1. (a) Working notes: MOCK TEST PAPER 2 INTERMEDIATE (IPC): GROUP I Test Series: October, 2015 PAPER 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT SUGGESTED ANSWERS/ HINTS 1. (i) Number of units sold at 80% capacity (ii) Turnover Selling price p.u. 8,00,000 25. Number of units sold at 100% capacity 32,000 units x 100 40,000 units 80. 32,000 units. 2. Component of fixed cost included in semi-variable cost of 32,000 units. Fixed cost { Total semi-variable cost Total variable cost } 1,80,000 32,000 units x 3.75 1,80,000 1,20,000 60,000 3. (i) Total fixed cost at 80% capacity (ii) Fixed cost + Component of fixed cost included in semi variable cost (Refer to working note 2) 90,000 + 60,000 1,50,000 Total fixed cost beyond 80% capacity Total fixed cost at 80% capacity + Additional fixed cost to be incurred 1,50,000 + 20,000 1,70,000 4. Variable cost and contribution per unit Variable cost per unit Material cost + Labour cost + Variable cost component in semi variable cost Contribution per unit 7.50 + 6.25 + 3.75 17.50 Selling price per unit Variable cost per unit 25 17.50 7.50 1
5. Profit at 80% capacity level Sales revenue Variable cost Fixed cost 8,00,000 5,60,000 (32,000 units x 17.50) 1,50,000 90,000 (i) Activity level at Break Even Point Fixed cost Break-even point (units) Contribution per unit (Refer to working notes 3 & 4) Activity level at BEP (Refer to working note 1(ii)) 1,50,000 7.50 20,000 units Break - Even point (units) No. of units at 100% capacity level x 100 20, 000 units x 100 50% 40,000 units (ii) Number of units to be sold to earn a net income of 8% of sales Let x be the number of units sold to earn a net income of 8% of sales. Mathematically it means that : (Sales revenue of x units) Variable cost of x units + Fixed cost + Net income Or, 25x 8 17.5x + 1,50,000 + x ( 25x) 100 Or, 25x 17.5x + 1,50,000 + 2x or x (1,50,000/5.5) units or x 27,273 units. (iii) Activity level needed to earn a profit of 95,000 The profit at 80% capacity level, is 90,000 which is less than the desired profit of 95,000, therefore the needed activity level would be more than 80%. Thus the fixed cost to be taken to determine the activity level needed should be 1,70,000 (Refer to Working Note 3 (ii)) 2
Units to be sold to earn a profit of 95,000 Fixed cost + Desired profit Contribution per unit 1,70,000 + 95,000 7.5 35,333,33 units Activity level needed to earn a profit of 95,000 35,333.33 units 40, 000 units 88.33% x 100 (iv) Selling price per unit, if break-even point is to be brought down to 40% (16,000 units) activity level Let x be the selling price per unit Units at Break-even point 16,000 units Break-even-point Fixed cost Contribution per unit At 16,000 units 1,50,000 (x - 17.50) (b) (i) Or (x 17.50) Or (x 17.50) 1,50,000 16, 000 units 75 8 units Or 8x (8 x 17.50) 75 Or 8x 140 75 Or 8x 215 Or x 26.875 Hence, S.P. (per unit) 26.875 Minimum stock of A Re-order level (Average consumption Average time required to obtain delivery) 8,000 kg. (200 units 10 kg. 2 weeks) 4,000 kg. 3
(ii) Maximum stock of B Re-order level (Min. Consumption Min. Re-order period) + Re-order quantity 4,750 kg. (175 units 4 kg. 3 weeks) + 5,000 kg. 9,750-2,100 7,650 kg. (iii) Re-order level of C Maximum re-order period Maximum Usage 4 weeks (225 units 6 kg.) 5,400 kg. OR Minimum stock of C + (Average consumption Average delivery time) 2,000 kg. + [(200 units 6 kg.) 3 weeks] 5,600 kg. (iv) Average stock level of A Minimum stock level of A + 1 2 Re-order quantity 4,000 kg. + 1 2 10,000 kg. 4,000 + 5,000 9,000 kg. OR Minimum stock + Maximum stock 2 4,000 + 16,250 2 10,125 kg. (Refer to Working Note) Working note Maximum stock of A ROL + ROQ (Minimum consumption Minimum re-order period) 8,000 kg. + 10,000 kg. [(175 units 10 kg.) 1 week] 16,250 kg. (c) Evaluation of effect of relaxing the discount policy on company s profit A. Incremental Revenue Increase in contribution ( 5,00,000 15%) 75,000 Reduction in investment in receivable cost of capital Present : 80 lacs 0.95 20 days 4,22,222 360 days 4
