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REVISIONARY TEST PAPER

JUNE 2010

GROUP II
PAPER - 8 : COST & MANAGEMENT ACCOUNTING

THE INSTITUTE OF COST AND WORKS ACCOUNTANTS OF INDIA


12, SUDDER STREET, KOLKATA-700 016

Revisionary Test Paper (Revised Syllabus-2008)

INTERMEDIATE EXAMINATION
(REVISED SYLLABUS - 2008)

GROUP - II Paper-8 : COST AND MANAGEMENT ACCOUNTING


Q. 1. (a) Match the following expressions in column I with the most relevant topic in column II : Column I Flexible budget Differential cost analysis Debenture interest JIT system Uniform costing Escalation clause Cost driver Standard costing Notional cost Telephone charges Column II Cost control Inventory management ABC costing Considers cost by behaviour Semi-variable cost Item of reconciliation Does not involve any cash out flow Technique to assist interfirm comparison Decision making Price change of material or labour

(b) Fill in the blanks : (i) The total of indirect expenses is known as .. (ii) Ordering cost and carrying cost are in nature. (iii) The purpose of cost control accounts is to control the . (iv) The scarce factor of production is known as . (v) LIFO method of pricing issues is useful during periods of . (vi) Sales proceeds from abnormal losses are credited to .. A/c. (vii) The balance of cost of sales account is transferred to . (viii) At break even point total revenue is equal to . Cost. (ix) When the production volume is nil, the loss will be equal to .. (x) Two industries where batch costing is used are . and .. (c) State whether the following statements are True (T) or False (F) : (i) Incentive systems benefit only workers. (ii) Job costing is ideal where the products are dissimilar and non-repetitive in nature. (iii) Service departments usually do not render services to each other. (iv) Idle time variance is always adverse. (v) Fixed cost vary with volume rather than time. (vi) Contract costing is only a variant of job costing. (vii) Under absorption of overhead results in higher amount of profits. (viii) Debit balance in administration overhead account represents over absorbed overheads.

Group-II : Paper-8 : Cost & Management Accounting

(d) Choose the correct answer from the brackets : (i) In a manufacturing company, the production passes through four processes A, B,C & D sequentially and the output of each process is the input of the subsequent process. The following is the loss of the four processes : A 12% B 14% C 16% D 15% The output in process D is 6,754.44 kg., the input of process A is a) 12,500 kgs. b) 11,400 kgs. c) 10,475 kgs. d) 12,800 kgs. (ii) Standard costs are a) Estimated cost b) Budgeted cost c) Expected cost d) Scientifically pre-determined cost. (iii) The cost of obsolete inventory acquired several years ago, to be considered in a keep vs. disposal decision is an example of : a) Uncontrollable cost b) Sunk cost c) Avoidable cost d) Opportunity cost (iv) Budgeted sales for the next year is 5,00,000 units. Desired ending finished goods inventory is 1,50,000 units and equivalent units in ending W-I-P inventory is 60,000 units. The opening finished goods inventory for the next year is 80,000 units, with 50,000 equivalent units in beginning W-I-P inventory. How many equivalent units should be produced? a) 5,80,000 b) 5,50,000 c) 5,00,000 d) 5,75,000 (v) If the asset turnover and profit margin of a company are 1.85 and 0.35 respectively, the return on investment is a) 0.65 b) 0.35 c) 1.50 d) 5.29 (e) Identify the correct answer, in the following cases : (i) A company is currently operating at 80% capacity level. The production under normal capacity level is 1,50,000 units. The variable cost per unit is Rs. 14 and the total fixed costs are

Revisionary Test Paper (Revised Syllabus-2008)

(ii)

(iii)

(iv)

(v)

Rs. 8,00,000. If the company wants to earn a profit of Rs. 4,00,000, then the price of the product per unit should be.(Rs. 37.50, Rs. 38.25, Rs. 24.00). The potential demand for a product in the next period is estimated to be Rs. 1,75,000 units. The company has the capacity to produce 7,00,000 units and could sell 1,75,000 units at a price of Rs. 625 per unit. The demand would double for every decrease of Rs. 75 in the selling price. The company expects a minimum margin of 20%. At full capacity level, the target cost per unit will be .(Rs. 475, Rs. 440, Rs. 380). Consider the following data pertaining to the production of a company for a particular month : Opening stock of raw material Rs. 11,570 Closing stock of raw material Rs. 10,380 Purchase of raw material during the month Rs. 1,28,450 Total manufacturing cost charged to product Rs. 3,39,165 Factory overheads are applied at the rate of 45% of direct labour cost. The amount of factory overheads applied to production is ............ (Rs. 65,025, Rs. 94,287, Rs. 1,52,624) Consider the following particulars for a month : Budgeted fixed production overhead cost Rs. 1,10,000 Budgeted production 5,500 units The fixed overhead cost was under absorbed by Rs. 12,000 and the fixed production overhead expenditure variance was Rs. 2,500 (Adverse). The number of units produced during the month was.. (5,025, 5,625, 4775) The budgeted annual sales of a firm is Rs. 80 lakhs and 25% of the same is cash sales. If the average amount of debtors of the firm is Rs. 5 lakhs, the average collection period of credit sales .. months. (1.5, 1, 0.5)

Answer 1. (a) Column I Flexible budget Differential cost analysis Debenture interest JIT system Uniform costing Escalation clause Cost driver Standard costing Notional cost Telephone charges Answer 1. (b) (i) Overheads. (ii) Variable. (iii) Cost of production. Column II Considers cost by behaviour Decision making Item of reconciliation Inventory management Technique to assist interfirm comparison Price change of material or labour ABC costing Cost control Does not involve any cash out flow Semi-variable cost

Group-II : Paper-8 : Cost & Management Accounting

(iv) (v) (vi) (vii) (viii) (ix) (x)

Key Factor. Inflation. Abnormal loss A/c. Costing profit & loss A/c. Total Fixed cost Pharmaceutical, readymade garment.

Answer 1. (c) (i) False Through Incentive system productivity can be improved by motivating workers. So it is beneficial to workers as well as employers. (ii) True Under Job costing method, cost of an individual job or work order is ascertained separately. Hence, it is ideal where the products are dissimilar and non-repetitive in nature. (iii) False Service departments can render services to each other, e.g. boiler house staff can use canteen facility. (iv) True This variance indicates the loss caused due to abnormal idle time. So, it will be always adverse. (v) False Fixed is fixed for a period. So , it varies with time rather than volume. (vi) True Contract costing can be termed as an extension of Job costing as each contract is nothing but a job completed. (vii) True - Under absorption of overhead results in higher amount of profits. (viii) True - Debit balance in administration overhead account represents over absorbed overheads. Answer 1. (d) (i) (a) The input in process A = 6,754.44 / (0.88 0.86 0.84 0.85) = 12,500 kgs. (ii) (d) The standard costs are scientifically pre-determined costs. (iii) (b) Costs of obsolete inventory represent the sunk cost because the costs have already been incurred. (iv) (a) Using production related budgets, units to produce equals budgeted sales + desired ending finished goods inventory + desired equivalent units in ending W-I-P inventory beginning finished goods inventory equivalent units in beginning W-I-P inventory. Therefore, in this case, units to produce is equal to 5,00,000 + 1,50,000 + 60,000 80,000 50,000 = 5,80,000. (v) (a) Return on investment = Asset turnover Profit margin = 1.85 0.35 = 0.65 Answer 1. (e) (i) Rs. 24.00 Total fixed cost Expected profit Variable cost at 80% level (80% 1,50,000 units Rs. 14) Total price

Rs. 8,00,000 Rs. 4,00,000 Rs. 16,80,000 Rs. 28,80,000

Per unit price at 80% level = (Rs. 28,80,000/1,20,000 units) = Rs. 24.00.

Revisionary Test Paper (Revised Syllabus-2008)

(ii) Rs. 380 Target cost = Selling price at full capacity - 20% profit margin Price (Rs.) Demand (units) 625 1,75,000 550 3,50,000 475 7,00,000 Target cost = Rs. 475 20% Rs. 475 = Rs. 475 Rs. 95 = Rs. 380. (iii) Rs. 65,025 Raw material used = = Manufacturing cost = Rs. 3,39,165 = 1.45 Direct labour = Direct labour = The amount of factory overhead = Op. Stock + Purchases Cl. Stock Rs. 11,570 + Rs. 1,28,450 Rs. 10,380 = Rs. 1,29,640 Raw material used + Direct labour + Factory overhead Rs. 1,29,640 + Direct labour + 45% of Direct labour Rs. 2,09,525 Rs. 1,44,500 45% of Rs. 1,44,500 = Rs. 65,025.

(iv) Rs. 5,025 Fixed overhead recovery rate

= Fixed overhead cost / Production (units) = Rs. 1,10,000/ 5,500 units = Rs. 20 / unit Budgeted fixed overhead Rs. 1,10,000 Add : Fixed overhead expenditure variance Rs. 2,500 Actual fixed overhead Rs. 1,12,500 Absorbed overhead = Actual fixed overhead Under absorbed overhead = Rs. 1,12,500 12,000 = Rs. 1,00,500 Actual production = Overhead absorbed / Fixed overhead rate = Rs. 1,00,500 / Rs. 20 = 5,025 units. (v) 1 month. Total annual sales = Rs. 80 lakhs Total cash sales = 25 % of 80 lakhs. = 20 lakhs. Total credit sales = 75% of 80 lakhs = 60 lakhs Average amount of debtors =5 lakhs = 1 months average credit sales. Therefore, average collection period is 1 month.

Q. 2. (a) How costs can be classified based on function? (b) The finishing shop of a company employs 50 direct workers. Each worker is paid Rs. 300 as wages per week of 40 hours. When necessary, overtime is worked upto a maximum of 15 hours per week per worker at time rate plus one-half as premium. The current output on an average is 6 units per man hour which may be regarded as standard output. If bonus scheme is introduced, it is expected that the output will increase to 8 units per man hour. The company is considering introduction of either Halsey Scheme or Rowan Scheme of Wage Incentive system. The budgeted weekly output is 15,000 units. The selling price is Rs. 8 per unit

Group-II : Paper-8 : Cost & Management Accounting

and the direct Material Cost is Rs. 5 per unit. The variable overheads amount to Rs. 0.40 per direct labour hour and the fixed overhead is Rs, 6,000 per week. Prepare a Statement to show the effect on the Companys weekly Profit of the proposal to introduce (a) Halsey Scheme, and (b) Rowan Scheme. Answer 2. (a) 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. (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 companys 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. Answer 2. (b) Working notes: 1. Total available hours per week (50 workers 40 hours) 2. Total standard hours required to produce 15,000 units (15,000 units/6 units per hour) 3. Total labour hours required after the introduction of bonus scheme to produce 15,000 units (15,000 units / 8 units per man hour) 4. Time saved in hours for incentive system (2,500 hours 1,875 hours) 5. Overtime worked (2,500 2,000) 6. Wage rate per hour (Rs.) (Rs. 300/40 hours) 7. Bonus: 1 (a) Halsey Scheme = Time saved Wage rate per hour 2 1 = 625 hours Rs. 7.5 = Rs. 2,344 2 (b) Rowan Scheme

2,000 2,500 1,875

625 500 7.50

Time saved Time taken Wage rate per hour Time allowed 625 hours 2,500 hours 1,875 hours Rs. 7.50 = Rs. 3,516

Revisionary Test Paper (Revised Syllabus-2008)

Statement showing the effect on the Companys Weekly Present profit by the introduction of Halsey & Rowan schemes Present Rs. 1,20,000 75,000 18,750 (2,500 hrs Rs. 7.5) 1,875 (500 hrs. Rs. 3.75) 1,000 (2,500 hrs. 0.40 P) 6,000 1,02,625 17,375 Halsey Rs. 1,20,000 75,000 14,063 1,875 hrs Rs. 7.5) Rowan Rs. 1,20,000 75,000 14,063 (1,875 hrs. Rs. 7.5)

Sales revenue: (A) (15,000 units Rs. 8) Direct material cost (15,000 units Rs. 5) Direct wages (Refer to working notes 2 & 3) Overtime premium

Bonus (Refer to working notes 7 (a) & (b)) Variable overheads

2,344 750 (1,875 hrs. 0.40 P) 6,000 98,157 21,843

3,517 750 (1,875 hrs. 0.40 P) 6,000 99,330 20,670

Fixed overheads Total cost : (B) Profit: {(A)- (B)}

From the above, it can be shown that the profit increased by Rs. (21,843 17,375) = Rs. 4,468 in Halsey scheme and by Rs. (20,670 17,375) = Rs. 3,295 in case of Rowan scheme. Q. 3. (a) What do you mean by time and motions study? Why is it so important to management? (b) Raw materials Alpha costing Rs. 120 per kg. and Beta costing Rs. 70 per kg. are mixed in equal proportions for making product Gama. The loss of material in processing works out to 20% of the product. The production expenses are allocated at 50% of direct material cost. The end product is priced with a margin of 15% over the selling price. Material Beta is not easily available and substitute raw material Theta has been found for Beta costing Rs. 60 per kg. It is required to keep the proportion of this substitute material in the mixture as minimum as possible and at the same time maintain the selling price of the end product at existing level and ensure the same quantum of profit as at present. You are required to compute the ratio of the mix of the raw materials Alpha and Theta. Answer 3. (a) 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

Group-II : Paper-8 : Cost & Management Accounting

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: 1. Improved methods, layout, and design of work ensures effective use of men, material and resources. 2. 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. 3. Highest possible level of efficiency is achieved in all respect. 4. Provides information for setting labour standards - a step towards labour cost control and cost reduction. 5. Useful for fixing wage rates and introducing effective incentive scheme. Answer 3. (b) Working Notes : (i) Computation of material mix ratio : Let 1 kg. of product Gama requires 1.20 kg. of input of materials Alpha and Beta. Raw materials are mixed in equal proportions. 1.20 = .60 kg. Then raw material Alpha = 2 1.20 = .60 kg. Then raw material B E = 2 (ii) Computation of selling price / kg. of product Gama Rs. Raw material Alpha .60 kg. 120 = Rs. 72 Raw material Beta .60 kg. 70 = Rs. 42 114.00 Production expenses (50% of material cost) 57.00 Total cost 170.00 Add: profit 15% of the selling price(170/0.85) 0.15 30.00 Selling price 200.00 Computation of proportions of materials Alpha and Theta in Gama Let material Theta required in product Gama be m kg. Then for producing 1 kg of product Gama, material Alpha requirement = (1.20 m) kg. To maintain same level of profit and selling price as per Working note (ii), it is required that the total cost of material in 1 kg. of product Gama should not exceed Rs. 114, i.e., m kg. Rs. 60 + (1.20 -m) kg. 120 = Rs. 114 or 60 m + 144 120 m = 114 or 60 m = 30 or m = 0.5 kg. Raw material Alpha requirement in product Gama = 1.20 .5 = .70 kg. So, proportion of material Alpha and Theta = .70 : .50 i.e. 7 : 5.

