SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 1 of 9

STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2

Marks
Question No. 1
(a) Calculation of Annual Saving:
Calculation of Total Cost – without Just-in-Time (JIT) Inventory System:
Ovens Irons Blenders Total [Rupees]
Total direct cost (Rs. per unit) 3,640 4,216 5,940
Budgeted production (Units) 75,000 75,000 75,000
273,000,000 316,200,000 445,500,000 1,034,700,000 1.0
Overheads – Variable (Rupees):
Setup 13,000,000 13,000,000 19,500,000 45,500,000 0.5
Machine handling 16,000,000 20,000,000 22,400,000 58,400,000 0.5
Inspection 18,000,000 18,000,000 27,000,000 63,000,000 0.5
Machining 43,200,000 72,000,000 67,200,000 182,400,000 0.5
Distribution and warehousing 12,000,000 15,000,000 16,800,000 43,800,000 0.5
Overheads – Fixed (Rupees):
Setup 42,660,000
Machine handling 52,890,000
Inspection 59,880,000
Machining 144,540,000
Distribution and Warehousing 42,900,000
Total cost – without JIT 1,770,670,000 1.5
Calculation of Total Cost – with Just-in-Time (JIT) Inventory System:
Ovens Irons Blenders Total [Rupees]
Direct material (Rs. per unit) 2,520 2,924 3,960 0.75
Direct labour (Rs. per unit) 1,456 1,680 2,574 0.75
Total direct cost (Rs. per unit) 3,976 4,604 6,534 0.75
Budgeted production (Units) 75,000 75,000 75,000
Direct cost (Rupees) 298,200,000 345,270,000 490,050,000 1,133,520,000 1.0
Overheads – Variable (Rupees):
Setup 9,100,000 9,100,000 13,650,000 31,850,000 0.5
Machine handling 11,200,000 14,000,000 15,680,000 40,880,000 0.5
Inspection 13,500,000 13,500,000 20,250,000 47,250,000 0.5
Machining 36,720,000 61,200,000 57,120,000 155,040,000 0.5
Distribution and warehousing – – – – 0.5
Overheads – Fixed (Rupees):
Setup 36,660,000 0.25
Machine handling 47,890,000 0.25
Inspection 50,880,000 0.25
Machining 139,540,000 0.25
Distribution and warehousing – 0.25
Total cost – with JIT 1,683,510,000 1.5
Increase/ (Decrease) in Total Cost:
Rupees
Total cost – without JIT 1,770,670,000 0.5
Total cost – with JIT 1,683,510,000 0.5
Decrease in total cost 87,160,000 1.0

Recommendations:
JIT will result in savings of Rs.87,160,000 per annum. 0.5
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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 2 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
(b) (i) Target Costing: 03
Target costing is a customer-oriented technique. The first stage requires market research
to determine the customers’ perceived value of the product based on its functions and its
attributes.
The target profit margin depends on the planned return on investment (ROI) for the
organization as a whole and profit as a percentage of sales. This is then decomposed into
a target profit for each product which is subsequently deducted from the target price to
give the target cost.
The target cost is compared with the predicted actual cost. If the predicted actual cost is
above the target cost intensive efforts are made to close the gap so that the predicted cost
equals the target cost.

(ii) Functional Analysis: 03

Functional analysis is an analysis of the relationship between product functions, their
perceived value to the customer and their cost of provision.

(iii) Value Analysis: 03

Value analysis also known as value engineering is a systematic interdisciplinary
examination of factors affecting the cost of a product or service in order to devise means
of achieving the specified purpose at the required standard of quality and reliability at the
target cost.
The aim of Value Analysis is to achieve the assigned target cost by:
(i) Identifying improved product designs that reduce the product’s cost without sacrificing
functionality
(ii) Eliminating unnecessary functions that increase the product’s costs and for which
customers are not prepared to pay for extra.

