers in their planning and control activities. Management accounting activities include collecting, classifying, processing, analyzing, and reporting information to managers. It is so designed that its information help decision making within the firm. Its scope include information on sales backlogs, unit quantities, prices, demands on capacity resources, and extensive performance measures based on physical or non-financial measures. The challenge is to develop management accounting practices that support the basic managerial tasks of organizing, planning, and controlling operations to achieve excellence throughout the organization. b. Value Analysis (December 2013) (July, 2015) (2.5 Marks) Value analysis is a technique applied to analyze all aspect of an existing product or component to determine in minimum cost necessary for specific function requirement. It is also known as value engineering. This may result in various alterations being made to the product with object of reducing costs. Value analysis looks at the function that the product fulfils and inquiries into the possibility of performing the same function more cheaply, even though this may mean completely redesigning the product or developing an entirely different items. Value analysis a multi-disciplinary method of enhancing product value by improving the relationship of worth to cost through the study of function.the primary advantage of value analysis is reduction in product cost. It improves sale and customer satisfaction as it determines the exact requirements of customer and product designing is done accordingly. Steps involved in value analysis are: Collecting relevant information Deciding alternatives Approval of the accepted alternative Execution Follow-up c. Replacement price method (July, 2015)(2.5 Marks) Replacement price method is defined as "the price at which it is possible to purchase an item, identical to that which is being replaced/revalued'. It is also referred to as market price method. Under this method, materials issued are valued at the replacement cost of the items. This method pre-supposes that determination of the replacement cost of material at the time of each issue, i.e. the cost at which identical materials could be currently purchased. The product cost under this method is at current price, which is the main objective of the replacement price method. This method is based on view that cost should reflect current market conditions. When this method is used, profit is made during rising prices and loss is incurred during falling prices. d. Period costs (July, 2015)(2.5 Marks) The costs which are not associated with production are called period costs. They are treated as an expense of the period in which they are incurred. They may be fixed or variable. They are charged against the revenue of the relevant period. Differences between opinions exist whether certain costs should be considered as product or period costs. There is an opinion that variable manufacturing costs are product costs whereas fixed manufacturing and other costs are period costs as they are closely related to the passage of time than to manufacturing of product. 5

6 Compiler of Suggested s e. Sunk costs (December, 2015)(2.5 Marks) These costs are the costs of resources already acquired which will be unaffected by choices between various alternatives. These are historical costs, which are incurred in the past and not relevant to the particular decision making problem, being considered. While considering the replacement of plant, the depreciated book value of the old asset is irrelevant as the amount is a sunk cost, which is to be written off at the time of replacement. Another example of Sunk cost is that of development cost already incurred.. Question No 3 Discuss the treatment of research and development expenditures in cost accounting. (December, 2014)(2.5 Marks) If research is conducted in the methods of production, the expenses should be charged to production overhead. If the research relates to administration, the expenses arecharged to administration overheads. If it is related to market research, the expenses are charged to S & D overheads. Development costs incurred in connection with a particular product should be charged directly to that product. Such expenses are usually treated as deferred revenue expenditure and recovered as cost per unit of the product when production is fully established. Routine nature research expenses are charged to general overheads. 6

7 Compiler of Suggested s Chapter 2: Material Control 7

8 Compiler of Suggested s Question No 1: Write short note on a. Treatment of spoilage and defectives (June 2010)(2.5 Marks) Spoilage occurs when materials are so damaged in manufacturing operations that they are taken out of the process and disposed off without further work. Normal spoilage is included in cost either by charging the loss to the production order or charging it to production overhead. The cost of abnormal spoilage is charged to costing profit and loss account. Defectives represent unit of output which fail to comply with a set quality standard. These can be subsequently rectified, sold as 'seconds' or disposed off as scrap. Normal defectives can be recovered; charged to good production: charged to general overhead; or charged to department. If defectives are abnormal and are due to causes beyond the control of organization, they should be charged to profit and loss account. b. Pareto Inventory Analysis (June 2012)(2.5 Marks) Unit cost commonly affects the degree of control that should be maintained over an inventory item. As unit cost increases, internal controls (such as inventory access) are typically tightened and perpetual inventory system is more often used. Recognition of cost-benefit relationships may result in a Pareto Inventory Analysis, which separates inventory into three groups based on annual cost-to-volume usage. Items having the highest value are referred to as A items; C items represent the lowest value; and all other items are categorized as B items. Once this categorization is done, management can determine the best inventory control method for items in each category. c. Explain Economic Ordering Quantity. (December 2012)(4 Marks) a) Economic Order Quantity (EOQ): Purchase department in manufacturing concerns is usually faced with the problem of deciding the quantity of various items which they should purchase. If purchases of material are made in bulk then inventory carrying cost will be high. On the other hand if order size is small each time, then the ordering cost will be high. In order to minimise ordering and carrying costs it is necessary to determine the order quantity which minimises these two costs. The size of the order for which both ordering and carrying cost are minimum is known as economic order quantity. Calculation of EOQ made as follows: EOQ = 2AO/C Where; A= Annual requirement O= Ordering cost per order C= Carrying cost per unit per annum At EOQ level total cost of material including ordering and holding cost will be minimal. d. Continuous stock taking is complementary to the perpetual inventory system (December, 2015)(2.5 Marks) 8