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Revisionary Test Paper (Revised Syllabus-2008)

Q. 4. 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 Materials Rs. 6,50,000 1,70,000 1,00,000 7,80,000 1,36,000 1,20,000 Direct Wages Rs. 80,000 3,50,000 70,000 96, 000 2,70,000 90,000 Factory Overheads Rs. 3,60,000 1,40,000 1,25,000 3,90,000 84,000 1,35,000 Director Labour Hour 20,000 1,00,000 50,000 24,000 90,000 60,000 Machine Hours

Budget Machining Assembly Packing Actual Machining Assembly Packing

80,000 10,000 96,000 11,000

The details of one of the representative jobs produced during the month are as under: Job No. 100 Department Direct Direct Director Machine Materials Wages Labour Hours Rs. Rs. Hour 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 companys current policy and the method(s) recommended by you. Answer : (i) Computation of overhead absorption rate (as per the current policy of the company) Department Machinery Assembly Packing Total Budgeted Factory Overheads Rs. 3,60,000 1,40,000 1,25,000 6,25,000 Budgeted Direct Wages Rs. 80,000 3,50,000 70,000 5,00,000

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Overhead absorption rate =

Budgeted factory overheads Budgeted direct wages


Rs. 6 ,25,000 100 Rs. 5,00 ,000

= 125% of Direct wages Selling price of the Job No. 100 Rs. 2,100.00 660.00 825.00 3,585.00 1,075.50 4,660.50

Direct Materials (Rs. 1,200 + Rs. 600 + Rs. 300) Direct Wages (Rs. 240 + Rs. 360 + Rs. 60) Overheads (125% Rs. 660) Total factory cost Add: Mark-up @30% Selling price

(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: Machine hour rate =

Budgeted factory overheads Budgeted machine hours Rs. 3,60,000 = 80,000 hours
= Rs. 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 Rs. 1,40,000 1,00,000 hours

= Rs. 1.40 per hour

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Revisionary Test Paper (Revised Syllabus-2008)

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 =

Budgeted factory overhead Direct labour hours

Rs. 1,25,000 50,000 hours

= Rs. 2.50 per hour (iii) Selling price of Job 100 [based on the overhead application rates calculated in (ii) above) Direct materials 2,100.00 Direct wages 660.00 Overheads (Refer to Working Note) 1,078.00 Factory cost 3,838.00 Add: Mark up 1,151.40 (30% of Rs. 3,838) _______ Selling Price 4,989.40 Working Note : Overhead Summary Statement Dept. Basis Machining Assembly Packing Machine hour Direct labour hour Direct labour hour

Hours 180 120 40

Rate Rs. 4.50 1.40 2.50 Total

Overheads Rs. 810 168 100 1,078

(iv) Department-wise statement of total under or over recovery of overheads (a) Under current policy Machining Rs. 96,000 1,20,000 3,90,000 (2,70,000) Departments Assembly Packing Rs. Rs. 2,70,000 90,000 3,37,500 84,000 2,53,500 1,12,500 1,35,000 (22,500) Total Rs.

Direct Wages (Actual) Overheads recovered @ 125% of Direct wages: (A) Actual overheads: (B) (Under)/Over recovery of overheads: (A B)

5,70,000 6,09,000 (39,000)

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(b) As per methods suggested Basis of overhead recovery Machine hours Hours worked Rate/hour (Rs.) Overhead recovered (Rs.): (A) Actual overheads (Rs.): (B) (Under)/Over recovery: (A B) 96,000 4.50 4,32,000 3,90,000 42,000

Direct Labour hours 90,000 1.40 1,26,000 84,000 42,000

Direct Labour hours 60,000 2.50 1,50,000 1,35,000 15,000

Total Rs.

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

Q. 5. (a) In a manufacturing company where costing is done with a view to fix prices, state whether and, if so, to what extent the following items are includible in cost. (i) Bonus and gratuity (ii) Depreciation on plant and machinery. (b) Gemini Enterprises undertakes three different jobs A, B and C. All of them require, the use of a special machine and also the use of a computer. The computer is hired and the hire charges work out to Rs. 3,60,000/- per annum. The expenses regarding the machine are estimated as follows. Rs. Rent for the quarter 13,500 Depreciation per annum 1,50,000 Indirect charges per annum 1,20,000 During the first month of operation the following details were taken from the job register : Job A B C Number of hours the machine was used : (a) Without the use of computer 700 1000 (b) With the use of the computer 500 700 1,100 You are required to compute the machine hour rate:(i) For the firm as a whole for the month when the computer was used and when the computer was not used. (ii) For the individual jobs A, B and C. Answer 5. (a) The Cost Accountant makes no decision on pricing . Pricing is the domain of top management and sometimes sales management. The cost accountant only helps management in providing cost data and also determines the financial effects of fixing prices or the change in prices on the profitability of the undertaking. Here the cost accountant is required to analyse whether , and if so the extent to which bonus and gratuity ; depreciation on plant and machinery be included as elements of cost. (i) Bonus and gratuity : Bonus under the payment of Bonus Act is to be paid compulsorily to the workers although the amount of bonus may vary with amount of profit earned. A minimum bonus of 8.33% is, however, payable irrespective of profit or loss earned by the concern. The amount of bonus, therefore, may be included in a direct labour cost to the extent of the minimum bonus, as the same is payable even in a loss situation. Any amount paid as bonus in excess of the minimum may be considered as an appropriation of profit. However, bonus linked with productivity is definitely a part of the overhead cost.

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Revisionary Test Paper (Revised Syllabus-2008)

So far as gratuity is concerned, it is indeed directly linked with the wages and is not by any means related to the profits. Accordingly, it should be treated as an element of cost: (ii) Depreciation on plant and machinery : Depreciation on fixed assets represents the consumption of the value of the concerned assets in the process of operations. This consumption, is therefore an indirect cost of the production and operations. Without this, true cost of production cannot be obtained. Hence, depreciation charged in the accounts is considered as includible as an element of cost. Answer 5. (b) Working Notes : (i) Total machine hours used (700 + 1000 + 500 + 700 + 1,100) (ii) Total machine hours without the use of computers (700 + 1000) (iii) Total machine hours with the use of computer (500 + 700 + 1,100) (iv) Total overhead of the machine per month Rent (Rs. 13,500 /3) Depreciation ( Rs. 1,50,000 / 12) Indirect charges (Rs. 1,20,000/12) Total (v) Computer hire charges for a month = Rs. 30,000 (Rs. 3,60,000 / 12) (vi) Overheads for using machines without computer = Rs. 11,475 4,000 1,700 2,300 Rs. 4,500 12,500 10,000 27,000

Rs. 27,000 4 ,000 hrs. 1,700 hrs.


(vii) Overheads for using machine with computer = Rs. 45,525

Rs. 27,000 4 ,000 hrs. 2,300 hrs. + Rs. 3


(a) Machine Hour Rate of Gemini Enterprises for the firm as a whole, for a month. (1) When the computer was used :

Rs. 45,525 = Rs. 19.80 per hour. 2,300 hours Rs. 27,000 = Rs.6.75 per hour. 4 ,000 hours

(2) When the computer was not used :

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(b) Machine hour rate for the individual jobs. Job Rate per hr. Rs. 6.75 19.80 A Hrs 700 500 1,200 Rs. 4,725 9,900 14,625 12.19 B Hrs 1,000 700 1,700 Rs. 6,750 13,860 20,610 12.12 C Hrs 1,100 1,100 Rs. 21,780 21,780 19.80

Overheads Without computer With computer Machine hour rate

Q. 6. (a) A factory incurred the following expenditure during the year 2008 : Rs. 15,00,000 10,00,000 4,00,000 3,50,000

Direct material consumed Manufacturing Wages Manufacturing overhead : Fixed Variable

7,50,000 32,50,000

In the year 2009, 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 workers. (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. (b) A company runs a hotel. For this purpose, it has hired a building at a rent of Rs. 12,000 per month alongwith 5% of total taking. It has three types of suites for its customers, viz., Normal, Executive and Luxury. Following information is given : Type of suite Normal Executive Luxury Number 90 60 25 Occupancy percentage 100% 80% 60%

The rent of Executive suite is to be fixed at twice of the Normal suite and that of Luxury suite as 2.5 times of the Executive suite. The other expenses for the year 2009 are as follows: Rs. Staff salaries 11,40,000 Room attendants wages 3,60,000 Lighting, heating and power 1,72,000

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Revisionary Test Paper (Revised Syllabus-2008)

Repairs and renovation 98,800 Laundry charges 64,400 Interior decoration 59,200 Sundries 1,22,400 Provide profit @ 25% on total taking and assume 365 days in a year. You are required to calculate the rent to be charged for each type of suite. Answer 6. (a) Budgeted Cost Sheet for the year 2009 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 Add: 15% increase Variable Add: 70% increase Cost of production Add: 1/9 of Cost or 10% on selling price Selling price 15,00,000 5,25,000 20,25,000 1,01,250 10,00,000 5,00,000 Amount Rs.

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

4,00,000 60,000 4,60,000 3,50,000 2,45,000 5,95,000 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 Rs. 5,35,500 170% = 9,10,350. Hence, total costs shall be Rs. 47,94,100 and profit shall be 1/9th of Rs. 47,94,100 = 5,32,678. Thus, selling price shall be 53,26,778. Answer 6. (b) Total equivalent single room suites Nature of suite Normal suites Executive suites Luxury suites

Occupancy 90 365 100% = 32,850 60 365 80% = 17,520 25 365 60% = 5,475

Equivalent Normal suites 32,850 1 = 32,850 17,520 2 = 35,040 5,475 5 = 27,375 Total 95,265

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(ii) Statement of total cost : Rs. Staff salaries 11,40,000 Room attendants wages 3,60,000 Lighting, heating and power 1,72,000 Repairs and renovation 98,800 Laundry charges 64,400 Interior decoration 59,200 Sundries 1,22,400 20,16,800 Building rent 12,000 12 + 5% on total taking 1,44,000 + 5% on takings Total cost 21,60,800 + 5% on total takings Profit is 25% of total takings \ Total takings = Rs. 21,60,800 + 30% of total takings Let x be rent for Normal suite Then 95,265 x = 21,60,800 + 30% of (95,265 x) or 95,265 x = 21,60,800 + 28,580 x or 66,685 x = 21,60,800 or x = 32.40 (iii) Rent to be charged for Normal suite = Rs. 32.40 Rent for Executive suites Rs. 32.40 2 = Rs. 64.80 Rent for Luxury suites Rs. 32.40 5 = Rs. 162.00

Q. 7. (a) A lorry starts with a load of 25 tonnes of goods from station A. It unloads 5 tonnes at station B and rest of goods at station C. It reaches back directly to station A after getting reloaded with 18 tonnes of goods at station C. The distance between A to B, B to C and then from C to A are 60 kms. 100, and 150 kms respectively. Compute Absolute tones kms and Commercial tones kms. (b) A Company operates separate cost accounting and financial accounting systems. The following is the list of Opening balances as on 1.04.2009 in the Cost Ledger. Debit Rs. 64,050 1,25,514 36,936 Credit Rs. 2,26,500

Stores Ledger Control Account WIP Control Account Finished Goods Control Account General Ledger Adjustment Account

18

Revisionary Test Paper (Revised Syllabus-2008)

Transactions for the quarter ended 30.06.2009 are as under: Rs. Materials purchased 32,040 Materials issued to production 48,000 Materials issued for factory repairs 1,080 Factory wages paid (including indirect wages Rs. 23,000) 93,000 Production overheads incurred 1,14,240 Production overheads under-absorbed and written-off 3,840 Sales 3,07,200 The Companys gross profit is 25% on Factory Cost. At the end of the quarter, WIP stocks increased by Rs. 9,000. Prepare the relevant Control Accounts, Costing Profit and Loss Account and General Ledger Adjustment Account to record the above transactions for the quarter ended 30.06.2009. Answer 7. (a) Absolute tones kms: It is the sum total of tones kms. arrived at by multiplying various distances by respective load quantities carried. Mathematically it is: = 25 tonnes 60 kms + 20 tonnes 100 kms + 18 tonnes 150 kms. = 6,200 tonnes kms. Commercial tones kms = Average load Total kms. travelled. =

25 + 20 + 18 tones 310 kms. 3

= 6,510 tonnes kms. Answer 7. (b) General Ledger Adjustment A/c Dr. Particulars To Sales To Balance c/d Rs. 3,07,200 2,16,180 Particulars By Balance b/d By Stores ledger control A/c By Wages control A/c By Overheads control A/c By Costing Profit & Loss A/c Cr. Rs. 2,26,500 32,040 93,000 1,14,240 57,600 5,23,380

5,23,380 Stores Ledger Control A/c Dr. Particulars To Balance b/d To General ledger adj. A/c Rs. 64,050 32,040 96,090 Particulars By WIP control A/c By Factory overhead control A/c By Balance c/d