Question No. 2
Optimal Production Plan:
Contribution for both Products:
Products A B
Sales price (Rs. per unit) 3,000 2,200
Government levy (Rs. per unit) (450) (330) 0.5
Sales commission (Rs. per unit) (225) (120) 0.5
Net selling price (Rs. per unit) 2,325 1,750 0.5
Direct Cost:
Material – X (Rs. per kg) 900 750 0.5
– Y (Rs. per litre) 600 450 0.5
Packing material (Rs. per unit) 15 10 0.5
Total direct cost 1,515 1,210 0.5
Contribution (Rs. per unit) 810 540 0.5

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
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provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of thes e suggested answers. It is clarified that the ICMA Pakistan shall not be liable
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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 3 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
Built up the linear programing model, as follows:
Let A = Number of unit of product ‘A’ produced and sold 0.25
Let B = Number of unit of product ‘B’ produced and sold 0.25
Function Equation
1. Contribution function C = 810A +540B 0.75
2. Machining capacity 1.5A + 2B ≤ 720 0.75
3. Assembly capacity 3.5A + 2B ≤ 1,200 0.75
4. Maximum output of A A ≤ 500 0.75
5. Minimum output of A A ≥ 0 0.75
6. Maximum output of B B ≤ 400 0.75
7. Minimum output of A B ≥ 0 0.75

Objective is to maximize:
C = 810A + 540B 0.5
Now, draw these functions (equations on the graph)
Output of A constraint : Line, A = 500 . . . . . . . . . . . . . . Equation-4 0.5
Output of B constraint : Line, B = 400 . . . . . . . . . . . . . . Equation-1 0.5
Draw lines of Equation-1 and Equation-4 with these coordinates
Machine Capacity Constraint:
Find the coordinates on 1.5A + 2B = 720 . . . . . . . . . . . . . . . . . . . . Equation-2
If A = 0 , B = 360 (0, 360) 0.5
If B = 0, A = 480 (480, 0) 0.5
Draw line of Equation-2 with these coordinates
Assembly Capacity Constraint:
Find the coordinates on 3.5 A+2B = 1,200 . . . . . . . . . . . . . . . . . . . . Equation-3 0.5
If A = 0 , B = 600 (0, 600) 0.5
If B = 0, A = 343 (343, 0) 0.5
Draw line of Equation-3 with these coordinates

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provided suggested answers on the basis of certain assumptions for general guidance of the students and there may be other possible answers/ solutions based on different assumptions and understanding. The ICMA Pakistan and its
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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 4 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
Optimum Output Mix:
Both the ‘machine’ (line of Equation-2) and ‘assembly’ (line of Equation-3) constraints intersect at
point ‘x’ [A = 240 and B = 180] on the graph as under:

600
550 Equation-4
500 Equation-3
450
400 B = 400 Equation-1
350
300
5.0
250
200
x
150
100
Equation-2
50 A = 500
0
50 100 150 200 250 300 350 400 450 500

So, the output mix is to product and sell 240 units of product ‘A’ and 180 units of product ‘B’.
Profit is maximized at this product mix as under:
Rupees
Contribution – Product ‘A’ (240 x Rs.810 per unit) 194,400 0.25
Contribution – Product ‘B’ (180 x Rs.540 per unit) 97,200 0.25
291,600 0.25
Less: Fixed Cost:
– Machine (110,000) 0.25
– Assembly (85,000) 0.25
Net profit 96,600 0.5

This optimum output mix can be determined exactly by solving simultaneous equations for
‘machine’ and ‘assembly’ constraints.
1.5A + 2B = 720 . . . . . . . . . . . . . . . . . . . . . . . . Equation-2 0.5
3.5A +2B = 1,200 . . . . . . . . . . . . . . . . . . . . . . . . Equation-3 0.5
Subtracting Equation-2 from Equation-3, it gives: 0.5
2A = 480 0.5
A = 240
Put A = 240 in Equation-3: 0.5
3.5 x 240 + 2B = 1,200 0.5
2B = 1,200 – 840 0.5
B = 180 0.5
Output mix is 240 units of product ‘A’ and 180 units of product ‘B’. 0.5

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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 5 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
Question No. 3
Decision-Making, using Decision Tree:
EV = Expected value in Rs. ‘000’ Profit [Rs. ‘000’]
Obtain Information Demand Weak 0.2 Choose LHR 5,500 1.0
EV = Demand Moderate 0.5 Choose ISB 7,500 1.0
9,950 Demand Strong 0.3 Choose KHI 17,000 1.0

KHI Demand Weak 0.2 4,500 1.0

No information EV = Demand Moderate 0.5 7,000 1.0
9,500 Demand Strong 0.3 17,000 1.0

ISL Demand Weak 0.2 3,500 1.0

No information EV= Demand Moderate 0.5 7,500 1.0
7,000 Demand Strong 0.3 8,500 1.0

