Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Paper – 8: Cost Accounting & Financial management Question.1 (a) ABC Ltd. is having 400 workers at the beginning of the year and 500 workers at the end of the year. During the year 20 workers were discharged and 15 workers left the organization. During the year the company has recruited 65 workers Of these, 18 workers were recruited in the vacancies of those leaving, while the rest were engaged for an expansion scheme. The labour turnover rate under separation method is : (a) 22.20% (b) 7.78% (c) 4.00% (d) 14.40% Answer: (b) - 7.78% Average number of workers = (400 + 500)/2

=450

Separation method No. of Separationduringtheperiod =  100 Av.no. of workers duringtheperiod =

20  15 450

 100

= 7.78% (b)

A Manufacturer used 400 units of a component every month and he buys them entirely from an outside supplier @ ` 40 per unit. The order placing and receiving cost is ` 100 and storage and carrying cost is 10% of the value of stock. To get maximum benefit the firm should place order for how many units at a time? (a) 300 units (b) 490 units (c) 450 units (d) 500 units Answer: (b) - 490 units = EOQ  =

=

2  AnnualDemand  Ordering Cost StorageCost

2  400  12  100 10% of ` 40 9,60,000

4 = 490 units (c)

Consider the following data pertaining to the production of a company for a particular month : ` 11,570 Opening Stock of raw material ` 10,380 Closing Stock of raw material

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 ` 1,28,450 Purchase of raw material during the month ` 3,39,165 Total manufacturing cost charged to product Factory overheads are applied at the rate of 45% of direct labour cost. The amount of factory overheads applied to production is (a) ` 65,025 (b) ` 94,287 (c) ` 1,52,624 (d) ` 60, 654 Answer: (a) - ` 65,025 Raw material used = Op. Stock + Purchases – Cl. Stock = ` 11,570 + ` 1,28,450 – ` 10,380 = ` 1,29,640 Manufacturing cost= Raw material used + Direct labour + Factory overhead ` 3,39,165= ` 1,29,640 + Direct labour + 45% of Direct labour 1.45 Direct labour = ` 2,09,525 Direct labour = ` 1,44,500 The amount of factory overhead = 45% of ` 1,44,500 = ` 65,025. (d) Illustrate Indirect Expenses. Answer: Indirect Expenses are expenses which cannot be allocated but which can be apportioned to or absorbed by cost centres or cost units such as rent, insurance, municipal taxes, general manager salary and canteen and welfare expenses, power and fuel, cost of training new employees lighting and heating, telephone expenses etc. (e)

For a particular item of store, the following information are available: Re-order level = 1600 units Normal Consumption per week = 200 units Re-order period = 2 to 4 weeks Maximum Consumption will be: (a) 600 units (b) 500 units (c) 400 units (d) 300 units Answer: (c) - 400 units Let Maximum Consumption will be a Re-order level = Maximum Consumption × Maximum re-order period 1600= a × 4 Therefore, 4a = 1600  a=400 (f)

For a department the standard overhead rate is ` 2.50 per hour and the overhead allowances are as follows: Budget Overhead Allowances (`) Activity Level (Hours) 4,000 11,000 8,000 19,000

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 12,000 27,000 Calculate: (i) Fixed Cost (ii) The Standard Activity Level on the basis of which the Standard Overhead rate has been worked out. (a) ` 5,000, 6,000 hrs. (b) ` 4,000, 5,000 hrs. (c) ` 3,000, 6000 hrs. (d) ` 2,000, 4,000 hrs. Answer: (c) - `3,000, 6,000 hrs. (i) Fixed Cost Variable Overhead per hour =

High Level Cost - Low Level Cost

High Level Hours - Low level Hours = [(27,000 – 11,000) / (12,000 – 4,000)] =`2 Fixed Cost= 11,000 – (4,000 × 2) =` 3,000 (ii) Standard Activity Level at which the Standard rate has been determined = Fixed Cost /Fixed OH per hour = 3,000 / (2.50 – 2) = 6,000 Hours (g)

Vishnu Steels Ltd. has issued 30,000 irredeemable 14% debentures of ` 150 each. The cost of floatation of debentures is 5% of the total issued amount. The company’s taxation rate is 40%. The cost of debentures is: (a) 8.95% (b) 7.64% (c) 9.86% (d) 8.84% Answer: (d) - 8.84% ` Total issued amount (30,000 x ` 150) 45,00,000 Less: Floatation cost (` 45,00,000 x 5/100) 2,25,000 Net proceeds from issue 42,75,000 Annual interest charge= ` 45,00,000 x 14/100 = ` 6,30,000

Kd 

I(1- t ) 6,30,000(1- 0.40)  42,75,000 NP

=0.0884 or 8.84% (h)

The balance sheet of ABC Ltd. Shows the capital structure as follows : 2,50,000 equity shares of ` 10 each; 32,000, 12% preference shares of ` 100 each; general reserve of ` 14,00,000; securities premium account ` 6,00,000; 25,000, 14% fully secured non-convertible debentures of ` 100 each.; term loans from financial institutions ` 10,00,000. The leverage of the firm is:

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (a) 67.2% (b) 62.5% (c) 59.8% (d) 56.3% Answer: (c) - 59.8% Fixed income funds = Preference share capital + Debentures + Term loans = ` 32,00,000 + ` 25,00,000 + ` 10,00,000= ` 67,00,000 Equity funds = Equity share capital + General reserve + Securities premium = ` 25,00,000 + ` 14,00,000 + ` 6,00,000= ` 45,00,000 Total funds used in the capital structure = ` 67,00,000 + ` 45,00,000= ` 1,12,00,000 Leverage = (`67,00,000/ `1,12,00,000) × 100 = 59.8% (i)

A company has obtained quotes from two different manufacturers for an equipment. The details are as follows : Product Cost (` Million) Estimated life (years) Make X 4.50 10 Make Y 6.00 15 Ignoring operation and maintenance cost, which one would be cheaper? The company’s cost of capital is 10%. [Given: PVIFA (10%, 10 years) = 6.1446 and PVIFA (10%, 15 years)= 7.6061] (a) Make X will be cheaper (b) Make Y will be cheaper (c) Cost will be the same (d) None of the above Answer: (a) - Make X will be cheaper Make X Purchase cost = ` 4.50 million Equivalent annual cost = 4.50/6.1446 = ` 0.73235 Make Y Purchase cost = ` 6.00 million Equivalent annual cost = 6.00/7.6061 = ` 0.78884 million Therefore, equivalent annual cost of make X is lower than make Y, make X is suggested to purchase. (j)

According to the second method of lending by a bank as per Tandon committee suggestion, the maximum permissible bank borrowing – based on the following information is : Total current assets ` 40,000; Current assets other than bank borrowings ` 10,000; Core current assets ` 5,000. (a) ` 22,500 (b) ` 20,000 (c) ` 16,250 (d) ` 18,500 Answer: Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament)

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (b) - ` 20,000 MPBF under second method = (75% current assets) – (Current liabilities other than bank borrowings) = (` 40,000 x 75/100) – ` 10,000 = ` 20,000

Section A Question.2 (a) A job can be executed either through workman M or N. M takes 32 hours to complete the job while N finishes it in 30 hour The standard time to finish the job is 40 hour The hourly wage rate is same for both the worker In addition workman M is entitled to receive bonus according to Halsey plan (50%) sharing while N is paid bonus as per Rowan plan. The works overheads are absorbed on the job at ` 7.50 per labour hour worked. The factory cost of the job comes to ` 2,600 irrespective of the workman engaged. Find out the hourly wage rate and cost of raw materials input. Also show cost against each element of cost included in factory cost. Answer Working notes: 1. Time saved and wages: Workmen Standard time (hrs) Actual time taken (hrs) Time saved (hrs) Wages paid @ ` x per hr. (`) 2. Bonus Plan: Time saved (hrs) Bonus (`)

M 40 32 08 32x Halsey 8 4x

Rowan 10 7.5x

 10 hrs  40 hrs  30hrs  ` 

 8 hrs  ` x    2 3.

Total wages: Workman M: Workman N:

N 40 30 10 30x



x



32x + 4x = ` 36x 30x + 7.5x = ` 37.5x

Let Material Cost be y Statement of factory cost of the job Workmen

M ` y 36x

N ` y 37.5x

Material cost Wages (Refer to working note 3) Works overhead 240 225 Factory cost 2,600 2,600 The above relations can be written as follows: 36x + y + 240 = 2,600 …. (i) 37.5x+ y+ 225 = 2,600 …..(ii)

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Subtracting (i) from (ii) we get 1.5x – 15 = 0 or 1.5 x = 15 or x = ` 10 per hour On substituting the value of x in (i) we get y = ` 2,000 Hence the wage rate per hour is ` 10 and the cost of raw material input is ` 2,000 on the job. (b)

What do you understand by the term ‘pre-determined rate of recovery of overheads’? What are the bases that are usually advocated for such pre-determination? How do over absorption and under-absorption of overheads arise and how are they disposed off in Cost Accounts?

Answer The term ‘pre-determined’ rate of recovery of overheads’ refers to a rate of overhead absorption. It is calculated by dividing the budgeted overhead expenses for the accounting period by the budgeted base for the period. This rate of overhead absorption is determined prior to the start of the activity; that is why it is called a ‘pre-determined rate’. The use of the pre-determined rate of recovery of overheads enables prompt preparation of cost estimates and quotations and fixation of sales prices. For prompt billing on a provisional basis before completion of work, as for example in the case of cost plus contracts, pre-determined overhead rates are particularly useful. Bases Available: The bases available for computing ‘pre-determined rate of recovery of overheads’ are given below:(i) Rate per unit of output (ii) Direct labour cost method (iii) Direct labour hours method (iv) Machine hour rate method (v) Direct material cost method (vi) Prime cost method. The choice of a suitable method for calculating ‘pre-determined rate of recovery of overhead, depends upon several facto` Some important ones are- type of industry, nature of product and processes of manufacture, nature of overhead expenses, organisational set-up, policy of management etc. Reason for over/under absorption of overheads: Over-absorption of overheads arises due to one or more of the following reasons. (i) Improper estimation of overhead. (ii) Error in estimating the level of production. (iii) Unanticipated changes in the methods or techniques of production. (iv) Under-utilisation of the available capacity. (v) Seasonal fluctuations in the overhead expenses from period to period. Methods for absorbing under/over absorbed overheads: The over-absorption and underabsorption of overheads can be disposed off in cost accounting by using any one of the following methods: (i) Use of supplementary rates (ii) Writing off to costing profit & loss Account (iii) Carrying over to the next year’s account

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (i) Use of supplementary rates: This method is used to adjust the difference between overheads absorbed and overhead actually incurred by computing supplementary overhead rates. Such rates may be either positive or negative. A positive rate is intended to add the unabsorbed overheads to the cost of production. The negative rate, however corrects the cost of production by deducting the amount of overabsorbed overheads. The effect of applying such a rate is to make the actual overhead get completely absorbed. (ii) Writing off to costing profit & loss account: When over or under-absorbed amount is quite negligible and it is not felt worthwhile to absorb it by using supplementary rates, then the said amount is transferred to costing profit & loss Account. In case underabsorption of overheads arises due to factors like idle capacity, defective planning etc., it may also be transferred to costing profit & loss Account. (iii) Carrying over to the next year’s account: Under this method the amount of over/under absorbed overhead is carried over to the next period. This method is not considered desirable as it allows costs of one period to affect costs of another period. Further, comparison between one period and another is rendered difficult. Therefore, this method is not proper and has only a limited application. However, this method may be used when the normal business cycle extends over more than one year, or in the case of a new project, the output is low in the initial years. Question.3 (a) A factory incurred the following expenditure during the year 20112: ` Direct material consumed

15,00,000

Manufacturing Wages

10,00,000

Manufacturing overhead: Fixed

4,00,000

Variable

3,50,000

7,50,000

32,50,000 In the year 2013, following changes are expected in production and cost of production. (i) Production will increase due to recruitment of 50% more workers in the factory. (ii) Overall efficiency will decline by 10% on account of recruitment of new work ers. (iii) There will be an increase of 15% in Fixed overhead and 70% in Variable overhead. (iv) The cost of direct material will be decreased by 5%. (v) The company desire to earn a profit of 10% on selling price. Ascertain the cost of production and selling price. Answer: Budgeted Cost Sheet for the year 2013 Particulars Direct material consumed Add: 35% due to increased output Less: 5% for decline in price Direct wages (manufacturing) Add: 50% increase Prime cost Manufactured Overhead: Fixed

Amount ` 15,00,000 5,25,000 20,25,000 1,01,250 10,00,000 5,00,000

19,23,750 15,00,000 34,23,750

4,00,000

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Add: 15% increase

60,000 4,60,000

Variable Add: 70% increase

3,50,000 2,45,000 5,95,000

Cost of production Add: 1/9 of Cost or 10% on selling price Selling price

10,55,000 44,78,750.00 4,97,638.88 49,76,388.88

Production will increase by 50% but efficiency will decline by 10%. 150 – 10% of 150 = 135% So increase by 35%. Note: If we consider that variable overhead once will change because of increase in production (From 3,50,000 to 5,95,000) then with efficiency declining by 10% it shall be 5,35,500 and then again as mentioned in point No. (iii) of this question it will increase by 70% then variable overhead shall be ` 5,35,500  170% = 9,10,350. Hence, total costs shall be ` 47,94,100 and profit shall be 1/9 th of ` 47,94,100 = 5,32,678. Thus, selling price shall be 53,26,778. (b)

What are the essential features of an effective Wage Plan?

