Paper 4

PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
PART I : COST ACCOUNTING

QUESTIONS
1. (i) The standard and actual figures of a firm are as under:

Standard time for the job 1,000 hours
Standard rate per hour Re. 0.50
Actual time taken 800 hours
Actual wages paid Rs. 360
Compute
(i) Rate variance
(ii) Efficiency variance
(iii) Total labour cost variance
(ii) Wage negotiations are going on with the recognized Labour Union and the
Management wants you to formulate an incentive scheme with a view to increase
productivity.
The case of three typical workers Ram, Shyam and Mohan who produce
respectively 180, 120 and 100 units of the company’s product in a normal day of 8
hours is taken up for study.
Assuming that day wages would be guaranteed at 75 paise per hour and the piece
rate would be based on a standard hourly output of 10 units calculate the earnings
of each of the three workers and the labour cost per 100 pieces under (a) Halsey,
scheme and (b) The Rowan scheme.
Basic Concepts
2. (i) What are the practical difficulties is usually confronted while installing a costing
system ?
(ii) Discuss the essential of a good cost accounting system?
Material
3. (i) What are the considerations which governs the fixation of the maximum and
minimum levels of inventory.
(ii) Alians Ltd. distributes wide range of Water purifier systems. One of its best selling
items is a standard water purifier. The management of Himalaya Ltd. uses the EOQ
decision model to determine optimal number of standard water purifiers to
order. Management now wants to determine how much safety stock to hold.
Alians Ltd. estimates annual demand (360 working days) to be 18,000 standard
water purifiers. Using the EOQ decision model, the company orders 3,600 standard
© The Institute of Chartered Accountants of India

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2011
water purifiers at a time. The lead-time for an order is 12 days. The annual carrying
cost of one standard purifier is Rs. 450. Management has also estimated the
additional stock out costs would be Rs. 900 for shortage of each standard water
purifier.
Alians Ltd. has analysed the demand during 200 past re-order periods. The records
indicate the following patterns:
Demand during lead time Number of times
quantity was demanded
540 6
560 12
580 16
600 130
620 20
640 10
660 6
200
(i) Determine the level of safety stock for standard water purifier that the Alians
Ltd. should maintain in order to minimize expected stock out costs and
carrying 'costs. Carrying costs should be computed on safety stock, which
shall remain in hand at all times during the year. (Consider safety stock levels
of 0, 20, 40 and 60 units).
(ii) What would be the Alians Ltd.'s new re-order point?
Labour
4. In Iyris Manufacturing Co., the basic wage rate is Rs. 10 per hour and overtime rates are
as follows:
Before and after normal working hours : 175% of basic wage rate
Sundays and holidays : 225% of basic wage rate
During the previous year, the following hours were worked:
Normal time : 1,00,000 hours
Overtime before and after working hours : 20,000 hours
Overtime on Sundays and holidays : 5,000 hours
Total : 1,25,000 hours
The following hours have been worked on job ‘Z’ :
Normal : 1000 hours
Overtime before and after working hrs. : 100 hours
Sundays and holidays : 25 hours
Total : 1125 hours

You are required to calculate the labour cost chargeable to jobs ‘Z’ and overhead in each
of the following instances:
(a) Where overtime is worked regularly throughout the year as a policy due to the
labour shortage.
(b) Where overtime is worked irregularly to meet the requirements of production.
(c) Where overtime is worked at the request of the customer to expedite the job.
Overhead
5. Avon Ltd. has three production departments and two service departments. Following
details relating to overheads analysed to production and service departments is made
available to you.
Rs
Production department A 48,000
B 42,000
C 30,000
Service department PQR 14,040
STU 18,000
The expenses of service department are apportioned as follows:
Production departments Service
departments
A B C PQR STU
Service department PQR 20% 40% 30% 10%
Service department STU 40% 20% 20% 20%
You are required to allocate the service department costs over the production
departments using the simultaneous equation method.
Non Integrated Accounts
6. (i) What are the reasons for disagreement of profits as per cost accounts and financial
accounts? Discuss.
(ii) The financial books of Xerox Ltd. reveal the following data for the year ended
31st March, 2010:
Opening Stock: Rs.
Finished goods 875 units 74,375
Work-in-process 32,000
1.4.09 to 31.3.10
Raw materials consumed 7,80,000
Direct Labour 4,50,000
3

Factory overheads 3,00,000

Goodwill 1,00,000
Administration overheads 2,95,000
Dividend paid 85,000
Bad Debts 12,000
Selling and Distribution Overheads 61,000
Interest received 45,000
Rent received 18,000
Sales 14,500 units 20,80,000
Closing Stock: Finished goods 375 units 41,250
Work-in-process 38,667
The cost records provide as under:
¾ Factory overheads are absorbed at 60% of direct wages.
¾ Administration overheads are recovered at 20% of factory cost.
¾ Selling and distribution overheads are charged at Rs. 4 per unit sold.
¾ Opening Stock of finished goods is valued at Rs. 104 per unit.
¾ The company values work-in-process at factory cost for both Financial and
Cost Profit Reporting.
Required:
(a) Prepare statements for the year ended 31st March, 2010 show
¾ the profit as per financial records
¾ the profit as per costing records.
(b) Present a statement reconciling the profit as per costing records with the profit
as per Financial Records.
Contract Costing
7. Ambuja construction company undertook a contract at an estimated price of Rs.125 lacs.
The relevant data for the year ended 31.03.2010 are as under:
(Rs. '000)
Materials issued to site 5,000
Direct wages paid 3,200
Plant hired 700
Site office costs 270
Materials returned from site 100
Direct expenses 1100
Work certified 10,000
4

Progress payment received 7,200

A special plant was purchased specifically for this contract at Rs. 8,00,000 and after use
on this contract till the end of 31.02.2010, it was valued at Rs.5,00,000. This cost of
materials at site at the end of the year was estimated at Rs. 18,00,000. Direct wages
accrued as on 31.03.2010 was Rs. 1,10,000.
Required
Prepare the Contract Account for the year ended 31st March, 2010 and compute the profit
to be taken to the Profit and Loss account.
Operating Costing
8. In order to develop tourism, Jet Airways has been given permit to operate three flights in
a week between Malaysia and Singapore (both side). The airline operates a single
aircraft of 160 seats capacity. The normal occupancy is estimated at 60% throughout the
year of 52 weeks. The one-way fare is Rs. 7,200. The cost of operation of flights are:
Fuel cost (variable) Rs. 96,000 per flight
Food served on board on non-chargeable basis Rs. 125 per passenger
Commission 5% of fare applicable for all booking
Fixed cost:
Aircraft lease Rs. 3,50,000 per flight
Landing Charges Rs. 72,000 per flight
Required:
(i) Calculate the net operating income per flight.
(ii) The airline expects that its occupancy will increase to 108 passengers per flight if
the fare is reduced to Rs. 6,720. Advise whether this proposal should be
implemented or not.
Process Costing
9. Aiasha Co Ltd. produces a component, which passes through two processes. During the
month of January 2011, materials for 40,000 components were put into Process I of
which 30,000 were completed and transferred to Process II. Those not transferred to
Process II were 100% complete as to materials cost and 50% complete as to labour and
overheads cost. The Process I costs incurred were as follows:
Direct Materials Rs.15,000
Direct Wages Rs.18,000
Factory Overheads Rs.12,000
Of those transferred to Process II, 28,000 units were completed and transferred to
finished goods stores. There was a normal loss with no salvage value of 200 units in
Process II. There were 1,800 units, remained unfinished in the process with 100%
complete as to materials and 25% complete as regard to wages and overheads.
5

No further process material costs occur after introduction at the first process until the end
of the second process, when protective packing is applied to the completed components.
The process and packing costs incurred at the end of the Process II were:
Packing Materials Rs.4,000
Direct Wages Rs.3,500
Factory Overheads Rs.4,500
Required:
(i) Prepare Statement of Equivalent Production, Cost per unit and Process I A/c.
(ii) Prepare statement of Equivalent Production, Cost per unit and Process II A/c.
Standard Costing
10. M & S Ltd. produces an article by blending two basic raw materials. The following
standards have been set up for raw materials :
Materials Standards Mix Standard Price per kg.
A 40% Rs. 4.00
B 60% Rs. 3.00
The standard loss in processing is 15%. During March, 2011 the company produced
1700 kg of finished output.
The position of stock and purchases for the month of March, 2011 is as under:
Material Stock on Stock on Purchased during
1-03-11 31-03-11 March, 2011
Kg Kg Kg. Cost
A 35 5 800 3400
B 40 50 1200 3000
Calculate the following variances :
(a) Materials price variance ; (b) Materials usage variance;
(c) Materials yield variance; (d) Materials mix variance;
(e) Total materials cost variance.
Assume first in first out method for issue of material. The opening stock is to be valued
at standard price.
Marginal Costing
11. The Dabour Co. Ltd. Is developing the annual profit plan. They have just reviewed the
“first cut” at the annual income statement and are concerned with the Rs. 1,10,000
indicated profit on a sales volume of 20,000 units. The fixed cost structure of
6