LHR Demand Weak 0.2 5,500 1.0

No information EV= Demand Moderate 0.5 7,000 1.0
9,100 Demand Strong 0.3 15,000 1.0
With no perfect information, Karachi should be selected, as it has highest expected value of
Rs.9,500,000. 1.0
The value of perfect information is:
Rs. ‘000’
EV of profit without perfect information (if Karachi is chosen) 9,500 0.75
EV of profit with perfect information 9,950 0.75
Value of perfect information 450 0.5

Question No. 4
(a) (i) Contribution generated by City Electronics with No Production Constraint in Motor Division:
Rupees
Units of Washing Marginal Contribution of City
Price Sales
Machine Cost [W-1] Electronics
0 50,000 – – –
50 45,000 2,250,000 600,000 1,650,000 1.0
100 40,000 4,000,000 1,200,000 2,800,000 1.0
150 35,000 5,250,000 1,800,000 3,450,000 1.0
200 30,000 6,000,000 2,400,000 3,600,000 1.0
250 25,000 6,250,000 3,000,000 3,250,000 1.0

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suggested answers provided on and made available through the ICMA Pakistan’s website may only be referred, relied upon or tre ated as general guidelines and NOT a substitute for professional advice. The ICMA Pakistan has
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Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of thes e suggested answers. It is clarified that the ICMA Pakistan shall not be liable
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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 6 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
W-1: Marginal Cost (Rs. per unit):
Marginal cost – Motor Division 5,000
– Assembly Division 7,000
12,000 0.5
Marginal Cost (Rupees):
Marginal cost per unit 12,000
Number of units 50
600,000 0.5

It can be seen that optimum level of output and price is to sell 200 units at Rs.30,000. The
critical point is that transferring ‘motors’ from Motor Division to Assembly Division involves
no opportunity cost to City Electronics as a whole. 1.0

(ii) Contribution generated by City Electronics with Production Constraint in Motor Division:
Rupees
Units of
Marginal Opportunity Contribution
Washing Price Sales
Cost Cost [W-2] Margin
Machine
0 50,000 – – – –
50 45,000 2,250,000 600,000 575,000 1,075,000 1.0
100 40,000 4,000,000 1,200,000 1,150,000 1,650,000 1.0
150 35,000 5,250,000 1,800,000 1,725,000 1,725,000 1.0
200 30,000 6,000,000 2,400,000 2,300,000 1,300,000 1.0
250 25,000 6,250,000 3,000,000 2,875,000 375,000 1.0

W-2: Opportunity Cost:

Sales price of motors (Rs. per unit) 16,500
Marginal cost of motors (Rs. per unit) (5,000)
Contribution of motors (Rs. per unit) 11,500 0.5
Number of units of motors foregone 50
Contribution margin lost (Rs. per unit) 11,500
Opportunity cost (Rupees) 575,000 0.5

The critical thing, here, is that each unit of washing machine sold results in the sale of a
unit of motors (with Rs.11,500 contribution) being forgone. Hence, an opportunity cost of
Rs.11,500 results from each unit of washing machine sold. It can be seen that the
optimum level of output is 150 units at price of Rs.35,000 per washing machine. In this
case, the transfer price of Rs.16,500 (being marginal cost plus opportunity cost, or market
price) induces optimum behaviour from the point of view of City Electronics as a whole. 1.0

DISCLAIMER: These suggested answers including write-ups, tables, charts, diagrams, graphs, figures etc., are uploaded for the use of ICMA Pakistan members, students and faculty members only. No part of it can be reproduced,
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Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of thes e suggested answers. It is clarified that the ICMA Pakistan shall not be liable
to attend or receive any comments, observations or critiques related to the suggested answers.
 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 7 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
(b) Contribution generated by Assembly Division with No Production Constraint in Motor Division:
Rupees
Units of Washing Marginal Contribution of City
Price Sales
Machine Cost [W-3] Electronics
0 40,000 – – –
50 45,000 2,250,000 1,175,000 1,075,000 1.0
100 40,000 4,000,000 2,350,000 1,650,000 1.0
150 35,000 5,250,000 3,525,000 1,725,000 1.0
200 30,000 6,000,000 4,700,000 1,300,000 1.0
250 25,000 6,250,000 5,875,000 375,000 1.0

W-3: Marginal Cost (Rs. per unit):

