PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

Question No. 1 is compulsory.

Attempt any five questions out of the remaining six questions.
In case, any candidate answers extra question(s)/ sub-question(s) over and above the
required number, then only the requisite number of questions first answered in the answer
book shall be valued and subsequent extra question(s) answered shall be ignored.
Working notes should form part of the answer.
Question 1
Answer the following:
(a) ASJ manufacturer produces a product which requires a component costing ` 1,000 per unit.
Other information related to the component are as under:
Usage. of component 1,500 units per month
Ordering cost ` 75 per order
Storage cost rate 2% per annum
Obsolescence rate 1% per annum
Maximum usage 400 units per week
Lead Time 6-8 weeks
The firm has been offered a quantity discount of 5% by the supplier on the purchase of
component, if the order size is 6,000 units at a time.
You are required to compute:
(i) Economic Order Quantity (EOQ)
(ii) Re-order Level and advise whether the discount offer be accepted by the firm or not.
(b) A company planned to produce 2,000 units of a product in a week of 40 hours by employing
65 skilled workers. Other relevant information are as follows:
• Standard wages rate : ` 45 per hour
• Actual production : 1800 units
• Actual number of worker employed: 50 workers in a week of 40 hours
• Actual wages rate : ` 50 per hour
• Abnormal time loss due to machinery breakdown :100 hours.
You are required to calculate:
(i) Labour cost, rate, idle time and efficiency variances.
(ii) Reconcile the variances.

© The Institute of Chartered Accountants of India

2 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

(c) S Ltd. has furnished the following information for the year ending 31 st March, 2018:
`
Net profit before taxation 20,78,000
Depreciation charged to P&L Account 8,00,000
Profit on sale of plant & machinery 2,20,000
Increase in debtors 2,40,000
Decrease in stock 6,80,000
Decrease in other current liabilities 1,50,000
Increase in creditors 20,000
Purchases of plant and machinery 23,20,000
Proceeds from issue of share capital 15,00,000
Dividend paid 7,20,000
Income-tax paid 7,28,000
You are required to calculate cash from operating activities in accordance with AS-3.
(d) JC Ltd. is planning an equity issue in current year. It has an earning per share (EPS) of
` 20 and proposes to pay 60% dividend at the current year end. With a PIE ratio 6.25, it
wants to offer the issue at market price. The flotation cost is expected to be 4% of the
issue price.
Required: Determine the required rate of return for equity share (cost of equity) before
the issue and after the issue (4 x 5 = 20 Marks)
Answer
(a) (i) Annual usage of Components (A) = 1500×12 =18,000 Units
Ordering Cost (O) = ` 75 per order
Carrying cost per unit per annum (C) i.e. Storage cost + Obsolescence cost = 2% +
1% = 3%
Calculation of Economic Order Quantity
2AO 2 ×18,000 units × ` 75
EOQ = = = 300 units
C ` 1000 × 3%
(ii) Re- Order level: = (Maximum usage × Maximum lead time)
= 400 units  8weeks
= 3,200 units

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 3

Evaluation of Profitability of Different Options of Order Quantity

When EOQ is ordered
(`)
Purchase Cost (18,000 × 1,000) 1,80,00,000
A (18000 x 75) 4,500
Ordering Cost ( ×O )
Q 300
Q 300 4,500
Carrying Cost ( × C ×i ) ( × 30 )
2 2
Total Cost 1,80,09,000
When Quantity Discount is accepted
(`)
Purchase Cost [18,000 - (1,000-5%)] 1,71,00,000
A 18,000 225
Ordering Cost ( ×O ) ( × 75 )
Q 6,000
Q 6000 85,500
Carrying Cost ( × C ×i ) ( × 950 × 3% )
2 2
Total Cost 171,85,725
So, Savings in cost = ` 8,23,275 (`1,80,09,000 – ` 1,71,85,725)
Advice – The total cost of inventory is higher if EOQ is adopted. If we accept
quantity discount of 5% offered by the supplier, ‘ASJ’ will save ` 8,23,275/-. Hence,
the company is advised to accept the quantity discount.
(b) (i) Labour cost variance (SH x Std. Rate) – (AH paid x AR)]
 ` 40× ` 65 
 ` 2,000 ×`1,800  × ` 45   ` 50× ` 40× ` 50 
 
= (` 1,05,300 – ` 1,00,000)
= ` 5,300 (F)
Labour Rate Variance = AH paid (SR-AR)
= ` 2,000 (45-50) = ` 10,000 (A)
Labour efficiency variance = SR (SH – AH worked)
= `45 (` 2,340 – ` 1,900) = ` 19,800(F)
Idle time variance = SR  Idle time = ` 45  ` 100 = ` 4,500(A)

© The Institute of Chartered Accountants of India

4 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

(ii) Reconciliation
Labour Cost Variance = Labour Rate Variance + Labour efficiency variance + Idle
time variance
Or
` 10,000 (A) + ` 19,800 (F) + ` 4,500 (A) = ` 5,300(F)
(c) Statement of Cash Flows for the year ended 31 st March 2018 (as per AS-3)
(`)
Cash flow from Operating Activities
Net profit before taxation 20,78,000
Add: Depreciation charged to P & L account 8,00,000
Less: Profit on Sale of Plant & Machinery (2,20,000)
Operating profit before working capital changes 26,58,000
Add: Decrease in Stock 680000
Add: Increase in Creditors 20000
Less: Increase in Debtors (240000)
Less: Decrease in Current Liabilities (150000) 310000
Cash generated from Operating activities 29,68,000
Less: Income tax 7,28,000
Net Cash from Operating activities 22,40,000
(d) Workings
• P0 = EPS × P/E = 20 × 6.25 = 125
• r = Rate of Return on Retained Earnings = 100/6.25 = 16%
• Retention ratio = b = 1 – Dividend Payout Ratio = 1 – 0.60 = 0.40
• Growth rate = g = br = 0.40 ×0.16 = 0.064
• D0 = EPS × Dividend Payout
= 20 × 60%
= 12
• D1 = D0 (1+ g) = 12 (1+0.064) = 12.768
Cost of Equity before issue
D1 12.768
ke = + g= + 0.064 = 0.1021+ 0.064 = 0.1661 or 16.61%
P0 125

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 5

Cost of Equity after issue

D1 12.768
ke = +g = + 0.064 = 0.1064 + 0.064 = 0.1704 or 17.04%
P0 120
Question 2
(a) A company is producing an identical product in two factories. The following are the
details in respect of both factories:
Factory X Factory Y
Selling price per unit ( `) 50 50
Variable cost per unit ( `) 40 35
Fixed cost (`) 2,00,000 3,00,000
Depreciation included in above fixed cost ( `) 40,000 30,000
Sales in units 30,000 20,000
Production capacity (units) 40,000 30,000
You are required to determine:
(i) Break Even Point (BEP) each factory individually.
(ii) Cash break even point for each factory individually.
(iii) BEP for company as a whole, assuming the present product mix is in sales ratio.
(iv) Consequence on profit and BEP if product mix is changed to 2:3 and total demand
remain same. (8 Marks)
(b) G Ltd. has furnished the following information relating to the year ended 31st March, 2017 and
31st March, 2018:
31st March, 2017 31st March, 2018
Share Capital 40,00,000 40,00,000
Reserve and Surplus 20,00,000 25,00,000
Long term loan 30,00,000 30,00,000
• Net profit ratio: 8%
• Gross profit ratio: 20%
• Long-term loan has been used to finance 40% of the fixed assets.
• Stock turnover with respect to cost of goods sold is 4.
• Debtors represent 90 days sales.
• The company holds cash equivalent to 1½ months cost of goods sold.
• Ignore taxation and assume 360 days in a year.

© The Institute of Chartered Accountants of India

6 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

You are required to prepare Balance Sheet as on 31 st March, 2018 in following format:
Liabilities (` ) Assets (` )
Share Capital - Fixed Assets -
Reserve and Surplus - Sundry Debtors -
Long-term loan - Closing Stock -
Sundry Creditors - Cash in hand -
(8 Marks)
Answer
(a)
Factory X Factory Y
(i) Break Even Point:
 Fixed Cost  2,00,000 3,00,000
 
 Contribution  50 - 40 50 - 35
= 20,000 units = 20,000 units
(ii) Cash Break Even Point:
 Fixed Cost - Depreciation  2,00,000 - 40,000 3,00,000 - 30,000
 
 Contribution  10 15
= 16,000 units = 18,000 units

Complete Fixed Cost

(iii) BEP as a whole =
Composite Contribution
` 2,00,000 + ` 3,00,000
=
3 2
10 × + 15 ×
5 5
` 5,00,000
= = 41,667 units
6+ 6
2
(iv) New Sales Mix = 50,000 × = 20,000 of X
5
3
= 50,000 × = 30,000 of Y
5
2 3
Calculation of Composite contribution = 10 × + 15 ×
5 5
= 4+9 = `13

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 7

Consequence on profit
Existing Mix New Mix
Contribution 50,000  12 = 6,00,000 50,000  13 = 6,50,000
Less: Fixed Cost 5,00,000 5,00,000
Profit 1,00,000 1,50,000
 Increase in profit = ` 1, 50,000 – ` 1, 00,000
= ` 50,000
Consequence on BEP
Complete Fixed Cost
New BEP as a whole =
Composite Contribution
5,00,000
= = 38,462 units
13
So, BEP Reduced by 3205 units (41,667 – 38,462)
(b) Change in Reserve & Surplus = ` 25, 00,000 – ` 20,00,000 = ` 5,00,000
So, Net profit = ` 5, 00,000
(i) Net Profit Ratio = 8%
5,00,000
 Sales = =` 62,50,000
8%
(ii) Cost of Goods sold
= Sales – Gross profit Margin
= ` 62, 50,000 – 20% of ` 62, 50,000
= ` 50, 00,000
` 30,00,000
(iii) Fixed Assets = =` 75,00,000
40%
Cost of Goods Sold 50,00,000
(iv) Stock = = = ` 12,50,000
STR 4
62,50,000
(v) Debtors = × 90 = ` 15,62,500
360
50,00,000
(vi) Cash Equivalent = ×1.5 = ` 6,25,000
12

© The Institute of Chartered Accountants of India

8 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

Balance Sheet as on 31st March 2018

Liabilities (`) Assets (`)
Share Capital 40,00,000 Fixed Assets 75,00,000
Reserve and Surplus 25,00,000 Sundry Debtors 15,62,500
Long-term loan 30,00,000 Closing Stock 12,50,000
Sundry Creditors 14,37,500 Cash in hand 6,25,000
(Balancing Figure)
1,09,37,500 1,09,37,500
Question 3
(a) A company wants to outsource the operation of its canteen to a contractor. The company
will provide space for cooking, free electricity and furniture in the canteen. The contractor
will have to provide lunch to 300 workers of which 180 are vegetarian (Veg) and the rest
are non-vegetarian (Non-Veg). In the case of non-veg meals, there will be a non-veg
item in addition to the veg items. A contractor who is interested in the contract has
analysed the costs likely to be incurred. His analysis is given below:
Cereals ` 8 per plate
Veg items ` 5 per plate
Non-veg items ` 15 per plate
Spices ` 1 per plate
Cooking oil ` 4 per plate
One cook Salary ` 13,000 per month
Three helpers Salary ` 7,000 per month per head
Fuel Two commercial cylinders per month, price ` 1000 each.

On an average the canteen will remain open for 25 days in a month. The contractor
wants to charge the non-veg meals at 1.50 times of the veg meals.
You are required to calculate:
(i) The price per meal (veg and non-veg separately) that contractor should quote if he
wants a profit of 20% on his takings.
(ii) The price per meal (separately for veg and non-veg) that a worker will be required
to pay if the company provides 60% subsidy for meals out of welfare fund.
(8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 9

(b) A company is considering to engage a factor. The following information is available:

• The current average collection period for the company's debtors is 90 days and ½%
of debtors default. The factor has agreed to pay money due after 60 days and will
take the responsibility of any loss on account of bad debts.
• The annual charge for factoring is 2% of turnover. Administration cost saving is
likely to be ` 1,00,000 per annum.
• Annual credit sales are ` 1,20,00,000. Variable cost is 80% of sales price. The
company's cost of borrowing is 15% per annum. Assume 360 days in a year.
Should the company enter into a factoring agreement? (8 Marks)
Answer
(a) Calculation of cost and amount chargeable by the Contractor
Particulars Veg. Non-Veg
No of Meals per Day 180 120
No of Meals per Month 180×25 = 4,500 120×25 = 3,000
Variable Cost: ` `
Cereals 8 per plate -
Veg items 5 per plate -
Cooking Oil 4 per plate -
Spices 1 per plate -
Total Variable Cost 18 × 7500 (4500 + 3000) 1,35,000
Additional variable cost of Non-veg meal 15 × 3000 45,000
Total Variable Cost 1,80,000
Fixed Cost:
Salary of Cook 13,000
Salary of Helpers (7,000 × 3) 21,000
Fuel 2,000 36,000
Total Cost 2,16,000
Profit 20% on his takings or 25% on Cost 54,000
Total amounts chargeable by the 2,70,000
Contractor
(i) No. of Non-Veg Meals 3,000
Equivalent No. of Veg Meals = 3,000 × 1.5 = 4,500

© The Institute of Chartered Accountants of India

10 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

No. of Non Veg Meals = 4,500

Total 9,000
` 2,70,000
Price per Veg Meal = = ` 30
` 9,000
Price per Non Veg. Meal = ` 30 × 1.5 = ` 45/-
(ii) Price per meal when a worker will have to pay
Veg meal ` 30 – Subsidy (60% of ` 30)
= ` 30 – ` 27 = ` 12/-
Non-Veg Meal ` 45 – Subsidy (60% of ` 45)
` 45 – ` 27 = ` 18/-
Note: Cost of Veg and non-veg meal calculated separately and then profit of 20% on overall
takings and 25% profit on overall Cost is added to determine the total price to be charged.
(b) Presently, the Debtors of the company pay after 90 days. However, the factor has agreed
to pay after 60 days only. So, the investment in debtors will be reduced by 30 days.
The annual charge in cash flows through entering into a factoring agreement is:
` `
A. Annual Charge (2%  1,20,00,000) (2,40,000)
B. Administration Cost Saved 1,00,000
Existing Average Debtors (` 1,20,00,000 ÷ 360  90) 30,00,000
days
Average New Debtors (` 1,20,00,000 ÷360  60) days 20,00,000
Reduction in Debtors 10,00,000
Variable Cost thereof 80% 8,00,000
C. Interest Saving @ 15% on ` 8,00,000 1,20,000
D. Bad Debt Saved @ 0.5% of ` 1,20,00,000 60,000
E. Net Annual Benefits of Factoring (B + C + D – A) 40,000

Advice: Therefore, the factoring agreement is worthwhile and should be undertaken.

Question 4
(a) ABC Ltd. produces an item which is completed in three processes - X, Y and Z. The
following information is furnished for process X for the month of March, 2018 :

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 11

Opening work-in-progress (5,000 units):

Materials ` 35,000
Labour ` 13,000
Overheads ` 25,000
Units introduced into process X (55,000 units):
Materials ` 20,20,000
Labour ` 8,00,000
Overheads ` 13,30,000
Units scrapped: 5,000 units
Degree of completion:
Materials 100%
Labour & Overheads 60%
Closing work-in-progress (5,000 units):
Degree of completion:
Materials 100%
Labour & Overheads 60%
Units finished and transferred to Process Y: 50,000 units
Normal loss: 5% of total input (including opening works-in progress) Scrapped units fetch
` 20 per unit.
Presuming that average method of inventory is used, prepare
(i) Statement of Equivalent production
(ii) Statement of Cost for each element
(iii) Statement of distribution of cost
(iv) Abnormal loss account (8 Marks)
(b) Following are the selected financial information of A Ltd. and B Ltd. for the year ended
March 31, 2018:
A Ltd. B Ltd.
Variable Cost Ratio 60% 50%
Interest ` 20,000 ` 1,00,000
Operating Leverage 5 2
Financial Leverage 3 2
Tax Rate 30% 30%

© The Institute of Chartered Accountants of India

12 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

You are required to find out

(i) EBIT
(ii) Sales
(iii) Fixed Cost
(iv) Identify the company which is better placed with reasons based on leverages.
(8 Marks)
Answer
(a) (i) Statement of Equivalent Production
Equivalent production
Material Labour &
Input Units Output Units
Overheads
(%) Units (%) Units
Opening WIP 5,000 Completed and 50,000 100 50,000 100 50,000
transferred to
Process ‘Y’
Units 55,000 Normal loss 3,000 -- -- -- --
introduced (5% of 60,000 units)
Abnormal loss 2,000 100 2,000 60 1,200
Closing WIP 5,000 100 5,000 60 3,000
60,000 60,000 57,000 54,200
(ii) Statement of Cost
Cost at the Cost Total cost Equivalent Cost per
beginning added Units unit
Details of process
(`) (`) (`) (`) (`)
Material 35,000 20,20,000 20,55,000
Less: Value of normal
loss
(3,000 units × ` 20) (60,000)
19,95,000 57,000 35
Labour 13,000 8,00,000 8,13,000 54,200 15
Overheads 25,000 13,30,000 13,55,000 54,200 25
Total 73,000 41,50,000 41,63,000 75

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 13

(iii) Statement of Distribution of Cost

(`)
Completed and transferred to Process-Y (50,000 units × ` 75) 37,50,000
Abnormal Loss:
Materials (2,000 units × ` 35) 70,000
Wages (1,200 units × ` 15) 18,000.00
Overheads (1,200 units × ` 25) 30,000.00
1,18,000
Closing WIP:
Materials (5,000 units × ` 35 1,75,000
Wages (3,000 units × ` 15) 45,000
Overheads (3,000 units × ` 25) 75,000
2,95,000
(iv) Abnormal Loss Account
Particulars Units Amount Particulars Units Amount
To Process-X 2,000 1,18,000 By Cost Ledger Control 2,000 40,000
A/c A/c.
By Costing Profit & - 78,000
Loss A/c.
2,000 1,18,000 2,000 1,18,000
(b) Company A
EBIT
(i) Financial Leverage =
EBT i.e EBIT Interest
EBIT
So, 3 =
EBIT - 20,000
Or, 3 (EBIT – 20,000) = EBIT
Or, 2 EBIT = 60,000
Or, EBIT = 30,000
Contribution Contribution
(ii) Operating Leverage = Or, 5 =
EBIT ` 30,000
Or, Contribution = ` 1, 50,000

© The Institute of Chartered Accountants of India

14 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

Contribution ` 1,50,000
Sales = = = `3,75,000
P / VRatio(1- variable cost ratio) 40%
(iii) Fixed Cost = Contribution – EBIT
= ` 1, 50,000 – 30,000
or, Fixed cost = ` 1,20,000
Company B
EBIT
(i) Financial Leverage =
EBT i.e EBIT Interest
EBIT
So, 2 =
EBIT -1,00,000
Or, 2 (EBIT – 1,00,000) = EBIT
Or, 2 EBIT -2,00,000 = EBIT
Or, EBIT = ` 2,00,000
Contribution Contribution
(ii) Operating Leverage = Or, 2 =
EBIT ` 2,00,000
Or, Contribution = ` 4,00,000
Contribution ` 4,00,000
Sales = = = ` 8,00,000
P / VRatio(1- variable cost ratio) 50%
(iii) Fixed Cost = Contribution – EBIT
= ` 4, 00,000 – ` 2,00,000
or, Fixed cost = ` 2,00,000
Income Statements of Company A and Company B
Company A (`) Company B (`)
Sales 3,75,000 8,00,000
Less: Variable cost 2,25,000 4,00,000
Contribution 1,50,000 4,00,000
Less: Fixed Cost 1,20,000 2,00,000
Earnings before interest and tax (EBIT) 30,000 2,00,000
Less: Interest 20,000 1,00,000
Earnings before tax (EBT) 10,000 1,00,000
Less: Tax @ 30% 3,000 30,000
Earnings after tax (EAT) 7,000 70,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 15

Comment based on Leverage

Comment based on leverage – Company B is better than company A of the
following reasons:
• Capacity of Company B to meet interest liability is better than that of
companies A (from EBIT/Interest ratio)
30,000 2,00,000
[A = = 1.5, B = = 2]
20,000 1,00,000
• Company B has the least financial risk as the total risk (business and financial)
of company B is lower (combined leverage of Company A – 15 and Company
B- 4)
Question 5
Answer all four:
(a) List important factors which must be taken into consideration for increasing labour
productivity.
(b) What are the essential pre-requisites of integrated accounting system?
(c) Discuss the factors to be taken into consideration while determining the requirement of
working capital.
(d) Differentiate between Business risk and Financial risk. (4 x 4 = 16 Marks)
Answer
(a) Factors for increasing labour productivity: The important factors which must be taken
into consideration for increasing labour productivity are as follows:
1. Employing only those workers who possess the right type of skill.
2. Placing a right type of man on the right job.
3. Training young and old workers by providing them the right types of opportunities.
4. Taking appropriate measures to avoid the situation of excess or shortage of labour
at the shop floor.
5. Carrying out work study for the fixation of wage rate, and for the simplification and
standardisation of work.
(b) Essential pre-requisites of Integrated Accounting System: The essential pre-
requisites of Integrated Accounting System include the following:
1. The management’s decision about the extent of integration of the two sets of books.
Some concerns find it useful to integrate upto the stage of primary cost or factory cost
while other prefer full integration of the entire accounting records.