Rs. 9,90,000 appears to be high and they have some doubts about departing from the
unit sales price of Rs. 100. There is a general agreement that the “profit target should be
Rs. 2,20,000”.
You are required to compute.
(a) The budgeted break-even point in rupees and in units and the number of units
required to be sold to earn the target profit;
(b) What will be the new Break-even-point in the following cases:
(i) – If sales price is increased by 20%, and sales will be dropped by 15% then what
would be the new break-even point in rupees and in units. What would be the
new profit figures? How many units would have to be sold to earn the target
profit?
(ii) – A decrease in fixed costs of Rs. 55,000 and a decrease in variable costs of 6%
are contemplated. What would be new B.E.P. in rupees? How many units
must be sold to earn a target profit?
Budgetary Control
12. Little Angel School has a total of 150 students consisting of 5 sections with 30 students
per section. The school plans for a picnic around the city during the week – end to
places such as the zoo, the amusement park, the planetarium etc. A private transport
operator has come forward to lease out the buses for taking the students. Each bus will
have a maximum capacity of 50 (excluding 2 seats reserved for the teachers
accompanying the students. The school will employ two teachers for each bus, paying
them an allowance of Rs. 50 per teacher. It will also lease out the required number of
buses. The following are the other cost estimates:
Cost per student
Breakfast Rs. 5
Lunch 10
Tea 3
Entrance fee at zoo 2
Rent Rs. 650 per bus.
Special permit fee Rs. 50 per bus
Block entrance fee at the planetarium Rs. 250.
Prizes to students for games Rs. 250.
No costs are incurred in respect of the accompanying teachers (except the allowance of
Rs. 50 per teacher).
You are required to prepare:

(a) A flexible budget estimating the total cost for the levels of 30, 60, 90, 120 and 150
students. Each item of cost is to be indicated separately.
(b) Compare the average cost per student at these levels.
(c) What will be your conclusions regarding the break-been level of student if the
school proposes to collect Rs. 45 per student?
13. (i) Discuss the process of estimating profit/loss on incomplete contracts
(ii) Discuss the treatment of by-product Cost in Cost Accounting.
(iii) Distinguish between Job Costing & Batch Costing?
SUGGESTED ANSWERS/HINTS
1. (i) Standard labour cost Rs.

(1,000 hours × Re. 0.50) 500
Actual wages paid 360
Actual rate per hour: Rs. 360/800 hours = Re. 0.45
Calculation of Variances
(i) Rate variance = Actual time (Standard rate – Actual rate)
= 800 hours (Re. 0.50 – Re. 0.45) = Rs. 40 (F)
(ii) Efficiency variance = Standard rate per hour (Standard time – Actual
time)
= Re. 0.50 (1,000 hrs. – 800 hrs.) = Rs. 100 (F)
(iii) Total labour cost variance= Standard labour cost – Actual labour cost
= (Standard rate × standard time) – (Actual rate ×
Actual time)
= (Re .50 × 1,000 hrs.) – (Re .45 × 800 hrs.)
=Rs. 500 – Rs. 360
= Rs. 140(F).

(ii) (a) Halsey Scheme

Name of Actual Std. Time Actual Time
Total Bonus Labour
Workers output for actual time saved
Wages Hrs. cost per
(units) output for Hrs.
inclu- (50% of 100
Hrs. actual ding time pieces**
Output Bonus* saved)
Hrs. Rs. Hrs. Rs.
Ram 180 18 10 8 9.75 5 5.42
Shyam 120 12 4 8 7.50 2 6.25
Mohan 100 10 2 8 6.75 1 6.75
24.00
*Total wages = (Actual hours worked + Bonus hours) Rate per hour
Hence total wages of Ram are : (8 + 5) Rs. 0.75 = Rs. 9.75
Similarly, the total wages of Shyam and Mohan are Rs. 7.50 and Rs. 6.75 respectively.
Total Wages including wages
** Labour cost per 100 pieces = x 100 pieces
Actual Output (units)
9.75
Labour cost per 100 pieces for Ram : x 100 = Rs.5.42
180
Similarly, Labour cost per 100 pieces of Shyam and Mohan are Rs. 6.25 and Rs. 6.75
respectively.
(b) Rowan Scheme
Name of Actual Std. Actual Time Bonus* Wages Bonus Total Labour
workers output Time for time saved hours for @ 0.75 earning cost per
(units) actual taken in (hours) actual per 100
output hours hrs. @ Bonus pieces**
(hours) 0.75 P. hour
per hour
Rs. Rs. Rs. Rs.

(1) (2) (3) (4) (5) (6) (7) (8) 7+8=(9) (10)
Ram 180 18 8 10 4.44 6.00 3.33 9.33 5.18
Shyam 120 12 8 4 2.67 6.00 2.00 8.00 6.67
Mohan 100 10 8 2 1.6 6.00 1.20 7.20 7.20
24.53
Time saved
* Bonus hours = Time taken ×
Standard time

8 hours × 10 hours
Bonus hours of Ram = = 4.44
18 hours
Similarly, bonus hours of Shyam and Mohan are 2.67 hours and 1.6 hours respectively.
Total wages including wages
** Labour cost per 100 pieces = x 100 pieces
Actual Output (units)
9.33
Labour cost per 100 pieces for Ram x 100 = Rs. 5.18
180
Similarly, Labour cost per 100 pieces of Shyam and Mohan are Rs. 6.67 and Rs. 7.20
respectively.
Basic Concepts
2. (i) The practical difficulties usually confronted while installing a costing system in a
manufacturing company are as follows:
(a) Lack of top management support: Installation of a costing system do not
receive the support of top management. They consider it as an interference in
their work. They believe that such a system will involve additional paperwork.
They also have a misconcept in their minds that the system is meant for
keeping a check on their activities.
(b) Resistance from cost accounting departmental staff: The staff resists because of fear
of loosing their jobs and importance after the implementation of the new system.
(c) Non cooperation from user departments: The foremen, supervisor and other
staff members may not cooperate in providing requisite data, as this would not
only add to their responsibilities but will also increase paper work of the entire
team as well.
(d) Shortage of trained staff: Since cost accounting system’s installation involves
specialised work, there may be a shortage of trained staff.
(ii) Essentials of a good cost accounting system:
Various essentials of a good cost accounting system are as follows:
¾ It should be tailor-made, practical, simple and capable of meeting the
requirements of a business concern.
¾ The data used by the system should be accurate, otherwise it may distort the
output of system.
¾ Cost of installing & operating the system should justify the results.
¾ Cost accounting system should have the support of top management of the
concern.
¾ The system should have the necessary support from all the user’s
departments.
10

Material
3. (i) Considerations for the fixation of maximum level of inventory.
Maximum level of an inventory item is its maximum quantity held in stock at any
time. The mathematical formula used for its determination is as follows:
Maximum level = Re-order level – (Minimum Consumption × Minimum Re-order
period) + Re-order quantity.
The important considerations which should govern the fixation of maximum
level for various inventory items are as follows:
(1) The fixation of maximum level of an inventory item requires information about
re-order level. The re-order level itself depends upon its maximum rate of
consumption and maximum delivery period. It in fact is the product of
maximum consumption of inventory item and its maximum delivery period.
(2) Knowledge about minimum consumption and minimum delivery period for each
inventory item should also be known.
(3) The determination of maximum level also requires the figure of economic order
quantity. Economic order quantity means the quantity of inventory to be
ordered so that total ordering and storage cost is minimum.
(4) Availability of funds, storage capacity, nature of items and their price also are
important for the fixation of minimum level.
(5) In the case of important materials due to their irregular supply, the maximum
level should be high.
Considerations for the fixation of minimum level of inventory
Minimum level indicates the lowest figures of inventory balance, which must be
maintained in hand at all times, so that there is no stoppage of production due to
non-availability of inventory. The formula used for its calculation is as follows:
Minimum level of inventory = Re-order level – (Average rate of consumption ×
Average time of inventory delivery).
The main considerations for the fixation of minimum level of inventory are as
follows:
1. Information about maximum consumption and maximum delivery period in
respect of each item to determine its re-order level.
2. Average rate of consumption for each inventory item.
3. Average delivery period for each item. The period can be calculated by
averaging the maximum and minimum period.
(ii) (i) Determination of the level of safety stock to minimize expected stock out costs
and carrying costs
Average daily usage
11

Annual demand
=
No. of working days
18,000 units
= = 50 units per day
360 days
Re-order point = Average daily usage × Lead time

