Copyright Reserved

No. of Pages No. of Questions

= =

09 06

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

CA PROFESSIONAL (STRATEGIC LEVEL I) EXAMINATION DECEMBER 2011

13304 - STRATEGIC MANAGEMENT ACCOUNTING

Time allowed : 3 hours Instructions to candidates: (1) (2) (3) i. Section - A - Question No. 01 is compulsory. ii. Section - B - Answer any four (04) questions. Begin each answer on a separate page. Submit all workings All answers should be in English language, in the answer booklets provided. Marks : 100 marks

______________________________________________________________________________

SECTION - A
Question No. 01 (a) Agri group is engaged in agriculture cum food processing industry. It has three main subsidiaries which are considered as Strategic Business Units (SBU) and engaged in following activities SBU X Cultivating fruits and vegetables and supplied to SBU Y SBU Y Processing fruits and vegetables and packing appropriately and supplied to SBU Z SBU Z Wholesale distribution of canned processed food products The Company performance is managed based on the results of the SBU and all transfer prices between SBUs are based on market prices. The Key performance indicator (KPI) for the group at top level is the Economic Value Addition (EVATM) and for SBU performance it is the ROI. The calculations prepared for this purpose for the last financial year are given below.
KPI workings for the year ended 31st March 2011 - Agri Group Rs Mn Property, Plant and Equipment 718 Profit before tax Current Assets 2,744 Current Liabilities - 1,914 Required Return @ 15% WACC Borrowings 452 Actual profit Net Assets / Capital & Reserves 1,096 Value Creation Rs Mn 272 164 272 108

KPI workings for the year ended 31st March 2011 - SBU SBU X SBU Y SBU Z Holding Co. Rs Mn Rs Mn Rs Mn Rs Mn Turnover 1634 1264 4636 Profit before interest and tax 114 112 116 -38 Total Assets less current liabilities 542 478 464 64 Return on Investment 21% 23% 25%

The CEO of Agri Group has recently attended a workshop on performance management and had learnt that the KPI calculations done in the company are not the most accurate. He has invited one of the consultants who conducted the workshop to study the way in which KPIs are calculated in Agro Group and suggest any improvements. The consultant after studying the calculations and other company records has come up with an adjusted calculation as given below. Having seen the adjusted calculation the CEO has got excited on the fact that the group is destroying value instead of creating value as reported in the internal calculations.
Adjusted computation prepared by the consultant for the Y/E 31st March 2011 - Agri Group Adjusted Capital & Reserves As per balance sheet Add Borrowings (Note 1) Research & Development (Note 2) Advertising (Note 3) Goodwill write off (Note 4) Adjusted Capital Rs Mn 1,096 452 348 210 814 2,920 Adjusted Profit Profit before tax Add: Interest paid Research & Development Advertising Less: Tax paid Adjusted Profit before tax Required Return @ 15% WACC Actual (adjusted) profit Loss of Value Rs Mn 272 32 42 46 96 296 438 296 142

Analysis of Adjusted amounts by the Consultant (Rs Mn) SBU X SBU Y SBU Z Holding Co. Borrowings (Note 1) Research & Development (Note 2) Advertising (Note 3) Goodwill write off (Note 4) 0 210 206 608 160 348 262 30

Additional notes to the adjusted calculations Note 2 Research and Development (Rs 348Mn) represents the amounts written off to income statement in the last five years. These amounts had been spent on research work pertaining to new processes and products which have been later implemented and now contributing to more efficient results. (2)

Note 3 Advertising (Rs 210Mn) represents the amounts incurred in launching new products which have started contributing to the profit. Note 4 Goodwill write off represents the goodwill on acquisition of some businesses by Agri Group when they considerably expanded five years ago. The business units so acquired are now performing well and contributing to group profits As per the information provided by the consultant, you are required to: 1. Prepare revised balance sheet and performance statements for each SBU and Group and calculate EVA and return on investment for each SBU and Group. Holding company assets, liabilities and expenses (losses) are to be reallocated to SBUs based on turnover and Group tax to be reallocated to SBUs based on profit before interest and tax. (8 marks) Compare the statement you prepared in (1) above with the original KPI workings and comment on the different results and identify the SBUs which create/destruct value of the Agri Group. (6 marks) SBU Z has an annual advertisement budget of Rs. 3.0 million and is considering which of the two methods it should use to advertise its products : one is TV advertisement and the other is newspaper advertisement. Following information is estimated as per past advertising campaign. TV Rs. 300,000 0.25 0.40 0.35 4,000 3,000 2,000 Newspaper Rs. 150,000 0.35 0.45 0.20 1,500 1,000 750

2.

