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The Institute of Chartered Accountants of India

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

Question No. 1 is compulsory.
Attempt any five questions from the remaining six questions.
Working notes should form part of the answers.
Question 1
Answer the following:
(a) Primex Limited produces product 'P'. It uses annually 60,000 units of a material 'Rex'
costing ` 10 per unit. Other relevant information are:
Cost of placing an order

` 800 per order

Carrying cost

15% per annum of average inventory

Re-order period

10 days

Safety stock

600 units

The company operates 300 days in a year.

You are required to calculated:
(i)

Economic Order Quantity for material 'Rex'.

(ii) Re-order Level

(ill) Maximum Stock Level
(iv) Average Stock Level
(b) Journalise the following transactions assuming cost and financial accounts are
integrated :

`
(i)

Materials issued :
Direct

3,25,000

Indirect

1,15,000

(ii) Allocation of wages (25% indirect)

6,50,000

(iii) Under/Over absorbed overheads:

Factory (Over)

2,50,000

Administration (Under)

1,75,000

(iv) Payment to Sundry Creditors

1,50,000

(v) Collection from Sundry Debtors

2,00,000

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42

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

(c) Calculate the degree of operating leverage, degree of financial leverage and the degree
of combined leverage for the following firms :
Production (in units)

N
17,500

S
6,700

D
31,800

Fixed costs

4,00,000

3,50,000

2,50,000

Interest on loan

1,25,000

75,000

Nil

Selling price per unit

85

130

37

Variable cost per unit

38.00

42.50

12.00

(d) X Ltd. is considering the following two alternative financing plans:

Plan - I

Plan - II

Equity shares of ` 10 each

4,00,000

4,00,000

12% Debentures

2,00,000

2,00,000

6,00,000

6,00,000

Preference Shares of ` 100 each

The indifference point between the plans is ` 2,40,000. Corporate tax rate is 30%.
Calculate the rate of dividend on preference shares.
(4 x 5 = 20 Marks)
Answer
(a) (i)

Economic Order Quantity (E.O.Q)

=

2Annual requirement of 'Rex' Ordering cost per order

Annual carrying cost per unit per annum
2 60,000units ` 800

` 10 15%

9,60,00,000
` 1.5

= 8,000 units
(ii) Re-order Level

= Safety Stock + (Normal daily Usage Re-order period)

= 600 + (

60,000units
300days

= 600 + 2,000
= 2,600 units

The Institute of Chartered Accountants of India

10 days)

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

43

(iii) Maximum Stock Level = E.O.Q (Re-order Quantity) + Safety Stock

= 8,000 units + 600 units
= 8,600 units
(iv) Average Stock Level

= Minimum Stock level +

= 600* +

1
2

Re-order Quantity

8,000 units

= 4,600 units
OR
Average Stock Level

=
=

MaximumStock level + MinimumStock level

2
8,600units + 600units
2

= 4,600 units
* Minimum Stock Level

= Re-order level (Normal daily usage Re-order period)

= 2,600 (

60,000units
300days

10 days)

= 2,600 2,000
= 600 units
OR
Minimum Stock Level

= Safety Stock level = 600 units

Note: Various levels can be calculated in different other ways. However answers
will be the same.
(b)

Journal Entries under Integrated system of accounting

Particulars
(i)

Work-in-Progress Ledger Control A/c

Dr.

3,25,000

Factory Overhead Control A/c

Dr.

1,15,000

To Stores Ledger Control A/c

(Being issue of Direct and Indirect materials)

The Institute of Chartered Accountants of India

4,40,000

44

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

(ii)

Work-in Progress Ledger Control A/c

Dr.

4,87,500

Factory Overhead control A/c

Dr.

1,62,500

To Wages Control A/c

6,50,000

(Being allocation of Direct and Indirect wages)

(iii) Factory Overhead Control A/c

Dr.

2,50,000

To Costing Profit & Loss A/c

2,50,000

(Being transfer of over absorption of Factory

overhead)
Costing Profit & Loss A/c

Dr.

1,75,000

To Administration Overhead Control A/c

(Being transfer of under
Administration overhead)

absorption

1,75,000
of

(iv) Sundry Creditors A/c

Dr.

1,50,000

To Cash/ Bank A/c

1,50,000

(Being payment made to creditors)

(v) Cash/ Bank A/c

Dr.