Cr. Rs. 48,000 1,080 47,010 96,090

Group-II : Paper-8 : Cost & Management Accounting

19

WIP Control A/c Dr. Particulars To Balance b/d To Stores ledger control A/c To Wages control A/c To Factory, O/H control A/c Rs. 1,25,514 48,000 65,400 1,39,080 3,77,994 Particulars By Finished goods control A/c By Balance c/d Cr. Rs. 2,43,480 1,34,514

3,77,994

Finished Goods Control A/c Dr. Particulars To Balance b/d To WIP control A/c Rs. 36,936 2,43,480 2,80,416 Particulars By Cost of sales A/c (Refer to note) By Balance c/d Cr. Rs. 2,45,760 34,656 2,80,416

Note : Gross profit is 25% of Factory cost or 20% on sales. Hence cost of sales = Rs. 3,07,200 20% of Rs. 3,07,200 = Rs. 2,45,760 Factory Overhead Control A/c Dr. Particulars To Stores ledger control A/c To Wages control A/c To General ledger adj. A/c Rs. 1,080 27,600 1,14,240 1,42,920 Particulars By Costing & profit loss A/c By WIP control A/c Cr. Rs. 3,840 1,39,080 1,42,920

Cost of Sales A/c Dr. Particulars To Finished goods control A/c Rs. 2,45,760 Particulars By Costing Profit & Loss A/c Cr. Rs. 2,45,760

Sales A/c Dr. Particulars To Costing Profit & Loss A/c Rs. 3,07,200 Particulars By GLA A/c Cr. Rs. 3,07,200

20

Revisionary Test Paper (Revised Syllabus-2008)

Wages Control A/c Dr. Particulars To General ledger adj. A/c Rs. 93,000 93,000 Costing Profit & Loss A/c Dr. Particulars To Factory O H Control A/c To Cost of sales A/c To General ledger adj. A/c (Profit) Rs. 3,840 2,45,760 57,600 3,07,200 Trial Balance (as on 30.6.2001) Dr. Particulars Stores ledger control A/c WIP control A/c Finished goods control A/c To General ledger adjustment A/c Rs. 47,010 1,34,514 34,656 2,16,180 Particulars Cr. Rs. Particulars By Sales A/c Cr. Rs. 3,07,200 Particulars By Factory overhead control A/c By WIP control A/c Cr. Rs. 27,600 65,400 93,000

3,07,200

2,16,180 2,16,180

Q. 8. (a) What do you understand by Batch Costing? In which industries it is applied? (b) Leo Limited undertakes to supply 1,200 units of a component per month for the months of October, November and December 2009. Every month a batch order is opened against which materials and labour cost are booked at actual. Overheads are levied at a rate per labour hour. The selling price is contracted at Rs. 18/- per unit. From the following data, present the cost and profit per unit of each batch order. Month Batch Output Material Labour (Numbers) Cost Cost Rs. Rs. October 2009 1,500 7,500 3,000 November 2009 1,800 10,800 3,600 December 2009 1,200 6,000 2,400 Labour is paid at the rate of Rs. 2 per hour. The other details are: Month Overheads October 2009 14,400 November 2009 10,800 December 2009 18,000

Total Labour Hours 4,800 3,600 6,000

Group-II : Paper-8 : Cost & Management Accounting

21

Answer 8. (a) Batch Costing: It is a form of job costing. In this, the cost of a group of products is ascertained. The unit of cost is a batch or a group of identical products instead of a single job, order or contract. Separate cost sheets are maintained for each batch of products by assigning a batch number. The cost per unit is ascertained by dividing the total cost of a batch by the number of items produced in that batch. Batch costing is employed by companies manufacturing in batches. It is used by readymade garment factories for ascertaining the cost of each batch of cloths made by them. Pharmaceutical or drug industries, electronic component manufacturing units, radio manufacturing units too use this method of costing for ascertaining the cost of their product. Answer 8. (b) Leo Limited Statement of Cost and Profits Per Unit of Each Batch (A) Batch Output (Numbers) October 1,500 Rs. 27,000 October Rs. 7,500 3,000 4,500 15,000 12,000 10 8 November 1,800 Rs. 32,400 November Rs. 10,800 3,600 5,400 19,800 12,600 11 7 December 1,200 Rs. 21,600 December Rs. 6,000 2,400 3,600 12,000 9,600 10 8 Total 4,500 Rs. 81,000 Total Rs. 24,300 9,000 13,500 46,800 34,200

(B) Sales Value (C) Costs

Material Wages Overheads* Total (D) Profit/Batch (BC) (E) Cost/Unit (CA) (F) Profit/Unit (DA) * See note (ii) Notes :

October (i) Labour Hours (Labour Cost/Labour rate per hour)

November

December

Rs. 3,000 2
= 1,500

Rs. 3,600 2
= 1,800

Rs. 2,400 2
= 1,200

(ii) Overheads per hour (Total Overhead/ Total Labour hours) (iii) Overhead for the batch (i)(ii) (i)(ii)

Rs. 14,400 4,800


Rs.3 Rs. 4,500

Rs. 10,800 3,600


Rs.3 Rs. 5,400

Rs. 18,000 6,000


Rs.3 Rs. 3,600

22

Revisionary Test Paper (Revised Syllabus-2008)

Q. 9. (a) Reliance India Limited undertook a contract for Rs. 5,00,000 on 1st July, 2008. On 30th June, 2009 when the accounts were closed, the following details about the contract were gathered: Rs. Materials Purchased 1,25,000 Wages Paid 56,250 General Expenses 12,500 Plant Purchased 62,500 Materials on Hand 30.06.09 31,250 Wages Accrued 30.06.09 6,250 Work Certified 2,50,000 Cash Received 1,87,500 Work Uncertified 18,750 Depreciation of Plant 6,250 The above contract contained an escalation clause which read as follows: In the event of prices of materials and rates of wages increase by more than 5% the contract price would be increased accordingly by 30% of the rise in the cost of materials and wages beyond 5% in each case. It was found that since the date of signing the agreement the prices of materials and wage rates increased by 20%. The value of the work certified does not take into account the effect of the above clause. Prepare the contract account. Workings should form part of the answer. (b) Distinguish between Operating Costing and Operation Costing. Answer 9. (a) Working Notes : Calculation Escalation on amount 1. Material consumed = Materials purchases Closing stock = Rs. (1,25,000 - 31,250) = Rs. 93,750 Total increase (93,750 * 20/120) = Rs. 15,625 Less : Increase upto 5% (93,750 * 5/120) = Rs. 3,906 Increase over 5% = Rs. 11,719 2. Wages paid + Accrued = Total wages Total increase (62,500 * 20/120) Increase upto 5% (62,500 * 5/120) Increase over 5% = = = = Rs. (56,250 + 6,250) = Rs. 62,500 Rs. 10,417 Rs. 2,604 Rs. 7,813

3. Total increase of materials and labour over 5% = Rs. (11,719 + 7,813) = Rs. 19,532 Increase in contract price = Rs. 19,532 * 30/100 = Rs. 5,860

Group-II : Paper-8 : Cost & Management Accounting

23

To To To To To To To

Reliance India Ltd. Contract Account for the year ended 30-06-2009 Particulars Rs. Particulars Materials purchased 1,25,000 By Material in hand Wages 56,250 By Escalation Clause A/c. Add: Outstanding 6,250 62,500 By Work-in-progress General expenses 12,500 work certified Plant depreciation 6,250 work uncertified Notional profit 99,610 3,05,860 Profit & Loss A/c. 24,903 By Notional profit b/d Work in Progress Reserve 74,707 99,610

Rs. 31,250 5,860 2,50,000 18,750 3,05,860 99,610 99,610

Since the degree of completion is only 40%, the profit taken to Profit & Loss A/c. calculated as follows : 1 Cash received = Notional profit 3 Work certified
1 1,87,500 = 99,610 3 2,50,000 = Rs. 24,903

Answer 9. (b) Operating Costing : It is a method of costing applied by undertakings which provide service rather than production of commodities. Like unit costing and process costing, operating costing is thus a form of operation costing. The emphasis under operating costing is on the ascertainment of cost of rendering services rather than on the cost of manufacturing a product. It is applied by transport companies, gas and water works, electricity supply companies, canteens, hospitals, theatres, school etc. Within an organisation itself certain departments too are known as service departments which provide ancillary services to the production departments. For example, maintenance department; power house; boiler house; canteen; hospital; internal transport. Operation Costing : It represent a refinement of process costing. In this each operation instead of each process of stage of production is separately costed. This may offer better scope for control. At the end of each operation, the unit operation cost may be computed by dividing the total operation cost by total output. Q. 10. A product passes through three processes A, B and C. The details of expenses incurred on the three processes during the year 2009 were as under : Process A B C Units issued / introduced cost 10,000 per unit Rs. 100 Rs. Rs. Rs. Sundry Materials 10,000 15,000 5,000 Labour 30,000 80,000 65,000 Direct Expenses 6,000 18,150 27,200 Selling price per unit of output 120 165 250

24

Revisionary Test Paper (Revised Syllabus-2008)

Management expenses during the year were Rs. 80,000 and selling expenses were Rs. 50,000. These are not allocable to the processes. Actual output of the three processes was: A 9,300 units, B- 5,400 units and C- 2,100 units. Two third of the output of Process A and one half of the output of Process B was passed on to the next process and the balance was sold. The entire output of process C was sold. The normal loss of the three processes, calculated on the input of every process was: Process A- 5%; B- 15% and C- 20% The Loss of Process A was sold at Rs. 2 per unit, that of B at Rs. 5 per unit and of Process C at Rs. 10 per unit. Prepare the Three Processes Accounts and the Profit and Loss Account. Answer 10. Process A Account Dr. Particulars To Units brought in (Rs.10010,000) To Sundry Materials To Labour To Direct expenses Cr. Units Rs. Particulars Units Rs. 10,000 10,00,000 By Normal Loss 500 1,000 (5% of 10,000 units @ Rs. 2/- p.u.) 10,000 30,000 By Abnormal loss 200 22,000 6,000 (Working note 1) By Process B A/c 6,200 6,82,000 (Output to be transferred Rs. 1106,200) (Working Note 1) By Profit & Loss A/c 3,100 3,41,000 (Rs. 110 3,100 units) (Working Note 1) 10,000 10,46,000 10,000 10,46,000 Process B Account Dr. Particulars To Process A A/c To Sundry Materials To Labour To Direct expenses To Abnormal gain (Working Note 2) Units 6,200 Rs. Particulars 6,82,000 By Normal Loss 15,000 (15% of 6,200 Units = 930 80,000 units @ Rs. 5/- p.u.) 18,150 By Process C A/c 19,500 (Output to be transferred) Rs. 150 2,700 (Working Note 2) By Profit & Loss A/c (Rs. 150 2,700) 8,14,650 Units 930 Cr. Rs. 4,650

2,700 4,05,000

130

6,330

2,700 4,05,000 6,330 8,14,650

Group-II : Paper-8 : Cost & Management Accounting

25

Process C Account Dr. Particulars To Process B A/c To Sundry Materials To Labour To Direct expenses Units 2,700 Rs. Particulars 4,05,000 By Normal Loss 5,000 (20% of 2,700 units = 540 65,000 units @ Rs. 10/- p.u.) 27,200 By Abnormal Loss (Working Note 3) By Profit & Loss A/c (Rs. 230 2,100 units) (Working Note 3) 5,02,200 Profit & Loss Account Dr. Particulars To Process A A/c To Process B A/c To Process C A/c To Management Expenses To Selling Expenses To Abnormal Loss A/c (Working Note 4) Units 3,100 2,700 2,100 Rs. Particulars 3,41,000 By Sale 4,05,000 (Process As Output 4,83,000 @ Rs. 120/- p.m.) By Sale 80,000 (Process Bs Output 50,000 @ Rs. 165/- p.u.) 34,800 By Sale (Process Cs Output @ Rs. 250/- p.u.) By Abnormal gain A/c (Working Note 5) By Net Loss 7,900 13,93,800 Units 3,100 Cr. Rs. 3,72,000 Units 540 Cr. Rs. 5,400

60

13,800

2,100 4,83,000

2,700

2,700 5,02,200

2,700

4,45,500

2,100

5,25,000

18,850 32,450 13,93,800

7,900

Working Notes : 1. (i) Per unit cost of normal production under process A :
Normal cost of normal output Normal production output

Rs. 10,46,000 - Rs. 1,000 = Rs. 110 9,500 units

(ii) Value of Abnormal loss under process A : Abnormal loss units = Normal production Actual production = 9,500 9,300 = 200 units

26

Revisionary Test Paper (Revised Syllabus-2008)

Value of Abnormal Loss = Per unit cost of normal production Abnormal loss units = Rs. 110 200 Rs. 22,000. 2. (i) Per unit cost of normal production under process B :
= (Rs. 7,95,150 - Rs. 4 ,650) Rs. 7,9 = 5,270 5,2

(ii) Value of Abnormal gain under process B : Abnormal gain units = Normal loss Actual loss = 930 800 = 130 units = Per unit cost of normal production Abnormal gain units = Rs. 150 130 units = Rs. 19,500. 3. (i) Per unit cost of normal production under process C :

(Rs. 5,02,200 - Rs. 5,400) Rs. 4 ,9 = 2,160 2,160 units

(ii) Value of Abnormal loss under process C : Abnormal loss units = Normal production Actual production = 2,160 units 2,100 units = 60 units = Rs. 230 60 units = Rs. 13,800 4. Abnormal Loss Account Dr. Particulars To Process A A/c To Process C A/c Units 200 60 Cost Amount Particulars p.u. Rs. 110 22,000 By Sale proceeds of Process A Loss 230 13,800 By Sale proceeds of Process C loss By Profit & Loss A/c 35,800 5. Abnormal Gain Account Dr. Units Cost p.u. Amount Particulars Rs. Rs. To Normal loss shortfall 130 5 650 By Process B To Profit & Loss A/c 18,850 19,500 Particulars Cr. Units Cost p.u. Amount Rs. Rs. 130 150 19,500 19,500 Units 200 60 Cost p.u. 2 10 Cr. Amount Rs. 400 600 34,800 35,800