(b)

Cost per insertion Probability of response

High Average Low High Average Low

Number of responses per insertion

In either case only 30% of the responses can be expected to produce a sale. Each sale generates a net contribution of Rs. 400. You are required to: (i) Construct a pay-off matrix for the above information and calculate the expected net income in total for each advertising method. (6 marks) Calculate the standard deviation of each advertising method and derive the coefficient of variation and assess the relative risk of each method. (6 marks) By interpreting the results obtained in (i) & (ii) above, advice SBU Z on the method it should use for its advertising campaign. (2 marks) (Total 28 marks) (3)

(ii)

(iii)

SECTION - B
(Answer any four (04) questions) Question No. 02 Car Component Company (CCC) is engaged in manufacturing various components for car engines. CCC is considering investing in the production of a new component C3 which is expected to have a market life of 5 years. The business development team has undertaken an analysis of the proposed project of which the important information is shown below.
Investment Project for component C3 (All figures are in Rs Mn) Year 0 Investment Investment in Machinery 900 Cumulative investment in working capital 60 960 Operating Performance Sales Materials Labour Overheads Interest Depreciation

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

80 80

100 100

120 120

140 140

140 140

700 107 214 10 115 180 626 74 26 48 1.00 1.00 960 118.4 12.3% 0.87 0.77

980 150 300 20 115 180 765 215 75 140 0.76 0.59

1064 180 360 20 115 180 855 209 73 136 0.66 0.46

1148 210 420 20 115 180 945 203 71 132 0.57 0.35

1064 180 360 20 115 180 855 209 73 136 0.50 0.27 0.43 0.21

Taxable Profit Taxation Profit after tax Discounting Factors @ 15% Discounting Factors @ 30% Total Initial Investment Average annual after tax profit Accounting Rate of Return

All of the above cash flow and profit estimates have been prepared in terms of present day costs and prices on the basis that sales price could be increased to compensate for any increase in costs. (4)

You have the following additional information. 1. 2. 3. 4. 5. 6. 7. Selling prices, working capital requirements and overheads expenses are expected to be affected by an inflation rate of 5% per annum Material costs and labour costs are expected to be affected by an inflation rate of 10% per annum Capital allowances at 25% per annum straight line are available in respect of machinery Taxation on profits is at 35% payable one year in arrears Machinery will have no residual value at the end of five years The companys real after tax cost of capital is 8% per annum and rate of inflation is 6.5% per annum All receipts and payments arise at the end of the year to which they relate except for those in year 0

You are required to: 1. Show that the inflation adjusted cost of capital to the nearest whole number is 15% (2 marks) 2. Estimate the Net Present Value and Internal Rate of Return of the proposed project. State clearly any assumptions that you make (12 marks) 3. Comment on the results and on the Accounting Rate of Return which the business development team has calculated and give your recommendation (4 marks) (Total 18 marks) Question No. 03. AgroChemi (Pvt) Ltd., is an agricultural chemical manufacturing company using process manufacturing system. It operates a standard costing system to value work in progress and finished products. The Company manufatures a special grade of fungicide Ru-anti used in Rubber Estates, in two manufaturing processes. The output of Process I namely Material X is immediately transferred to Process II. The Material X and Y are introduced to the Process II at the beginning of the process. Due to long processing time, 14% from the total output is provided as normal process loss. The normal loss in Material Y is relatively higher than Material X due to its extra weightlessness.

(5)

This normal loss comprises of; Description Material X Material Y Total Material Loss (X & Y) Loss proportion - 1/11 of Material X input by weight - 1/6 of Material Y input by weight - 14% from the Output by weight

However the final output of this product should include a standard mix of 60% of Material X and 40% of Material Y respectively, in order to meet its best specification. However the recipe of the actual output often varies within acceptable limits from this standard which is normal. These losses are evenly distributed during the processing time. The output of the Process II is packaged at the end of the process in a special 5 Kg., pack. The packing materials are introduced at the end of the process and provided no losses. The following standard cost/pricing details are also given; - The standard cost of Material X, Rs. 300/- per Kg. - Material Y, @ Rs. 200/- per Kg. - Packing Material per pack of Ru-ant is Rs. 60/- Direct Labour - 4 hours per pack @ Rs. 150/- per hour - Variable Overheads @ Rs. 10/- per labour hour - Fixed Overheads @ Rs. 20/- per labour hour - Selling price is decided at standard cost plus 40% profit on the selling price Labour and Variable Overheads are absorbed evenly throughout the processing and fixed production overheads are absorbed only for the completed goods. The following details relating to the month of November 2011, were extracted from the Company records; Weight of Work in progress as at 1 November = 13,375 Kgs (50% completed) Weight of Work in progress as at 30 November = 19,460 Kgs (80% completed) No. of Packs completed during the month = 55,000 (all the completed output were in a acceptable recipe) Actual material consumption for the period Material X = 185,200 Kgs Material Y = 136,000 Kgs You are required to; (a) (b) (c) Calculate unit standard cost and selling price for a 5Kg pack of Ru-ant. Prepare a statement of equivalent units for the month of November. (3 marks) (8 marks)

(d)

Compute the standard cost of opening work in progress, closing work in progress and finished goods. (3 marks). Calculate the Material Mix Variance and Yield Variance. (4 marks) (Total 18 marks) (6)

