# CA PE II Question Papers Group II

# Cost Accounting and Financial Management May 2004

This Paper has 23 answerable questions with 0 answered.

Total No. of Questions— 9]

Time Allowed : 3 Hours

*Maximum Marks : 100
Answers to questions are to be given only in English except in the cases of candidates who have opted for Hindi medium. If a candidate who has not opted for Hindi medium, answers in Hindi, his answers in Hindi will not be valued.
Question Nos.1 and 6 are compulsory.
Attempt three questions out of the remaining Question numbers 2, 3, 4 and 5 and attempt two questions from the remaining Question numbers 7, 8 and 9.
Working notes should form part of the answer.
Marks
1. (a) RST Limited specializes in the distribution of pharmaceutical products. It buys from the pharmaceutical companies and resells to each of the three different markets :
(i) General Supermarket Chains
(ii) Drugstore Chains
(iii) Chemist Shops
The following data for the month of April, 2004 in respect of RST Limited has been reported :*

General Supermarket

Chains Drugstore

Chains Chemist

Shops

Average revenue per delivery

Average cost of goods Rs. 84,975

Rs. 82,500 Rs. 28,875

Rs. 27,500 Rs. 5,445

Rs. 4,950

sold per delivery 330 825 2,750

In the past, RST Limited has used gross margin percentage to evaluate the relative profitability of its distribution channels.

The company plans to use activity based costing for analysing the probability of its distribution channels.

The Activity analysis of RST Limited is as under :

Activity Area Cost Driver

Customer purchase order processing

Line–item ordering

Store delivery

Cartons dispatched to stores

Purchase orders by customers

Line–items per purchase order

Store deliveries

Cartons dispatched to a store per deliver

Shelf stocking at customer store Hours of shelf stocking

The April, 2004 operating costs (other than cost of goods sold) of RST Limited are Rs. 8,27,970. These operating costs are assigned to five activity areas. The cost in each area and the quantity of the cost allocation basis used in that area for April, 2004 are as follows :

Activity Area Total costs

in April, 2004 Total Units of Cost

Allocation Base used

in April, 2004

Customer purchase Order processing Rs. 2,20,000 5,500 orders

Line–item ordering Rs. 1,75,560 58,520 line items

Store delivery Rs. 1,95,250 3,905 store deliveries

Cartons dispatched to stores Rs. 2,09,000 2,09,000 cartons

Shelf Stocking at Customer Store Rs.28,160 1,760 hours

Other data for April, 2004 include the following :

General

Supermarket

Chains Drugstore

Chains Chemist

Shops

Total number of orders

Average number of line

items per order

Total number of

store deliveries

Average number of cartons

shipped per store delivery

Average number of hours of 385

14

330

300 990

12

825

80 4,125

10

2,750

16

shelf–stocking per store delivery 3 0.6 0.1

Required :

(i) Compute for April, 2004 gross–margin percentage for each of its three distribution channels and compute RST Limited‘s operating income.

(ii) Compute the April, 2004 rate per unit of the cost–allocation base for each of the five activity areas.

(iii) Compute the operating income of each distribution channel in April, 2004 using the activity–based costing information. Comment on the results. What new insights are available with the activity–based cost information?

(iv) Describe four challenges one would face in assigning the total April, 2004 operating costs of Rs. 8,27,970 to five activity areas.

3+3+2+4 (0)

(b) Discuss the essentials of a good Cost Accounting system. 2 (0)

(c) Discuss the treatment of under–absorbed and over–absorbed factory overheads in costaccounting 4 (0)

2. (a) MST Limited has collected the following data for its two activities. It calculates activity cost rates based on cost driver capacity.

Activity

Power

Quality Inspections Cost Driver

Kilowatt hours

Number of Inspections Capacity

50,000 Kilowatt hours

10,000 Inspections Cost

Rs. 2,00,000

Rs. 3,00,000

The company makes three products, M,S and T. For the year ended March 31, 2004, the following consumption of cost drivers was reported :

Product Kilowatt Hours Quality Inspections

M

S 10,000

20,000 3,500

2,500

T 15,000 3,000

Required :

(i) Calculate the effective rate of earnings under the Halsey scheme and the Rowanscheme.