9 Compiler of Suggested s Under Perpetual Inventory system, a continuous record of receipt and issue of material is maintained by the stores department. In other words, in this system, stock control cards or bin cards and the stores ledger show clearly the receipts, issues and balance of all items in stock at all times. This system facilitates planning of production and ensures that production is not interrupted for want of materials and stores. Continuous Stock taking means physical verification of stores items on a continuous basis to reveal the position of actual balances. Such a verification is conducted round the year, thus covering each item of store twice or thrice. Any discrepancies, irregularities or shortages brought to the notice, as a result of continuous stock verification are reported to the appropriate authorities for initiating necessary rectification measures. This system works as a moral check as stores staff and acts as a deterrent to dishonesty. A perpetual inventory system is usually supported by a programme of continuous stock taking. That is continuous stock taking is complementary to the perpetual inventory system. Sometimes the two terms are considered synonymous but it is not so. The success of the perpetual inventory system depends upon the maintenance and upto date writing up of (i) the stores ledger and (ii) bincards/stock control cards, Continuous stock taking, ensures the veracity of figures shown by the above records. Question No 2: Distinguish between a. Waste and Scrap. (June 2011)(2.5 Marks) Waste represents the portion of basic raw materials lost in production process having no recoverable value. Waste may be visible remnants of basic raw materials or invisible e.g. disappearance of basic raw materials through evaporation, smoke etc. Shrinkage of material due to natural causes may also be a form of a material wastage. In the production process, waste of material does occur, such waste has no recoverable scheme, hence there is no chance of recovery from it. Scrap is the incidental material residue coming out of certain types of manufacturing processes, usually of small amount and low value, recoverable without further processing. Scrap is visible and do have recoverable value. Material defective goods may be sold as scrap. b. Bin cards and Store ledger (June 2012)(2.5 Marks) Bin cards Store ledger Bin Cards maintained by Store Keeper Store ledger is maintained by cost accounting department It is the store recording documents It is an accounting record It contains information as records to quantities; It contains both quantitative and value receipt, issue and balance information of receipt, issue and balance Entries in bin cards are made when transaction Entries are made only after the transaction has take place; i.e. entities made and movement of taken place goods are made. Bin Card records each transaction Store ledger records the same information in a Inter Departmental transfer of materials does not appear summarized form Inter Departmental transfer of materials appear here. 9

10 Compiler of Suggested s c. Bill of material and Material requisition note (December, 2014)(2.5 Marks) Bill of material It is a comprehensive list of materials with exact description and specifications, required for a job or other production units. This also provides information about required quantities so that if there is any deviation from the standards, it can easily be detected. It is prepared by the Engineering or Planning Department in a standard form. The purpose of bill of material is to act as a single authorisation for the issue of all materials and stores items mentioned in it. It provides an advance intimation to store department about the requirements of materials. It reduces paper work. It serves as a work order to the production department and a document for computing the cost of material for a particular job or work order to the cost department. Material requisition note It is a formal written demand or request, usually from the production department to store for the supply of specified materials, stores etc. It authorises the storekeeper to issue the requisitioned materials and record the same on bin card. The purpose of material requisition note is to draw material from the store by concerned departments. Question No 3: Jagger Products Ltd. manufactures toy dolls in a moulding process. The management accountant has been taken ill and you have been requested to assist in identifying the usual monthly adjustments to measure output and cost of output. Opening work-in-progress amounted to 8000 dolls, with costs attached of materials 398,400 and labour/conversion of 384,000. Materials are added at the beginning of the moulding process. Opening work-in-progress is 50% complete in terms of labour/conversion costs. During the month, a further dolls have been input to the process, incurring material costs of 2,400,000 and labour/conversion costs of 3,993,600. Completed dolls totaled in the month, leaving 6000 in work-in-progress, 60% complete in terms of labour/conversion costs. The company operates a FIFO approach to accounting for stock movements. You are required to compute/prepare: i) Equivalent unit statement and cost per equivalent unit; ii) Costs attached to closing work-in-progress; iii) Costs attached to units started and completed; iv) Costs attached to completion of opening work-in-progress. (June 2010)(10 Marks) 10

11 Compiler of Suggested s Equivalent unit statement Particulars Materials Labour/ Remarks Conversion Units Units Opening work-in-progress (8000 units 50% complete in terms of labour/ conversion) Units started and completed (40000 units less closing WIP of 6000 units on FIFO basis) Closing work-in-progress (6000 units 60% complete in terms of labour/ conversion) Equivalent units Total () Costs to be accounted for 2,400,000 3,993,600 6,393,600 incurred in the month Costs per equivalent unit (ii) Costs attached to closing work-in-progress Particulars of costs Equivalent Unit Rate per Unit () Total costs () Materials ,000 Labour/ conversion ,600 Total 705,600 (iii) Costs attached to unit started and completed Particulars of costs Equivalent Rate per Total costs () Unit Unit () Total costs ,304,000 (iv) Costs attached to completion of opening work-in-progress Particulars of costs Equivalent Unit Rate per Unit () Total costs () Materials (already complete) 0 Labour/ conversion ,000 Total 384,000 Note: In completing opening work-in-progress, costs incurred last month and brought forward (Materials 398,400 and Labour/ conversion 384,000) will also be transferred to finished goods. Question No 4: SV Limited which has established its product K furnishes the following forecast of sales in units for I Quarter II Quarter III Quarter IV Quarter 11

