Answer to MTP_Intermediate_Syllabus 2012_Jun2015_Set 2

PAPER – 10: COST & MANAGEMENT

ACCOUNTANCY

Academics Department, The Institute of Cost Accountants of India (Statutory Body under an Act of Parliament) Page 1
 Answer to MTP_Intermediate_Syllabus 2012_Jun2015_Set 2

The following table lists the learning objectives and the verbs that appear in the syllabus
learning aims and examination questions:

Learning objectives Verbs used Definition

KNOWLEDGE List Make a list of
State Express, fully or clearly, the
What you are expected details/facts
to know Define Give the exact meaning of
Describe Communicate the key features
of
Distinguish Highlight the differences
COMPREHENSION between
Explain Make clear or intelligible/ state
What you are expected the meaning or purpose of
to understand Identity Recognize, establish or select
after consideration
Illustrate Use an example to describe or
explain something
Apply Put to practical use
Calculate Ascertain or reckon
LEVEL B

mathematically
APPLICATION
Demonstrate Prove with certainty or exhibit by
practical means
How you are expected to
Prepare Make or get ready for use
apply
Reconcile Make or prove consistent/
your knowledge
compatible
Solve Find an answer to
Tabulate Arrange in a table
Analyse Examine in detail the structure
of
ANALYSIS Categorise Place into a defined class or
division
How you are expected Compare Show the similarities and/or
to analyse the detail of and contrast differences between
what you Construct Build up or compile
have learned Prioritise Place in order of priority or
sequence for action
Produce Create or bring into existence

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 Answer to MTP_Intermediate_Syllabus 2012_Jun2015_Set 2

Paper – 10: Cost & Management Accountancy

Time Allowed: 3 Hours Full Marks: 100

This paper contains 4 questions. All questions are compulsory, subject to

instruction provided against each question. All workings must form part of
your answer.
Assumptions, if any, must be clearly indicated.

1. Answer all questions [2x10=20]

(a) XYZ Company fixes the inter-divisional transfer prices for its products on the
basis of cost plus an estimated return on investment in its divisions. The
relevant portion of the budget for the Division A for the year 2013 -14 is given
below.
Particulars Amount in `
Fixed Assets 5,00,000
Current Assets (other than debtors) 3,00,000
Debtors 2,00,000
Annual Fixed Cost for the Division 8,00,000
Variable Cost Per unit of product 10
Budgeted Volume of Production per year (units) 4,00,00
Desired Return on Investment 20%
You are required to determine the transfer price for Division A.

Answer:
Computation of Transfer Price per unit
Particulars Amount (`)
Variable cost 10.00
Fixed cost (8,00,000 / 4,00,000) 2.00
Total Cost 12.00
Add: Desired return (10,00,000 x 20%) ÷ 4,00,000 0.50
Transfer Price 12.50

(b) Selling price of a product is `5 per unit, variable cost is `3 per unit and fixed
cost is `12,000. Calculate the break-even point in unit.

Answer:
Contribution=Sales-variable cost
=5-3
=2

Break-even point=Fixed cost/contribution per unit

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=12,000/2
=6,000 units

(c) Bharat Ltd. is preparing its cash budget for the period. Sales are expected to
be ` 1,00,000 in April 2014, `2,00,000 in May 2014, ` 3,00,000 in June 2014 and `
1,00,000 in July 2014. Half of all sales are cash sales, and the other half are on
credit. Experience indicates that 70% of the credit sales will be collected in
the month following the sale, 20% the month after that, and, 10% in the third
month after the sale. Calculate the budgeted collection for the month of July
2014.

Answer
Collection from
July 2014 cash sales will be half of total sales or `50,000
From April ` 50,000 of credit sales, collection should be 10% or `5,000
From May ` 1,00,000 of credit sales, collections should be 20% or `20,000
From June ` 1,50,000 of credit sales, collection will be 70% or ` 1,05,000

Thus total collections will amount to ` 1,80,000

(d) Budgeted sales for the next year is 5,00,000 units. Desired ending finished
goods inventory is 1,50,000 units and equivalent units in ending W-I-P inventory
is 60,000 units. The opening finished goods inventory for the next year is
80,000 units, with 50,000 equivalent units in beginning W-I-P inventory How
many equivalent units should be produced?