= 50 units per day × 12 days = 600 units
Possible safety stock level = Possible demand − Reorder point
Probability of demand during lead-time is
Demand during No. of time quantity Probability
lead time was demanded
540 6 0.03
560 12 0.06
580 16 0.08
600 130 0.65
620 20 0.10
640 10 0.05
660 6 0.03
200 1.00
Safety Demand Stock-out Prob. Relevant No. of Expected Relevant Total

of
Stock realizations in units stock- stock- orders stock-out carrying Relevant
out out cost cost
level resulting (3)=(2) − (5)=(3)× per (7)= (8) = (1) × costs
900 year (4)×(5) ×
(6)
(units) in Stock- 600 – (1) (Rs.) Rs.450 (9)=(7)+(8)
outs
(1) (2) (3) (4) (5) (6) (Rs.) (Rs.) (Rs.)
0 620 20 0.10 18,000 10 18,000
640 40 0.05 36,000 10 18,000
660 60 0.03 54,000 10 16,200
− − − − 52,200 0 52,200
20 640 20 0.05 18,000 10 9,000
660 40 0.03 36,000 10 10,800
19,800 9,000 28,800
40 660 20 0.03 18,000 10 5,400 18,000 23,400
60 Nil Nil − − − 0 27,000 27,000
Decision:
12

Safety stock of 40 units would minimize Alians Ltd.’s total expected stock-out
and carrying cost.
(ii) New Re-order Point = ROL + Safety Stock
= 600 units + 40 units
= 640 units
Labour
4. Workings
Computation of average inflated wage rate (including overtime premium) :
Basic wage rate : Rs. 10 per hour
Overtime wage rate before and after working : Rs. 10 × 175% = Rs. 17.50 per hour
hours
Overtime wage rate for Sundays and holidays : Rs. 10 × 225% = Rs. 22.50 per hour
Annual wages for the previous year for normal : 1,00,000 hrs. × Rs. 10 = Rs. 10,00,000
time wages
For overtime before and after working hours : 20,000 hrs. × Rs. 17.50 = Rs. 3,50,000
Wages for overtime on Sundays and holidays : 5,000 hrs. × Rs. 22.50 = Rs. 1,12,500
Total wages for 1,25,000 hrs. = Rs. 14,62,500
Average inflated wage rate Rs. 14,62,500
= Rs. 11.70 per hour
1,25,000 hours
(a) Where overtime is worked regularly as a policy due to labour shortage, the
overtime premium is treated as a part of labour cost and job is charged at an
inflated wage rate.
Hence,
Labour cost chargeable to job XYZ = Total hours × Inflated wage rate
= 1,125 hrs. × Rs. 11.70 = Rs. 13,162.50
(b) Where overtime is worked irregularly to meet the requirements of production,
basic wage rate is charged to the job and overtime premium is charged to factory
overheads as under :
Labour cost chargeable to
Job XYZ : 1,125 hours @ Rs. 10 per hour = Rs. 11,250.00
Factory overhead : 100 hrs. × Rs. (17.50 – 10) = Rs. 750.00
25 hrs. × Rs. (22.50 – 10) = Rs. 312.50
Total factory overhead Rs. 1,062.50
13

(c) Where overtime is worked at the request of the customer, overtime premium is
also charged to the job as under :
Rs.
Job XYZ labour cost 1,125 hrs. @ Rs. 10 = 11,250.00
Overtime premium 100 hrs. @ Rs. (17.50 – 10) = 750.00
25 hrs. @ Rs. (22.50 – 10) = 312.50
Total 12,312.50
Overhead
5. Calculation of Total Overheads of Service Departments PQR and STU as per
Simultaneous Equation Method:
Let
X = total overhead of service department PQR
Y = total overhead of service department STU
The total overhead transferred into service departments 1 and 2 can be expressed as
X = 14,040 +0.2 Y
Y = 18,000 + 0.1 X
Rearranging the above equations:
X – 0.2 Y =14,040 ………………………………..(1)
- 0.1X + Y =18,000 ………………………………..(2)
Multiplying equation (1) by 5 and equation (2) by 1, we get
5X – Y =70,200
-0.1X + Y =18,000
Adding the above equations together we have
4.9X =88,200
or X =18,000
and hence Y =19,800
Apportionment of the values of X and Y to the production departments in the
agreed percentages
A B C Total
Allocation as per overhead 48,000 42,000 30,000 1,20,000
analysis
Allocation of service 3,600(20%) 7,200(40%) 5,400(30%) 16,200
department PQR
14

Allocation of service 7,920(40%) 3,960(20%) 3,960(20%) 15,840

department STU
59,520 53,160 39,360 1,52,040
Non Integrated Accounts
6. (i) Reasons for disagreement of ‘Profits as per Financial accounts and Cost accounts
are as below. There are certain items which are included in Financial accounts but
not in Cost Accounts. Likewise there are certain items which are in Cost Accounts
but not in Financial accounts.
Examples of financial charges which appear only in financial books are:
a. Loss on the sale of fixed assets and investments.
b. Interest on bank loans, mortgage etc.
c. Expenses relating to the issue and transfer of shares and debentures like
stamps duty expenses; discount on shares and debentures etc.
d. Penalties and fines.
Examples of incomes which are recorded in the financial books only are:
a. Profit on the sale of investments and fixed assets.
b. Interest received on investments and bank deposits.
c. Dividend received on investment in shares.
d. Fees received on issue and transfer of shares etc.
e. Rental income.
There are abnormal or special items of expenditure and income which are not included
in the cost of production. Their inclusion in cost of production, would result into incorrect
cost ascertainment. Different bases of charging depreciation also accounts for the
disagreement of profits as per financial and cost accounts. Different methods of
valuation of closing stock adopted in cost and financial accounts will also account for the
difference in profits under financial and cost accounts.
(ii) Statement of Profit as per financial records
OR
Profit & Loss Account of the company
(for the year ended March 31, 2010)
Rs. Rs.
To Opening stock of Finished 74,375 By Sales 20,80,000
Goods
To Work-in-process 32,000 By Closing stock of finished 41250
Goods
15

To Raw materials consumed 7,80,000 By Work-in-Process 38,667

To Direct labour 4,50,000 By Rent received 18,000
To Factory overheads 3,00,000 By Interest received 45,000
To Goodwill 1,00,000
To Administration overheads 2,95,000
To Selling & distribution overheads 61,000
To Dividend paid 85,000
To Bad debts 12,000
To Profit 33,542 ________
22,22,917 22,22,917
Statement of Profit as per costing records

(for the year ended March 31,2010)
Rs.
Sales revenue (A) (14,500 units) 20,80,000
Cost of sales:
Opening stock (875 units x Rs. 104) 91,000
Add: Cost of production of 14,000 units (Refer to working note 2) 17,92,000
Less: Closing stock 48,000
 Rs. 17,92,000 × 375 units 
 
 14,000 units 
Production cost of goods sold (14,500 units) 18,35,000
Selling & distribution overheads (14,500 units x Rs. 4) 58,000
Cost of sales: (B) 18,93,000
Profit: {(A) – (B)} 1,87,000
(ii) Statement of Reconciliation
(Reconciling the profit as per costing records with the profit as per financial records)
Rs. Rs.
Profit as per Cost Accounts 1,87,000
Add: Administration overheads over absorbed 3,667
(Rs. 2,98,667 – Rs. 2,95,000)
Opening stock overvalued (Rs. 91,000 – Rs. 74,375) 16,625
Interest received 45,000
Rent received 18,000 83,292
2,70,292
16

Less: Factory overheads under recovery 30,000

(Rs. 3,00,000 – Rs. 2,70,000)
Selling & distribution overheads under recovery 3,000
(Rs. 61,000 – Rs. 58,000)
Closing stock overvalued (Rs. 48,000 – Rs. 41,250) 6,750
Goodwill 1,00,000
Dividend 85,000
Bad debts 12,000 2,36,750
Profit as per financial accounts 33,542
Working notes:
1. Number of units produced
Units
Sales 14,500
Add: Closing stock 375
Total 14,875
Less: Opening stock 875
Number of units produced 14,000
2. Cost Sheet
Rs.
Raw materials consumed 7,80,000
Direct labour 4,50,000
Prime cost 12,30,000
Factory overheads (60% of direct wages) 2,70,000
Factory cost 15,00,000
Add: Opening work-in-process 32,000
Less: Closing work-in-process 38,667
Factory cost of goods produced 14,93,333
Administration overheads 2,98,667
(20% of factory cost)
Cost of production of 14,000 units 17,92,000
(Refer to working note 1)
Cost of production per unit:
17

