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# SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 1 of 7

## STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2

Marks
Question No. 1
(a) Difference between Value Analysis and Functional Analysis: 4.0
 Value analysis is an examination of the factors affecting the cost of a product or service
with the objective of achieving the speciﬁed purpose most economically at the required
level of quality and reliability.
 Functional analysis is an analysis of the relationships between product functions, the cost
of their provision and their perceived values to the customers.
 Value analysis is thus a form of cost reduction, which is based upon investigating the
processes involved in providing a product or service whereas functional analysis focuses
on the value to the customers of each function of the product or service and from this
determines whether it is necessary to reduce the cost of providing each function.

## (b) (i) Calculations through Learning Curve:

Rupees
–0.322
(1) Average cost for first 8 batches [Rs.4,000,000 x (8) ] 2,047,694 1.0
(2) Total cost for 8 batches (Rs.2,047,694 x 8) 16,381,552 1.0
–0.322
Average cost for 7 batches [Rs.4,000,000x(7) = Rs.2,137,659] 1.0
Total cost for 7 batches (Rs.2,137,659 x 7) (14,963,613) 0.5
Direct labour cost for 8th batch 1,417,939 0.5
(3) Sales (Rs.450 x 400,000) 180,000,000 1.0
Non-labour related cost over product’s life (Rs.350 x 400,000) (140,000,000)
Total labour cost over product’s life [Rs.16,381,552 +
(Rs.1,417,939 x 8) (27,725,064) 1.0
Contribution 12,274,936 1.0

(ii) In order to achieve a contribution of Rs.16,000,000, the total labour cost over the products
lifetime would have to equal Rs.24,000,000 (Rs.40,000,000 – Rs.16,000,000). 1.0
This equals an average batch cost of Rs.1,500,000 (Rs.24,000,000 ÷ 16). 0.5
This represents 37.5% (Rs.1,500,000 ÷ Rs.4,000,000) of the cost of the first batch. 1.0
16 batches represents 4 doublings of output. 0.5
Therefore, the rate of learning required 78% ( 4 0.375 ). 1.0

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provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be
SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 2 of 7
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
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Question No. 2
Calculation of Feasible Option:
Rupees
Options Speedo Cheepo
A Annual cash inflows – before tax 15,000,000 13,500,000
B Tax (29%) [A x Tax rate] (4,350,000) (3,915,000) 1.0
C Net [A – B] 10,650,000 9,585,000 1.0
D Present value (PV) factor for annuity [PVIFA @ 12%] 3.605 3.102
E PV [C x D] 38,393,250 29,732,670 1.0
F Disposal value 5,000,000 4,000,000
G PV factor [PVIF @ 12%] 0.567 0.659
H PV of disposal [F x G] 2,835,000 2,636,000 1.0
I PV of tax saving [W-1] 9,671,816 8,135,172
J Initial investment (50,000,000) (40,000,000)
K Net present value (NPV) [E + H + I + J] 900,066 503,842 1.0
L Annual equivalent cash-flows [K ÷ D] 249,672 162,425 1.0
M PV of investment in perpetuity [L ÷ Required rate of return] 2,080,600 1,476,591 1.0

## W-1: Present Value (PV) of Tax Saving:

Rupees
Present Value
Present Value (PV) of
Tax Depreciation Tax Saving (PV) Factor
Tax Saving
Year [PVIF]
Speedo Cheepo
Speedo Cheepo Speedo Cheepo Speedo Cheepo
[12%] [11%]
1 12,500,000* 10,000,000* 3,625,000 2,900,000 0.893 0.901 3,237,125 2,612,900 1.0
1 5,625,000 4,500,000 1,631,250 1,305,000 0.893 0.901 1,456,706 1,175,805 1.0
2 4,781,250 3,825,000 1,386,563 1,109,250 0.797 0.812 1,105,091 900,711 1.0
3 4,064,063 3,251,250 1,178,578 942,863 0.712 0.731 839,148 689,233 1.0
4 3,454,454 14,423,750 1,001,792 4,182,888 0.636 0.659 637,140 2,756,523 1.0
5 14,575,233 – 4,226,818 – 0.567 – 2,396,606 – 1.0
9,671,816 8,135,172 1.0
*Initial

## Option ‘Speedo’ is more feasible. 1.0

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stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be
SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 3 of 7
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
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Question No. 3
(a) Transfer Pricing:
Rs. per set
Market price 28,000
Variable cost 20,000
Opportunity cost 8,000 1.0
Transfer price (as per general rule):
Variable cost 20,000
Opportunity cost 8,000
28,000 1.0

## (b) (i) Decision-Making:

The Machining (Finishing) Division’s Manager is likely to reject the special order because
the division’s incremental cost on the special order exceeds its incremental revenue. 1.0
Rs. per set
Sale price 36,000
Transfer in cost (28,000)
8,000 1.0
Loss in special order (2,000) 1.0