260

260

Group-II : Paper-8 : Cost & Management Accounting

27

Q. 11. (a) What are the advantages of integrated accounting? (b) The following is the Trading and Profit & Loss Account of Omega Limited : Dr. Cr. Particulars Rs. Particulars Rs. To Materials consumed 23,01,000 By Sales To Direct wages 12,05,750 (30,000 units) 48,75,000 To Production Overheads 6,92,250 By Finished goods To Administration Overheads 3,10,375 Stock (1,000 units) 1,30,000 To Selling and Distribution Overheads 3,68,875 By Work-in-progress: To Preliminary Expenses written off 22,750 Materials 55,250 To Goodwill written off 45,500 Wages 26,000 To Fines 3,250 Production To Interest on Mortgage 13,000 Overheads 16,250 97,500 To Loss on Sale of machine 16,250 By Dividends received 3,90,000 To Taxation 1,95,000 To Net Profit for the year 3,83,500 By Interest on bank deposits 65,000 55,57,500 55,57,500 Omega Limited manufactures a standard unit. The Cost Accounting records of Omega Ltd. show the following: (i) Production overheads have been charged to work-in-progress at 20% on Prime cost. (ii) Administration Overheads have been recovered at Rs. 9.75 per finished Unit. (iii) Selling & distribution Overheads have been recovered at Rs. 13 per Unit sold. (iv) The Under- or Over-absorption of Overheads has not been transferred to costing P/L A/c. Required : (i) Prepare a proforma Costing Profit & Loss account, indicating net profit. (ii) Prepare Control accounts for production overheads, administration Overheads and selling & distribution Overheads. (iii) Prepare a statement reconciling the profit disclosed by the cost records with that shown in Financial accounts. Answer 11. (a) Advantages of Integrated Accounting : Integrated Accounting is the name given to a system of accounting whereby cost and financial accounts are kept in the same set of books. Such a system will have to afford full information required for Costing as well as for Financial Accounts. In other words, information and data should be recorded in such a way so as to enable the firm to ascertain the cost (together with the necessary analysis) of each product, job, process, operation or any other identifiable activity. For instance, purchases are analysed by nature of material and its end-use. Purchases account is eliminated and direct postings are made to Stores Control Account, Work-in-Progress account, or Overhead Account. Payroll is straightway analysed into direct labour and overheads. It also ensures the ascertainment of marginal cost, variances, abnormal losses and gains. In fact all information that management requires from a system of Costing for doing its work properly is made available. The integrated accounts give full information in such a manner so that the

28

Revisionary Test Paper (Revised Syllabus-2008)

profit and loss account and the balance sheet can be prepared according to the requirements of law and the management maintains full control over the liabilities and assets of its business. The main advantages of Integrated Accounting are as follows: (i) Since there is one set of accounts, thus there is one figure of profit. Hence the question of reconciliation of costing profit and financial profit does not arise. (ii) There is no duplication of recording of entries and efforts to maintain separate set of books. (iii) Costing data are available from books of original entry and hence no delay is caused in obtaining information. (iv) The operation of the system is facilitated with the use of mechanized accounting. (v) Centralization of accounting function results in economy. Answer 11. (b) (i) Materials Wages Prime Cost Production overheads (20% of Prime Cost) Less : Add : Work in Progress Manufacturing cost incurred during the period Admn. Ohs (9.75 31000) Cost of Production

Costing Profit & Loss A/c Rs. 23,01,000 12,05,750 35,06,750 7,01,350 42,08,100 97,500 41,10,600 3,02,250 44,12,850 1,42,350 42,70,500 3,90,000 46,60,500 2,14,500 48,75,000

Less : Add :

1000 Closing Finished goods stock 4412850 31000 COGS Selling & distribution OHs ( 30,000 Rs. 13) Cost of Sales Profit (Balance figure) Sales
Production OH A/c Rs. 6,92,250 By WIP A/c 9,100 7,01,350 Admn. OH A/c Rs. 3,10,375 By Finished goods A/c By Balance c/d 3,10,375

(ii) To Gen ledger Adj. A/c To Balance c/d

Rs. 7,01,350 7,01,350 Rs. 3,02,250 8,125 3,10,375

To Gen. Ledger Adjustment A/c

Group-II : Paper-8 : Cost & Management Accounting

29

To Gen. Ledger Adjustment A/c To bal C/d

Selling & Distribution OHs A/c Rs. 3,68,875 By Cost of Sales A/c 21,125 3,90,000

Rs. 3,90,000 3,90,000

(iii)

Reconciliation Statement Profits as per cost accounts Add : Prodn. OHs over absorbed Selling & distribution OHs (Over absorbed) Dividend received Interest on bank deposits Less : Admn Ohs under-absorbed Preliminary exp. w/off Goodwill w/off Fines Interest on Mortgage Loss on sale of machinery Taxation Write-down of Finished stock (1,42,350 130,000) Profit as per Financial Accounts Rs. 2,14,500 9,100 21,125 3,90,000 65,000 8,125 22,750 45,500 3,250 13,000 16,250 1,95,000 12,350

4,85,225 6,99,725

3,16,225 3,83,500

Q. 12. SUNMOON Ltd. produces 2,00,000; 30,000; 25,000; 20,000 and 75,000 units of its five products A, B, C, D and E respectively in a manufacturing process and sells them at Rs. 17, Rs. 13, Rs. 8, Rs 10 and Rs. 14 per unit. Except product D remaining products can be further processed and then can be sold at Rs. 25, Rs. 17, Rs. 12 and Rs. 20 per unit in case of A, B, C and E respectively. Raw material costs Rs. 35,90,000 and other manufacturing expenses cost Rs. 5,47,000 in the manufacturing process which are absorbed on the products on the basis of their. Net realisable value. The further processing costs of A, B, C and E are Rs, 12,50,000, Rs. 1,50,000; Rs. 50,000 and Rs. 1,50,000 respectively. Fixed costs are Rs. 4,73,000. You are required to prepare the following in respect of the coming year. (a) Statement showing income forecast of the company assuming that none of its products are to be further processed. (b) Statement showing income forecast of the company assuming that products A, B, C and E are to be processed further. Can you suggest any other production plan whereby the company can maximise its profits. If yes, then submit a statement showing income forecast arising out of adoption of that plan.

30

Revisionary Test Paper (Revised Syllabus-2008)

Answer 12. Working Note : Statement showing apportionment of joint costs on net realisable value basis Products Sales Value Post separation Net reaisable Apportioned cost Value joint costs (1) (2) (1) (2) = (3) (4) Rs. Rs. Rs. Rs. A 50,00,000 12,50,000 37,50,000 26,25,000 (2,00,000 units x Rs. 25) B 5,10,000 1,50,000 3,60,000 2,52,000 (30,000 units x Rs. 17) C 3,00,000 50,000 2,50,000 1,75,000 (25,000 units x Rs. 12) D 2,00,000 2,00,000 1,40,000 (20,000 units x Rs. 10) E 15,00,000 1,50,000 13,50,000 9,45,000 (75,000 units x Rs. 20) 59,10,000 41,37,000 Total joint cost = Raw materials costs + Manufacturing expenses = Rs. 35,90,000 + Rs. 5,47,000 = Rs. 41,37,000 Apportioned joint cost =
Total joint cost Net re Total net realisable value of e

Apportioned joint cost for product A =

Rs. 41,37,000 Rs. 37,50,000 = Rs. 26,25,000 Rs. 59,10,000

Similarly, the apportioned joint cost for products B, C, D and E are Rs. 2,52,000, Rs. 1,75,000, Rs. 1,40,000 and Rs. 9,45,000 respectively (a) Statement showing income forecast of the company assuming that none of its products are further processed
Product A Rs. Sales revenue 34,00,000 (2,00,000 units Rs. 17) Less: Apportioned joint cost (Refer to working note) Excess of revenue over joint cost of manufacturing Less: Fixed cost Profit 26,25,000 B Rs. 3,90,000 (30,000 units Rs 13) 2,52,000 C Rs. 2,00,000 (25,000 1,75,000 D Rs. 2,00,000 (20,000 1,40,000 E Rs. (75,000 9,45,000 41,37,000 Total Rs.

10,50,000 52,40,000

units Rs. 8) units Rs. 10) units Rs. 14)

7,75,000

1,38,000

25,000

60,000

1,05,000 11,03,000

4,73,000 6,30,000

Group-II : Paper-8 : Cost & Management Accounting

31

(b) Statement showing income forecast of the company; assuming that products A, B, C and E are further processed (Refer to working note) Products Total A B C D E Rs. Rs. Rs. Rs. Rs. Rs. Sales revenue: (X) Apportioned joint cost: (Y) Further processing cost: (Z) Total manufacturing cost (K) = (Y) + (Z) Excess of sales revenue over total manufacturing Cost: [(X) (K)] Less: Fixed cost Profit 50,00,000 26,25,000 12,50,000 38,75,000 11,25,000 5,10,000 2,52,000 1,50,000 4,02,000 1,08,000 3,00,000 1,75,000 50,000 2,25,000 75,000 2,00,000 15,00,000 75,10,000 1,40,000 9,45,000 41,37,000 1,50,000 16,00,000 1,40,000 10,95,000 57,37,000 60,000 4,05,000 17,73,000

4,73,000 13,00,000

Suggested production plan for maximising profits On comparing the figures of excess of revenue over cost of manufacturing in the above statements one observes that the concern is earning more after further processing of A, C and E products but is loosing a sum of Rs 30,000 in the case of product B (if it is processed further). Hence the best production plan will be to sell A, C and E after further processing and B, D at the point of split off. The profit statement based on this suggested production plan is as below : Profit statement based on suggested production plan Products A Rs. Sales revenue (X) Apportioned joint Cost: (Y) Further processing Cost: (Z) Total manufacturing cost: (K) = (Y) + (Z) Excess of sales revenue over manufacturing cost {(X)-(K)} Less: Fixed cost Profit 50,00,000 26,25,000 12,50,000 38,75,000 11,25,000 Total Rs.

B Rs. 3,90,000 2,52,000 2,52,000 1,38,000

C Rs. 3,00,000 1,75,000 50,000 2,25,000 75,000

D Rs.

E Rs.

2,00,000 15,00,000 73,90,000 1,40,000 9,45,000 41,37,000 1,50,000 14,50,000 1,40,000 10,95,000 55,87,000 60,000 4,05,000 18,03,000 4,73,000 13,30,000

Hence the profit of the company has increased by Rs. 30,000

32

Revisionary Test Paper (Revised Syllabus-2008)

Q. 13. (a) Family Store wants information about the profitability of individual product lines: Soft drinks, Fresh produce and Packaged food. Family store provides the following data for the year 2008-09 for each product line : Soft drinks Rs. 7,93,500 Rs. 6,00,000 Rs. 12,000 360 300 540 1,26,000 Fresh produce Rs. 21,00,600 Rs. 15,00,000 Rs. 0 840 2,190 5,400 11,04,000 Packaged food Rs. 12,09,900 Rs. 9,00,000 Rs. 0 360 660 2,700 3,06,000

Revenues Cost of goods sold Cost of bottles returned Number of purchase orders placed Number of deliveries received Hours of shelf-stocking time Items sold

Family store also provides the following information for the year 2008-09 : Activity Bottles returns Ordering Delivery Shelf stocking Customer Support Description of Activity Returning of empty bottles Placing of orders for purchases Physical delivery and receipt of goods Stocking of goods on store shelves and on-going restocking Assistance provided to customers including check-out Total cost Rs. 12,000 Rs. 1,56,000 Rs. 2,52,000 Rs. 1,72,800 Rs. 3,07,200 Cost-allocation Base Direct tracing to soft drink line 1,560 purchase orders 3,150 deliveries 8,640 hours of shelfstocking time 15,36,000 items sold

Required : (i) Family store currently allocates support cost (all cost other than cost of goods sold) to product lines on the basis of cost of goods sold of each product line. Calculate the operating income and operating income as a % of revenues for each product line. (ii) If Family Store allocates support costs (all costs other than cost of goods sold) to product lines using an activity based costing system, calculate the operating income and operating income as a% of revenues for each product line. (iii) Comment on your answers in requirements (i) and (ii). (b) Explain briefly each of the following categories in Activity based Costing by giving at least two examples : (i) Unit level activities (ii) Batch level activities

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Answer 13. (a) (i)

Statement of Operating income and Operating income as a percentage of revenues for each product line (When support costs are allocated to product lines on the basis of cost of goods sold of each product) Soft Drinks Rs. 7,93,500 6,00,000 1,80,000 7,80,000 13,500 1.70% Fresh Produce Packaged Foods Total Rs. Rs. Rs. 21,00,600 12,09,900 41,04,000 15,00,000 9,00,000 30,00,000 4,50,000 2,70,000 9,00,000 19,50,000 11,70,000 39,00,000 1,50,600 39,900 2,04,000 7.17% 3.30% 4.97%

Revenues: (A) Cost of Goods sold (COGS): (B) Support cost (30% of COGS): (C) Total cost: (D) = {(B) + (C)} Operating income: E= {(A)-(D)} Operating income as a percentage of revenues: (E/A) x 100) Working notes : 1. Total support cost : Bottles returns Ordering Delivery Shelf stocking Customer support Total support cost

Rs. 12,000 1,56,000 2,52,000 1,72,800 3,07,200 9,00,000

2. Percentage of support cost to cost of goods sold (COGS) :


= Total support cost 100 Total cost of goods sold

Rs. 9,00,000 100 = 30% Rs. 30,00,000

3. Cost for each activity cost driver : Activity(1) Ordering Delivery Shelf-stocking Customer support Total cost Rs. (2) 1,56,000 2,52,000 1,72,800 3,07,200 Cost allocation base(3) 1,560 purchase orders 3,150 deliveries 8,640 hours 15,36,000 items sold Cost driver rate(4)=[(2)(3)] 100 per purchase order 80 per delivery 20 per stocking hour 0.20 per item sold

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Revisionary Test Paper (Revised Syllabus-2008)

(ii) Statement of Operating income and Operating income as a percentage of revenues for each product line (When support costs are allocated to product lines using an activity-based costing system) Soft drinks Rs. 7,93,500 6,00,000 12,000 36,000 24,000 10,800 25,200 7,08,000 85,500 10.78% Fresh Produce Rs. 21,00,600 15,00,000 0 84,000 1,75,200 1,08,000 2,20,800 20,88,000 12,600 0.60% Packaged Food Rs. 12,09,900 9,00,000 0 36,000 52,800 54,000 61,200 11,04,000 1,05,900 8.75% Total Rs. 41,04,000 30,00,000 12,000 1,56,000 2,52,000 1,72,800 3,07,200 39,00,000 2,04,000 4.97%

Revenues: (A) Cost & Goods sold Bottle return costs Ordering cost*(360:840:360) Delivery cost*(300:2,190:660) Shelf stocking cost*(540:5,400:2,700) Customer Support cost* (1,26,000:11,04,000:3,06,000) Total cost: (B) Operating income C:{(A)- (B)} Operating income as a % of revenues * Refer to working note : 3

(iii) Comment : Managers believe that activity based costing (ABC) system is more credible than the traditional costing system. The ABC system distinguishes with different type of activities at family store more precisely. It also tracks more precisely how individual product lines use resources. Soft drinks consume less resources than either fresh produce or packaged food. Soft drinks have fewer deliveries and require less shelf stocking time. Family store managers can use ABC information to guide their decisions, such as how to allocate a planned increase in floor space. Pricing decision can also be made in a more informed way with ABC information. Answer 13. (b) (i) Unit level activities - The cost of some activities (mainly primary activities) are strongly corelated to the number of units produced. These activities are known as unit level activities. Examples are : (a) The use of indirect materials. (b) Inspection or testing of every item produced or say every 100th item produced. (c) Indirect consumables. (ii) Batch level activities The cost of some activities (mainly manufacturing support activities) are driven by the number of batches of units produced. These activities are known as Batch level activities. Examples are : (a) Material ordering. (b) Machine set up cost. (c) Inspection of products - like first item of every batch.