To Sundry Debtors A/c

2,00,000
2,00,000

(Being payment received from debtors)

(c) Computation of Degree of Operating Leverage (DOL), Degree of Financial Leverage
(DFL) and Degree of Combined Leverage (DCL)
Firm N
Output (Units)

Firm S

Firm D

17,500

6,700

31,800

85

130

37

Sales Revenue (A)

14,87,500

8,71,000

11,76,600

Variable Cost/Unit

38.00

42.50

12.00

Less: Variable Cost (B)

6,65,000

2,84,750

3,81,600

Contribution (A-B)

8,22,500

5,86,250

7,95,000

Less: Fixed Cost

4,00,000

3,50,000

2,50,000

EBIT

4,22,500

2,36,250

5,45,000

Less: Interest on Loan

1,25,000

75,000

PBT

2,97,500

1,61,250

5,45,000

Selling Price/Unit

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PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

DOL =

DFL=

C
EBIT

45

8,22,500

5,86,250

7,95,000

4,22,500

2,36,250

5,45,000

= 1.95

= 2.48

= 1.46

EBIT

4,22,500

2,36,250

5,45,000

PBT

2,97,500

1,61,250

5,45,000

= 1.42

= 1.47

= 1.00

1.95 x 1.42

2.48 x 1.47

1.46 x 1

OR

= 2.77

= 3.65

= 1.46

Contribution
PBT

8,22,500
= 2.76
2,97,500

5,86,250
= 3.64
1,61,250

7,95,000
= 1.46
5,45,000

DCL = OL x FL

DCL =

(d) Computation of Rate of Preference Dividend

EBIT = 2,40,000
Tax rate = 30%
(EBIT Interest) (1 Tax rate) EBIT (1 Tax rate) Preference Dividend
=
No. of Equity Shares (N1 )
No. of Equity Shares (N2 )
(2,40,000 - 24,000) (1- 0.30) 2,40,000 (1- 0.30) - Preference Dividend
=
40,000
40,000
2,16,000 (1- 0.30) 1,68,000 - Preference Dividend
=
40,000
40,000

1,51,200

= 1,68,000 Preference Dividend

Preference Dividend = 1,68,000 1,51,200

Preference Dividend = 16,800
Rate of Dividend

Preference Dividend
16,800
x 100 = 8.4%
x 100 =
Preference Share Capital
2,00,000

Question 2
(a) The following information relates to a bus operator:
Cost of the bus
Insurance charges
Manager-cum accountant's salary

The Institute of Chartered Accountants of India

18,00,000

3% p.a.
8,000 p.m.

46

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

Annual Tax

`
`
`

Garage Rent
Annual repair & maintenance
Expected life of the bus
Scrap value at the end of 15 years

`
`
`
`
`
`

Driver's salary
Conductor's salary
Stationery
Engine oil, lubricants (for 1200 kms.)
Diesel and oil (for 10 kms.)

50,000
2,500 p.m.
1,50,000
15 years
1,20,000
15,000 p.m.
12,000 p.m.
500 p.m.
2,500
52

Commission to driver and conductor (shared equally)

10% of
collections

Route distance

20 km long

The bus will make 3 round trips for carrying on the average 40 passengers in each trip.
Assume 15% profit on collections. The bus will work on the average 25 days in a month.
Calculate fare for passenger-km.

(8 Marks)

(b) The assets of SONA Ltd. consist of fixed assets and current assets, while its current
liabilities comprise bank credit in the ratio of 2 : 1. You are required to prepare the
Balance Sheet of the company as on 31st March 2013 with the help of following
information:
Share Capital

` 5,75,000

Working Capital (CA-CL)

` 1,50,000

Gross Margin

25%

Inventory Turnover

5 times

Average Collection Period

1.5 months

Current Ratio

1.5:1

Quick Ratio

0.8: 1

Reserves & Surplus to Bank & Cash

4 times

The Institute of Chartered Accountants of India

(8 Marks)

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

47

Answer
(a) Working Notes:
(i)

Calculation of Depreciation of Bus (Per month)

=
=

Cost of the bus Scrap value at the endof the15 years

Expectedlife of the bus
` 18,00,000 ` 1,20,000
15 years

= ` 1,12,000 p.a.
Depreciation per month =

` 1,12,000
12months

= ` 9,333.33

(ii) Calculation of total distance travelled and Passenger-km. per month

Total distance

= 3 trips 2 20 k.m. 25 days = 3,000 k.m.

Total Passenger-km. = 3 trips 2 20 k.m. 25 days 40 passengers

= 1,20,000 Passenger-k.m.
(iii) Cost of Engine oil, Lubricants and Diesel & oil (Per month)
Engine oil & lubricants

=
=

Totaldistance travelled
1,200 K.m.
3,000K.m.
1,200 K.m.