© The Institute of Chartered Accountants of India

16 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

2. A suitable coding system must be made available so as to serve the accounting

purposes of financial and cost accounts.
3. An agreed routine, with regard to the treatment of provision for accruals, prepaid
expenses, other adjustment necessary for preparation of interim accounts.
4. Perfect coordination should exist between the staff responsible for the financial and cost
aspects of the accounts and an efficient processing of accounting documents should be
ensured.
Under this system there is no need for a separate cost ledger. Of course, there will be a
number of subsidiary ledgers; in addition to the useful Customers Ledger and the Bought
Ledger, there will be: (a) Stores Ledger; (b) Finished Stock Ledger and (c) W-I-P Ledger.
(c) Factors to be taken into consideration while determining the requirement of
working capital:
(i) Production Policies (ii) Nature of the business
(iii) Credit policy (iv) Inventory policy
(v) Abnormal factors (vi) Market conditions
(vii) Conditions of supply (viii) Business cycle
(ix) Growth and expansion (x) Level of taxes
(xi) Dividend policy (xii) Price level changes
(xiii) Operating efficiency. (xiv) Receivables
(xv) Technology and Manufacturing policies (xvi) Short term financing options
(d) Difference between Business risk and Financial risk.
Business risk refers to the risk associated with the firm’s operations. It is an unavoidable
risk because of the environment in which the firm has to operate and the business risk is
represented by the variability of earnings before interest and tax (EBIT). The variability in
turn is influenced by revenues and expenses. Revenues and expenses are affected by
demand of firm’s products, variations in prices and proportion of fixed cost in total cost .
Whereas, Financial risk refers to the additional risk placed on firm’s shareholders as a
result of debt use in financing. Companies that issue more debt instruments would have
higher financial risk than companies financed mostly by equity. Financial risk can be
measured by ratios such as firm’s financial leverage multiplier, total debt to assets ratio
etc.
Question 6
(a) Delta Ltd. is a manufacturing concern having two production departments P I and P2 and
two service departments S 1 and S2. After making a primary distribution of factory
overheads, the total overheads of all departments are as under:

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 17

(in `)
P1 4,02,000
P2 2,93,000
S1 3,52,000
S2 33,000
Overheads of service departments are reapportioned as below :
P1 P2 S1 S2
S1 40% 50% - 10%
S2 50% 40% 10% -
A product 'Z' passes through all the two production departments – P1 and P2 and each
unit of product remain there in process for 2 and 3 hours respectively. The material and
labour cost of one unit of product ‘Z’ is ` 500 and ` 350 respectively.
The company run for all the 365 days of the year and 16 hours per day.
You are required:
(i) To make secondary distribution of overheads of service departments by applying
Simultaneous Equation method and
(ii) Determine the total cost of one unit of product Z. (8 Marks)
(b) A proposal to invest in a project, which has a useful life of 5 years and no salvage value
at the end of useful life, is under consideration of a firm. It is anticipated that the project
will generate a steady cash inflow of ` 70,000 per annum. After analyzing other facts of
the project, following information were revealed:
Internal rate of return - 13%
Desirability factor - 1.07762
You are required to find out:
(i) Cost of project
(ii) Cost of capital
(iii) Payback period
(iv) Net present value
Present value factors at different rates are given as under:
Year 10% 11% 12% 13%
1 0.909 0.901 0.893 0.885
2 0.826 0.812 0.797 0.783

© The Institute of Chartered Accountants of India

18 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

3 0.751 0.731 0.712 0.693

4 0.683 0.659 0.636 0.613
5 0.621 0.593 0.567 0.543
Total 3.790 3.696 3.605 3.517
Note: Use only above present values to solve this question. (8 Marks)
Answer
(a) (i) Overheads of service cost centres Let S 1 be the overhead of service cost centre S 1
and S2 be the overhead of service cost centre S 2.
S1 = 3,52,000 + 0.10 S 2
S2 = 33,000 + 0.10 S 1
Substituting the value of S 2 in S1 we get
S1 = 3,52,000 + 0.10 (33,000 + 0.10 S 1)
S1 = 3,52,000 + 3,300 + 0.01 S 1
0.99 S1 = 3,55,300
 S1 = ` 3,58,889
 S2 = 33,000 + 0.10  3,58,889
= `68,889
Secondary Distribution Summary
Particulars Total (`) P1 (`) P2 (`)

Allocated and Apportioned over- 6,95,000 4,02,000 2,93,000

heads as per primary distribution
S1 3,58,889 1,43,556 1,79,445
S2 68,889 34,445 27,556
5,80,001 5,00,001
(ii) Working for Overhead rate per hour
P1 P2
Total overheads cost (`) 5,80,001 5,00,001
Production hours worked 5,840 5,840
Rate per hour (`) 99.32 85.62

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 19

Calculation of per unit Total Cost of Product Z

(`)
Direct material 500.00
Direct labour 350.00
Prime cost 850.00
Production on overheads
P1 2 hours  ` 99.32 = 198.64
P2 3 hours  ` 85.62 = 256.86 455.50
Total cost 1,305.50
(b) (i) Cost of Project
Annual cash inflows = ` 70,000
Useful life = 5 years
Desirability factor = 1.07762
At 13% internal rate of return (IRR), the sum of total cash inflows = cost of the
project i.e. initial cash outlay
Considering the discount factor table @ 13%, cumulative present value of cash
inflows for 5 years is 3.517
Hence, Total Cash inflows for 5 years for the Project is
` 70,000 × 3.517 = ` 2,46,190
Hence, Cost of the Project = ` 2,46,190
(ii) Cost of Capital
Sum of Discounted Cash inflows
Profitability index =
Cost of the Project
Sum of Discounted Cash inflows
1.07762 
` 2,46,190
Sum of Discounted Cash inflows = ` 2,65,300
Since, Annual Cash Inflows = ` 70,000
Rs. 2,65,300
Hence, cumulative discount factor for 5 years = = 3.79
Rs. 70,000
From the discount factor table @ 10%, cumulative present value of cash inflows for
5 years is 3.79

© The Institute of Chartered Accountants of India

20 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

Hence, Cost of Capital = 10%

(iii) Payback Period
Cost of the Project ` 2,46,190
Payback period = = = 3.517 years
Annual Cash Inflows ` 70,000
(iv) Net Present Value (NPV)
NPV = Sum of Present Values of Cash inflows – Cost of the Project
= ` 2,65,300 – ` 2,46,190 = ` 19,110
Net Present Value = ` 19,110
Question 7
Answer any four of the following:
(a) Discuss cost classification based on variability and controllability.
(b) Describe the salient features of budget manual.
(c) State the different types of packing credit.
(d) (i) State distinct groups of variances that arise in standard costing.
(ii) Explain 'Sale and Lease Back.
(e) Why money in the future is worth-less than similar money today? Give reasons and
explain. (4 x 4 = 16 Marks)
Answer
(a) Cost classification based on variability
(a) Fixed Costs – These are the costs which are incurred for a period, and which,
within certain output and turnover limits, tend to be unaffected by fluctuations in the
levels of activity (output or turnover). They do not tend to increase or decrease with
the changes in output. For example, rent, insurance of factory building etc., remain
the same for different levels of production.
(b) Variable Costs – These costs tend to vary with the volume of activity. Any
increase in the activity results in an increase in the variable cost and vice-versa.
For example, cost of direct labour, etc.
(c) Semi-variable Costs – These costs contain both fixed and variable components
and are thus partly affected by fluctuations in the level of activity. Examples of semi
variable costs are telephone bills, gas and electricity etc.
Cost classification based on controllability
(a) Controllable Costs - Cost that can be controlled, typically by a cost, profit or
investment centre manager is called controllable cost. Controllable costs incurred in

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 21

a particular responsibility centre can be influenced by the action of the executive

heading that responsibility centre. For example, direct costs comprising direct
labour, direct material, direct expenses and some of the overheads are generally
controllable by the shop level management.
(b) Uncontrollable Costs - Costs which cannot be influenced by the action of a
specified member of an undertaking are known as uncontrollable costs. For
example, expenditure incurred by, say, the tool room is controllable by the foreman
in-charge of that section but the share of the tool-room expenditure which is
apportioned to a machine shop is not to be controlled by the machine shop foreman.
(b) Salient features of Budget Manual
• Budget manual contains many information which are required for effective
budgetary planning.
• A budget manual is a collection of documents that contains key information for
those involved in the planning process.
• An introductory explanation of the budgetary planning and control process, including
a statement of the budgetary objective and desired results is included in Budget
Manual
• Budget Manual contains a form of organization chart to show who is responsible for
the preparation of each functional budget and the way in which the budgets are
interrelated.
• In contains a timetable for the preparation of each budget.
• Copies of all forms to be completed by those responsible for preparing budgets,
with explanations concerning their completion is included in Budget Manual.
• A list of the organization’s account codes, with full explanations of how to use them.
• Information concerning key assumptions to be made by managers in their budgets,
e.g. rate of inflation etc.
(c) Different Types of Packing Credit
Packing credit may be of the following types:
(i) Clean Packing credit: This is an advance made available to an exporter only on
production of a firm export order or a letter of credit without exercising any charge
or control over raw material or finished goods. It is a clean type of export advance.
Each proposal is weighted according to particular requirements of the trade and
credit worthiness of the exporter. A suitable margin has to be maintained. Also,
Export Credit Guarantee Corporation (ECGC) cover should be obtained by the
bank.

© The Institute of Chartered Accountants of India

22 INTERMEDIATE (IPC) EXAMINATION: MAY, 2018

(ii) Packing credit against hypothecation of goods: Export finance is made available
on certain terms and conditions where the exporter has pledgeable interest and the
goods are hypothecated to the bank as security with stipulated margin. At the time
of utilising the advance, the exporter is required to submit alongwith the firm export
order or letter of credit, relative stock statements and thereafter continue submitting
them every fortnight and whenever there is any movement in stocks.
(iii) Packing credit against pledge of goods: Export finance is made available on
certain terms and conditions where the exportable finished goods are pledged to the
banks with approved clearing agents who will ship the same from time to time as
required by the exporter. The possession of the goods so pledged lies with the bank
and is kept under its lock and key.
(iv) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture,
processing, purchasing, or packing of goods meant for export against a firm order
qualifies for the packing credit guarantee issued by Export Credit Guarantee
Corporation.
(v) Forward exchange contract: Another requirement of packing credit facility is that if
the export bill is to be drawn in a foreign currency, the exporter should enter into a
forward exchange contact with the bank, thereby avoiding risk involved in a possible
change in the rate of exchange.
(d) (i) Distinct groups of variances in standard costing:
The three distinct groups of variances that arise in standard costing are:
(i) Variances of efficiency. These are the variance, which arise due to efficiency
or inefficiency in use of material, labour etc.
(ii) Variances of prices and rates: These are the variances, which arise due to
changes in procurement price and standard price.
(iii) Variances due to volume: These represent the effect of difference between
actual activity and standard level of activity.
(ii) Sale and Lease Back
It is arrangement under which an entity sells the asset to another party and
simultaneously takes it back from the other party under a lease arrangement.
The important features of sale and lease back arrangement are:
(a) The lessee gets a lumpsum amount as sale consideration of the asset.
(b) The lessee continues to use the asset.
(e) Time Preference of money
Time value of money means that worth of a rupee received today is different from the
worth of a rupee to be received in future. The preference of money now as compared to
future money is known as time preference for money.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 23

A rupee today is more valuable than rupee after a year due to several reasons:
➢ Risk  there is uncertainty about the receipt of money in future.
➢ Preference for present consumption  Most of the persons and companies in
general, prefer current consumption over future consumption.
➢ Inflation  In an inflationary period a rupee today represents a greater real
purchasing power than a rupee a year hence.
➢ Investment opportunities  Most of the persons and companies have a preference
for present money because of availabilities of opportunities of investment for
earning additional cash flow.
Many financial problems involve cash flow accruing at different points of time for
evaluating such cash flow an explicit consideration of time value of money is required .

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
Question No. 1 is compulsory.
Attempt any five questions out of the remaining six questions.
In case, any candidate answers extra question(s)/ sub-question(s) over and above the
required number, then only the requisite number of questions first answered in the answer
book shall be valued and subsequent extra question(s) answered shall be ignored.
Working notes should form part of the answer.
Question 1
Answer the following:
(a) A skilled worker is paid a guaranteed wage rate of ` 150.00 per hour. The standard time
allowed for a job is 50 hours. He gets an effective hourly rate of wages of `180.00 under
Rowan Incentive Plan due to saving in time. For the same saving in time, calculate the
hourly rate of wages he will get, if he is placed under Halsey Premium Scheme (50%).
(b) Premier Construction Company undertook a contract for ` 5,00,000 on 1st August, 2016.
On 31st March, 2017 when the accounts were closed, the following information was
available:
Cost of work uncertified ` 1,20,000
Cash received ` 2,50,000 (80 of work certified)
Profit transferred to costing Profit and Loss ` 80,000
account at the end of the year on Incomplete
contract
Calculate:
(i) The value of work in progress certified
(ii) Degree of completion of contract
(iii) Notional Profit and
(iv) Cost of contract as on 31-03-2017
(c) Mr. B will require ` 30 lakhs after 10 years from now. He wants to ascertain an amount to
be invested in a fund which pays interest @ 10% per annum.
Following options are available to him:
(i) to make annual payment into the fund at the end of each year.
(ii) to invest a lumpsum amount in the fund at the end of the year.
(iii) to make annual payment into the fund in the beginning of each year.
Find out the amount to be invested under each of the options given above.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

Factors are as under:

FVIF/CVF (10%, 10) = 2.594
FVIFA/CVFA (10%,10) = 15.937
PVIF/PVF (l0%, 10) = 0.386
PVIFA/PVFA (10%,10) = 6.145
(d) The X Ltd. is willing to raise funds for its new project which requires an investment of
` 84 lakhs. The company has two options:
Option 1: To issue Equity Shares ( ` 10 each) only
Option II: To avail term loan at an interest rate of 12%. But in this case, as insisted
by the financing agencies, the company will have to maintain a debt
equity proportion of 2:1.
The corporate tax rate is 30%.
Find out the point of indifference for the project. (4 x 5 = 20 Marks)
Answer
(a) Increase in hourly rate of wages under Rowan Plan is ` 30 i.e. (`180 – ` 150)
TimeSaved
 ` 150 = `30 (Please refer Working Note)
Time Allowed
TimeSaved
Or,  ` 150 = ` 30
50hours
1,500
Or, Time saved = = 10 hours
150
Therefore, Time Taken is 40 hours i.e. (50 hours – 10 hours)
Effective Hourly Rate under Halsey System:
Time saved = 10 hours
Bonus @ 50% = 10 hours × 50% × ` 150 = ` 750
Total Wages = (`150 × 40 hours + ` 750) = ` 6,750
Effective Hourly Rate = ` 6,750 ÷ 40 hours = ` 168.75
Working Note:
Time Taken
(Time Taken  Rate per hour)   Time Saved  Rate per hour
Time Allowed
Effective hourly rate =
Time Taken

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

Time Taken
×Time Saved×Rate per hour
Time Taken×Rate per hour Time Allowed
Or, ` 180 = +
Time Taken Time Taken
Time Taken×Rate per hour Time Taken 1
Or, ` 180 - =  Time Saved  Rateper hour 
Time Taken Time Allowed Time Taken
Time Saved
Or, ` 180 – ` 150 = × ` 150
Time Allowed
(b) (i) Value of work in progress certified:
Since, Cash Received of ` 2,50,000 is 80% of work certified
` 2,50,000
Therefore, Value of work in progress certified = = ` 3,12,500
80%
(ii) Degree of completion of contract:
Valueof workcertified ` 3,12,500
= 100 =  100 = 62.5%
Valueof contract ` 5,00,000
(iii) Notional Profit:
2 Cash Received
Profit transferred to Costing Profit & Loss A/c = ×Notional Profit ×
3 Value of work certified

(Since contract completion is 62.5% i.e. more than 50%)

2 ` 2,50,000
Or, ` 80,000 = × Notional Profit×
3 ` 3,12,500
Notional Profit = ` 1,50,000
(iv) Cost of contract as on 31-03-2017:
= Value of Work certified + Cost of work uncertified – Notional profit
= ` 3,12,500 + `1,20,000 – ` 1,50,000
= ` 2,82,500
(c) Future Value = ` 30,00,000
Interest (i) = 10% p.a.
Period (n) = 10 years
(i) To make annual payment into the fund at the end of each year:
 (1  i)n  1 
Future Value = Annual Payment × (FVIFA n, i) or Annual Payment ×  
 i 

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

` 30,00,000 = A (FVIFA 10%, 10)

Rs.30,00,000
Or, A = = ` 1,88,241.2
15.937
(ii) To invest a lumpsum amount in the fund at the end of the year:
Future Value = Amount × (FVIF 10%, 10) or Amount × (1+ 0.1) 10
` 30,00,000
Or, A = = ` 11,56,515
2.594
(iii) To make annual payment into the fund at the beginning of each year:
Future Value = Annual Payment × (FVIFA n, i) × (1+i)
` 30,00,000 = A (FVIFA 10%, 10) × (1+ 0.1)
` 30,00,000 ` 30,00,000
Or, A = = = ` 1,71,125 (approx.)
15.937  1.1 17.531
(d) Workings Notes
1. Capital Structure
Option-I: 100% equity capital i.e. ` 84,00,000
8,40,000 equity shares @ ` 10 each
Option-II: Equity capital = ` 84,00,000/3 × 1 = ` 28,00,000
2,80,000 equity shares @ ` 10 each
12% Term Loan = ` 84,00,000/3 × 2 = ` 56,00,000
2. Interest on Term loan
` 56,00,000 × 12% = ` 6,72,000
Computation of indifference point between Option-I & Option-II
EPSOption-I = EPSOption-II
EBIT(1  t) (EBIT  Interest)(1  t)
Or, =
No.of equity shares No.of equity shares
EBIT(1  0.3) (EBIT ` 6,72,000)(1 0.3)
Or, =
8,40,000shares 2,80,000shares
0.7EBIT 0.7EBIT ` 4,70,400
Or, =
3 1
Or, 2.1 EBIT – 14,11,200 = 0.7 EBIT

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

14,11,200
Or, 1.4 EBIT =
1.4
Or, EBIT = ` 10,08,000
So, Point of Indifference for the project is Rs 10,08,000/-
Question 2
(a) A Ltd. produces 'M' as a main product and gets two by products - 'P' and 'Q' in the course
of processing.
Following information are available for the month of October, 2017:
M P Q
Cost after separation - ` 60,000 ` 30,000
No. of units produced 4500 2500 1500
Selling price (per unit) ` 170 ` 80 ` 50
Estimated Net profit to sales - 30% 25%
The joint cost of manufacture upto separation point amounts to ` 2,50,000.
Selling expenses amounting to ` 85,000 are to be apportioned to the three products in
the ratio of sales units.
There is no opening and closing stock.
Prepare the statement showing:
(i) Allocation of joint cost.
(ii) Product wise over all profitability and
(iii) Advise the company regarding results if the by product ' P' is not further processed
and is sold at the point of separation at ` 60 per unit without incurring selling
expenses. (8 Marks)
(b) A firm can make investment in either of the following two projects. The firm anticipates its
cost of capital to be 10. The pre-tax cash flows of the projects for five years are as
follows:
Year 0 1 2 3 4 5
Project A (`) (2,00,000) 35,000 80,000 90,000 75,000 20,000
Project 8 (`) (2,00,000) 21,8000 10,000 10,000 4000 3000
Ignore Taxation.
An amount of `35000 will be spent on account of sales promotion in year 3 in case of
Project A. This has not been taken into account in calculation of pre -tax cash flows.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

The discount factors are as under:

Year 0 1 2 3 4 5
PVF (10%) 1 0.91 0.83 0.75 0.68 0.62
You are required to calculate for each project:
(i) The payback period
(ii) The discounted payback period
(iii) Desirability factor
(iv) Net Present Value (8 Marks)
Answer
(a) (i) Statement showing allocation of Joint Cost
Particulars P Q
No. of units Produced 2,500 1,500
Selling Price Per unit (`) 80 50
Sales Value (`) 2,00,000 75,000
Less:Estimated Profit (P-30% & Q -25%) (60,000) (18,750)
Cost of Sales 1,40,000 56,250
Less: Selling Expenses (Refer Working note-1) (25,000) (15,000)
Cost of Production 1,15,000 41,250
Less:Cost after separation (60,000) (30,000)
Joint Cost allocated 55,000 11,250

(ii) Statement of Profitability

Particulars M (`) P (`) Q (`)
Sales Value (A) 7,65,000 2,00,000 75,000
(4,500 × `170)
Less: Joint Cost 1,83,750 55,000 11,250
(2,50,000-55,000- 11,250)
- Cost after separation - 60,000 30,000
- Selling Expenses 45,000 25,000 15,000
(Refer Working note-1)
(B) 2,28,750 1,40,000 56,250

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

Profit (A –B) 5,36,250 60,000 18,750

Overall Profit = ` 5,36,250 + ` 60,000 + ` 18,750 = ` 6,15,000
(iii) If the by-product P is not further processed and is sold at the point of
separation:
Amount (`)
Sales value at the point of separation 1,50,000
(2,500 units × ` 60)
Less: Joint cost 55,000
Profit 95,000
Profit after further processing 60,000
Incremental Profit 35,000
If the by-product P is sold at the point of separation, it will give an additional profit of
` 35,000 to the company, hence, the company should sell by-product P without
further processing.
Working Note:
1. Apportionment of Selling expenses among M, P and Q
` 85,000
Product M-  9 = ` 45,000
17
` 85,000
By-product P-  5 = ` 25,000
17
` 85,000
By-product Q-  3 = ` 15,000
17
(b) Calculation of Present Value of cash flows
Year PV factor Project A Project B
@ 10% Cash flows (`) Discounted Cash flows Discounted
Cash flows (`) Cash flows
0 1.00 (2,00,000) (2,00,000) (2,00,000) (2,00,000)
1 0.91 35,000 31,850 2,18,000 1,98,380
2 0.83 80,000 66,400 10,000 8,300
3 0.75 55,000(90,000-35,000) 41,250 10,000 7,500
4 0.68 75,000 51,000 4,000 2,720

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

5 0.62 20,000 12,400 3,000 1,860

Net Present 2,900 18,760
Value
(i) The Payback period of the projects:
Project-A: The cumulative cash inflows upto year 3 is `1,70,000 and remaining
amount required to equate the cash outflow is ` 30,000 i.e. (` 2,00,000 –
` 1,70,000) which will be recovered from year-4 cash inflow. Hence, Payback period
will be calculated as below:
` 30,000
3 years + = 3.4 years Or 3 years 4.8 months Or 3 years 4 months and 24
` 75,000
days
Project-B: The cash inflow in year-1 is `2,18,000 and the amount required to
equate the cash outflow is ` 2,00,000, which can be recovered in a period less than
a year. Hence, Payback period will be calculated as below:
` 2,00,000
= 0.917 years Or 11 months
` 2,18,000
(ii) Discounted Payback period for the projects:
Project-A: The cumulative discounted cash inflows upto year 4 is `1,90,500 and
remaining amount required to equate the cash outflow is ` 9,500 i.e. (` 2,00,000 –
` 1,90,500) which will be recovered from year-5 cash inflow. Hence, Payback period
will be calculated as below:
` 9,500
4 years + = 4.766 years Or 4 years 9.19 months Or 4 years 9 months and 6
` 12,400
days
Project-B: The cash inflow in year-1 is `1,98,380 and remaining amount required to
equate the cash outflow is ` 1,620 i.e. (` 2,00,000 – ` 1,98,380) which will be
recovered from year-2 cash inflow. Hence, Payback period will be calculated as
below:
` 1,620
1 year + = 1.195 years Or 1 Year 2.34 months Or 1 Year 2 months and 10
` 8,300
days.
(iii) Desirability factor of the projects
Discountedvalue of Cash Inflows
Desirability Factor (Profitability Index) =
Discountedvalueof Cash Outflows

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

` 2,02,900
Project A = = 1.01
` 2,00,000
` 2,18,760
Project B = = 1.09
` 2,00,000
(iv) Net Present Value (NPV) of the projects:
Please refer the above table.
Project A- ` 2,900
Project B- ` 18,760
Question 3
(a) XYZ Limited produces an article and uses a mixture of material X and Y. The standard
quantity and price of materials for one unit of output is as under:
Material Quantity Price (` )
X 2000 KG 1.00 per kg.
Y 800 KG 1.50 per kg.
During a period, 1500 units were produced. The actual consumption of materials and
prices are given below:
Material Quantity Price (` )
X 31,00,000 kg 1.10 per kg.
Y 12,50,000 kg 1.60 per kg.
Calculate:
(i) Standard cost for actual output
(ii) Material cost variance
(iii) Material Price variance
(iv) Material usage variance (8 Marks)
(b) The current credit sales of a firm is ` 15 lakhs and the firm still has an unutilized
capacity. In order to boost its sales, the firm is willing to relax its credit policy.
The firm proposes a new credit policy of 2/10 net 60 days as against the present policy of
1/10 net 45 days. The firm expects an increase in the sales by 12%. However, it is also
expected that bad debts will go upto 2% of sales from 1.5%.
The contribution to sales ratio of the firm is 28%. The firm's tax rate is 30% and firm
requires an after tax return of 15% on its investment.
Should the firm change the credit policy? (8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

Answer
(a)
(i) Standard cost for Actual output:
Material X = 1,500 units × 2,000 kg. × ` 1 = 30,00,000
Material Y = 1,500 units × 800 kg. × ` 1.50 = 18,00,000 ` 48,00,000
(ii) Material Cost Variance:
= Standard Cost for actual output – Actual Cost
= (SQ × SP) – (AQ × AP)
Material X = {30,00,000 - (31,00,000 kg. × ` 1.10)}
= 30,00,000 – 34,10,000 = 4,10,000 (A)
Material Y = {18,00,000 – (12,50,000 kg. × ` 1.60)}
= 18,00,000 – 20,00,000 = 2,00,000 (A) 6,10,000 (A)
(iii) Material Price Variance:
= AQ (SP – AP)
Material X = 31,00,000 kg. (` 1.00 – ` 1.10) = 3,10,000 (A)
Material Y = 12,50,000 kg. (` 1.50 – ` 1.60) = 1,25,000 (A) 4,35,000 (A)
(iv) Material Usage Variance:
= SP (SQ – AQ)
Material X = ` 1.00 {(1,500 × 2,000) – 31,00,000}
= 30,00,000 – 31,00,000 = 1,00,000 (A)
Material Y = ` 1.50 {(1,500 × 800) – 12,50,000}
= ` 1.50 (12,00,000 – 12,50,000) = 75,000 (A) = 1,75,000
(A)
(b) Evaluation of Credit policies
Particulars Present policy (`) Proposed policy (`)
Credit Sales 15,00,000 16,80,000
(112% of 15,00,000)
Variable Cost (72%) (10,80,000) (12,09,600)
Contribution 4,20,000 4,70,400
Bad debt (22,500) (33,600)
(15,00,000× 1.5%) (16,80,000 × 2%)
Profit Before Tax (PBT) 3,97,500 4,36,800

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

Tax @ 30% (1,19,250) (1,31,040)