Answer: The essential features of an effective Wage Plan may be enumerated as follows: (i) It should be based upon scientific time and motion study to ensure a fair output and a fair remuneration. (ii) There should be guaranteed minimum wages at a satisfactory level. (iii) The wages should be related to the effort put in by the employee. It should be fair to both the employees and employer. (iv) The scheme should be flexible to permit any necessary variations which may arise. (v) There must be continuous flow of work. After completing one piece, the workmen should be able to go over to the next without waiting. (vi) After a certain stage, the increase in production must yield decreasing rate so as to discourage very high production which may involve heavy rejections. (vii) The scheme should aim at increasing the morale of the workers and reducing labour turnover. (viii) The scheme should not be in violation of any local or national trade agreements. (ix) The operating and administrative cost of the scheme should be kept at a minimum. Question.4 (a) A company uses three raw materials P, Q and R for a particular product for which the following data apply:Raw Usage per Re-order Material unit of Quantity product (Kgs) (Kgs) P 10 10,000 Q 4 5,000 R 6 10,000

Price per Delivery in period (in weeks) Kg Mini Average Maximum mum 0.10 0.30 0.15

1 3 2

2 4 3

3 5 4

Re-order level (Kgs)

Minimum level (Kgs)

8.000 4,500

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament)

2,000

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Weekly production varies from 175 to 225 units, averaging 200 units of the said product. What would be the following quantities:(i) Minimum Stock of P (ii) Maximum Stock of Q (iii) Re-order level of R (iv) Average Stock level of P. Answer: (i) Minimum stock level of P = Reorder Level - (Normal Usage x Avg. Delivery Time) = 8,000 kgs - {(200 units x 10 kg) x 2 weeks} = 4,000 kgs. (ii) Maximum stock of Q = Reorder Level + Reorder Quantity - Minimum consumption to obtain delivery = 4,500 kgs + 5,000 kgs - (175 units x 4 kgs x 3 weeks) = 7,400 kgs. (iii) Reorder Level of R Maximum reorder period x Maximum usage = 4 weeks x (225 units x 6 kgs) = 5400 kgs. OR = Min. stock + (Avg. rate of consumption x Avg. Delivery Period) = 2,000 kgs + {(200 x 6) x 3 weeks) = 5,600 kgs. (iv) Average stock level of P Minimum level + 1/2 Reorder Quantity 4,000 kgs + 1/2 x 10,000 = 9,000 kgs. OR (Minimum stock + Maximum stock) ÷ 2 (4,000 + 16,250)* ÷ 2 = 10,125 kgs. (Reorder Level + Reorder Quantity) - (Min. consumption x Minimum Reorder Period). 8,000 + 10,000 kg - {(175 x 10 x 1} = 16,250 kgs (b)

From the following details of stores receipts and issues of material “EXE" in a manufacturing unit, prepare the Store Ledger using Weighted Average Method of valuing the issues. Opening stock 2,000 units @ ` 5.00 each Nov. 1 Nov. 3. Issued 1,500 units to production Nov. 4. Received 4,500 units @ ` 6.00 each Nov. 8. Issued 1,600 units to production' Nov. 9. Returned to stores 100 units by Production Department (from the issues of Nov. 3) Nov. 16. Received 2,400 units @ ` 6.50 each Nov. 19. Returned to supplier 200 units out of the quantity received on Nov. 4 Nov. 20. Received 1,000 units @ ` 7.00 each Issued Nov. 24. Issued to production 2,100 units Nov. 27. Received 1,200 units @ ` 7.50 each Nov. 29. Issued to production, 2,800 units. (Use rates up to two decimal places).

Answer: Date Qty. Nov.

Stores Ledger (Weighted Average Method) Receipts Issues Rate Amount Qty. Rate Amount Qty. ` ` ` `

Stock Rate `

Amount `

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament)

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 1 3 4 8 9 16 19 20 24 27 29

4,500

6.00

27,000

100 2,400

5.00 6.50

500 15,600

1,000

7.00

7,000

1,200

7.50

9,000

1,500

5.00

7,500

1,600

5.90

9,440

200

6.00*

1,200

2,100

6.26

13,146

2,800

6.52

18,256

2,000 500 5,000 3,400 3,500 5,900 5,700 6,700 4,600 5,800 3,000

5.00 5.00 5.90 5.90 5.87 6.13 6.13 6.26 6.26 6.52 6.52

10,000 2,500 29,500 20,060 20,560 36,160 34,960 41,960 28,814 37,814 19,558

* Returned to supplier out of the quantity received on Nov. 4 Question.5 A factory has three production departments: The policy of the factory is to recover the production overheads of the entire factory by adopting a single blanket rate based on the percentage of total factory overheads to total factory wages. The relevant data for a month are given below: Department Direct Direct Factory Direct Labour Machine Material (`) Wages (`) Overheads (`) Hour Hours Budget Machining 6,50,000 80,000 3,60,000 20,000 80,000 Assembly 1,70,000 3,50,000 1,40,000 1,00,000 10,000 Packing 1,00,000 70,000 1,25,000 50,000 ------Actual Machining 7,80,000 96,000 3,90,000 24,000 96,000 Assembly 1,36,000 2,70,000 84,000 90,000 11,000 Packing 1,20,000 90,000 1,35,000 60,000 The details of one of the representative jobs produced during the month are as under: Job No. 100 Department Direct Material Direct Wages Direct Labour Machine (`) (`) Hour Hours Machining 1,200 240 60 180 Assembly 600 360 120 30 Packing 300 60 40 – The factory adds 30% on the factory cost to cover administration and selling overheads and profit. Required: (i) Calculate the overhead absorption rate as per the current policy of the company and determine the selling price of the Job No. 100. (ii) Suggest any suitable alternative method(s) of absorption of the factory overheads and calculate the overhead recovery rates based on the method(s) so recommended by you. (iii) Determine the selling price of Job 100 based on the overhead application rates calculated in (ii) above. (iv) Calculate the department wise and total under or over recovery of overheads based on the company's current policy and the method(s) recommended by you. Answer Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 10

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (i) Computation of overhead absorption rate (As per the current policy of the company) Department Machinery Assembly Packing Total

Budgeted Factory Overheads (`) 3,60,000 1,40,000 1,25,000 6,25,000

Overhead absorption rate = =

Budgeted Direct Wages (`) 80,000 3,50,000 70,000 5,00,000

Budgeted factory overheads Budgeted direct wages

` 6,25,000 ` 5,00,000

× 100

× 100

= 125% of Direct wages Selling price of the Job No. 100 ` 2,100.00

Direct Materials (` 1,200 + ` 600 + ` 300 Direct Wages 660.00 (` 240 + ` 360 + ` 60) Overheads 825.00 (125% × ` 660) Total factory cost 3,585.00 Add: Mark-up 1,075.50 Selling price 4,660.50 (ii) Methods available for absorbing factory overheads and their overhead recovery rates in different departments. 1. Machining Department In the Machining department, the use of machine time is the predominant factor of production. Hence machine hour rate should be used to recover overheads in this department. The overhead recovery rate based on machine hours has been calculated as under: Budgeted factory overheads Machine hour rate = Budgeted machine hours =

` 3,60,000 80,000 hours

= ` 4.50 per hour 2. Assembly Department In this department direct labour hours is the main factor of production. Hence direct labour hour rate method should be used to recover overheads in his department. The overheads recovery rate in this case is: Direct labour hour rate =

Budgeted factory overheads Budgeted direct labour hours

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 =

` 1,40,000 1,00,000 hours

= ` 1.40 per hour 3. Packing Department Labour is the most important factor of production in this department. Hence direct labour hour rate method should be used to recover overheads in this department. The overhead recovery rate is in this case comes to: Direct labour hour rate =

Budget ed factory overhead Direct labour hours =

` 1,25,000 50,000 hours

= ` 2.50 per hour (iii) Selling price of Job 100 [based on the overhead application rates calculated in (ii) above) ` 2,100.00 660.00 1,078.00 3,838.00 1,151.40 _______ 4,989.40

Direct materials Direct wages Overheads (Refer to Working Note) Factory cost Add: Mark up (30% of ` 3,838) Selling Price Working Note Overhead Summary Statement Dept. Basis Hours Machining Machine hour 180 Assembly Direct labour 120 hour Packing Direct labour 40 hour

Rate `

Total

4.50 1.40

Overheads ` 810 168

2.50

100 1,078

(iv) Department-wise statement of total under or over recovery of overheads (a) Under current policy Departments Machining Assembly Packing Total ` ` ` ` Direct Wages (Actual) 96,000 2,70,000 90,000 Overheads recovered @ 1,20,000 3,37,500 1,12,500 5,70,000 125% of Direct wages: (A) Actual overheads: (B) 3,90,000 84,000 1,35,000 6,09,000 (Under)/Over recovery of (2,70,000) 2,53,500 (22,500) (39,000) overheads: (A – B)

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (b) As per methods suggested Basis of overhead recovery Machine Direct Direct hours Labour labour hours hours Hours worked 96,000 90,000 60,000 Rate/hour (`) 4.50 1.40 2.50 Overhead recovered (`): 4,32,000 1,26,000 1,50,000 (A) Actual overheads (`): (B) 3,90,000 84,000 1,35,000 (Under)/Over recovery: (A – 42,000 42,000 15,000 B)

Total `

7,08,000 6,09,000 99,000

Question.6 (a) The overhead expenses recorded in the books of a manufacturing Company for the year ended 30th June, 2013 are given below: Total ` Production Department Service Department Packing ` Machine General Maintenance Shop ` Plant ` and Stores ` Indirect 29,300 8,000 6,000 4,000 11,300 labour Maintenance 10,040 3,600 1,400 2,040 3,000 Material Miscellaneous 3,500 800 2,000 300 400 supplies Supervisor’s 8,000 ------8,000 ----Salary Cost and 20,000 ------20,000 ----payroll salaries Power 16,000 Rent 24,000 Heat and Fuel 12,000 Insurance 2,000 Taxes 4,000 Depreciation 2,00,000 3,28,840 12,400 9,400 34,340 14,700 The following data are also available: Floor space Radiator (sq.ft) section Machine Shop 1,000 90 Packing 400 180 General Plant 200 60 Maintenance and 800 120 Stores 2,400 450

No. of employees 40 20 6 10

Value of assets (`) 64,000 20,000 1,000 15,000

H.P. ×hours

76

1,00,000

5,000

3,500 500 ----1,000

Expenses charged to the Maintenance and Stores are to be distributed to other departments by the following percentages: Machine Shop – 50%, Packing – 20%, General Plant – 30% General Plant Overheads are to be distributed on the basis of number of employees. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 13

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Show the distribution of overheads to production and service departments and determine the amount of production departments, overhead after redistribution. Carry through 2 cycles. Answer: Distribution of Overeads for the Year Ended 30th June, 2013 Particulars Basis of Production Depts. Service Deots. allocation Packing ` Machine General Maintenance Shop ` Plant ` and Stores ` Indirect Direct 8,000 6,000 4,000 11,300 labour Maintenance Direct 3,600 1,400 2,040 3,000 Materials Misc. Direct 800 2,000 300 400 Supplies Supervisor’s Direct ------8,000 ---Salaries Cost and Direct ------20,000 ---payroll salaries 12,400 9,400 34,340 14,700 Power H.P. × Hours 11,200 1,600 -----3,200 (7:1:2) Rent Floor space 10,000 4,000 2,000 8,000 (sq. ft) Heat & Fuel Radiator 2,400 4,800 1,600 3,200 section Insurances Value of 1,280 400 20 300 assets Taxes Value of 2,560 800 40 600 assets Depreciation Value of 1,28,000 40,000 2,000 30,000 assets Total 1,67,840 61,000 40,000 60,000 Maintenance Percentages 30,000 12,000 18,000 (-)60,000 and Stores General No. of 33,143 16,571 (-)58,000 8,268 Plant employees Maintenance Percentages 4,143 1,657 2,486 (-)8,286 etc. General Plant Total (b)