TotalCost of Production Rs.17,92,000

= = = Rs.128
No.of unitsproduced 14,000units
Contract Costing
7. Contract Account for the year ended 31st March, 2010
Dr. Cr.
Rs. ‘000 Rs. ‘000
To Materials issued to site 5,000 By Materials at site 1,800
To Direct wages 3,200 By Materials 100
To Wages accrued 110 returned 8,780
To Plant hired 700 By Cost of contract
To Site Office Costs 270
To Direct expenses 1100
To Depreciation of special plant 300 _____
10,680 10,680
To Cost of contract 8,780 By Work certified 10,000
To Notional Profit 1,220
10,000 10,000
By Notional profit 1220
To Profit & Loss A/c 585.60
To Profit & Loss Reserve A/c 634.40
1220 1220
Working notes
Cost of work certified
1. Percentage of contract completion = × 100
Value of the contract
100 lacs
= × 100 = 80%
125 lacs
2. Since the percentage of Contract completion is more than 50 % but less than
90% therefore the profit to be taken to Profit and Loss Account can be
computed by using the following formula.
2 Cash received
Profit to be taken to P & L A/c = × Notional Profit ×
3 Work certified
2 7,200
= × 1220 x = Rs. 585.60
3 10,000
18

Operating Costing
8.
No. of passengers 160×60/100 = 96 Rs Rs.
(i) Fare collection 96×7,200 6,91,200
Variable costs:
Fuel 96,000
Food 96×125 12,000
Commission 5% 34,560
Total variable Costs 1,42,560
Contribution per flight 5,48,640
Fixed costs: Lease 3,50,000
Crew 72,000 4,22,000
Net income per flight 1,26,640
(ii) Fare collection 108×6,720 7,25,760
Variable costs:
Fuel 96,000
Food 108×125 13,500
Commission @ 5% 36,288
Total Variable Cost 1,45,788
Contribution 5,79,972
There is an increase in contribution by Rs. 31,332. Hence the proposal is acceptable
Process Costing
9. Process I
Statement of Equivalent Production and Cost
Material Labour and Total
Overheads
Units completed 30,000 30,000
Closing Inventory 10,000 5,000
Equivalent Production 40,000 35,000
Rs. Rs. Rs.
Current Process cost 15,000 30,000 45,000
Cost/unit 0.375 0.8571
19

Closing inventory cost 3,750 4,286 8,036

Material transferred to Process II 36,964
Process I Account
Units Rs. Units Rs.
Direct material 40,000 15,000 Process II A/c 30,000 36,964
Direct wages 18,000 Work-in-progress inventory 10,000 8,036
Factory overheads 12,000
40,000 45,000 40,000 45,000
Process II
Statement of Equivalent Production and Cost
Material Labour and Overheads Total
Units completed 28,000 28,000
Closing Inventory 1,800 450
Equivalent Production 29,800 28,450
Process cost 36,964 8,000 44,964
Cost/unit 1.24 0.2812
Closing inventory 2,232 127 2,359
42,605
Packing material cost 4,000
Rs. 46,605
Process II Account
Units Rs. Units Rs.
To Material transferred 30,000 36,964 By Finished goods
from Process I stores A/c 28,000 46,605
To Packing Material 4,000 By WIP stock 1,800 2,359
To Direct wages 3,500 By Normal loss 200 −
To Factory overheads 4,500 ______ ______
30,000 48,964 30,000 48,964
Standard Costing
10. Material used :
A-35 kg + 800 kg – 5 kg. = 830 kg.
B-40 kg + 1200 kg – 50 kg. = 1190 kg.
Actual cost of materials used :
20

A – 35 kg. x Rs. 4 per Kg = Rs. 140.00

795 kg. x (3,400/800) = 3,378.75
B - 40 kg. x Rs. 3 per Kg 120.00
1,150 kg. x (3,000/1,200) = 2,875.00
6,513.75
Standard cost of materials used :
A – 830 kg. x Rs. 4 per Kg = 3,320.00
B – 1,190 kg x 3 per Kg = 3,570.00
6,890.00
Standard cost of material, in standard proportion.
A - (40/100) x 2,020 x Rs. 4 per Kg = 3,232
B – (60/100) x 2,020 x Rs. 3 per Kg = 3,636
6,868.00
Standard material cost of output
Suppose total weight of mix (input) = 100 kg.
Therefore, A – 40 kg. x Rs. 4 per Kg = 160
B – 60 kg × Rs. 3 per kg = 180
100 kg 340
Less loss 15% 15
85 kg.
For out put 85 kg. the cost (standard) = Rs. 340
For output 1,700 kg. the cost = (340/85) x 1,700 = Rs.6,800
Materials Price Variance = Actual cost of materials used – Standard cost of
materials used
= 6,513.75 – 6,890.00
= Rs. 376.25 (F)
Materials Mix Variance = Standard cost of materials used – Standard cost of
material in standard proportion
= 6890.00 – 6868.00 = 22.00 (A)
Materials Yield Variance = Standard cost of material in standard proportion –
Standard material cost of output
= 6868.00 – 6800 = 68 (A)
21

Materials Usage Variance = Standard cost of materials used – Standard material

cost of output
= 6890.00 – 6800.00 = 90 (A)
Total Materials Cost Variance = Actual cost of materials used – Standard material
cost of output
= 6513.75 – 6800.00 = 286.25 (F)
Note: Material Price Variance has been calculated on the basis of material used.
Marginal Costing
11. (a) Sales volume (units) 20,000
Total Per unit
Sales Rs. 20,00,000 Rs. 100.00
Fixed Cost 9,90,000 49.50
Profit 1,10,000 5.50
Contribution 11,00,000 55.00
Variable Cost 9,00,000 45.00
55
P/V Ratio = Contribution/Sales × 100 = × 100 = 55%
100
Break Even Sales in units = Fixed cost ÷ Contribution per unit
= Rs. 9,90,000 /55 = 18,000 units
Break Even Sales in Rupees = 18,000 units × Rs. 100 Rs. 18,00,000
Target Profit Rs. 2,20,000
Fixed cost 9,90,000
Target contribution (Profit + Fixed Cost) 12,10,000 …(i)
Number of units to be sold = Target contribution ÷ Contribution per unit
= Rs. 12,10,000 ÷ Rs. 55 = 22,000 units
(b) (i) 20% increase in price = Rs. 100 + 20 Rs. 120
Less: Variable cost per unit 45
Contribution per unit 75
Break Even Point = Rs. 9,90,000 ÷ Rs. 75 = 13,200 units
Break Even Sales = 13,200 X Rs. 120 = Rs. 15,84,000
Net Profit figure with 15% reduction in sales is 17,000 units
( 20000 – 15% of 20000)
Contribution (17,000 X Rs. 75) Rs. 12,75,000
22

Less: Fixed cost 9,90,000

Net Profit 2,85,000
No. of units to be sold to earn target contribution of Rs. 12,10,000 as at
(i) above
= Target contribution ÷ Contribution per unit
= Rs. 12,10,000 ÷ 75 = Rs. 16,133
(ii) In this condition:
Revised Fixed Cost Rs. 9,35,000
Revised variable cost per unit Rs. 45 less 6% 42.30
Revised contribution per unit = Rs. 100 – Rs. 42.30 57.70
Break Even Sales=Revised Fixed Cost ÷ Revised Contribution Ratio
=Rs.9,35,000 ÷ 0.5770=Rs.16,20,451
Target Profit Rs. 2,20,000
Revised Fixed Cost 9,35,000
Revised Contribution 11,55,000
No. of units to be sold = Rs. 11,55,000 ÷ Rs. 57.70 = 20,017 units.
Budgetary Control
12. (a) Flexible Budget for different levels
No. of Students 30 60 90 120 150
Variable Costs Rs. Rs. Rs. Rs. Rs.
Breakfast 150 300 450 600 750
Lunch 300 600 900 1,200 1,500
Tea 90 180 270 360 450
Entrance fee 60 120 180 240 300
Total (A) 600 1,200 1,800 2,400 3,000
Variable cost/unit 20 20 20 20 20
Semi-variable costs
Bus rent 650 1,300 1,300 1,950 1,950
Special permit fee 50 100 100 150 150
Allowance for teachers 100 200 200 300 300
Total (B) 800 1,600 1,600 2,400 2,400
Fixed Cost
23