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Q. 14. (a) What is the difference between Contribution and Profit? (b) ABC Ltd. has to date spent Rs. 75,000 on a research project and it expects that when completed in a further year the results of that research can be sold for Rs. 1,00,000. In trying to decide whether to proceed, the business identifies the additional expenses necessary to complete the research : Materials : Rs. 30,000. This materials (Already in store and paid for) is very toxic and will have to be disposed off in sealed containers at a cost of Rs. 2,500. Labour : Rs. 20,000. The research project uses highly skilled labour taken from the production department of the company. If they were working on normal producton, the company could earn Rs. 25,000 additional contribution to profit in the next year after paying the skilled labour. Research staff : Rs. 30,000. The research unit will close down after the project has been completed and voluntary retirement pay has already been agreed at Rs. 12,500. General overheads : Rs. 20,000. The research unit is apportioned a share of the total fixed costs of the business. The Management Accountant of the Company has presented the following analysis recommended against continuation, since the analysis that the company would lose Rs. 25,000 more by continuing the project that by abandoning now. The Managing Director seeks your opinion as the group Management Accountant about the analysis presented by the Management Accountant. Abandon now Rs. 75,000 Complete the project Rs. 1,00,000 Rs. 75,000 30,000 20,000 30,000 20,000 25,000 75,000

Sales Costs to date Additional costs : Material Labour Research staff Overheads Loss in contribution Net loss

2,00,000 1,00,000

Answer 14. (a) Difference between Contribution and Profit Contribution 1. It includes fixed cost and profit. 2. Marginal Costing technique uses the concept of contribution. 3. At break-even point, contribution equals to Fixed cost. 4. Contribution concept is used in managerial decision making. Profit 1. It does not include Fixed cost. 2. Profit is the accounting concept to determine profit or loss of a business concern. 3. Only the sales in excess or break-even points results in profit. 4. Profit is computed to determine the profitability of product and the concern.

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Revisionary Test Paper (Revised Syllabus-2008)

Answer 14. (b) The analysis presented by the Management Accountant does not speak about his expertise in presenting decision-making data. He has not considered the sunk cost, relevant and irrelevant cost and opportunity cost concepts. The conclusions drawn by the Management Accountant are incorrect due to the following reasons : (i) The company has already spent Rs. 75,000 on a research project. The company cannot retrieve the amount already spent, if it discontinues the project. It is sunk cost, and irrelevant for decision making. (ii) The materials worth Rs. 30,000 purchased in the past is still lying in store and it has no substitute use. Thus Rs. 30,000 is again a sunk cost and the same cannot be considered for decision analysis. The amount of Rs. 2,500 spent on disposing it off will have to be taken into consideration. (iii) If the research project is abandoned, labour cost of Rs. 20,000 is not relevant as the same will be used by production department. If the research project is continued, it is necessary to consider the contribution foregone (opportunity cost of Rs. 25,000) plus Rs. 20,000 labour cost to be paid by research department. (iv) Salaries of research staff will be saved if the research project is abandoned. This is relevant to this decision. The voluntary retirement pay has already been agreed and it forms part of sunk cost and, therefore, it is irrelevant to this decision analysis. (v) Apportionment of general overheads to research project is irrelevant as it is a fixed overhead. This cost will continue to be incurred by the production department irrespective of whether the research project is continued or not. The correct analysis is given below : Statement showing relevant cost of continuing or discontinuing the research project : Abandon the project Rs. 2,500 2,500 (2,500) Complete the project Rs. 1,00,000 45,000 30,000 75,000 25,000

Sale proceeds from research Relevant costs : Disposal cost of material Labour (Rs. 25,000 + Rs. 20,000) Research staff cost Total cost Profit /(Loss)

If the project is abandoned, the companys loss will be Rs. 2,500. However, if the research project is completed, the company will earn a profit of Rs. 25,000. Therefore, company should continue the project. Q. 15. (a) What is the difference between Joint product and By-product? (b) S.V. Ltd. manufactures a product which is obtained basically from a series of missing operations. The finished product is packaged in the company made Glass Bottles and packed in attractive cartons. The company is organized into two independent divisions viz. one for the manufacture of the End product and the other for the manufacture of Glass Bottles. The product manufacturing division can buy all the bottle requirements from the Bottle manufacturing division. The General Manager of the Bottle manufacturing division has obtained the following quotations from the outside manufacturers for the supply of empty bottles.

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Volume (Empty bottles) 8,00,000 12,00,000

Total purchase value (Rs.) 14,00,000 20,00,000

A cost analysis of the Bottle manufacturing division for the manufacture of empty bottles reveals the following production costs. Volume (Empty bottles) 8,00,000 12,00,000 Total cost (Rs.) 10,40,000 14,40,000

The production cost and sales value of the end product marketed by the product manufacturing division are as under : Volume (Bottles of end product) 8,00,000 12,00,000 Total cost of end product (excluding cost of empty bottles) Rs. 64,80,000 96,80,000 Sales value (packed in bottles) Rs. 91,20,000 1,27,80,000

There has been considerable discussion at the corporate level as to the use of proper price for transfer of empty bottles from the Bottle manufacturing division to product manufacturing division. This interest is heightened because a significant portion of the Divisional General Managers salary is in incentive bonus based on profit centre results. As the Corporate Management Accountant responsible for defining the proper transfer prices for the supply of empty bottles by the Bottles manufacturing division to the Product manufacturing division, you are required to show for the two levels of volumes of 8,00,000 and 12,00,000 bottles, the profitability by using (i) Market price and (ii) Shared profit relative to the costs involved basis for the determination of transfer prices. The profitability position should be furnished separately for the two divisions and the company as a whole under each method. Discuss also the effect of these methods on the profitability of the two divisions. Answer 15. (a) Difference between Joint Product and By-product : Joint Product 1. Joint products are the products of equal economic importance. 2. Joint products are produced from same input and process. 3. Joint products are not produced incidentally. 4. Joint products have significant impact on total cost at the point of separation. By-product 1. By-products importance. are of lesser economic

2. By-products are produced from wastage, scrap or discarded material of the main process. 3. By-products emerge incidentally also. 4. By-products have little impact on total cost.

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Revisionary Test Paper (Revised Syllabus-2008)

Answer 15. (b) (i) Profitability based on cost Particulars a. Determination of transfer price Sales (Packed Product) Costs : Bottle Mfg. Division Product Mfg. Division Total costs Profit Bottle Mfg. Division (16,00,000 10,40,000/75,20,000) (16,60,000 14,40,000/1,11,20,000) Product Mfg. Division (balance profit) Transfer price of bottles Cost Profit Total Price per bottle (b) Profitability Bottle Mfg. Division Sales (8,00,000 1.58) & (12,00,000 1.38) Less : Costs Profit Product Mfg. Division Sales Costs : Bottle cost Product cost Total cost Profit Companys total profit (ii) Profitability based on market price Particulars Bottle Mfg. Division Market price Cost Profit Product Mfg. Division Sales Costs : Bottle cost Product cost Total cost Profit Companys total profit 8,00,000 bottles (A) 91,20,000 10,40,000 64,80,000 75,20,000 16,00,000 2,21,276 13,78,724 10,40,000 2,21,276 12,61,276 1.58 2,14,964 14,45,036 14,40,000 2,14,964 16,54,964 1.38 12,00,000 bottles 1,27,80,000 14,40,000 96,80,000 1,11,20,000 16,60,000

(B) (A B)

12,64,000 10,40,000 2,24,000 (A) 91,20,000 12,64,000 64,80,000 77,44,000 13,76,000 16,00,000

16,56,000 14,40,000 2,16,000 1,27,80,000 16,56,000 96,80,000 1,13,36,000 14,44,000 16,60,000

(B) (A B)

Rs. 8,00,000 bottles 12,00,000 bottles 14,00,000 10,40,000 3,60,000 (A) 91,20,000 14,00,000 64,80,000 78,80,000 12,40,000 16,00,000 20,00,000 14,40,000 5,60,000 1,27,80,000 20,00,000 96,80,000 1,16,80,000 11,00,000 16,00,000

(B) (A B)

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The market price method gives a better profitability to the Bottle Mfg. Division. In the cost based method, however, its profit is lower at higher output of 12,00,000 bottles. The market price method gives a lesser profitability to the Product Mfg. Division as compared cost based method, whereas it is reduced in market based transfer price for bottles. This will act as disincentive to increase production in either case to the concerned departments and ultimately the companys overall profits will suffer. Some other mode is, therefore, required to be worked out so as to raise the profitability of both the divisions when output is raised instead of following either of these methods so as to avoid disincentive. Q. 16. (a) A company manufactures a single product in its factory utilizing 60% of its capacity. The selling price and cost details are given below : Rs. 5,40,000 96,000 1,20,000 18,000 2,00,000 21,000 25,000

Sales (6000 units) Direct materials Direct labour Direct expenses Fixed overheads : Factory Administration Selling and distribution

An analysis of fixed overheads reveals that 12.5% of factory overheads and 20% of selling and distribution overheads are variable with production and sales. Administration overheads are wholly fixed. Since existing product could not achieve budgeted level for two consecutive years, the Company decides to introduce a new product with marginal investment but largely using present plant and machinery. The cost estimates of the new products are as follows : Cost elements Rs. Per unit Direct materials 16.00 Direct labour 15.00 Direct expenses 1.50 Variable factory overheads 2.00 Variable selling and distribution overheads 1.50 It is expected that 2,000 units of the new products can be sold at a price of Rs. 60 per unit. The fixed factory overheads are expected to increase by 10%, while fixed selling and distribution expenses will go up by Rs. 12,500 annually. Administration overheads remain unchanged. However, there will be an increase of working capital to the extent of Rs. 75,000 which take the total project cost to Rs. 8.75 lakhs. The company considers that 20% pre-tax and interest return on investment is the minimum acceptable to justify any new investment. Required : (i) Should the new product be introduced? (ii) Given the data above and making any assumptions that you consider appropriate, are there any further observations or recommendations you wish to make?

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Revisionary Test Paper (Revised Syllabus-2008)

Q. 16. (b) What is P.V. Ratio? How it can be improved? Answer 16. (a) Statement of Profiles :Existing and New Products Rs. Particulars Sales quantity Sales value (a) Less : Variable costs : Direct materials Direct labour Direct expenses Variable overheads Total variable cost (b) Contribution (a) (b) Less : Fixed overheads : Factory Administration Selling and distribution Total fixed cost Profit Profitability of new product introduction Existing products New product Amount Per unit Amount Per unit 6,000 units 2,000 units 5,40,000 90 1,20,000 60.00 96,000 1,20,000 18,000 30,000 2,64,000 2,76,000 1,75,000 21,000 20,000 2,16,000 60,000 16 20 3 5 44 46 32,000 30,000 3,000 7,000 72,000 48,000 17,500 12,500 30,000 18,000 16.00 15.00 1.50 3.50 36.00 24.00 Total Amount 6,60,000

3,36,000 3,24,000

2,46,000 78,000

Incremental Profit 100 = Incremental Investment

The rate of return on incremental investment exceeds the minimum acceptable 20% pre-tax and interest return on investment to justify new investment. Hence, new product is suggested for introduction. Further observations and recommendations Particulars With the existing product After introduction of new production Contribution as % of sales 51.1% 40% Capacity utilisation 60% 80% (assuming new product will also utilize the same machine capacity as of existing product) Investment (Rs. Lakhs) 8.00 8.75 Profit (Rs. Lakhs) 0.60 0.78 Return on investment 7.5% 8.91% It is observed from the above that the predetermined rate of return on investment is 20% whereas the company is presently earning only 7.5% on investment of Rs. 8,00,000 with the existing product. With the introduction of new product, the ROI has slightly increased from 7.5% to 8.91%, but it is still far below the