Answer
Using production related budgets, units to produce equals budgeted sales + desired
ending finished goods inventory + desired equivalent units in ending W-I-P inventory –
beginning finished goods inventory – equivalent units in beginning W-I-P inventory.

Therefore, in this case, units to produce is equal to 5,00,000 + 1,50,000 + 60,000 – 80,000
– 50,000 = 5,80,000.

(e) State out-of-pocket cost.

Answer:
Out-of-Pocket Cost: This is the portion of the cost associated with an activity that
involves cash payment to other parties, as opposed to costs which do not require any
cash outlay, such as depreciation and certain allocated costs. Out-of-Pocket costs are
very much relevant in the consideration of price fixation during trade recession or
when a make-or-buy decision is to be made.

(f) State Cost Audit.

Answer:
Cost audits help to ascertain whether an organization‟s cost accounting records are
so maintained as to give a true and fair view of the cost of production,
processing,
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manufacturing, and mining of a product. Therefore, cost audits can be used to the
benefit of management, consumers and shareholders by (a) helping to identify
weaknesses in cost accounting systems, and (b) to help drive down costs by
detecting wastage and inefficiencies. Cost audits are also of assistance to
governments in helping to formulate tariff and taxation policies.

(g) Difference between Cost Accounting policy and Cost Accounting system.

Answer:
Cost Accounting Policy of a company should state the policy adopted by the company
for treatment of individual cost components in cost determination.
The Cost Accounting system of a company, on the other hand, would provide a flow of
the cost accounting data/information across the activity flow culminating in arriving at
the cost of final product/activity.

(h) The Cost(C) of a firm is given by the function C = x3 + 12x² – 10x+5, find the
Average Cost, & Marginal cost and x being the output.

Answer:
Total Cost (C) = x3 + 12x2 – 10x + 5 (given)
Average Cost (C/x) = x2 + 12x – 10 + 5/x
Marginal Cost (dc /dx) = 3x2 + 24x – 10

(i) The Demand and Supply function under perfect Competition are y=16-x2 and
y=2x2+4 respectively. Find the Market Price.

Answer:
Under Perfect Competition Market Price is : Demand = Supply i.e.

16 – x2 = 2x2 + 4
Or 16 – x2 – 2x2 – 4 = 0
Or -3x2 + 12 = 0
Or -3x2 = - 12
12
 x2 = =4
3
x= 4=±2 i.e. 2 or -2 (since Quantity /units cannot be negative, rejecting the
negative value (-2)

Market Price y= 16 - x2
= 16 - 22 = 16 - 4 = 12 (when x = + 2)

(j) State the conditions for price discrimination.

Answer:
The price discrimination is possible if the following conditions are satisfied.

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 More than one Market: There must be two or more than two separate markets
otherwise the price discrimination is not possible. Different markets must be essential
for charging different prices from different persons.
 Different elasticity: The elasticity of demand in each market must be different. It
means that if one market is less elastic than the other it should be elastic. If the
elasticity of demand is equal in all markets there will be no scope for price
discrimination.

2. Answer

any two questions from a, b and c.

[2x20=40] (a)
(i) A radio manufacturing company finds that while it costs `6.25 each to make
componenet
X 273 Q, the same is available in the market at `5.75 each, with an assurance of
continued supply. The breakdown of cost is:
Materials `2.75 each
Labour `1.75 each
Other Variable Costs `0.50 each
Depreciation and other Fixed Cost `1.25 each
Total Cost `6.25 each
(I) Should you make or buy?
(II) What would be your decision if the supplier offered the component at `4.85
each?
[3+2]
Answer:
(I) The variable cost of manufacturing a component is `5 calculated as follows:
Materials `2.75
Labour `1.75
Other Variable Costs `0.50
`5.00

The market price is `5.75. This is more than the variable cost by Re. 0.75. It is
therefore not profitable to procure from outside because in any case the fixed costs
will continue to be incurred. However, if the surplus capacity released on account of
procuring the component from outside could be put to a more profitable use, it may
be better to buy from outside rather than manufacturing the component.

(II) In case the supplier is prepared to supply the component at `4.85, there is saving of
15 paise in the variable cost too. Hence, it is profitable to procure from outside. The
surplus capacity released may be put to some other profitable use.