Profit After Tax (PAT) 2,78,250 3,05,760
Opportunity Cost (Refer working note) (20,250) (30,240)
Net Profit 2,58,000 2,75,520
In proposed scheme the net profit is more by ` 17,520 i.e. (` 2,75,520 – ` 2,58,000),
hence, company should change the credit policy.
Working Note:
Opportunity Cost on Credit sales:
15 45days
Present policy = `10,80,000   = ` 20,250
100 360days
15 60days
Proposed policy = `12,09,600   = ` 30,240
100 360days
Assumption:
(i) Cash discount is not availed by the debtors.
(ii) Debtors are utilising full credit period for payment.
(iii) No. of days in a year is 360 days.
Question 4
(a) A company, with 90% Capacity utilization, is manufacturing a product and makes a sale
of ` 9,45,000 at ` 30 per unit. The cost data is as under:
Materials - ` 9 .00 per unit
Labour - ` 7,00 per unit
Semi variable cost (including
variable cost of ` 4.25 per unit) - ` 2,10,000.
Fixed cost is ` 94,500 upto 90% level of output (capacity). Beyond this, an additional
amount of ` 15,000 will be incurred.
You are required to calculate:
(i) Level of output at break-even point
(ii) Number of units to be sold to earn a net income of 10% of sales
(iii) Level of output needed to earn a profit of ` 1,41,375 (8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

(b) The following details of a company for the year ended 31 st March, 2017 are given below:
Operating leverage 2:1
Combined leverage 2.5:1
Fixed Cost excluding interest ` 3.4 lakhs
Sales ` 50 lakhs
8% Debentures of ` 100 each ` 30.25 lakhs
Equity Share Capital of ` 10 each 34 lakhs
Income Tax Rate 30%
Required:
(i) Calculate Financial Leverage
(ii) Calculate P/V ratio and Earning per Share (EPS)
(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a
high or low assets turnover?
(iv) At what level of sales, the Earning before Tax (EBT) of the company will be equal to
zero? (8 Marks)
Answer
(a) Working Note:
1. Current utilization 90% capacity and Turnover is ` 9,45,000
No. of units = `9,45,000/`30 = 31,500 units
Variable Cost per units:
Material 9.00
Labour cost 7.00
Variable overheads 4.25
Total Variable Cost 20.25
Selling price 30.00
Contribution per unit (Selling price – Variable Cost) 9.75
Calculation of Total Fixed Cost
Particulars (`)
Semi-variable cost 2,10,000
Less: Variable cost (31,500 units × `4.25) 1,33,875
Fixed Cost 76,125

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

Add: Fixed cost upto 90% level 94,500

Total Fixed Cost 1,70,625
2. Present Profit:
Contribution (31,500 units at ` 9.75) 3,07,125
Less: Fixed cost 1,70,625
Profit 1,36,500
(i) Break-even point = Total Fixed Cost /Contribution per unit
= `1,70,625/ ` 9.75 = 17,500 Units

17,500
At 17,500 units, output level is = × 90% = 50%
31,500
So, at 50% activities level, this company reaches at BEP

Fixed Cost + Profit

(ii) Sales (Units) =
Contribution per unit
10% of sales = 10% of ` 30 = ` 3 per unit profit.
Let us assume ‘S’ is the no. of units to be sold, hence profit will be 3S
` 1,70,625 + 3S
So, S =
` 9.75
Or, 9.75 S = 1,70,625+3S
Or, S = 1,70,625 ÷ 6.75 = 25,278 units.
` 1,70,625 +1,41,375
(iii) Sales (units) =
` 9.75
= `3,12,000 ÷ ` 9.75 = 32,000 units
32,000 units is beyond 90% activity level. In such case, the fixed cost will be
increased by ` 15,000 to ` 3,27,000.
` 3,27,000 33,538
Then, S = = 33,538 units i.e. × 100 = 95.82% activity level.
` 9.75 35,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

(b) (i) Financial leverage

Combined Leverage = Operating Leverage (OL)  Financial Leverage (FL)
2.5 = 2  FL Or, FL = 1.25
Financial Leverage = 1.25
(ii) P/V Ratio and Earning per share (EPS)
Contribution(C)
Operating leverage = × 100
Contribution - Fixed Cost (FC)
C
2= Or, C = 2 (C – 3,40,000)
C - 3,40,000
Or, C = 2C – 6,80,000 Or, Contribution = ` 6,80,000
Contribution (C) 6,80,000
Now, P/V ratio = × 100 = × 100 = 13.6%
Sales (S) 50,00,000

Therefore, P/V Ratio = 13.6%

EBT = Sales – Variable Cost – Fixed Cost – Interest
= `50,00,000 – ` 50,00,000 (1-0.136) – `3,40,000 – (8% × `30,25,000)
= ` 50,00,000 – ` 43,20,000 – ` 3,40,000 – ` 2,42,000
= ` 98,000
PAT = EBT(1-T)
= ` 98,000(1-0.3) = ` 68,600
Profit after tax
EPS =
No. of equity shares
` 68,600
EPS = = ` 0.202
3,40,000shares
(iii) Assets turnover
Sales ` 50,00,000
Assets turnover = = = 0 .78
Total Assets * ` 34,00,000 ` 30,25,000
0.78 < 1.5 means lower than industry turnover.
*Total Asset = Equity share capital + 8% Debentures
(iv) EBT zero means 100% reduction in EBT. Since combined leverage is 2.5, sales
have to be dropped by 100/2.5 = 40%. Hence new sales will be

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

` 50,00,000  (100 – 40) % = ` 30,00,000.

Therefore, at ` 30,00,000 level of sales, the Earnings before Tax (EBT) of the
company will be zero.
Alternatively
Fixed Cost + Interest + desired Profit
Required sales when EBT is zero =
P/V Ratio
` 3,40,000 + ` 2,42,000 + zero
=
13.60%
` 5,82,000
=
13.60%
= ` 42,79,412
[Note: The question can also be solved by first calculating EBIT with the help of Financial
Leverage. Accordingly answer to the requirement(ii) and (iv) will also vary]
Question 5
(a) Identify the methods of costing where:
(i) all costs are directly charged to a specific job.
(ii) all costs are directly charged to a group of products.
(iii) the nature of the product is complex and method cannot be ascertained.
(iv) cost is ascertained for a single product.
(b) What are the motivational factors for adopting a reconciliation process? Expl ain.
(c) What is 'Bill discounting'? How does it differ from 'Factoring'? Explain.
(d) Which method of comparing a number of investment proposals is most suited if each
proposal involves different amount of cash inflows? Explain and state its limitation s.
(4 x 4 = 16 Marks)
Answer
(a) (i) Job Costing
(ii) Batch Costing
(iii) Multiple Costing
(iv) Single or Output Costing
(b) When the cost and financial accounts are kept separately, it is imperative that these
should be reconciled, otherwise the cost accounts would not be reliable. The
reconciliation of two set of accounts can be made, if both the sets contain sufficient detail

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

as would enable the causes of differences to be located. It is therefore, important that in

the financial accounts, the expenses should be analysed in the same way as in cost
accounts.
Motivation for reconciliation is:
 To ensure reliability of cost data
 To ensure ascertainment of correct product cost
 To ensure correct decision making by the management based on Cost & Financial data.
(c) Bills Discounting:
Advances are allowed by banks against security of bills. When a bill is discounted, the
borrower is paid the present worth.
The differences between Factoring and Bills discounting are as follows:
(i) Factoring is called as ‘Invoice factoring’ whereas bills discounting is known as
“Invoice discounting”.
(ii) In factoring the parties are known as client, factor and debtor whereas in bills
discounting they are known as Drawer, Drawee and Payee.
(iii) Factoring is a sort of management of book debts whereas bills discounting is a sort
of borrowing from commercial banks.
(iv) For Factoring there is no specific Act, whereas in the case of bills discounting, the
Negotiable Instrument Act is applicable.
(d) Profitability Index (PI) method is best suited if each investment proposal involves
different amount of cash inflows. PI considers both present value of cash inflows and
present value of cash outflows.
Mathematically, the desirability factor is calculated as below:
Sum of Discounted Cash inflows
Initial Cash outlay or Total Discounted Cash outflow (as the case may be)
PI is known as a superior method of comparing a number of investment proposal than
Net present value method (NPV).
Limitations of PI
 Profitability index fails as a guide in resolving capital rationing where projects are
indivisible.
 Once a single large project with high NPV is selected, possibility of accepting
several small projects which together may have higher NPV than the single project
is excluded.

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

 Also situations may arise where a project with a lower profitability index selected
may generate cash flows in such a way that another project can be taken up one or
two years later, the total NPV in such case being more than the one with a project
with highest Profitability Index.
Question 6
(a) APP Limited is a manufacturing concern and recovers overheads at a pre-determined
rate of ` 30 per man-day.
The following additional information of a period are also available for you:
Total factory overheads incurred ` 51,00,000
Man-days actually worked 1,50,000
Sales (in units) 50,000
Stock at the end of the period:
Completed units 5,000
incompleted units (50% completed) 10,000
There was no opening stock of finished goods and works in progress.
On analyzing the situation, it was discovered that 60% of the unabsorbed overheads
were due to defective planning and balance were attributable to increase in overhead
costs.
How would you treat unabsorbed overheads in cost accounts? (8 Marks)
(b) XY Ltd. provides the following information for the year ending 31st March, 2017:

Equity Share Capital ` 8,00,000

Closing Stock ` 1,50,000
Stock Turnover Ratio 5 times
Gross profit ratio 20%
Net profit/Sales 16%
Net profit/Capital 25%
Equity Share Capital ` 8,00,000
You are required to prepare:
Trading and Profit & Loss Account for the year ending 31 st March, 2017. (8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

Answer
(a)
Amount (`)
Total factory overheads incurred 51,00,000
Less: Absorbed factory overheads (` 30 × 1,50,000) (45,00,000)
Under-absorption of Overheads 6,00,000
60% of ` 6,00,000 i.e. ` 3,60,000 would be transferred to Costing P/L Account
40% of ` 6,00,000 i.e. ` 2,40,000 would be apportioned over Sales unit and Stock by
using supplementary overheads rate.
` 2,40,000
Supplementary overheads Rate = =`4
50,000 + 5,000 + 5,000

On Sales (50,000 units × ` 4) 2,00,000

On Finished Goods (5,000 units × ` 4) 20,000
On Work in Progress (10000 × 50% × ` 4) 20,000
2,40,000

(b) Working Note:

1. Calculation of Net Profit
Net Pr ofit
 25%
Capital
Net Profit 25
Or,  Or, Net Profit = ` 2,00,000
` 8,00,000 100

2. Calculation of Sales
Net Profit 16
=
Sales 100
` 2,00,000 16
Or,  Or, Sales = ` 12,50,000
Sales 100
3. Calculation of Gross Profit
Gross profit = ` 12,50,000 × 20%
= ` 2,50,000

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

4. Calculation of Opening Stock

Cost of Sales
Stock Turnover Ratio = = 5 times
Average Stock
` 12,50,000  (1 0.2)
Or, =5
AverageStock
` 10,00,000
Or, Average Stock = = ` 2,00,000
5
1,50,000 + OpeningStock
Average Stock = = 2,00,000
2
Or, Opening Stock = 4,00,000 – 1,50,000 = ` 2,50,000
Trading and Profit & Loss Account
Particulars (`) Particulars (`)
To Opening Stock 2,50,000 By Sales 12,50,000
To Purchases 9,00,000 By Closing Stock 1,50,000
(Balancing figure)
To Gross Profit (Balance c/d) 2,50,000
14,00,000 14,00,000
To Miscellaneous expenses 50,000 By Gross Profit (Balance b/d) 2,50,000
(Balancing figure)
To Net Profit 2,00,000
2,50,000 2,50,000
Question 7
Answer any four of the following:
(a) Distinguish between 'Bin Card' and 'Stores Ledger'.
(b) Explain 'Retention Money' and 'Progress payment' in contract.
(c) Explain:
(i) Flexible Budget
(ii) Operating lease
(d) Explain 'Concentration Banking' and 'Lock Box System'.
(e) Explain 'Finance Function'. (4 x 4 = 16 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

Answer
(a) Difference between Bin Card & Stores Ledger
Bin Card Stores Ledger
(i) It is maintained by the storekeeper in It is maintained in costing department.
the store.
(ii) It contains only quantitative details of It contains information both in quantity
material received, issued and and value.
returned to stores.
(iii) Entries are made when transactions It is always posted after the
take place. transaction.
(iv) Each transaction is individually Transactions may be summarized and
posted. then posted.
(v) Inter-department transfers do not Material transfers from one job to
appear in Bin Card. another job are recorded for costing
purposes.
(b) Retention Money: In a contract, a contractee generally keeps some amount payable to
contractor with himself as security deposit. In a contract, a contractor undertakes to
complete a job work on the basis of pre- determined terms and conditions and work
specifications. To ensure that the work carried out by the contractor is as per the plan
and specifications, it is monitored periodically by the contractee. To have a cushion
against any defect or undesirable work the contractee withhold some money payable to
contractor. This security money withheld by the contractee is known as retention money.
In some contracts the contractor has to deposit some security money before staring of
the contract as a term of contract. This is known as Earnest money. If any deficiency or
defect is noticed in the work, it is to be rectified by the contractor before the release of
the retention money. Retention money provides a safeguard against the risk of loss due
to faulty workmanship.
Mathematically:
Retention Money = Value of work certified – Payment actually made/ cash paid
Progress Payment: A Contractor gets payments for work done on a contract based on
work completion. Since, a contract takes longer period to complete and requires large
investment in working capital to progress the contract work, hence, it is desirable by the
contractor to have periodic payments from the contractee against the work done to avoid
working capital shortage. For this a contactor enters into an agreement with the
contractee and agrees on payment on some reasonable basis, which generally, includes
percentage of work completion as certified by an expert.

© The Institute of Chartered Accountants of India

70 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2017

Mathematically:
Progress payment = Value of work certified – Retention money – Payment to date
(c) (i) Flexible Budget: According to CIMA, “a flexible budget is defined as a budget
which, by recognizing the difference between fixed, semi-variable and variable costs
is designed to change in relation to the level of activity attained.” Unlike static
(fixed) budgets, flexible budgets show the expected results of a responsibility center
for different activity levels.
(ii) Operating Lease: A lease is classified as an operating lease if it does not secure
for the lessor the recovery of capital outlay plus a return on the funds invested
during the lease term. Normally, these are callable lease and are cancellable with
proper notice. The term of this type of lease is shorter than the asset’s economic
life. The lessee is obliged to make payment until the lease expiration, which
approaches useful life of the asset.
(d) Concentration Banking: In concentration banking the company establishes a number
of strategic collection centres in different regions instead of a single collection centre at
the head office. This system reduces the period between the time a customer mails in
his remittances and the time when they become spendable funds with the company.
Payments received by the different collection centers are deposited with their respective
local banks which in turn transfer all surplus funds to the concentration bank of head
office. The concentration bank with which the company has its major bank account is
generally located at the headquarters. Concentration banking is one important and
popular way of reducing the size of the float.
Lock Box System: Another means to accelerate the flow of funds is a lock box system.
While in concentration banking, remittances are received by a collection centre and
deposited in the bank after processing. The purpose of lock box system is to eliminate
the time between the receipts of remittances by the company and deposited in the bank.
A lock box arrangement usually is on regional basis which a company chooses according
to its billing patterns.
(e) The finance function is most important for all business enterprises. It remains a focus of
all activities. It starts with the setting up of an enterprise. It is concerned with raising of
funds, deciding the cheapest source of finance, utilization of funds raised, making
provision for refund when money is not required in the business, deciding the most
profitable investment, managing the funds raised and paying returns to the providers of
funds in proportion to the risks undertaken by them. Therefore, it aims at acquiring
sufficient funds, utilizing them properly, increasing the profitability of the organization and
maximizing the value of the organization and ultimately the shareholder’s wealth.

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT
Question No. 1 is compulsory.
Answer any five questions from the remaining six questions.
Working notes should form part of the answer.
Question 1
Answer the following:
(a) RST Company Ltd. has computed labour turnover rates for the quarter ended 31 st March,
2017 as 20%, 10% and 5% under flux method, replacement method and separation
method respectively. If the number of workers replaced during that quarter is 50, find out
(i) Workers recruited and joined (ii) Workers left and discharged and (iii) Average number
of workers on roll. (5 Marks)
(b) AB Ltd. has furnished the following information:
Budgeted Actual
July 2016
Number of working days 25 27
Production (in units) 20,000 22,000
Fixed Overheads ` 30,000 ` 31,000
Budgeted fixed overhead rate is ` 1.00 per hour. In July 2016, the actual hours worked
were 31,500. In relation to fixed overheads, calculate:
(i) Efficiency Variance
(ii) Capacity Variance
(iii) Calendar Variance
(iv) Volume Variance
(v) Expenditure Variance (5 Marks)
(c) You are given the following information of 5 firms of the same industry:
Name of the Firm Change in Change in Operating Change in Earning
Revenue Income per share
M 28% 26% 32%
N 27% 34% 26%
P 25% 38% 23%
Q 23% 43% 27%
R 25% 40% 28%

© The Institute of Chartered Accountants of India

48 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

You are required to calculate:

(i) Degree of operating leverage and
(ii) Degree of combined leverage for all firms. (5 Marks)
(d) VK Co. Ltd. has total cash disbursement amounting ` 22,50,000 in the year 2017 and
maintains a separate account for cash disbursements. Company has an administrative
and transaction cost on transferring cash to disbursement account ` 15 per transfer. The
yield rate on marketable securities is 12% per annum.
You are required to determine optimum cash balance according to William J Baumol
Model. (5 Marks)
Answer
No. of workers replaced
(a) Labour Turnover Rate (Replacement method) = 100
Average no. of workers
10 50
Or, =
100 Averageno.of wor ker s
Thus, Average No. of workers = 500
No. of workers separated
Labour Turnover Rate (Separation method) = 100
Average No. of workers
5 Number of wor ker s separated
Or, =
100 500
Thus, No. of workers separated = 25
Labour Turnover Rate (Flux Method)
No. of Separations + No. of Accession (Joinings)
= 100
Average no. of workers
20 25 No. of accessions (Joinings)
Or, =
100 500
Or, 100 (25 + No. of Accessions) = 10,000
Or, 25 + No. of Accessions =100
Thus, No. of Accessions = 100 - 25 =75
Accordingly,
(i) Workers recruited and Joined = 75
(ii) Workers left and discharged = 25
(iii) Average number of workers on roll = 500

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

(b) Workings:
` 30,000
(1) Budgeted Hours = = 30,000 hours
` 1 per hour
(2) Standard Fixed Overhead rate per hour (Standard Rate):
Budgeted fixed overheads ` 30,000
= = = ` 1.00
Budgeted Hours 30,000hours
30,000hours
(3) Standard Hour per unit of output = = 1.5 hours
20,000units
(4) Standard hours for Actual Output = 22,000 units × 1.5 hours = 33,000 Hours
` 30,000
(5) Budgeted Overhead per day for budgeted days = = ` 1,200
25days
(6) Budgeted Overhead for actual days worked = ` 1,200 × 27 days = ` 32,400
30,000hours
(7) Budgeted Hours for Actual days worked = 27days = 32,400 hours
25days
Computation of Variances in relation to Fixed Overheads:
(i) Efficiency Variance
= Standard Rate × (Standard hours for actual output – Actual hours worked)
= `1.00 (33,000 hours – 31,500 hours) = ` 1,500 (Favourable)
(ii) Capacity Variance
= Standard Rate × (Actual Hours – Budgeted Hours for actual days worked)
= `1.00 (31,500 hours – 32,400 hours) = ` 900 (Adverse)
(iii) Calendar Variance
= Standard Fixed Overhead Rate per day × (Actual Working days – Budgeted
working days)
= `1,200 (27 days – 25 days) = ` 2,400 (Favourable)
(iv) Volume Variance
= Standard Rate × (Standard hours – Budgeted hours)
= `1.00 (33,000 hours – 30,000 hours) = ` 3,000 (Favourable)
(v) Expenditure Variance
= Budgeted Overheads – Actual Overheads
= ` 30,000 – ` 31,000 = ` 1,000 (Adverse)

© The Institute of Chartered Accountants of India

50 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

Note: Overhead Variances may also be calculated based on output.

(c) Calculation of Degree of Operating leverage and Degree of Combined leverage
Firm Degree of Operating Leverage (DOL) Degree of Combined Leverage (DCL)
%changeinOperatingIncome %changeinEPS
= =
%changeinRevenue %changeinRevenue

26% 32%
M = 0.929 = 1.143
28% 28%
34% 26%
N = 1.259 = 0.963
27% 27%
38% 23%
P = 1.520 = 0.920
25% 25%
43% 27%
Q = 1.870 = 1.174
23% 23%
40% 28%
R = 1.60 = 1.120
25% 25%

(d) Determination of Optimum Cash Balance according to William J. Baumol’s Model

2UP
C=
S
Where,
C = Optimum cash balance
U = Annual cash disbursement
P = Fixed cost per transaction
S = Opportunity cost of one-rupee p.a.
Therefore, Optimum Cash Balance
2 ` 22,50,000 `15
= = 56,25,00,000
0.12
= ` 23,717.08 or ` 23,717
Question 2
(a) KMR Ltd. produces product AY, which passes through three processes ‘XM’, ‘YM’ and
‘ZM’. The output of process ‘XM’ and ‘YM’ is transferred to next process at cost plus 20
percent each on transfer price and the output of process ‘ZM’ is transferred to finished

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

stock at a profit of 25 percent on transfer price. The following information are available in
respect of the year ending 31 st March, 2017:
Process- Process- Process- Finished
XM (` ) YM (` ) ZM (` ) Stock
(` )
Opening Stock 30,000 54,000 80,000 90,000
Material 1,60,000 1,30,000 1,00,000 -
Wages 2,50,000 2,16,000 1,84,000 -
Manufacturing Overheads 1,92,000 1,44,000 1,33,000 -
Closing Stock 40,000 64,000 78,000 1,00,000
Inter process profit included in Nil 8,000 20,000 40,000
Opening Stock
Stock in processes is valued at prime cost. The finished stock is valued at the price at
which it is received from process ‘ZM’. Sales of the finished stock during the period was
` 28,00,000.
You are required to prepare:
(i) All process accounts and
(ii) Finished stock account showing profit element at each stage. (8 Marks)
(b) PQ Limited wants to expand its business and has applied for a loan from a commercial
bank for its growing financial requirements.
The records of the company reveals that the company sells goods in the domestic market
at a gross profit of 25% not counting depreciation as part of the cost of goods sold.
The following additional information is also available for you:
`
Sales-Home at one month’s credit 1,20,00,000
Sales-Export at three months’ credit (sales price 10% below home 54,00,000
price)
Material used (supplied extends two months’ credit) 45,00,000
Wages paid ½ month in arrear 36,00,000
Manufacturing Expenses (Cash) paid (one month in arrear) 54,00,000
Adm. Expenses paid one month in arrear 12,00,000
Income tax payable in four installments of which one falls in the next 15,00,000
financial year

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

The company keeps one month’s stock of each of raw materials and finished goods and
believes in keeping ` 10,00,000 available to it including the overdraft limit of ` 5,00,000
not yet utilized by the company. Assumes a 15% margin for contingencies. Ignore the
work-in-progress.
You are required to ascertain the requirement of the working capital of the company.
(8 Marks)
Answer
(a) (i) Process ‘XM’ Account
Dr. Cr.
Particulars Cost (`) Profit Total Particulars Cost Profit Total
(`) (`) (`) (`) (`)
To Opening Stock 30,000  30,000 By Process 5,92,000 1,48,000 7,40,000
‘YM’ A/c
(Transfer)
To Material 1,60,000  1,60,000
To Wages 2,50,000  2,50,000
Total 4,40,000  4,40,000
Less: Closing stock 40,000  40,000
Prime Cost 4,00,000 4,00,000
To Manufacturing
Overheads 1,92,000  1,92,000
Total cost 5,92,000  5,92,000
To Costing Profit
and Loss A/c (20%
on transfer Price or
25% on cost) 1,48,000 1,48,000
5,92,000 1,48,000 7,40,000 5,92,000 1,48,000 7,40,000

Process ‘YM’ Account

Dr. Cr.
Particulars Cost Profit Total Particulars Cost Profit Total
(`) (`) (`) (`) (`) (`)

To Opening Stock 46,000 8,000 54,000 By Process 10,72,758 4,52,242 15,25,000

‘ZM’ A/c
(Transfer)
To Process ‘XM’ A/c 5,92,000 1,48,000 7,40,000
To Material 1,30,000 -- 1,30,000
To Wages 2,16,000 -- 2,16,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