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target rate of return. The present contribution of 51.1% has fallen to 40%, with the introduction of new product even though the capacity utilization has increased from 60% to 80% of the total capacity available with the company. It is observed from the data available that direct labour cost and factory overheads of Rs. 1,20,000 and Rs. 2,00,000 respectively are the major costs to be investigated into and controlled. The profitability of the company can be improved by utilizing the balance capacity of 20%. Unless the company taken appropriate steps to improve its profitability, the increase in costs due to inflation may wipe off its marginal profits and may turn the company into loss-making one. Answer 16. (b) Profit Volume ratio (P.V. ratio) reveal the rate of contribution per product as a percentage of turnover. It indicates the relationship of contribution to turnover. P.V. ratio may be expressed with the help of the following formula : P.V. ratio =
Contribution 100 Sales

Better P.V. ratio is an index of sound financial health of companys product. P.V. ratio can be improved, if contribution is improved. Contribution can be improved by taking any of the following steps : (i) Increase in sale prices (ii) Reducing marginal cost by efficient utilisaiton of men, material and machines. (iii) Concentrating on the sales of products with relatively netter P.V. ratio. Q. 17. (a) A Pharmaceutical Company produces formulations having a shelf life of one year. The company has an opening stock of 15,000 boxes on 1st January, 2009 and expects to produce 65,000 boxes as was in the just ended year of 2008. Expected sale would be 75,000 boxes. Costing department has worked out escalation in cost by 25% on variable cost and 10% on fixed cost for the year 2009. Fixed costs estimated at Rs. 14,30,000. New price announced for 2009 is Rs. 50 per box. Variable cost of the opening stock is Rs. 20 per box. Required : (i) To find out break-even volume for the year 2009, and (ii) To estimate the profits that would be realized on the sale during 2009. (b) In decision-making only relevant costs should be considered. Explain. (c) Give three examples of Cost Drivers of following business functions (i) Research and development (ii) Design of products, services and processes (iii) Marketing Answer 17. (a) (i) Since the product has a shelf life of one year, the company will first liquidate the stock on hand on 1st January. Contribution earned on this sale of 15,000 boxes will be 15,000 boxes (Rs. 50 less Rs. 20) = Rs. 4.50 lakhs Fixed cost for the year is placed at Rs. 14.30 lakhs and, therefore, the balance fixed cost to be recovered works out to Rs. 9.80 lakhs. Variable cost would go up by 25%. The variable cost for the year 2009 would therefore be Rs. 20 1.25 = Rs. 25. On this basis new contribution from selling price of Rs. 50 works out to Rs. 25 per box. Break-even volume for balance fixed cost = 9,80,000/25 = 39,200 boxes. Break even for the year = 15,000 + 39,200 = 54,200 boxes.

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Revisionary Test Paper (Revised Syllabus-2008)

(ii) Total fixed cost Rs. 14.30 lakhs Production 65,000 boxes Fixed cost per box Rs. 22 This is higher by 10% compared to 2008. The element of fixed cost of opening stock would therefore be Rs. 20. Following is the price break up : Rs. Particulars Opening stock Current production Variable cost 20 25 Fixed cost 20 22 Profit margin 10 3 50 50 Profit on sale of 75,000 boxes during 2004 : No of Boxes 15,000 @ Rs. 10 60,000 @ Rs. 3 75,000

Rs. Lakhs 1.50 1.80 3.30

Answer 17. (b) Relevant costing for decision making purposes is not only important to classify costs according to the way in which they behave, but also as to whether or not they are relevant to a particular decision. A relevant cost is a future cost which differs between alternatives. It can also be defined as any cost which affected by the decision at hand. The main features of a relevant cost are as follows : (i) It must be a future cost i.e. one which is expected to be incurred and not a historic (sunk) cost which has already been incurred. (ii) It must be an incremental (additional) or avoidable cost. In considering a range of alternative actions, costs which will be identical for all alternatives are irrelevant and can be ignored for the purpose of decision-making. Every decision deals with future. The function of the decision-maker is to select the courses of action for the future. A relevant cost is a future cash flow arising as a direct consequence of the decision under review. Only relevant costs should be considered in decision making, because it is assumed that in the long-run future profits will be maximized if the cash profits of the company, i.e. the cash earned from sales minus the cash expenditures on making and selling the goods, are also maximized. Answer 17. (c) Business functions (i) Research & Development

(ii) Design of products, services and processes

Cost Drivers Number of research projects Personnel hours on a project Technical complexities of the projects Number of products in design Number of parts per product Number of engineering hours

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(iii) Marketing

Number of advertisement run Number of sales personnel Sales revenue Number of products and volume of sales (in quantitative terms)

Q. 18. (a) What is difference between Forecast and Budget? (b) The sales, cost, selling price and processing time of three different products produced by a company for the year just ended are given below : Product B 5,000 40 36 1

Particulars Annual sales Selling price Unit cost Processing time/pack

(no. of packs of 250 gms.) (Rs./pack) (Rs./pack) (Hrs.)

A 6,000 50 42 1.5

C 1,000 30 21 2

The total processing hours available to the company is 16,000 hrs which is fully utilized. Fixed manufacturing overheads are fully absorbed in unit cost at a rate of 200% of variable cost. For the coming year the demand for the three products has been estimated as under : A 6,000 packs, B 6,000 packs, C- 1,000 packs Considering that the selling prices are fixed and the processing time can be switched from one product line to another, calculate the best production programme for next operating year indicating the increase in net profit that will result. Answer 18. (a) Difference between Forecast and Budget Forecast 1. Forecast is merely an estimate of what is likely to happen. It is a statement of probable events which are likely to happen under anticipated conditions during a specified period of time. 2. Forecasts, being statements of future events, do not connote any sense of control. Budget 1. Budget shows the policy and programme to be followed in a period under planned conditions. 2. A budget is a tool of control since it represents actions which can be shaped according to will so that it can be suited to the conditions which may or may not happen. 3. It begins when forecasting ends. Forecasts are converted into budget. 4. Budgets have limited scope. It can be made of phenomenon capable of being expressed quantitatively.

3. Forecasting is a preliminary step for budgeting. It ends with the forecast of likely events. 4. Forecasts are wider in scope and it can be made in those spheres, also where budgets cannot interfere.

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Revisionary Test Paper (Revised Syllabus-2008)

Answer 18. (b) Calculation of variable cost per pack Fixed cost = 200% of Variable cost Or, FC : VC = 2 : 1; and Total cost = 2 + 1 = 3 VC = 1/3 of Total cost. Variable cost A = 1/3 of Rs. 42 = Rs. 14 B = 1/3 of Rs. 36 = Rs. 12 C = 1/3 of Rs. 21 = Rs. 7 Data from last years operation Particulars Sales (No. of packs) Selling price per pack (Rs.) Variable cost per pack (Rs.) Contribution per pack (Rs.) Total contribution (Rs.) Processing time (hour/pack) Contribution per key factor (Rs.) Ranking Best production programme for next year Particulars Demand Processing time required : Processing time allotted Production Contribution (no. of packs) Hour Hour (no. of packs) (Rs.) A 6,000 9,000 9,000 6,000 2,16,000 B 6,000 6,000 6,000 6,000 1,68,000 C 1,000 2,000 1,000 500 11,500 Total 17,000 16,000 3,95,500

A 6,000 50 14 36 2,16,000 1.5 24 II

B 5,000 40 12 28 1,40,000 1 28 I

C 1,000 30 7 23 23,000 2 11.5 III

Total

3,79,000

Increase in profit 3,95,500 3,97,000 = Rs. 16,500 Q. 19. (a) The sales forecast for January to May 2009 and actual sales for November and December, 2008 for Plysales Co. are given as under : Month Sales (Rs.) Actual November, 2008 80,000 December 70,000 Forecast January, 2009 80,000 February 1,00,000 March 80,000 April 1,00,000 May 90,000

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20% of sales is in cash and rest is on credit, payment of which is realized in the third month. The following other information are also available : (i) Amount of purchase is budgeted at 60% of the Sales Turnover of a month and paid in the third month of purchase. (ii) Variable expenses is 5% of Turnover time lag of payment half month (iii) Commission on credit sales @ 5% is payable in the third month (iv) Rent and other expenses amounting Rs. 3,000 paid every month (v) Payment for purchase of fixed assets Rs. 50,000 in March, 2009 (vi) Payment for taxes in April, 2009 Rs. 20,000 (vii) There will be an opening cash balance of Rs. 25,000. You are required to prepare a Cash Budget for five months from January to May 2009. (b) How flexible budget can help in management decision making? Answer 19. (a) Working notes : Collection from Sundry Debtors & Commission on Credit Sales 2008 (Actual) Nov. Dec. 80,000 70,000 16,000 14,000 64,000 56,000 3,200 2,800 2009 (Forecast) Feb. Mar. Apr. 1,00,000 80,000 1,00,000 20,000 16,000 20,000 80,000 64,000 80,000 56,000 64,000 80,000 4,000 3,200 4,000 2,800 3,200 4,000 Rs.

Particulars Sales Cash sales 20% Credit sales 80% Collection of debtors Commission on credit sales (5%) Payment of commission

Jan. 80,000 16,000 64,000 64,000 3,200 3,200

May 90,000 18,000 72,000 64,000 3,600 3,200 Rs.

Calculation of payment to creditors 2008 Particulars Nov. Purchases (60% of sales) 48,000 Payment to Sundry Creditors (3rd month of purchase) Dec. 42,000 Jan. 48,000 48,000 2009 Feb. Mar. 60,000 48,000 42,000 48,000

Apr. 60,000 60,000

May 54,000 48,000

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Revisionary Test Paper (Revised Syllabus-2008)

Cash Budget of Plysales Co. for the months January to May 2009. Particulars Opening balance Receipts : Cash sales Collection from sundry debtors Total (A) Payments : Payment to Sundry Creditors Variable expenses Commission Rent Fixed assets Taxes Total (B) Closing balance Jan. 25,000 16,000 64,000 80,000 48,000 3,750 3,200 3,000 57,950 47,050 Feb. 47,050 20,000 56,000 76,000 42,000 4,500 2,800 3,000 52,300 70,750 Mar. 70,750 16,000 64,000 80,000 48,000 4,500 3,200 3,000 50,000 1,08,700 42,050 Apr. 42,050 20,000 80,000 1,00,000 60,000 4,500 4,000 3,000 20,000 91,500 50,550 May 50,550 18,000 64,000 Total 25,000 90,000 3,28,000

82,000 4,18,000 48,000 2,46,000 4,750 22,000 3,200 16,400 3,000 15,000 50,000 20,000 58,950 3,69,400 73,600 73,600

Answer 19. (b) Flexible budget is a budget which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover, or other variable factors, etc. It is designed to change in relation to the level of activity actually attained. A flexible budget is one that takes account of a range of possible volumes. It is sometimes referred to as a multi-volume budget. The range of possible outputs may be known as the relevant range. Flexing a budget takes place when the original budget is deliberately amended to take account of change activity levels. Flexible budget enable an organization to predict its performance and income levels at a given range of sales levels and activity levels. It can be seen the impact of changes in sales and production levels on revenue, expenses and ultimately income. It enables more accurate assessment of managerial and organizational performance. So, Flexible budget is an important aid to management to decision making. Q. 20. A manufacturing company, ABC Ltd. has just completed a project with a capacity to manufacture 50,000 units per month and the same is ready for commercial production. It has got an offer from another manufacturer to produce its products with their Brand name by using the facility created. The Management is considering which of the two options, either to produce its own brand or to manufacture for others, it should accept. The following data are available : (i) Average selling price per unit Rs. 3,500 (ii) Cost of material 75% of selling price. However, the company has engaged a firm to carry out Value Engineering and indications are that it may come down by 3% during 3 to 6 months next. (iii) Power and fuel up to 15,000 units production/m Rs. 325 per unit; at 30,000 units production/ m, Rs. 225 per unit (The Power and Fuel cost per unit reduces on pro rata basis with increase in production).

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(iv) Indirect material and consumables Rs. 25 per unit. (v) Fixed costs per month : a. Employment cost Rs. 50 lakhs b. Overheads (Administrative and Factory) Rs. 15 lakhs c. Overhead (Selling and Distribution) Rs. 20 lakhs (vi) Variable Selling and Distribution cost works out to 6% of Sale price. (vii) Depreciation p.m. Rs. 40 lakhs (viii) Working capital requirement @ 18% interest - at level of production of 15,000 units/month Rs 10 crores - at level of production of 20,000 units/month Rs. 13 crores - at level of production of 30,000 units/month Rs. 20 crores The price offered by the manufacturer for carrying out conversion job Rs. 700 per unit. The other manufacturer would provide all Material other than Indirect material and consumables. You are required to work out a Budget showing Profitability under the two alternatives for three levels of production at 15,000 units/month, 20,000 units/month, 30,000 units/month and find out the best course of action as a short term measure and as long term measure. Answer 20. Statement showing budgeted profitability of ABC Ltd. at various levels/ month 15,000 units level Own Converbrand sion manufacture 525.00 105.00 393.75 3.75 3.75 50.00 50.00 48.75 48.75 15.00 15.00 20.00 31.50 562.75 (37.75) 40.00 15.00 (92.75) 20.00 137.50 (32.50) 40.00 (72.50) 20,000 units level Own Converbrand sion manufacture 700.00 140.00 525.00 5.00 5.00 50.00 50.00 58.00 58.00 15.00 15.00 20.00 42.00 715.00 (15.00) 40.00 19.00 (74.00) 20.00 148.00 (8.00) 40.00 (48.00) 30,000 units level Own Converbrand sion manufacture 1050.00 210.00 787.50 7.50 7.50 50.00 50.00 67.50 67.50 15.00 15.00 20.00 63.00 1010.50 39.50 40.00 30.00 (30.50) 20.00 160.00 50.00 40.00 10.00

Particulars

Sales value (a) Material Indirect material/consumables Employment cost Power and fuel Other fixed overheads Selling & distribution overhead Fixed Variables Total (b) (a) (b) Depreciation Interest on W.C. Net profit/ (loss)

Comment : In the short-run it would be beneficial to do the conversion job provided the level of operation is not below 20,000 units. But carrying out conversion job cannot be a long-term solution as the unit would become dependent upon the other party for job order. Moreover, it cannot built up its market demand for its own product.