No. of employees

1,657

829

2,36,783

92,057

(-)2,486

Total ` 29,300 10,040 3,500 8,000 20,000

70,840 16,000 24,000 12,000 2,000 4,000 2,00,000 3,28,840

-----

Meera Industries Limited is a single product organization having a manufacturing capacity of 6,000 units per week of 48 hours The output data vis-à-vis different elements of cost for three consecutive weeks are given below: Units Produced Direct Material Direct Labour Total Factory Overheads (Variable & Fixed) ` 4,800 ` 6,000 ` 37,200 2,400

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 2,800 3,600

5,600 7,200

7,000 9,000

38,400 40,800

As a Cost Accountant, you are asked by the Company Management to work out the selling price assuming an activity level of 4,000 units per week and a profit of 20% on selling price. Answer: Variable Overheads Per unit = Change in expenses /Change in output = (38,400 – 37,200 /2,800 – 2,400) = ` 3.00 This result can also be verified from the figures given for third week. Calculation of Fixed Overheads: Total Factory Overheads for 2,400 units Less: Total Variable Overheads for 2,400 units (2,400 units × ` 3.00) Total Fixed Overheads for the Company

` 37,200 7,200 30,000

This result can also be verified from the figures of next two weeks. Statement Showing Cost of 4,000 units 4,000 units × ` 4,800 /2,400 Direct Material 4,000 units × ` 6,000 /2,400 Direct Labour: 4,000 units × ` 3.00 Variable Overheads: Fixed Overheads: Total Cost

8,000 10,000 12,000 30,000 60,000

Profit for 4,000 units: Profit required is 20% on selling price or 25% of cost Cost will be = (100-20) = ` 80. Profit desired will amount to ` 60,000 × 25/100 = ` 15,000 This selling price for 4,000 units can be ascertained as under: Cost of 4,000 units ` 60,000 Profit ` 15,000 Total Sales ` 75,000 Selling price per unit = 75,000 ÷ 4,000 = ` 18.75 Question.7 (a) Two fitters, a labourer and a boy undertake a job on piece rate for ` 1,290. The time spent by each of them is ` 220 ordinary working hours. The rates of pay on time-rate basis, are ` 1.50 per hour for each of the two fitters, Re 1 per hour for the labourer and Re 0.50 per hour for the boy. Calculate: (i) The amount of piece-work premium and the share of each worker, when the piecework premium is divided proportionately to the time wages paid (ii) The selling price of the above job on the basis of the following additional data: Cost of direct material ` 2,010; Works Overhead at 20% of Prime Cost, Selling Overhead at 10% of Work Cost and Profit at 25% on Cost of Sales. Answer: (i) Calculation of wages: 2 Fitters @ ` 1.50 per hour for 220 hours each

` 660

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 15

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 ` 220 ` 110 ` 990

1 Labourers @ Re. 1 per hour for 220 hours 1 Boy @ Re. 0.50 per hour for 220 hours Total Piece Work Premium Total Wages agreed on piece-rate basis Less: Wages calculated on time basis Piece Work Premium [as in (i) above]

1,290 990 300

Amount of premium will be paid to workers in the ratio of 660:220:110 (or 6:2:1) as follows: ` 2 Fitters 200.00 1 Labourer 66.67 1 Boy 33.33 300.00 (ii) Computation of Selling Price: Direct Material Direct Wages Prime Cost Work Overheads at 20% in Prime Cost Work Cost Selling Expenses at 10% in Work Cost Cost of Sales Add: Profit at 25% on Cost of Sales Selling Price (b)

` 2,010 1,290 3,300 660 3,960 396 4,356 1,089 5,445

A publishing house purchases 2,000 units of a particular item per year at a unit cost of ` 20, the ordering cost per order is ` 50 and the inventory carrying cost is 25%. Find the optimal order quantity and the minimum total cost including purchase cost. If a 3% discount is offered by the supplier for purchases is lots of 1,000 or more, should the publishing house accept the order?

Answer: EOQ without discount 2 ab 2 x 2,000unitsx `50  = = 200 units CS `20 x 25% No. of orders to be placed = 2,000 ÷ 200 = 10 orders Average inventory (200 ÷ 2) = 100 unit Ordering cost (10 x `50) Carrying Cost of average inventory (100 x 5) Purchase Cost (2,000 x `20)

`500 500 40,000 41,000

EOQ with discount Unit Cost after discount = ` 20 - (3% of 20) = ` 19.40 Carrying Cost = 25% of ` 19.40 = ` 4.85 Lot size = 1,000 units, i.e., 2 orde` Average inventory (1,000 ÷ 2) = 500 units Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 16

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014

` Ordering cost (2 x `50) Carrying Cost of average inventory (500 x `4.85) Purchase Cost (2,000 x `19.40)

100 2,425 38,800 41,325

The above computation shows that supplier's offer for 3% discount should not be accepted. However, higher discount should be negotiated with the supplier. Question.8 (a) The Purchase Department of your organisation has received an offer of quantity discounts on its orders of materials as under: Price per tonne (`) Tonnes 1,200 Less than 500 1,180 500 and less than 1,000 1,160 1,000 and less than 2,000 1,140 2,000 and less than 3,000 1,120 3,000 and above

(b)

The annual requirement for the material is 5,000 tonnes. The delivery cost per order is ` 1,200 and the stock holding cost is estimated at 20% of material cost per annum. You are required to advise the Purchase Department the most economical purchase level. From the following data for the year ended 31st December, 2013, calculate the inventory turnover ratio of the two items and put forward your comments on them, Material A Material B ` 10,000 ` 9,000 Opening stock 1/1/2013 Purchase during the year 52,000 27,000 Closing stock 31/12/2013 6,000 11,000

Answer: (a) Statement showing the most economic purchase level 1. Order Size (tone) 400 500 2. No. of orders 12.5 10 (annual requirement ÷ order size) 3. Value of order 480 590 Order size × price per tonne) (`’000) 4. Average inventory (Value per order ÷ 2) (`’000) 240 295 5. Ordering Cost (No. of cost x ordering cost per order) (`1,200) 15,000 12,000 48,000 59,000 Carrying cost (20% of item 4) Total of 5 63,000 71,000 Add: Annual cost of material (Annual demand ÷ Price per tonne) 60,00,000 59,00,000

1,000 5

2,000 2.5

3,000 1.67

1,160

2,280

3,360

580

1,140

1,680

6,000 1,16,000 1,22,000

3,000 2,28,000 2,31,000

2,000 3,36,000 3,38,000

58,00,000

57,00,000

56,00,000

Total annual cost 60,63,000 59,71,000 59,22,000 ` 59,22,000 is the total minimum cost at 1,000 order size. Therefore, the most economical purchase level is 1,000 tonne

59,31,000

59,38,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 17

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (b)

First of all it is necessary to find out the cost of material consumed

Cost of Material consumed Opening stock Add: Purchases Less: Closing Stock Materials consumed Average inventory : (Op. Stock + Cl. Stock) ÷ 2 Inventory Turnover ratio : (Consumption ÷ Avg. inventory) Inventory Turnover (No. of days) : (No. of days in a year ÷ I. T. Ratio)

Materials A `10,000 52,000 62,000 6,000 56,000 8,000 7 times

Materials B `9,000 27,000 36,000 11,000 25,000 10,000 2.5 times

52 days

146 days

Comments: Material A is more fast moving than Material B. (c)

List out the advantages of Cost control.

Answer: Advantages of Cost Control The advantages of cost control are mainly as follows (i) Achieving the expected return on capital employed by maximising or optimizing profit (ii) Increase in productivity of the available resources (iii) Reasonable price of the customers (iv) Continued employment and job opportunity for the workers (v) Economic use of limited resources of production (vi) Increased credit worthiness (vii)Prosperity and economic stability of the industry Question.9 (a) What do you mean by time and motions study? Why is it so important to management? Answer: Time and motions study: It is the study of time taken and motions (movements) performed by workers while performing their jobs at the place of their work. Time and motion study has played a significant role in controlling and reducing labour cost. Time Study is concerned with the determination of standard time required by a person of average ability to perform a job. Motion study, on the other hand, is concerned with determining the proper method of performing a job so that there are no wasteful movements, hiring the worker unnecessarily. However, both the studies are conducted simultaneously. Since materials, tools, equipment and general arrangement of work, all have vital bearing on the method and time required for its completion. Therefore, their study would be incomplete and would not yield its full benefit without a proper consideration of these factors. Time and motion study is important to management because of the following features: (i) Improved methods, layout, and design of work ensures effective use of men, material and resources. (ii) Unnecessary and wasteful methods are pin-pointed with a view to either improving them or eliminating them altogether. This leads to reduction in the work content of an operation, economy in human efforts and reduction of fatigue. (iii) Highest possible level of efficiency is achieved in all respect. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 18

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (iv) Provides information for setting labour standards - a step towards labour cost control and cost reduction. (v) Useful for fixing wage rates and introducing effective incentive scheme. (b)

Fair Play Co. Ltd has introduced a Scanlon Plan of incentive bonus for its employees in 2013 based on the following information relating to previous three years: Year Sales Revenue Total Salaries & Wages ` ` 2010 1,25,000 45,000 2011 1,30,000 28,000 2012 1,35,000 32,000 For 2013 the sales revenue has been ` 1,50,000 and total salaries and wages payment has been ` 36,000. What is the amount due as bonus to the employees according to Scanlon Plan? If 30% is set aside in a bonus equalisation fund how much money is available to be paid out as Scanlon bonus for 2013?

Answer: Average of Sales Revenue = (1,25,000 + 1,30,000 + 1,35,000) ÷ 3 = `1,30,000 Average salary = (45,000 + 28,000 + 32,000) ÷ 3 = ` 35,000 % of average salary & wages on average sales = 35,000 / 1,30,000 = 26.92% The share of employees in 2013 = 1,50,000 x 26.92 / 100 = ` 40,380 (-) Paid as wages = ` 36,000 = ` 4,380 (-) Transfer to bonus equalization fund (30%) = ` 1,314 Amount still to be paid as bonus = ` 3,066 Question.10 (a) From the records of an oil distributing company, the following summarized information is available for the month of March 2013: Sales for the month: `19,25,000 Opening Stock as on 01-03-2013: 1,25,000 litres @ `6.50/litre. Purchases (including freight and insurance): March 5: 1,50,000 litres @ `7.10/litre March 27: 1,00,000 litres @ `7.00/litre Closing stock as on 31-3-13: 1,30,000 litres General Administration expenses for the month: `45,000 On the basis of the above information, work out the following using FIFO and LIFO methods of inventory valuation assuming pricing of issues is being done at the end of the month after all receipts during the month : (i) Value of closing stock as on 31- 03-2013 (ii) Cost of goods sold during March 2013 (iii) Profit or loss for March 2013 Answer: (i) Valuation of closing stock as on 31-3-2013 (i) FIFO Method, (the closing stock will comprise the items purchased in the end) 1,00,000 30,000 1,30,000

Litres purchased on 27-3-13 @ `7.00 Litres from purchase made on 05-03-13 @ `7.10 Value of closing stock under FIFO method

`7,00,000 2,13,000 9,13,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 19

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (ii) LIFO Method: (The closing stock will comprise the item lying opening stock and purchased in the beginning) `8,12,500 1,25,000 Litres purchased on 27-03-13 @ `6.50 5,000 Litres from purchase made on 05-03-13 @ `7.10 35,500 1,30,000 Value of closing stock under FIFO method 8,48,000 (ii)

Cost of Goods Sold

Opening stock as on 1-3-2013 Purchases made on 5th March Purchases made on 27th March Total Less Closing stock as per (a) Cost of material consumed Add general Administration Expenses Cost of goods sold (iii)

LIFO Method `8,12,500 10,65,000 7,00,000 25,77,500 8,48,000 17,29,500 45,000 17,74,500

FIFO Method `17,09,500 19,25,000 2,15,500

LIFO Method `17,74,500 19,25,000 1,50,500

Profits

Cost of goods sold Sales Profit (b)

FIFO Method `8,12,500 10,65,000 7,00,000 25,77,500 9,13,000 16,64,500 45,000 17,09,500

Discuss how payment of wages will it be dealt with casual workers and workers employed on outdoor works in Cost Accounts.