Total 9,84,000 1,56,000 11,40,000

Less: Closing stock 55,242 8,758 64,000
Prime Cost 9,28,758 1,47,242 10,76,000
To Manufacturing
Overheads 1,44,000 -- 1,44,000
Total cost 10,72,758 1,47,242 12,20,000
To Costing Profit and -- 3,05,000 3,05,000
Loss A/c (20% on
transfer Price or 25%
on cost)
10,72,758 4,52,242 15,25,000 10,72,758 4,52,242 15,25,000

Process ‘ZM’ Account

Dr. Cr.
Cost Profit Total Cost Profit Total
Particulars (`) (`) (`)
Particulars (`) (`) (`)

To Opening Stock 60,000 20,000 80,000 By Finished Stock 14,91,258 11,00,742 25,92,000
A/c (Transfer)
To Process ‘YM’ A/c 10,72,758 4,52,242 15,25,000
To Material 1,00,000 -- 1,00,000
To Wages --
1,84,000 1,84,000
Total 14,16,758 4,72,242 18,89,000
Less: Closing stock 58,500 19,500 78,000
Prime Cost 13,58,258 4,52,742 18,11,000
To Manufacturing
Overheads 1,33,000 -- 1,33,000
Total cost 14,91,258 4,52,742 19,44,000
To Costing Profit and -- 6,48,000 6,48,000
Loss A/c (25% on
transfer Price or 33
1/3% on cost)
14,91,258 11,00,742 25,92,000 14,91,258 11,00,742 25,92,000

(ii) Finished Stock Account

Dr. Cr.
Particulars Cost Profit Total Particulars Cost Profit Total
(`) (`) (`) (`) (`) (`)

To Opening Stock 50,000 40,000 90,000 By Costing 14,83,725 13,16,275 28,00,000

P&L A/c
(Transfer)

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

To Process ‘ZM’ A/c 14,91,258 11,00,742 25,92,000

Total 15,41,258 11,40,742 26,82,000
Less: Closing stock 57,533 42,467 1,00,000
14,83,725 10,98,275 25,82,000
To Costing Profit -- 2,18,000 2,18,000
and Loss A/c (Profit)
(Balancing figure)
14,83,725 13,16,275 28,00,000 14,83,725 13,16,275 28,00,000

Calculation of amount of unrealized profit on closing stock:

Process ‘XM’ = Nil
`1,56,000
Process ‘YM’ = × ` 64,000 = ` 8,758.
` 11,40,000
` 4,72,242
Process ‘ZM’ = × `78,000 = `19,500.
`18,89,000
`11,00,742
Finished Stock = × ` 1,00,000 = ` 42,467.
`25,92,000
Note: Unrealised profit on closing finished stock can also be calculated on the basis of
Average cost.
(b) Statement of Working Capital Requirement for PQ Ltd
(`) (`)
A. Current Assets
(i) Inventories:
Material (1 month)
 ` 45,00,000 
  1 month 
 12months  3,75,000
Finished goods (1 months)
 ` 1,35,00,000 
  1 month 
 12months  11,25,000 15,00,000
(ii) Receivables (Debtors)
 ` 90,00,000 
For Domestic Sales   1 month 
 12months  7,50,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

 ` 45,00,000 
For Export Sales   3months 
 12months  11,25,000 18,75,000
(iii) Cash in hand & at bank
(` 10,00,000 – ` 5,00,000) 5,00,000
Total Current Assets 38,75,000
B. Current Liabilities:
(i) Payables (Creditors) for materials (2 months)
 ` 45,00,000 
  2months 
 12months  7,50,000
(ii) Outstanding wages (0.5 months)
 `36,00,000 
  0.5month 
 12months  1,50,000
(iii) Outstanding manufacturing expenses
 `54,00,000 
  1month 
 12months  4,50,000
(iv) Outstanding administrative expenses
 ` 12,00,000 
  1 month 
 12months  1,00,000
(v) Income tax payable (` 15,00,000 ÷ 4) 3,75,000
Total Current Liabilities 18,25,000
Net Working Capital (A – B) 20,50,000
Add: 15% contingency margin 3,07,500
Total Working Capital required 23,57,500
Working Note:
1. Calculation of Cost of Goods Sold and Cost of Sales
Domestic (`) Export (`) Total (`)
Sales 1,20,00,000 54,00,000 1,74,00,000
Less: Gross profit @ 25% on
domestic sales and 16.67% on
export sales (Working note-2) (30,00,000) (9,00,000) (39,00,000)
Cost of Goods Sold/ Cash Cost
of Sales 90,00,000 45,00,000 1,35,00,000

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

2. Calculation of gross profit on Export Sales:

Let domestic selling price is `100. Gross profit is `25, and then cost per unit is `75
Export price is 10% less than the domestic price i.e. `100 – (1- 0.1) = `90
Now gross profit will be `90 - `75 = `15
`15
Therefore, Gross profit at domestic price will be  100 = 15%
`100
`15
Or, gross profit at export price will be  100 = 16.67%
`90
Assumptions
(i) It is assumed that administrative expenses relating to production activities.
(ii) Value of opening and closing stocks are equal.
(iii) Receivables are calculated based on cost of goods sold

Question 3
(a) The following information was obtained from the records of a manufacturing unit:
` `
Sales 80,000 units @ ` 25 20,00,000
Material consumed 8,00,000
Variable Overheads 2,00,000
Labour Charges 4,00,000
Fixed Overheads 3,60,000 17,60,000
Net Profit 2,40,000
Calculate:
(i) The number of units by selling which the company will neither lose nor gain
anything.
(ii) The sales needed to earn a profit of 20% on sales.
(iii) The extra units which should be sold to obtain the present profit if it is proposed to
reduce the selling price by 20% and 25%.
(iv) The selling price to be fixed to bring down its Break-even Point to 10,000 units
under present conditions. (8 Marks)
(b) PNR Limited and PXR Limited are identical in every respect except capital structure.
PNR limited does not employ debts in its capital structure whereas PXR Limited employs

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

12% Debentures amounting to ` 20,00,000. The following additional information are

given to you:
(i) Income tax rate is 30%
(ii) EBIT is ` 5,00,000
(iii) The equity capitalization rate of PNR Limited is 20% and
(iv) All assumptions of Modigliani - Miller Approach are met.
Calculate:
(i) Value of both the companies,
(ii) Weighted average cost of capital for both the companies. (8 Marks)
Answer
(a) Workings:
(1) Contribution per unit = Selling price per unit – Variable cost per unit
= ` 25 – {` (8,00,000 + 2,00,000 + 4,00,000) ÷ 80,000 units}
= ` 25 – ` 17.50 = ` 7.50
Contributionper unit ` 7.50
(2) Profit-Volume (P/V) Ratio = 100 = 100 = 30%
Selling priceper unit ` 25
Calculations:
(i) The number of units to be sold for neither loss nor gain i.e. Break-even units:
Fixed Overheads ` 3,60,000
= = = 48,000 units
Contribution per unit `7.50

(ii) The sales needed to earn a profit of 20% on sales:

As we know
S=V+F+P
(S = Sales; V = Variable Cost; F = Fixed Cost; P = Profit)
Suppose Sales units are x then
` 25x = ` 17.5 x + ` 3,60,000 + ` 5x
` 25x – ` 22.5x = ` 3,60,000
`3,60,000
Or, x = = 1,44,000 units
` 2.5
Therefore, Sales needed = 1,44,000 units  `25 = `36,00,000 to earn a profit of
20% on sales.

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

(iii) Calculation of extra units to be sold to earn present profit of ` 2,40,000 under
the following proposed selling price:
When selling price is reduced by
20% 25%
Selling price per unit (`) 20.00 18.75
(` 25 × 80%) (` 25 × 75%)
Less: Variable Cost per unit (`) 17.50 17.50
Contribution per unit (`) 2.50 1.25
Desired Contribution:
Fixed Overheads (`) 3,60,000 3,60,000
Desired Profit (`) 2,40,000 2,40,000
6,00,000 6,00,000
(a) Sales unit for desired  ` 6,00,000   ` 6,00,000 
contribution  `2.50   `1.25 
   
 DesiredContribution  2,40,000 units 4,80,000 units
 
 Contributionper unit 
(b) Units presently sold 80,000 units 80,000 units
(c) Extra units to be sold {(a) – (b)} 1,60,000 units 4,00,000 units
(iv) Sales price to bring down BEP to 10,000 units:
FixedCost
B.E.P (Units) =
Contribution per unit
`3,60,000
Or, Contribution per unit = = `36
10,000units
So, Sales Price (per unit) = Variable Cost + Contribution
= `17.5 + `36 = `53.50
(b) (i) Calculation of Value of Firms PNR Ltd. and PXR Ltd. according to Modigliani-
Miller Approach:
Market Value of Firm PNR (Unlevered)
EBIT (1 - t ) ` 5,00,000 (1- 0.30 )
Vu = =
Ke 20%
`3,50,000
= = `17,50,000
20%

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

Market Value of Firm PXR (Levered)

Vg = Vu + TB
= `17,50,000 + (`20,00,000 × 0.30)
= ` 17,50,000 + ` 6,00,000 = ` 23,50,000
(ii) Computation of Weighted Average Cost of Capital (WACC):
WACC of ‘PNR Ltd.’ = 20% (i.e. Ke = Ko)
WACC of ‘PXR Ltd.’
PXR Ltd. (`)
EBIT 5,00,000
Interest to Debt holders @12% (2,40,000)
EBT 2,60,000
Taxes @ 30% (78,000)
Income available to Equity Shareholders 1,82,000
Total Value of Firm 23,50,000
Less: Market Value of Debt (20,00,000)
Market Value of Equity 3,50,000
Return on equity (Ke) = 1,82,000 / 3,50,000 0.52
Computation of WACC of PXR Ltd
Component of Capital Amount Weight Cost of Capital WACC
Equity 3,50,000 0.149 0.52 0.0775
Debt 20,00,000 0.851 0.084* 0.0715
Total 23,50,000 0.1490
*Kd= 12% (1- 0.3) = 12% × 0.7 = 8.4%
WACC = 14.90%
Question 4
(a) The following information have been extracted from the cost records of JKL
Manufacturing Company Ltd:
`
Stores:
Opening Balance 90,000
Purchases 4,80,000

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

Transfer from WIP 2,40,000

Issue to WIP 4,80,000
Issue for repairs 60,000
Deficiency found in stock 18,000
Work-in-Progress:
Opening Balance 1,80,000
Direct wages applied 1,80,000
Overhead charged 7,20,000
Closing Balance 1,20,000
Finished Production:
Entire production is sold at a profit of 10% on cost from work-in- -
progress
Wages Paid 2,10,000
Overhead Incurred 7,50,000
Prepare Stores Ledger Control A/c., Work-in-Progress Control A/c., Overheads Control
A/c. and Costing Profit & Loss A/c. (8 Marks)
(b) Following information relate to a concern:
Debtors Velocity 3 months
Credits Velocity 2 months
Stock Turnover Ratio 1.5
Gross Profit Ratio 25%
Bills Receivables ` 25,000
Bills Payables ` 10,000
Gross Profit ` 4,00,000
Fixed Assets to turnover Ratio 4
Closing stock of the period is ` 10,000 above the opening stock.
Find out:
(i) Sales and cost of goods sold
(ii) Sundry Debtors
(iii) Sundry Creditors
(iv) Closing Stock
(v) Fixed Assets (8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

Answer
(a) Stores Ledger Control A/c
Particulars (`) Particulars (`)
To Balance b/d 90,000 By Work in Progress Control 4,80,000
A/c
To General Ledger 4,80,000 By Overhead Control A/c 60,000
Adjustment A/c
To Work in Progress Control 2,40,000 By Overhead Control A/c 18,000*
A/c (Deficiency)
By Balance c/d 2,52,000
8,10,000 8,10,000
*Deficiency assumed as normal (alternatively can be treated as abnormal loss)
Work in Progress Control A/c
Particulars (`) Particulars (`)
To Balance b/d 1,80,000 By Stores Ledger Control 2,40,000
A/c
To Stores Ledger Control A/c 4,80,000 By Costing P/L A/c
(Balancing figures being Cost 12,00,000
of finished goods)
To Wages Control A/c 1,80,000 By Balance c/d 1,20,000
To Overheads Control A/c 7,20,000
15,60,000 15,60,000
Overheads Control A/c
Particulars (`) Particulars (`)
To Stores Ledger Control A/c 60,000 By Work in Progress 7,20,000
Control A/c
To Stores Ledger Control A/c 18,000 By Balance c/d* (Under 1,38,000
absorption)

To Wages Control A/c 30,000

(` 2,10,000- `1,80,000)
To Gen. Ledger Adjust. A/c 7,50,000
8,58,000 8,58,000
*Alternatively may be transferred to Costing P& L A/c

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

Costing Profit & Loss A/c

Particulars (`) Particulars (`)
To Work in progress 12,00,000 By Gen. Ledger Adjust. A/c 13,20,000
Control A/c (Sales) (12,00,000+1,20,000)

To Gen. Ledger Adjust. A/c 1,20,000

(Profit)
13,20,000 13,20,000
General Ledger Adjustment A/c may also be written as Cost Ledger Control A/c
(b) (i) Determination of Sales and Cost of goods sold:
Gross Profit
Gross Profit Ratio = × 100
Sales
25 ` 4,00,000
Or, =
100 Sales
4,00,00,000
Or, Sales = = ` 16,00,000
25
Cost of Goods Sold = Sales – Gross Profit
= ` 16,00,000 - ` 4,00,000 = ` 12,00,000
(ii) Determination of Sundry Debtors:
Debtors velocity is 3 months or Debtors’ collection period is 3 months,
12months
So, Debtors’ turnover ratio = =4
3months
Credit Sales
Debtors’ turnover ratio =
Average AccountsRe ceivable
` 16,00,000
= =4
Bills Receivable+ SundryDebtors
Or, Sundry Debtors + Bills receivable = ` 4,00,000
Sundry Debtors = ` 4,00,000 – ` 25,000 = ` 3,75,000
(iii) Determination of Sundry Creditors:
Creditors velocity of 2 months or credit payment period is 2 months.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

12 months
So, Creditors’ turnover ratio = =6
2 months
CreditPurchases *
Creditors turnover ratio =
Average AccountsPayables
` 12,10,000
= =6
Sundry Creditors+ Bills Payables
So, Sundry Creditors + Bills Payable = ` 2,01,667
Or, Sundry Creditors + ` 10,000 = ` 2,01,667
Or, Sundry Creditors = ` 2,01,667 – ` 10,000 = ` 1,91,667
(iv) Closing Stock
Cost of Goods Sold ` 12,00,000
Stock Turnover Ratio = = =1.5
Average Stock Average Stock
So, Average Stock = ` 8,00,000
Opening Stock+ Closing Stock
Now Average Stock =
2
Opening Stock+ (Opening Stock+ `10,000)
Or = ` 8,00,000
2
Or, Opening Stock = ` 7,95,000
So, Closing Stock= ` 7,95,000 + ` 10,000 = ` 8,05,000
(v) Calculation of Fixed Assets
Cost of GoodsSold
Fixed Assets Turnover Ratio = =4
FixedAssets
`12,00,000
Or, =4
Fixed Assets
Or, Fixed Asset = ` 3,00,000
Workings:
*Calculation of Credit purchases:
Cost of goods sold = Opening stock + Purchases – Closing stock
` 12,00,000 = ` 7,95,000 + Purchases – ` 8,05,000
` 12,00,000 + ` 10,000 = Purchases
` 12,10,000 = Purchases (credit).

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

Assumption:
(i) All sales are credit sales
(ii) All purchases are credit purchase
(iii) Stock Turnover Ratio and Fixed Asset Turnover Ratio may be calculated either
on Sales or on Cost of Goods Sold.

Question 5
(a) Explain 'Cost Unit' and 'Cost Centre'.
(b) What are the essential factors for installing a cost accounting system? Explain.
(c) Distinguish between 'Funds Flow' and 'Cash Flow'.
(d) Distinguish between 'Profit Maximization' and 'Wealth Maximization' objective of a firm.
(4 × 4 = 16 Marks)
Answer
(a) (i) Cost Units: It is a unit of product, service or time (or combination of these) in
relation to which costs may be ascertained or expressed.
We may for instance determine the cost per tonne of steel, per tonne kilometre of a
transport service or cost per machine hour. Sometime, a single order or a contract
constitutes a cost unit. A batch which consists of a group of identical items and
maintains its identity through one or more stages of production may also be
considered as a cost unit.
Cost units are usually the units of physical measurement like number, weight, area,
volume, length, time and value.
(ii) Cost Centre: It is defined as a location, person or an item of equipment (or group of
these) for which cost may be ascertained and used for the purpose of Cost Control.
Cost Centres are of two types:
Personal Cost Centre: It consists of a person or group of persons e.g. Mr. X,
supervisor, foreman, accountant, engineer, process staffs, mining staffs, doctors
etc.
Impersonal Cost Centre: It consists of a location or an item of equipment (or group
of these) e.g. boiler house, cooling tower, weighing machine, canteen, and
generator set etc.
OR
Cost Centres in a manufacturing concern are of two types:

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

Production Cost Centre: it is a cost centre where raw material is handled for
conversion into finished products. Here both direct and indirect expenses are
incurred. Machine shops, welding shops and assembly shops etc. are examples of
production cost centres.
Service Cost Centre: It is a cost centre which serves as an ancillary unit to
production cost centre. Payroll processing department, HRD, Power house, Gas
production shops, Plant maintenance centres etc. are example of service cost
centres.
(b) Before installation of a system of cost accounting in a manufacturing organisation the
under mentioned factors should be studied:
(i) Objective: The objective of costing system, for example whether it is being
introduced for fixing prices or for insisting a system of cost control.
(ii) Nature of Business or Industry: The Industry in which business is operating.
Every business industry has its own peculiar feature and costing objectives.
According to its cost information requirement cost accounting methods are followed.
For example, Indian Oil Corporation Ltd. has to maintain process wise cost
accounts to find out cost incurred on a particular process say in crude refinement
process etc.
(iii) Organisational Hierarchy: Costing system should fulfill the requirement of different
level of management. Top management is concerned with the corporate strategy,
strategic level management is concerned with marketing strategy, product
diversification, product pricing etc. Operational level management needs the
information on standard quantity to be consumed, report on idle time etc.
(iv) Knowing the product: Nature of product determines the type of costing system to
be implemented. The product which has by-products requires costing system which
account for by-products as well. In case of perishable or short self- life, marginal
costing method is required to know the contribution and minimum price at which it
can be sold.
(v) Knowing the production process: A good costing system can never be
established without the complete knowledge of the production process. Cost
apportionment can be done on the most appropriate and scientific basis if a cost
accountant can identify degree of effort or resources consumed in a particular
process. This also includes some basic technical know-how and process peculiarity.
(vi) Information synchronisation: Establishment of a department or a system requires
substantial amount of organisational resources. While drafting a costing system,
information needs of various other departments should be taken into account. For
example, in a typical business organisation accounts department needs to submit
monthly stock statement to its lender bank, quantity wise stock details at the time
filing returns to tax authorities etc.

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

(vii) Method of maintenance of cost records: The manner in which Cost and Financial
accounts could be inter-locked into a single integral accounting system and in which
results of separate sets of accounts, cost and financial, could be reconciled by
means of control accounts.
(viii) Statutory compliances and audit: Records are to be maintained to comply with
statutory requirements, standards to be followed (Cost Accounting Standards and
Accounting Standards).
(ix) Information Attributes: Information generated from the Costing system should be
possess all the attributes of an information i.e. complete, accurate, timeliness,
confidentiality etc. This also meets the requirements of management information
system.
(c) The points of distinction between Funds flow and Cash flow are as below:
Funds flow Cash flow
(i) It ascertains the changes in financial (i) It ascertains the changes in balance
position between two accounting of cash in hand and bank.
periods.
(ii) It analyses the reasons for change in (ii) It analyses the reasons for changes
financial position between two in balance of cash in hand and bank
balance sheets
(iii) It reveals the sources and application (iii) It shows the inflows and outflows of
of finds. cash.
(iv) It helps to test whether working (iv) It is an important tool for short term
capital has been effectively used or analysis.
not.
(v) The two significant areas of analysis
are cash generating efficiency and
free cash flow.
(d) Distinguish between ‘Profit Maximization’ and ‘Wealth Maximization’: Profit
maximisation is a short-term objective and cannot be the sole objective of a company. It
is at best a limited objective. If profit is given undue importance, a number of problems
can arise like the term profit is vague, profit maximisation has to be attempted with a
realisation of risks involved, it does not take into account the time pattern of returns and
as an objective it is too narrow.
Whereas, on the other hand, wealth maximisation, as an objective, means that the
company is using its resources in a good manner. If the share value is to stay high, t he
company has to reduce its costs and use the resources properly. If the company follows
the goal of wealth maximisation, it means that the company will promote only those
policies that will lead to an efficient allocation of resources.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

Question 6
(a) You are given the following data of a manufacturing concern:
`
Variable Expenses (at 50% capacity):
Materials 48,00,000
Labour 51,20,000
Others 7,60,000
Semi variable expenses (at 50% capacity):
Maintenance and Repairs 5,00,000
Indirect Labour 19,80,000
Sales Dept. Salaries 5,80,000
Sundry Administrative Expenses 5,20,000
Fixed Expenses:
Wages & Salaries 16,80,000
Rent, Rates and Taxes 11,20,000
Depreciation 14,00,000
Sundry Administrative Exp. 17,80,000
The fixed expenses remain constant for all levels of production. Semi variable expenses
remain constant between 45% and 65% of capacity whereas it increases by 10%
between 65% and 80% capacity of 20% between 80% and 100 % capacity.
Sales at various levels are as under:
Capacity Sales (`)
75% 2,40,00,000
100% 3,20,00,000
Prepare flexible budget at 75% and 100% capacity. (8 Marks)
(b) X Limited is considering to purchase of new plant worth ` 80,00,000. The expected net
cash flows after taxes and before depreciation are as follows:
Year Net Cash Flows (` )
1 14,00,000
2 14,00,000
3 14,00,000

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

4 14,00,000
5 14,00,000
6 16,00,000
7 20,00,000
8 30,00,000
9 20,00,000
10 8,00,000
The rate of cost of capital is 10%.
You are required to calculate:
(i) Pay-back period
(ii) Net present value at 10 discount factor
(iii) Profitability index at 10 discount factor
(iv) Internal rate of return with the help of 10% and 15% discount factor
The following present value table is given for you:
Present value of ` 1 at Present value of ` 1 at
Year
10% discount rate 15% discount rate
1 .909 .870
2 .826 .756
3 .751 .658
4 .683 .572
5 .621 .497
6 .564 .432
7 .513 .376
8 .467 .327
9 .424 .284
10 .386 .247
(8 Marks)
Answer
(a) Preparation of Flexible Budget
Particulars Capacity Levels
50% (`) 75% (`) 100% (`)
A Sales Given 2,40,00,000 3,20,00,000
B. Costs:

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

(i) Variable Expenses:

Materials 48,00,000 72,00,000 96,00,000
Labour 51,20,000 76,80,000 1,02,40,000
Others 7,60,000 11,40,000 15,20,000
1,06,80,000 1,60,20,000 2,13,60,000
(ii) Semi-Variable
Expenses:
Maintenance and Repairs 5,00,000 5,50,000 6,00,000
Indirect Labours 19,80,000 21,78,000 23,76,000
Sales Dept. salaries 5,80,000 6,38,000 6,96,000
Sundry Administrative 5,20,000 5,72,000 6,24,000
Expenses
35,80,000 39,38,000 42,96,000
(iii) Fixed Expenses:
Wages & Salaries 16,80,000 16,80,000 16,80,000
Rent, Rates and Taxes 11,20,000 11,20,000 11,20,000
Depreciation 14,00,000 14,00,000 14,00,000
Sundry Administrative 17,80,000 17,80,000 17,80,000
Expenses
59,80,000 59,80,000 59,80,000
Total Cost {(i) + (ii) + (iii)} 2,02,40,000 2,59,38,000 3,16,36,000
C. Profit/ (Loss) {(A) – (B)} (19,38,000) 3,64,000
At 75% and 100% capacity level, the semi-variable costs increased by 10% and 20%
respectively.
(b) (i) Calculation of Pay-back Period
Cash Outlay of the Project = ` 80,00,000
Total Cash Inflow for the first five years = ` 70,00,000
Balance of cash outlay left to be paid back in the 6 th year ` 10,00,000
Cash inflow for 6 th year = 16,00,000
So the payback period is between 5 th and 6th years, i.e.,
`10,00,000
5 years + = 5.625 years or 5 years 7.5 months
`16,00,000

