EXTRA ATTEMPT, MAY 2014 EXAMINATIONS

ICMA. Monday, the 26th May 2014

STRATEGIC MANAGEMENT
ACCOUNTING (AF-601)
Pakistan
SEMESTER-6
Extra Reading Time: 15 Minutes
Maximum Marks: 100 Roll No.:
Writing Time: 03 Hours
(i) Attempt all questions.
(ii) Answers must be neat, relevant and brief.
(iii) In marking the question paper, the examiners take into account clarity of exposition, logic of arguments,
effective presentation, language and use of clear diagram/ chart, where appropriate.
(iv) Read the instructions printed inside the top cover of answer script CAREFULLY before attempting the paper.
(v) Use of non-programmable scientific calculators of any model is allowed.
(vi) DO NOT write your Name, Reg. No. or Roll No., or any irrelevant information inside the answer script.
(vii) Question Paper must be returned to invigilator before leaving the examination hall.
Answer Script will be provided after lapse of 15 minutes Extra Reading Time (9:15 a.m. or 2:15 p.m. [PST] as the case may be).
Marks
Q. 1 High Tech is a renowned group of companies across the country. High Tech Automobiles, a
group member, manufactures automobile spare parts and sells its products to wholesalers
and retailers. Air filter and oil filter, produced by the company are popular products among the
customers. The company is run by the true professionals. The company’s management is
quite pleased with its performance for the current year. Projected sales for 2014, indicate that
70,000 air filters and 140,000 oil filters will be sold. The projected operating statement, which
appears below, shows that High Tech Automobiles will earn after tax profit around 15% of
sales:
High Tech Automobiles
Projected Operating Statement
for the year ended December 31, 2014
Air Filter Oil Filter
Total Total Total
Per Unit Per Unit (Rs. ‘000’)
Amount Amount
(Rs.) (Rs.)
(Rs. ‘000’) (Rs. ‘000’)
Sales 21,000 300 63,000 450 84,000
Production costs:
Materials 5,600 80 12,600 90 18,200
Direct labour 2,800 40 8,400 60 11,200
Variable overhead 2,800 40 5,600 40 8,400
Fixed overhead 1,400 20 4,200 30 5,600
Total 12,600 180 30,800 220 43,400
Gross Profit 8,400 120 32,200 230 40,600
Fixed selling and
administrative costs 20,800
Net income before taxes 19,800
Income taxes (35%) 6,930
Net income 12,870
The market share of air filter is stable for the last few years, and the company does not intend
to change the air filter price. However, the competition among manufacturers of oil filter has
been increasing. Though, the company is producing superior quality oil filters and this brand
is very popular among the consumers but the director marketing has strongly recommended
to reduce the price of its oil filters from Rs. 450 to Rs. 400 per unit from January 1, 2015. The
managing director agreed to the proposal considering the price reductions expected from
competitors.

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The company is fully aware of the impact of advertisement on its sales. Therefore, it has been
planned to spend an additional Rs. 1,140,000 on advertising during the next year. As a
consequence of these actions, management estimates that 80% of its total revenue will be
derived from oil filters sales as compared with 75% in 2014. As in prior years, the sales mix is
assumed to be the same at all volume levels.
The total fixed overhead costs will remain the same in 2015. The variable overhead rates
(applied on direct labour hour base) will also not change. However, the cost of raw material
components will be cheaper in 2015 and it is estimated that material cost will decrease by
10% for the air filter and 20% for the oil filter in 2015. Direct labour cost for both products will
increase by 10% in the coming year.
High Tech Electronics:
The CEO of High Tech Electronics, a subsidiary of High Tech, is examining projected sales
and cost data for the coming year. The company sells three products, each of which has the
same selling price. The projected income of three products for the year is as under:
Rs. ‘000’
Product-A Product-B Product-C Total
Sales (Rs. 20 per unit) 1,200 720 480 2,400
Variable costs:
Cost of goods sold 720 504 384 1,608
Other operating costs 180 108 72 360
Total 900 612 456 1,968
Contribution margin 300 108 24 432
Fixed costs 262.8
Net income 169.2
You have recently joined the company as management accountant. The board of directors is
considering a special advertising campaign, but does not want to dilute the effectiveness of
the campaign by trying to promote more than one product and managing director has asked
you to recommend one of the product to be promoted in the advertising campaign?
The board is also examining possible ways to increase profitability. The purchasing
department has found an alternate supplier for each of its products. Each supplier will sell to
the company at a price 10% lower than is currently being paid. However, the quality of the
products would not be as high, therefore a reduction in sales of 15% is anticipated. The
company can change suppliers for only one product at a time. The managing director seeks
your help before taking any rational decision and postponed the matter for the next meeting to
be held next week.
As a management accountant of High Tech Electronics, you will have to choose one of the
followings three mutually exclusive projects for a new product to be launched in near future.
Each of the projects could lead to varying net profits which are classified as outcomes I, II and
III. Your assistant has constructed the following pay-off table or matrix. Rs. ‘000’
Net Profit
Project
Outcome-I Outcome-II Outcome-III
X 250 325 400
Y 350 300 375
Z 450 400 275
Probability 0.2 0.6 0.2
In addressing the query raised by your assistant, you have stated that the main weakness of
the maximin basis for decision making is that it ignores the probabilities that various different
outcomes might occur contrary to the expected value (EV) basis for decision making.