(ii) Calculate the savings to the ZED Limited in terms of direct labour cost per piece.

(iii) Discuss the factors the management considers in choosing a capacity level to compute the budgeted fixed overhead cost rate.

2+2+2=6 (0)

(b) ZED Limited is working by employing 50 skilled workers. It is considered the introduction of incentive scheme–either Halsey scheme (with 50% bonus) or Rowan scheme–of wage payment for increasing the labour productivity to cope up the increasing demand for the product by 405. It is believed that proposed incentive scheme could bring about an average 20% increase over the present earnings of the workers; it could act as sufficient incentive for them to produce more. Because of assurance, the increase in productivity has been observed as revealed by the figures for the month of April, 2004.

Hourly rate of wages (guaranteed)

Average time for producing one unit by one worker at the

previous performance (This may be taken as time allowed)

Number of working days in the month

Number of working hours per day of each worker

Actual production during the month Rs. 30

1.975 hours

24

8

6,120 units

Required :

(i) Calculate the effective rate of earnings under the Halsey scheme and the Rowan scheme

(ii) Calculate the savings to the ZED Limited in terms of direct labour cost per piece

(iii) Advise ZED Limited about the selection of the scheme to fulfill his assurance.

4+2+2=8 (0)

3. (a) JKL Limited produces two products–J and K–together with a by–product L from a single main process (process I). Product J is sold at the point of separation for Rs. 55 per kg, whereas product K is sold for Rs. 77 per kg after further processing into product K2. By–product L is sold without further processing for Rs. 19.25 per kg.

Process I is closely monitored by a team of chemists, who planned the output per 1,000 kg of input materials to be as follows :

Product J

Product K

Product L

Toxic waste 500kg

350 kg

100 kg

50 kg

The toxic waste is disposed at a cost of Rs. 16.50 per kg, and arises at the end of processing.

Process II which is used for further processing of product K into product K2 has the following cost structure :

Fixed costs

Variable cost Rs. 2,64,000 per week

Rs. 16.50 per kg processed

The following actual data relate to the first week of the month:

Product I

Opening Work–in–progress

Material input

Direct Labour

Variable Overheads

Fixed Overheads

Outputs :

Product J

Product K

Product L

Toxic waste

Closing Work–in–progress

Nil

40,000 kg costing Rs.6,60,000

Rs.4,40,000

Rs.1,76,000

Rs.2,64,000

19,200 kg

14,400 kg

4,000 kg

2,400 kg

Nil

Product II

Opening Work–in–progress

Input of product K

Output of product K2

Closing Work–in–progress(50%

converted and conversion costs

were incurred in accordance with

the planned cost structure)

Nil

14,400 kg

13,200 kg

1,200 kg

Required :

(i) Prepare Process I account for the first week of the month using the final sales value method of attribute the pre–separation costs to join products.

(ii) Prepare the toxic waste account and Process II account for the first week of the month

(iii) Comment on the method used by the JKL Limited to attributed the pre–separation costs to joint products.

(iv) Advise the management of JKL Limited whether or not, on purely financial grounds, it should continue to process product K into product K2 :

(a) If product K could be sold at the point of separation for Rs. 47.30 per kg; and

(b) If the 60% of the weekly fixed costs of Process II were avoided by but processing product K further.

3+3+2+2 (0)

(b) Discuss the requisite of inter–firm comparison system. 4 (0)

4. (a) EPS is a Public School having 25 buses each plying in different directions for the transport of its school students. In view of large number of students availing of the bus service, the buses work two shifts daily both in the morning and in the afternoon. The buses are garaged in the school. The workload of the students has been so arranged that in the morning, the first trip picks up senior students and the second trip plying an hour later picks up junior students. Similarly, in the afternoon, the first trip takes the junior students and an hour later the second trip takes the senior students home.

The distance travelled by each bus, one way is 16 kms. The school works 24 days in a month and remains closed for vacation in May and June. the bus fee, hwoever, is payable by the students for all the 12 months in a year. The details of expenses for the year 2003-2004 are as under :

Driver’s salary-payable

for all the 12 months

Cleaner’s salary payable for

all the 12 months (one cleaner has

been employed for every five buses)

License Fees, Taxes etc.