12 Compiler of Suggested s Units 12,000 15,000 13,500 9,000 The opening stock on is expected to be 10,000 units and the company proposes to maintain a closing stock of 4,500 units on The rejection in the process of manufacture of product K is 12% and the production will be spread out uniformly throughout the year. Two raw materials C and D are used for the manufacture of product K. At present the company orders inventory of the two raw materials in quantities equivalent to 13 weeks consumption. The management of the company has been advised that considerable economies in provisioning of raw materials can be effected by changing over to the ordering system based on economic order quantities. The Materials Manager has complied the following data: C D Raw material quantity required per unit of output of K (kg) Raw material usage rate/week (kg) 2,300 4,000 Price per kg () Lead time to obtain deliveries (weeks) 5 3 Order costs per order () Carrying Costs 20% 25% You are required to: i) Prepare a Production and Raw Material Requirement Budget for the year ii) Calculate the Economic Order Quantity for raw materials C & D using Tabular Method assuming order sizes of 1,200, 1,800, 2,400 and 3,000. iii) The company feels that a safety stock should be built up to cover a lead time of 8 weeks and 5 weeks respectively for C and D and increase in the usage of raw materials up to 3,000 kg and 5,000 kg respectively for C and D per week. Calculate the ordering level to meet the above requirement. iv) Based on the ordering level calculate at (iii) above, find the saving arising from switching over to the new ordering system. (June 2010)(15 Marks) Annual Production budget (quantitative) Total annual sales (12, , , ,000) Add: desired closing Stock Units 49,500 4,500 54,000 10,000 Less: Expected Opening Stock Production of good units 44,000 Rejection 12% Units to be produced 44,000 x (100/88) 50,000 (b) Material Budget (Quantitative) C D Quantity per unit 2.4 kg 4.2 kg Material requirement per annum (kg) 120, ,000 ii) Computation of Economic Order Quantity (EOQ) EOQ for C 12

13 Lot Size No of Orders Average Inventory Ordering Costs Compiler of Suggested s Inventory Carrying Cost Total Costs 1, , ,240 1, ,030 2, , , , ,000 EOQ for D 1, , ,350 1, , ,070 2, , ,200 2,080 3, , ,500 2,200 Thus, EOQ for Material C is 2,400 units while for Material D it is 1,800 units. iii) Computation of Revised Ordering Level C Kg D kg Normal Ordering Level = Lead Time x Inventory Usage (2,300 x 5) = 11,500 (4,000 x 3) = 12,000 Usage over increased lead time C : 2,300 x 3 6,900 D : 4,000 x 2 8,000 Usage increase per week C : (3,000 2,300) x 8 5,600 D : (5,000 4,000) x 5 5,000 Revised ordering level 24,000 25,000 iv) Computation of Savings due to change in system (a) Present : No. of orders p.a. 4 4 Average Inventory (once in 13 weeks) (120,000/4 x ½) = 15,000 (210,000/4 x ½) = 26,250 Ordering cost Carrying cost (15,000 x 2 x 20%) = 6,000 (26,250 x 4 x 25%) = 26,250 Total cost 6,040 26,290 (b) Proposed : Total cost (See (ii) above) 980 2,070 (c) Saving : (a) (b) 5,060 24,220 Question No 5: What is maximum and minimum stock level? Explain how these are calculated. (December 2010)(6 Marks) Maximum level of stock indicates the maximum quantity of an item of material which should be held in stock at any time. The stock in hand is regulated in such a way that normally, it does not exceed this level. While fixing the maximum level, following factors needs to be considered: 13