Proposed: ( 80 lacs 0.95 + 5 lacs 0.85) 14 days 3,12,083 360 days Reduction in investment in receivable 1,10,139 (4,22,222 3,12,083) Cost of savings on investment in receivable ( 1,10,139 10%) 11,014 86,014 B. Incremental Cost Increase in discount Present: ( 80 lacs 1% 0.5) 40,000 Proposed : ( 85 lacs 2% 0.8) 1,36,000 Net increase in discount 96,000 C. Net effect on profits (A B) 86,014 96,000 ( ) 9,986 Since, the proposed discount policy will reduce the profits of the company to the extent of 9,986. Therefore, it is not advisable for the company to relax the present discount policy. (d) Company A Net Profit Return on Capital Employed Capital Employed Capital Employed in this case is equal to Total Assets. Net Profit 2,75,000 4 11,000 100 Total Assets 2,75,000 45,833 6 Return on Capital employed 11,000 100 24% 45, 833 Company B Sales 4,680 100 18,720 25 5
Net Profit 18,720 19 3,556.80 100 Return on Capital Employed 3,556.80 100 8.368% 42, 500 2. (a) School Contract Account Particulars Amount () Particulars Amount () To Plant 2,40,000 By Material returned 47,000 To Hire of plant 77,000 By Plant c/d 1,65,000 To Materials 6,62,000 By Materials c/d 50,000 To Direct wages 9,60,000 By WIP c/d: Add: Accrued 40,000 10,00,000 Value of work certified 24,00,000 To Wages related costs 1,32,000 Cost of work not certified 1,80,000 To Direct expenses 34,000 To Supervisory staff: Direct 90,000 Indirect 20,000 1,10,000 To Regional office expenses 50,000 To Head office expenses 30,000 To Surveyors fees 27,000 To Notional profit c/d 4,80,000 28,42,000 28,42,000 To Cost P&L A/c 2,40,000 By Notional Profit b/d 4,80,000 To WIP (reserve) c/d 2,40,000 Working Note: 4,80,000 4,80,000 (i) Calculation of percentage of work completion: 24,00,000 100 30,00,000 80% (ii) Calculation of profit attributable to the contact: 2 18,00,000 4,80,000 2,40,000 3 24,00,000 6
(b) (i) Computation of Earnings Per Share (EPS) for each Plan Particulars Plan A Plan B Plan C Earnings Before Interest Tax (EBIT) 1,60,000 1,60,000 1,60,000 Less: Interest on debt at 8% ---- 16,000 ---- Earnings Before Tax 1,60,000 1,44,000 1,60,000 Less: Tax at 50% 80,000 72,000 80,000 Earnings After Tax 80,000 72,000 80,000 Less: Preference Dividend at 8% ---- ----- 16,000 Earnings available for equity shareholders 80,000 72,000 64,000 Number of Equity Shares 20,000 10,000 10,000 Earnings per share (EPs) 4.00 7.20 6.40 (ii) Financial Break-even Point for Each Plan Plan A : There is no fixed financial charges, hence the financial break-even point for Plan A is zero. Plan B : Fixed interest charges is 16,000, hence the financial break-even point for Plan B is 16,000 Plan C : Fixed Charge for preference dividend is 16,000, hence, the financial break-even point for Plan C is 16,000 (iii) Between Plan A and C (X - 0) (1-.5) - 0 (X - 0)(1-.5) - 16000 20,000 10,000 or.5x.5x - 16,000 20,000 10,000 or,.5x - X -32,000 or,.5x 32,000 or, X 64,000 Thus point of indifference between plan A and C is 64,000. 7
3. (a) Calculation of equivalent units Units Material 1 Material 2 Wages & Overheads % Units % Units % Units Completed 46,500 -- -- -- From opening WIP 6,000 -- 40 2,400 60 3,600 From input 40,500 100 40,500 100 40,500 100 40,500 Closing work in 4,000 100 4,000 50 2,000 30 1,200 process Normal loss 3,000 -- -- -- Abnormal loss 500 100 500 80 400 60 300 54,000 45,000 45,300 45,600 This month s costs 1,92,300 1,10,400 27,180 54,720 Less: Revenue from normal loss Cost per equivalent unit Evaluation of September 2015, Output 2,400 2,400 -- -- 1,89,900 1,08,000 27,180 54,720 4.2 2.4 0.6 1.2 Total Material 1 Material 2 Wages Overheads Sundries Completed from opening WIP (last month) 19,440 19,440 From opening WIP (this month) 5,760 1,440 1,440 2,880 From input 1,70,100 97,200 24,300 16,200 32,400 Finished goods 1,95,300 97,200 25,740 17,640 35,280 19,440 Closing work-inprocess 12,240 9,600 1,200 480 960 Normal loss (revenue) 2,400 2,400 Abnormal loss 1,800 1,200 240 120 240 2,11,740 1,08,000 27,180 18,240 36,480 21,840 8
Process C Account Units () Units () To Opening WIP 6,000 19,440 By Finished goods 46,500 1,95,300 To Process B 48,000 1,10,400 By Closing WIP 4,000 12,240 To Direct materials 27,180 By Normal loss 3,000 2,400 added (revenue) To Direct wages 18,240 By Abnormal loss 500 1,800 To Production Overhead 36,480 54,000 2,11,740 54,000 2,11,740 Abnormal loss Account Units () Units () To Process C 500 1,800 By Process C - revenue for abnormal scrap 500 400 By Costing Profit and loss 1,400 account 500 1,800 500 1,800 Finished Goods Account To Process C 46,500 1,95,300 (b) (a) Cost of Project M Units Units At 15% I.R.R., the sum total of cash inflows Cost of the project i.e. Initial cash outlay is Given: Annual cost saving 40,000 Useful life 4 years IRR 15% Now, considering the discount factor table @ 15% cumulative present value of cash inflows for 4 years is 2.855 Therefore, Total of cash inflows for 4 years for Project M is ( 40,000 2.855) 1,14,200 Hence, cost of the project is 1,14,200 Payback period of the Project M Payback period Cost of the project Annual cost saving 9