` 2,500

` 2,500

= ` 6,250
Diesel and Oil

=
=

Totaldistance travelled
10 K.m.
3,000K.m.
10 K.m.

` 52

` 52 = ` 15,600

Statement showing the Operating Cost per Passenger-km.

`
(i)

Standing Charges:
Depreciation {Working Note- (i)}

The Institute of Chartered Accountants of India

9,333.33

48

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

` 18,00,000

Insurance Charge
3%

4,500

Manager-cum-accountants salary

8,000

12

4,166.67

` 50,000
Annual Tax (p.m.)

12

Garage Rent

2,500

28,500

(ii) Maintenance Charges:

12,500

` 1,50,000
Repair & Maintenance per month

12

(iii) Running Cost:

Drivers Salary

15,000

Conductors Salary

12,000

Stationery

500

Engine oil & Lubricants {Working Note- (iii)}

6,250

Diesel and oil {Working Note- (iii)}

15,600

Total running cost before deducting commission to

driver and conductor

49,350

Total cost excluding commission to driver and

conductor

49,350
90,350

Drivers commission on collection*

6,023.34

Conductors commission on collection*

6,023.33

Total Cost (i) +(ii) + (iii)

1,02,396.67

Add: Profit**

18,070

Total Collection

1,20,466.67

Working note:
Total costs before commission on collection and net profit is ` 90,350.
Commission on collection to driver and conductor is 10% of collection and Profit is
15% of collection means
100% - (10% + 15%) i.e. 75%

= ` 90,350

So, Total collection

` 90,350
75

100 = ` 1,20,466.67

*Total Commission on collection = 10% ` 1,20,466.67 = ` 12,046.67

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PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

Drivers share

= 50% ` 12,046.67 = 6,023.34

Conductors share

= 50% ` 12,046.67 = 6,023.33

** Profit on collection

= ` 1,20,466.67 15% = ` 18,070

Fare per Passenger-km.

=
=

Total Collection
Total Passenger - km. {Working Note (ii)}
` 1,20,466.67
1,20,000

= ` 1.004 (appx.)
(b) Working Notes:
(1) Computation of Current Assets (CA) and Current Liabilities (CL)
Current Assets
= Current Ratio
Current Liabilities
CA
CL

1.5
1

CA

= 1.5CL

CA - CL

= 1,50,000

1.5 CL- CL = 1,50,000

2.

0.5 CL

= 1,50,000

CL

CA

= 1.5 x 3,00,000 = 4,50,000

1,50,000
= 3,00,000
0.5

Computation of Bank Credit (BC) and Other Current Liabilities (OCL)

Bank Credit
Other CL

2
1

BC

= 2 OCL

BC + OCL

= CL

2 OCL + OCL

= 3,00,000

3 OCL

= 3,00,000

OCL

= 1,00,000

Bank Credit

= 2 1,00,000 = 2,00,000

The Institute of Chartered Accountants of India

49

50

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

3.

Computation of Inventory
Quick Ratio

=
=

4.

Quick Assets
Current Liabilities

Current Assets - Inventories

Current Liabilities
4,50,000 - Inventories
3,00,000

0.8

0.8 3,00,000

= 4,50,000 Inventories

Inventories

= 4,50,000 2,40,000 = 2,10,000

Computation of Debtors
Inventory Turnover

= 5 times

Average Inventory

COGS

COGS
Inventory Turnover

= 2,10,000 5 = 10,50,000

Average Collection Period (ACP)

Debtors Turnover =

360
ACP

360
45

= 1.5 months = 45 days

=8

Sales - COGS
100 = 25%
Sales
25Sales
Sales - COGS =
100

Sales 0.25 Sales

= COGS

0.75 Sales

= 10,50,000

Sales

10,50,000
= 14,00,000
0.75

Debtors

Sales
Debtors Turnover

5.

14,00,000
= 1,75,000
8

Computation of Bank and Cash

Bank & Cash

= CA - (Debtors + Inventory)
= 4,50,000 (1,75,000 + 2,10,000)= 4,50,000 3,85,000 = 65,000

The Institute of Chartered Accountants of India

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

6.