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Revisionary Test Paper (Revised Syllabus-2008)

Budgeted profitability statement of own brand at different levels p.m. Particulars Sales value Material Indirect material/consumables Employment cost Power & fuel Variable selling and distribution costs Fixed overhead : Administrative & factory Selling & distribution 15000 units 525.00 378.00 3.75 50.00 48.75 31.50 15.00 20.00 547.00 (22.00) 40.00 15.00 (77.00) (72.50) 20,000 units 700.00 504.00 5.00 50.00 58.00 42.00 15.00 20.00 694.00 6.00 40.00 19.00 (53.00) (48.00) 30,000 units 1050.00 756.00 7.50 50.00 67.50 63.00 15.00 20.00 979.00 71.00 40.00 30.00 1.00 10.00

Depreciation Interest on W.C. Net profit/(loss) Corresponding position if any jobbing is done

But still it would be advantageous to be jobbing. In this context, as the gap in narrowing down a more detailed study of contribution per unit at different range of products might be worthwhile to work out and a healthy mix of both production and jobbing might be aimed at. Q. 21. (a) The monthly budgets for manufacturing overhead of a concern for two levels of activity were as follows : Capacity Budgeted production (units) Wages Consumable stores Maintenance Power and fuel Depreciation Insurance 60% 600 Rs. 1,200 900 1,100 1,600 4,000 1,000 9,800 100% 1,000 Rs. 2,000 1,500 1,500 2,000 4,000 1,000 12,000

You are required to : (i) Indicate which of the items are fixed, variable and semi variable (ii) Prepare a budget for 80% capacity; and (iii) Find the total cost, both fixed and variable, per unit of output at 60%, 80% and 100% capacity. Q. 21. (b) What are the steps of Zero Based Budgeting?

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Answer 21. (a) (i) Fixed : Depreciation Insurance

Since it remains constant at both the given levels. Same as above.

Variable : Wages Because it is Rs. 2 per unit at both the given levels. Consumable stores Because it is Rs. 1.50 per unit at both the given levels. Semi-variable : Maintenance Power and fuel

Since it is neither fixed nor the quantum of increase is proportionate to the increase in volume. Same as above.

(ii) First of all, find out the variable portion of semi-variable overhead. Working notes : Maintenance : Variable portion =
Change in overhead = Rs. 400 400 = Re. 1 per unit. Change in production Fixed portion = Rs. 1,100 (600 units Re. 1) = Rs. 500 At 80% capacity level = (800 units Re. 1) + Rs. 500 = Rs. 1,300

Power and fuel : Variable portion = Rs. 400 400 = Re. 1 per unit. Fixed portion = Rs. 1,600 (600 units Re. 1) = Rs. 1,000 At 80% capacity level = (800 units x Re. 1) + Rs. 1,000 = Rs. 1,800 Budget for 80% capacity level Budgeted production (80% capacity) Wages @ Rs. 2 per unit Consumables stores @ Rs. 1.5 per unit Maintenance as per above working Power and fuel - do Depreciation Insurance Total 800 units 1,600 1,200 1,300 1,800 4,000 1,000 10,900

To sum up, the variable cost per unit works out to Rs. 5.50. It consists of wages Rs. 2, consumable stores Rs. 1.50, maintenance Re. 1 and power and fuel Re. 1. The total fixed cost comes to Rs. 6,500 i.e. maintenance RS. 500 + power and fuel Rs. 1,000 + depreciation Rs. 4,000 + insurance Rs. 1,000.

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Revisionary Test Paper (Revised Syllabus-2008)

(iii) Total cost per unit 60% 600 5.50 10.83 16.33 Capacity 80% 100% 800 1,000 Rs. Per unit 5.50 5.50 8.13 6.50 13.63 12.00

Production (units) Variable cost Fixed cost (Rs. 6,500 production) Total

It should be noted that total cost (both fixed and variable) per unit is required and nor total cost at different capacity levels. Answer 21. (b) Steps of Zero Based Budgeting : Corporate objectives should be established and laid down in detail. Decision units are identified by dividing the organization according to functions or departments. The activity of each function or department is described, analysed and documented. The targets and objectives of each activity are clearly determined ignoring existing budget. The performance assessment and measurement criteria for each activity are clearly defined. Each separate activity of the organization is described in a decision package. In performance of an activity, the alternative methods and costs are evolved. Each activity or decision package is evaluated and ranked by cost benefit analysis. The benefits achieved at different levels of fundings are analysed. The consequences of not funding the activity are to be estimated. Resources in the budget are then allocated according to the resources available and the evaluation and ranking of the competing package. Available resources are directed towards alternatives in order of priority to ensure optimum results. Q. 22. From the details given below, reconcile the budgeted sales with the actual sales and budgeted profit with actual profit brining out the important variances : Particulars Sales quantity Product M Product N Sales price per unit Product M Product N Cost per unit Product M Product N Budget 2,000 3,000 Rs. 12 Rs. 8 Rs. 9 Rs. 6 Actual 1,800 3,500 Rs. 14 Rs. 7 Rs. 10 Rs. 5

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Answer 22. Actual sales at standard mix is computed below : M 5,300 40% = 2,120 N 5,300 60% = 3,180 5,300 Product Actual price Actual qty. in Actual mix (a) 14 1,800 = 25,200 7 3,500 = 24,500 Rs. 49,700 Standard price Actual qty. in Actual qty. in Std. Actual mix mix (b) (c ) 12 1,800 = 21,600 12 2,120 = 25,440 8 3,500 = 28,000 8 3,180 = 25,440 Rs. 49,600 Rs. 50,880

M N Total

Std. qty. in Std. mix (d) 12 2,000 = 24,000 8 3,000 = 24,000 Rs. 48,000

Sales variances Price variance Mix variance Volume variance Net variance Alternatively, (i) Price variance (ii) Volume variance (iii) Mix variance (iv) Quantity variance

(a) (b) (b) (a) (c ) (b)

= = =

49,700 49,600 49,600 50,880 50,880 48,000

= = =

Rs. 100 (F) 1,280 (A) 2,880 (F) 1,700 (F)

(a) (b) (b) (d) (b) (c ) (c ) (d)

= = = =

100 (F) 1,600 (F) 1,280 (A) 2,880 (F)

Note : (iii) and (iv) are sub variance of (ii) Product Actual qty. in Actual mix (a) 3 1,800 = 5,400 2 3,500 = 7,000 Rs, 12,400 Standard profit Actual qty. in Std. qty. in Std. Std. mix mix (b) (c) 3 2,120 = 6,360 3 2,000 = 6,000 2 3,180 = 6,360 2 3,000 = 6,000 Rs. 12,720 Rs. 12,000 Actual qty. x (Std. cost Actual cost) (d) 1,800 -1 = -1,800 3,500 1 = 3,500 (+) Rs. 1,700 Rs. 320 (A) 720 (F) 1,700 (F) 100 (F) 2,200 (F)

M N Total

Profit variance Mix variance Volume variance Cost variance (d) Price variance as per the tabulation

(a) (b) (b) (c)

= =

12,400 12,720 12,720 12,000

Total

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Revisionary Test Paper (Revised Syllabus-2008)

Reconciliation Particulars Budget Add : Price variance Volume variance Cost variance Less : Mix variance Actuals Comprising M N Sales (Rs.) 24,000 24,000 48,000 100 2,880 50980 (1,280) 49,700 25,200 24,500 6,000 6,000 Profit (Rs.) 12,000 100 720 1,700 14,520 (320) 14,200 7,200 7,000

M N

Q. 23. (a) The following standards have been set to manufacture a product : Direct material Rs. 2 units of A @ Rs. 4 per unit 8.00 3 units of B @ Rs. 3 per unit 9.00 15 units of C @ Re. 1 per unit 15.00 32.00 Direct labour 3 hrs. @ Rs. 8 per hour 24.00 Total standard prime cost 56.00 The company manufactured and sold 6,000 units of the product during the year. Direct material costs were as follows : 12,500 units of A at Rs. 4.40 per unit 18,000 units of B at Rs. 2.80 per unit 88,500 units of C at Rs. 1.20 per unit The company worked 17,500 direct labour hours during the year. For 2,500 of these hours the company paid at Rs. 12 per hour while for the remaining the wages were paid at standard rate. Calculate materials price variances and usage variances and labour rate and efficiency variances. (b) What are the objectives of Standard Costing Technique? Answer 23. (a) For material cost variances Actual cost of material used A B C 12,500 units x Rs. 4.40 = Rs. 55,000 18,000 units x Rs. 2.80 = Rs. 50,400 88,500 units x Rs. 1.20 = Rs. 1,06,200 Rs. 2,11,600

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Standard cost of material used A 12,500 units Rs. 4.00 = Rs. 50,000 B 18,000 units Rs. 3.00 = Rs. 54,000 C 88,500 units Rs. 1.00 = Rs. 88,500 Rs. 1,92,500 Standard material cost of production 6,000 units Rs. 32 = Rs. 1,92,000 Variances Material price variance = Actual cost of material used Standard cost of material used = Rs. 2,11,600 Rs. 1,92,500 = Rs. 19,100 (A) Material usage variance = Standard cost of material Standard material cost of production = Rs. 1,92,500 Rs. 1,92,000 = Rs. 500 (A) For labour cost variance Actual wages paid to workers 2,500 hrs. Rs. 12 = Rs. 30,000 15,000 hrs. Rs. 8 = Rs. 1,20,000 Rs. 1,50,000 Payment involved, if workers had been paid at standard rate = 17,500 hrs. Rs. 8 = Rs. 1,40,000 Standard labour cost of output achieved = 6,000 units Rs. 24 = Rs. 1,44,000 Variances : Labour rate variance = Rs. 1,50,000 Rs. 1,40,000 = Rs. 10,000 (A) Labour efficiency variance = Rs. 1,40,000 Rs. 1,44,000 = Rs. 4,000 (F) Answer 23. (b) Objectives of Standard costing technique : To provide a formal basis for assessing performance and efficiency To control costs by establishing standards and analysis of variances To enable the principle of Management by exception to be practiced at the detailed, operational level To assist in setting budgets The standard costs are readily available substitutes for actual average unit costs and can be used for stock and work-in-progress valuations, profit planning and decision making and as a basis of pricing where cost-plus systems are used To assist in assigning responsibility for non-standard performance in order to correct deficiencies or to capitalize on benefits

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Revisionary Test Paper (Revised Syllabus-2008)

To motivate staff and management To provide a basis for estimating To provide guidance on possible ways of improving performance Q. 24. (a) A raw material X, is used in the production of Chemical M and an extract from the standard cost card for Chemical M showing the rates of usage and expected price is as follows : Chemical M Standard Cost Card (extract) Material per unit 10 kgs of X @ Rs. 6 kg = standard material cost. During the current period 270 units of Chemical M were produced and the usage was 2,850 kgs with an actual material cost of Rs. 16,530. Due to world price movements X was freely available at Rs. 5.5 kg during the period. Calculate (i) The traditional variances (ii) The planning and operating variances (b) What are the causes of variance? Answer 24. (a) (i) Traditional variances 1. Material price variance 2. Material Usage Variance Total material cost variance Rs. 16,530 (2,850 Rs.6) (2,850 2,700) Rs. 6 Rs. 570 (F) 900 (A) 330 (A)

(ii) Planning and operating variances/ planning variance (uncontrollable) (Rs. 2,700 Rs. 6) (Rs. 2,700 Rs. 5.5) = Rs. 1,350 (F) Operating variances (controllable) 1. Operating price variance Rs. 16,530 (2,850 Rs. 5.5) = 2. Operating usage variance (2,850 2,700) Rs. 5.5 = Total operating material variance Planning variance + Operating variance = Traditional variance = Rs. 1,350 (F) + 1,680 (A) = Rs. 330 (A) Note : 1. The planning variance shows the total difference due to uncontrollable factors, i.e., the worldwide price change, and is the difference between old standard price and the new standard price for the standard quantity of material that should be used. If the planning variance is correct all that is left are controllable factors which are analysed by the operating variances. 2. The operating variances follows the normal procedures for material variances except that the new standard price of Rs. 5.5 is used. It will be noted that the operating price variance shows that there have been purchasing inefficiencies which contracts with the traditional price variance which showed apparent purchasing efficiency. Rs. 855 (A) 825 (A) 1,680 (A)

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Answer 24. (b) The causes of variances can be categorized as follows : (i) Implementation deviation results from a human or mechanical failure to achieve an attainable income. (ii) Prediction deviation results from errors in specifying the parameter values in decision model. (iii) Measurement deviation arises as a result of error in measuring the actual outcome. (iv) Model deviation arises as a result of an erroneous formulation in a decision model. (v) Random deviations due to chance fluctuations of a parameter for which no cause can be assigned. Q. 25. Gems and Co. manufactures a product for which the standard selling price has been ascertained as below : Per unit (Rs.) Materials 2 units at Rs. 20 40 Labour 20 hrs. @ Rs. 2.00 40 Variable overhead 8 Fixed overhead 20 Total cost 108 Profit 32 Selling Price 140 During the budget period, the company could produce and sell only 8,000 units, as against a budget of 10,000 units. The companys profit and loss account is presented below : Profit and Loss Account for the year ended Particulars To To To To To materials (16,500 units) Wages (1,70,000 hours) Variable overhead Fixed overhead Net profit Rs. 3,96,000 3,46,800 60,000 1,84,000 1,33,200 11,20,000 Particulars By Sales (8,000 units) Rs. 11,20,000

11,20,000

4,000 hours were lost due to power failure. There was no opening or closing W-I-P. You are to Reconcile the actual profit with the standard profit, in terms of the variances.