(ii) The Machining (Finishing) Division’s Manager’s likely decision to reject the special order is
not in the best interests of the company as a whole, since the company’s incremental
revenue on the special order exceeds its incremental cost. 2.0
Rs. per set
Incremental revenue in special order 36,000
Incremental cost for special order:
Variable cost incurred – Forging Division 20,000
– Machining (Finishing) Division 10,000
Total variable cost 30,000 1.0
Profit in special order 6,000 1.0

## (iii) Transfer Price (as per general rule):

Rs. per set
Variable cost 20,000
Opportunity cost –* 1.0
20,000 1.0
*Since the Forging Division has excess capacity

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be
SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 4 of 7
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
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Now, the Machining (Finishing) Division’s manager will have an incentive to accept the
special order since the division's incremental revenue on the special order exceeds the
incremental cost. 1.0
Rs. per set
Sale price 36,000
Transfer in cost (20,000)
16,000 1.0
Profit in special order 6,000 1.0

Question No. 4
(a) Decision-Making to Accept the Offer:
Rs. per engine
Selling price 60,000
Variable costs:
Direct materials 30,000
Direct labour 20,000
Factory overheads [Rs.20,000 x (Rs.900,000 – Rs.540,000) ÷
Rs.1,000,000] 7,200 1.0
Total 57,200 1.0
Profit 2,800 1.0

The price offered by customer is above the cost and the sale of the automobile engine will
make a contribution to profit and as it is a special order, without an impact on future sales, the
offer should be accepted. 1.0

## (b) Minimum Selling Price: 1.0

The minimum selling price should be the total cost or Rs.57,200 in this case as this is the floor
for pricing.

## (c) Advantages of Using Variable Costing Policy: 3.0

 Basing prices on variable costs assure the company that the increase and decrease in
cost with business activity will be covered. The present policy is more difficult to apply
because percentage changes affect both, costs that change, and costs that remain
constant. As a result, the floor, below which the company should not go, is not known.
 Variable costs help in cost-volume profit (CVP) analysis.
 Short-term planning can be manipulated by using variable costing. Future sales and
productions level in order to know the level of expenditure at various production level can
be determined.

## (d) Disadvantages of Pricing Policy based on Variable Costs: 3.0

 The company must be sure that the mark-up percentage is large enough to cover the fixed
costs involved and produced the desired amount of profit. There is a potential danger that
this policy can lead to under-pricing.
 It does not help in better understanding of the effect of fixed costs on net profit.
DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be
SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 5 of 7
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
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Question No. 5
(a) Calculation of Net Present Value (NPV) and Expected NPV:
Rupees
Net Present Value (NPV)*
Economic Condition Probability
Project ‘A’ Project ‘B’ Project ‘C’
Good 0.3 983,840 1,000,500 1,011,300 1.5
Normal 0.5 766,800 831,000 775,740 1.5
Bad 0.2 658,280 605,000 540,180 1.5
Expected NPV** 810,208 836,650 799,296 1.5
OR 2.0 + 2.0 + 2.0 = 6.0
* NPV = [Annual cash-flow (after-tax) x PVIFA] – Initial investment required
** Expected NPV = Sum of the product of Probabilities of Economic Condition and each Project’s NPV

## (b) Selection of Viable Project:

NPV [Rupees]
Measure Viability
Project ‘A’ Project ‘B’ Project ‘C’ Maximum
 Risk-neutral Project ‘B’ will be selected
810,208 836,650 799,296 836,650
(expected) under Maximini rule. 2.0
 Risk-averse Project ‘A’ will be also
658,280 605,000 540,180 658,280
(minimum) selected under Maximini rule. 2.0
 Risk-taking Project ‘C’ will be selected
983,840 1,000,500 1,011,300 1,011,300
(maximum) under Maximax rule. 2.0
OR 0.5 + 0.5 + 0.5 + 1.5 + 3.0 = 6.0

## (c) Project to be Selected under ‘Minimax Regret’ Rule:

Regret of NPV [Rupees]
Economic Conditions
Project ‘A’ Project ‘B’ Project ‘C’ Minimum
Good 27,460 10,800 – – 1.25
Normal 64,200 – 55,260 – 1.25
Bad – 53,280 118,100 – 1.25
Minimax Regret 64,200 53,280 118,100 53,280 1.25
OR 1.25 + 1.25 + 1.25 + 1.25 = 5.0
Project ‘B’ will be selected under ‘minimax regret’ rule. 1.0

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be
SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 6 of 7
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
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Question No. 6
(a) Calculation of Expected Net Present Value (NPV) and Profitability Index (PI):
Rupees
Expected Net Present Values (NPV) of Projects
AP BD CS SR G1 MC
Year-1 3,125,500 3,348,750 2,143,200 2,768,300 1,786,000 1,562,750 1.5
Year-2 2,789,500 3,466,950 1,912,800 2,470,700 1,992,500 3,267,700 1.5
Year-3 2,492,000 2,278,400 2,242,800 2,207,200 2,136,000 2,919,200 1.5
Year-4 2,226,000 – 2,321,400 1,971,600 2,226,000 – 1.0
Year-5 1,984,500 – – – 1,134,000 – 0.5
Present value
(PV) of inflow 12,617,500 9,094,100 8,620,200 9,417,800 9,274,500 7,749,650
Out-flow (12,300,000) (9,000,000) (8,750,000) (9,000,000) (9,000,000) (7,500,000)
Net present
value (NPV) 317,500 94,100 (129,800) 417,800 274,500 249,650 1.5
Profitability
Index (PI) 1.026 1.010 0.985 1.046 1.031 1.033 1.5
OR 1.5 + 1.5 + 1.5 + 1.5 + 1.5 + 1.5 = 9.0