Cost of Capital 1,14,200 40,000 2.855 or 2 years 11 months approximately If the profitability index (PI) is 1, discounted cash inflows and outflows would be equal. In this case, (PI) is 1.064. Therefore, present value cash inflows would be more by 0.064 (1.064-I) than outflow. Probability index (PI) or 1.064 Discounted cash inflows cost of the project Discounted cash inflows 1,14,200 or 1.064 1,14,200 1,21,509 Hence discounted cash inflows 1,21,509 Since, Annual cost saving is 40,000. Hence, cumulative discount factor for 4 years 1,21,509 40,000 3.037725 or 3.038 Considering the discount factor table at discount rate of 12%, the cumulative discount factor for 4 years is 3.038 Hence, the cost of capital is 12% Net present value of the project N.P.V. Total present values of cash inflows Cost of the project 1,21,509 1,14,200 7,309 4. (a) Stores Control () () To Balance b/d 54,250 By Work in progress 1,97,750 To Cost ledger control account 2,16,590 By Balance c/d 73,090 2,70,840 2,70,840 To Balance c/d 73,090 10
Work in-progress Control To Balance b/d 89,100 By Finished goods control 5,12,050 To Stores control 1,97,750 By Balance c/d 73,980 To Direct wages 85,480 To Production overhead control 2,13,700 To Balance b/d 73,980 Finished Goods Control 5,86,030 5,86,030 To Balance b/d 42,075 By Cost of goods sold 4,93,460 To Work-in-progress 5,12,050 By Balance c/d 60,665 To Balance c/d 60,665 Production overhead control 5,54,125 5,54,125 To Cost ledger control 2,08,220 By Work-in -progress 2,13,700 To Additional depreciation 12,500 By Under -absorbed 7,020 (b) (a) Working Notes: 2,20,720 2,20,720 1. Manufacturing expenses Sales 24,00,000 Less: Gross profit margin at 20% 4,80,000 Total Manufacturing cost 19,20,000 Less: Materials consumed 6,00,000 Wages 4,80,000 10,80,000 Manufacturing expenses 8,40,000 Less: Cash manufacturing expenses (50,000 12) 6,00,000 Depreciation 2,40,000 11
2. Total cash costs Manufacturing costs 19,20,000 Less: Depreciation 2,40,000 Cash Manufacturing costs 16,80,000 Add: Administrative expenses 1,50,000 Add: Sales promotion expenses 75,000 Total cash costs 19,05,000 Statement showing the Requirements of Working Capital of the Company Current Assets: Debtors 1/6 th of total cash costs (1/6 19,05,000) 3,17,500 (Refer to Working note 2) Sales promotion expenses (prepaid - 75,000/4) 18,750 Stock of raw materials (1 month) 50,000 Finished goods (1/12 of cash manufacturing costs) 1,40,000 ( 16,80,000 x 1/12) (Refer to Working note 2) Cash in hand 80,000 Less: Current liabilities Creditors for goods (2 months 6,00,000/6) 1,00,000 Wages (1 month 4,80,000/12) 40,000 Manufacturing expenses (1 month 6,00,000/12) 50,000 6,06,250 Administrative expenses (1 month 1,50,000/12) 12,500 2,02,500 Net working capital 4,03,750 Add: Safety margin 10% 40,375 Working Capital Required 4,44,125 Note: As no information is given about the nature of administrative overhead, it is assumed that, it is not incurred for production activities and excluded from Cost of Manufacturing /Cost of Production. 12
5. (a) Accounting treatment of idle time wages & overtime wages in cost accounts: Normal idle time is treated as a part of the cost of production. Thus, in the case of direct workers, an allowance for normal idle time is built into the labour cost rates. In the case of indirect workers, normal idle time is spread over all the products or jobs through the process of absorption of factory overheads. Under Cost Accounting, the overtime premium is treated as follows: If overtime is resorted to at the desire of the customer, then the overtime premium may be charged to the job directly. If overtime is required to cope with general production program or for meeting urgent orders, the overtime premium should be treated as overhead cost of particular department or cost center which works overtime. Overtime worked on account of abnormal conditions should be charged to costing Profit & Loss Account. If overtime is worked in a department due to the fault of another department