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Required:
(a) How many air filters and oil filters will High Tech Automobiles have to sell in 2014 if the
company neither earn any profit nor incur loss? 07
(b) How many air filters and oil filters will High Tech Automobiles have to sell in 2015 to
break-even? 08
(c) How much total sales revenue is required if High Tech Automobiles is to earn after tax
profit in 2015 equal to 15% on sales? 05
(d) Which product do you recommend High Tech Electronics to promote in the advertising
campaign? 02
(e) Would you recommend High Tech Electronics to change supplier and if so, which
product would you recommend? Support your answer with calculations? 06
(f) Assume that the company did not initiate the advertising campaign, nor did it change
suppliers for any product. However, at the year end, the company showed a net income
of Rs. 47,700 on sales of Rs. 2,530,000. The CEO of High Tech Electronics is worried as
to why net income was so low when sales had exceeded the forecasted amount.
Analysis of the sales mix for the year is under:
Rupees
Product Sales
A 690,000
B 460,000
C 1,380,000
Total 2,530,000

Explain the reasons why net income was lower than projected? (Show your working.) 06
(g) Which project should be undertaken among mutually exclusive projects i.e., ‘X’, ‘Y’ and
‘Z’ based on expected values of each project? Would your recommendation be different
if the maximin basis is opted? 06

Q. 2 Excellent Engineering Ltd., a Lahore based company, is a renowned name for its quality
sports cycles for many years. The company is worried about extremely difficult market
conditions and forecasts losses for the forthcoming year. The budgeted cost details for the
two types of sports cycles ‘Sporty’ and ‘Lexon’ for the next year, based on current conditions,
are as follows: Rupees
Sporty Lexon
Direct materials 5,800 8,000
Direct labour 2,600 4,000
Total direct cost (per sports cycle) 8,400 12,000
Budgeted production (sports cycles) 75,000 75,000
No. of production runs 1,000 1,500
No. of orders executed 5,000 5,600
Machine hours 180,000 168,000

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The annual overheads are as under:
Fixed (Rs. ‘000’) Variable (Rs.)
Set ups 85,000 26,000 per production run
Materials handling 105,000 8,000 per order executed
Inspection 120,000 36,000 per production run
Machining 30,000 800 per machine hour
Distribution and warehousing 86,000 6,000 per order executed
426,000

To control the situation, the company hired a consultant to introduce the just-in-time (JIT)
manufacturing system on fast track basis in the company to reduce costs. The consultant has
finally proposed that the introduction of the JIT system would have the following impact on
fixed and variable costs:
Direct labour Increase by 20%
Set ups Decrease by 30%
Materials handling Decrease by 30%
Inspection Decrease by 30%
Machining Decrease by 15%
Distribution and warehousing Eliminated
The followings table shows the price/ demand relationship for each type of sports cycle per
annum:
Sporty Lexon
Price (Rs.) Demand (Qty) Price (Rs.) Demand (Qty)
13,000 45,000 20,000 45,000
15,000 35,000 25,000 30,000
The production manager of Excellent Engineering Ltd., has emphasized that the company
must close down ‘Sporty’ to avoid the heavy losses and increase the profit. The analysis of
costs revealed that some of the fixed costs are directly attributable to the individual production
line and could be avoided if a line is closed down. The specific fixed costs for each of the
production lines are 10% for ‘Sporty’ and 5% for ‘Lexon’, of total fixed costs under JIT
arrangement. The management accountant forecasts that if a line is dosed down, the
available space could be rent out for Rs. 5 million annually.
Required:
Based on the proposed JIT manufacturing system:
(a) Calculate the total annual savings based on the budgeted production levels. 06
(b) What is the profit maximizing price and output level considering the total contribution
margin of each product line of sports cycle and the price/ demand relationship per
annum if the revised variable cost per sports cycle remains constant? 09
(c) Would the company be able to overcome heavy losses for the forthcoming year if it opts
for optimum production plan? Is there any change in the financial outcome of the
company if ‘Sporty’ is closed down? 05