Answer: Casual and Outdoor Workers Casual Workers are employed temporarily, for a short duration to cope with sporadic increase in volume of worker. If the permanent labour force is not sufficient to cope effectively with a rush of work, additional labour (casual workers) are employed to work for a short duration. Outdoor workers are those workers who do not carry out their work in the factory premises. Such workers either carry out the assigned work in their homes or at a site outside the factory. Casual workers are engaged on a daily basis. Wages are paid to them either at the end of the day’s work or after a periodic interval. Wages paid are charged as charged as direct or indirect labour cost depending on their identifiability with specific jobs, work orders, or department. Rigid control should be exercised over the out-workers especially with regard as follows: (i) Reconciliation of materials drawn/ issued from the store with the output. (ii) Ensuring the completion of output during the stipulated time so as to meet comfortably the orders and contracts. Question.11 (a) How costs can be classified based on function? Answer: Based on the functions, the cost can be classified into: (i) Production Cost – The production cost is inclusive of all direct material, direct labour, direct expenses and manufacturing expenses. It refers to costs concerned with manufacturing activity which starts with supply of material and ends with primary packing of the product. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 20

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (ii) Administration Cost – The Administration cost in incurred for carrying the administrative function of the organization i.e. cost of policy formulation and its implementation to attain the objectives of the organization. (iii) Selling and Distribution Cost – The Selling cost refers to the cost of selling function i.e. the cost of activities relating to create and stimulate demand for company’s products and to secure orders. The Distribution costs will be incurred on goods made available to the customers. These costs include the cost of maintaining and creating demand of product, making the goods available in the hands of customer. (iv) Research and Development Cost – The Research cost is the cost of searching for new products, new manufacturing process, improvement of existing products, processes or equipment and the Development cost is the cost of putting research result on commercial basis. (b)

State the method of Costing suitable for the following industries. Also mention the cost unit for each. (i) Textile Mills (ii) Electricity Undertakings (iii) Automobile repair workshops (iv) Brick making (v) Cement manufacture (vi) Passenger Bus Service

Answer: The method of Costing and Cost Units applicable against each of the industries are given below: Industry Method of Costing Cost Unit Textile Mills Process Costing Kg of yarn for Spinning Metre of cloth for Weaving Electricity Undertakings Operating Costing KWH. Automobile repair workshops Job Costing Vehicle Brick making Single Output Costing 1000 bricks Cement Manufacturing Process Costing Tonne Passenger Bus Service Operating Costing Passenger Kilometre Question.12 (a) Write down the objective and functions of Cost Accounting Standard Board? Answer: Objectives and Functions of the Cost Accounting Standards Board: The objectives of the CASB are to develop high quality Cost Accounting Standards to enable the management to take informed decisions and to enable regulators to function more effectively by integrating, harmonizing and standardizing Cost Accounting Principles and Practices. The following will be the functions of the CASB:(i) To issue the framework for the Cost Accounting Standards. (ii) To equip the Cost & Management Accounting professionals with better guide lines on cost Accounting Principles. (iii) To assists the members in preparation of uniform cost statements under various statutes. (iv) To provide from time to time interpretations on Cost Accounting Standards. (v) To issue application guidance relating to particular standard. (vi) To propagate the Cost Accounting Standards and to persuade the users to adopt them in the preparation and presentation of general purpose Cost Statement. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 21

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (vii)To persuade the government and appropriate authorities to enforce Cost Accounting Standards, to facilitate the adoption thereof, by industry and corporate entities in order to achieve the desired objectives of standardization of Cost Accounting Practices. (viii) To educate the users about the utility and the need for compliance of Cost Accounting Standards. (b)

Valuation of Receipt of Material (special treatment related to exchange rate difference) Purchase of Materials $ 60,000 [ Forward contract rate $ = 58.40 but $ = 60.60 on the date of importation]; Import Duty paid ` 5,65,000; Freight inward ` 1,62,000 ; Insurance paid for import by road ` 48,000; Cash discount ` 33,000; CENVAT Credit refundable ` 37,000; Payment made to the foreign vendor after a month, on that date the rate of exchange was $ = 65,20. Compute the landed cost of material.

Answer: Computation of Landed Cost of Material Particulars Purchase price of Material [ 60,000 x 60.60]

Amount (`) 36,36,000

Add

Import Duties of purchasing the material

5,65,000

Add

Freight Inward during the procurement of material

1,62,000

Add

Insurance of the material (In case of import of material by Road / Sea) Total

Less

CENVAT Credit refundable Value of Receipt of Material

48,000 44,11,000 37,000 43,74,000

Note: (i) Excess payment made to the vendor due to exchange fluctuation is not an includible cost, hence not considered. (ii) Though the forward contract rate was $ = 58.40, but the exchange rate on the date of importation is considered. Hence, included in the cost of materials. Accordingly, the purchase cost is computed considering the $ = 60.60. Question.13 (a) Explain the scope of Cost Accountancy. Answer: Scope of Cost Accountancy The scope of Cost Accountancy is very wide and includes the following:(i) Cost Ascertainment: The main objective of Cost Accounting is to find out the Cost of product / services rendered with reasonable degree of accuracy. (ii) Cost Accounting: It is the process of Accounting for Cost which begins with recording of expenditure and ends with preparation of statistical data. (iii) Cost Control: It is the process of regulating the action so as to keep the element of cost within the set parameters. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 22

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (iv) Cost Reports: This is the ultimate function of Cost Accounting. These reports are primarily prepared for use by the management at different levels. Cost reports helps in planning and control, performance appraisal and managerial decision making. (v) Cost Audit: Cost Audit is the verification of correctness of Cost Accounts and check on the adherence to the Cost Accounting plan. Its purpose is not only to ensure the arithmetic accuracy of cost records but also to see the principles and rules have been applied correctly. To appreciate fully the objectives and scope of Cost Accounting, it would be useful to examine the position of Cost Accounting in the broader field of general accounting and other sciences. i.e Financial Accounting , Management Accounting, Engineering and Service Industry. (b)

Gross pay `12,80,000 (including cost of idle time hours paid to employee `85,000); Accommodation provided to employee free of cost [this accommodation is owned by employer, depreciation of accommodation `2,00,000, maintenance charges of the accommodation `1,00,000, municipal tax paid for this accommodation `5,000], Employer’s Contribution to P.F. `1,00,000 (including a penalty of `2,000 for violation of PF rules), Employee’s Contribution to P.F. `75,000. Compute the Employee cost.

Answer: Computation of Employee Cost Particulars Gross Pay ( net of cost of idle time) =[12,80,000 (-) 85,000] Add

Cost of accommodation provided by employer = Depreciation (+) Municipal Tax paid (+) maintenance charges = 2,00,000 + 5,000 + 1,00,000 = 1,93,000

Add

Employer’s Contribution to PF excluding penalty paid to PF authorities [ = 1,00,000 (-) 2,000] Employee Cost

Amount(`) 11,95,000 3,05,000

98,000 15,98,000

Note: (i) Assumed that the entire accommodation is exclusively used by the employee. Hence, cost of accommodation provided includes all related expenses/costs, since these are identifiable /traceable to the cost centre. (ii) Cost of idle time hours is an excludible item. Since it is already included in the gross pay, hence excluded. (iii) Penalty paid to PF authorities is not a normal cost. Since, it is included in the amount of contribution, it is excluded. Question.14 (a) What are the general principles of measurement of Direct Expenses as per CAS-10 Answer: General principles of measurement of Direct Expenses as per CAS-10: (i) Identification of direct expenses shall be based on traceability in an economically feasible manner. (ii) Direct expenses incurred for bought out resources shall be determined at invoice price including all taxes and duties and any other expenditure directly attributable there to net of trade discounts, taxes and duties refundable or to be credited. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 23

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (iii) Direct expenses incurred in lump-sum shall be amortized on the basis of estimated output or benefit to be derived from such expenses. (iv) Finance cost incurred in connection with self generated or procured resources shall not form part of the direct expenses. (v) Any subsidy or grant or incentive or any amount received or receivable with respect to any direct expenses shall be reduced for ascertainment of the cost of the cost object. (vi) Penalties / damages paid to statutory authorities shall not be form part of the direct expenses. (vii)Any change in the cost accounting principles applied for measurement of the direct expenses should be made only if it is required by law or for compliance with the requirements of a Cost Accounting Standard or a change would result in a more appropriate preparation or presentation of Cost Statement of the organization. (b)

A manufacturing unit produces two products A and B. The following information is furnished: Particulars

Product A

Product B

Units produced ( Qty)

30,000

25,000

Units Sold (Qty)

20,000

22,000

Machine Hours utilised

10,000

5,000

Design charges

17,000

20,000

Software development charges

24,000

36,000

Royalty paid on sales `54,000 [@ `2 per unit sold, for both the products]; Royalty paid on units produced `35,000 [@ Re.1 per unit purchased, for both the products], Hire charges of equipment used in manufacturing process of Product A only `10,000, Compute the Direct Expenses. Answer: Computation of Direct Expenses Particulars

Product A

Product B

Royalty paid on Sales

40,000

44,000

Add

Royalty paid on units produced

30,000

25,000

Add

Hire charges of equipment used in manufacturing process of Product A only

10,000

----

Add

Design Charges

17,000

20,000

Add

Software development charges related to production

24,000

36,000

1,21,000

1,25,000

Direct Expenses

Note: (i) Royalty on production and royalty on sales are allocated on the basis of units produced and units sold respectively. These are directly identifiable and traceable to the number of units produced and units sold. Hence, this is not an apportionment. (ii) No adjustments are made related to units held, i.e. closing stock. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 24

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Question.15 (a) State the circumstances in which time rate system of wage payment can be preferred in a factory. What are the advantages of this system? Answer: In time based wage payment plans, standard time is predetermined and the efficiency of each individual worker is assessed to compensate them for higher efficiency in work as compared to standard time set. These plans can be suitably applied in the following circumstances: (i) Where the output of an individual worker cannot be measured reasonably. (ii) Where the work is required to be closely supervised. (iii) Where the quality of work is more important. (iv) Where output of an individual worker is not in his control. (v) Where increase in output is negligible compares to the incentive. The advantages of time rate remuneration plans are as follows: (i) It is commonly recognized by all trade unions as well as worker (ii) It is a guaranteed income assured to the worker (iii) It is very easy to understand and simple to calculate the earnings of worker (iv) It involves less clerical work and detailed records are not necessary. (v) Since the production is not the criteria for calculation of wages, tools and materials are handled carefully. Wastage is also minimized. (b)

How do you deal with the following in Cost Accounts? (i) Data processing cost. (ii) Spoiled Work

Answer: The treatment will be as follows: (i) Data Processing Control: In the environment of processing information with the help of computers, the data processing cost represents the cost incurred for processing data relating to accounts, secretarial, personnel, finance, marketing, sales etc. This may be done either utilizing in house facilities or hiring outside facilities. The cost incurred is accumulated for separate service centre if in-house facilities are made available. Where the costs of data processing centre or hiring charges are identifiable to a particular department or activity it should be charged with its portion of cost. In case of common costs incurred for service of all departments, the data processing cost should be apportioned to different departments on equitable basis. (ii) Spoiled Work: The loss by spoilage may be inherent to the nature of the product or it may be caused by normal circumstances. If it is of an inherent nature and cannot be avoided, it would be charged either to the specific job in which it is accrued or should be recovered as overhead charge from the entire production, where there is no specific job or work order. In case it has been caused by abnormal circumstances, it should be charged to the Costing Profit and Loss Account. While accounting for loss by spoilage, any proceeds of the scrap should be accounted for either as a deduction from spoilage or by crediting it to the account which has been debited with the spoilage. (c)

Distinction between Allocation & Apportionment.

Answer: Distinction between Allocation & Apportionment Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 25

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Although the purpose of both allocation and apportionment is identical, i.e to identify or allot the costs to the cost centres or cost unit, both are not the same. Allocation deals with the whole items of cost and apportionment deals with proportion of items of cost. Allocation is direct process of departmentalization of overheads, where as apportionment needs a suitable basis for sub-division of the cost. Whether a particular item of expense can be allocated or apportioned does not depends on the nature of expense, but depends on the relation with the cost centre or cost unit to which it is to be charged. Question.16 (a) What are the implications of Economic Order Quantity in proper inventory management? Answer: 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 cost 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. (b)

What is the role of a Management Accountant in cost control and cost reduction?

Answer: Management Accountants role in cost control and cost reduction is perhaps central to his role as a member of the management team. Indeed, for effective cost control, it may be necessary to spend more on the items which will reduce waste and scrap, improve quality, increase productivity or conserve energy. In any large organization the points at which costs are incurred are usually numerous and relatively few line managers have the mechanism of collating and analyzing all the costs they incur, with a view to implementing cost control measures. The Management Accountant is uniquely placed in this respect and it usually falls on him to play a catalytic role in getting the management team to work together to achieve specific cost control objectives. It is also up to the Management Accountant to channelize the cost control and cost reduction efforts into areas which will give the greater results. Without this direction, cost control and cost reduction can too often degenerate into symbolic actions like reusing envelopes or downgrading the class of air travel, which generally have little impact on the overall cost structure but can substantially harm morale and motivation. it is important for the Management Accountant to guide the company’s cost control and cost reduction programme into productive lines and not let it degenerate into a morale damaging axing of petty expenditure. Question.17 Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 26

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (a)

What is an idle capacity? What are the costs associated with it? How are these treated in product costs?