(ii) Explain about Zero Based Budgeting. [6]

Answer:
Zero Based Budgeting (ZBB)
It differs from the conventional system of budgeting. It starts from scratch or zero and
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not on the basis of trends or historical levels of expenditure. In the customary
budgeting system, the last year's figures are accepted as they are, or cut back or
increases are

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granted. Zero based budgeting on the other hand, starts with the premise that the
budget for next period is zero so long the demand for a function, process, project or
activity is not justified for each rupee from the first rupee spent. The assumptions are
that without such a justification no spending will be allowed. The burden of proof thus
shifts to each manager to justify why the money should be spent at all and to indicate
what would happen if the proposed activity is not carried out and no money is spent.

The first step in the process of zero based budgeting is to develop an operational plan
or decision package. A decision package identifies and describes a particular activity
with a view to:
 evaluate and allot ranking of the activity against other activities competing for the
same scarce resources, and
 Decide whether to accept or reject or amend the activity.

For this purpose, each package should give details of costs, returns, purpose, expected
results, the alternatives available and a statement of the consequences if the activity
is reduced or not performed at all.
The advantages of Zero based budgeting are:
 Out of date and inefficient operations are identified.
 Allows managers to promptly respond to changes in the business environment.
 Instead of accepting the current practice, it creates a challenging and questioning
attitude.
 Allocation of resources is made according to needs and the benefits derived.
 It has a psychological impact on all levels of management which makes each
manager responsible for his actions taken

(iii) A manufacturing concern, engaged in mass production produces

standardized electric motors in one of its departments. From the following
particulars of a job of 50 motors you are required to value the work-in-progress
and finished goods.

[5+4]
I. Costs incurred as per job card:
Particulars `
Direct Material 75,000
Direct Labour 20,000
Overheads 60,000

II. Selling price per motor: `4,500

III. Selling and distribution expenses are at 30% of sales value.
IV. 25 Motors are completed and transferred to finished goods.
V. Completion stage of work-in-progress:
Particulars
Direct Material 100%
Direct Labour & Overheads 60%

Answer:
Statement of equivalent production and cost
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Direct Material Labour &

Particulars Overheads Total
% Quantity % Quantity
Transferred to Finished 100 25 100 25
Goods
Work-in-progress 100 25 60 15
Equivalent Units 50 40
Total Cost (`) 75,000 80,000 1,55,000
Cost per Equivalent Unit (`) 1,500 2,000 3,500

Actual Cost of Production per Unit of Finished Goods

Particulars `
Direct Material 1,500
Labour & Overheads 2,000
Total 3,500

Market Value per Unit of Finished Goods

Particulars `
Selling price 4,500
Less: Selling & Distribution Overheads @ 30% of `4,500 1,350
Total 3,150

Stocks should be at the lower of the cost (i.e., `3,500) or market value (i.e., `3,150). Hence,
basis of valuation will be market value in this case.

Value of Work-in-progress
Particulars `
Direct Material: `1,500 x 25 units 37,500
Labour & Overheads: `(3,150 – 1,500) × 15 units 24,750
Total 62,250

Value of Finished Goods Stock

25 units × `3,150 `78,750
Total Value of Inventory = `78,750 + `62,250 1,41,000

(b)
(i) P Ltd. has two divisions; S and T. S transfer all its output to T, which finishes
the work. Costs and revenues at various levels of capacity are as follows:
Output S. cost T Net revenues Profit
(i.e. revenue minus costs
incurred in T)
Units ` ` `
600 600 2,950 2,350
700 700 3,250 2,550

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800 840 3,530 2,690

900 1,000 3,780 2,780
1,000 1,200 4,000 2,800
1,100 1,450 4,200 2,750
1,200 1,800 4,350 2,550

Company profits are maximized at `2,800 with output of 1,000 units. If P Ltd.
wish to select a transfer price in order to establish S and T as profit centres,
what transfer price would motivate the managers of S and T together to
produce 1,000 units, no more and no less?

P Ltd. wants that the transfer price should be set at `2.10 per unit. Comment
on this proposal. [6+(4+1)]

Answer:
The transfer price will be notional revenue to S and notional cost to T.
 S will continue to produce more output until the costs of further production exceed
the transfer price revenue.
 T will continue to want to receive more output from S until its net revenue from
further processing is not sufficient to cover the incremental transfer price costs.
Output Division S Division T
Incremental Costs Incremental Costs
Units ` `
600 - -
700 100 300
800 140 280
900 160 250
1,000 200 220
1,100 250 200
1,200 350 150
Since S will continue to produce more output if the transfer price exceeds the
incremental costs of production, a price of at least ` 200 per 100 units (`2 per unit) is
required to 'persuade' the manager of S to produce as many as 1,000 units, but a price
in excess of ` 250 per 100 units would motivate the manager of S to produce 1,100 units
(or more).