51

Computation of Reserves & Surplus

Reserves & Surplus
Bank & Cash

=4

Reserves & Surplus = 4 65,000 = 2,60,000

Balance Sheet of SONA Ltd. as on March 31, 2013
Liabilities

` Assets

Share Capital

5,75,000 Fixed Assets

Reserves & Surplus

2,60,000 Current Assets:

Current Liabilities:
Bank Credit
Other Current Liabilities

2,00,000

Inventories
Debtors

1,00,000

Bank & Cash

11,35,000

`
6,85,000
2,10,000
1,75,000
65,000
11,35,000

Question 3
(a) The rate of change of labour force in a company during the year ending 31st March, 2013
was calculated as 13%,8% and 5% respectively under 'Flux Method', 'Replacement
method' and 'Separation method'. The number of workers separated during the year is
40.
You are required to calculate:
(i)

Average number of workers on roll.

(ii) Number of workers replaced during the year.

(iii) Number of new accessions i.e. new recruitment.
(iv) Number of workers at the beginning of the year.

(8 Marks)

(b) APZ Limited is considering to select a machine between two machines 'A' and 'B'. The
two machines have identical capacity, do exactly the same job, but designed differently.
Machine 'A' costs ` 8,00,000, having useful life of three years. It costs ` 1,30,000 per
year to run.
Machine 'B' is an economy model costing ` 6,00,000, having useful life of two years. It
costs ` 2,50,000 per year to run.
The cash flows of machine 'A' and 'B' are real cash flows. The costs are forecasted in
rupees of constant purchasing power. Ignore taxes.
The opportunity cost of capital is 10%.

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52

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

The present value factors at 10% are :

Year
PVIF0.10,t
PVIFA0.10,2 = 1.7355
PVIFA0.10,3 = 2.4868

t1
0.9091

t2
0.8264

t3
0.7513

Which machine would you recommend the company to buy?

(8 Marks)

Answer
(a) (i)

Labour Turnover Rate (Separation method)

=

No. of workers separated

Average no. of workers onroll

40
Average no. of workers on roll

Or,

5
100

Or,

Average no. of workers on roll = 800

(ii) Labour Turnover Rate (Replacement method)

=

No. of workers replaced

Average no. of workers on roll

No. of workers replaced

Or,

8
100

Or,

No. of workers replaced = 64

800

(iii) Labour Turnover Rate (Flux Method)

=

No. of Separations + No. of accession (new recruitments)

Average No. of workers on roll

40 + No. of accessions (New recruitments)

800

Or,

13
100

Or,

100 (40 + No. of Accessions) = 10,400

Or, No. of new accessions = 64

(iv) No. of workers at the beginning of the year
Let workers at the beginning of the year were X
Average no. of workers on roll =

The Institute of Chartered Accountants of India

Wor ker s at the begining + Wor ker s at the end

2

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

800

X + ( X + New accessions Separations)

2

800

X + ( X + 64 40)
2

800

X + ( X + 24 )
2

2X

= 1,600 24

= 788 workers

(b)

53

Statement Showing Evaluation of Two Machines

Particulars

Machine A

Machine B

8,00,000

6,00,000

Running Cost of Machine per year (`) : (ii)

1,30,000

2,50,000

Cumulative PVF for 1-3 years @ 10% : (iii)

2.4868

Cumulative PVF for 1-2 years @ 10% : (iv)

1.7355

3,23,284

4,33,875

11,23,284

10,33,875

4,51,698.57
Or 4,51,699

5,95,721.69
Or 5,95,722

Purchase Cost (`) : (i)

Life of Machines (in years)

Present Value of Running Cost of Machines (`):

(v) = [(ii) x (iii)]
Cash Outflow of Machines (`) : (vi) = (i) + (v)
Equivalent Present Value of Annual Cash Outflow
[(vi) (iii)]

Recommendation: APZ Limited should consider buying Machine A since its equivalent
Cash outflow is less than Machine B.
Question 4
(a) SP Limited produces a product 'Tempex' which is sold in a 10 Kg. packet. The standard
cost card per packet of 'Tempex' are as follows:

`
Direct materials 10 kg @ ` 45 per kg

450

Direct labour 8 hours @ ` 50 per hour

400

Variable Overhead 8 hours @ ` 10 per hour

Fixed Overhead

80
200

1,130
Budgeted output for the third quarter of a year was 10,000 Kg. Actual output is 9,000 Kg.

The Institute of Chartered Accountants of India

54

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

Actual cost for this quarter are as follows :

`
Direct Materials 8,900 Kg @ ` 46 per Kg.