Answer: Idle Capacity: Idle capacity is that part of the capacity of a plant, machine or equipment which cannot be effectively utilised in production. In other words, it is the difference between the practical or normal capacity and capacity of utilisation based on expected sales. For example, if the practical capacity of production of a machine is to the tune of 10,000 units in a month, but is used only to produce 8,000 units, because of market demand of the product, and then in such a case, 2,000 units will be treated as the idle capacity of the machine. The idle capacity may arise due to lack of product demand, non-availability of rawmaterial, shortage of skilled labour, absenteeism, shortage of power, fuel or supplies, seasonal nature of product, etc Idle Capacity Costs: Costs associated with idle capacity are mostly fixed in nature. These include depreciation, repairs and maintenance charges, insurance premium, rent, rates, management and supervisory costs. These costs remain unabsorbed or unrecovered due to under-utilisation of plant and service capacity. Idle capacity cost can be calculated as follows:Aggregateoverhead related to plant Idle capacity cost = × Idle Capacity Normal plant capacity Treatment of Idle capacity cost: Idle capacity costs can be treated in product costing, in the following ways: (i) If the idle capacity cost is due to unavoidable reasons such as repairs, maintenance, changeover of job, etc, a supplementary overhead rate may be used to recover the idle capacity cost. In this case, the costs are charged to the production capacity utilized. (ii) If the idle capacity cost is due to avoidable reasons such as faulty planning, power failure etc., the cost should be charged to profit and loss account. (iii) If the idle capacity cost is due to seasonal factors, then, the cost should be charged to the cost of production by inflating overhead rates. (b)

Sunshine Ltd. buy and sell finished goods after carrying out some operations. They began the year with 3,000 units valued at ` 3 per unit. During the year they sold 25,000 units for an average sale price of ` 10 per unit. Purchases were as follows : 4,000 units @ ` 5 per unit 16,000 units @ ` 6 per unit 6,000 units @ ` 7 per unit The current replacement cost of the unit is ` 8 and the Company’s Taxation Manager advises that there may be significant tax advantages of purchasing at year-end at this price, as the company uses the LIFO method and has got the acceptance of the tax authorities for consistently using this method in its assessments. The corporate tax averages 30%. Bearing in mind that the warehouse space is limited to 10,000 units, work out the tax advantages and the cost of year-end purchasing under this situation given that the operating expenses for the year are ` 37,000.

Answer: Statement showing closing stock at the year end Total purchases during the year Opening stock

26,000 units 3,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 27

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 29,000 25,000 4,000

Less: Units sold during the year Total closing stock

Storage capacity is 10,000 units, year-end purchases can be up to 6,000. Profit statement without making year-end purchases (LIFO Method) Sales (25,000 x 10) Less: Cost of goods sold 6,000 x 7 = ` 42,000 16,000 x 6 = ` 96,000 3,000 x 5 = ` 15,000 Gross profit Less: Operating expenses (given) Taxable income Less: Income Tax @ 30% Profit after tax

`

2,50,000

1,53,000 97,000 37,000 60,000 18,000 42,000

Profit statement after year-end purchases of 6,000 units at current replacement cost Sales (25,000 x 10) 2,50,000 Less: Cost of goods 6,000 x 8 = 48,000 6,000 x 7 = 42,000 13,000 x 6 = 78,000 1,68000 Gross profit 82,000 Less: Operating expenses 37,000 Taxable income 45,000 Less: income tax @ 30% 13,500 Profit after tax 31,500 Tax advantage: By accepting the advice of Taxation Manager of Sunshine Ltd. will be able to effect a tax saving of ` 4,500 i.e. ` 18,000 – ` 13,500 = ` 4,500. Cost of year-end purchases: 6,000 units @ ` 8 = Less: Tax advantage Effective cost of closing inventory

48,000 4,500 43,500

Effective cost per unit of year-end purchase ` 43,500 ÷ 6,000 = ` 7.25. Question.18 (a) Super class Co. Ltd. Has three production department X, Y and Z and two service department A and B. The following estimated figures for a certain period have been made available: ` 10,000 Rent, Rates and Taxes Lighting and electricity 1,200 Idirect Wages 3,000 Power 3,000 Depreciation of Machinery 20,000 Other expenses and sundries 20,000 Following are further details which are also available:Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 28

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Floor Space (Sq. mts.) Light Point (Nos.) Direct Wages ` Horsepower of machines Cost Of Machinery (`) Working hours

Total 10,000 120 20,000 300 1,00,000

X 2,000 20 6,000 120 24,000 4,670

Y 2,500 30 4,000 60 32,000 3,020

Z 3,000 40 6,000 100 40,000 3,050

A 2,000 20 3,000 20 2,000 -----

B 500 10 1,000 ---2,000 -----

The expenses of the service departments A and B are to be allocated as follows: X Y Z A B A 20% 30% 40% ---10% B 40% 20% 30% 10% ----You are required to calculate the overhead absorption rate per hour in respect of the three production departments. What will be the total cost of an article with material cost of `80 and direct labour cost of ` 40 which passes through x, Y and Z for 2,3 and 4 hours respectively? Answer: Items

Rent, Rates and Taxe Lighting and Electricity Indirect Wages Power Depreciation of Machinery Other expenses and Sundries Direct Wages

Departmental Primary Distribution Summary Basis of Total Production Dept. Apportionment X Y Z `10,000 2,000 Floor Area 2,500 3,000

Service Dept. A 2,000

B 500

Light Point

1,200

200

300

400

200

100

Direct Wages Horse Power Cost of Machine Direct Wages

3,000 3,000 20,000

900 1,200 4,800

600 600 6,400

900 1,000 8,000

450 200 400

150 ----4000

20,000

6,000

4,000

6,000

3,000

1,000

Only Dept.

4,000

------

-----

-----

3,000

1,000

61,200

15,100

14,400

19,300

9,250

3,150

A B A B A Sub-total Grand total (`) Working Hours Rate per hour (`)

Service

Secondary Distribution X Y 1,850 2,775 1,630 815 82, 122 16 8 2 -----3,580 3,720 18,680 18,120 4,670 3,020 4 6

Z 3,700 1,222 163 13 2 5,100 24,400 3,050 8

A (9,250) 408 (408) 4 (4)

B 925 (4,075) 41 (41) --------

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 29

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Statement of Cost per Unit Materia Cost Labour Overhead X= 2 × 4 Y= 3 × 6 Z= 4 × 8 Total Productive Cost (b)

`80 `40 8 18 32

`120

58 178

A machine shop has 8 identical Drilling Machines manned by 6 operators. The machines cannot be worked without an operator wholly engaged on it. The original cost of all these 8 machines works out to ` 8 lakhs. These particulars are furnished for a six month period: Normal available hours per month 208 Absenteeism (without pay) – hours 18 Leave (with pay) – hours 20 Normal idle time unavoidable – hours 10 ` 20 Average rate of wages per day of 8 hours Production Bonus estimated 15% on wages Value of Power consumed ` 8,050 Supervision and Indirect Labour ` 3,300 Lighting and Electricity ` 1,200 These particulars are for a year: Repairs and maintenance including consumables 3% on value of machines. Insurance ` 40,000. Depreciation 10% on original cost. Other sundry works expenses ` 12,000 General Management expenses allocated ` 54,530. Your are required to work out a comprehensive machine hour rate for the Machine Shop.

Answer: Before computing the comprehensive machine hour rare, it is necessary to find out the total machine hours utilized and total wages paid to the operators. Computation of total machine hours utilized Normal available hours p.m. per operator 208 hours Less: Unutilised hours due to: Absenteeism 18 hours Leave 20 Idle time 10 48 Total hours utilized p.m. per operator 160 It is given in the question that the machines cannot work without an operator wholly engaged on it. Therefore, hours utilized for 6 operators, i.e., 5,760 hrs. represents the total machine hours. Total wages to 6 operators for 6 months Average rate of wages per hour = ` 20 ÷ 8 hrs. = ` 2.50. Normal hours for which wages are to be paid = 208 – 18 or 190 hrs. Wages for 6 months for 6 operators @ ` 2.50/hr. = 190 x 6 x 6 x 2.50 or ` 17,100. Computation of Comprehensive Machine hour rate for the Machine Shop ` Particulars Operators wages (as above) 17,100 Production Bonus (15% of wages) 2,565 Power consumed 8,050 Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 30

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Supervision and indirect labour Lighting and electricity Repairs and maintenance (3% of ` 8 lakhs) ÷ 2 Insurance (given for 12 months; reduced to 50% for 6 months) Depreciation for 6 months Other sundry works expenses for 6 months General management expenses for 6 months Total overheads for 6 months Comprehensive Machine Hour Rate = 1,37,480 ÷ 5,760 hrs. = ` 23.87 per hr.

3,300 1,200 12,000 20,000 40,000 6,000 27,265 1,37,480

Section B Question.19 ABC Ltd. Provides you the following information: Installed capacity Actual production and sales Selling price per unit Variable cost per unit Fixed costs Funds required

1,50,000 units 1,00,000 units Re. 1 Re. 0.50 ` 38,000 ` 1,00,000

Financial plan Capital structure A B C Equity shares of ` 100 each to be issued at 25% premium 60% 40% 35% 15% debt 40% 60% 50% 10% preference shares ` 100 each 15% No. of Equity Share 480 320 280 (Assume Income tax @ 40%) Required: (i) To calculate the degree of operating leverage, degree of financial leverage and degree to combined leverage for each financial plan. (ii) To calculate earnings per share and market price per share if price earning ratio in A plan is 10 times and in B and C plan is 8 times. (iii) To suggest which form of financing should be employed if the firm follows the policy of seeking to maximize the price of its shares. (iv) To calculate the indifference point between A and B plan. (v) To calculate the financial breakeven point for each plan and to suggest which plan has more financial risk. (vi) To calculate the cost breakeven point. Answer: Part (i), (ii) and (iii) Statement showing the calculation of degree of various leverages etc. Particulars Sales Less : Variable cost Contribution Less : Fixed Costs

Financial Plan A ` 1,00,000 50,000 50,000 38,000

Financial Plan B ` 1,00,000 50,000 50,000 38,000

Financial Plan C ` 1,00,000 50,000 50,000 38,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 31

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Earnings before Interest & tax (EBIT) Less : Interest Earnings before tax (EBIT) Less : Tax @ 40% Earnings after tax (EAT) Less : Pref. Dividend Earnings for equity shareholders No. of equity shares Earnings per share (EPS) Price earning ratio Market price Operating leverage (Contribution/ EBIT) Financial leverage (EBIT/ EBT) [EBT= EBT – (Pref. Dividend /1 – t)] Combined leverage (Operating leverage x Financial Leverage)

12,000 6,000 6,000 2,400 3,600 3,600 480 7.5 10 75 4.167 2.000

12,000 9,000 3,000 1,200 1,800 1,800 320 5.625 8 45 4.167 4.000

12,000 7,500 4,500 1,800 2,700 1,500 1,200 280 4.286 8 34.286 4.167 6.000

8.334

16.668

25.002

Recommendation: The market price is highest under Financial Plan A, therefore Financial Plan A is recommended. (iv) Calculation of Indifference Point between Plan A and Plan B Particulars Plan A EBIT X Less : Interest 6,000 EBT X – 6,000 Less : Tax @ 40% 0.4X – 2,400 EAT 0.6X – 3,600 No. of shares 480 EPS 0.6X – 3,600 480

Plan B X 9,000 X – 9,000 0.4X – 3,600 0.6X – 5,400 320 0.6X – 5,400 320

At different point, EPS under both plans will be equal. 0.6x - 3,600 0.6x - 5,400  480 320 192X – 11,52,000 96X X

= = =

288X – 25,92,000 14,40,000 15,000

The indifference point between Plan A and Plan B is at the EBIT level of ` 15,000 (v) Statement showing the calculation of Financial BEP Particulars Interest Preference dividend (after grossing up to tax) [Preference Dividend /1 - t] Financial BEP

Plan A 6,000 -

Plan B 9,000 -

Plan C 7,500 2,500

6,000

9,000

10,000

Comment: Since financial BEP for Plan C is highest, Plan C has the highest Financial Risk.