© The Institute of Chartered Accountants of India

70 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

(ii) Calculation of Net Present Value (NPV) @10% discount rate:

Year Net Cash Inflow (`) Present Value at Present Value (`)
Discount Rate of 10%
(a) (b) (c) = (a)× (b)
1 14,00,000 0.909 12,72,600
2 14,00,000 0.826 11,56,400
3 14,00,000 0.751 10,51,400
4 14,00,000 0.683 9,56,200
5 14,00,000 0.621 8,69,400
6 16,00,000 0.564 9,02,400
7 20,00,000 0.513 10,26,000
8 30,00,000 0.467 14,01,000
9 20,00,000 0.424 8,48,000
10 8,00,000 0.386 3,08,800
97,92,200
Net Present Value (NPV) = Cash Outflow – Present Value of Cash Inflows
= ` 80,00,000 – ` 97,92,200 = 17,92,200
(iii) Calculation of Profitability Index @ 10% discount rate:
Present Value of Cash inflows
Profitability Index =
Cost of the investment
` 97,92,200
= = 1.224
` 80,00,000
(iv) Calculation of Internal Rate of Return:
Net present value @ 10% interest rate factor has already been calculated in (ii)
above, we will calculate Net present value @15% rate factor.
Year Net Cash Inflow (`) Present Value at Present Value
Discount Rate of 15% (`)
(a) (b) (c) = (a)× (b)
1 14,00,000 0.870 12,18,000
2 14,00,000 0.756 10,58,400
3 14,00,000 0.658 9,21,200

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 71

4 14,00,000 0.572 8,00,800

5 14,00,000 0.497 6,95,800
6 16,00,000 0.432 6,91,200
7 20,00,000 0.376 7,52,000
8 30,00,000 0.327 9,81,000
9 20,00,000 0.284 5,68,000
10 8,00,000 0.247 1,97,600
78,84,000
Net Present Value at 15% = ` 78,84,000 – ` 80,00,000 = ` -1,16,000
As the net present value @ 15% discount rate is negative, hence internal rate of
return falls in between 10% and 15%. The correct internal rate of return can be
calculated as follows:
NPVL
IRR = L  H  L 
NPVL  NPVH
`17,92,200
= 10%  15%  10% 
`17,92,200  ( ` 1,16,000)
` 17,92,200
= 10%   5% = 14.7%
`19,08,200
Question 7
Answer any four of the following:
(a) Discuss briefly the principles to be followed while taking credit for profit on incomplete
contract.
(b) State the difference between Cost Accounting and Management Accounting.
(c) Explain the meaning and advantages of Factoring.
(d) Explain:
(i) Time Value of Money
(ii) A.B.C. Analysis
(e) Explain GDR and ADR. (4 × 4 = 16 Marks)

© The Institute of Chartered Accountants of India

72 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

Answer
(a) Principles to be followed while taking credit for profit on incomplete contracts:
The portion of profit to be credited to costing profit and loss account depends on the
stage of completion of a contract. The stage of completion of the contract refers to
certified work only and uncertified work is not considered.
The transfer of profit to the costing profit and loss account is done as under:
(i) Contract less than 25% complete: If the contract has just started or it is less than
25% complete, no profit is taken into account.
(ii) Contract is 25% or more but less than 50% complete: In this case one third of the
notional profit reduced in the ratio of cash received to work certified, may be
transferred to the profit and loss account. The amount of profit to be transferred to
the profit and loss account may be determined by using the following formula:
1 Cash received
× Notional profit ×
3 Work certified
(iii) Contract is 50% or more but less than 90% complete: In this case, two third of the
notional profit, reduced by the portion of cash received to work certified may be
transferred to the profit and loss account. In this case the formula to be used is as
under:
2 Cash received
× Notional profit ×
3 Work certified
(iv) Contracts nearing completion, say between 90% and 100% complete: When a
contract is nearing completion or 90% or more work has been done on a contract.
The amount of profit to be credited to costing profit and loss account may be
determined by using any one of the following formula.
Work certified
(a) Estimated profit ×
Contract price
Work certified Cash received
(b) Estimated profit × ×
Contract price Work certified
CashRe ceived
or Estimated profit ×
Contract price
Cost of work to date
(c) Estimated Profit ×
Estimated total cos t

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 73

Cost of work to date Cash received

(d) Estimated profit × 
Estimated total cost Work certified
Work certified
(e) Notional profit ×
Contract price
(b) Difference between Cost Accounting and Management Accounting
Basis Cost Accounting Management Accounting
(i) It records the quantitative It records both qualitative and
Nature
aspect only quantitative aspect.
(ii) It records the cost of It Provides information to
Objective producing a product and management for planning and
providing a service co-ordination
(iii) It only deals with cost It is wider in scope as it
Area Ascertainment. includes F.A., budgeting, Tax,
Planning.
(iv) Recording of It uses both past and It is focused with the projection
data present figures. of figures for future.
(v) It’s development is related It develops in accordance to
Development to industrial revolution. the need of modern business
world.
(vi) Rules and It follows certain principles It does not follow any specific
Regulation and procedures for rules and regulations.
recording costs of different
products
(c) Meaning of Factoring: Factoring is a specialised service related with receivable
management which involves credit investigation, sales ledger management, purchase
and collection of debts, credit protection as well as provision of finance against
receivables. In factoring, accounts receivables are generally sold to a financial institution,
known as factor, who charges commission and bears the credit risks associated with the
accounts receivables purchased by it.
The factor takes the responsibility of monitoring, follow-up, collection and risk
management related with receivables (debts).
Advantages of Factoring:
(1) The firm can convert accounts receivables into cash without bothering about
repayment.
(2) Factoring ensures a definite pattern of cash inflows.

© The Institute of Chartered Accountants of India

74 INTERMEDIATE (IPC) EXAMINATION: MAY, 2017

(3) Continuous factoring virtually eliminates the need for the credit department. That is
why receivables financing through factoring is gaining popularly as useful source of
financing short-term funds requirements of business enterprises because of the
inherent advantage of flexibility it affords to the borrowing firm. The seller firm may
continue to finance its receivables on a more or less automatic basis. If sales
expand or contract it can vary the financing proportionally.
(4) Unlike an unsecured loan, compensating balances are not required in this case.
Another advantage consists of relieving the borrowing firm of substantially credit
and collection costs and to a degree from a considerable part of cash management.
(d) (i) Time Value of Money: It means money has time value. A rupee today is more
valuable than a rupee after a year. Similarly, a rupee received in future is less
valuable than it is today. Time value of money can be of two types, present value of
money and future value of money. Concept of discounting is applicable to present
value of money and compounding is applicable to future value of money. In a
nutshell, time value of money represents monetary value arising out of difference of
time.
(ii) ABC Analysis: It is a system of selective inventory control whereby the measure of
control over an item of inventory varies with its usage value. It exercises
discriminatory control over different items of stores grouped on the basis of the
investment involved. Usually the items of material are grouped into three categories
viz; A, B and C according to their use value during a period. In other words, the high
use value items are controlled more closely than the items of low use value.
(i) 'A' Category of items consists of only a small percentage i.e., about 10 % of
the total items of material handled by the stores but require heavy invest ment
i.e., about 70% of inventory value, because of their high prices and heavy
requirement.
(ii) 'B' Category of items comprises of about 20% of the total items of material
handled by stores. The percentage of investment required is about 20% of the
total investment in inventories.
(iii) 'C category of items does not require much investment. It may be about 10% of
total inventory value but they are nearly 70% of the total items handled by
stores
(e) Global Depository Receipts (GDRs): It is a negotiable certificate denominated in
US dollars which represents a Non-US company’s publically traded local currency
equity shares. GDRs are created when the local currency shares of an Indian
company are delivered to Depository’s local custodian Bank against which the
Depository bank issues depository receipts in US dollars. The GDRs may be traded
freely in the overseas market like any other dollar-expressed security either on a

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 75

foreign stock exchange or in the over-the-counter market or among qualified

institutional buyers.
American Depository Receipts (ADRs): American Depository Receipts (ADRs)
are securities offered by non- US companies who want to list on any of the US
exchanges. It is a derivative instrument. It represents a certain number of
company’s shares. These are used by depository bank against a fee income. ADRs
allow US investors to buy shares of these companies without the cost of investing
directly in a foreign stock exchange. ADRs are listed on either NYSE or NASDAQ. It
facilitates integration of global capital markets. The company can use the ADR route
either to get international listing or to raise money in international capital market.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
Question No. 1 is compulsory.
Attempt any five questions out of the remaining six questions.
In case, any candidate answers extra question(s)/ sub-question(s) over and above the
required number, then only the requisite number of questions first answered in the answer
book shall be valued and subsequent extra question(s) answered shall be ignored.
Working notes should form part of the answer.
Question 1
Answer the following:
(a) The following figures are available from the records of ABC Company as at 31 st March.
2015 (` in lakhs) 2016 (` in lakhs)
Sales 200 250
Profit 30 45
Calculate:
(i) The P/V ratio and total fixed expenses.
(ii) The break-even level of sales.
(iii) Sales required to earn a profit of ` 70 lakhs.
(b) Supreme Limited is a manufacturer of energy saving bulbs. To manufacture the finished
product one unit of component ‘LED’ is required. Annual requirement of component ‘LED’
is 72,000 units, the cost being ` 300 per unit. Other relevant details for the year 2015-
2016 are:
Cost of placing an order : ` 2,250
Carrying cost of inventory : 12% per annum
Lead time-
Maximum : 20 days
Minimum : 8 days
Average : 14 days
Emergency purchase : 5 days
Consumption-
Maximum : 400 units per day
Minimum : 200 units per day
Average : 300 units per day

© The Institute of Chartered Accountants of India

46 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

You are required to calculate:

(i) Re-order quantity
(ii) Re-ordering level
(iii) Minimum stock level
(iv) Maximum stock level
(v) Danger level
(c) ABC Company’s equity share is quoted in the market at ` 25 per share currently. The
company pays a dividend of ` 2 per share and the investor’s market expects a growth
rate of 6% per year.
You are required to:
(i) Calculate the company’s cost of equity capital.
(ii) If the anticipated growth rate is 8% per annum, calculate the indicated market price
per share.
(iii) If the company issues 10% debentures of face value of ` 100 each and realises
` 96 per debenture while the debentures are redeemable after 12 years at a
premium of 12%, what will be the cost of debenture?
Assume Tax Rate to be 50%.
(d) The following information is related to YZ Company Ltd. for the year ended 31 st March,
2016:
Equity share capital (of ` 10 each) ` 50 lakhs
12% Bonds of ` 1,000 each ` 37 lakhs
Sales ` 84 lakhs
Fixed cost (excluding interest) ` 6.96 lakhs
Financial leverage 1.49
Profit-volume Ratio 27.55%
Income Tax Applicable 40%
You are required to calculate:
(i) Operating Leverage;
(ii) Combined leverage; and
(iii) Earnings per share.
Show calculations upto two decimal points. (5 × 4 = 20 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 47

Answer
(a) (i) Profit-Volume (P/V) Ratio:
Change in Pr ofit Pr ofit in2016 − Pr ofit in2015
= ×100 = ×100
Change inSales Salesin2016 − Salesin2015
` 45lakhs − ` 30lakhs
= ×100 = 30%
` 250lakhs − ` 200lakhs
Fixed Expenses:
2015 (` in lakhs) 2016 (` in lakhs)
Contribution 60 OR 75
(30% of 200) (30% of 250)
Less: Profit 30 45
Fixed Expenses 30 30

(ii) Break-even level of sales:

Fixed Expenses ` 30lakh
= = = ` 100 lakhs
P / V ratio 30%
(iii) Sales required to earn a profit of ` 70 lakhs:
FixedExpenses + Desiredprofit
=
P / V ratio
`30lakhs + ` 70lakhs
= = ` 333.33 lakhs
30%
(b) (i) Re- order Quantity (ROQ)
Annual Consumption of raw material (A) = 72,000 units
Cost of placing an order (O) = ` 2,250
Carrying cost per unit per annum (c × i) = ` 300 × 12% = ` 36

2AO
Economic Order Quantity (EOQ)/ROQ =
c ×i

2 × 72, 000 units × ` 2, 250

= = 3,000 units
` 36

© The Institute of Chartered Accountants of India

48 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

(ii) Re-order level (ROL) = Maximum consumption × Maximum lead time

= 400 units × 20 days = 8,000 units
(iii) Minimum Level = ROL – (Average consumption × Average lead time)
= 8,000 units – (300 units × 14 days)
= 3,800 units
(iv) Maximum Level = ROL + ROQ – (Minimum consumption × Minimum lead time)
= 8,000 units + 3,000 units – (200 units × 8 days)
= 9,400 units
(v) Danger level = Average Consumption × Emergency Delivery Time
= 300 units × 5 days = 1,500 units
Or,
= Minimum consumption × Emergency Delivery Time
= 200 units × 5 days = 1,000 units.
(c) (i) Cost of Equity Capital (Ke):
Expecteddividendper share (D1)
Ke = + Growthrate (g)
Market price per share (P 0)
` 2 ×1.06
= + 0.06 = 0.1448 or 14.48%
` 25
Note: The cost of equity can be calculated without taking the effect of growth on dividend.
(ii) Indicated market price per share when growth rate is 8% p.a.:
Expecteddividendper share (D1)
Ke = + Growthrate (g)
Market price per share (P 0)

Or
Expecteddividendper share (D1)
P0 =
Cost of equity (Ke ) − Growthrate (g)
` 2 ×1.08 ` 2.16
P0 = Or, P0 = = ` 33.33
0.1448 − 0.08 0.0648

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

(iii) Cost of Debenture (Kd):

(Using approximation method)
 RV − NP 
Interest (1 − tax rate) +  
Kd =  12 years 
 RV + NP 
 
 2 
Where, Tax rate = 50%
Net Proceeds (NP) = ` 96
Redeemable Value (RV) = ` 100 (1.12) = ` 112
 ` 112 − ` 96 
10% of ` 100(1 − 0.5) +  
Kd =  12 years 
 ` 112 + ` 96 
 
 2 
` 5 + 1.33
Kd = = 0.0608 or 6.08%
`104
OR
(Using Present Value method or YTM)
Identification of relevant cash flows
Year Cash flows
0 Current market price (P0) = ` 96
1 to 12 Interest net of tax [I(1-t)] = 10% of ` 100 (1 – 0.5) = ` 5
12 Redemption value (RV) = ` 100 (1.12) = ` 112
Calculation of Net Present Values (NPV) at two discount rates
Year Cash Discount Present Discount Present
flows factor @ Value factor @ Value
5%(L) 10% (H)
0 96 1.000 (96.00) 1.000 (96.00)
1 to 12 5 8.863 44.32 6.814 34.07
12 112 0.557 62.38 0.319 35.73
NPV +10.7 -26.2

© The Institute of Chartered Accountants of India

50 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

Calculation of IRR
NPVL
IRR = L + (H − L )
NPVL − NPVH

10.7 53.5
= 5% + (10% − 5% ) = 5% + = 6.45%
10.7 − ( −26.2) 36.9

Therefore, Kd = 6.45%
[Any other low and high rate as discount factor may also be used.]
(d) Computation of Profits after Tax (PAT)
Particulars Amount (`)
Sales 84,00,000
Contribution (Sales × P/V ratio) 23,14,200
Less: Fixed cost (excluding Interest) (6,96,000)
EBIT (Earnings before interest and tax) 16,18,200
Less: Interest on debentures (12% × `37 lakhs) (4,44,000)
Less: Other fixed Interest (balancing figure) (88,160)*
EBT (Earnings before tax) 10,86,040
Less: Tax @ 40% 4,34,416
PAT (Profit after tax) 6,51,624

(i) Operating Leverage:

Contribution ` 23,14,200
= = = 1.43
EBIT ` 16,18,200
(ii) Combined Leverage:
= Operating Leverage × Financial Leverage
= 1.43 × 1.49 = 2.13
Or,
Contribution EBIT
Combined Leverage = ×
EBIT EBT
Contribution ` 23,14,200
Combined Leverage = = = 2.13
EBT `10,86,040

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

EBIT ` 16,18, 200

* Financial Leverage = = = 1.49
EBT EBT
` 16,18, 200
So, EBT = = `10,86,040
1.49
Accordingly, other fixed interest
= ` 16,18,200 - ` 10,86,040 - ` 4,44,000 = ` 88,160
(iii) Earnings per share (EPS):

PAT ` 6,51,624
= = = ` 1.30
No.of shares outstanding 5,00,000 equity shares

Question 2
(a) A company has introduced a new product and marketed 20,000 units. Variable cost of
the product is ` 20 per units and fixed overheads are ` 3,20,000.
You are required to:
(i) Calculate selling price per unit to earn a profit of 10% on sales value, BEP and
Margin of Safely?
(ii) If the selling price is reduced by the company by 10%, demand is expected to
increase by 5,000 units, then what will be its impact on Profit, BEP and Margin of
Safety?
(iii) Calculate Margin of Safety if profit is ` 64,000. (8 Marks)
(b) The following figures and ratios pertain to ABG Company Limited for the year ending 31 st
March, 2016:
Annual Sales (credit) ` 50,00,000
Gross Profit Ratio 28%
Fixed assets turnover ratio (based on cost of goods sold) 1.5
Stock turnover ratio (based on cost of goods sold) 6
Quick ratio 1:1
Current ratio 1.5
Debtors collection period 45 days
Reserves and surplus to Share Capital 0.60 : 1
Capital gearing ratio 0.5
Fixed Assets to net worth 1.2 : 1

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

You are required to prepare the Balance Sheet as at 31 st March, 2016 based on the
above information. Assume 360 days in a year. (8 Marks)
Answer
(a) (i) Let ‘S’ be the selling price per unit, the equation can be written as:
Sales value = Variable Cost + Fixed Cost + Profit
Or, 20,000 units × S = (` 20 × 20,000 units) + `v3,20,000 + (10% of 20,000 units × S)
Or, 20,000S = ` 4,00,000 + ` 3,20,000 + 2,000S
Or, 20,000S – 2,000S = ` 7,20,000
Or, S = ` 40.
Therefore, Selling price per unit = ` 40
Break-even Point (in units):
FixedOverheads ` 3,20,000
= = = 16,000 units
Contributionper unit ` 40 − ` 20
Or,
Break-even point (in value):
Contributionper unit ` 40 − ` 20
P/V ratio = = = 50%
Selling price per unit ` 40
FixedOverheads ` 3,20,000
Break-even point (in value) = = = ` 6,40,000
P / V Ratio 50%
Margin of Safety:
= Total sales value – Break-even sale = ` 40 × 20,000 – ` 6,40,000
= ` 1,60,000 or 4,000 Units (20,000 Units – 16,000 Units)
Or,
Pr ofit 10%(` 40 × 20,000units)
Margin of Safety = = = ` 1,60,000
P / V Ratio 50%
(ii) Workings:
Profitability Statement
Amount (`)
Sales Value (` 36 × 25,000 units) 9,00,000
Variable Cost (` 20 × 25,000 units) (5,00,000)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

Contribution 4,00,000
Fixed overheads (3,20,000)
Profit 80,000

Impact on Profit:
Though there is no impact on the total profit amount but the rate of profit is
decreased from 10% to 8.89% (80,000/ 9,00,000 × 100).
Break-even point (BEP) (in units):
`3,20,000
= = 20,000 units
`36 − ` 20
Or,
Break-even point (BEP) (in value):
= Selling price per unit × BEP = ` 36 × 20,000 units = ` 7,20,000
Impact on Break-even point (BEP) :
The Break-even point is increased by 4,000 units (20,000 units – 16,000 units) or by
` 80,000 (` 7,20,000 – ` 6,40,000).
Impact on Margin of Safety:
= Total sales value – Break-even sale
= ` 9,00,000 – ` 7,20,000 = ` 1,80,000
Margin of safety is increased by ` 20,000 (1,80,000 – 160,000) or 1,000 units
(5,000 units – 4,000 units)
(iii) Margin of Safety when, profit is ` 64,000:
Pr ofit ` 64,000
= = = ` 1,28,000 or 3,200 units
P / V Ratio 50%
(b) Working Notes:
(i) Cost of Goods Sold = Sales – Gross Profit (28% of Sales)
= ` 50,00,000 – ` 14,00,000
= ` 36,00,000
(ii) Closing Stock = Cost of Goods Sold / Stock Turnover
= ` 36,00,000/6 = ` 6,00,000
(iii) Fixed Assets = Cost of Goods Sold / Fixed Assets Turnover
= ` 36,00,000/1.5 = ` 24,00,000

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

(iv) Current Assets : Current Ratio

= 1.5 and Liquid Ratio = 1
Stock = 1.5 – 1 = 0.5
Current Assets = Amount of Stock × 1.5/0.5
= ` 6,00,000 × 1.5/ 0.5 = ` 18,00,000
(v) Liquid Assets (Debtors and Cash & Cash equivalents)
= Current Assets – Stock
= `18,00,000 – ` 6,00,000
= `12,00,000
(vi) Debtors = Sales × Debtors Collection Period(days) /360 days
45
= ` 50,00,000 × = ` 6,25,000
360
(vii) Cash & Cash equivalents
= Liquid Assets – Debtors
= `12,00,000 – ` 6,25,000 = ` 5,75,000
(viii) Net worth = Fixed Assets / 1.2
= ` 24,00,000/1.2 = ` 20,00,000
(ix) Reserves and Surplus
Reserves & Surplus and Share Capital = 0.6 + 1 = 1.6
Reserves and Surplus = ` 20,00,000 × 0.6/1.6 = ` 7,50,000
(x) Share Capital = Net worth – Reserves and Surplus
= ` 20,00,000 – ` 7,50,000
= `12,50,000
(xi) Current Liabilities = Current Assets / Current Ratio
= `18,00,000/1.5 = `12,00,000
(xii) Long- term Debts
Capital Gearing Ratio = Long-term Debts / Equity Shareholders’ Fund (Net worth)
Or, Long-term Debts = ` 20,00,000 × 0.5 = `10,00,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

Balance Sheet as at 31st March, 2016

Liabilities Amount (`) Assets Amount (`)
Equity Share Capital 12,50,000 Fixed Assets 24,00,000
Reserves and Surplus 7,50,000 Current Assets:
Long-term Debts 10,00,000 Stock 6,00,000
Current Liabilities 12,00,000 Debtors 6,25,000
Cash & Cash eq. 5,75,000 18,00,000
42,00,000 42,00,000
Question 3
(a) The Trading and Profit and Loss Account of a company for the year ended 31-03-2016 is
as under:
Trading and Profit and Loss Account
` `
To Materials 26,80,000 By Sales (50,000 units) 62,00,000
To Wages 17,80,000 By Closing Stock (2,000 units) 1,50,000
To Factory Expenses 9,50,000 By Dividend received 20,000
To Administrative Expenses 4,80,200
To Selling Expenses 2,50,000
To Preliminary Expenses 50,000
written off
To Net Profit 1,79,800
63,70,000 63,70,000
In the Cost Accounts:
(i) Factory expenses have been allocated to production at 20% of Prime Cost.
(ii) Administrative expenses absorbed at 10% of factory cost.
(iii) Selling expenses charged at ` 10 per unit sold.
Prepare the Costing Profit and Loss Account of the company and reconcile the
Profit/Loss with the profit as shown in the Financial Accounts. (8 Marks)
(b) India Limited requires ` 50,00,000 for a new plant. This Plant is expected to yield
earnings before interest and taxes of ` 10,00,000. While deciding about the financial
plan, the company considers the objective of maximising earnings per share. It has three
alternatives to finance the project- by raising debt of ` 5,00,000 or ` 20,00,000 or
` 30,00,000 and the balance, in each case, by issuing equity shares. The company’s

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

share is currently selling at ` 150, but is expected to decline to ` 125 in case the funds
are borrowed in excess of ` 20,00,000. The funds can be borrowed at the rate of 9
percent upto ` 5,00,000, at 14 percent over ` 5,00,000 and upto ` 20,00,000 and at 19
percent over ` 20,00,000. The tax rate applicable to the company is 40 percent. Which
form of financing should company choose? Show EPS Amount upto two decimal points.
(8 Marks)
Answer
(a) Workings:
Preparation of Cost Sheet/ Cost Statement
Particulars Amount (`)
Materials 26,80,000
Wages 17,80,000
Prime Cost 44,60,000
Add: Factory expenses (20% of ` 44,60,000) 8,92,000
Factory Cost 53,52,000
Add: Administrative expenses (10% of ` 53,52,000) 5,35,200
Cost of Production 58,87,200
 ` 58,87,200 
Less: Closing Stock  × 2,000 units  (2,26,431)
 52,000 units 
Cost of Goods Sold 56,60,769
Add: Selling expenses (`10 × 50,000 units) 5,00,000
Cost of Sales 61,60,769
Profit (Balancing figure) 39,231
Sales Value 62,00,000

(It has been assumed that administrative expenses are related with production activities)
Costing Profit and Loss Account
Particulars Amount (`) Particulars Amount (`)
To Materials 26,80,000 By Sales 62,00,000
To Wages 17,80,000 By Closing stock 2,26,431
To Factory expenses 8,92,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

To Administrative expenses 5,35,200

To Selling expenses 5,00,000
To Profit (Balancing figure) 39,231
64,26,431 64,26,431
Reconciliation of profit as per Cost Accounts and as per Financial Accounts
Particulars Amount (`)
Profit as per Cost Accounts 39,231
Additions:
Administrative expenses (Over-absorbed) (` 5,35,200 – `4,80,200) 55,000
Selling expenses (Overcharged) (` 5,00,000 – ` 2,50,000) 2,50,000
Dividend received 20,000
3,64,231
Deductions:
Factory expenses (Under -absorbed) (` 9,50,000 – 8,92,000) 58,000
Closing stock (Over-valued) (`2,26,431 – ` 1,50,000) 76,431
Preliminary expenses written off 50,000
1,84,431
Profit as per Financial Accounts 1,79,800

(Reconciliation statement may also be prepared by taking financial profit as base.)