14 14 Compiler of Suggested s i) Maximum requirement of the material for production purpose, ii) Rate of consumption and time lag between the date of order and receipt of material (lead time), iii) Nature and properties of the material, e.g. this level is kept low for materials which are liable to quick deterioration. iv) Cost of storage and insurance, v) Economy in prices: Maximum levels for items which are available at discount in bulk purchase are generally high. vi) Financial considerations: Available of funds and price of the items. Minimum level of stock indicates the lowest quantity of an item of material which must be maintained in hand at all times so that there is no stoppage of production due to the unavailability of material. While fixing the minimum level, following factors are considered: i) Nature of the item: No minimum level is necessary for special materials purchased against the specific orders of a customer. ii) Rate of consumption of the material. iii) Lead time. Calculation of Maximum and Minimum Stock Level: Maximum and minimum level is calculated in the following manner: Maximum Level = Reorder level + Reordering Quantity Minimum consumption during the period required to obtain delivery Minimum Level = Reorder level (Normal usage per period x Average Delivery Time) Question No 6: X Ltd. is reviewing its stock policy, and has the following alternatives available for the evaluation of stock: i) Purchase stock twice in a month, 400 units. ii) Purchase monthly, 800 units iii) Purchase every three months, 2,400 units iv) Purchase every six month, 4,800 units v) Purchase annually, 9,600 units It is ascertained that the purchase price per unit is 40 for deliveries up to 2,000 units. A 5% discount is offered by the supplier on the whole order where deliveries are 2,001 to 4,000 units and 10% reduction on the total order for deliveries in excess of 4,000 units. Each purchase order incurs administration costs of 250. Interest on capital and other storage costs are per unit of average stock quantity held. Calculate the optimum order size. (June 2011)(4 Marks) The purchase cost is not constant per unit. It is therefore, not possible to use the EOQ formula. For optimum order size statement of cost is prepared as follows: Annual Purchase Cost Storage Admin Total Order size No. of Order Rate/unit Cost (Rs) Cost (Rs) Cost (Rs) 9, , , ,850 4, , , ,100 2, , ,000 1, , , ,000 3, , , ,500 6, ,500 The optimum order size is 4,800 units which cost 376,100 in total. Working Notes: (i) Order size up to 2,000 units, Purchase price is 40

15 Compiler of Suggested s Order size 2,001 4,000 units, Purchase price is 40 5% Discount = 38. Order size greater than 4,000 units, Purchase price is 40 10% Discount = 36. (ii) Storage cost: per unit of average stock For order size 400 units, Average stock 200 units = 2,500 and so on. Question No 7: During Poush 2067, a company purchased 1,200 kg. of raw materials. The following particulars relate to the purchase: i) Lot prices quoted by supplier and accepted by the company for placing the purchase order: (a) Lot up to / kg. (b) Between / kg. (c) Between / kg. ii) Trade discount 20%. iii) VAT at 13% extra; credit is to be taken. iv) Freight paid 240. v) Insurance paid at 2.5% on Invoice Value. vi) Stores overhead applied at 5% on total purchase cost of material. The entire quantity was received and issued to production. Required: Prepare a statement showing total cost of material purchased and unit cost of material issued to production. (December 2011)(5 Marks) Statement of total and per unit cost of materials Particulars Total Amount () Per unit Amount () Raw material / kg 24, Less: Trade 20% 4, , Add: 2, Invoice Value 21, Freight paid on 21, , Add: Stores 1, Less: VAT credit 2, ` 21, Question No 8: A company prepared the following budgeted income statement for next financial year: Particulars Amount () Amount () Sales (52, each) 44,200,000 Cost of goods sold: 15

16 Compiler of Suggested s Opening stock (2, each) 1,300,000 Purchases (52, each) 36,400,000 Closing stock (2, each) (1,400,000) 36,300,000 Gross profit 7,900,000 Expenditures: Purchasing cost- variable (@30,000 per order) 240,000 Purchasing cost- fixed 840,000 Transportation cost (@55,000 per order) 440,000 (charged by the supplier of goods) Stock insurance cost (5, each) 220,000 (based on average stockholding) Fixed warehouse costs 2,300,000 4,040,000 Net profit before tax 3,860,000 At present, sales occur evenly throughout the year and a buffer stock of 2,000 units is maintained. Recently, the company has contracted with supplier to buy 52,000 units of goods, the payment of which shall be made in equal monthly installment throughout the year irrespective of the order size. As per the contract, transportation costs are to be paid at the beginning of the year. The supplier has offered 10,000 discount in transportation cost per order if the company increase the order size from 6,500 units to a minimum of 10,000 units per order. The cost of capital of the company is 20% per annum. Required: i. Assuming that the buffer stock level of 2,000 units is maintained; calculate the optimal order size for the company. ii. Show the improvement in net profit before tax with the implementation of the optimal order size. (June 2012)(12 Marks) i) Calculation of Optimal Order Size To calculate optimal order size, we have to find out EOQ EOQ = (2 x A x O/ C) Where, EOQ= Economic Order Quantity A = Annual Usage O = Ordering Cost C = Carrying Cost 16

17 Compiler of Suggested s Now, EOQ = (2 x 52,000 x 85,000 / 40) = 14,866 units At this EOQ level, the company will be eligible to get concession of 10,000 on transportation cost from supplier. Therefore, the ordering cost should be taken as 75,000 for calculating EOQ. Hence, new EOQ is EOQ = (2 x 52,000 x 75,000 / 40) = 13,964 units The buffer stock level of 2,000 units are covered in above 13,964 units of order size, therefore, the optimal order size for the company is 13,964 units per order. ii) 17