4,09,400

Direct Labour 7,000 hours @ ` 52 per hour

3,64,000

Variable Overhead incurred

72,500

Fixed Overhead incurred

1,92,000

You are required to calculate :

(i)

Material Usage Variance

(ii) Material Price Variance

(iii) Material Cost Variance
(iv) Labour Efficiency Variance
(v) Labour Rate Variance
(vi) Labour Cost Variance
(vii) Variable Overhead Cost Variance
(viii) Fixed Overhead Cost Variance

(8 Marks)

(b) The following are the summarized Balance Sheet of Flexon Limited as on 31st March
2012 and 2013 :
Liabilities

31.3.12

31.3.13 Assets

31.3.12

31.3.13

Share Capital

8,00,000

8,00,000 Goodwill

15,000

15,000

General Reserve

1,40,000

1,80,000 Building

4,00,000

3,60,000

Profit & Loss A/c.

1,60,000

2,70,000 Plant

3,70,000

5,20,000

Sundry Creditors

1,71,000

1,67,000 Investment
(Long-term)

1,20,000

1,50,000

30,000 Stock

3,00,000

2,30,000

1,80,000 Debtors

1,80,000

2,00,000

66,000

1,52,000

Bills Payable
Provision for Tax

20,000
1,60,000

Cash & Bank

14,51,000 16,27,000
Additional Information:
(1) Depreciation charged during the year 2012-13:

The Institute of Chartered Accountants of India

14,51,000 16,27,000

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

55

On Plant - ` 40,000
On Building - ` 40,000
(2) Provision for tax of ` 1,90,000 was made during the year 2012-13.
(3) Interim dividend paid during the year 2012-13:
Interim Dividend

- ` 80,000

Corporate Dividend Tax - ` 13,596

Prepare:
(i)

Statement of changes in working capital

(ii) Funds flow statement for the year ended 31st March, 2013.

(8 Marks)

Answer
(a) (i)

Material Usage Variance = Std. Price (Std. Quantity Actual Quantity)

= ` 45 (9,000 kgs. 8,900 kgs.)
= ` 4,500 (Favourable)

(ii) Material Price Variance

= Actual Quantity (Std. Price Actual Price)

= 8,900 kgs. (` 45 ` 46)
= ` 8,900 (Adverse)

(iii) Material Cost Variance

= Std. Material Cost Actual Material Cost

= (SQ SP) (AQ AP)
= (9,000 kgs. ` 45) (8,900 kgs. ` 46)
= ` 4,05,000 ` 4,09,400
= `4,400 (Adverse)

(iv) Labour Efficiency Variance

= Std. Rate (Std. Hours Actual Hours)

= ` 50 (

9,000
10

8hours 7,000 hrs.)

= ` 50 (7,200 hrs. 7,000 hrs.)

= ` 10,000 (Favourable)
(v) Labour Rate Variance

= Actual Hours (Std. Rate Actual Rate)

= 7,000 hrs. (` 50 `52)
= ` 14,000 (Adverse)

(vi) Labour Cost Variance

= Std. Labour Cost Actual Labour Cost

= (SH SR) (AH AR)

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56

INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

= (7,200 hrs. ` 50) (7,000 hrs. ` 52)

= ` 3,60,000 ` 3,64,000
= `4,000 (Adverse)
(vii) Variable Cost Variance

= Std. Variable Cost Actual Variable Cost

= (7,200 hrs. ` 10) ` 72,500
= ` 500 (Adverse)

(viii) Fixed Overhead Cost Variance = Absorbed Fixed Overhead Actual Fixed Overhead
=

` 200
9,000kgs. ` 1,92,000
10 kgs.

= ` 1,80,000 ` 1,92,000
= ` 12,000 (Adverse)
(b) (i)

Schedule of Changes in Working Capital

Particulars

31st March
2012
(`)

Working Capital
2013 Increase
(`)
(`)

Decrease
(`)

(A) Current Assets

Stock

3,00,000

2,30,000

70,000

Debtors

1,80,000

2,00,000

20,000

66,000

1,52,000

86,000

5,46,000

5,82,000

1,71,000

1,67,000

4,000

20,000

30,000

10,000

Total (B)

1,91,000

1,97,000

Working Capital (A-B)