## (b) Ranking of Projects:

Projects
AP BD CS SR G1 MC
Net present value (NPV) 2 5 6 1 3 4 1.5
Profitability Index (PI) 4 5 6 1 3 2 1.5
OR 0.5 + 0.5 + 0.5 + 0.5 + 0.5 + 0.5 = 3.0

## (c) Reason for Ranking Difference: 1.0

The rankings differ because the net present value (NPV) is an absolute measure, whereas, the
profitability index (PI) is a relative measure that takes into account the different investment cost
of each project.

## (d) Selection of Viable Project:

The objective is to select a combination of investments that will maximize net present value
(NPV), subject to a total capital outlay of Rs.30 million. Projects ‘AP’ and ‘G1’ are mutually
exclusive and project ‘CS’ has a negative NPV. The following are potential combinations of
projects: 0.5
Rupees
Projects Expected NPV Initial Outlay/ Out-Flows
AP, BD, SR (317,500 + 94,100 + 417,800) = 829,400 30,300,000 0.5
AP, BD, MC (317,500 + 94,100 + 249,650) = 661,250 28,800,000 0.5
AP, SR, MC (317,500 + 417,800 + 249,650) = 984,950 28,800,000 0.5
BD, SR, G1 (94,100 + 417,800 + 274,500) = 786,400 27,000,000 0.5
BD, SR, MC (94,100 + 417,800 + 249,650) = 761,550 25,500,000 0.5
SR, G1, MC (417,800 + 274,500 + 249,650) = 941,950 25,500,000 0.5
OR 0.5 + 1.5 + 1.0 = 3.0
DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be
SUGGESTED SOLUTIONS/ ANSWERS – WINTER 2018 EXAMINATIONS 7 of 7
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
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Note that it is not possible to combine four projects within the constraints outlined above and
that expected NPV cannot be increased by combining two projects. Accepting projects ‘AP’,
‘SR’ and ‘MC’ will maximize NPV. This combination will require a total capital outlay of Rs.28.8
million, and the unused funds will be invested to yield a return of 10%. The risk-adjusted
discount rate for the investment will also be 10%. Therefore, the NPV of funds invested in the
money market will be zero. 0.5

Question No. 7
(a) Computation of Segment Margin and Average Assets:
Rupees
Sales 9,000,000
Variable costs (3,650,000)
Direct fixed costs (4,770,000)
Segment margin 580,000 0.5
Average assets [(Rs.3,600,000 + Rs.5,300,000) ÷ 2] 4,450,000 0.5

## (b) Profit margin = Rs.580,000 ÷ Rs.9,000,000 = 6.44% 0.5

Asset turnover = Rs.9,000,000 ÷ Rs.4,450,000 = 2.02 0.5
Return on investment (ROI) = Rs.580,000 ÷ Rs.4,450,000 = 13.00% 1.0

(c) The target return on investment (ROI) for the division was 15% (2.5 x 6). The division 1.0
generated an ROI of only 13%. Thus the division did not achieve its target rate of return
(ROR). The poor performance resulted from the division’s failure to achieve its targeted asset
turnover.

## (d) Residual income (RI) = Rs.580,000 – (13% x Rs.4,450,000) 1.0

= Rs.580,000 – Rs.578,500 = Rs.1,500 1.0

## (e) After-tax profits = Pre-tax income – Taxes

= Rs.580,000 – (Rs.580,000 x 29%) = Rs.411,800 1.0
Economic value added (EVA) = Rs.411,800 – (Rs.4,000,000 x 10%) = Rs.11,800 1.0
Economic value added (EVA) and residual income (RI) differ for three reasons. Firstly, RI is
based on pre-tax rather than after-tax income. Secondly, RI is based on the book value of
investment, whereas, EVA is based on the market value of investment. Thirdly, the target rates
of return differ between the methods. 1.0

(f) Return on investment (ROI), residual income (RI), and economic value added (EVA) are all 1.0
measures of short-term performance. These measures may be particularly inappropriate for
divisions that have long-term missions (such as high growth). In this case, the relatively large
growth (47.22%) in assets of Innovative Furnishing Solutions (IFS) products from the
beginning to the end of the period could indicate that this division is oriented toward growth. If
so, the ROI, RI, and EVA measures will provide an incentive contrary to the growth mission.

THE END
DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other po ssible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and
its Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of these suggested answers. It is clarified that the ICMA Pakistan shall not be