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Revisionary Test Paper (Revised Syllabus-2008)

Answer 25. Reconciliation Statement of Actual profit and Standard profit. Budgeted Profit Less : Sales volume variance (Adverse) Standard profit (10,000 @ Rs. 32) Rs. 32 (8,000 10,000) (8,000 units @ Rs. 32) Adverse 66,000 10,000 6,800 12,000 8,000 4,000 16,000 6,000 34,000 1,42,800 Favourable 3,20,000 64,000 2,56,000

Cost variances : 1. Direct materials (i) Price variance 16,500 (Rs. 20 Rs. 24) (ii) Usage variance Rs. 20 (16,000 16,500) 2. Direct Labour (i) Labour rate variance 1,70,000 (Rs. 2.00-Rs. 2.04) (ii) Labour efficiency variance Rs.2 (1,60,000 1,66,000) (iii) Idle time variance (Rs. 2.00 4,000) 3. Variable overheads (Rs. 8 8,000) Rs. 60,000 4. Fixed overheads (i) Expenditure variance (Rs. 2010,000) Rs. 1,84,000 (ii) Efficiency variance Rs. 20 (8,000 8,300) (iii) Capacity variance Rs. 20 (8,300 10,000) Total Less : Net adverse variance Actual profit for the period

20,000 1,22,800 1,33,200

Q. 26. (a) Enumerate the points on which uniformity is essential before introducing uniform costing system? (b) Discuss Management Accountants role in Cost Control and Cost Reduction. Answer 26. (a) Points on which uniformity is essential before introducing uniform costing system are: 1. The firms in the industry should be willing to share / furnish relevant data/ information. 2. A spirit of cooperation and mutual trust should prevail among the participating firms. 3. Mutual exchange of ideas, methods used, special achievements made, research and know-how etc. should be frequent. 4. Bigger firms should take the lead towards sharing their experience and know-how with the smaller firms to enable the latter to improve their performance. 5. Uniformity must be established with regard to several points before the introduction of uniform costing in an industry. In fact, uniformity should be with regard to following points: (a) Size of the various units covered by uniform costing. (b) Production methods (c) Accounting methods, principles and procedures used. Answer 26. (b) 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

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the items which will reduce waste and scrap, improve quality, increase productivity or conserve energy. In any large organization the position at which costs are incurred are usually numerous and relatively few line managers have the mechanism of collating and analysig all the costs they incur, with a view to implementing cost control measures. The Management Accountants 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 upto 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 may be instructive to remember that high quality low cost manufacturers like the Japanese car companies are typically very liberal with expenses like company paid holidays and entertainment on business account. Their cost control measures are directed towards everyone doing their jobs, work efficiently and productivity, not in poring down employee fringe benefits. It is important for the Management Accountant to guide the companys cost control and cost reduction programme into productive lines and not let it degenerate into a morale damaging axing of petty expenditure. Q. 27. (a) What are project life cycle costs? (b) Discuss different methods of establishment of Target cost. (c) Write four limitations of inter-firm comparison Answer 27. (a) Product life-cycle costs are incurred for products and services from their design stage through development to market launch, production and sales, and their eventual withdrawal from the market. In contrast project life-cycle costs are incurred for fixed assets, i.e. for capital equipment and so on. The component elements of a projects cost over its life-cycle could include the following : (i) Acquisition cost, i.e. costs of research, design, testing, production, construction, or purchase of capital equipment. (ii) Transportation and handling costs of capital equipment. (iii) Maintenance costs of capital equipment. (iv) Operation costs, i.e. the costs incurred in operations, such as energy costs, and various facility and other utility costs. (v) Training costs i.e., operator and maintenance training. (vi) Inventory costs i.e., cost of holding spare parts, warehousing etc. (vii) Technical data costs, i.e. costs of purchasing any technical data. (viii) Retirement and disposal costs at the end of the capital equipment life. Answer 27. (b) Three basic methods are used for setting target costs : First, there is the subtraction method which is based on the price of competitors product, where the target cost is worked backwards from the market price. The result may represent a very rigorous target, and it may be impossible to achieve. The second method of setting up the target cost is the addition method which is based on the existing technology and past cost data of the company. Normally it results in achievable targets because it is basically an extension of what has already been happening within the company. The greatest disadvantage of this method is that it is very inward looking and grossly ignores the market situation.

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The third method is the integrated method, a mixture of the subtraction and addition methods. However, in practice this integrated method involves many difficult problems. Answer 27. (c) The following are the limitations in the implementation of a scheme of inter firm comparison: 1. Top management feels that secrecy will be lost. 2. Middle management is usually not convinced with the utility of such a comparison. 3. In the absence of a suitable cost accounting system, the figures supplied may not reliable for the purpose of comparison. 4. Suitable basis of comparison may not be available. Q. 28. (a) Enumerate the benefits of transfer pricing policy. (b) A company fixes the inter-divisional transfer prices for its products on the basis of cost plus and estimated return on investment in its division. The relevant portion of the budget for the division A for the year 2009-10 is given below : Fixed assets Current assets (other than debtors) Debtors Annual fixed cost of the division Variable cost per unit of product Budgeted volume of production per year (units) Desired return on investment Rs. 5,00,000 3,00,000 2,00,000 8,00,000 10 4,00,000 28%

You are required to determine the transfer price for the Division A. (c) How to develop an ABC system? Answer 28. (a) An ideal transfer pricing policy will benefit the organization in the following ways : Divisional performance evaluation is made easier. It will develop healthy inter-divisional competitive spirit. Management by exception is possible. It helps in co-ordination of divisional objectives in achieving organizational goals. It provides useful information to the top management in making policy decisions like expansion, sub-contracting, closing down of a division, make or buy decisions, etc. Transfer price will act as a check on suppliers prices. It fosters economic entity and free enterprise system. It helps in self-advancement, generates high productivity and encouragement to meet the competitive economy. It optimizes the allocation of companys financial resources based on the relative performance of various profit centres, which in turn are influenced by transfer pricing policies.

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Answer 28. (b) Fixed assets Working Capital Current Assets Debtors Total investment Desired rate of return Total required return (i.e. profit) Rs. 10,00,000 28% = Budgeted production p.a. (units) Required return per unit Variable cost per unit Fixed cost per unit (Rs. 8,00,000 4,00,000) Transfer price for Division A

Rs. 5,00,000 Rs. 3,00,000 2,00,000 5,00,000 10,00,000 28% Rs. 2,80,000 4,00,000 Re. 0.70 10.00 2.00 12.70

Answer 28. (c) The following are the three key areas of ABC : Product cost differentiation Activities and their cost drivers Identification of non-value added cost In ABC system a cost centre is established for each cost driver and identification, measurement and control of cost drivers is essential in ABC. ABC is the planned and systematic study and determination of cost of each of the branches of business activities that add to the value of product and services. Q. 29. Your company decided to experiment by applying the principles of ABC to the four products currently made and sold. Details of the four products and relevant information are given below for one period : Product A B C D Output in units 120 100 80 120 Costs per unit : Rs. Rs. Rs. Rs. Direct material 40 50 30 60 Direct labour 28 21 14 21 Machine hours (per unit) 4 3 2 3 The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units. The production overhead is currently absorbed by using a machine hour rate, and the total of the production overhead for the period has been analysed as follows : Rs. Machine department costs (rent, business, rates, depreciation and supervision) 10,430 Set-up costs 5,250 Stores receiving 3,600 Inspection/Quality control 2,100 Materials handling and despatch 4,620 You have ascertained that the cost drivers to be used are as listed below for the overhead costs shown :

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Revisionary Test Paper (Revised Syllabus-2008)

Cost Set-up costs Stores receiving Inspection/ Quality control Materials handling and despatch

Cost driver Number of production runs Requisitions raised Number of production runs Orders executed

The number of requisitions raised on the stores was 20 for each product and the number of orders executed was 42, each order being for a batch of 10 of a product. You are required : (i) To calculate the total costs for each product if all overhead costs are absorbed on a machine hour basis. (ii) To calculate the total costs for each product, using activity based costing. (iii) To calculate and list the unit product costs from your figures in (i) and (ii) above, to show the differences and to comment briefly on any conclusions which may be drawn which could have pricing and profit implications. Answer 29. (i) Statement showing total cost of different products, assuming absorption of overhead on a machine hour basis. A B C D Direct material 40 50 30 60 Direct labour 28 21 14 21 Overhead 80 60 40 60 Cost of production per unit (a) 148 131 84 141 Output in units (b) 120 100 80 120 Total cost (Rs.) (a) (b) 17,760 13,100 6,720 16,920 Machine hours = 480 + 300 + 160 + 360 = 1,300 hours Rate per machine hour = Rs. 26,000 / 1,300 hrs. = Rs. 20 (ii) Cost Set-ups Stores/ receiving Inspection/ quality Handling/ dispatch

Rs. 5,250 3,600 2,100 4,620

Drivers Prod. Runs Requisition Prod. Runs Orders

No. 21 80 21 42

Cost/unit of driver Rs. 250 45 100 110

Production runs = (120/20) + (100/20) + (80/20) + (120/20) Requisitions = 20 for each product or 80 in total. It may be pointed out that machine department cost of Rs. 10,430 will continue to be absorbed on a machine hour basis as before. The relevant absorption rate will be = Rs. 10,430 / 1,300 = Rs. 8.02 per machine hour.

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Product Direct material Direct labour Set-ups Stores/receiving Inspection/ quality Handling/dispatch Machine dept. costs Cost per unit (c ) Product Cost per unit Cost per unit Difference (i) (ii) (ii) - (i)

A 4,800 3,360 1,500 900 600 1,320 3,851 16,331 136.09

B 5,000 2,100 1,250 900 500 1,100 2,407 13,257 132.57

C 2,400 1,120 1,000 900 400 880 1,284 7,984 99.80

D 7,200 2,520 1,500 900 600 1,320 2,888 16,928 141.07

A 148 136.09 (11.91)

B 131 132.57 1.57

C 84 99.80 15.80

D 141 141.07 0.07

The total overheads which are spread over the four products have been apportioned on different bases, causing the product cost to differ substantially in respect of Product A and C. A change from traditional machine hour rate to an activity based system may have effect on : (i) Pricing and profits to the extent that pricing is based on a cost-plus approach. (ii) Reported profits to the extent that stock levels fluctuate between reporting periods. Q. 30. Write short notes on : (i) Benchmarking (ii) Role of costs in pricing (iii) Application of service costing (iv) Opportunity cost (471) (v) Departmental overhead rate Answer 30. (i) Benchmarking Benchmarking is the continuous, systematic process of measuring ones output and/or work processes against the toughest competitors or those recognized best in the industry. Benchmarking should not be treated as just comparison. It is necessary to have a point of reference to know how well one is doing. Comparing the result with a competitor helps the management to get a goal that is both desirable and achievable but provides no clue on how the goals are to be achieved. Benchmarking is a systematic and continuous measurement process. It is a process of measuring and comparing an organisations business processes against business process leaders anywhere in the world, to gain information which will help the organization to improve its performance. It is basically a quality practice. Companies choose to benchmark excellent companies whose business processes are analgous to their own.

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Revisionary Test Paper (Revised Syllabus-2008)

Issues addressed in this process include building core competence to sustain competitive advantage, targeting specific shifts in strategy such as entering a new market or developing a new product, making an acquisition and creating a learning and adaptive organization. (ii) Role of costs in pricing Cost data constitute the fundamental element in the price setting process. Higher costs including promotional expenses involved in connection with advertising or personal selling as well as taxation may necessitate an upward adjustment of price. If costs go up, price rise can be quite justified. However, their relevance to the pricing decision must neither be under estimated nor exaggerated. No company should charge prices below full costs unless such a policy appears necessary or expedient in the short period. Costs are just one of the several factors to be considered in a pricing decision and for pricing purposes, costs are best regarded as floor below which a company will not normally price its products. Costs determine the profit consequences of the various pricing alternatives. Cost calculations may also help in determining whether the product whose price is determined by its demand is to be included in the product line or not. Though in the long run, all costs have to be covered for managerial decisions. In the short run direct costs are more relevant. In a single product firm, all costs are direct costs with respect to the product. In multi product firm, for pricing decisions, relevant costs are those costs that are directly traceable to an individual product. In addition, it must contribute to the common costs and to the realization of profit. (iii) Application of service costing The service costing is applied in the following situations : (a) Internal service departments Service costing is applied to the operations concerned in an organization which provide services to production departments. For example, Canteen for the staff, Hospital for the staff, boiler house for supplying steam to production departments, Captive Power generation unit, operation of fleet of vehicles for transport of raw material to factory or distribution of finished goods to the market outlets, computer department services used by other departments etc. (b) Service organizations When services are offered to outside customers with a profit motive and it is the business of the organisation in offering services, like Transport organization, Hotel business, Power generation company etc., service costing is applied. (iv) Opportunity cost Opportunity cost is the value of a benefit sacrificed in favour of an alternative course of action. It is the maximum amount that could be obtained at any given point of time if a resource was sold or put to the most valuable alternative use that would be practicable. Opportunity cost of good or service is measured in terms of revenue which could have been earned by employing that good or service in some other alternative uses. Opportunity cost can be defined as the revenue foregone by not making the best alternative use. Opportunity costs represent income foregone by rejecting alternatives. They are, therefore not incorporated into formal accounting systems because they do not incorporate cash receipts or outflows. Opportunity costs are, however, very relevant when examining alternative proposals or projects. When deciding whether or not to allocate capital to a project it is highly desirable to consider if the money could produce a better or worse return if invested elsewhere. One foregoes the potential benefits of Alternative A if one applied ones resources to Alternative B, and these foregone benefits constitute the opportunity cost of Alternative B. (v) Departmental overhead rate - To arrive at the department overhead rates it is necessary to have complete account of overhead expenses. These overhead expenses are either completely assigned

Group-II : Paper-8 : Cost & Management Accounting

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to the production and service departments or are apportioned by using suitable basis. This process of distributing overhead expenses between the production and service departments , is known as primary distribution. As the service departments in an organization are meant for rendering service to other production departments, their expenses are apportioned to the users viz. production departments. This process of apportioning service department expenses to the production departments by using suitable basis is known as secondary distribution. Thus by using primary and secondary distribution processes, the total overhead expenses are apportioned to the concerned production departments. These total overhead expenses of each production department may be absorbed by using a suitable method of overhead absorption. For example the total overheads of each department may be divided by labour hour, machine hours etc., to arrive at departmental overhead recovery rate.