18 Compiler of Suggested s Statement showing improvement in net profit before tax with implementation of optimal order size Particulars Amount () Amount () Sales (52, each) 44,200,000 Less Cost of goods sold: Opening stock (2, each) 1,300,000 Purchases (52, each) 36,400,000 Closing stock (2, each) (1,400,000) 36,300,000 Gross profit 7,900,000 Less Expenditures: Purchasing cost- variable (WN 1) 120,000 Purchasing cost- fixed 840,000 Transportation cost (WN 2) 180,000 Stock insurance cost (WN 3) 359,280 Fixed warehouse costs 2,300,000 3,799,280 Revised net profit before tax 4,100,720 Original net profit before tax 3,860,000 Improvement in net profit before tax 240,720 WN 1) Calculation of variable purchasing cost Annual requirement (units) 52,000 Order size (units) 13,964 No. of orders (Annual requirement/ order size) 4 Variable purchasing cost per order () 30,000 Total variable purchasing cost () 120,000 WN 2) Calculation of transportation cost No. of orders 4 Transportation cost per order () 45,000 Total transportation cost () 180,000 WN 3) Calculation of stock insurance cost Buffer stock level (units) 2,000 Average stock (13964/2) (units) 6,982 Total average stockholding 8,982 Insurance cost per unit () 40 Total stock insurance cost () 359,280 Question No 9: Discuss ABC analysis as a technique of inventory control. (December 2012)(2.5 Marks) It is a system of inventory control. It exercises discriminating control over different items of stores classified on the basis of investment involved. Usually they are divided into three categories according to their importance, namely, their value and frequency of replenishment during a period. 18

19 Compiler of Suggested s A category of items consists of only a small percentage i.e. about 10% of total items handles by the stores but require heavy investment about 70% of inventory value, because of their high price or heavy requirement or both. B category of items are relatively less important 20% of the total items of material handled by stores and % of investment required is about 20% of total investment in inventories. C category 70% of total items handled and 10% of value. For A category items, stocks levels and EOQ are used and effective monitoring is done. For B category same tools as in A category are applied. For C category of items, there is no need of exercising constant control. Orders for items in this group may be placed after 6 months or once in a year, after ascertaining consumption requirement. Question No 10: What is the Advantages of ABC analysis (June 2013)(2.5 Marks) Followings are the advantages of ABC analysis system: (i) It ensures that, without there being any danger of interruption of production for want of materials or stores, minimum investment will be made in inventories of stocks of materials or stocks to be carried. (ii) The cost of placing orders, receiving goods and maintaining stocks is minimized especially if the system is coupled with the determination of proper economic order quantities. (iii)management time is saved since attention need be paid only to some of the items rather than all the items as would be the case if the ABC system was not in operation. (iv) With the introduction of the ABC system much of the work connected with purchases can be systematized on a routine basis to be handled by subordinate staff. Question No 11: Sambriddhi Coffee Ltd. is the supplier of high quality coffee with gift packaging for export. Company is newly establishes and very conscious about the cost control. To be competitive in the market; company maintain definite level of stock as well. The following are the details of their operating during 2012: Average monthly market demand for coffee 2,500 Packet Ordering cost 100 per order Inventory carrying cost 20% per annum Cost of high quality material 500 per Kg. Normal usage of material 100 Kg. per week Minimum usage 50 Kg. per week Maximum usage 300 Kg. per week Lead time 4-6 weeks Using the above data and information compute: i) Economic Order Quantity ii) Reorder Level iii) Maximum Level of Stock iv) Minimum Level of Stock v) If the supplier is willing to supply quarterly 1,500 Kg. in one lot at a discount of 5%, is it worth accepting? (December 2013)(6 Marks) Computing EOQ 19

20 Compiler of Suggested s Let A= annual usage = Normal usage per week 52 Weeks = =5,200 Kg O = ordering cost per order = 100 Cost per unit = 500/Kg C= stock holding rate p.a. = 20% p.a. Q=Re-order quantity # CS= Carrying cost per unit p.a. = % = Rs 100 EOQ= 2AO/C = 2 5, /100 =102 units i. Reorder Level = Max. Usage Maximum Lead Time =300 Kg/week 6 weeks = 1,800 Kg ii. Maximum Level = Reorder Level + Reorder Qty - (Minimum Usage Minimum Lead Time) = 1, ( W.N.1) - (50 Kg per week 4 weeks) =1,702 Kg iii. Minimum level = Reorder Level (Avg or Normal Usage Average Lead Time) =1,800 ((100 (4+6/2)) = 1,300 Kg iv. Evaluation of price discount offer: The price discount offer can be decided upon only after comparing the total annual inventory cost at EOQ & total annual inventory cost at 1500 units of order size. Total annual inventory cost = Total Purchase Cost + Total Ordering Cost + Total Carrying cost of Average Inventory. = (A C) + (A\Q O) + 1\2 Q CS At Q= 102 units (i.e. EOQ) = (5, ) + (5200\ ) + (1\ ) = 26, 00, = Rs 26,10,198 (approx.) At Q= 1500 units = (5,200 (500-5%)) + (5,200\ ) + (1\ (500-5% 20%)) =24,70, = Rs 25,41,597 (approx.) If the re-order quantity is fixed at 1500 Kg, the total annual inventory cost will be lower. So the discount offer should be accepted. Assumption: Since, there is no specification about re order quantity, it has been assumed to be equal to EOQ units i.e. 102 Kg/order. Question No 12: 20