Block entrance fee 250 250 250 250 250

Prize to students 250 250 250 250 250
Total (C) 500 500 500 500 500
Total cost (A+B+C) 1,900 3,300 3,900 5,300 5,900
(b) Cost per student 63.33 55.00 43.33 44.17 39.33
(C) Break-even level
Collection per student = Rs. 45
Less Variable Cost 20
Contribution 25
Since semi-fixed costs relate to a block of 50 students, the fixed and semi-variable
cost for three levels will be:
Number of student Up to 50 51-100 101-150
Fixed Cost + Semi-variable cost Rs. 1,300 2,100 2,900
Contribution per unit 25 25 25
Break Even level of students 52 84 116
13. (i) Process of estimating profit / loss on incomplete contracts
a. If completion of contract is less than 25% no profit should be taken to profit
and loss account.
b. If completion of contract is upto 25% or more but less than 50% then
Cash received
1. 1/3 × Notional Profit ×
Work certified
2. may be taken to profit and loss account.
c. If completion of contract is 50% or more but less than 90% then
Cash received
1. 2/3 × Notional Profit ×
Work certified
2. may be taken to profit and loss account
d. If completion of contract is greater than or equal to 90% then one of the
following formulas may be used for taking the profit to profit and loss account.
Work certified
1. Estimated Profit ×
Contract price
Work certified Cash received
2. Estimated Profit × ×
Contract price Work certified
24

Cost of the work to date

3. Estimated Profit ×
Estimated total cos t
Cost of the work to date Cash received
4. Estimated Profit × ×
Estimated total cos t Work certified
Work certified
5. Notional Profit ×
Contract price
(ii) Treatment of by-product cost in Cost Accounting:
(a) When they are of small total value, the amount realized from their sale may be
dealt as follows:
¾ Sales value of the by-product may be credited to Profit and Loss Account
and no credit be given in Cost Accounting. The credit to Profit and Loss
Account here is treated either as a miscellaneous income or as additional
sales revenue.
¾ The sale proceeds of the by product may be treated as deduction from
the total costs. The sales proceeds should be deducted either from
production cost or cost of sales.
(b) When they require further processing:
In this case, the net realizable value of the by product at the split-off point may
be arrived at by subtracting the further processing cost from realizable value of
by products. If the value is small, it may be treated as discussed in (a) above.
(iii) Job Costing and Batch Costing
Accounting to job costing, costs are collected and accumulated according to job.
Each job or unit of production is treated as a separate entity for the purpose of
costing. Job costing may be employed when jobs are executed for different
customers according to their specification.
Batch costing is a form of job costing, a lot of similar units which comprises the
batch may be used as a cost unit for ascertaining cost. Such a method of costing is
used in case of pharmaceutical industry, readymade garments, industries
manufacturing parts of TV, radio sets etc.
25

PROFESSIONAL COMPETENCE EXAMINATION: MAY, 2011
PART II : FINANCIAL MANAGEMENT

QUESTIONS
1. Answer the following, supporting the same with reasoning/working notes:

(a) Company Zeta has credit sales of ` 4,00,00,000 and average receivables balance
of ` 30,00,000; you are required to compute the receivable collection period.
(b) Discuss briefly the concept of seed capital assistance.
(c) Explain briefly ‘Modified Internal Rate of Return (MIRR)’ method for evaluating
capital investment proposals.
(d) You are required to calculate the total current assets of Ananya Limited from the
given information:
Stock turnover = 5 times
Sales (All credit) = ` 7,20,000
Gross Profit Ratio = 25%
Current Liabilities = ` 2,40,000
Liquid Ratio = 1.25
Stock at the end is ` 30,000 more than stock in the beginning.
(e) Discuss the factors to be considered by a venture capitalist before financing any
risky project.
Working Capital Management
2. Electropipes Limited manufactures products used in the steel industry. The following
information regarding the company is given for your consideration:
(i) Expected level of production 6000 units.
(ii) Raw materials are expected to remain in stores for an average of two months before
issue to production.
(iii) Work-in-progress (50 percent complete as to conversion cost) will approximate to
1
month’s production.
2
(iv) Finished goods remain in warehouse on an average for one month.
(v) Credit allowed by suppliers is one month.
(vi) Two month’s credit is normally allowed to debtors.
(vii) A minimum cash balance of ` 45,000 is expected to be maintained.
(viii) Cash sales are 75 percent less than the credit sales.
(ix) Safety margin of 20 percent to cover unforeseen contingencies.
26

(x) The production pattern is assumed to be even during the year.

(xi) The cost structure for Electropipes Limited’s product is as follows:
`
Raw Materials 80 per unit
Direct Labour 20 per unit
Overheads (including depreciation ` 20) 80 per unit
Total Cost 180 per unit
Profit 20 per unit
Selling Price 200 per unit
You are required to estimate the working capital requirement of Electropipes Limited.
Investment Decisions
3. Shahji Limited is considering two mutually exclusive machines – Machine ‘A’ and
Machine ‘B’. Details of these machines are as follows:
Initial Outlay - Machine A: ` 16,00,000
Machine B: ` 24,00,000
Estimated Life - Machine A: 5 years
Machine B: 6 years
Required rate of return - 10 percent
Profit after tax and depreciation
Years 1 2 3 4 5 6
Machine A (`) 5,00,000 4,00,000 3,50,000 3,00,000 1,50,000 -
Machine B (`) 8,00,000 5,60,000 4,50,000 3,00,000 2,90,000 2,00,000
Both the machines will be depreciated on straight-line method.
You are required to rank the machines according to:
(i) Pay-back period method;
(ii) Accounting rate of return on initial investment; and
(iii) Net present value method.
Financing Decisions
4. You are required to compute the weighted average cost of capital (WACC) of Ganpati
Limited considering the given data by using:
(a) Book value weights and
(b) Market value weights.
27

The capital structure of Ganpati Limited is as under:

`
Debentures (` 100 per debenture) 5,00,000
Preference shares (` 100 per share) 5,00,000
Equity shares (` 10 per share) 10,00,000
20,00,000
The market prices of these securities are:
Debentures : ` 105 per debenture
Preference Shares : ` 110 per preference share
Equity Shares : ` 24 each.
Additional information:
(i) ` 100 per debenture redeemable at par, 10% coupon rate, 4% floatation costs, 10
year maturity.
(ii) ` 100 per preference share redeemable at par, 5% coupon rate, 2% floatation cost
and 10 year maturity.
(iii) Equity shares has ` 4 floatation cost and market price ` 24 per share.
The next year expected dividend is ` 1 with annual growth of 5 percent. The firm has
practice of paying all earnings in the form of dividend. The corporate tax rate is 50 percent.
Financial Analysis and Planning
5. Megatech Limited is a manufacturer of products for the construction industry and its
accounts are given for your consideration. You are required to calculate the liquidity and
working capital ratios from the accounts and comment on the ratios.
2010 2009
` ( in lakhs) ` ( in lakhs)
Turnover 2,065.0 1,788.7
Cost of Sales 1,478.6 1,304.0
Gross Profit 586.4 484.7
2010 2009
` ( in lakhs) ` ( in lakhs)
Current Assets
Stocks 119.0 109.0
Debtors (Refer to Note A) 400.9 347.4
Short-term Investments 4.2 18.8
Cash at bank and in hand 48.2 48.0
572.3 523.2
28

Current Liabilities
Loans and Overdrafts 49.1 35.3
Taxes 62.0 46.7
Dividend 19.2 14.3
Creditors (Refer to Note B) 370.7 324.0
501.0 420.3
Net Working Capital 71.3 102.9
Notes:
2010 2009
` `
A Trade Debtors 329.8 285.4
B Trade Creditors 236.2 210.8
6. The management of Fibroplast Limited is trying to establish a current assets policy. Fixed
assets are ` 6,00,000, and the company plans to maintain a 50 percent debt-to-assets
ratio. It has no operating current liabilities. The interest rate is 10 percent on all debts.
They are considering three alternative current asset policies - 40, 50 and 60 per cent of
projected sales. The company expects to earn 15 percent before interest and taxes on
sales of ` 30,00,000. The effective tax rate is 40 percent. You are required to calculate
the expected return on equity under each alternative?
Financing Decisions
7. Mahalaxmi Limited is setting up a project with a capital outlay of ` 60,00,000. It has two
alternatives in financing the project cost.
Alternative (A): 100% equity finance
Alternative (B): Debt-equity ratio 2:1
The rate of interest payable on the debt is 18 percent per annum. The effective tax rate
is 40 percent. Calculate the indifference point between the two alternative methods of
financing.
8. Shortblast Limited currently has sales of ` 30 lakhs, with an average collection period of
two months and no discounts are given. The management of the company is undecided
as to whether to allow a discount on sales of 2 percent to settle within one month. The
company assumes that all customers would take advantage of the discount. The
company can obtain a return of 30 percent on its investments. Advise the management
of Shortblast Limited regarding the change in policy.
29