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 32

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (vi) Statement showing the calculation of Cost or operating BEP Particulars Plan A Fixed cost 38,000 P/V Ratio 50% Cost BEP (in `) [Fixed Cost / P/V Ratio] 76,000 Cost BEP (in units) [BEP /Selling price per unit] 76,000

Plan B 38,000 50% 76,000 76,000

Plan C 38,000 50% 76,000 76,000

Question.20 (a) From the following information, ascertain whether the firm is following an optimal dividend policy as per Walter’s model : Total earnings ` 6,00,000 No. of equity shares of ` 100 each 40,000 Dividend paid ` 1,60,000 Price-earnings (P/E) Ratio 10 The firm is expected to maintain its rate of return of fresh investment. What should be the P/E ratio at which dividend policy will have no effect on the value of the share? Will your decision change if the P/E ratio is 5 instead of 10? Answer: Calculation of market price of share under Walter’s model:

R D  a (E - D) Rc P= Rc Where P E D Ra RC

= = = = =

Market price per share Earnings per share Dividend per share Internal rate of return on investment Cost of capital

Dividend per share (D) = ` 1,60,000 / 40,000 shares Earnings per share (E) = ` 6,00,000 / 40,000 shares

=`4 = ` 15

Rate of return on firms investment (Ra) = ` 6,00,000 /`40,00,000 x 100 = 15% of 0.15 RC = Cost of capital (inverse of P/E ratio i.e. 1/10) = 0.10

4 P=

0.15

(15- 4) 0.10 = 20.50 /0.10 = ` 205 0.10

Calculation of P/E ratio at which dividend policy will have no effect on the value of the share Firm’s dividend payout ratio = ` 1,60,000/ ` 6,00,000 = 0.2667 or 26.67% Rate of return of the firm (Ra ) is 15%, which is more than its cost of capital (R c ) is 10%. Therefore, by distributing 16.67% of earnings, the firm is not following an optimal dividend

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 33

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 policy. The optimal dividend policy for the firm would be to pay zero dividend and in such case, the market value of share under Walter’s model would be as follows :

0 P=

0.15

15  10 0.10 0.10

= 22.50 /0.10 = ` 225

The market value of the share would increase by not paying dividend and by retaining all the earnings of the company. Calculation of market value of share when P/E ratio is 5 instead of 10. The Rc of the firm is the inverse of P/E ratio i.e. 1/5 = 0.20. In such case Rc > Ra

4 P=

0.15

15 - 4 0.20 = 12.25 /0.20 = ` 61.25 0.20

The P/E ratio at which the dividend policy will have no effect on the value of the firm when Rc is equal to the rate of return of the firm Ra. Under the situation, P/E ratio is 5, the optimum dividend policy for the company would be 100% dividend payout at which the value of the firm would be maximum. (b)

M Ltd. has a capital of ` 10,00,000 in equity shares of ` 100 each. The shares are currently quoted at par. The company proposes declaration of a dividend of ` 10 per share. The capitalization rate for the risk class to which the company belongs is 12%. What will be the market price of the share at the end of the year, if – (i) no dividend is declared; and (ii) 10% dividend is declared? Assuming that the company pays the dividend and has net profits of ` 5,00,000 and makes new investments of ` 10,00,000 during the period, how many new shares must be issued ? Use the M. M. Model.

Answer: (i) Calculation of share price under MM – Dividend Irrelevancy Model P0 = P1 + D1 / 1 + ke (a) When dividend is not declared 100 = (P1 + 0 / 1 + 0.12) P1 = 100 x 1.12 = ` 112 (b) When dividend is declared 100 = (P1 + 10 / 1 + 0.12) P1 + 10 = 100 x 1.12 = ` 102

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (ii) Calculation of No. of shares to be issued Particulars Net income Less : Dividend paid Retained earnings New investments Amount to be raised by issue of new shares Market price per share No. of new shares to be issued

(i) (ii) (i)/(ii)

Verification of M. M. Dividend Irrelevancy Theory Particulars

Existing shares New shares Total no. of shares at the year end (i) Market price per share (ii) Total market value of shares at the end of year (i)x(ii)

If no dividend declared 5,00,000 5,00,000 10,00,000 5,00,000 112 4,464

If no dividend declared 10,000 4,464 14,464 112 ` 16,20,000

(`) If dividend declared 5,00,000 1,00,000 4,00,000 10,00,000 6,00,000 102 5,882

If dividend declared 10,000 5,882 15,882 ` 102 ` 16,20,000

Analysis – The market value of shares at the end of year will remain the same whether dividends are distributed or not declared. Question.21 (a) Explore the interrelationship between Investment, Finance and Dividend Decisions. Answer: The finance functions are divided into three major decisions, viz., investment, financing and dividend decisions. It is correct to say that these decisions are inter-related because the underlying objective of these three decisions is the same, i.e. maximisation of shareholders’ wealth. Since investment, financing and dividend decisions are all interrelated, one has to consider the joint impact of these decisions on the market price of the company’s shares and these decisions should also be solved jointly. The decision to invest in a new project needs the finance for the investment. The financing decision, in turn, is influenced by and influences dividend decision because retained earnings used in internal financing deprive shareholders of their dividends. An efficient financial management can ensure optimal joint decisions. This is possible by evaluating each decision in relation to its effect on the shareholders’ wealth. The above three decisions are briefly examined below in the light of their inter-relationship and to see how they can help in maximising the shareholders’ wealth i.e. market price of the company’s shares. Investment decision: The investment of long term funds is made after a careful assessment of the various projects through capital budgeting and uncertainty analysis. However, only that investment proposal is to be accepted which is expected to yield at least so much return as is adequate to meet its cost of financing. This have an influence on the profitability of the company and ultimately on its wealth. Financing decision: Funds can be raised from various sources. Each source of funds involves different issues. The finance manager has to maintain a proper balance between long-term and short-term funds. With the total volume of long-term funds, he has to ensure

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 35

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 a proper mix of loan funds and owner’s funds. The optimum financing mix will increase return to equity shareholders and thus maximise their wealth. Dividend decision: The finance manager is also concerned with the decision to pay or declare dividend. He assists the top management in deciding as to what portion of the profit should be paid to the shareholders by way of dividends and what portion should be retained in the business. An optimal dividend pay-out ratio maximises shareholders’ wealth. We can infer from the above discussion that investment, financing and dividend decisions are interrelated and are to be taken jointly keeping in view their joint effect on the shareholders’ wealth. (b)

A newly formed company has applied for a short-term loan to a commercial bank for financing its working capital requirement. As a Cost Accountant, you are asked by the bank to prepare an estimate of the requirement of the working capital for that company. Add 10% to your estimated figure to cover unforeseen contingencies. The information about the projected Profit and Loss Account of the company is as under: ` Sales 21,00,000 Cost of goods sold 15,30,000* Gross profit 5,70,000 Administrative expenses 1,40,000 Selling expenses 1,30,000 2,70,000 Profit before tax 3,00,000 Provision for tax 1,00,000 *Cost of goods sold has been derived as: Materials used 8,40,000 Wages and manufacturing expenses 6,25,000 Depreciation 2,35,000 Less: Stock of finished goods (10 % produced, not yet sold)

17,00,000 1,70,000 15,30,000 The figures given above relate only to the goods that have been finished and not to workin-progress; goods equal to 15% of the year’s production (in terms of physical units) are in progress on an average, requiring full materials but only 40% of the other expenses. The company believes in keeping two months’ consumption of material in stock. All expenses are paid one month in arrears’; suppliers of material extend 1 ½ months’ credit; sales are 20% cash; rest are at two months’ credit, 70% of the income-tax has to be paid in advance in quarterly installments. You can make such other assumptions as you deem necessary for estimating working capital requirement. Answer: Statement showing the Net Working Capital Estimate of the Company: Current Assets:

`

`

Stock of raw material (2 months): (` 8,40,000 x 2/12) Work-in-progress: Raw materials (` 8,40,000 x 15/100) Other expenses:

` 1,40,000

1,26,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 36

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Wages and manufacturing exp. 6,25,000 (6,25,000 ×15%x 40%)

Stock of finished goods: Stock Less: Depreciation 10% (i.e. 2,35,000 x 10%)

37,500

1,63,500

1,70,000 23,500

1,46,500

Debtors (2 months): Cost of goods sold – Dep. (15,30,000 – 2,11,500) 13,18,500 [Dep. (2,35,000 – 23,500)] Administrative expenses 1,40,000 Selling expenses 1,30,000 Total 15,88,500 Less: Cash sales @ 20% 3,17,700 (12,70,800x2/12)

2,11,800

Cash (say) Total investment in current assets

50,700 7,12,500

Less: Current liabilities: Creditors (1 ½ months) [` 8,40,000 /12) x 1 ½] Lag in payment of expenses (1month): Wages and manufacturing expenses (` 6,25,000 x 1/12) Administrative expenses (` 1,40,000 x 1/12) Selling expenses (` 1,30,000 x 1/12) Advance tax (1,00,000 x 70% x 3/12) Net working capital Add: 10% for contingencies Estimated working capital requirement

1,05,000

=52,083 = 11,667 = 10,833

74,583 17,500

1,97,083 5,15,417 51,542 5,66,959

Notes: (i) Depreciation is excluded from the computation of cost of goods sold as it is a non-cash item. (ii) Element of profit is excluded here. (iii) Assume that cash is required for ` 50,700 in order to meet the day-to-day expenses. Question.22 (a) Superior Engineering proposes a project with the following data : (i) Total asset: ` 450 lakhs (` 250 lakhs of Fixed Assets and ` 200 lakhs of Current Assets) (ii) Scheme of financing: ` 100 lakhs equity, ` 200 lakhs term loan, ` 100 lakhs working capital advance and ` 50 lakhs trade creditors. (iii) Interest rate: Term loan 12% p.a. and working capital advance: 15% p.a. (iv) Term loan is repayable in 5 equal installments, commencing from 3rd year of operations. (Assume that installment for each year is paid on the last day of the year). Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 37

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (v) (vi)

Depreciation: 30% on written down value. Production is expected to reach 60% of capacity in the 1st year of operations, 70% in the 2nd year and 80% from the 3rd year onwards. (vii) Expected revenue from the project will be ` 500 lakhs p.a. on 10% capacity utilization and corresponding Direct Costs are ` 200 lakhs. Fixed costs are ` 100 lakhs p.a. Working capital advance of ` 100 lakhs is on 80% capacity and proportionately reduced in the first two years. (viii) Tax rate applicable is 50%. Assuming that each year’s production is sold away in the same year, draw the projected profit & loss account for each year of operation and the operational cash flow. Also calculate the Debt Service Coverage Ratio. Answer: Projected Profit & Loss Account Year of operation Capacity utilization (%)

1 60

2 70

3 80

4 80

5 80

6 80

7 80

Revenue Direct variable costs Fixed costs Int. on working cap. adv. Profit before depreciation & interest on term loan Depreciation Interest on term loan Profit after dep. & int. Tax @ 50% PAT Operational cash flow (PAT + Dep. + Int. on term loan) Payments Int. on term loans Repayment of terms loan Total DSCR (Op. cash flow/ Total payments)

300 120 100 11.25

350 140 100 13.13

400 160 100 15.00

400 160 100 15.00

400 160 100 15.00

400 160 100 15.00

(` In lakhs) 400 160 100 15.00

68.75

96.87

125.00

125.00

125.00

125.00

125.00

75.00 24.00 (-) 30.25 68.75

52.50 24.00 20.37 10.19 10.19 86.68

36.75 24.00 64.25 32.13 32.13 92.87

25.73 19.20 80.07 40.04 40.04 84.96

18.01 14.40 92.59 46.30 46.30 78.70

12.61 9.60 102.80 51.40 51.40 73.60

8.82 4.80 111.38 55.69 55.69 69.31

24.00 -

24.00 -

24.00 40.00

19.20 40.00

14.40 40.00

9.60 40.00

4.80 40.00

24.00 2.86

24.00 3.61

64.00 1.45

59.20 1.44

54.40 1.45

49.60 1.48

44.80 1.55

Average DSCR = (Total operation cash flow) / (Total payment against debts) = (554.87 ÷ 320.00) = 1.73.

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (b)

Write down the Criticism on MM Hypothesis?