21 Compiler of Suggested s Write short note on What is the Advantages of Bin Cards (December 2013)(2.5 Marks) i. There would be fewer chances of mistakes being made as entries will be made at the same time as goods are received or issued by the person actually handling the materials. ii. Control over stock can be more effective, in as much as comparison of the actual quantity in hand at any time with the book balance is possible. iii. Identification of the different items of materials is facilitated by reference to the Bin Card the bin or storage receptacle. Question No 13: Explain Economic Ordering Quantity. What are the implications of Economic Order Quantity in proper inventory management? (June, 2014)(5 Marks) Economic Order Quantity (EOQ): Purchase department in manufacturing concerns is usually faced with the problem of deciding the quantity of various items which they should purchase. If purchases of material are made in bulk then inventory carrying cost will be high. On the other hand, if order size is small each time, then the ordering cost will be high. In order to minimize ordering and carrying costs it is necessary to determine the order quantity, which minimizes these two costs. The size of the order for which both ordering and carrying costs are minimum is known as economic order quantity. The prime objective of inventory management is to find out and maintain optimum level of investment in inventory to minimize the total costs associated with it. Economic Order Quantity is the size of the order for which both ordering and carrying costs are minimum. Economic Order Quantity forms the very basis of inventory management. It refers to the size of each purchase order quantity for each item, which gives the maximum economy in purchase of that raw material or finished goods or stores materials. While placing any order for purchase of any item, it must be ensured that the order quantity is neither too large nor too small. A large order, no doubt, shall also mean the lower ordering cost but it shall mean a higher and sometimes prohibitive carrying costs. On the other hand, a small order may reduce the inventory carrying cost but the ordering costs would increase as the company may have to place a new order every now and then, besides, it may result in occasional production halts also. Therefore, a proper balance has to be struck between these two factors and the Economic Order Quantity shall be fixed at a point, where the aggregate cost of the two is minimum i.e., the total cost associated with the inventory management is minimum. Question No 14: What do you mean by perpetual inventory system? State its advantages. (June, 2014)(2.5 Marks) Perpetual Inventory System means continuous stock taking. CIMA defines Perpetual Inventory System as the recording as they occur of receipts, issues and resulting balances of individual items of stock in either quantity or quantity and value. Under this system, a continuous record of receipt and issue of materials is maintained by the stores department & the information about the stock of materials is always available. Entries in the bin card and stores ledger are made after every receipt and issue and the balance is reconciled on regular basis with the physical stock. 21

22 Compiler of Suggested s The main advantages are: i) Physical stock can be counted and book balances adjusted as and when desired without waiting for the entire stock taking to be done. ii) Quick compilation of profit and loss account (for interim period) due to prompt availability of stock figures. iii) Discrepancies are easily located and thus corrective action can be promptly taken to avoid the recurrence. iv) A systematic review of perpetual inventory reveals the existence of surplus, dormant, obsolete and slow-moving materials, so that remedial measures may be taken in time. v) Fixation of various stock level and checking of actual balances in hand with these levels assist the storekeeper in maintaining stocks within limits and in initiating purchase requisitions for correct quantity at proper time. Question No 15: MTC Limited uses chemical X in one of its finished products. The chemical-x is purchased from a vendor outside Nepal. MTC Limited purchases 36,000 Ltr. of chemical X per year at the rate of 900 per Ltr plus import on such purchases. The chemical X is used evenly throughout the year in the production process on a 360 day per year basis. The Company incurs 1,75,000 on one year agreement for material supply with the vendor and it estimates that 35,000 will be incurred to place a single purchase order. The chemical X is needed to be kept in a very carefully controlled temperature and humidity conditions. MTC Ltd. Incurs 1.5% and % of the value of inventory as storage cost and as insurance cost respectively. Delivery from the vendor generally takes 12 days, but it can take as much as 16 days. The days of delivery time and percentage of their occurrence are shown in the following tabulation: Delivery time (days) : Percentage of occurrence : Required: i) Compute the economic order quantity (EOQ). ii) Assume the company is willing to assume a 10% risk of being out of stock. What would be the safety stock? The re-order point? iii) Assume 5% stock-out risk. What would be the total cost of ordering and carrying inventory (i) for one year? (ii) Economic Order Quantity (E.O.Q) = 2AO = 2x36,000 Ltrs. xrs = 12,000 litres C Rs Safety Stock at 10% risk of being out of stock Safety Stock required for two days i.e. for 13 th and 14 th day (December, 2014)(10 Marks) (iii) Safety stock = 36,000ltr x 2days = 200 litres 360 days Re-order Point = Minimum Stock level + Average lead time x Average consumption = x 100 = 1400 litres At 5% risk of being out stock, safety stock will be safety stock for three days 100 ltr x 3 days =300 ltr. Total Ordering Cost =36,000ltr x Rs 35,000 = Rs 1,05,000 12,000ltr 22