9. Seal Limited’s balance sheets as on 31st March, 2009 and 2010 are given below:
Liabilities 31.3.09 31.3.10 Assets 31.3.09 31.3.10
` ` ` `
Equity Capital 15,00,000 17,00,000 Fixed Assets 15,30,000 20,60,000
General Reserve 1,80,000 2,10,000 9% Investments
Profit & Loss A/c 1,50,000 6,00,000 (Long term) 90,000 2,40,000
12% debentures 3,00,000 4,50,000 Debtors 1,20,000 2,25,000
Creditors 60,000 2,25,000 Stock 5,70,000 5,55,000
Bills payables 60,000 50,000 Cash-in-hand 1,80,000 5,40,000
Bank overdraft 30,000 25,000 Underwriting
Proposed dividend 1,80,000 2,25,000 commission 7,500 9,000
Provision for tax 30,000 60,000 Discount on issue
Provision for of debentures 22,500 6,000
Doubtful debts 30,000 45,000
Unpaid interest
on debentures - 35,000
Unpaid dividend - 10,000
Total 25,20,000 36,35,000 Total 25,20,000 36,35,000
Additional information:
During the year ended 31st March, 2010 :
(i) A machine costing ` 2,10,000 (depreciation provided thereon ` 90,000) was sold for
` 75,000. Depreciation charged during the year was ` 2,10,000.
(ii) New shares and debentures were issued on 31st March, 2010.
(iii) Tax paid during the year was ` 15,000.
(iv) An interim dividend @ 15 percent was paid on equity shares.
(v) On 31st March, 2010, some investments were purchased for ` 2,70,000 and some
investments were sold at a profit of 20 percent on sale.
You are required to prepare the statement showing funds from operation.
Time Value of Money
10. Mr. Shanker, an executive in an MNC, is thirty-five years old. He has decided it is time to
plan seriously for his retirement. At the end of each per year until he is sixty-five, he will
save ` 10,000 in a retirement account. If the account earns 10 percent per year, how
much will Mr. Shanker have saved at the age of sixty-five?
30


11. Nine-o-Nine Limited is into retail business. The following information is given for your
consideration:
(i) Purchases are 75 percent of sales or Purchases are sold at cost plus 33 1 3 percent.
(ii)
Budgeted Sales Labour Cost Expenses Incurred
` ` `
January 40,000 3,000 4,000
February 60,000 3,000 6,000
March 160,000 5,000 7,000
April 120,000 4,000 7,000
(iii) The policy of the management is to have sufficient stock in hand at the end of each
month to meet sales demand in the next half month.
(iv) Creditors for materials and expenses are paid in the month after the purchases are
made or the expenses incurred. Labour is paid in full by the end of each month.
(v) Expenses include a monthly depreciation charge of ` 2,000
(vi) (a) 75 percent sales are for cash.
(b) 25 percent of sales are on one month’s interest-free credit.
(vii) The company will buy equipment costing `18,000 on cash in February and will pay
a dividend of `20,000 in the month of March. The opening cash balance on 1st
February is `1,000.
You are required to prepare:
(a) A profit and loss account for the months of February and March; and
(b) A cash budget for the months of February and March.
12. Differentiate between the following:
(a) Euro Bonds and Foreign Bonds
(b) Inflation Bonds and Floating Rate Bonds
(c) Investment Decision and Financing Decision.
13. Write short notes on the following:
(a) Trade Credit
(b) Pre-Shipment Finance
(c) Traditional View of Capital Structure.
31

SUGGESTED ANSWERS/HINTS
1. (a) Computation of Receivables Collection Period

Average receivables
Receivables collection period =
Credit sales per day
Rs. 30,00,000
Receivables collection period =
Rs. 4,00,00,000 / 365 days
= 27 days
(b) Concept of Seed Capital Assistance
This scheme is designed by IDBI for professionally or technically qualified
entrepreneurs and/or persons possessing relevant experience, skills and
entrepreneurial traits. All the projects eligible for financial assistance from IDBI,
directly or indirectly, through refinance are eligible under this scheme. The project
cost should not exceed ` 2 crores and the maximum assistance under the project
will be restricted to 50 percent of the required promoter’s contribution or ` 15 lacs,
whichever is lower.
The seed capital assistance is interest-free but carries a service charge of 1 percent
per annum for the first five years and at increasing rate thereafter. However, IDBI
will have the option to charge interest at such rate as may be determined by IDBI on
the loan if the financial position and the profitability of the company so permits
during the duration of the loan.
(c) Modified Internal Rate of Return (MIRR) as a Method for Evaluating Capital
Investment Proposals
There are several limitations attached with the concept of the conventional internal
rate of return. The MIRR addresses some of these deficiencies, for example, it
eliminates multiple IRR rates; it addresses the reinvestment rate issue and
produces results which are consistent with the net present value (NPV) method.
To calculate MIRR, all cash flows, apart from the initial investment, are brought to
the terminal value using an appropriate discount rate (usually the cost of capital).
This results in a single stream of cash inflows in the terminal year. The MIRR is
obtained by assuming a single outflow in the zeroth year and the terminal cash
inflow as mentioned above. The discount rate which equates the present value of
the terminal cash inflow to the zeroth year outflow is called the MIRR.
(d) Computation of Total Current Assets of Ananya Limited
Cost of Goods Sold = Sales – Gross Profit
= 7,20,000 – 1,80,000 (25% of 7,20,000)
= ` 5,40,000
32

Cost of Goods Sold

Stock Turnover =
Average Stock
5,40,000
5 =
Average Stock
5,40,000
Average Stock = = ` 1,08,000
5
Closing Stock is ` 30,000 more than Opening Stock
Let Opening Stock = x
Closing stock will be (x + 30,000)
x + x + 30,000
= 1,08,000
2
2x = 2,16,000 – 30,000
1,86,000
x= = 93,000
2
Closing Stock will be (93,000 + 30,000) = ` 1,23,000
Liquid Assets
Liquid Ratio =
Current Liabilities
Liquid Assets
1.25 =
2,40,000
Liquid Assets = 3,00,000
Current Assets = Liquid Assets + Closing Stock
= 3,00,000 + 1,23,000
Current Assets = ` 4,23,000
(e) Factors to be considered by a Venture Capitalist before Financing Any Risky
Project
The factors that a venture capitalist should consider before financing any risky
project are as follows:
(i) Level of Expertise of Company’s Management: Most of the venture
capitalists believe that the success of a new project is highly dependent on the
quality of its management team. They expect that the entrepreneur should
have a skilled team of managers. Management is also required to show a high
level of commitment to the project.
33

(ii) Level of Expertise in Production: Venture capital should ensure that

entrepreneur and his team should have necessary technical ability to be able
to develop and produce new product / service.
(iii) Nature of New Product / Service: The venture capitalist should consider
whether the development and production of new product / service is technically
feasible. They should employ experts in their respective fields to examine the
idea proposed by the entrepreneur.
(iv) Future Prospects: Since the degree of risk involved in investing in the
company is quite high, venture capitalists should seek to ensure that the
prospects for future profits compensate for the risk. Therefore, they should
see a detailed business plan setting out the future business strategy.
(v) Competition: The venture capitalists should seek assurance that there is
actually a market for a new product. Further, they should see the research
carried on by the entrepreneur.
(vi) Risk borne by Entrepreneur: The venture capitalist is expected to see that
the entrepreneur bears a high degree of risk. This will assure them that the
entrepreneur has the sufficient level of commitment to the project as he will
incur a lot of loss, should the project fail.
(vii) Exit Route: The venture capitalist should try to establish a number of exist
routes. These may include a sale of shares to the public, sale of shares to
another business, or sale of shares to original owners.
(viii) Board Membership: In case of companies, to ensure proper protection of their
investment, venture s should seek a place on the Board of Directors. This will
enable them to have their say on all significant matters affecting the business.
2. Estimation of Working Capital Requirement
Statement Showing the Requirement of Working Capital
`
A. Current Assets
 2
Stock Raw Material  4,80,000 ×  80,000
 12 
Stock of Work-in-Progress 30,000
 1
Stock of Finished Goods  9,60,000 ×  80,000
 12 
 2
Debtors  7,68,000 ×  1,28,000
 12 
Cash in hand 45,000
Total Current Assets 3,63,000
34

B. Current Liabilities
 1
Creditors for Raw Material  4,80,000 ×  40,000
 12 
Total Current Liabilities 40,000
Net Working Capital (A – B) 3,23,000
Add: Safety Margin of 20 percent 64,600
Net Working Capital after adding Safety Margin 3,87,600
Working Notes:
(i) Calculation of Credit Sales
Let credit sales be x
Cash Sales = x – 3/4x
Total Sales = x + (x – 0.75x) = ` 12,00,000
2x – 0.75x = 12,00,000
12,00,000
X= × 4 = ` 9,60,000
5
(ii) Calculation of Stock of Finished Goods and Cost of Sales

Direct Material (6000 units x 80) = 4,80,000
Direct Labour (6000 units x 20) = 1,20,000
Overhead (excluding dep.) (6000 units x 60) = 3,60,000
Total Cash Cost 9,60,000
Add: Opening Stock of Finished Goods 80,000
Total Cost of Goods Available 10,40,000
Less: Closing Stock of Finished Goods (9,60,000÷12) 80,000
Total Cash Cost of Goods Sold 9,60,000
Cash Cost of Credit Sales