the overtime premium should be charged to the latter department (b) Problems of controlling the selling & distribution overheads are : (i) The incidence of selling & distribution overheads depends on external factors such as distance of market, nature of competition etc. which are beyond the control of management. (ii) They are dependent upon customers' behaviour, liking etc. (iii) These expenses are of the nature of policy costs and hence not amenable to control. The above problems of controlling selling & distribution overheads can be tackled by adopting the following steps: (a) Comparing the figures of selling & distribution overhead with the figures of previous period. (b) Selling & distribution overhead budgets may be used to control such overhead expenses by making a comparison of budgetary figures with actual figures of overhead expenses, ascertaining variances and finally taking suitable actions, (c) Standards of selling & distribution expenses may be set up for salesmen, territories, products etc. The laid down standards on comparison with actual overhead expenses will reveal variances, which can be controlled by suitable action (c) Features of Commercial Paper (CP) A commercial paper is an unsecured money market instrument issued in the form of a promissory note. Since the CP represents an unsecured borrowing in the money 13
market, the regulation of CP comes under the purview of the Reserve Bank of India which issued guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group. These guidelines were aimed at: (i) Enabling the highly rated corporate borrowers to diversify their sources of short term borrowings, and (ii) To provide an additional instrument to the short term investors. It can be issued for maturities between 7 days and a maximum upto one year from the date of issue. These can be issued in denominations of ` 5 lakh or multiples therefore. All eligible issuers are required to get the credit rating from credit rating agencies (d) Difference between Financial Lease and Operating Lease S. No. Finance 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. 2. 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 Usually, the lessor bears the cost of repairs, maintenance or of repairs, maintenance or operations. operations. 5. The lease is usually full payout. The lease is usually non-payout. 6. (a) (a) Production Budget (in Litres) June July August September Litres to be sold 6,000 7,500 8,500 7,000 Litres in closing stock 750 850 700 650 Litres in opening stock (750) (750) (850) (700) 6,000 7,600 8,350 6,950 Fruits used will be: 21,000 (6,000 Ltr 3.5 kg) June July August September 26,600 (7,600 Ltr 3.5 kg) 29,225 (8,350 Ltr 3.5 kg) 24,325 (6,950 Ltr 3.5 kg) 14
(b) Fruits purchase budget June July August Quantity to be used 21,000 26,600 29,225 Add: Quantity in closing stock 13,300 14,612.50 12,162.50 Less: Quantity in opening stock (5,800) (13,300) (14,612.50) Purchase budget 28,500 27,912.50 26,775 (c) (b) (i) Budgeted profit for the quarter- June to August June July August Total () () () () Sales: 6,000 105 6,30,000 7,500 105 7,87,500 8,500 105 8,92,500 6,30,000 7,87,500 8,92,500 23,10,000 Cost of sales: 6,000 75 (4,50,000) 7,500 75 (5,62,500) 8,500 75 (6,37,500) (16,50,000) Gross profit 1,80,000 2,25,000 2,55,000 6,60,000 Net Sales: 30 crores EBIT 3.6 crores @ 12% on sales ROI (Calculated on Capital Employed) EBIT 3.6 100 20% Capital Employed 10 + 2 + 6 in crores EBIT 3.6 Interest on Debt 0.9 EBT 2.7 Less: Tax @ 40% 1.08 EAT 1.62 Less: Preference dividend 0.26 Earnings available for Equity Shareholders 1.36 Return on equity 1.36 x 100 13.6% 10 15
Segments due to the presence of Preference Share capital and Borrowing (Debentures) Segment of ROE due to preference capital: [.20(1-.4)-.13] x.2 -.002 Segment of ROE due to Debentures: [.20 (1-.4) -.15 (1-.4)] x.6.018 or -.2% + 1.8% 1.6% The weighted average cost of capital is as follows Source Proportion Cost (%) WACC (%) (i) Equity 10/18 13.60 7.56 (ii) Preference shares 2/18 13.00 1.44 (iii) Debt 6/18 9.00 3.00 Total 12.00 (ii) Financial Leverage EBIT EBIT - Interest - Preference dividend 3.6 1.4757 3.6.9.26 Combined Leverage DFL x DOL 3 1.4754 x DOL 3 DOL 1.4754 Operating Leverage 2.033 7. (a) Operating Costing: It is a method of costing applied by undertakings which provide service rather than production of commodities. Like unit