(b) Calculation of Earnings per share (EPS):
Financing Plans
Particulars Plan I Plan II Plan III
(`) (`) (`)
Debt 5,00,000 20,00,000 30,00,000
Equity 45,00,000 30,00,000 20,00,000
Expected Earnings before interest and taxes (EBIT) 10,00,000 10,00,000 10,00,000
Less: Interest [WN (i)] (45,000) (2,55,000) (4,45,000)
Earnings before taxes (EBT) 9,55,000 7,45,000 5,55,000
Less: Taxes @ 40% 3,82,000 2,98,000 2,22,000
Earnings after taxes (EAT) 5,73,000 4,47,000 3,33,000

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

Number of shares [WN (ii)] 30,000 20,000 16,000

Earnings per share (EPS) [ EAT / No of Shares] 19.10 22.35 20.81
Financing Plan II (i.e. Raising debt of ` 20 lakhs and issue of equity share capital of
` 30 lakhs) is the option which maximises the earnings per share.
Working Notes (WN):
(i) Calculation of interest on Debt.
Plan I ` 5,00,000 × 9% ` 45,000
Plan II ` 5,00,000 × 9% ` 45,000
` 15,00,000 × 14% ` 2,10,000 ` 2,55,000
Plan III ` 5,00,000 × 9% ` 45,000
` 15,00,000 × 14% ` 2,10,000
` 10,00,000 × 19% ` 1,90,000 ` 4,45,000

Note: Instead of slab, the relevant interest rate can be applied on total amount.
(ii) Number of equity shares to be issued
` 45,00,000
Plan I: = 30,000 shares
` 150 (Market price of share)
` 30,00,000
Plan II: = 20,000 shares
` 150 (Market Price of Share)
` 20,00,000
Plan III: = 16,000 shares
` 125 (Revised Market Price of Share)
Question 4
(a) Royal transport company has been given a 50 kilometre long route to run 6 buses. The
cost of each bus is ` 7,50,000. The buses will make 3 round trips per day carrying on an
average 75 percent passengers of their seating capacity. The seating capacity of each
bus is 48 passengers. The buses will run on an average 25 days in a month. The other
information for the year 2016-17 is given below:
Garage Rent ` 6,000 per month
Annual Repairs & Maintenance ` 24,000 each bus
Salaries of 6 drivers ` 4,000 each per month
Wages of 6 conductors ` 1,600 each per month
Wages of 6 cleaners ` 1,000 each per month

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

Manager’s salary ` 10,000 per month

Road Tax, Permit fee, etc. ` 6,000 for a quarter
Office expenses ` 2,500 per month
Cost of diesel per litre ` 66
Kilometer run per litre for each bus 6 kilometres
Annual Depreciation 20% of cost
Annual Insurance 4% of cost
Engine oils & lubricants (for 1,000 kilometres) ` 2,000
You are required to calculate the bus fare to be charged from each passenger per
1
kilometer (upto four decimal points), if the company wants to earn profit of 33 percent
3
on taking (total receipts from passengers). (8 Marks)
(b) Following information relates to ABC company for the year 2016:
(i) Projected sales: (` in lakhs)
Month August September October November December
Sale 35 40 40 45 46
(ii) Gross profit margin will be 20% on sale.
(iii) 10% of projected sale will be cash sale. Out of credit sale of each month, 50% will
be collected in the next month and the balance will be collected during the second
month following the month of sale.
(iv) Creditors will be paid in the first month following credit purchase. There will be
credit purchase only.
(v) Wages and salaries will be paid on the first day of the next month. The amount will
be ` 3 lakhs each month.
(vi) Interim dividend of ` 2 lakhs will be paid in December 2016.
(vii) Machinery costing ` 10 lakhs will be purchased in September 2016. Repayment by
instalment of ` 50,000 p.m. will start from October 2016.
(viii) Administrative expenses of ` 1,00,000 per month will be paid in the month of their
incurrence.
(ix) Assume no minimum cash balance is required. Opening cash balance as on 01-10-
2016 is estimated at ` 10 lakhs.
You are required to prepare the monthly cash budget for the 3 month period (October
2016 to December 2016). (8 Marks)

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

Answer
(a) Working Notes:
1. Total Kilometres to be run during the year 2016-17
= 50 km.× 2 sides × 3 trips × 25 days × 12 months × 6 buses = 5,40,000 Kilometres
2. Total passenger Kilometres
= 5,40,000 km. × 48 passengers × 75% = 1,94,40,000 Passenger- km.
Operating Cost Sheet for the year 2016- 17
Particulars Total Cost (`)
A. Fixed Charges:
Garage rent (` 6,000 × 12 months) 72,000
Salary of drivers (` 4,000 × 6 drivers ×12 months) 2,88,000
Wages of Conductors (` 1,600 × 6 conductors × 12 months) 1,15,200
Wages of Cleaners (` 1,000 × 6 cleaners × 12 months) 72,000
Manager’s salary (`10,000 × 12 months) 1,20,000
Road Tax, Permit fee, etc. (` 6,000 × 4 quarters) 24,000
Office expenses (` 2,500 × 12 months) 30,000
Depreciation (` 7,50,000 × 6 buses × 20%) 9,00,000
Insurance (` 7,50,000 × 6 buses × 4%) 1,80,000
Total (A) 18,01,200
B. Variable Charges:
Repairs and Maintenance (` 24,000 × 6 buses) 1,44,000
Diesel {(5,40,000 km. ÷ 6 km.) × ` 66} 59,40,000
Engine oils & lubricants {(` 2000. ÷ 1000 km.) × 5,40,000 km} 10,80,000
Total (B) 71,64,000
Total Cost (A+B) 89,65,200
Add: 33 1/
3% Profit on takings or 50% on cost 44,82,600
C. Total Takings (Total bus fare collection) 1,34,47,800
D. Total Passenger-km. (Working Note 2) 1,94,40,000
E. Bus fare to be charged from each passenger per km. (C ÷ D) 0.6918

Operating cost sheet can also be calculated for (i) six buses per month, (ii) per bus
per annum and (iii) per bus per month. However, the final answer will remain same.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

(b) Cash Budget for the months of October 2016 to December 2016 (Amount in lakhs)
Particulars October (`) November (`) December (`)
(i) Opening cash balance 10.00 14.25 21.25
(ii) Cash Sale 4.00 4.50 4.60
(10% of 40) (10% of 45) (10% of 46)
(iii) Cash collection for
credit sale:
- For August sale 15.75 - -
(35× 90% × 50%)
- For September sale 18.00 18.00 -
(40× 90% × 50%) (40× 90% × 50%)
-For October sale - 18.00 18.00
(40× 90% × 50%) (40× 90% × 50%)
- For November sale - - 20.25
(45× 90% × 50%)
Total cash collection from 33.75 36.00 38.25
credit sales (iii)
Total Cash inflow (A) 47.75 54.75 64.10
(iv) Payment to creditors:
- For September purchase 29.00 - -
{(80% of ` 40)- 3}
- For October purchase - 29.00 -
{(80% of ` 40)- 3}
- For November purchase - - 33.00
{(80% of ` 45)- 3}
Total of payment made to 29 29 33
creditors (iv)
(v) Payment of wages & 3.00 3.00 3.00
salaries
(vi) Interim Dividend - - 2.00
(vii) Instalment for machinery 0.50 0.50 0.50
(viii) Administrative expenses 1.00 1.00 1.00
Total Cash outflow (B) 33.50 33.50 39.50
Closing cash balance (A-B) 14.25 21.25 24.60

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

Question 5
Answer all four:
(a) Write short notes on:
(i) Sunk Cost
(ii) Opportunity Cost
(b) What is meant by “cost centre”? What are the different type of cost centres?
(c) List the emerging issues (any four) affecting the future role of CFO.
(d) State advantages of Debt. Securitisation. (4 × 4 = 16 Marks)
Answer
(a) (i) Sunk Cost: Historical costs incurred in the past are known as sunk costs. They play
no role in decision making in the current period. For example, in the case of a
decision relating to the replacement of a machine, the written down value of the
existing machine is a sunk cost and therefore, not considered.
(ii) Opportunity Cost: This cost refers to the value of sacrifice made or benefit of
opportunity foregone in accepting an alternative course of action. For example, a
firm financing its expansion plan by withdrawing money from its bank deposits. In
such a case the loss of interest on the bank deposit is the opportunity cost for
carrying out the expansion plan.
(b) It is defined as a location, person or an item of equipment (or group of these) for which
cost may be ascertained and used for the purpose of Cost Control.
Cost Centres are of two types:
Personal Cost Centre: It consists of a person or group of persons e.g. Mr. X, supervisor,
foreman, accountant, engineer, process staffs, mining staffs, doctors etc.
Impersonal Cost Centre: It consists of a location or an item of equipment (or group of
these) e.g. boiler house, cooling tower, weighing machine, canteen, and generator set
etc.
Cost Centres in a manufacturing concern are of two types:
Production Cost Centre: it is a cost centre where raw material is handled for conversion
into finished products. Here both direct and indirect expenses are incurred. Machine
shops, welding shops and assembly shops etc. are examples of production cost centres.
Service Cost Centre: It is a cost centre which serves as an ancillary unit to production
cost centre. Payroll processing department, HRD, Power house, Gas production shops,
Plant maintenance centres etc. are example of service cost centres.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

(c) Emerging Issues/Priorities Affecting the Future Role of Chief Financial Officer
(CFO)
(i) Regulation: Regulation requirements are increasing and CFOs have an
increasingly personal stake in regulatory adherence.
(ii) Globalisation: The challenges of globalisation are creating a need for finance
leaders to develop a finance function that works effectively on the global stage and
that embraces diversity.
(iii) Technology: Technology is evolving very quickly, providing the potential for CFOs
to reconfigure finance processes and drive business insight through ‘big data’ and
analytics.
(iv) Risk: The nature of the risks that organisations face are changing, requiring more
effective risk management approaches and increasingly CFOs have a role to play in
ensuring an appropriate corporate ethos.
(v) Transformation: There will be more pressure on CFOs to transform their finance
functions to drive a better service to the business at zero cost impact.
(vi) Stakeholder Management: Stakeholder management and relationships will
become important as increasingly CFOs become the face of the corporate brand.
(vii) Strategy: There will be a greater role to play in strategy validation and execution,
because the environment is more complex and quick changing, calling on the
analytical skills CFOs can bring.
(viii) Reporting: Reporting requirements will broaden and continue to be burdensome for
CFOs.
(ix) Talent and Capability: A brighter spotlight will shine on talent, capability and
behaviours in the top finance role.
(d) Advantages of Debt Securitisation: Debt securitisation is a method of recycling of
funds and is especially beneficial to financial intermediaries to support lending volumes.
The advantages of debt securitisation are as follows:
(a) To the originator:
(i) The asset is shifted off the Balance Sheet, thus giving the originator recourse
to off balance sheet funding.
(ii) It converts illiquid assets to liquid portfolio.
(iii) It facilitates better balance sheet management; assets are transferred off
balance sheet facilitating satisfaction of capital adequacy norms.
(iv) The originator’s credit rating enhances.
(b) For the investors: Securitisation opens up new investment avenues. Though the
investor bears the credit risk, the securities are tied up to definite assets.

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

Question 6
(a) The following information is available from the cost records of a Company for the month
of July, 2016:
(1) Material purchased 22,000 pieces ` 90,000
(2) Material consumed 21,000 pieces
(3) Actual wages paid for 5,150 hours ` 25,750
(4) Fixed Factory overhead incurred ` 46,000
(5) Fixed Factory overhead budgeted ` 42,000
(6) Units produced 1,900
(7) Standard rates and prices are:
Direct material ` 4.50 per piece
Standard input 10 pieces per unit
Direct labour rate ` 6 per hour
Standard requirement 2.5 hours per unit
Overheads ` 8 per labour hour
You are required to calculate the following variances:
(i) Material price variance
(ii) Material usage variance
(iii) Labour rate variance
(iv) Labour efficiency variance
(v) Fixed overhead expenditure variance
(vi) Fixed overhead efficiency variance
(vii) Fixed overhead capacity variance. (8 Marks)
(b) Following is the capital structure of RBT Limited as on 31st March 2016:
Particulars Book Value (`) Market Value (`)
Equity Shares of ` 10 each 50,00,000 1,05,00,000
Retained earnings 13,00,000 -
11% Preference shares of ` 100 each 7,00,000 9,00,000
14% debentures of ` 100 each. 30,00,000 36,00,000
Market price of equity shares is ` 40 per share and it is expected that a dividend of ` 4
per share would be declared. The dividend per share is expected to grow at the rate of

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

8% every year. Income tax rate applicable to the company is 40% and shareholder’s
personal income tax rate is 20%.
You are required to calculate:
(i) Cost of capital for each source of capital,
(ii) Weighted average cost of capital on the basis of book value weights,
(iii) Weighted average cost of capital on the basis of market value weights. (8 Marks)
Answer
(a) (i) Material price variance (on the basis of Single plan):
= Actual QuantityPurchased (Std. Price – Actual Price)
 `90,000 
=22,000 pcs  ` 4.50 −  = `9,000* (Favourable)
 22,000pcs 
OR
Material price variance (on the basis of Partial plan):
= Actual Quantityconsumed (Std. Price – Actual Price)
 `90,000 
= 21,000 pcs  ` 4.50 −  = `8,591* (Favourable)
 22,000pcs 
(*Figure may slightly differ due to rounding off the actual price per unit)
(ii) Material usage variance:
= Std. price per piece (Std. Quantity – Actual Quantityconsumed)
= `4.50 (1,900 units × 10 – 21,000) = ` 9,000 (Adverse)
(iii) Labour rate variance:
= Actual hours paid (Std. rate – Actual rate)
 `25,750 
= 5,150 hours  ` 6 −  = ` 5,150 (Favourable)
 5,150hours 
(iv) Labour efficiency variance:
= Std. rate per hour (Std. hours – Actual hoursworked)
= `6 (1,900 units × 2.5 hours – 5,150 hours) = ` 2,400 (Adverse)
(v) Fixed overhead expenditure variance:
= Budgeted Overhead – Actual Overhead
= ` 42,000 – ` 46,000 = ` 4,000 (Adverse)

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

(vi) Fixed overhead efficiency variance:

= Std. rate (Std. hours - Actual hours worked)
= `8 (1,900 units × 2.5 hours - 5,150 hours) = ` 3,200 (Adverse)
Or,
Fixed overhead efficiency variance on basis of units
= Std. rate per unit (Actual output – Standard output for actual hours)
= `20 (1,900 units - 5,150 / 2.5 hours) = ` 3,200 (Adverse)
(vii) Fixed overhead capacity variance:
= Std. rate (Actual hours worked – Budgeted hours)
 ` 42,000 
= ` 8  5,150hours −  = ` 800 (Adverse)
 `8 
Or,
Fixed overhead capacity variances on basis of units
= Std. rate per unit (Standard output for actual hours – Budgeted output)
= `20 (2,060 units - 42,000 / 20) = ` 800 (Adverse)
(b) (i) Calculation of Cost of Capital for each source of capital:
(a) Cost of Equity share capital:
D0 (1 + g) 4(1 + 0.08)
Ke = +g = + 0.08
Market Pr ice per share (P0 ) ` 40
` 4.32
= + 0.08 = 0.188 or 18.8%
` 40
(b) Cost of Preference share capital (Kp) = 11%
(c) Cost of Debentures (Kd) = r (1 – t) = 14% (1 – 0.4) = 8.4%.
(d) Cost of Retained Earnings (Ks)= Ke (1 – tp) = 18.8 (1 – 0.2) = 15.04%
(ii) Weighted Average Cost of Capital (WACC) on the basis of book value weights
Source Amount (`) Weights After tax Cost WACC (%)
of Capital (%)
(a) (b) (c) = (a) × (b)
Equity share 50,00,000 0.50 18.80 9.40
Retained earnings 13,00,000 0.13 15.04 1.96
11% Preference share 7,00,000 0.07 11.00 0.77

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

14% Debentures 30,00,000 0.30 8.40 2.52

1,00,00,000 1.00 14.65
(iii) Weighted Average Cost of Capital (WACC) on the basis of market value weights
Source Amount (`) Weights After tax Cost WACC (%)
of Capital (%)
(a) (b) (c) = (a) × (b)
Equity share 1,05,00,000 0.70 18.80 13.16
11% Preference share 9,00,000 0.06 11.00 0.66
14% Debentures 36,00,000 0.24 8.40 2.016
1,50,00,000 1.000 15.836
Note: The cost of equity can be calculated without taking the effect of growth on dividend.
Accordingly WACC can be calculated.
Question 7
Answer any four of the following:
(a) What is meant by Job Costing? Give examples of (any four) industries where it is used.
(b) Give the method of costing and the unit of cost against the under noted industries:
(i) Road transport
(ii) Steel
(iii) Bicycles
(iv) Bridge construction
(c) Explain briefly the functions of Treasury Department.
(d) Explain the following:
(i) Bridge finance
(ii) Conversion cost
(e) Explain the relevance of time value of money. (4 × 4 = 16 Marks)
Answer
(a) Job Costing:
Meaning: It is a method of costing which is used when the work is undertaken as per
the customer’s special requirement. When an inquiry is received from the customer,
costs expected to be incurred on the job are estimated and on the basis of this estimate,
a price is quoted to the customer. Actual cost of materials, labour and overheads are
accumulated and on the completion of job, these actual costs are compared with the
quoted price and thus the profit or loss on it is determined.

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2016

Example: Job costing is applicable in printing press, ship-building, heavy machinery,

foundry, general engineering works, machine tools, interior decoration, repairs and other
similar work.
(b)
Industry Method of Costing Suggestive Unit of Cost
(i) Road Transport Operating Costing Passenger k.m. or tonne k.m.
(ii) Steel Process Costing/ Single Tonne/ Metric Ton (MT)/ per
or Unit Costing kg/ per bar
(iii) Bicycles Multiple Costing Number/ per piece
(iv) Bridge Construction Contract Costing Project/ Unit
(c) The functions of treasury department management are to ensure proper usage, storage
and risk management of liquid funds so as to ensure that the organisation is able to meet
its obligations, collect its receivables and also maximize the return on its investments.
Towards this end the treasury function may be divided into the following:
(i) Cash Management: The efficient collection and payment of cash both inside the
organisation and to third parties is the function of treasury department. Treasury
normally manages surplus funds in an investment portfolio.
(ii) Currency Management: The treasury department manages the foreign currency risk
exposure of the company. It advises on the currency to be used when invoicing
overseas sales. It also manages any net exchange exposures in accordance with the
company policy.
(iii) Fund Management: Treasury department is responsible for planning and sourcing
the company’s short, medium and long-term cash needs. It also participates in the
decision on capital structure and forecasts future interest and foreign currency
rates.
(iv) Banking: Since short-term finance can come in the form of bank loans or through
the sale of commercial paper in the money market, therefore, treasury department
carries out negotiations with bankers and acts as the initial point of contact with
them.
(v) Corporate Finance: Treasury department is involved with both acquisition and
disinvestment activities within the group. In addition, it is often responsible for investor
relations.
(d) (i) Bridge Finance: Bridge finance refers, normally, to loans taken by the business,
usually from commercial banks for a short period, pending disbursement of term
loans by financial institutions, normally it takes time for the financial institution to
finalise procedures for creation of security, tie-up participation with other institutions
etc. even though a positive appraisal of the project has been made. However, once
the loans are approved in principle, firms in order not to lose further time in starting

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

their projects arrange for bridge finance. Generally, rate of interest on bridge
finance is higher as compared with that on term loans.
(ii) Conversion cost: It is the cost of transforming basic material into finished goods
Conversion Cost consists of direct wages, direct expenses and manufacturing
overheads. So,
Conversion Cost= Direct labour Cost + Direct Expenses + Manufacturing Overhead
Or
Conversion Cost = Factory Cost – Direct Materials Cost
(e) Time value of money means that worth of a rupee received today is different from the
worth of a rupee to be received in future. The preference of money now as compared to
future money is known as time preference for money.
A rupee today is more valuable than rupee after a year due to several reasons:
♦ Risk − There is uncertainty about the receipt of money in future.
♦ Preference for present consumption − Most of the persons and companies in
general, prefer current consumption over future consumption.
♦ Inflation − In an inflationary period a rupee today represents a greater real
purchasing power than a rupee a year hence.
♦ Investment opportunities − Most of the persons and companies have a preference
for present money because of availabilities of opportunities of investment for
earning additional cash flow.
♦ Many financial problems involve cash flow accruing at different points of time for
evaluating such cash flow an explicit consideration of time value of money is
required.