By a similar argument, T will continue to want more output from S if the incremental
revenue exceed the transfer costs from S. If T wants 1,000 units the transfer price must
be less than ` 220 per 100 units. However, if the transfer price is lower than ` 200 per 100 units,
T will ask for 1,100 units from S in order to improve its divisional profit further.

In summary
 The total company profit is maximized at 1,000 units of output.
 Division S will, want to produce 1,000 units, no more and no less, if the transfer price
is between ` 2 and ` 2.50 (`200 to ` 250 per 100 units).
 Division T will want to receive and process 1,000 units, no more and no less, if the
transfer price is between `2 and `2.20

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 A transfer price must therefore be selected in the range `2.00 to `2.20 per unit
(exclusive).

If a price of `2.10 per unit is selected, profits at 1,000 units of output would be:
`2.10
Particulars Division S Division T Total
Sales/net revenue Costs 2,100 4,000 4,000
Profit 1,200 2,100 1,200
900 1,900 2,800

At a transfer price of `2.10 any increase in output above 1,000 units, or shortfall in output
below this amount, would reduce the profits of the company as a whole, but also the
divisional profits of S and T.

(ii) Relevant data relating to a Company are:

Products
A B C Total
Production and sales (Units) 60,000 40,000 16,000
Raw material usage in units 10 10 22
Raw material costs (`) 45 40 22 24,76,000
Direct labour hours 2.5 4 2 3,42,000
Machine hours 2.5 2 4 2,94,000
Direct Labour Costs (`) 16 24 12
No. of production runs 6 14 40 60
No. of deliveries 18 6 40 64
No. of receipts 60 140 880 1,080
No. of production orders 30 20 50 100

Overheads: `
Setup 60,000
Machines 15,20,000
Receiving 8,70,000
Packing 5,00,000
Engineering 7,46,000
The Company operates a JIT inventory policy and receives each component
once per production run.

Required:
I. Compute the product cost based on direct labour-hour recovery rate of
overheads.
II. Compute the product cost using activity based costing. [2+5]

Answer:
I. Traditional method of absorption of overhead i.e. on the basis of Direct Labour Hours

Total Overheads 36,96,000

[Hours(60,000x 2.5) (40,000x 4) (16,000x 2])
=

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= 36,96,000/3,42,000
= `10.81 per labour hour

Calculation of Factory cost of the products under

Traditional Method of apportioning overheads:
A B C
` ` `
Raw Material 45.000 40.00 22.00
Direct Labour 16.000 24.00 12.00
Overheads (2.5 x 10.81) 27.025 43.24 21.62
Factory cost (Total) 88.025 107.24 55.62

II. Under Activity Based Costing System

Computation of Cost driver‟s rates
Cost Pool Cost Driver Cost per cost driver
Set up cost No. of production run 60,000/ 60 = ` 1,000 per run
Machines Machine hour rate 15,20,000/ 2,94,000 = `5.17 per
machine hour
Receiving cost No. of receipts 8,70,000/ 1,080 = `805.56
Packing No. of deliveries 5,00,000/ 64= `7,812.5 per delivery
Engineering No. of production order 7,46,000/ 100= `7,460 per order

(iii) List out the two limitation of Inter-firm Comparison.

[2] Answer:
 A sense of complacence on the part of the management who may be satisfied with
the present level of profits.
 Absence of a proper system of Cost Accounting so that the costing figures supplied
may not be relied upon for comparison purposes.

(c)
(i) A factory has a key resource (bottleneck) of Facility X which is available for
15,650 minutes per week. Budgeted factory costs and data on two products,
A and B, are shown below:
Product Selling Material Time in Facility X
price/Units cost/Unit
A `30 `15.00 2.5 minutes
B `30 `13.125 5 minutes

Budgeted factory cost per week:

`
Direct labour 18,750
Indirect labour 9,375
Power 1,312.5
Depreciation 16,875

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Space Costs 6,000

Engineering 2,625
Administration 3,750
Actual production during the last week is 2,375 units of product A and 325 units
of product
B. Actual factory cost was
`58,687.5. Calculate:
(I) Total factory costs (TFC)
(II) Cost per factory minute
(III) Return per factory minute for both products
(IV) TA ratios for both product
(V) Throughput cost per the week
(VI) Efficiency ratio
[1+1+3+2+11/2+11/2]

Answer:

(I) Total factory cost= Total of all costs except materials.