3,55,000

3,85,000 1,10,000

80,000

Cash & Bank

Total (A)
(B) Current Liabilities
Sundry Creditors
Bills Payable

Increase in Working Capital

Total

30,000
3,85,000

30,000

3,85,000 1,10,000

1,10,000

Funds Flow Statement as on 31st March, 2013

Sources of Fund
Funds from Operation

` Application of Fund
5,13,596

The Institute of Chartered Accountants of India

Increase in Working Capital

30,000

Interim Dividend

80,000

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

57

Purchase of Investment

30,000

Corporate Dividend Tax

13,596

Purchase of Plant

1,90,000

Payment of Income Tax

1,70,000

5,13,596

5,13,596

Working Notes:
Adjusted Profit and Loss A/c
Particulars

` Particulars

To General Reserve

40,000 By Net Profit for 2012

`
1,60,000

To Depreciation:
Plant

40,000

Building

40,000

To Goodwill

By Funds from Operations

5,13,596

80,000
-

To Interim Dividend

80,000

To Corporate Dividend
Tax

13,596

To Provision for Tax

To Net Profit for 2013

1,90,000
2,70,000
6,73,596

6,73,596

Provision for Tax A/c

Particulars
To Bank A/c (Tax Paid)
To Balance b/d

` Particulars
1,70,000 By Bal. b/d
1,80,000 By P&L A/c
3,50,000

`
1,60,000
1,90,000
3,50,000

Plant & Machinery A/c

Particulars
To Bal. b/d
To Bank

` Particulars
`
3,70,000 By Depreciation
40,000
1,90,000 By Bal. c/d
5,20,000
5,60,000
5,60,000
(Note: Schedule of changes in the working capital maybe computed alternatively by
taking provision for tax as current liability and working out the problem accordingly.)

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Question 5
(a) Explain the following terms in relation to process costing:
(i)

Equivalent Production

(ii) Inter-process profit

(b) Elaborate the practical application of Marginal Costing.
(c) What is Virtual Banking? State its advantages.
(d) What is Over capitalisation? State its causes and consequences.

(4 x 4 = 16 Marks)

Answer
(a) (i)

Equivalent Production: When opening and closing stocks of work-in-process exist,

unit costs cannot be computed by simply dividing the total cost by total number of
units still in process. We can convert the work-in-process units into finished units
called equivalent production units so that the unit cost of these uncompleted (W-I-P)
units can be obtained. Equivalent Production units = Actual number of units in
production Percentage of work completed. It consists of balance of work done on
opening work-in-process, current production done fully and part of work done on
closing WIP with regard to different elements of costs viz., material, labour and
overhead.

(ii) Inter-Process Profit: In some process industries the output of one process is transferred to the next process not at cost but at market value or cost plus a percentage
of profit. The difference between cost and the transfer price is known as interprocess profits.
(b) Practical applications of Marginal costing:
(i)

Pricing Policy: Since marginal cost per unit is constant from period to period, firm
decisions on pricing policy can be taken particularly in short term.

(ii) Decision Making: Marginal costing helps the management in taking a number of
business decisions like make or buy, discontinuance of a particular product,
replacement of machines, etc
(iii) Ascertaining Realistic Profit: Under the marginal costing technique, the stock of
finished goods and work-in-progress are carried on marginal cost basis and the
fixed expenses are written off to profit and loss account as period cost. This shows
the true profit of the period.
(iv) Determination of production level: Marginal costing helps in the preparation of
break-even analysis which shows the effect of increasing or decreasing production
activity on the profitability of the company.

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(c) Virtual Banking and its Advantages

Virtual banking refers to the provision of banking and related services through the use of
information technology without direct recourse to the bank by the customer.
The advantages of virtual banking services are as follows:

Lower cost of handling a transaction.

The increased speed of response to customer requirements.

The lower cost of operating branch network along with reduced staff costs leads to
cost efficiency.

Virtual banking allows the possibility of improved and a range of services being
made available to the customer rapidly, accurately and at his convenience.

(Note: Students may answer any two of the above advantages)

(d) Overcapitalization and its Causes and Consequences
It is a situation where a firm has more capital than it needs or in other words assets are
worth less than its issued share capital, and earnings are insufficient to pay dividend and
interest.
Causes of Over Capitalization
Over-capitalisation arises due to following reasons:
(i)

Raising more money through issue of shares or debentures than company can
employ profitably.

(ii) Borrowing huge amount at higher rate than rate at which company can earn.
(iii) Excessive payment for the acquisition of fictitious assets such as goodwill etc.
(iv) Improper provision for depreciation, replacement of assets and distribution of
dividends at a higher rate.
(v) Wrong estimation of earnings and capitalization.
(Note: Students may answer any two of the above reasons)
Consequences of Over-Capitalisation
Over-capitalisation results in the following consequences:
(i)

Considerable reduction in the rate of dividend and interest payments.

(ii) Reduction in the market price of shares.

(iii) Resorting to window dressing.