Insurance Premium

Repairs and Maintenance

Purchase price of the bus

Life of the bus

Scrap value

Diesel Cost

Rs. 5,000 per month per driver

Rs. 3,000 per month per cleaner

Rs. 2,300 per bus per annum

RS. 15,600 per bus per annum

Rs. 16,400 per bus per annum

Rs. 16,50,000 each

16 years

Rs. 1,50,000

Rs. 18.50 per litre

Each bus gives an average of 10 kms per litre of diesel. The seating capacity of each bus is 60 students. The seating capacity is fully occupied during the whole year.

The school follows differential bus fees based on distance travelled as under :

Students picked up and

dropped within the range

of distance from the School Bus Fee

Percentage of Students

availing this facility

4 kms

8 kms 25% of Full

50% of Full 15%

30%

16 kms Full 55%

Ignore interest. Since the bus fees has to be based on average cost, you are required to :

(i) Prepare a statement showing the expenses of operating a single bus and the fleet of 25 buses for a year.

(ii) Work out average cost per student per month in respect of :

(a) Students coming from a distance of upto 4 kms from the School;

(b) Students coming from a distance of upto 8 kms from the School; and

(c) Students coming from a distance of upto 16 kms from the School;

7+3=10 (0)

(b) Distinguish between Cost control and Cost reduction 4 (0)

5. (a)

IPL Limited uses a small casting in one of its finished products. The castings are purchased from a foundry. IPL Limited purchases 54,000 castings per year at a cost of Rs. 800 per casting.

The castings are used evenly throughout the year in the production process on a 360–day–per–year basis. The company estimates that it costs Rs. 9,000 to place a single purchase order and about Rs. 300 to carry one casting in inventory for a year. The high carrying costs result from the need to keep the castings in carefully controlled temperature and humidity conditions, and from the high cost of insurance.

Delivery from the foundry generally taken 6 days, but it can take as much as 10 days. The days of delivery time and percentage of their occurrence are shown in the following tabulation :

Delivery time (days) : 6 7 8 9 10

Percentage of occurrence : 75 10 5 5 5

Required :

(i) Compute the economic order quantity (EQO).

(ii) Assume the company is willing to assume a 15% risk of being out of stock. What would be the safety stock? The re–order point?

(iii) Assume the company is willing to assume a 5% risk of being out of stock. What would be safety stock? The re–order point?

(iv) Assume 5% stock–out risk. What would be the total cost of ordering and carrying inventory for one year?

(v) Refer to the original data. Assume that using process re–engineering the company reduces its cost of placing a purchase order to only Rs. 600. In addition, company estimates that when the waste and inefficiency caused by inventories are considered, the true cost of carrying a unit in stock is Rs. 720 per year.

(a) Compute the new EOQ.

(b) How frequently would the company be placing an order, as compared to the old purchasing policy?

2+1+1+2+3=9 (0)

(b) Why is it necessary to reconcile the profits between the Cost Accounts and Financial Accounts? 5 (0)

6. (a) The following annual figures relate to MNP Limited :

Sales (at three months credit)

Materials consumed (suppliers extend one and half

month’s credit

Wages paid (one month in arrear)

Manufacturing expenses outstanding at the end of the

year (cash expenses are paid one month in arrear)

Total Administrative expenses for the year (cash

expenses are paid one month in arrear)

Sales promotion expenses for the year (paid quarterly

in advance) Rs. 90,00,000

Rs. 22,50,000

Rs. 18,00,000

Rs. 2,00,000

Rs. 6,00,000

Rs. 12,00,000

The company sells its products on gross–profit of 25% assuming depreciation as a part of cost of production. It keeps two month’s stock of finished goods and one month’s stock of raw materials as inventory. It keeps cash balance of Rs. 2,50,000.

Assume a 5% safety margin, work out the working capital requirements of the company on cash basis. Ignore work–in–progress.

6 (0)

(b) The cash flows mutually exclusive projects are as under :

t0 t1 t2 t3 t4 t5 t6

Project ‘P’(Rs.) (40,000) 13,000 8,000 14,000 12,000 11,000 15,000

Project ‘J’(Rs.) (20,000) 7,000 13,000 12,000 — — —

Required :

(i) Estimate the net present value (NPV) of the project ’P‘ and ’J‘ using 15% as the hurdle rate.

