Management Accounting

Final Examination 2 June 2014

Summer 2014 100 marks - 3 hours
Module F Additional reading time - 15 minutes

Q.1 (a) Briefly discuss any four criticisms on standard costing system. (04)

(b) SMPL is a leading construction company and is working on major projects

throughout the country. It has been awarded a construction contract having a total
value of Rs. 9,600 million. The project has to be completed within 6 months.

Following are the relevant details:

(i) SMPL would receive a mobilization advance of 10% of contract value which
will be adjustable against progress bills.
(ii) Progress bills would be raised at the end of each month on the basis of
percentage of work completed. Preparation of monthly progress bills would
require 15 days. A further 45 days would be required for verification and
processing of progress bills.
(iii) 5% retention money shall be withheld from the progress bills and shall be
released at the end of maintenance period of four months.
(iv) All receipts are subject to withholding of 6% income tax.
(v) The projected work completion schedule shows that work would be completed
in three stages. 20% work would be completed in the first stage, 30% in the
second stage and 50% in the third stage. Work on each stage would be evenly
distributed and each stage would be completed in 2 months’ time.
(vi) The following projections have been prepared by SMPL:

Net profits are estimated at 20% of cost.

Cost of cement & steel would be 55% of total project cost. The ratio of
quantities of cement and steel is 3.75:1 respectively and their prices are
Rs. 10,000 and Rs. 60,000 per ton respectively. 80% of the steel and 60%
of cement would be required in the first stage. 25% of the remaining
quantities would be required in each of the four remaining months.

50% payments are required to be made to cement & steel suppliers at the
time of delivery and the remaining 50% after 30 days.

Cost of sub-contracting work is estimated at Rs. 1,500 million.
Sub-contractors will start work in the second month and the work would
be evenly distributed over the next five months. Progress bills would be
raised on 10th of the next month while SMPL would be liable to release
the payment within 20 days of receipt of progress bill.

Other costs on the project would be incurred evenly over the period of the
contract. 30 days credit would be available on all expenditures.

(vii) The entire project would be financed by utilising the running finance facility
carrying interest @ 12% per annum which would be charged on month end
balance.

Required:
Assuming that the project commences on the first day of the year, prepare a
statement showing monthly cash flows relating to the project for the first eight
months of the year. (18)
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Q.2 ABC Limited which produces and sells a single product is faced with liquidity issues. In
order to improve its financial position, it intends to revise its working capital policies as
follows:
(i) The standard price of the product is Rs. 100 per unit. 500,000 units are sold per
month. Presently, 20% of all units are sold for cash and ABC offers a cash discount
of 8% on such sales. The present credit terms are 3/30, net 60 and 40% of the credit
customers pay within 30 days.

ABC intends to revise the credit terms to 4/15, net 30. As a result, the overall sales
volume is expected to decline by 5% whereas the proportion of cash sales is expected
to increase to 30% of total sales. It is also envisaged that 50% of credit customers
would avail 4% discount.

(ii) The existing policy of holding 45 days of stock would be revised downwards to
30 days.

(iii) The suppliers offer credit terms of 2/20, net 60. Presently, prompt payments are
made to avail the discount. ABC has now decided to utilize the maximum credit
period offered by the suppliers.

The variable cost per unit is Rs. 80 of which 70% constitutes raw material cost. The
company's cost of funds is 15%.

Required:
Evaluate and discuss the management’s decision as regards the revision of its working
capital policies. (15)

Q.3 Sigma Limited is the manufacturer of a single product which passes through two divisions
A and B. The semi-finished goods produced in Division A are sold in the open market as
well as supplied to Division B where each unit is processed further. The performance of
managers of both the divisions are evaluated based on the divisional profitability. Managers
are free to adopt policies which maximize profits of their divisions.

Information related to two divisions is given below:

Division A Division B
Production capacity Units 1,500 1,500
Existing demand (outside customers) Units 300 900
Maximum demand (outside customers) Units 600 1,800
Current selling price per unit (outside customers) Rs. 44,000 84,000
Variable cost per unit Rs. 32,000 34,000

Division A offers 10% discount on its selling price to Division B.

The marketing director is reviewing the pricing policy to explore the possibility of increasing
the sales. He has carried out a research which shows that:

sale of semi-finished product would be stable at this level in the coming years; and

market dynamics do not allow the company to increase current prices of finished
goods produced by Division B; however, sale would increase by 300 units for every
2% decrease in price of finished goods.