4
9,60,000 × = ` 7,68,000
5
35

(iii) Calculation of Stock of Work-in-Progress

 4,80,000 
Raw material  × 0.5  = ` 20,000
 12 
Wages (1,20,000/12 × 0.5 × 50%) = 2,500
Overheads (3,60,000/12 × 0.5 × 50%) 7,500
` 30,000
3. Ranking of Two Machines according to Payback Period Method, Accounting Rate
of Return (ARR) Method and Net Present Value (NPV) Method
Calculation of Cash inflows and Present Value
Machine A Machine B
Years P.V. Profit Dep. Cash Present Profit Dep. Cash Present
factor after Tax Inflows Value after Tax Inflows Value
@10% & Dep. & Dep.
` ` ` ` ` ` ` ` `
1 0.909 5,00,000 3,20,000 8,20,000 7,45,380 8,00,000 4,00,000 12,00,000 10,90,800
2 0.826 4,00,000 3,20,000 7,20,000 5,94,720 5,60,000 4,00,000 9,60,000 7,92,960
3 0.751 3,50,000 3,20,000 6,70,000 5,03,170 4,50,000 4,00,000 8,50,000 6,38,350
4 0.683 3,00,000 3,20,000 6,20,000 4,23,460 3,00,000 4,00,000 7,00,000 4,78,100
5 0.621 1,50,000 3,20,000 4,70,000 2,91,870 2,90,000 4,00,000 6,90,000 4,28,490
6 0.564 2,00,000 4,00,000 6,00,000 3,38,400
Total 17,00,000 33,00,000 25,58,600 26,00,000 50,00,000 37,67,100
Initial Outlay
Depreciation =
Estimated Life
Depreciation of Machine A = ` 16,00,000/5 = ` 3,20,000 per annum
Depreciation of Machine B = ` 24,00,000/6 = ` 4,00,000 per annum
(i) Calculation of Payback Period
Years 1 2 3 4 5 6
Cum. Cash Inflows of 8,20,000 15,40,000 22,10,000 28,30,000 33,00,000 -
Machine “A” (` )
Cum. Cash Inflows of 12,00,000 21,60,000 30,10,000 37,10,000 44,00,000 50,00,000
Machine “B” (` )
60,000
Pay back Period for A = 2 + = 2.09 years
6,70,000
36

2,40,000
Pay back period for B = 2 + = 2.28 years
8,50,000
(ii) Calculation of Accounting Rate of Return (ARR) on Initial Investment
Average Annual Income
ARR = × 100
Initial Investment
17,00,000
Average Annual Income for A = = ` 3,40,000
5
26,00,000
Average Annual Income for B = = ` 4,33,333
6
Rs. 3,40,000
ARR for A = × 100 = 21.25%
Rs. 16,00,000
Rs. 4,33,333
ARR for B = × 100 = 18.06%
Rs. 24,00,000
(iii) Calculation of Net Present Value (NPV)
NPV of A = ` 25,58,600 – ` 16,00,000 = ` 9,58,600
NPV of B = ` 37,67,100 – ` 24,00,000 = ` 13,67,100
(iv) Ranking According to the Three Methods
Basis of Rank Machine A Machine B
Payback Period I II
ARR I II
NPV II I
4. Computation of Weighted Average Cost of Capital (WACC)

1
Cost of Equity = K e = + 0.05
20
= 0.05 + 0.05
= 0.10
(100 − 96)
10(1 − 0.5) +
Cost of Debt = K d = 10
(100 + 96)
2
 5 + 0.4 
=  × 2 = 0.055 (approx.)
 196 
37

 2 
 5 + 10 
Cost of Preference Shares = K p =  
 198 
 2 
 5.2 
=   = 0.053 (approx.)
 99 
Calculation of WACC (K0) using Book Value Weights
Source of Capital Book Value Specific Cost (K%) Total Cost
10% Debentures 5,00,000 0.055 27,500
5% Preference Shares 5,00,000 0.053 26,500
Equity Shares 10,00,000 0.10 1,00,000
20,00,000 1,54,000
Rs. 1,54,000
K0 = = 0.077 (approx.)
Rs. 20,00,000
Calculation of WACC using Market Value Weights
Source of Capital Market Value Specific Cost (K%) Total Cost
10% Debentures 5,25,000 0.055 28,875
5% Preference Shares 5,50,000 0.053 29,150
Equity Shares 24,00,000 0.10 2,40,000
34,75,000 2,98,025
Rs. 2,98,025
K0 = = 0.086 (approx.)
Rs. 34,75,000
5. Computation of Liquidity and Working Capital Ratios for Megatech Limited
2010 2009
Current Ratio 572.3 523.2
= 1.14 = 1.24
501.0 420.3
Quick Ratio 453.3 414.2
= 0.90 = 0.99
501.0 420.3
Debtors’ Payment Period 329.8 285.4
× 365 = 58 days × 365 = 58 days
2,065.0 1,788.7
Stock Turnover Period 119.0 109.0
× 365 = 29 days × 365 = 31 days
1,478.6 1,304.0
Creditors’ Turnover 236.2 210.8
Period × 365 = 58 days × 365 = 59 days
1,478.6 1,304.0
38

Analysis: Megatech Limited is a manufacturing group serving the construction industry,

and so would be expected to have comparatively lengthy debtors’ turnover period,
because of the relatively poor cash flow in the construction industry. It is clear that the
company compensates for this by ensuring that they do not pay for raw materials and
other costs before they have sold their stocks of finished goods (hence the similarity of
debtors’ and creditors’ turnover periods.)
Megatech Limited’s current ratio is a little lower than average but its quick ratio is better
than average and very little less than the current ratio. This suggests that the stock levels
are strictly controlled, which is reinforced by the low stock turnover period. It would seem
that working capital is tightly managed, to avoid the poor liquidity which could be caused
by a high debtors’ turnover period and comparatively high creditors.
6. Alternative Balance Sheets of Fibroplast Limited
Restricted (40%) Moderate (50%) Relaxed (60%)
` ` `
Current Assets (% of sales) 12,00,000 15,00,000 18,00,000
Fixed Assets 6,00,000 6,00,000 6,00,000
Total Assets 18,00,000 21,00,000 24,00,000
Debt 9,00,000 10,50,000 12,00,000
Equity 9,00,000 10,50,000 12,00,000
Total Liabilities and Equity 18,00,000 21,00,000 24,00,000
Alternative Income Statements of Fibroplast Limited
Restricted Moderate Relaxed
` ` `
Sales 30,00,000 30,00,000 30,00,000
EBIT 4,50,000 4,50,000 4,50,000
Interest (10%) 90,000 1,05,000 1,20,000
Earnings before Taxes 3,60,000 3,45,000 3,30,000
Taxes (40%) 1,44,000 1,38,000 1,32,000
Net Income 2,16,000 2,07,000 1,98,000
Return on Equity (ROE) 24.0% 19.7% 16.5%
7. Alternatives in Financing and its Financial Charges

(A) By issue of 6,00,000 equity shares of ` 10 each amounting to ` 60 lakhs. No
financial charges are involved.
(B) By raising the funds in the following way:
39

Debt = ` 40 lakhs
Equity = ` 20 lakhs (2,00,000 equity shares of ` 10 each)
18
Interest payable on debt = 40,00,000 ×
100
= ` 7,20,000
The indifference point between the two alternatives is calculated by:
(EBIT − I1 ) (1 − T) (EBIT − I2 ) (1 − T)
=
E1 E2
Where, EBIT = Earnings before interest and taxes
I1 = Interest charges in Alternative (A)
I2 = Interest charges in Alternative (B)
T = Tax rate
E1 = Equity shares in Alternative (A)
E2 = Equity shares in Alternative (B)
Putting the values, the break-even point would be as follows:
(EBIT − 0) (1 − 0.40) (EBIT − 7,20,000) (1 − 0.40)
=
6,00,000 2,00,000
(EBIT) (0.60) (EBIT − 7,20,000) (0.60)
=
6,00,000 2,00,000
EBIT(0.60) 0.60(EBIT − 7,20,000)
=
3 1
EBIT = 3EBIT−21,60,000
−2 EBIT = −21,60,000
21,60,000
EBIT =
2
EBIT = 10,80,000
Therefore, it can be seen that the EBIT at indifference point explains that the
earnings per share for the two alternatives is equal.
8. Advise to Management regarding Change in Discount Policy
Here the change in policy i.e. the offer of a discount, is not expected to increase sales
demand but to reduce the collection period, which would result in saving in the working
capital investment required.
40