23 Compiler of Suggested s Total Carrying cost of inventory = (Safety Stock + Average inventory) Carrying Cost per litre per annum = ( /2 x 12,000 ltr.) Rs = Rs 1,10,250 Total cost of ordering & carrying inventory = 1,05, ,10,250 = Rs 2,15,250 Working Notes Risk of being out of stock Delivery Time Percentage of Occurrence (%) Cumulative percentage of Occurrence (%) Risk of non Occurrence (%) 12 days days days days days Ordering Cost per order (O)- Rs 35,000 Cost per litre of chemical-x Rate per litre Rs 900 Add: Import Rs 90 Rs 990 Carrying cost per litre per annum of chemical-x (C) % (1.5% %) of Rs 990= Rs17.50 (Note: Amount of 175,000 incurred on making agreement for material supply will be apportioned over the entire quantity of 36,000 ltr and included with cost of chemical X. However for the purpose of calculating carrying cost i.e storage cost and insurance cost only invoice cost of material is taken. Invoice cost consist of cost per litre of chemical X plus import duty.) Question No 16: Discuss the accounting treatment for spoilage and defectives in cost-accounts (December, 2014)(2.5 Marks) Normal spoilage (i.e. which is inherent in the operation) costs are included in cost either by charging the loss due to spoilage to the production order or by charging it to production overhead so that it is spread over all the products. Any value realized from the sale of spoilage is credited to production order or production overhead account, as the case may be. The cost of abnormal spoilage are charged to Costing Profit & Loss Account. Defectives that are considered inherent in the process and are identified as normal can be recovered by using any one of the following method. Charged to good products Charged to general overheads Charged to departmental overheads. 23

24 Compiler of Suggested s If defectives are abnormal, they are to be debited to Costing Profit & Loss Account. Question No 17: From the following data for the year ended 31 st December, 2014 calculate the inventory turnover ratio of the two items and put forward your comment on them, Material P Material Q Opening Stock 1/1/ ,000 9,000 Purchase during the year 104,000 54,000 Closing Stock 31/12/ ,000 22,000 (July, 2015)(4 Marks) First of all it is necessary to find out the cost of material consumed. Cost of material consumed Materials P Materials Q Opening stock 20,000 9,000 Add:Purchases 1,04,000 54,000 1,24,000 63,000 Less: Closing stock 12,000 22,000 Material consumed 1,12,000 41,000 Average inventory(op. Stock+Cl. Stock) 2 16,000 15,500 Inventory Turnover ratio( Consumption Avg. inventory) 7 times 2.64 times Inventory Turnover (No. of days ): (No of days in a year 52 days 146 days I.T.Ratio) Comments: Material P is more fast moving than Material Q. Question No 18: What is Just in time (JIT) purchases? What are the advantages of such purchases? (July, 2015)(2 Marks) Just in time (JIT) purchases means the purchase of goods or materials such that delivery immediately precedes their use. Advantages of JIT purchases: Main advantages of JIT purchases are as follows; i) The suppliers of goods or materials cooperate with the company and supply requisite quantity of goods or materials for which order is placed before the start of production. ii) JIT purchases result in cost savings for example, the cost of stock out, inventory carrying, materials handling are reduced. iii) Due to frequent purchases of raw materials, its issue price is likely to be very close to the replacement price. Consequently the method of pricing to be followed for valuing material issues becomes less important for companies using JIT purchasing. JIT purchasing are now attempting to extend daily deliveries to as many areas as possible so that the goods spend less time in warehouses or on store shelves before they are exhausted. 24

25 Compiler of Suggested s Chapter 3: Labor Control 25

26 Compiler of Suggested s Question No 1: Calculate the earnings of workers A and B from the following particulars for a month and allocate the labour cost to each job X, Y and Z: Basic Wages () Dearness Allowance Contribution to Provident Fund (on basic wages) Contribution to Employees Life Insurance (on basic wages) Overtime Hours A % 8% 2% 10 B % 8% 2% - The Normal working hours for the month are 200. Overtime is paid at double the total of normal wages and dearness allowance. Employer s contribution to life Insurance and Provident Fund are made at the rates equal to employees contributions. The two workers were employed on jobs X, Y and Z in the following proportions: Workers A Worker B Overtime was done on job Y. Jobs X Y Z 40% 30% 30% 50% 20% 30% (June 2010)(10 Marks) Statement Showing Earnings of Workers A and B Workers: A B Basic Wages Dearness Allowance (50% of Basic Wages) Overtime Wages (Refer to Working Note 1) 15 - Gross Wages earned Less: - Provident Fund 8% of Basic wages and ELI % of Basic wages Net Wages paid Statement of Labour Cost: Gross Wages (excluding overtime) Employer s Contribution to P.F. and E.L.I Ordinary wages Labour Rate per hour 0.80 ( 160/200) ( 256/200) Statement showing allocation of Wages to Jobs Jobs Total Wages: X Y Z Worker A: Ordinary Wages: (4 : 3 :3) Overtime Workers B:

27 Compiler of Suggested s Ordinary Wages: (5: 2 : 3) Working Notes: Normal Wages are considered as basic wages Overtime = 2 x (Basic wage + D.A.) 200 = 2 ( 150/200) 10 hours = 15/-. Question No 2: Write short note on Shift Premium and Overtime Premium (June 2010)(2.5 Marks) Shift premium/differential refers to the payment of higher hourly rates for working in less desirable shifts of job, such as evening or night shift. It is charged to factory overhead control rather than work-in-process, and spread over all units produced because they are not caused by specific units. For example, if day time rate per hour is 50 and night time rate is 60 per hour, the shift premium per hour is 10 only, which is charged to factory overhead. Overtime work is caused due to random scheduling of jobs, requirement of a specific job and poor workmanship or negligence. It may be paid at the regular rate or higher rate as required. If higher rate is paid for the overtime hours, the differential is termed as overtime premium. If it is caused by random scheduling of jobs, it is treated as shift premium; if it is caused by requirement of specific job, it is charged to that specific job; and if it is caused by poor workmanship or negligence, it is charged to profit and loss account. Question No 3: Two workmen BED and DEB, produce the same product using the same material. Their normal wage rate is also the same. BED is paid bonus according to the Rowan system, while DEB is paid bonus according to the Halsey System. The time allowed to make the product is 100 hours. BED takes 60 hours while DEB takes 80 hours to complete the product. The factory overhead rate is 10 per man-hour actually worked. The factory cost for the product for BED is 7,280 and for DEB it is 7,600. You are required to find the normal rate of wages of BED and DEB. (December 2010)(6 Marks) Let x be the cost of material and y be the normal rate of wage per hour. Factory cost of workman BED: Material cost Wages x 60 y Bonus under Rowan System: Time saved x Hours Worked x Rate per Hour Time allowed Overhead (60 x 10) = 600 Factory cost = x + 60 y + 24 y = 7,280, Or x + 84 y = 6,680 (i) Factory cost of workman DEB: Material x Wages 80 y 27

28 Bonus under Halsey Premium Plan = (Hours Saved x 50)/ 100 x Rate per Hour = 20 x ½ y = 10 y Overhead (80 x 10) = 800 Compiler of Suggested s Factory cost = x + 80y + 10 y = 7,600, Or x + 90 y = 6,800 (ii) Deducting equations (i) from (ii), 6 y = 120, Or, y = 120/6 = 20 The normal rate of wages is therefore 20 per Hour. Question No 4: The existing incentive system of Beta Ltd. is as under: Normal working week : 5 days of 8 hours each plus 3 late shifts of 3 hours each. Rate of payment : Day work: 160 per hour : Late shift: 225 per hour Average output per operator for 49 hours week i.e. including 3 late shifts : 120 articles. In order to increase output and eliminate overtime, it was decided to switch on to a system of payment by results. The following information is obtained: Time-rate (as usual) : 160 per hour Basic time allowed for 15 articles : 5 hours Piece-work rate : Add 20% to basic piece-rate Premium Bonus : Add 50% to time. Required: Prepare a statement showing hours worked, weekly earnings, number of articles produced and labour cost per article for one operator under the following systems: i) Existing time-rate ii) Straight piece-work iii) Rowan system iv) Halsey premium system Assume that 135 articles are produced in a 40 hour week under straight piece work, Rowan premium system, and Halsey premium system above and worker earns half the time saved under Halsey premium system. (June 2011)(8 Marks) Table showing Labour cost per article: Method of payment Hours Weekly Number of Labour cost Worked earnings articles per article produced Existing time rate 49 8, Straight piece rate system 40 8, Rowan Premium system 40 9, Halsey Premium system 40 8,

29 Compiler of Suggested s Working notes: Existing time rate Weekly wages per hour 6, per hour 2,025 8,425 Piece Rate system: Basic time: 5 hours for 15 articles (120/40hour=3hr/Article) Cost of 15 articles at hourly rate of 160/hr. 800 Add 20% Rate per article = 960/15 = 64 Earning for the week = 135 articles 64 = 8,640 Rowan Premium system: Basic Time : 5 hours for 15 articles Add : 50% to time 7.5 hours for 15 articles Or 30 minutes per article Time allowed for 135 articles = 67.5 hours Actual time taken for 135 articles = 40 hours TA HW Earnings = (HW RH) + HW RH TA = (40 hrs. 160) + 40 Rs = 9, Halsey Premium System: 50 Earnings = HW RH + (TA HW) RH 100 = ½ ( ) 160 = 8,600 Question No 5: Rolland Limited operates a group incentive scheme in one of its department. A minimum hourly rate is guaranteed to each of the six employees in the group if actual output for the week is less than the standard output. If actual output is greater than the standard output, the hourly rate of each employee is increased by 4% for each additional 600 units of output produced. The standard output for the group is 12,000 units for a 40 hour week. During the week ended 31 st December, 2010, each employee in the group worked 40 hours; actual output and minimum hourly rates were as follows: Employee Actual output (units) Minimum hourly rate () Lal 2, Hari 2, Mohan 2, Shyam 2,