costing and process costing, operating costing is thus a form of operation costing. The emphasis under operating costing is on the ascertainment of cost of rendering services rather than on the cost of manufacturing a product. It is applied by transport companies, gas and water works, electricity supply companies, canteens, hospitals, theatres, school etc. Within an organisation itself certain departments too are known as service departments which provide ancillary services to the production departments. For example maintenance department; power house, boiler house, canteen, hospital, internal transport etc. Operation Costing: It represents a refinement of process costing. In this each operation instead of each process of stage of production is separately costed. This may offer better scope for control. At the end of each operation, the unit operation cost may be computed by dividing the total operation cost by total output. 16
(b) Time value of money means that worth of a rupee received today is different from the worth of a rupee to be received in future. The preference of money now as compared to future money is known as time preference for money. A rupee today is more valuable than rupee after a year due to several reasons: Risk there is uncertainty about the receipt of money in future. Preference for present consumption Most of the persons and companies in general, prefer current consumption over future consumption. Inflation In an inflationary period a rupee today represents a greater real purchasing power than a rupee a year hence. Investment opportunities Most of the persons and companies have a preference for present money because of availabilities of opportunities of investment for earning additional cash flow. Many financial problems involve cash flow accruing at different points of time for evaluating such cash flow an explicit consideration of time value of money is required (c) Both bin cards and stores ledger are perpetual inventory records. None of them is a substitute for the other. These two records may be distinguished from the following points of view: (i) Bin cards are maintained by the store keeper, while the stores ledger is maintained by the cost accounting department. (ii) Bin card is the stores recording document whereas the stores ledger is an accounting record. (iii) Bin card contains information with regard to quantities i.e. their receipt, issue and balance while the stores ledger contains both quantitative and value information in respect of their receipts, issue and balance. (iv) In the bin card entries are made at the time when transaction takes place. But in the stores ledger entries are made only after the transaction has taken place. (v) Inter departmental transfer of materials appear only in stores ledger. (vi) Bin cards record each transaction but stores ledger records the same information in a summarized form (d) Treatment of by-product cost in Cost Accounting: (i) When they are of small total value, the amount realized from their sale may be dealt as follows: Sales value of the by-product may be credited to Costing Profit & Loss Account and no credit be given in Cost Accounting. The credit to Costing 17
(ii) Profit & Loss Account here is treated either as a miscellaneous income or as additional sales revenue. The sale proceeds of the by-product may be treated as deduction from the total costs. The sales proceeds should be deducted either from production cost or cost of sales. When they require further processing: In this case, the net realizable value of the by-product at the split-off point may be arrived at by subtracting the further processing cost from realizable value of by-products. If the value is small, it may be treated as discussed in (i) above (e) Virtual Banking and its Advantages Virtual banking refers to the provision of banking and related services through the use of information technology without direct recourse to the bank by the customer. The advantages of virtual banking services are as follows: Lower cost of handling a transaction. The increased speed of response to customer requirements. The lower cost of operating branch network along with reduced staff costs leads to cost efficiency. Virtual banking allows the possibility of improved and a range of services being made available to the customer rapidly, accurately and at his convenience. 18