= `18,750 + `9,375 + `1,312.5 + `16,875 + `6,000 + `2,625 + `3,750
= `58,587.5

(II) Cost per Factory Minute=Total Factory Cost÷ Minutes available

= `58,687.5 ÷ 15,650
=`3.75

(III)

(a) Return per bottleneck minute for the product Selling Price  M
A= aterialCost M inutesin
bottleneck
= (30-15)/ 2.5
= `6

(b) Return per bottleneck minute for the product Sellingprice  M aterialCost
B= M inutesin bottleneck
= (30 – 13.125)/ 5
= `3.375

Returnper M inute
(IV) Throughput Accounting (TA) Ratio for the product A=
Costper M inute
= (6/ 3.375)
=`1.778

Returnper M inute
Throughput Accounting (TA) Ratio for the product B=
Costper M inute
= (3.375/ 3.75
=`0.9

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Based on the review of the TA ratios relating to two products, it is apparent that if we
only made product B, the enterprise would suffer a loss, as its TA ratio is less than 1.
Advantage will be achieved, when product A is made.
(V) Standard minutes of throughput for the week:
= [2,375 × 2.5] + [325 ×5]
= 5,937.5 + 1,625
=7,562.5 minutes
Throughput Cost per week:
=7,562.5 × `3.75 per minutes
=`28,359.375

(VI) Efficiency % =( Throughput Cost/ Actual TFC) %

= (`28,359.375/ `58,687.5) ×100
=48.323%

The bottleneck resource of facility A is advisable for 15,650 minutes per week but
produced only 30,250 standard minutes. This could be due to:
 The process of a „wandering‟ bottleneck causing facility A to be underutilized.
 Inefficiency in facility A.

(ii) The share of production and the cost-based fair price computed separately
for a common product for each of the four companies in the same industry
are as follows:
A B C D
Share of Production (%) 40 25 20 15
Costs:
Direct materials (` /Unit) 75 90 85 95
Direct Labour (` /Unit) 50 60 70 80
Depreciation (` /Unit) 150 100 80 50
Other Overheads(` /Unit) 150 150 140 120
Total (` / Unit) 425 400 375 345
Fair Price (` /Unit) 740 615 550 460
Capital employed per Unit:
(i) Net Fixed Assets(` /Unit) 1,500 1,000 800 500
(ii) Working Capital (` /Unit) 70 75 75 75
Total (` /Unit) 1,570 1,075 875 575
Required:
What should be the uniform price that should be fixed for the common product?
[10]

Answer:
Assume Total Production = 100
A B C D Total
Price 740 615 550 460
(-)Cost 425 400 375 345
Profit per unit 315 215 175 115
Share of 40 25 20 15

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production(%)
Total Return 12,600
5,375 3,500 1,725 23,200
Capital Employed 1,570 x 40
1,075 x 25 875 x 2 575 x 15 1,15,800
23,
 Average Return on Capital Employed = = 20% (approx)
200

1,15, 800
Calculation of Uniform Price
A [425 + (20% of 1,570)] x 40 29,560
B [400 + (20% of 1,075)] x 25 15,375
C [375 + (20% of 875)] x 20 11,000
D [345+ (20% of 575)] x 15 6,900
Total Cost + Profit 62,835
No. of Units 100
 62, 835 
Uniform Price Per Unit   = 628.35
100
 

3. Answer any two questions from a, b and c. [2x8=16]

(a) “It is not possible to merge Cost Audit with Financial Audit to have a
Composite Audit.” Discuss. [8]

