CWA/ICWA Final :: Management Accounting—Decision Making : December 2002

*F-17(MDM)* *Revised Syllabus*
Time Allowed : 3 Hours		Full Marks : 100
The figures in the margin on the right side indicate full marks
Answer Question No. 1 which is compulsory and any five from the rest.
Marks

(a)

A company has the following budget based on orders from home market:

	Rs.	Rs.
Sales (2000 units) Cost of Sales Direct Material Direct Labour Variable overhead Fixed overhead	1,000 4,000 1,000 3,000	10,000 9,000
		1,000

At this level of output, the company has speare capacity and it is therefore planning to development export market. It believes that it will be able to sell an additional 750 units, the limit of its production due to a shortage of raw materials. No additional fixed costs would be incurred and selling price and variable costs per unit would be the same as for the home market.

Before launching its export campaign, however, the company is approached by a home buyer who whishes to purchase 200 deluxe models which twice as much materials as the standard model. What is the minimum price which should be charged this order is accepted?

(b)

An investment in new machinery is being considered. The machine will cost Rs. 40,000 and will last for seven years. It is expected to yield savings in raw material cost of Rs. 4,000 p.a. (due to lower wastage) and it is hoped also to achieve labour savings of Rs. 7,000 p.a., however the arrangement have not yet been discussed with the trade union. The company's cost of capital is 12%.

What percentage change in the estimated labour savings will render the project not viable? Given that the present value of an auuity for 7 years at 12% = Rs. 4.564.

(c)

The annual demand for an item of raw material is 3,000 units and the purchase price is Rs. 100 per unit. The incremental cost of processing an order is Rs. 150 and the carrying cost per annum is 10 per unit. What is the optimal order quantity and the total relevant cost of this order quantity?

(d)

Star Bicycle Company, produced and sold 1,10,000 bicycle annually, under the brand name 'Smart' with price tag Rs. 899. Like all other players in the industry. Star too was running under capacity. The manufacturing cost of these cycles was-material Rs. 300, labour Rs. 200 and Manufacturing Rs. 300, 40% of the manufacturing cost was variable. General and administration expenses were 50% of labour cost.

Star has now received a proposal to sell 25,000 bicycles per year under the brand name 'Jeet' to a chain store at a price of Rs. 800. The brand will be exclusive for the chain stores as they will market it as their own product. Expenditure for producing 'Jeet' will be the same as that of Star as design of 'Jeet' will exactly be same as that of 'Star' with only some cosmetic changes. To produce 'Jeet' however, Rs. 6,00,000 additional fund will be required on an average. Further it estimated that sale of 'Jeet' through the chain store will reduce the sale of 'Star' by 10,000 units.

You are required to calculate the relevant cost of 'Jeet", given that the weighted average cost of capital Star Co. is 15%.

M. Ltd has two divisions - Division 1 and Division 2. Division 2 can buy from Division 1 or from outside suppliers. Division 1 can sell at the market price all the output that it can produce. The profit statements for the year for the company as a whole appears as follows:

Profit Statement for the year ended December 31
		Rs.	Rs.	Rs.
Total Sales	1,80,000
Cost of goods sold:
Opening Stocks
Manufacturing Costs:-
Raw materials Labour Overhead Percentage Supplier Labour Overhead	Division 1 Division 1 Division 1 Division 2 Division 2 Division 2	40,000 30,000 20,000 15,000 20,000 10,000	1,35,000
Cost of goods available for sale Deduct Closing Stock at cost			1,35,000
Division 1 Division 2			— 10,000	1,25,000
Gross Profit Operating expenses:				55,000
Sales and Admn. Exp. Sales and Admn. Exp. Head Office overhead	Division 1 Division 2	11,000 12,000 14,000		37,000
Net Profit before tax				18,000

Closing stock of Rs. 10,000 and valued at the cost of production incurred in Division 1. This stocks are as yet unprocessed. The market value of unprocessed is Rs. 12,000. The sales for the year can be broken down as follows:

Division 1 Division 2		Rs. 40,000 Rs. 1,40,000
		Rs. 1,80,000

The market value of the unprocessed material actually transferred from Division 1 to Division 2 (exclusive of the closing stock) was Rs. 1,00,000.
Required:

(a)

Prepare division profit statement that might be used to ovaluate the performance of the two division managers.

Please turn over

( 2 )

F-17(MDM)
Revised syllabus

Marks

(b)

Explain the transfer pricing policy you have used in preparing the statement and the state whether it is suitable for decision making purposes.

XYZ Ltd. manufactures three different products for an industrial market. The cost accounting system used by XYZ is a traditional one in the sense that it is very much like the systems literally thousands of firms have used for many years.

In Exhibit 1 data in regard to sales prices and sales volume for three products are shown along with basic production and standard cost statistics, There is only one production department—machines—and it takes a little more than 1 labour hour for each machine hour (11,250/10,000) at the current product mix. Labour is paid at Rs. 20/hr. including fringe benefits and machine cost is Rs. 70/hr.

Exhibit 1 Basic product Information
Three products
	A	B	C	Total
Production	10,000 units in 1 run	15,000 units in 3 runs	5,000 units in 2 runs
Shipments	10,000 units in 1 shipment	15,000 units in 5 shipments	5,000 units in 20 shipments
Selling Prices
Target	Rs. 162.61	Rs. 134.09	Rs. 81.31
Actual	162.61	125.96	105.70
Manufacturing Cost
Raw material	5 components @ Rs. 4/component = Rs. 20	6 components @ Rs. 5 per component = Rs.30	10 components @ Rs. 1 per component = Rs. 10
Labour usage
Set-up labour	10 hours per production run	10 hours per production run	11 hours per production run	150 hours
Run labour	½ hour per part	1/3 hour per part	¼ hour per part	11,250 hrs
Machine usage	¼ hour per part	1/3 hour per part	½ hour per part	10,000 hrs
Other Overheads
Receiving dept.				300,000
Engineering dept.				500,000
Packing dept.				200,000

The total overhead distribution to the three products produced in the machine department (as is present done) is shown in Exhibit 2. Overhead is assigned to products based on direct labour cost.