Transfer price of motors (market price) 16,500
Marginal Cost of Assembly Division 7,000
23,500 0.5
Marginal Cost (Rupees):
Marginal cost per unit 23,500
Number of units 50
1,175,000 0.5

The transfer price system is likely to induce Assembly Division to produce 150 washing
machines at Rs.35,000 per washing machine. This maximizes the contribution to Assembly
Division but it is sub-optimal from the point of view of the company as a whole, as calculated in
part (a) above. 1.0

(c) General Rule for Transfer Pricing: 04

What the above analysis suggests is that the general rule for transfer pricing is that unit should
be transferred at marginal cost plus opportunity cost. Where there is no production constraint
in Motor Division then this rule gives a transfer price of Rs.5,000, which will induce the
optimum price and output in Assembly Division. Where there is a production constraint in
Motor Division then the rule gives a transfer price Rs.16,500 (Rs.5,000 marginal cost plus
Rs.11,500 opportunity cost) and this now induces the optimum price and output in Assembly
Division.

Question No. 5
(a) Evaluation of Performance, using Economic Value Addition (EVA) Concept:
EVA = NOPAT – (Capital employed x WACC)
Rs. in million
Net operating profit after tax (NOPAT) [W-1] 556 0.5
Capital employed [W-2] 4,888 0.5
Weighted average cost of capital (WACC) [W-4] 11.53% (564) 0.5
EVA (8) 0.5

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stored in a retrieval system or transmitted in any physical/ or electronic form or by any other means including electronic, mechanical, photocopying, recording or otherwise without prior written permission of the ICMA Pakistan. The
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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 8 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
Workings:
Rs. in million
W-1: Net operating profit after tax (NOPAT)
Operating profit 850
Accounting depreciation 315
Provision for doubtful debt 40
Research and development cost 55
Non-cash items 28
Economic depreciation (520)
Tax paid (paid in cash only) (115)
Tax adjustment on interest expense (325 x 30%) (98) 0.5
NOPAT 556 0.5

W-2: Capital Employed:

Capital employed – at the start of the year 4,850
Provision for doubtful debt [W-3] 17 0.5
Other non-cash items – Non-cash items in year 2017 21
4,888 0.5

W-3: Provision for Doubtful Debt:

Provision for doubtful debt – at the end of 2018 57
Movement in year 2018 (40)
Provision – at the start of the year 17 0.5

W-4: Weighted Average Cost of Capital (WACC)

Equity (35% x 18%) 6.30% 0.5
Debt [65% x {11.5% x (1 – 30%)}] 5.23% 0.5
11.53% 0.5
Interpretation:
Negative EVA (–8) for the year 2018, suggests that Faisalabad Unit, instead of creating wealth
of shareholders, is actually decreasing it. Specifically, NOPAT is not sufficient enough to cover
the economic cost of capital that has been employed to generate that value.
Such a position is not sustainable in the long run and will lead to dissatisfaction of
shareholders of the company. Management should look into the matter to increase the NOPAT
or decrease the cost of capital. 01

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 SUGGESTED SOLUTIONS/ ANSWERS – SUMMER 2019 EXAMINATIONS 9 of 9
STRATEGIC MANAGEMENT ACCOUNTING [S4] – STRATEGIC LEVEL-2
Marks
(b) Break-even Level of EVA, assuming Capital Employed Unchanged:
At current Cost of Capital, Management must increase the profit at least by Rs.37 million to
bring the unit at Breakeven level on EVA. 1.0
Current Position of Cost of Capital:
Rs. in million
Net operating profit after tax (NOPAT) 556
Capital employed 4,888
Weighted average cost of capital (WACC) 11.53% (564)
EVA (8) 0.5

Cost of capital should be reduced by Rs.8 million to Rs.556 million to make the EVA at
break-even.
Required Cost of Capital Percentage (%):
Cost of capital ÷ Capital employed x 100 = (556 ÷ 4,888) x 100 = 11.37% 0.5
Required cost of capital is 11.37%, as capital employed cannot be changed. The management
should reduce the cost of capital either by arranging the equity and debt at lower rate or
revising the capital structure with a higher then existing portion of debt (that is cheaper than
equity). 1.0

THE END

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Council Members, Examiners or Employees shall not be liable in respect of any damages, losses, claims and expenses arising out of using contents of thes e suggested answers. It is clarified that the ICMA Pakistan shall not be liable
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