(ii) Estimate the internal rate of return (IRR) of the Project ’P‘ and ’J‘.

(iii) Why there is a conflict in the project choice by using NPV and IRR criterion?

(iv) Which criteria you will use in such a situation? Estimate the value at that criterion. Make a project choice.

The present value interest factor values at different rates of discount are as under :

Rate of discount t0 t1 t2 t3 t4 t5 t6

0.15

0.18

0.20

0.24

0.26 1.00

1.00

1.00

1.00

1.00 0.8696

0.8475

0.8333

0.8065

0.7937 0.7561

0.7182

0.6944

0.6504

0.6299 0.6575

0.6086

0.5787

0.5245

0.4999 0.5718

0.5158

0.4823

0.4230

0.3968 0.4972

0.4371

0.4019

0.3411

0.3149 0.4323

0.3704

0.3349

0.2751

0.2499

2+2+1+2=7 (0)

(c) Discuss the relationship between the cost of equity and financial leverage in accordance with MM Proposition II. 5 (0)

7. (a) ABC Limited has the following book value capital structure :

Equity Share Capital (150 million shares, Rs. 10 par)

Reserves and Surplus

10.5% preference Share Capital (1 million shares, Rs. 100 par)

9.5% Debentures (1.5 million debentures, Rs. 1000 par)

8.5% Term Loans from Financial Institutions Rs.

Rs.

Rs.

Rs.

Rs. 1,500 million

2,250 million

100 million

1,500 million

500 million

The debentures of ABC Limited are redeemable after three years and are quoting at Rs. 981.05 per debenture. The applicable income tax rate for the company is 35%.

The current market price per equity share is Rs. 60. The prevailing default–risk free interest rate on 10–year GOI Treasury Bonds is 5.5%. The average market risk premium is 8%. The beta of the company is 1.1875.

The preferred stock of the company is redeemable after 5 years is currently selling at Rs. 98.15 per preference share.

Required :

*(i) Calculate weighted average cost of capital of the company using market
(ii) Define the marginal cost of capital schedule for the firm if it raises Rs. 750 million for a new project. The firm plans to have a target debt to value ratio of 20%. The beta of new project is 1.4375. The debt capital will be raised through term loans. It will carry interest rate of 9.5% for the first 100 million and 10% for the next Rs. 50 million.
6+3=9 (0)
(b) Discuss the functions of a Chief Financial Officer. 3 (0)
8. (a) PQR Limited has decided to go in for a new model of Mercedes Car. The cost of the vehicle is Rs. 40 lakhs. The company has two alternatives :
(i) taking the car on finance lease; or
(ii) borrowing and purchasing the car.
LMN Limited is willing to provide the car on finance lease of PQR Limited for five years at an annual rental of Rs. 8.75 lakhs, payable at the end of the year.
The vehicle is expected to have useful life of 5 years, and it will fetch a net salvage value of Rs. 10 lakhs at the end of year five. The depreciation rate for tax purpose is 40% on written–down value basis. The applicable tax rate for the company is 35%. The applicable before–tax borrowing rate for the company is 13.8462%.
What is the net advantage of leasing for the PQR Limited? The values of present value interest factor at different rates of discount are as under :
Rate of
discount t1 t2 t3 t4 t5
0.138462 0.8784 0.7715 0.6777 0.5953 0.5229
0.09 0.9174 0.8417 0.7722 0.7084 0.6499
8 (0)
(b) Discuss the Return on assets (ROA) and Return on Equity (ROE) by bringing out clearly the impact of financial leverage. 4 (0)
9. Write short notes on any four of the following : 3×4=12
(a) American Depository Receipts vs. Global Depository Receipts. (0)
(b) Deep Discount Bonds vs. Zero Coupon Bonds (0)
(c) Factoring vs. Debt Securitization. (0)
(d) William J Baumal vs. Miller–Orr Cash Management Model (0)
(e) Cash Flow Analysis vs. Fund Flow Analysis. (0)*