Answer: Criticism on MM Hypothesis The arbitrage process is the behavioural and operational foundation for MM Hypothesis. But this process fails the desired equilibrium because of the following limitations. (i) Rates of interest are not the same for the individuals and firms. The firms generally have a higher credit standing because of which they can borrow funds at a lower rate of interest as compared to individuals. (ii) Home – Made leverage is not a perfect substitute for corporate leverage. If the firm borrows, the risk to the shareholder is limited to his shareholding in that company. But if he borrows personally, the liability will be extended to his personal property also. Hence, the assumption that personal or home – made leverage is a perfect substitute for corporate leverage is not valid. (iii) The assumption that transaction costs do not exist is not valid because these costs are necessarily involved in buying and selling securities. (iv) The working of arbitrage is affected by institutional restrictions, because the institutional investors are not allowed to practice home – made leverage. (v) The major limitation of M – M hypothesis is the existence of corporate taxes. Since the interest charges are tax deductible, a levered firm will have a lower cost of debt due to tax advantage when taxes exist. Question.23 (a) The projected cash flows and the expected net abandonment values for a project are given below: Cash inflows (`) Abandonment value (`) Year 0 (-) 1,00,000 Nil 1 35,000 65,000 2 30,000 45,000 3 25,000 20,000 4 20,000 nil Should the project be abandoned and if so, when? Cost of capital may be taken as 10%. Present value (PV) factor @ 10% is 1.000, 0.909, 0.826, 0.751 an d0.683 for 0,1,2,3 & 4 years respectively. Answer Expected NPV over 4 years of economic life: Year Cash flow Abandonment PV factor @ NPV (`) of NPV (`) of (`) value (`) 10% cash flow abandonment value 0 (-) 1,00,000 1.000 (-) 1,00,000 1 35,000 65,000 0.909 31,815 59,085 2 30,000 45,000 0.826 24,780 37,170 3 25,000 20,000 0.751 18,775 15,020 4 20,000 0.683 13,660 Total (-) 10,970 From the table above, the Total NPV of the project (NPV of cash flows + NPV of abandonment value) at the end of each year are computed as shown below: Year Total NPV at the end of 3 years 2 years 1 year Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 39

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 0 1

2

3

(-) 1,00,000 31,815

24,780

(-) 1,00,000 31,815

24,780 37,170

(-) 1,00,000 31,815 59,085

Abandonment value

Abandonment value

18,775 15,020

Abandonment value Total (-) 9,610 (-) 6,235 (-) 9,100 Conclusion: The project should be abandoned since there is no +ve NPV at the end of any year. Further, it should be abandoned at the end of 2 nd year, where the losses are the minimal. (b)

State the importance of Cost of Capital.

Answer: Importance of Cost of Capital The Cost of Capital is very important in Financial Management and plays a crucial role in the following areas: (i) Capital budgeting decisions: The cost of capital is used for discounting cash flows under Net Present Value method for investment proposals. So, it is very useful in capital budgeting decisions. (ii) Capital structure decisions: An optimal capital is that structure at which the value of the firm is maximum and cost of capital is the lowest. So, cost of capital is crucial in designing optimal capital structure. (iii) Evaluation of final Performance: Cost of capital is used to evaluate the financial performance of top management. The actual profitably is compared with the actual cost of capital of funds and if profit is greater than the cost of capital the performance nay be said to be satisfactory. (iv) Other financial decisions: Cost of capital is also useful in making such other financial decisions as dividend policy, capitalization of profits, making the rights issue, etc. Question.24 A company is considering two mutually exclusive projects X and Y. Project X costs ` 30,000 and Project Y ` 36,000. You are given below the net present value probability. Project X Project Y NPV estimate (`) NPV estimate (`) Probability Probability 3,000 0.1 3,000 0.2 6,000 0.4 6,000 0.3 12,000 0.4 12,000 0.3 15,000 0.1 15,000 0.2 (i) Compute the expected net present value of projects X and Y. (ii) Compute the risk attached to each project. (iii) Which project do you consider more risky and why? (iv) Compute the probability index of each project.

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Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Answer: (i) Statement showing computation of expected net present value of the projects X and Y.

NPV estimate (`) 3,000 6,000 12,000 15,000

Project X Probability

Project Y Probability

Expected NPV estimate (`) value 0.1 300 3,000 0.2 0.4 2,400 6,000 0.3 0.4 4,800 12,000 0.3 0.1 1,500 15,000 0.2 1.0 EV = 9,000 1.0 Thus the expected net present value of both projects X and Y are same. (ii) Computation of Standard Deviation of each project : For Project X NPV Estimates (`) Probability (P) (µ - 9,000) (µ) 0.1 3,000 -6,000 0.4 6,000 -3,000 0.4 12,000 + 3,000 0.1 15,000 + 6,000 1.0 Variance

Expected value 600 1,800 3,600 3,000 EV = 9,000

P (µ - 9,000)2 36,00,000 36,00,000 36,00,000 36,00,000 1,44,00,000

Standard deviation of Project X = √1,44,00,000 = ` 3,794.73 For Project Y Probability (P) 0.2 0.3 0.3 0.2

NPV Estimates (`) (µ) 3,000 6,000 12,000 15,000

(µ - 9,000)

P (µ - 9,000)2

- 6,000 - 3,000 + 3,000 + 6,000 Variance

72,00,000 27,00,000 27,00,000 72,00,000 1,98,00,000

Standard deviation of Project Y = √1,98,00,000 = ` 4,450 (iii) Risk is measured by the possible variation of outcomes around the expected value and the decision will be taken keeping in view the variation in the expected value where two projects have the same expected value, the decision maker would choose the project which has smaller variation in expected value. In the selection of one of the two projects X and Y, project Y is preferable because the possible profit which may occur is subject to loss variation (or dispersion), much higher risk is lying with project Y. (iv) Computation of profitability of each project : Profitability Index = Present value of cash inflows ÷ Present value of cash outflow NPV = Sum of total cash inflows – Project cost Sum of total cash inflows = Project cost + NPV Project X = ` 30,000 + ` 9,000 = ` 39,000 Project Y = ` 36,000 + ` 9,000 = ` 45,000 Profitability Index: Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 41

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Project X = ` 39,000/ 30,000 = 1.30 Project Y = ` 45,000/ 36,000 = 1.25 Thus profitability index of Project X is more than that of Project Y. Question.25 (a) The following is the condensed Balance sheet of NHPC Ltd. at the beginning and end of the year. Balance Sheets As at ……………….. Particulars Cash Sundry debtors Temporary investments Prepaid expenses Inventories Cash surrender value of Life Insurance Policy Land Building, machinery etc. Debenture discount

31.12.2011 31.12.2012 50,409 40,535 77,180 73,150 1,10,500 84,000 1,210 1,155 92,154 1,05,538 4,607 5,353 25,000 25,000 1,47,778 1,82,782 4,305 2,867 5,13,143 5,20,380 Sundry creditors 1,03,087 95,656 Outstanding expenses 12,707 21,663 4% mortgage debentures 82,000 68,500 Accumulated depreciation 96,618 81,633 Allowance for inventory loss 2,000 8,500 Reserve for contingencies 1,06,731 1,34,178 Surplus in P & L A/c 10,000 10,250 Share capital 1,00,000 1,00,000 5,13,143 5,20,380 The following information concerning the transaction are available: (i) Net profit for 2012 as per Profit and loss account was ` 49,097 (ii) A 10% cash dividend was paid during the year. (iii) The premium of Life Insurance Policies were ` 2,773 of which ` 1,627 was charged to Profit and Loss Account of the year. (iv) New machinery was purchased for ` 31,365 and machinery costing ` 32,625 was sold during the year. Depreciation on machinery sold had accumulated to ` 29,105 at the date of sale. It was sold as scrap for ` 1,500. The remaining increase in Fixed Assets resulted from construction of a Building. (v) The Mortgage Debentures mature at the rate of ` 5,000 per year. In addition to the above, the company purchased and retired ` 8,500 of Debentures at ` 103. Both the premium on retirement and the applicable discount were charged to Profit and Loss Account. (vi) The allowance for Inventory Loss was created by a charge to expenses in each year to provide for obsolete items. (vii)A debit to reserve for contingencies of ` 11,400 was made during the year. This was in respect of a past tax liability. You are required to prepare a statement showing the Sources and Applications of funds for the year 2012.

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 42

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Answer: Statement of Sources and Applications of Funds For the year ended 31st December 2013 ` Sources Applications Sale of Machinery 1,500 Purchase of machinery Trading profit (adjusted) 75,457 Payment for construction building 76,957 Dividend paid Add: Decrease in working 28,600 Redemption of debentures capital Tax liability paid Premium on Life Policy (1,146 + 1,627) 1,05,557

` 31,365 36,264

of

10,000 13,755 11,400 2,773 1,05,557

Workings: Statement of Change in Working Capital 2012 ` Current Assets : Cash Sundry debtors Temporary investments Prepaid expenses Inventories Less : Current Liabilities : Sundry creditors Out. Expenses

2013 `

50,409 77,180 1,10,500 1,210

40,535 73,150 84,000 1,155

92,154

1,05,538

3,31,453

3,04,378

1,03,087 12,707

95,656 21,663 1,15,794 2,15,659 2,15,659

Working capital Decrease in working capital

4% Mortgage Debenture A/c. Dr. ` Particulars Particulars To, 4% Mortgage debenture 13,500 By bal b/d holders To, Bal c/d 68,500 82,000

1,17,319 1,87,059 28,600 2,15,659

Cr. ` 82,000

82,000

4% Mortgage Debenture holders’ A/c. Dr. Particulars To, Bank A/c.

Cr. ` 13,755

13,755

Particulars By, 4% Mortgage debenture a/c. By, P & L A/c.

` 13,500 255 13,755

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 43

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Accumulated Depreciation A/c. Dr. Particulars To, Building, machinery etc. To, Bal c/d

Cr. ` 29,105 81,633 1,10,738

Particulars By, Bal b/d By, P & L A/c.

` 96,618 14,120 1,10,738

Allowance for Inventory Loss A/c. Dr. Particulars To, Bal c/d

Cr. ` 8,500

Particulars By, Bal b/d By, P & L A/c. (bal. fig.)

8,500

` 2,000 6,500 8,500

Reserve for Contingencies A/c. Dr. Particulars To, Tax liability (paid) To, Bal c/d

Cr. ` 11,400 1,34,178 1,45,578

Particulars By, Bal b/d By, P & L A/c. (bal. fig.)

` 1,06,731 38,847 1,45,578

Life Insurance Policy A/c. Dr. Particulars To, Bal b/d To, Bank (premium)

Cr. ` 4,607 1,146 5,753

Particulars By, P & L A/c. (excess over surrender value) By, Balance c/d

` 400 5,353 5,753

Building and Machinery A/c. Dr. Particulars To, Balance b/d To, Bank a/c (Purchase) To, Bank a/c. (bal. fig.) (Construction cost of building)

Cr. ` 1,47,778 31,365 36,264

Particulars By, Accumulated Dep. By, Bank a/c. (sales) By, P & L a/c. (loss on sale) By, Balance c/d

2,15,407

` 29,105 1,500 2,020 1,82,782 2,15,407

Debenture Discount A/c. Dr. Particulars To, Balance b/d

Cr. ` 4,305

Particulars By, P & L a/c. (bal. fig.) By, Balance c/d

4,305

` 1,438 2,867 4,305

Profit and Loss A/c. Dr. Particulars To, Dividend To, Life insurance policy

Cr. ` 10,000 400

Particulars By, Balance b/d By, Trading profit (adjusted bal.

` 10,000 75,457

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 44

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 fig.) To, Debenture discount To, Reserve for contingencies To, Allow. For inventory loss To, 4% Mort. Debentureholders To, Accumulated depreciation To, Building and Mach. (loss) To, Bank (life insurance premium) To, Balance c/d

1,438 38,847 6,500 255 14,120 2,020 1,627 10,250 85,457

85,457

Question.26 (a) List out the features of Security and Exchange Board of India. Answer: The burgeoning growth of the stock markets in India has necessitated the establishment of a separate regulating agency for the securities market. Accordingly, Indian Government has passed the Securities & Exchange Board of India Act, 1992 to provide the establishment of the Securities & Exchange Board of India on the lines of Securities Exchange Commission of USA to protect the interests of investors in securities and to promote the development of and to regulate the securities market. The main features of SEBI are as follows: (i) SEBI is an autonomous body created by the Government of India in 1988 and given statutory form in 1992 with the SEBI Act 1992. (ii) Its Head office is in Mumbai and has regional offices in Chennai, Kolkata, and Delhi. (iii) SEBI is the regulator of Securities markets in India. (iv) SEBI has to be responsive to the needs of three groups, which constitute the market:  The issuers of securities.  The investors.  The market intermediaries. (v) SEBI has three functions rolled into one body quasi-legislative, quasi-judicial and quasi-executive. (vi) It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity. (vii) Though this makes it very powerful, there is an appeal process to create accountability. There is a Securities Appellate Tribunal which is a three member body. (viii) A second appeal lies directly to the Supreme Court. (b)

Distinguish between Fund Flow Statement and Cash Flow Statement.

Answer: The following are the main differences between a Funds Flow Statement and a Cash Flow Statement:Funds Flow Statement

Cash Flow Statement

1. Funds Flow Statement reveals the change in Cash Flow Statement reveals the changes in working capital between two Balance Sheet cash position between two balance sheet dates. dates 2. Funds Flow Statement is based on accounting

Cash Flow Statement is based on cash basis of

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 45

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Funds Flow Statement

Cash Flow Statement accounting

3. In the case of Funds Flow Statement a No such schedule of changes in working capital schedule of changes in working capital is is prepared for a Cash Flow Statement. prepared. 4. Funds Flow Statement is useful in planning, Cash Flow Statement as a tool of financial analysis Intermediate and long term financing. is more useful for short-term analysis and cash planning. 5. Funds Flow Statement deals components of working capital.

with

all Cash Flow Statement deals only with cash and cash equivalents.