Answer:
Even though there are considerable areas of overlapping between cost and financial
records, a composite audit requirement between the two is not feasible on the
following grounds:
 Different information systems – It is difficult to collect the accounting information
required for cost ad financial audit purposes, in a single format.
 Objective of audit – The main objective of financial audit is to express an opinion
on the truth and fairness of the information contained in the financial statements.
But the main objective of cost audit is to verify the cost statements and see
whether a true and fair cost of production and of marketing has been worked out.
 Focus of audit – Cost Audit focuses on review of information in respect of each
cost element in detail. Hence, the focus of audit and review of information is
much different from that of financial audit.
 Classification of accounting data – Financial Accounts present data under the
natural accounting heads. However, Cost Records present information based on
product lines and cost-centres.
 Confidentiality – The Financial Audit Report is too general and is made public as
per the requirements of the Companies Act, 1956. The Cost Auditor Report may
contain certain information which the Company considers confidential.
 Applicability – The maintenance of Cost Accounting Records by all types of
industries may also not be practicable. At present, small-scale industrial
undertakings are exempted from maintaining Cost Accounting Records, even of
they belong to industry which is required to maintain Cost Records.

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 Toll of management – Cost Audit can be considered as tool of internal

management by a Company to operate effectively in a competitive environment
by disclosing weaknesses in a cost accounting system and disclosing
inefficiencies at all levels of organization. On the other hand, Financial Audit can
give a picture of the overall results only.
 Extensive nature – The Cost Auditor does not have to state only whether the Cost
Statements reflect a true and fair view, but has to go much beyond and express
his opinion also on propriety and efficiency aspects.

(b)
(i) State the term Telecommunication Services and Write its coverage. [6]

Answer:
The Companies (Cost Records and Audit) Rules, 2014 has covered “Telecommunication
services made available to users by means of any transmission or reception of signs,
signals, writing, images and sounds or intelligence of any nature (other than broadcasting
services) and regulated by the Telecom Regulatory Authority of India under the Telecom
Regulatory Authority of India Act, 1997 (24 of 1997)”. The Telecom Regulatory Authority
of India Act, 1997 defines "telecommunication service" as “service of any description
(including electronic mail, voice mail, data services, audio text service, video text
services, radio paging and cellular mobile telephone services) which is made available
to users by means of any transmission or reception of signs, signals, writing, images and
sounds or intelligence of any nature, by wire, radio, visual or other electro-magnetic
means but shall not include broadcasting services”.
Subsequently, the Central Government has included broadcasting services within the
ambit of telecommunication services by notifying “broadcasting services and cable
services to be telecommunication service”. [Notification No. 39 issued by Ministry of
Communication and Information Technology dated 9 January 2004, S.O. No. 44(E) issued
by TRAI, vide F. No. 13-1/2004].
In view of the above, Telecommunication Services made available to users and regulated
by the Telecom Regulatory Authority of India under the Telecom Regulatory Authority
of India Act, 1997 would include all such services being regulated by TRAI including
broadcasting services.

(ii) Variance Accounting is also part of a system of Cost Records. Explain

[2] Answer.
The company may maintain Cost Records on any basis other than actual, i.e., Standard
Costing System. In such case, the Cost Records should revel the following:
 Particulars of norms and standards established – both physical and financial
 Details of variances recognized and accounted by the Costing System.
 Time of recognition of variances and the method of accounting – either single plan
or partial plan.
 Method of disposition of variances at the end of the period.

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(c) List out the objectives of Cost Audit. [8]

Answer:
Cost Audit has both general and social objectives. The general objectives can be described
to include the following:
 Verification of cost accounts with a view to ascertaining that these have been
properly maintained and compiled according to the cost accounting system followed
by the enterprise.
 Ensuring that the prescribed procedures of cost accounting records rules are duly
adhered to Detection of errors and fraud.
 Verification of the cost of each “cost unit” and “cost center” to ensure that these
have been properly ascertained.
 Determination of inventory valuation.
 Facilitating the fixation of prices of goods and services.
 Periodical reconciliation between cost accounts and financial accounts.
 Ensuring optimum utilization of human, physical and financial resources of the
enterprise.
 Detection and correction of abnormal loss of material and time.
 Inculcation of cost consciousness.
 Advising management, on the basis of inter-firm comparison of cost records, as
regards the areas where performance calls for improvement.
 Promoting corporate governance through various operational disclosures to the
directors.
 Among the social objectives of cost audit, the following deserve special mention:
 Facilitation in fixation of reasonable prices of goods and services produced by the
enterprise. Improvement in productivity of human, physical and financial resources
of the enterprise.
 Channelising of the enterprise resources to most optimum, productive and
profitable areas.
 Availability of audited cost data as regards contracts containing escalation clauses.
 Facilitation in settlement of bills in the case of cost-plus contracts entered into by
the Government.
 Pinpointing areas of inefficiency and mismanagement, if any for the benefit of
shareholders, consumers, etc., such that necessary corrective action could be taken
in time.