(a) Change in Debtors

`
Current Value of Debtors (2/12×` 30,00,000) 5,00,000
New Value of Debtors (1/12×` 30,00,000) 2,50,000
Reduction in Investment in Debtors 2,50,000
(b) Cost of Reduction in Debtors
The cost of reducing debtors is the cost of the discounts, i.e.
2%×` 30,00,000 = ` 60,000
(c) The reduction in debtors of ` 2,50,000 would cost the company ` 60,000 per
annum. If the company can earn 30 percent on its investments, the benefit is:
The discount policy would be worthwhile, since the benefit of ` 75,000 exceeds the
cost of ` 60,000.
Note: The above solution values debtors at sales value.
9. Statement Showing Funds from Operation
`
Closing Balance as per Profit and Loss A/c 6,00,000
Less: Opening Balance as per Profit & Loss A/c 1,50,000
4,50,000
Add : Proposed Dividend during the year 2,25,000
Interim Dividend paid during the year 2,25,000
Transfer to General Reserve 30,000
Provision for Tax 45,000
Depreciation 2,10,000
Interest on Debentures 36,000
Discount on Issue of Debentures 16,500
Loss on Sale of Machine 45,000 8,32,500
12,82,500
Less : Income on Investment 8,100
Profit on Sale of Investment 30,000 38,100
Funds from Operation 12,44,400
10. Computation of Savings of Mr. Shanker
Mr. Shanker’s savings plan looks like an annuity of ` 10,000 per year for 30 years. It is
easy to become confused when you just look at age, rather than at both dates and age. A
common error is to think there are only 65 – 36 = 29 payments. Now to determine the
41

amount Mr. Shanker will have at the age of sixty-five, we need to compute the future
value of this annuity:
1
FV = ` 10,000 ×
0.10
(
× 1.1030 − 1 )
= ` 10,000 x164.49
= ` 16,44,900 or, 16,45,000
11. (a) Profit and Loss Account for Nine-o-Nine Limited
February March Total
` ` ` ` ` `
Sales 60,000 1,60,000 2,20,000
Cost of Purchases 45,000 1,20,000 1,65,000
(75 percent)
Gross Profit 15,000 40,000 55,000
Less: Labour 3,000 5,000 8,000
Expenses 6,000 9,000 7,000 12,000 13,000 21,000
6,000 28,000 34,000
Working Notes:
(i) Receipts
`
February 75% of February Sales (75% × ` 60,000) 45,000
+ 25% of January Sales (25% × ` 40,000) 10,000
55,000
March 75% of March Sales (75% × ` 1,60,000) 1,20,000
+ 25% of February Sales (25%× ` 60,000) 15,000
1,35,000
(ii) Purchases
January February
` `
For January Sales 15,000
(50% of ` 30,000)
For February Sales 22,500 (50% of ` 45,000) 22,500
(50% of ` 45,000)
For March Sales - (50% of ` 1,20,000) 60,000
37,500 82,500
These purchases are paid for in February and March.
(iii) Expenses
Cash expenses in January (` 4,000 – ` 2,000) and February (` 6,000 – `
2,000) are paid for in February and March respectively. Depreciation is not a
cash item.
42

(b) Nine – o - Nine Limited’s Cash Budget for

the Months of February and March
February March Total
` ` `
Receipts from Sales 55,000 1,35,000 1,90,000
Payments
Trade Creditors 37,500 82,500 1,20,000
Expenses Creditors 2,000 4,000 6,000
Labour 3,000 5,000 8,000
Equipment Purchase 18,000 - 18,000
Dividend - 20,000 20,000
Total Payments 60,500 1,11,500 1,72,000
Receipts less Payments (5,500) 23,500 18,000
Opening Cash balance b/f 1,000 (4,500) 1,000
Closing Cash balance c/f (4,500) 19,000 19,000
12 (a) Euro Bonds and Foreign Bonds
Euro bonds are debt instruments which are not denominated in the currency of the
country in which they are issued. E.g. a Yen note floated in Germany. Such bonds
are generally issued in a bearer form rather than as registered bonds and in such
cases they do not contain the investor’s names or the country of their origin. These
bonds are an attractive proposition to investors seeking privacy.
Whereas, on the other hand, Foreign bonds are debt instruments issued by foreign
corporations or foreign governments. Such bonds are exposed to default risk, especially
the corporate bonds. These bonds are denominated in the currency of the country
where they are issued, however, in case these bonds are issued in a currency other
than the investors home currency, they are exposed to exchange rate risks. An example
of a foreign bond is ‘A British firm placing dollar denominated bonds in USA’.
(b) Inflation Bonds and Floating Rate Bonds
Inflation Bonds are the bonds in which interest rate is adjusted for inflation. Thus,
the investor gets interest which is free from the effects of inflation. For example, if
the interest rate is 11 per cent and the inflation is 5 per cent, the investor will earn
16 per cent meaning thereby that the investor is protected against inflation.
On the other hand, Floating Rate Bonds, as the name suggests, are the bonds
where the interest rate is not fixed and is allowed to float depending upon the
market conditions. This is an ideal instrument which can be resorted to by the
issuers to hedge themselves against the volatility in the interest rates. This has
become more popular as a money market instrument and has been successfully
issued by financial institutions like IDBI, ICICI etc.
(c) Investment Decision and Financing Decision
The investment of long term funds is made after a careful assessment of the various
projects through capital budgeting and uncertainty analysis. However, only that
43

investment proposal is to be accepted which is expected to yield at least so much

return as is adequate to meet its cost of financing. This have an influence on the
profitability of the company and ultimately on its wealth. Such types of decisions are
known as investment decisions.
On the other hand, Financing Decisions relate to raising of funds from various
sources. Each source of funds involves different issues. The finance manager has
to maintain a proper balance between long-term and short-term funds. With the total
volume of long-term funds, he has to ensure a proper mix of loan funds and owner’s
funds. The optimum financing mix will increase return to equity shareholders and
thus maximise their wealth.
13. (a) Trade Credit
It represents credit granted by suppliers of goods, etc., as an incident of sale. The
usual duration of such credit is 15 to 90 days. It generates automatically in the
course of business and is common to almost all business operations. It can be in
the form of an 'open account' or 'bills payable'.
Trade credit is preferred as a source of finance because it is without any explicit
cost and till a business is a going concern it keeps on rotating. Another very
important characteristic of trade credit is that it enhances automatically with the
increase in the volume of business.
(b) Pre-Shipment Finance
This generally takes the form of packing credit facility; packing credit is an advance
extended by banks to an exporter for the purpose of buying, manufacturing, processing,
packing, shipping goods to overseas buyers. Any exporter, having at hand a firm export
order placed with him by his foreign buyer or an irrevocable letter of credit opened in his
favour, can approach a bank for availing of packing credit. An advance so taken by an
exporter is required to be liquidated within 180 days from the date of its commencement
by negotiation of export bills or receipt of export proceeds in an approved manner. Thus
packing credit is essentially a short term advance.
(c) Traditional View of Capital Structure
The traditional theory of capital structure proposes that an optimal capital exists,
and so under this theory a company can increase its total value by the sensible use
of gearing. The traditional theory argues that:
• Ke rises with increased gearing due to the increasing financial and bankruptcy risk;
• Kd rises only at high gearing levels when bankruptcy risk increases;
• Replacing more expensive equity finance with less expensive debt finance
decreases the company’s WACC, up to a joint; and
• Once an optimum level of gearing is reached, Ke increases by a rate which
more than offsets the effect of using cheaper debt, and so the WACC
increases.
44

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PAPER – 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

PART I : COST ACCOUNTING

1. (i) The standard and actual figures of a firm are as under:

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Factory overheads 3,00,000

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Progress payment received 7,200

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© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

1. (i) Standard labour cost Rs.

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(ii) (a) Halsey Scheme

Rs. Rs. Rs. Rs.

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© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Re-order point = Average daily usage × Lead time

Safety Demand Stock-out Prob. Relevant No. of Expected Relevant Total

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© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Allocation of service 7,920(40%) 3,960(20%) 3,960(20%) 15,840

© The Institute of Chartered Accountants of India

To Raw materials consumed 7,80,000 By Work-in-Process 38,667

Statement of Profit as per costing records

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Less: Factory overheads under recovery 30,000

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TotalCost of Production Rs.17,92,000

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© The Institute of Chartered Accountants of India

Closing inventory cost 3,750 4,286 8,036

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A – 35 kg. x Rs. 4 per Kg = Rs. 140.00

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Materials Usage Variance = Standard cost of materials used – Standard material

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Less: Fixed cost 9,90,000

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Block entrance fee 250 250 250 250 250

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Cost of the work to date

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PART II : FINANCIAL MANAGEMENT

1. Answer the following, supporting the same with reasoning/working notes:

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(x) The production pattern is assumed to be even during the year.

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The capital structure of Ganpati Limited is as under:

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Financial Analysis and Planning

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Working Capital Management

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1. (a) Computation of Receivables Collection Period