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INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

(iv) Some companies may opt for reorganization. However, sometimes the matter gets
worse and the company may go into liquidation.
(Note: Students may answer any two of the above consequences)
Question 6
(a) Calculate Machine Hour Rate from the following particulars:
Cost of Machine

` 25,00,000

Salvage Value

` 1,25,000

Estimated life of the machine

25,000 Hours

Working Hours (per annum)

3,000 Hours

Hours required for maintenance

400 Hours

Setting-up time required

8% of actual working hours

Additional Information:
(i)

Power 25 units @ ` 5 per unit per hour.

(ii) Cost of repairs and maintenance ` 26,000 per annum.

(iii) Chemicals required for operating the machine ` 2,600 per month.
(iv) Overheads chargeable to the machine ` 18,000 per month.
(v) Insurance Premium (per annum) 2% of the cost of machine
(vi) No. of operators - 02 (looking after three other machines also)
(vii) Salary per operator per month ` 18,500

(8 Marks)

(b) PTX Limited is considering a change in its present credit policy. Currently it is evaluating
two policies. The company is required to give a return of 20% on the investment in new
accounts receivables. The company's variable costs are 70% of the selling price.
Information regarding present and proposed policies is as follows:
Present

Policy

Policy

Policy

Option 1

Option 2

30,00,000

42,00,000

45,00,000

Debtors turnover ratio

4 times

3 times

2.4 times

Loss due to bad debts

3% of sales

5% of sales

6% of sales

Annual Credit Sales (`)

Note: Return on investment in new accounts receivable is based on cost of investment in

debtors.
Which option would you recommend?

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Answer
(a) Computation of Machine Hour Rate
Setting-up time
is
Unproductive
(Machine hour2,407*)

Particulars

Setting-up
time is
Productive
(Machine
hour- 2,600)

Fixed Charges (Standing Charges):

Overhead Chargeable ` 18,000 12 = ` 2,16,000
Rs` 2,16,000 Rs` 2,16,000
2,407 hours ; 2,600 hours

89.74

83.08

46.12

42.69

20.77

19.23

156.63

145.00

95.00

95.00

125.00

125.00

10.80

10.00

12.96

12.00

400.39

387.00

Operators Salary:
R
` 18,500 12 2 Operators
= ` 1,11,000
4 machines
` 1,11,000 R
` 1,11,000
R
2,407 hours ; 2,600 hours

Insurance: 2% of `25,00,000 = `50,000

Variable Expenses (Machine Expenses) per hour
Depreciation :
Power:

` 25,00,000 ` 1,25,000
25,000 hours

( 25 units ` 5)

Repairs and Maintenance :

` 26,000
2,407 hours ;

` 26,000
2,600 hours

Rs` 2,600 12 Rs` 2,600 12

Chemical :
;

2,407 hours 2,600 hours

Machine Hour Rate

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(Hours)

Working Hours

3,000

Less: Maintenance hours

400
2,600

Less: Setting-up hours

Actual working hours (

193
2,600hours
100)
108

2,407

Assumptions:
1. Working hours (i.e. 3,000 hours) are inclusive of maintenance and setting-up time.
2. It is assumed that no power is consumed by the machine during unproductive hours i.e.
during maintenance and unproductive setting-up hours.
3. Depreciation is calculated on the basis of estimated life of the machine hours. Hence per
unit machine hour rate of depreciation will be same.
Note: As this numerical problem does not specifically mention about the nature of settingup time; means whether setting-up time is unproductive or productive is not clear. The
problem can be solved assuming setting-up time either as productive or as unproductive.
The question may be solved based on logical assumption regarding the nature of settingup time (i.e. unproductive or productive) and for furnishing any one or both the situation.
(b) Statement of Evaluation of Credit Policies of PTX Limited (based on Total Cost
Approach)

Sales Revenue
Less: Variable Cost @70%
Contribution

Present
Policy

Policy
Option I

Policy
Option II

30,00,000
21,00,000

42,00,000
29,40,000

4,50,0000
31,50,000

9,00,000

12,60,000

13,50,000

(90,000)

(2,10,000)

(2,70,000)

(1,05,000)

(1,96,000)

(2,62,500)

7,05,000

8,54,000

8,17,500

Less: Other Relevant Costs

Bad Debt Losses
Investment Cost
(VC DTR) 20%
Profit

Recommendation: PTX Limited is advised to adopt Policy Option I.