4.

Answer any three questions from a, b, c and d.

[3x8=24] (a)
(i) Explain going rate pricing. [5]

Answer.
A method of pricing adopted by small firms – which are price followers – is known as going
rate pricing. Under this system, a firm sets its price according to the general pricing
structure in the industry or according to the price set by the price leader. In a sense,
each firm has “monopoly” power over its produce and it can, if it chooses, fix a

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monopoly price

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and face all the consequences of monopoly. In practice, however, it prefers the easier
and more practical method of choosing price going in the market. It will change its
price only when other firms do the same. Such a price policy is useful and safe to a
firm under certain circumstances. For instance, the firm may not have an accurate idea
of its costs or it may like to play safe and not provoke the larger firm to go for cut-
throat competition. Besides, it is difficult for each firm to calculate the full implication
of change in costs and prices and it is much better to follow the same pattern of pricing
adopted by others. Even a large firm may be satisfied with going rate pricing lest a
change in price by it unnecessarily disturbs the whole market. No firm would like to
“spoil” the common market by reducing the price.

(ii) The price of desktop computers was slashed from `50,000 to `25,000, and it
was observed that the sale of printers went up from 50 printers per month to
150 printers per month. Determine the cross price elasticity between
desktop and printers. [3]

Answer:
The cross price elasticity is as follows:

ΔQx Py
×
ΔPy Qx
First, we will ΔQx and ΔP as proportions of the average of the two data points.
compute So, y

50 +150
Q x= = 100
2
Py = 37, 500
ΔQx = 100 and ΔPy = 25,000
So,
100 37, 500

-25, 000 100 = -1.5

The answer indicates that x and y are compliments.

(b)
 x2 
(i) NANDINI ELECTRICALS an electronics firm assumes a cost function C(x) x 
 200 ,
 10 
 
where 'x' is a monthly output in thousands of units. Its revenue function is
given by R(x) = x(1100-1.5x).
Find:
(I) the output required per month to make the Marginal Profit = 0; and
(II) the Profit of this level of output [3+1]

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Answer:

(I). Profit = R(x)- C(x) 1100x- x3

2  200x
1.5x - 10
x
3 - 1.5x2
=
10  900x(sayP)
2
3x
Marginal Profit (MP) = dp 3x  900
dx 10
-
Pr Marginal Profit (MP) = O (given)
3x2
 - 3x  900 
0 10
=> -3x2 - 30x + 9000 = 0
x2 + 10x - 3000 = 0
x2 + 60x - 50x -3000 = 0
or, x(x + 60) - 50(x + 60) = 0 or,
(x - 50)(x + 60) = 0
Either x = 50 or x = -60
[Since units cannot be negative rejecting the negative value (- 60)]
The required output level = 50 (thousand) units.

(II). Total Profit at output x = 50 (thousand) units.

3x
 -  900x
2
1.5x 10
1,25,000
- - 3,750  45,000 `28,750thousand
10

(ii) The demand function for a particular brand of Pocket Calculators is P = 75 -

0.3Q –0.05Q2. Find the consumer’s surplus at the quantity (Q) of 15
calculators. [4]

Answer:
P = 75 – 0.3Q – 0.05Q2
At Q = 15, P = 75 – 0.3 x 15 – 0.05 x 152
= 59 .25 (on reduction)
Now PQ = 59.25 x 15 = 888.75

Consumer‟s surplus = 
15
PdQ- PQ 
15
75 - 0.3Q- 0.05Q2 dQ - PQ
0 0

 2 Q3 15
Q

 75Q- 0.3 2 - 0.05
3


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 - 888.75
0

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 Answer to MTP_Intermediate_Syllabus 2012_Jun2015_Set 2