Question No. 04. Natures Comfort (Pvt) Ltd., manufactures an orthopedic mattress (OM01) for both local and export markets. The company operates a full standard costing system. The following information is relevant for the month of November 2011. Standard Material and Labour Costs for a unit of OM01; Material R - 03 Kg. @ Rs. 400/- each Material F 20 Kg. @ Rs. 200/- each Direct Labour 1 hours @ Rs. 125/hour Rs. 1,200.00 Rs. 4,000.00 Rs. 187.50

The following information is also given for the month of November; Opening Stock for November 2011 (Kg.) 2,000 4,300 Closing Stock for November 2011 (Kg.) 3,500 3,100

Utilisation (Kg.) 15,500 100,500

Material R Material F

During the period under review, 40% of the Material R was purchased at Rs. 405/- per Kg., and the balance at 403/- per Kg. while total quantity of Material F was purchased at Rs. 198/- per Kg. 7,600 direct labour hours were utilised at a cost of Rs. 965,200/- to complete 5,000 mattresses during the month under review. No work in process stocks were recorded both at the beginning and end of the period. You are required to: (a) (b) Calculate material price and usage variances, and labour rate and efficiency variances. (4 marks) Write up accounting entries to record the above transactions and variances in journal form. (6 marks) Explain the possible disadvantages of recognizing/charging the material price variance as in part (a) and (b) above. (3 marks) The management has decided that the material usage variance should not be investigated because of the additional cost that should be incurred for the investigation. According to the past experience of the Company, the cost for an investigation into a variance would be Rs. 75,000/- and the cost of correcting the process if the situation is controllable, is estimated to be Rs. 60,000/-. The present value of future expected savings from taking the corrective action is estimated at Rs. 200,000/-. The probability that the variance is controllable is estimated to be 70%. Explain with calculations whether the variance should be investigated. (7) (5 marks) (Total 18 marks)

(c)

(d)

Question No. 05 Lestar PLC is engaged in exploration of oil. Lestar has found a new potential site where oil is expected to exist and Rs. 70 million has to be paid to acquire the land rights before any excavation work is commenced. Based on the volume of oil the Operating results have been classified into three: High, Medium and Low. The present values of operating cash flows under the three classifications have been estimated to be Rs.500 million, Rs.300 million and Rs.100 million. Lestar can do a scientific test, if necessary, at a cost of Rs. 30 million before acquiring the land rights to find out existence of oil. The test will only say whether the site will be rich or poor with reference to the volume of oil that can be anticipated. The probability of scientific test forecasting poor status is 30%. The probabilities for High, Medium and Low demand under different circumstances are given in the below table.
Operating Result Medium 20% 10% 30%

If proceeded without a scientific test If the scientific test result is 'Rich' If the scientific test result is 'Poor'

High 50% 70% 10%

Low 30% 20% 60%

The initial investment required in machinery and equipment will be Rs. 110 million having no residual value. However if Lestar so wish, they can shift some of the equipment from one of their other sites located close by. This option will result in a contribution loss of Rs. 40 million in present value terms. If the project is commissioned with this used machinery the operating cash flows will be reduced by 30%. The management has decided that this option will not be considered if the scientific test result is Rich in case such test is carried out. You as the Management Accountant of Lestar PLC, are required to: 1. Construct a decision tree showing all the options available to Lestar PLC. (8 marks) 2. Evaluate the options based on the decision tree showing all relevant workings. (8 marks) 3. Clearly state your recommendation as to the best course of action that Lestar PLC should undertake. (2 mark) (Total 18 marks)

(8)

Question No. 06 PremierHouse (Pvt) Ltd., is a subsidiary of reputed group of companies in the country, engaged in manufacturing of various electrical items and trading to the local market. The company held its board meeting recently to discuss the performance for the six months ended 30 June 2011 and future strategies. The following paragraph on the review of the period was extracted from board papers. The company has recorded a turnover of Rs. 1.95 billion for the period, an increase of 50% over the budget and 45% over the corresponding period. The profit for the six months was Rs. 0.25 billion which is an increase of 20% over the budget. The increasing labour issues (labour turnover and absenteeism) and high manufacturing defects due to quality issues in input materials were among the main issues for the low profitability. During the meeting it was revealed that the main competitor (the market leader) of the company has also recorded new heights in their turnover and profits. Taking these issues into account the board has decided to study the applicability of the Benchmarking and Kaizen Costing, for the company to gain competitive advantages in order to bring the company to a dominant position in the market. You as the Finance Manager of the Company are requested to write a report to the Board on the Benchmarking Exercise and Kaizen Costing. Part A (i) Describe what Benchmarking is and benchmarking methods that can be used by the company. (3 marks) Suggest (04) appropriate areas for the company to benchmark. Briefly explain the benchmarking process. Comment the possible barriers in launching a benchmark programme. (2 marks) (3 marks) (3 marks)

(ii) (iii) (iv)

Part B (v) (vi) (vii) Briefly explain what Kaizen Costing is and how it differs from Benchmarking. (2 marks) Evaluate applicability of Kaizen Costing in the present situation of Premier House. (3 marks) Explain process of Kaizen Costing. (2 marks) (Total 18 marks)

(9)