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Q. 3 ABC Ltd., has developed a design for a new product, Besta. It intends to sell the product at
full production cost plus a profit margin of 40%. The estimated production cost and selling
price for the first unit of the Besta are as follows: Rupees
Direct materials 4,000
Direct labour (200 hours at Rs. 30 per hour) 6,000
Fixed production overhead (Rs. 40 per direct labour hour) 8,000
Total production cost 18,000
Profit margin (40%) 7,200
Selling price 25,200

The management of the company expects reductions in the time to produce subsequent units
of the Besta, and an 80% learning curve is expected.
A customer has expressed an interest in buying units of the Besta, and has asked the
following questions:
(a) If he bought the first Besta for Rs. 25,200 and immediately ordered another one, what
would be the selling price for the second Besta? 03
(b) If he waited until ABC Ltd., has sold the first two Bestas to another customer, and then
he ordered the third and the fourth unit. What will be the average price for the third and
fourth unit? 03
(c) If he decided to buy eight Bestas immediately, and asked ABC Ltd., to quote a single
price for all eight units, what price would be charged? 04
Required:
Answer the above questions of the customer. Substantiate your answers with workings.

Q. 4 (a) Tasty Food Restaurant is a family owned restaurant that specializes in seafood. You are
a qualified CMA and just joined the restaurant. Previously, the management of the
restaurant did not pay attention for preparation of flexible budget. However, Mr. Agha,
the owner of the restaurant has appreciated your proposal of preparing flexible budget
and showed his consent to implement it from April 2014. You have forecasted the
restaurant’s monthly revenues and costs data for 90% activity level as under:
Rs./ Meal
Revenue 330
Variable cost:
Cost of ingredients 125
Utilities 4
Miscellaneous 16
Fixed cost: Rupees
Wages and salaries 208,000
Rent 44,000
Utilities 16,000
Miscellaneous 12,000
The actual results for April 2014 are as under:
Rupees
Revenue 558,400
Cost of ingredients 222,200
Wages and salaries 202,600
Utilities 21,600
Rent 44,000
Miscellaneous 44,800

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Required:
(i) Prepare the restaurant’s planning budget for April 2014 assuming that 1,800 meals
are served. 04
(ii) Assume that 1,700 meals were actually served in April 2014. Prepare a flexible
budget for this level of activity. 04
(iii) Prepare a flexible budget performance report for the restaurant for April 2014,
showing variances between planning budget, flexible budget and actual results.
Indicate whether variances are favourable (F) or unfavourable (U). 07

(b) A financial controller while commenting on the practice of participation in the setting of
budgets in his company states, “We bring in the supervisors of budget areas, we tell
them that we want their frank opinion but most of them just sit there and nod their
heads. We know they’re not coming out with exactly how they feel. I guess budgets
scare them.”
Required:
Briefly suggest reasons why managers may be reluctant to participate fully in setting
budgets. 05

Q. 5 Beta Ltd., has been offered supplies of 20,000 kg special ingredient ‘A’ at a transfer price of
Rs. 75 per kg by Alpha Ltd., which is part of the same group of companies. Alpha Ltd.,
processes and sells special ingredient ‘A’ to external customers at Rs. 75 per kg. Alpha Ltd.,
bases its transfer price on cost plus 25% profit mark-up. Total cost has been estimated as
75% variable and 25% fixed.
Required:
Discuss the transfer prices at which Alpha Ltd., should offer to transfer special ingredient ‘A’
to Beta Ltd., so that group profit maximizing decisions may be taken on financial grounds in
each of the following situations:
(a) Alpha Ltd., has an external market for all of its production of special ingredient ‘A’ at a
selling price of Rs. 75 per kg. However, Rs. 7.5 per kg of variable packing cost would be
avoided in case of internal transfer to Beta Ltd. 05
(b) Conditions are as per (a) but Alpha Ltd., has production capacity for 3,000 kg of special
ingredient ‘A’ for which no external market is available. 02
(c) Conditions are as per (b) but Alpha Ltd., has an alternative use for some of its spare
production capacity. This alternative use is equivalent to 2,000 kg of special ingredient
‘A’ and would earn a contribution of Rs. 30,000. 03

THE END

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