6. Funds Flow Statement reveals the sources and Cash Flow Statement is prepared by taking into application of funds. The difference represents consideration the inflows and outflows in terms of net increase or decrease in working capital. operating, investing and financing activities. The net difference represents the net increase or decrease in cash and cash equivalents. Question.27 From the following information, prepare Trading and Profit and Loss Account: Debt-Equity Ratio (Long-term Debt/Shareholders’ Funds) 2:1 Capital Gearing Ratio 3:1 (Funds bearing fixed payments to Equity Shareholder’s Funds) 15% Long-term Debts ` 8,00,000 Return on Equity Shareholder’s Funds 25% Tax Rate 50% 15%Preference Share Capital ? Break-up of Cost Profit: Materials 40% Labour 25% Manufacturing Expenses 10% Depreciation on Plant 10% Office & Selling Expenses 2.5% Operating Profit 12.5% 100% Answer Dr. To To To To To

Trading and Profit & Loss Account for the year ended..... Particulars ` Particulars Materials Labour Expenses Mfg. Expenses Depreciation Gross Profit @ 15%

To Office & Adm. Exp. To Interest @ 15% To Tax 50%

9,60,000 6,00,000 2,40,000 2,40,000 3,60,000 24,00,000

By Sales

60,000 1,20,000 By Gross Profit 90,000

Cr. ` 24,00,000

24,00,000

3,60,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 46

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 To Net Profit after Tax

90,000

To Preference Dividend To Balance for Equity Shareholders @ 25%

3,60,000 15,000 By Net Profit after Tax 75,000 90,000

3,60,000 90,000 90,000

Working Notes: (i) Calculation of Equity Shareholders’ Funds Long-term Debts Debt Equity Ratio =

Lont - termdebt Shareholders Fund

2 = ` 8,00,000 / Shareholders’ Funds Shareholders’ Funds = ` 8,00,000/2 = ` 4,00,000 Supposing Pref. Share Capital = x Equity Shareholders’ Funds = ` 4,00,000 – x (ii) Calculation of Pref. Share Capital Capital Gearing Ratio =

Lont - termDebt Plus Pref. Share Capital EquityShareholdres' Fund

3 = ` 8,00,000 + x / ` 4,00,000 - x ` 12,00,000 – 3x = ` 8,00,000 + x x = ` 1,00,000 Pref. Share Capital = ` 1,00,000 Equity Shareholders’ Fund = ` 4,00,000 – ` 3,00,000 (iii) Calculation of Operating Profit Return on Equity =

Net Profit after Int.Tax & Pref. Div. EquityShareholders' Funds

25%= x / ` 3,00,000 x = ` 75,000

A. B. C. D. E. F. G.

Net Profit after Int. Tax & Pref. Dividend Add: Pref. Dividend Net Profit After Int. & Tax (A + B) Add: Tax @ 50% Net Profit before Tax Interest on Long-term Debt @ 15% on ` 8,00,000 Operating Profit (E + F) (iv) Calculation of Sales Operating Cost Ratio 87.5%

` 75,000 15,000 90,000 90,000 1,80,000 1,20,000 3,00,000

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 47

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (Material + Labour + Mfg. Exp. + Office & Selling Exp. Operating Profit Ratio Sales (Operating Profit / sales) × 100 Material Labour Manufacturing Expenses Office & Selling Expenses

100 – 87.5% = 12.5% ` 3,00,000 /12.5% = `24,00,000 40% of ` 24,00,000 = `9,60,000 25% of ` 24,00,000 = ` 6,00,000 10% of `24,00,000 = `2,40,000 2.5% of 24,00,000 = ` 60,000

Question.28 (a) The following information pertains to RICO Ltd. Net Profit Outstanding 12% preference share Number of share outstanding Return on Investment Equity Capitalization rate

(Amount in `) 60 200 6 lakh 20% 16%

Required: (i) What should be dividend pay-out ratio so as to keep the share price at ` 41.25 bu using WALTER MODEL? (ii) What is the optimum dividend pay-out ratio according to Walter Model. Answer: (i) Net Profit Less: Preference dividend (0.12× 200 lakh) Earning for Equity Shareholders Earning per share (EPS)= 36 lakh /6 lakh

` 60.00 24.00 36.00 ` 6.00 per sahre

Let the dividend payout ratio be X. So the share price will be: Here, D = Dividend per share = 6x P = [D + (E – D) (r/Ke)] / Ke P = Market price per share = ` 41.25 E = Earnings per share = ` 6 r = Return on investment = 20% = 0.20 Ke = Cost of equity = 16% = 0.16 Here, ` 41.25 = [6x+ (6 – 6x)(0.20/0.16)]/0.16 = [6x + (6 – 6x) ×1.25] / 0.16 = [6x + 7.50 – 7.5x] / 0.16 or, 6.6 = 7.50 – 1.5x or 1.5x = 7.50 – 6.60 = 0.90 x = 0.90 / 1.5 = 0.60 i.e., 60% So, the required dividend payout ratio will be : 60%. (ii) According to Walter’s model where the return on investment (20%) is more than the cost of equity, (16%) the price per share increase as the dividend payout ratio decrease. Hence the optimum dividend payout ratio in this case is nil. (b)

Venture Capital is considered to be a high risk capital. Do you agree? Enumerate the main features of Venture Capital investment.

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 48

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 Answer: The venture capital can be defined as the “long term equity investments in business which display potential for significant growth and financial return”. The term ‘venture capital’ comprises of two words viz. ‘venture’ and ‘capital’. The dictionary meaning of ‘venture’ is a course of proceedings associated with risk, the outcome of which is uncertain and ‘capital means resources to start the enterprise. In a narrower sense venture capital is understood as the capital which is available for financing new venture. Broadly, it can be interpreted as the investment of long-term equity finance where the venture capitalist earns his return from capital gain. The venture capital financing refers to the financing of new high risky venture promoted by qualified entrepreneurs who lack experience and funds to give shape to their ideas. In a broad sense, under venture capital financing, venture capitalist make investment to purchase equity of debt securities from inexperienced entrepreneurs who undertake highly risky venture with potential of success. The main features of venture capital investment are: (i) Providing finance of entrepreneurial talents (ii) Providing capital to persons having managerial skills. (iii) Expecting a high return in the form of capital gain. The venture capital schemes are designed to promote technological advancement and innovation through introduction of new products, process or plants and equipments. The activities which, in general need venture capital support are: (i) Commercial production of viable new process or products. (ii) Technological up-gradation, including adoption of imported technology suitable to Indian condition. (iii) Energy conservation with innovative technology. (iv) Commercial exploitation of proven technology. Thus, the distinguishing characteristic of venture capital sources is an investment policy aimed at achieving most of the profit through capital gain. Question.29 (a) What are the characteristics of Financial Lease? Answer: A Financial Lease is usually characterized by the following features: (i) The present value of the total lease rentals payable during the period of the lease exceeds or is equal substantially the whole of the fair value of the leased asset. It implies that within the lease period, the lessor recovers his investment in the asset along with an acceptable rate of return. (ii) As compared to Operaring Lease, a Financial Lease is for a longer period of time. (iii) It is usually non cancellable by the lessee prior to its expiration date. (iv) The lessee is generally responsible for the maintenance, insurance and services of the asset. However, the terms of lease agreement, in some cases may require the lessor to maintain and service the asset. Such an arrangement is called “maintenance or gross lease”. But usually in an Operating Lease, it is lessee who has to pay for maintenance and service costs and such a lease is known as “net lease”. (v) A Financial Lease usually provides the lessee an option of renewing the lease for further period at a normal rent. (b) Write short note on Global Depository Receipt. Answer: Global Depository Receipt (GDR)

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 49

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 A GDR is a negotiable instrument, basically a bearer instrument which is traded freely in the international market either through the stock exchange or over the counter or among Qualified International Buyers (QIB). It is denominated in US Dollars and represents shares issued in the local currency. Characteristics (i) The shares underlying the GDR do not carry voting rights. (ii) The instruments are freely traded in the international market. (iii) The investors earn fixed income by way of dividend. (iv) GDRS can be converted into underlying shares, depository/ custodian banks reducing the issue. The market of GDR: the GDR operates in the following way (i) An Indian company issues ordinary equity shares. (ii) These shares are deposited with a custodian bank (mostly domestic bank) (iii) The custodian bank establishes a link with a depository bank overseas. (iv) The depository bank, in turn issues depository receipts in dollars. (v) Funds are raised when the foreign entities purchase those depository receipts at an agreed price. (vi) The dividends on such issues are paid by the issuing company to the depository bank in local currency. (vii)The depository bank converts the dividends into US Dollars at the ruling exchange rate and distributes it among the GDR holders. Advantages of GDR (i) The Indian companies are able to tap global equity market to raise currency. (ii) The exchange risk borne by the investors as payment of the dividend is made in local currency. (iii) The voting rights are vested only with depository. Question.30 (a) Write down the advantages of Ratio Analysis. Answer: Advantages of Ratio Analysis Ratio Analysis is (useful) relevant in assessing the performance of a firm in respect of the following purposes: (i) To measure the liquidity position: The purpose of ratio analysis to measure the liquidity position of a firm. Whether the firm is able to meet its current obligations when they become due or not? A firm can be said to be liquid, if it has sufficient liquid funds to pay the interest charges on short-term debt within a year. The liquidity ratios are useful in credit analysis by banks and other financial institutions. (ii) To know the solvency position: Ratio analysis is helpful for assessing the long-term financial liability of the firm. The long term solvency is measured through the leverage, and profitability ratios. These ratios reveal the strengths and weaknesses of a firm in respect of the solvency position. The leverage ratios indicate the proportion of various sources of finance in the firm’s capital structure, particularly the ratio of debt and equity share capital. (iii) Operating efficiency or turnover of the firm: The ratios are helpful in measuring the operating efficiency or the turnover of the firm. These ratios indicate the efficiency in utilizing the assets of the firm such as fixed assets turnover ratio, total resources turnover ratio etc. (iv) To assess the profitability position of the firm: The ratios are useful to assess and measure the profitability of the firm in respect of sales and the investments. These ratios are concerned about the over –all profitability of the firm. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 50

Revisionary Test Paper_Intermediate_Syllabus 2012_Jun2014 (v) Inter - firm and intra – firm comparison: Ratios are not only reflects the financial position of a firm, but also serves as a tool for remedial actions. This is made possible only due to inter-firm comparison. This would demonstrate the relative position of the firm vis-à-vis its competitors If there is any variance in the ratios either with the industry average or with, those of competitors, the firm has to identify the reasons and would take remedial measures. (vi) Trend Analysis: The trend analysis of ratios indicates whether the financial position of a firm is improving or deteriorating over the yea ` The significance of a trend analysis of ratio lies in the fact that the analysis can know the direction of movement whether the movement is favourable or unfavourable. Thus, ratio analysis is considered better than a mere comparison of figures in carrying out an over – all appraisal of a company’s business. (b)

Surya Industries Ltd. is marketing all its products through a network of dealers. All sales are on credit and the dealers are given one month time to settle bills. The company is thinking of changing the credit period with a view to increase its overall profits. The marketing department has prepared the following estimates for different periods of credit: Particulars Credit period Sales Fixed costs Bad debts

Present Policy

Plan I

Plan II

Plan III

1 120 30 0.6

1.5 130 30 0.9

2 150 35 1

3 180 40 2

(in months) (` Lakhs) (` Lakhs) (% of sales)

The company has a contribution/sales ratio of 40% further it requires a pre-tax return on investment at 20%. Evaluate each of the above proposals and recommend the best credit period for the company. Answer: Analysis of Credit Policies

(` in Lakhs)

Credit Period (months)

Current Policy (1)

Plan I (1.5) Plan II (2)

Plan III (3)

Credit sales

120

130

150

180

Less: Variable cost @ 60%

72

78

90

108

Contribution Less: Fixed cost

48 30

52 30

60 35

72 40

18

22

25

32

102

108

125

148

8.5

13.5

20.83

37.00

Cost of Investment in debtors @ 20% (b)

1.70

2.70

4.17

7.40

Credit sales Bad debts (% of sales)

120 0.6%

130 0.9%

150 1%

180 2%

0.72

1.17

1.50

3.60

15.58

18.13

19.33

21.00

Operating Profit

(a)

Cost of Sales (Variable Cost + Fixed Cost) Investment in debtors [Cost of sales x Credit period / 12 months)

Bad debts Net Profit

(c) (a) – [(b) + (c)]

Analysis: The net profit is higher if 3 months credit period is allowed. Hence, it is suggested to adopt plan III. Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 51