Required:
(a) Determine how the company could maximize its profits. (12)
(b) Determine the transfer price at which manager of Division A would agree to the
decision based on (a) above. Also describe the possible viewpoint of manager of
Division B. (04)
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Q.4 Sajjad Enterprises Limited (SEL) has signed an MOU with the government to set up a plant
for production of a medicine which would be distributed to the general public at a highly
subsidised rate. The MOU envisages that the arrangement would last a total of 5 years from
the commencement of sale. Negotiations are underway for determination of price at which
the government would purchase the medicine.

Following are the relevant details:

(i) A foreign supplier has agreed to supply the plant at a cost of US$ 20 million. An
advance of 30% is required to be paid at the time of placing the order while balance
amount is payable after 6 years of the supply of the plant. A mark-up of 5% would be
required to be paid on the outstanding amount at the end of each year.
(ii) SEL would be required to submit a bank guarantee to the supplier in US Dollars.
SEL’s bankers have agreed to issue the guarantee at a cost of 0.35% per quarter
subject to maintaining a cash margin in Pak Rupees equivalent of 25% of the
guaranteed amount. Bank has agreed to pay a return of 4% per annum on amount
placed as margin.
(iii) 15 acres of land will be required for the plant and a local authority has offered to
lease the land at a consideration of Rs. 2 million per acre for 6 years, besides an
annual ground rent of Rs. 95,000 per acre. An amount of Rs. 600,000 per acre will
be required for the development of the project site.
Other related supplies will be procured against payment on delivery basis at a cost of
Rs. 600 million. A period of one year will be required to complete the project from
the date of lease of land and receiving of plant.
(iv) Cost of production would be Rs. 5 per unit plus fixed costs of Rs. 50 million per
annum (excluding depreciation).
(v) SEL would depreciate the plant over 5 years. It is expected that at the end of 5 years’
term, the plant would be sold for Rs. 50 million.
(vi) Estimated capacity of the plant is 100,000 units per day with 5 days annual shut
down plan for maintenance and other reasons. Assume 365 days in a year.
(vii) Surplus funds can be placed with banks at 10% per annum while local borrowing is
available at 14% per annum.
(viii) Current exchange rate is Rs. 100 per US$ and the rupee is expected to depreciate at
3% per annum.

Required:
Calculate the price per unit that SEL should accept to earn a profit of 20% on its total costs,
over the life of the plant. (15)

Q.5 A company manufactures two products Alpha and Beta. Alpha can only be used in
combination with Beta in the ratio of 4:1 respectively. Beta has separate uses also. Projected
information per unit for the next year is as follows:

Alpha Beta
Selling price Rs. 6,800 5,800
Material cost Rs. 3,500 2,600
Variable manufacturing costs (other than labour and machine cost) Rs. 380 340
Applied fixed overheads Rs. 250 180
Machine hours 5 4
Labour hours 3 6

The available capacity for the next year is 40,000 machine hours and 30,000 labour hours.
Machine time costs Rs. 320 per hour and labour is paid at Rs. 140 per hour.

Maximum demand for Alpha is 6,000 units. Beta has unlimited demand.
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Required:
(a) Determine the optimal production plan for the next year which maximizes the profit
of the company. (13)
(b) Compute the shadow prices of scarce resources assuming that maximum demand
remains constant. (04)

Q.6 Zee Printing is a partnership concern, operating with three different printing machines. The
production is carried out in two shifts of eight hours each. The related information is as
follows:

Machine-1 Machine-2 Machine-3

Monthly production capacity in 2 shifts (Sheets) 4,500,000 5,500,000 7,000,000
Number of workers per shift 45 35 54
Actual capacity utilization of 2 shifts 80% 85% 90%
Existing net realizable value of machines (Rs.) 14,280,000 22,950,000 54,000,000

Monthly fixed costs Amount in Rs.

Depreciation 340,000 425,000 750,000
Labour 1,354,500 1,172,500 1,971,000
Rent 330,000 350,000 400,000

The management is unable to get the projected printing orders as the market conditions are
not conducive enough and the situation is not expected to change in the foreseeable future.
The management has therefore decided to dispose of one of the machines to reduce fixed
costs.

After the disposal of the machine, the existing demand will be met by working overtime
hours. Management wants to keep an additional spare capacity of at least 2.6 million sheets
to meet any special order.

The company's policy is to pay overtime to labour at one and a half time of normal rate. As
per the agreement with labour union, all workers will be allowed to work the same number
of overtime hours.

The company’s required rate of return on capital is 15%.

Required:
Prepare calculation to show which machine is the most feasible to dispose of. (15)

(THE END)