© 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) The following particulars refer to process used in the treatment of material subsequently,
incorporated in a component forming part of an electrical appliance:
(i) The original cost of the machine used (Purchased in June 2008) was ` 10,000. Its
estimated life is 10 years, the estimated scrap value at the end of its life is ` 1,000,
and the estimated working time per year (50 weeks of 44 hours) is 2,200 hours of
which machine maintenance etc., is estimated to take up 200 hours.
No other loss of working time expected, setting up time, estimated at 100 hours, is
regarded as productive time. (Holiday to be ignored).
(ii) Electricity used by the machine during production is 16 units per hour at cost of a 9
paisa per unit. No current is taken during maintenance or setting up.
(iii) The machine required a chemical solution which is replaced at the end of week at a
cost of ` 20 each time.
(iv) The estimated cost of maintenance per year is ` 1,200.
(v) Two attendants control the operation of machine together with five other identical
machines. Their combined weekly wages, insurance and the employer's contribution
to holiday pay amount ` 120.
(vi) Departmental and general works overhead allocated to this machine for the current
year amount to ` 2,000.
You are required to calculate the machine hour rate of operating the machine.
(b) A dairy product company manufacturing baby food with a shelf life of one year furnishes
the following information:
(i) On 1st January, 2016, the company has an opening stock of 20,000 packets whose
variable cost is `180 per packet.
(ii) In 2015, production was 1,20,000 packets and the expected production in 2016 is
1,50,000 packets. Expected sales for 2016 is 1,60,000 packets.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 47

(iii) In 2015, fixed cost per unit was ` 60 and it is expected to increase by 10% in 2016.
The variable cost is expected to increase by 25%. Selling price for 2016 has been
fixed at ` 300 per packet.
You are required to calculate the Break-even volume in units for 2016.
(c) (i) What is a sinking fund and how is it calculated ?
(ii) A company has purchased a plant for ` 10,00,000 with a useful life of 6 years. It
expects that ` 15,00,000 will be required to replace the plant after 6 years. To
ensure that money is available at the time of replacement, the company has created
a sinking fund.
You are required to determine the amount to be deposited annually, if the fund
earns interest at 8% per annum. Given CVFA0.08,6 = 7.336.
(d) A company had the following balance sheet as on 31st March, 2015
Liabilities Amount (`) Assets Amount (`)
Equity share capital of ` 10 each 40,00,000 Fixed Assets (Net) 1,28,00,000
Reserve & Surplus 8,00,000 Current Assets 32,00,000
15% Debentures 80,00,000
Current Liabilities 32,00,000
1,60,00,000 1,60,00,000
The additional information given is as under:
Fixed cost per annum (excluding interest) ` 32,00,000
Variable operating cost ratio 70%
Total assets turnover ratio 2.5
Income tax rate 30%
Calculate the following:
(i) Operating Leverage
(ii) Financial Leverage
(iii) Combined Leverage
(iv) Earning per share (5 × 4 = 20 Marks)
Answer
(a) Working Notes:
(i) Total Productive hours = Estimated Working hours – Machine Maintenance hours
= 2,200 hours – 200 hours = 2,000 hours

© The Institute of Chartered Accountants of India

48 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

` 10,000 - ` 1,000
(ii) Depreciation per annum = = ` 900
10 years
(iii) Chemical solution cost per annum = ` 20 × 50 weeks = ` 1,000
` 120 × 50 weeks
(iv) Wages of attendants (per annum) = = ` 1,000
6 machines

Calculation of Machine hour rate

Particulars Amount Amount
(per annum) (per hour)
A. Standing Charge
(i) Wages of attendants 1,000
(ii) Departmental and general works overheads 2,000
Total Standing Charge 3,000
 3,000  1.5
Standing Charges per hour  
 2,000 

B. Machine Expense
(iii) Depreciation 900 0.45
(iv) Electricity - 1.37
 ` 0.09×16units×1,900hours 
 
 2,000hours 

(v) Chemical solution 1,000 0.50

(vi) Maintenance cost 1,200 0.60
Machine operating cost per hour (A + B) 4.42
(b) Working Notes:
Particulars 2015 (`) 2016 (`)
Fixed Cost 72,00,000 79,20,000
(` 60 × 1,20,000 units) (110% of ` 72,00,000)
Variable Cost 180 225
(125% of ` 180)

Calculation of Break-even Point (in units):

Since, shelf life of the product is one year only, hence, opening stock is to be sold first.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

(`)
Total Contribution required to recover total fixed cost in 79,20,000
2016 and to reach break-even volume.
Less: Contribution from opening stock 24,00,000
{20,000 units × (` 300 – ` 180)}
Balance Contribution to be recovered 55,20,000
Units to be produced to get balance contribution
` 55,20,000
= = 73,600 packets.
` 300 − ` 225
Break-even volume in units for 2016
Packets
From 2016 production 73,600
Add: Opening stock from 2015 20,000
93,600
(c) (i) It is the fund created for a specified purpose by way of sequence of periodic
payments over a time period at a specified interest rate. Size of the sinking fund is
calculated as follows:
FVA = R[FVIFA (i,n)]
Where, ‘FVA’ is the amount to be saved, ‘R’ is the periodic payment and ‘n’ the
payment period.
Alternatively, the sinking fund amount can be calculated by using following formula.
(1 + i)n − 1
Maturity value of Sinking Fund = Sinking Fund deposit ×
i
(ii) Amount to be deposited annually
Future Value ` 15,00,000
= = = ` 2,04,471.10
CVFA (8%,6 years) 7.336

Alternatively, amount to be deposited can be calculated as follows:

(1 + i)n − 1
Maturity value of Sinking Fund = Sinking Fund deposit ×
i
6
15,00,000 = Sinking fund amount × (1+0.08) – 1 / 0.08
Sinking fund amount to be deposited = `2,04,464

© The Institute of Chartered Accountants of India

50 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

(d) Workings:
Sales
Total Assets Turnover Ratio i.e. = 2.5
Total Assets
Since total Assets = ` 1,60,00,000
So, Sales = 2.5 × ` 1,60,00,000 = ` 4,00,00,000
Computation of Profit after tax (PAT/ EAT):
Particulars Amount (`)
Sales Turnover 4,00,00,000
Less: Variable Cost (70% of ` 4,00,00,000) (2,80,00,000)
Contribution 1,20,00,000
Less: Fixed Costs (32,00,000)
Earnings Before Interest and Tax (EBIT) 88,00,000
Less: Interest on Debenture (15% of ` 80,00,000) (12,00,000)
Earnings Before Tax (EBT) 76,00,000
Less: Income Tax @30% (22,80,000)
Earnings After Tax (EAT or PAT) 53,20,000

Contribution ` 1,20,00,000
(i) Operating Leverage = = = 1.36
EBIT ` 88,00,000

EBIT ` 88,00,000
(ii) Financial Leverage = = = 1.16
EBT ` 76,00,000

Contribution ` 1,20,00,000
(iii) Combined Leverage = = = 1.58
EBT ` 76,00,000
Or
Combined Leverage = Operating Leverage × Financial Leverage
= 1.36 × 1.16 = 1.58
PAT / EAT ` 53,20,000
(iv) Earning per share = = = ` 13.30
No.of Shares 4,00,000 shares
Question 2
(a) The following information is available from a company's records for March, 2016:

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

(a) Opening Balance of Creditors Account ` 25,000

(b) Closing Balance of Creditors Account ` 40,000
(c) Payment made to Creditors ` 5,80,000
(d) Opening Balance of Stores Ledger Control Account ` 40,000
(e) Closing Balance of Stores Ledger Control Account ` 65,000
(f) Wages paid (for 8000 hours) 20% relate to indirect workers ` 4,00,000
(g) Various indirect expenses incurred ` 60,000
(h) Opening balance of WIP control account ` 50,000
(i) Inventory of WIP at the end of the month includes material worth ` 35,000 on
which 400 labour hours have been booked.
(j) Factory overhead is charged to production at budgeted rate based on direct
labour hours.
(k) Budgeted overhead cost is ` 20,80,000 for budgeted direct labour hours
1,04,000.
You are required to prepare Creditors A/c, Stores Ledger Control A/c, WIP Control A/c,
Wages Control A/c and Factory Overhead Control A/c. (8 Marks)
(b) With the following ratios and further information given below prepare a Trading Account,
Profit and Loss Account and Balance Sheet of ABC Company.
Fixed Assets `40,00,000
Closing Stock `4,00,000
Stock turnover ratio 10
Gross profit ratio 25 percent
Net profit ratio 20 percent
Net profit to capital 1/5
Capital to total liabilities 1/2
Fixed assets to capital 5/4
Fixed assets/Total current assets 5/7
(8 Marks)
Answer
(a) Creditors A/c
Dr. Cr.
Particulars (`) Particulars (`)
To Bank A/c 5,80,000 By Balance b/d 25,000

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

To Balance c/d 40,000 By Stores ledger control A/c 5,95,000

(Materials purchased)(Bal. figure)
6,20,000 6,20,000
Stores Ledger Control A/c
Dr. Cr.
Particulars (`) Particulars (`)
To Balance b/d 40,000 By WIP control A/c 5,70,000
(Balancing figure)
To Creditors A/c 5,95,000 By Balance c/d 65,000
(Materials purchased)
6,35,000 6,35,000
Work-in-Process Control A/c
Dr. Cr.
Particulars (`) Particulars (`)
To Balance b/d 50,000 By Finished goods control A/c 10,05,000
(Balancing figure)
To Stores ledger control A/c 5,70,000 By Balance c/d:
To Wages control A/c 3,20,000 - Material 35,000
(80% of ` 4,00,000) - Labour 20,000
(` 50* × 400 hours)
- Factory Oh 8,000
(` 20** × 400 hours)
63,000
To Factory Overhead control 1,28,000
A/c
10,68,000 10,68,000
* Direct Labour Hour Rate = ` 3,20,000/ 6,400 hours = ` 50
** Factory Overhead Rate = ` 20,80,000/ 1,04,000 = ` 20
Wages Control A/c
Dr. Cr.
Particulars (`) Particulars (`)
To Bank A/c 4,00,000 By WIP control A/c 3,20,000
(80% of ` 4,00,000)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

By Factory OH Control A/c 80,000

(20% of ` 4,00,000)
4,00,000 4,00,000
Factory Overhead Control A/c
Dr. Cr.
Particulars (`) Particulars (`)
To Wages control A/c 80,000 By WIP control A/c 1,28,000
(` 20 × 6,400 hours)
To Bank A/c 60,000 By Balance c/d 12,000
(Indirect expenses)
1,40,000 1,40,000
(b) Workings:
Fixed Assets 5
(i) =
TotalCurrent Assets 7
` 40,00,000 × 7
Or, Total Current Assets = = ` 56,00,000
5
Fixed Assets 5 ` 40,00,000 × 4
(ii) = Or, Capital = = ` 32,00,000
Capital 4 5
Capital 1
(iii) = Or, Total liabilities = ` 32,00,000 × 2 = ` 64,00,000
TotalLiabilities * 2
*It is assumed that Total liabilities does not include capital.
Net Pr ofit 1
(iv) = Or, Net Profit = ` 32,00,000 × 1/5 = ` 6,40,000
Capital 5
Net Pr ofit 1
(v) = Or, Sales = ` 6,40,000 × 5 = ` 32,00,000
Sales 5
(vi) Gross Profit = 25% of ` 32,00,000 = ` 8,00,000
Cost of GoodsSold(i.e.Sales − Grossprofit)
(vii) Stock Turnover = = 10
Average Stock
`32,00,000 − ` 8,00,000
= = 10
Average Stock

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

OpeningStock + ` 4,00,000
Or, Average Stock = ` 2,40,000 Or, = ` 2,40,000
2
Or, Opening Stock = ` 80,000
Trading Account
Particulars (`) Particulars (`)
To Opening Stock 80,000 By Sales 32,00,000
To Manufacturing exp./ 27,20,000
Purchase
(Balancing figure)
To Gross Profit b/d 8,00,000 By Closing Stock 4,00,000
36,00,000 36,00,000

Profit and Loss Account

Particulars (`) Particulars (`)
To Operating Expenses 1,60,000 By Gross Profit c/d 8,00,000
(Balancing figure)
To Net Profit 6,40,000
8,00,000 8,00,000

Balance Sheet
Capital and Liabilities (`) Assets (`)
Capital 32,00,000 Fixed Assets 40,00,000
Liabilities 64,00,000 Current Assets:
Closing Stock 4,00,000
Other Current Assets
(Bal. figure) 52,00,000
96,00,000 96,00,000
Question 3
(a) X Associates undertake to prepare income tax returns for individuals for a fee. They use
the weighted average method and actual costs for the financial reporting purposes.
However, for internal reporting, they use a standard costs system. The standards, based
on equivalent performance, have been established as follows:
Labour per return 5 hrs @ ` 40 per hour
Overhead per return 5 hrs @ ` 20 per hour

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

For March 2015 performance, budgeted overhead is `98,000 for standard labour hours
allowed.
The following additional information pertains to the month of March 2015:
March 1 Return-in-process (25% complete) 200 No.
Return started in March 825 Nos
March 31 Return-in-process (80% complete) 125 Nos
Cost Data:
March 1 Return-in-process labour ` 12,000
- Overheads ` 5,000
March 1 to 31 Labour : 4,000 hours ` 1,78,000
Overheads ` 90,000
You are required to compute:
(a) For each element, equivalent units of performance and the actual cost per
equivalent unit.
(b) Actual cost of return-in-process on March 31.
(c) The standard cost per return.
(d) The labour rate and labour efficiency variance as well as overhead volume and
overhead expenditure variance. (8 Marks)
(b) A trader whose current sales are ` 4,20,000 per annum and an average collection period
of 30 days, wants to pursue a more liberal policy to improve sales. A study made by a
management consultant reveals the following information:
Credit Policy Increase in Increase in Sales Present default
Collection Period anticipated
I 10 days ` 21,000 1.5%
II 30 days `52,500 3%
III 45 days `63,000 4%
The selling price per unit is ` 3. Average cost per unit is `2.25 and variable cost per unit
is ` 2. The current bad-debts loss is 1%. Required return on additional investment is
20%. Assume a 360 days year.
Which of the above policies would you recommend for adoption? (8 Marks)

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

Answer
(a) (a) Statement Showing Cost Elements Equivalent Units of Performance and the
Actual Cost per Equivalent Unit
Detail of Returns Detail of Details Equivalent Units
Input Output Labour Overheads
Units
Units Units % Units %
Returns in 200 Returns 900 900 100 900 100
Process at Start Completed in
March
Returns Started in 825 Returns in 125 100 80 100 80
March Process at the
end of March
1,025 1,025 1,000 1,000

Costs: (`) (`)

From previous month 12,000 5,000
During the month 1,78,000 90,000
Total Cost 1,90,000 95,000
Cost per Equivalent Unit 190.00 95.00
(b) Actual cost of returns in process on March 31:
Numbers Stage of Rate per Total
Completion Return (`) (`)
Labour 125 returns 0.80 190.00 19,000
Overhead 125 returns 0.80 95.00 9,500
28,500
(c) Standard Cost per Return:
Labour 5 Hrs × ` 40 per hour = ` 200
Overhead 5 Hrs × ` 20 per hour = ` 100
` 300
Budgeted volume for March = ` 98,000 / 1000 = 980 Returns
Actual labour rate = ` 178000 / 4000 = `44.50

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

(d) Computation of Variances:

Statement Showing Output (March only) Element Wise Labour Overhead
Actual performance in March in terms of equivalent units as
Calculated above 1,000 1,000
Less: Returns in process at the beginning of March in
terms of equivalent units i.e. 25% of returns (200) 50 50
950 950
Variance Analysis:
Labour Rate Variance
= Actual Time × (Standard Rate – Actual Rate)
= Standard Rate × Actual Time – Actual Rate × Actual Time
= ` 40 × 4,000 hrs. – ` 1,78,000 = ` 18,000(A)
Labour Efficiency Variance
= Standard Rate × (Standard Time – Actual Time)
= Standard Rate × Standard Time – Standard Rate × Actual Time
= ` 40 × (950 units × 5 hrs.) – ` 40 × 4,000 hrs.
= ` 30,000(F)
Overhead Expenditure or Budgeted Variance
= Budgeted Overhead – Actual Overhead
= ` 98,000 – ` 90,000
= ` 8,000(F)
Overhead Volume Variance
= Recovered/Absorbed Overhead – Budgeted Overhead
= 950 Units × 5 hrs. × `20 – ` 98,000 = ` 3,000(A)
(b) A. Statement showing the Evaluation of Debtors Policies (Total Approach)
Particulars Present Policy Proposed Proposed Proposed
(30 days) Policy I Policy II Policy III
(40 days) (60 days) (75 days)
(`) (`) (`) (`)
A. Expected Profit:
(a) Credit Sales 4,20,000 4,41,000 4,72,500 4,83,000
(b) Total Cost (other than

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

Bad Debts)
(i) Variable Costs 2,80,000 2,94,000 3,15,000 3,22,000
[Sales x ` 2/` 3]
(ii) Fixed Costs (W.N. 35,000 35,000 35,000 35,000
1)
Total Cost (Variable Cost 3,15,000 3,29,000 3,50,000 3,57,000
+ Fixed Cost)
(c) Bad Debts 4,200 6,615 14,175 19,320
(1% of (1.5% of (3% of (4% of
4,20,000) 4,41,000) 4,72,500) 4,83,000)
(d) Expected Profit [(a) – 1,00,800 1,05,385 1,08,325 1,06,680
(b) – (c)]
B. Opportunity Cost of 5,250 7,311 11,667 14,875
Investments in (3,15,000x
30 20
x ) (3,29,000x
40
x
20
) (3,50,000x
60 20
x ) (3,57,000x
75 20
x )
Receivables * 360 100 360 100 360 100 360 100

C. Net Benefits (A – B) 95,550 98,074 96,658 91,805

Recommendation: The Proposed Policy I (i.e. increase in collection period by 10 days or
total 40 days) should be adopted since the net benefits under this policy are higher as
compared to other policies.
Working Note- 1:
(i) Calculation of Fixed Cost
= [Average Cost per unit – Variable Cost per unit] × No. of Units sold
= [(2.25 – 2) × (` 4, 20,000/3)] = ` 35,000
*Calculation of Opportunity Cost of Average Investments
Collectionperiod Rate of return
Opportunity Cost = Total Cost × ×
360 days 100

Note 1 : It is assumed that all sales are credit sales only.

Note 2 : This question can also be solved based on incremental approach as well as by
computing Expected Rate of Return.

Question 4
(a) A factory producing article A also produces a by-product B which is further processed
into finished product. The joint cost of manufacture is given below:

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

Material ` 5,000
Labour ` 3,000
Overhead ` 2,000
` 10,000
Subsequent cost in ` are given below:
A B
Material 3,000 1,500
Labour 1,400 1,000
Overhead 600 500
5,000 3,000
Selling prices are A ` 16,000
B ` 8,000
Estimated profit on selling prices is 25% for A and 20% for B.
Assume that selling and distribution expenses are in proportion of sales prices. Show
how you would apportion joint costs of manufacture and prepare a statement showing
cost of production of A and B. (8 Marks)
(b) Given below are the data on a capital project 'C':
Cost of the project ` 2,28,400
Useful life 4 years
Profitability index 1.0417
Internal rate of return 15%
Salvage value 0
You are required to calculate:
(i) Annual cash flow
(ii) Cost of capital
(iii) Net present value (NPV)
(iv) Discounted payback period
Given the following table of discount factors:
Discount Factor 15% 14% 13% 12%
1 years 0.869 0.877 0.885 0.893

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

2 years 0.756 0.769 0.783 0.797

3 years 0.658 0.675 0.693 0.712
4 years 0.572 0.592 0.613 0.636
(8 Marks)
Answer
(a) Apportionment of Joint Costs
Particulars A (`) B (`)
Selling Price 16,000 8,000
Less: Estimated profit 4,000 1,600
(25% of `16,000) (20% of ` 8,000)
Cost of sales 12,000 6,400
Less: Selling & Distribution exp. 267 133
(Refer working note) (` 400 × 2/3) (` 400 × 1/3)
Less: Subsequent cost 5,000 3,000
Share of Joint cost 6,733 3,267
So, Joint cost of manufacture is to be distributed to A & B in the ratio of 6733 : 3267
Statement showing Cost of Production of A and B
Elements of cost Joint Cost Subsequent Cost Total Cost
A B A B A B
Material 3,367 1,633 3,000 1,500 6,367 3,133
Labour 2,020 980 1,400 1,000 3,420 1,980
Overheads 1,346 654 600 500 1,946 1,154
Cost of production 11,733 6,267
Working Note:
Calculation of Selling and Distribution Expenses
Particulars (`)
Total Sales Revenue (` 16,000 + ` 8,000) 24,000
Less: Estimated Profit (` 4,000 + ` 1,600) (5,600)
Cost of Sales 18,400
Less: Cost of production:
- Joint Costs (10,000)
- Subsequent costs (` 5,000 + ` 3,000) (8,000)
Selling and Distribution expenses (Balancing figure) 400

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

(b) (i) Annual Cash Flow:

At 15% internal rate of return (IRR), the sum of total cash inflows = cost of the
project i.e. initial cash outlay
Cost of the Project = ` 2,28,400 and Useful life = 4 years
Considering the discount factor table @ 15%, cumulative present value of cash
inflows for 4 years is 2.855 (0.869 + 0.756 + 0.658 + 0.572)
So, Annual cash flow × 2.855 = ` 2,28,400
` 2,28,400
Hence, Annual Cash flow = = ` 80,000
2.855
(ii) Cost of Capital:
Sum of Discounted Cash inflows
Profitability index =
Cost of the Project
Sum of Discounted Cash inflows
1.0417 =
` 2,28,400
Sum of Discounted Cash inflows = ` 2,28,400 × 1.0417 = ` 2,37,924.28
Since, Annual Cash Inflows = ` 80,000
` 2,37,924.28
Hence, cumulative discount factor for 4 years = = 2.974
80,000
From the discount factor table, at discount rate of 13%, the cumulative discount
factor for 4 years is 2.974 (0.885 + 0.783 + 0.693 + 0.613 )
Hence, Cost of Capital = 13%
(iii) Net Present Value (NPV):
NPV = Sum of Present Values of Cash inflows – Cost of the Project
= ` 2,37,924.28 – ` 2,28,400 = ` 9,524.28
Net Present Value = ` 9,524.28
Alternative

NPV = Cost of Project × (Profitability Index – 1)

= 2,28,400 × (1.0417 – 1) or 2,28,400 × 0.0417 = 9,524.28
(iv) Discounted Payback Period :
Year Annual Cash PV of Re.1 @ PV of Cash Cumulative PV of
flow 13% flow Cash inflow
1 80,000 0.885 70,800 70,800

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

2 80,000 0.783 62,640 1,33,440

3 80,000 0.693 55,440 1,88,880
4 80,000 0.613 49,040 2,37,920
39,520
Discounted Payback Period = 3+ = 3.8059 years
49,040
Or = 3 years, 9 Months and 21 days
Question 5
(a) State the difference between cost control and cost reduction.
(b) Write treatment of items associated with purchase of material:
(i) Cash discount
(ii) Subsidy/Grant/Incentives
(iii) VAT or State Sales Tax
(iv) Commission/ brokerage paid
(c) Distinguish between operating lease and finance lease.
(d) Describe the three principles relating to selection of marketable securities. (4 × 4 = 16 Marks)
Answer
(a) Difference between Cost Control and Cost Reduction
Cost Control Cost Reduction
1. Cost control aims at 1. Cost reduction is concerned with
maintaining the costs in reducing costs. It challenges all
accordance with the standards and endeavours to better
established standards. them continuously.
2. Cost control seeks to attain 2. Cost reduction recognises no condition as
lowest possible cost under permanent, since a change will result in
existing conditions. lower cost.
3. In case of Cost Control, 3. In case of cost reduction it is on present
emphasis is on past and and future.
present.
4. Cost Control is a preventive 4. Cost reduction is a corrective function. It
function. operates even when an efficient cost
control system exists.
5. Cost control ends when targets 5. Cost reduction has no visible end.
are achieved.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

(b) Treatment of items associated with purchase of material

Sl. No. Items Treatment
(i) Cash discount Cash discount is not deducted from the
purchase price.
(ii) Subsidy/Grant/Incentives Any subsidy/ grant/ incentive received from the
Government or from other sources deducted
from the cost of purchase.
(iii) VAT or State Sales Tax State Sales Tax/VAT is paid on intra-state sale
and collected from the buyers. It is excluded
from the cost of purchase if credit for the same
is available. Unless mentioned specifically it
should not form part of cost of purchase.
(iv) Commission or Commission or brokerage paid is added with the
brokerage paid cost of purchase.
(c) Distinguish between Operating Lease and Financial Lease
Point Operating Lease Finance Lease
Ownership The lessee is only provided the The risk and reward incidental to
use of the asset for a certain ownership are passed on to the
time. Risk incident to ownership lessee. The lessor only remains the
belongs only to the lessor. legal owner of the asset.
Bearing The lessor bears the risk of The lessee bears the risk of
risk obsolescence. obsolescence.
Purchase The lessee does not have any It allows the lessee to have a
option option to buy the asset during purchase option during the lease
the lease period. period.
Expenses Usually, the lessor bears the cost The lessor does not bear the cost of
borne of repairs, maintenance or repairs, maintenance or operations.
operations.
Treatment Lease payment is treated like Finance lease is generally treated
operating expenses like rent. like a loan.
(d) Three principles relating to selection of marketable securities are as follows
Safety: Return and risks go hand in hand. As the objective in this investment is
ensuring liquidity, minimum risk is the criterion of selection.
Maturity: Matching of maturity and forecasted cash needs is essential. Prices of long term
securities fluctuate more with changes in interest rates and are therefore, more risky.