Exhibit 2 Calculation of Unit Costs
		A Rs.	B Rs.	C Rs.
Raw material Direct labour Overheads (labour Rs. basis)		20.00 10.00 75.70	30.00 6.67 50.49	10.00 5.00 37.85
Set up Machines Receiving Engineering Packing	Rs. 3,000 700,000 300,000 500,000 200,000
Total	1,703.000	105.70	87.16	52.85

Overhead rate = Rs. 1,703,000/Rs. 225,000 = 757%
Questions:

(a)

Do you think that there is anything wrong with the present cost system? Give reason.

(b)

If XYZ Ltd. was aware of Activity based costing, do you think that it would have given a dramatic different assessment of the opinion under consideration?

X Ltd. has for some years manufactured a product called C which is used as a component in a variety of electrical items. Although the product C is in demand, the technology of the design is becoming obsolete. The company has developed a new product D which is based on new technology.

The management of X Ltd. is considering whether to continue production of C or discontinue the C and staff production of D. The company do not have the resources to produce both the products.

If C is produced, unit sales in year 1 are forecast to be 24,000 but declining by 4,000 units in each subsequent year. Additional equipment costing Rs. 70,000 must be purchased now if C production is to continue.

If D is produced, then unit sales in year 1 are forecast to be 6,000 but after that the sales will increase rapidly. Additional equipment costing Rs. 6,20,000 should be purchased now if D production is to start.

Relevant details of the two products are as follows:-
	C (Rs.)	C (Rs.)
Variable cost per unit Selling price per unit	25 55	50 105

The company appraises investments using a 12% per annum compound cost of Money and ignores cash flows beyond five years from the start of investment.

(a)

Advise the company on the minimum annual growth in units sales of D needed to justify starting production of D now. Support your answer with financial evaluation.

(b)

Advise management of the number of years to which its investment appraisal time horizon (currently five years) would have to be extended in order to justify starting production D now if the forecast annual increase in D sales is 2,800 units.
P.V. of Re. 1 at 12% discount are as follows:

Year	1	2	3	4	5	6	7	8
P.V	0.8929	0.7972	0.7118	0.6355	0.5674	0.5067	0.4523	0.4039

A company is considering whether to launch a new product. The success of the idea depends on the ability of a competitor to bring out a competing product (the probability of which is estimated to be 0.6) and the relationship of the competitor's price to the firm's price.

Please turn over

( 3 )

F-17(MDM)
Revised syllabus

Marks

Table A shows the profit for each price range that could be set by the company related to the possible competing prices.

	Table A (Profit in Rs. '000)
	If the competitor's price is
If the company's price is	Low	Medium	High	Profit if no competitor
Low Medium High	30 34 10	42 45 30	45 49 53	50 70 90

The company must set its price first because its product will be on the market earlier so that the competitor will not able to react the price. Estimate of the probability of a competitor's price are shown in Table B.

	Table B
	Competitor's price expected to be
If the company's price is	Low	Medium	High
Low Medium High	0.80 0.20 0.05	0.15 0.70 0.35	0.05 0.10 0.60

(a)

Draw a decision free and analyse the problem.

(b)

Recommend what the company should do.

The operating result of Sona Ltd. for the previous year was a under:

Sales Mix
Product	% of Mix	P.V. Raio
A B C D	40 10 30 20 100%	20 6 12 10

Total Sales value of the products was Rs. 80 lakhs.
Total fixed overhead amounted to /rs. 10 lakhs. The Raw material content, which is entirely imported, is 50% of the respective variable cost of the item.
The forecast of the year just started are as under:-

(i)

The raw material cost will go up by 10%.

(ii)

The raw material availability will be restricted to Rs. 35 lakhs from the imported source.

(iii)

The maximum potential sales of any of the four products in the current year is 40% of the total sale value of the previous year.

(iv)

In the sale price of the products there will be an uniform 5% increase.

You are required to:-

(a)	Prepare statement of probability for the previous year.
(b)	Set a product mix with maximize profit for the current year and prepare a statement showing forecast profitability for the current year.

(a)

Describe the factor which bring about learning curve effect.

(b)

A company has designed a prototype Electronic Starter for which the following information are available—

Direct labour hour
Direct material cost
Direct labour rate
Variable overhead
Fixed overhead

=
=
=
=
=

260 hours
Rs. 30,000
Rs. 20 per hour
130% of direct labour,
70% of direct labour.

Based on the demonstration of the prototype, the company has received order for 50 unit during first six months and another 75 units during the following six months thereafter.

A learning curve effect of 80% is applicable. It is expected that in view of large volume, a 5% discount on material cost will be available in first six months and a 10% discount thereafter. The rates of overhead will remain unchanged and the same percentages would apply.

The company sets the selling price with a 40% mark up on costs. Determine the selling price per unit for the first 50 units and the next 75 units.
(The index of learning rate of learning curve effect of 80% is 0.3219.)

(a)

Define Residual Income and describe the advantage and disadvantage of measuring performance on the basis of Residual Income.

(b)

Write short notes on any three:
(Your answer should be restricted to maximum five sentences on each topic.)

(i)	Relevant cost;
(ii)	Economic Value to Customer (EVC);
(iii)	Theory of Constraints;
(iv)	Cost leadership;
(v)	Economic Value Addition.

4x3=12

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