(Note: In the above solution, investment in accounts receivable is based on total cost of
goods sold on credit. Since fixed costs are not given in the problem, therefore, it is assumed

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63

that there are no fixed costs and investment in receivables is determined with reference to
variable costs only. The above solution may alternatively be worked out on the basis of
incremental approach. However, the recommendation would remain the same.)
Question 7
Answer any four of the following:
(a) What is the meaning of Margin of Safety (MOS)? State the relationship between
Operating Leverage and Margin of Safety Ratio.
(b) Describe the steps involved in the budgetary control technique.
(c) 'Management of marketable securities is an integral part of investment of cash.'
Comment.
(d) What do you mean by capital structure? State its significance in financing decision.
(e) (i)

State the main elements of leveraged lease.

(ii) State the escalation clause in contract costing.

(4 x 4 = 16 Marks)

Answer
(a) Margin of Safety (MoS) is the excess of total sales over the Break even sales. MoS defines
the amount upto which level sales can decline before occurring loss. Therefore MoS = Total
Sales - Break even sales
Sales Break even sales and MoS ratio =
Break even sales
Sales
(BE sales) will depend on contribution margin (BE sales = Fixed Cost Contribution margin).
Contribution margin is related to operating leverage also. Operating leverage is calculated as
Contribution Operating profit and contribution margin plays an important role in it. If sales
are expected to increase, higher operating leverage will result in higher profit. When sales
are expected to decrease, lower operating leverage will result in higher profit. Higher variable
cost and lower fixed cost will result into higher MoS and risk will be lower and vice versa.
So like Operating leverage, MoS is a measure of risk as to what extent an organisation is
exposed to change in sales volume.
(b) There are certain steps involved in the budgetary control technique. They are as follows:
(i)

Definition of objectives: A budget being a plan for the achievement of certain

operational objectives, it is desirable that the same are defined precisely. The
objectives should be written out; the areas of control demarcated; and items of revenue and expenditure to be covered by the budget stated.

(ii) Location of the key (or budget) factor: There is usually one factor (sometimes
there may be more than one) which sets a limit to the total activity. Such a factor is
known as key factor. For proper budgeting, it must be located and estimated
properly.

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INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

(iii) Appointment of controller: Formulation of a budget usually required whole time

services of a senior executive known as budget controller; he must be assisted in
this work by a Budget Committee, consisting of all the heads of department along
with the Managing Director as the Chairman.
(iv) Budget Manual: Effective budgetary planning relies on the provision of adequate
information which are contained in the budget manual. A budget manual is a
collection of documents that contains key information for those involved in the
planning process.
(v) Budget period: The period covered by a budget is known as budget period. The
Budget Committee determines the length of the budget period suitable for the
business. It may be months or quarters or such periods as coincide with period of
trading activity.
(vi) Standard of activity or output: For preparing budgets for the future, past statistics
cannot be completely relied upon, for the past usually represents a combination of
good and bad factors. Therefore, though results of the past should be studied but
these should only be applied when there is a likelihood of similar conditions
repeating in the future.
(c) Management of Marketable Securities is an Integral Part of Investment of Cash
Management of marketable securities is an integral part of investment of cash as it
serves both the purposes of liquidity and cash, provided choice of investment is made
correctly. As the working capital needs are fluctuating, it is possible to invest excess
funds in some short term securities, which can be liquidated when need for cash is felt.
The selection of securities should be guided by three principles namely safety, maturity
and marketability.
(d) Concept of Capital Structure and its Significance in Financing Decision
Capital structure refers to the mix of a firms capitalisation i.e. mix of long-term sources of
funds such as debentures, preference share capital, equity share capital and retained
earnings for meeting its total capital requirement.
Significance in Financing Decision
The capital structure decisions are very important in financial management as they
influence debt equity mix which ultimately affects shareholders return and risk. These
decisions help in deciding the forms of financing (which sources to be tapped), their
actual requirements (amount to be funded) and their relative proportions (mix) in total
capitalisation. Therefore, such a pattern of capital structure must be chosen which
minimises cost of capital and maximises the owners return.

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PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

(e) (i)

65

Main Elements of Leveraged Lease

Under this lease, a third party is involved beside lessor and lessee. The lessor borrows
a part of the purchase cost (say 80%) of the asset from the third party i.e., lender. The
asset so purchased is held as security against the loan. The lender is paid off from the
lease rentals directly by the lessee and the surplus after meeting the claims of the
lender goes to the lessor. The lessor is entitled to claim depreciation allowance.

(ii) Escalation Clause - If during the period of execution of a contract, the prices of
materials, or labour etc., rise beyond a certain limit, the contract price will be
increased by an agreed amount. Inclusion of such a clause in a contract deed is
called an Escalation Clause

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