 2 3
= 7515 - 0.3 15 15 
- 0.05  - 888.75
 2 3

=1035 – 888.75 = 146.25
Hence the consumer‟s surplus is 146.25

(c)
(i) Calculate the trend values by the method of least squares from the data
given below and estimate the sales for the year 2014.
Year 2010 2011 2012 2013 2014
Sales 105 111 120 129 135
[4]
Answe
r:
Calculation of Trend values by Least Squares Method
Year (t) Sales Y Time deviation(X) XY X2 Trend values Yc
2010 105 -2 -210 4 104.4
2011 111 -1 -111 1 112.2
2012 120 0 0 0 120.0
2013 129 +1 +129 1 127.8
2014 135 +2 +270 4 135.6
N= 5 ∑Y = 600 ∑X = 0 ∑XY= 78 ∑X2 = 10 ∑Yc = 600

Equation of Trend line = Yc = a + bX => Yc = a + (t-2012)

Since X=0, a = ∑Y/N = 120
b = ∑XY/ ∑X = 7.8
2

The equation of Straight line would be Y = 120 + 7.8X. The value of Y when X = 2014 or
in terms of deviation X = +5
Y2014 = 120 + (7.8 x 5) = 120 + 39 = 159
Trend value for 2010= 120 + (2010 – 2011) x 7.8 = 104.4
Similarly trend values for 2011, 2012 etc have been calculated.

(ii) The efficiency (E) of a small manufacturing concern depends on the number of
workers (W)
- 3
W
and is given by: 10E = + 30W - 392. Find the strength of the workers, which
40 give
maximum efficiency. [4]

Answer:
3
Given 10 E w + 30W – 39.2
= 40
3
-W
Efficiency (E) = + 3W – 392
400

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 Answer to MTP_Intermediate_Syllabus 2012_Jun2015_Set 2

dE 1
=- x 3W2 + 3 = 0
dW 400
=> 3W2
= 1200 => W = 20
2 2
d E 6W d E -6(20) -3
=-  at W = 20 = <0
2 400 2 400 10
dW dW =
Maximum Efficiency at W = 20
Hence the Strength of Workers = 20

(d) Describe the pricing policies for introduction stage of a new product.

[8] Answer:
There are two alternative price strategies which a firm introducing a new product can
adopt, viz., skimming price policy and penetration pricing policy.
A. Skimming Price Policy:
When the product is new but with a high degree of consumer acceptability, the firm
may decide to charge a high mark up and, therefore, charge a high price. The
system of charging high prices for new products is known as price skimming for the
object is to “skim the cream” from the market. There are many reasons for adopting
a high mark- up and, therefore, high initial price:
 The demand for the new product is relatively inelastic. The high prices will not
stop the new consumers from demanding the product. The new product,
novelty, commands a better price. Above all, in the initial stage, there is hence
cross elasticity of demand is low.
 If life of the product promises to be a short one, the management may fix a
high price so that it can get as much profit as possible and, in as short a period
as possible.
 Such an initially high price is also suitable if the firm can divide the market into
different segments based on different elasticity‟s. The firm can introduce a
cheaper model in the market with lower elasticity.
 High initial price may also be needed in those cases where there is heavy
investment of capital and when the costs of introducing a new product are high.
The initial price of a transistor radio was ` 500 or more (now ` 50 or even less);
electronic calculators used to cost ` 1,000 or more, they are now available for `
100 or so.
B. Penetration Price Policy:
Instead of setting a high price, the firm may set a low price for a new product by
adding a low mark-up to the full cost. This is done to penetrate the market as quickly
as possible. The assumptions behind the low penetration price policy are:
 The new product is being introduced in a market which is already served by
well- known brands. A low price is necessary to attract gradually consumers
who are already accustomed to other brands.
 The low price will help to maximize the sales of the product even in the short
period. The low price is set in the market to prevent the entry of new products.
Penetration price policy is preferred to skimming price under three conditions:

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In the first place, skimming price offering a high margin will attract many rivals to enter
the market. With the entry of powerful rivals into the market, competition will be
intensified, price will fall and profits will be competed away in the long run. A firm will
prefer a low penetration price if it fears the entry of powerful rivals with plenty of
capital and new technology. For a low penetration price, based on extremely low mark-
up will be least profitable and potential competitors will not be induced to enter the
market.
Secondly, a firm will prefer low penetration price strategy if product differentiation is
low and if rival firms can easily imitate the product. In such a case, the objective of the
firm to fix low price is to establish a strong market based and build goodwill among
consumers and strong consumer loyalty.
Finally, a firm may anticipate that its main product may generate continuing demand
for the complementary items. In such a case, the firm will follow penetration pricing for
its new product, so that the product as well as its complements will get a wider market.

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