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

Marketability: It refers to the convenience, speed and cost at which a security can be
converted into cash. If the security can be sold quickly without loss of time and price it is
highly liquid or marketable.
Question 6
(a) (i) The M-Tech Manufacturing Company is presently evaluating two possible
processes for the manufacture of a toy. The following information is available:
Particulars Process A (`) Process B (`)
Variable cost per unit 12 14
Sales price per unit 20 20
Total fixed costs per year 30,00,000 21,00,000
Capacity (in units) 4,30,000 5,00,000
Anticipated sales (Next year, in units) 4,00,000 4,00,000
Suggest:
1. Which process should be chosen?
2. Would you change your answer as given above, if you were informed that the
capacities of the two processes are as follows:
A - 6,00,000 units; B - 5,00,000 units? Why? (4 Marks)
(ii) State the difference between Fixed Budget and Flexible Budget. (4 Marks)
(b) The X Company has following capital structure at 31 st March, 2015 which is considered
to be optimum.
`
14% Debentures 3,00,000
11% Preference Shares 1,00,000
Equity (1,00,000 shares) 16,00,000
20,00,000
The company’s share has a current market price of `23.60 per share. The expected
dividend per share next year is 50% of 2015 EPS. The following are the earning per
share figure for the company during proceeding ten years. The past trends are expected
to continue.
Year EPS (`) Year EPS (`)
2006 1.00 2011 1.61
2007 1.10 2012 1.82

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

2008 1.21 2013 1.95

2009 1.33 2014 2.15
2010 1.46 2015 2.36
The company issued new debentures carrying 16% rate of interest and the current
market price of debenture is ` 96.
Preference shares ` 9.20 (with dividend of ` 1.1 per share) were also issued. The
company is in 50% tax bracket.
(i) Calculate after tax cost of (a) New debt (b) New Preference share (c) New equity
share (consuming new equity from retained earnings).
(ii) Calculate marginal cost of capital when no new shares was issued.
(iii) How much can be spent for capital investment before new ordinary shares must be
sold? Assuming the retained earning for next year's investment are 50% of 2015.
(iv) What will be the marginal cost of capital when the funds exceeds the amount
calculated in (iii), assuming new equity is issued at ` 20 per share? (8 Marks)
Answer
(a) (i) (1) Comparative Profitability Statements
Particulars Process- A (`) Process- B (`)
Selling Price per unit 20.00 20.00
Less: Variable Cost per unit 12.00 14.00
Contribution per unit 8.00 6.00
Total Contribution 32,00,000 24,00,000
(` 8 × 4,00,000) (` 6 × 4,00,000)
Less: Total fixed costs 30,00,000 21,00,000
Profit 2,00,000 3,00,000
*Capacity (units) 4,30,000 5,00,000
Total Contribution at full capacity 34,40,000 30,00,000
(` 8 × 4,30,000) (` 6 × 5,00,000)
Fixed Cost 30,00,000 21,00,000
Profit 4,40,000 9,00,000
Process- B should be chosen as it gives more profit.
(2)
Particulars Process- A (`) Process- B (`)
*Capacity (units) 6,00,000 5,00,000

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

Total contribution 48,00,000 30,00,000

(` 8 × 6,00,000) (` 6 × 5,00,000)
Fixed Cost 30,00,000 21,00,000
Profit 18,00,000 9,00,000
Process-A be chosen.
*Note: It is assumed that capacity produced equals sales.

(ii) Difference between Fixed and Flexible Budgets

Fixed Budget Flexible Budget
1. It does not change with actual It can be re-casted on the basis of
volume of activity achieved. Thus activity level to be achieved. Thus it
it is rigid is not rigid.
2. It operates on one level of activity It consists of various budgets for
and under one set of conditions different level of activity.
3. If the budgeted and actual activity It facilitates the cost ascertainment
levels differ significantly, then and price fixation at different levels of
cost ascertainment and price activity.
fixation do not give a correct
picture.
4. Comparisons of actual and It provided meaningful basis of
budgeted targets are comparison of actual and budgeted
meaningless particularly when targets.
there is difference between two
levels.
(b) (i) Calculation of after tax cost of the followings:
I(1- t) `16 (1-0.5)
(a) New Debentures (Kd) = = x 100 = 8.33%
NP ` 96
Preference Dividend
New Preference Shares (Kp) =
Net Proceed
` 1.10
= x 100 = 11.96%
` 9.20
(b) Equity Shares (Consuming New Equity from Retained Earnings) (Ke)
Expecteddividend(D1 )
= + Growthrate (G)
Current market price (P0 )

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

50% of ` 2.36
= 100 + 10% * = 5% + 10% = 15%
` 23.60
* Growth rate (on the basis of EPS) is calculated as below :
EPS in current year - EPS in previous year
EPS in previous year
` 2.36 - ` 2.15
=  100 = 10%
` 2.15
(Approximate 10% figure is taken because of decimal figures)
[*Alternative calculation of Growth rate:- Growth rate is calculated on basis
average growth of EPS i.e. 10 + 10 + 9.92 + 9.77 + 10.27 + 13.04 + 7.14 + 10.25 +
9.76 = 90.15 / 9 =10.01 or 10%
Or,
The EPS for 2006 is given `1 and whereas for 2015 is given at ` 2.36. This has
resulted in increase of ` 1.36 over a period of 9 years.
The growth rate can be calculated by using formula:
Et = E0 ( 1 + g)t
2.36 = 1 ( 1 + g)9 , using the CVF table, ` 1 becomes ` 2.36 at the end of 9th year at
the compound interest rate of 10%. Therefore, the growth rate is taken at 10%.]
(ii) Calculation of Marginal cost of capital (on the basis of existing capital
structure):
Source of capital Weight After tax Cost of Weighted Average Cost of
capital (%) Capital [WACC (%)]
(a) (b) (a) × (b)
Debenture 0.15 8.33% 1.25
Preference 0.05 11.96% 0.60
shares
Equity shares 0.80 15.00% 12.00
Marginal cost of 13.85
capital
(iii) The company can spent for capital investment before issuing new equity
shares and without increasing its marginal cost of capital:
Retained earnings can be available for capital investment
= 50% of 2015 EPS × equity shares outstanding

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

= 50% of ` 2.36 × 1,00,000 shares = ` 1,18,000

Since, marginal cost of capital is to be maintained at the current level i.e. 13.85%, the
retained earnings should be equal to 80% of total additional capital for investment.
 ` 1,18,000 
Thus, investment before issuing equity  ×100 = ` 1, 47,500
 80 
The remaining capital of ` 29,500 i.e. (` 1,47,500 – ` 1,18,000) shall be financed by
issuing New Debenture and New Preference Shares in the ratio of 3 : 1 (3,00,000 :
1,00,000 ) respectively.
(iv) If the company spends more than ` 1, 47,500 as calculated in part (iii) above, it will
have to issue new shares at ` 20 per share.
The cost of new issue of equity shares will be:
Expecteddividend(D1 ) 50% of `2.36
Ke= + Growthrate (g) = 100 + 10%
Current market price (P0 ) `20

= 5.9% + 10% = 15.9%

Calculation of marginal cost of capital (assuming the existing capital structure will
be maintained):
Source of capital Weight Cost (%) Weighted Average Cost of
(a) (b) Capital [WACC (%)]
(a) × (b)
Debenture 0.15 8.33 1.25
Preference shares 0.05 11.96 0.60
Equity shares 0.80 15.90 12.72
Marginal cost of capital 14.57

Question 7
Answer any four of the following:
(a) What is cost plus contract? What are its advantages?
(b) Narrate the objectives of cost accounting.
(c) State, which of the following would result in inflow/outflow of funds, if the funds were
defined as working capital.
(i) Purchase of a fixed asset on credit of two months.
(ii) Sale of a fixed asset (book value ` 8,000) at a loss of `7,000.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

(iii) Payment of final dividend already declared.

(iv) Writing off Bad debts against a provision for doubtful debts.
(d) State the principles that should be followed while designing the capital structure of a
company.
(e) Explain what do you mean by:
(i) Leveraged Lease
(ii) Profit Centres (4×4 =16 Marks)
Answer
(a) Cost plus contract: Under cost plus contract, the contract price is ascertained by adding
a percentage of profit to the total cost of the work. Such types of contracts are entered
into when it is not possible to estimate the contract cost with reasonable accuracy due to
unstable condition of material, labour services etc.
Following are the advantages of cost plus contract:
(i) The contractor is assured of a fixed percentage of profit. There is no risk of
incurring any loss on the contract.
(ii) It is useful specially when the work to be done is not definitely fixed at the time of
making the estimate.
(iii) Contractee can ensure himself about the ‘cost of contract’ as he is empowered to
examine the books and documents of the contractor to ascertain the veracity of the
cost of contract.
(b) The main objectives of introduction of a Cost Accounting System in a manufacturing
organization are as follows:
(i) Ascertainment of cost: The main objective of a Cost Accounting system is to
ascertain cost for cost objects. Costing may be post completion or continuous but
the aim is to arrive at a complete and accurate cost figure to assist the users to
compare, control and make various decisions.
(ii) Determination of selling price: Cost Accounting System in a manufacturing
organisation enables to determine desired selling price after adding expected profit
margin with the cost of the goods manufactured.
(iii) Cost control and Cost reduction: Cost Accounting System equips the cost
controller to adhere and control the cost estimate or cost budget and assist them to
identify the areas of cost reduction.
(iv) Ascertainment of profit of each activity: Cost Accounting System helps to
classify cost on the basis of activity to ascertain activity wise profitability.

© The Institute of Chartered Accountants of India

70 INTERMEDIATE (IPC) EXAMINATION: MAY, 2016

(v) Assisting in managerial decision making: Cost Accounting System provides

relevant cost information and assists managers to make various decisions.
(c)
Sl. No. Result in inflow/ outflow of funds
(i) outflow, Total current liabilities are increased but total current assets
remain unchanged.
(ii) Inflow, current assets are increased but total current liabilities remain
unchanged.
(iii) No effect, Both the total current assets and current liabilities remain
unchanged.
OR
If examinees assumed that proposed dividend as Non- current liability then
payment of final dividend is considered as out flow of fund.
(iv) No effect, Neither the total current assets nor the total current liabilities are
affected.

(d) The fundamental principles are:

(i) Cost Principle: According to this principle, an ideal pattern or capital structure is
one that minimises cost of capital structure and maximises earnings per share
(EPS).
(ii) Risk Principle: According to this principle, reliance is placed more on common
equity for financing capital requirements than excessive use of debt. Use of more
and more debt means higher commitment in form of interest payout. This would
lead to erosion of shareholders value in unfavourable business situation.
(iii) Control Principle: While designing a capital structure, the finance manager may
also keep in mind that existing management control and ownership remains
undisturbed.
(iv) Flexibility Principle: It means that the management chooses such a combination
of sources of financing which it finds easier to adjust according to changes in need
of funds in future too.
(v) Other Considerations: Besides above principles, other factors such as nature of
industry, timing of issue and competition in the industry should also be considered.
(e) (i) 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 and asset so purchased is held as security against the

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 71

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) Profit Centres are the part of a business which is accountable for both cost and
revenue. These are responsible for generating and maximizing profits. Performance
of these centres is measured with the volume of profit it earns.

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT
Question No. 1 is compulsory.
Answer any five questions from the remaining six questions.
Working notes should form part of the answer
Question 1
(a) Human Resources Department of A Ltd. computed labour turnover by replacement
method at 3% for the quarter ended June 2015. During the quarter, fresh recruitment of
40 workers was made. The number of workers at the beginning and end of the quarter
was 990 and 1,010 respectively.
You are required to calculate the labour turnover rate by Separation Method and Flux
Method.
(b) A company gives the following information:
Margin of Safety ` 3,75,000
Total Cost ` 3,87,500
Margin of Safety (Qty.) 15,000 units
Break Even Sales in Units 5,000 units
You are required to calculate:
(i) Selling price per unit
(ii) Profit
(iii) Profit/ Volume Ratio
(iv) Break Even Sales (in Rupees)
(v) Fixed Cost
(c) From the following details of X Ltd., prepare the Income Statement for the year ended
31st December, 2014:
Financial Leverage 2
Interest ` 2,000
Operating Leverage 3
Variable cost as a percentage of sales 75%
Income tax rate 30%
(d) A company issues 25,000, 14% debentures of ` 1,000 each. The debentures are
redeemable after the expiry period of 5 years. Tax rate applicable to the company is 35%
(including surcharge and education cess).

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 47

Calculate the cost of debt after tax if debentures are issued at 5% discount with 2%
flotation cost. (4 × 5 = 20 Marks)
Answer
No. of workers replaced during the quarter
(a) Labour Turnover by Replacement Method =
Average no. of workers onrollduring the quarter
No. of workers replaced during the quarter
Or, 0.03 =
(990 + 1,010) ÷ 2
Or, No. of workers replaced during the quarter = 0.03 × 1,000 = 30 workers
(i) Labour Turnover by Separation Method
No. of workers separated during the quarter
= × 100
Average no. of workers onrollduring the quarter
Worker at begining + Fresh recruitment + Replacements – Workers at closing
= × 100
Average no. of workers onrollduring the quarter
990 + 40 + 30 − 1,010 50 wor ker s
= × 100 = × 100 = 5%
(990 + 1,010) ÷ 2 1,000 wor ker s
(ii) Labour Turnover by Flux Method
No. of workers (Separated+ Replaced+ Fresh Re cruitment) during the quarter
= × 100
Average no. of workers onrollduring the quarter
50 + 30 + 40 120 wor ker s
= × 100 = × 100 = 12%
(990 + 1,010) ÷ 2 1,000 wor ker s
Marginof Safety inRupee value
(b) (i) Selling Price per unit =
Marginof Safety inQuantity

` 3,75,000
= = ` 25
15,000units

(ii) Profit = Sales Value – Total Cost

= Selling price per unit × (BEP units + MoS units) – Total Cost
= ` 25 × (5,000 + 15,000) units – ` 3,87,500
= ` 5,00,000 – ` 3,87,500 = ` 1,12,500

© The Institute of Chartered Accountants of India

48 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

Pr ofit
(iii) Profit/ Volume (P/V) Ratio = × 100
Marginof Safety inRupee value

` 1,12,500
= × 100 = 30%
` 3,75,000

(iv) Break Even Sales (in Rupees) = BEP units × Selling Price per unit
= 5,000 units × ` 25 = ` 1,25,000
(v) Fixed Cost = Contribution – Profit
= Sales Value × P/V Ratio – Profit
= (` 5,00,000 × 30%) – ` 1,12,500
= ` 1,50,000 – ` 1,12,500 = ` 37,500
(c) Workings:
EBIT EBIT
(i) Financial Leverage = Or, 2 =
EBIT − Interest EBIT − ` 2,000
Or, EBIT = ` 4,000
Contribution Contribution
(ii) Operating Leverage = Or, 3 =
EBIT ` 4,000
Or, Contribution = ` 12,000
Contribution ` 12,000
(iii) Sales = = = ` 48,000
P / V Ratio 25%
(iv) Fixed Cost = Contribution – Fixed cost = EBIT
= `12,000 – Fixed cost = `4,000 Or, Fixed cost = ` 8,000
Income Statement for the year ended 31st December 2014
Particulars Amount (`)
Sales 48,000
Less: Variable Cost (75% of ` 48,000) (36,000)
Contribution 12,000
Less: Fixed Cost (Contribution - EBIT) (8,000)
Earnings Before Interest and Tax (EBIT) 4,000
Less: Interest (2,000)
Earnings Before Tax (EBT) 2,000

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

Less: Income Tax @ 30% (600)

Earnings After Tax (EAT or PAT) 1,400
(d) Calculation of Cost of Debt after Tax:
 RV − NP 
I(1 − t) + 
Cost of Debt (Kd) =  n 
RV + NP
2
Where, I = Interest payment i.e. 14% of ` 1,000 = ` 140
t = Tax rate applicable to the company i.e. 35%
RV = Redeemable value of debentures i.e. ` 1,000
NP = Net proceeds per debentures
= ` 1,000 × {1 – (0.05 + 0.02)}
= ` 1,000 × 0.93 = ` 930
n = Redemption period of debentures i.e 5 years
 ` 1,000 – ` 930 
` 140(1 − 0.35) +  
Therefore, Kd =  5 years  × 100
 ` 1,000 + ` 930 
 2 

` 91 + ` 14
= × 100 = 10.88 %
` 965

The Cost of Debt can also be calculated using the formula, where first Cost of Debt before tax
is calculated and then tax adjustment is made. Accordingly:
 RV − NP 
I+ 
n  ` 140 + 14
Cost of Debt (Kd) =  × (1 − t) × 100 = (1 − 0.35) × 100 = 10.37%
RV + NP ` 965
2
Question 2
(a) M.L. Auto Ltd. is a manufacturer of auto components and the details of its expenses for
the year 2014 are given below:
(`)
(i) Opening Stock of Material 1,50,000
(ii) Closing Stock of Material 2,00,000

© The Institute of Chartered Accountants of India

50 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

(iii) Purchase of Material 18,50,000

(iv) Direct Labour 9,50,000
(v) Factory Overhead 3,80,000
(vi) Administrative Overhead 2,50,400
During 2015, the company has received an order from a car manufacturer where it
estimates that the cost of material and labour will be ` 8,00,000 and ` 4,50,000
respectively. M.L. Auto Ltd. charges factory overhead as a percentage of direct labour
and administrative overhead as a percentage of factory cost based on previous year's
cost.
Cost of delivery of the components at customer's premises is estimated at ` 45,000.
You are required to:
(i) Calculate the overhead recovery rates based on actual costs for 2014.
(ii) Prepare a detailed cost statement for the order received in 2015 and the price to be
quoted if the company wants to earn a profit of 10% on sales. (8 Marks)
(b) VRA Limited has provided the following information for the year ending 31st March, 2015.
Debt Equity Ratio 2: 1
14% long term debt ` 50,00,000
Gross Profit Ratio 30%
Return on equity 50%
Income Tax Rate 35%
Capital Turnover Ratio 1.2 times
Opening Stock ` 4,50,000
Closing Stock 8% of sales
You are required to prepare Trading and Profit and Loss Account for the year ending 31st
March, 2015. (8 Marks)
Answer
(a) (i) Calculation of Overhead Recovery Rate:
Factory Overheadin 2014
Factory Overhead Recovery Rate = × 100
Direct Labour Costsin2014

` 3,80,000
= × 100 = 40% of Direct labour
` 9,50,000

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

Administrative Overhead Recovery Rate

Administrative Overheadin 2014
= × 100
Factory Costsin2014(W.N.)

` 2,50,400
= × 100 = 8% of Factory Cost
` 31,30,000
Working Note: Calculation of Factory Cost in 2014
Particulars Amount (`)
Opening Stock of Material 1,50,000
Add: Purchase of Material 18,50,000
Less: Closing Stock of Material (2,00,000)
Material Consumed 18,00,000
Direct Labour 9,50,000
Prime Cost 27,50,000
Factory Overhead 3,80,000
Factory Cost 31,30,000
(ii) Detailed Cost Statement for the Order received from M.L. Auto Ltd. during 2015
Particulars Amount (`)
Material 8,00,000
Labour 4,50,000
Factory Overhead (40% of ` 4,50,000) 1,80,000
Factory Cost 14,30,000
Administrative Overhead (8% of ` 14,30,000) 1,14,400
Cost of delivery 45,000
Total Cost 15,89,400
Add: Profit @ 10% of Sales or 11.11% of cost or 1/9 of 15,89,400 1,76,600
Sales value (Price to be quoted for the order) (` 15,89,400 /0.9) 17,66,000
Hence the price to be quoted is `17,66,000 if the company wants to earn a profit of 10% on
sales.

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

Debt 2
(b) Debt Equity Ratio = 2 :1; =
Equity 1
` 50,00,000
Equity = = ` 25,00,000
2
Net Profit after tax (PAT)
Return on Equity = = 50%
Equity
Or, Net Profit after tax (PAT) = ` 25,00,000 × 50% = ` 12,50,000
100
Net Profit before tax = ` 12,50,000× = ` 19,23,077
65
Tax = ` 19,23,077 – `12,50,000 = ` 6,73,077
Sales Sales
Capital Turnover Ratio = = 1.2 Or, = 1.2
Capital (` 25,00,000 + ` 50,00,000)
So, Sales = ` 75,00,000 × 1.2 = ` 90,00,000
Closing Stock = ` 90,00,000 × 8% = ` 7,20,000
Gross Profit = ` 90,00,000 × 30% = ` 27,00,000
Trading A/c for the year ending 31st March, 2015
Dr. Cr.
Amount (`) Amount (`)

To Opening Stock 4,50,000 By Sales 90,00,000

To Purchases (Balancing figure) 65,70,000 By Closing Stock 7,20,000
To Gross Profit c/f to P&L A/c 27,00,000
97,20,000 97,20,000
Profit & Loss A/c for the year ending 31st March, 2015
Amount (`) Amount (`)
To Interest on long term debt @14% 7,00,000 By Gross Profit b/f 27,00,000
from Trading A/c
To Miscellaneous Exp. (balancing 76,923
figure)
To Income Tax 6,73,077
To Net Profit 12,50,000
27,00,000 27,00,000

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

Question 3
(a) XY Co. Ltd manufactures two products viz., X and Y and sells them through two
divisions, East and West. For the purpose of Sales Budget to the Budget Committee,
following information has been made available for the year 2014-15:
Budgeted Sales Actual Sales
Product
East Division West Division East Division West Division
X 400 units at ` 9 600 units at ` 9 500 units at ` 9 700 units at ` 9
Y 300 units at` 21 500 units at ` 21 200 units at ` 21 400 units at ` 21
Adequate market studies reveal that product X is popular but under priced. It is expected
that if the price of X is increased by ` 1, it will, find a ready market. On the other hand, Y
is overpriced and if the price of Y is reduced by ` 1 it will have more demand in the
market. The company management has agreed for the aforesaid price changes. On the
basis of these price changes and the reports of salesmen, following estimates have been
prepared by the Divisional Managers:
Percentage increase in sales over budgeted sales
Product East Division West Division
X + 10% + 5%
Y + 20% + 10%
With the help of intensive advertisement campaign, following additional sales (over and
above the above mentioned estimated sales by Divisional Mangers) are possible:
Product East Division West Division
X 60 units 70 units
Y 40 units 50 units
You are required to prepare Sales Budget for 2015-16 after incorporating above
estimates and also show the Budgeted Sales and Actual Sales of 2014-15. (8 Marks)
(b) Balance Sheets of KAS Limited as on 31st March, 2014 and 31st March, 2015 are
furnished below:
(Amount in Rupees)
Liabilities As at 31st As at 31st
March, 2014 March, 2015
Equity Share Capital 75,00,000 1,02,50,000
General Reserve 42,50,000 50,00,000
Profit & Loss Account 15,00,000 18,75,000

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

13 % Debentures of face value

58,00,000 43,50,000
` 100 each
Current Liabilities 30,00,000 32,50,000
Proposed Dividend 7,50,000 9,10,000
Provision for Income tax 22,50,000 24,75,000
Total 2,50,50,000 2,81,10,000
(Amount in Rupees)
Assets As at 31st As at 31st
March, 2014 March, 2015
Goodwill 10,00,000 7,75,000
Land & Building 68,00,000 61,20,000
Plant & Machinery 75,12,000 1,07,95,000
Investment 25,00,000 21,25,000
Stock 33,00,000 27,50,000
Debtors 24,45,000 36,20,000
Cash and Bank 14,93,000 19,25,000
Total 2,50,50,000 2,81,10,000
Following additional information is available:
(i) During the financial year 2014-15 the company issued equity shares at par.
(ii) Debentures were redeemed on 1st April, 2014 at a premium of 10%.
(iii) Some investments were sold at a profit of ` 75,000 and the profit was credited to
General Reserve Account.
(iv) During the year an old machine costing ` 23,50,000 was sold for ` 6,25,000. Its
written down value was ` 8,00,000.
(v) Depreciation is to be provided on plant and machinery at 20% on the opening
balance.
(vi) There was no purchase or sale of land and building.
(vii) Provision for tax made during the year was ` 4,50,000.
You are required to prepare a Cash Flow Statement for the year ended 31 st March, 2015.
(8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

Answer
(a) Statement Showing Sales Budget for 2015-16
Product X Product Y Total
Division Qty. Rate (`) Amt. (`) Qty. Rate (`) Amt. (`) Amt. (`)
East 5001 10 5,000 4003 20 8,000 13,000
West 7002 10 7,000 6004 20 12,000 19,000
Total 1,200 12,000 1,000 20,000 32,000
Workings
1. 400 × 110% + 60 = 500 units
2. 600 × 105% + 70 = 700 units
3. 300 × 120% + 40 = 400 units
4. 500 × 110% + 50 = 600 units
Statement Showing Sales Budget for 2014-15
Division Product X Product Y Total
Qty. Rate (`) Amt. (`) Qty. Rate (`) Amt. (`) Amt. (`)
East 400 9 3,600 300 21 6,300 9,900
West 600 9 5,400 500 21 10,500 15,900
Total 1,000 9,000 800 16,800 25,800
Statement Showing Actual Sales for 2014-15
Product X Product Y Total
Division
Qty. Rate (`) Amt. (`) Qty. Rate (`) Amt. (`) Amt. (`)
East 500 9 4,500 200 21 4,200 8,700
West 700 9 6,300 400 21 8,400 14,700
Total 1,200 10,800 600 12,600 23,400
(b) Cash Flow Statement
As on 31st Mach, 2015
Amount (`) Amount (`)
A. Cash flow from Operating Activities
Profit and Loss A/c (Closing) 18,75,000
Less: Profit and Loss A/c (Opening) 15,00,000
3,75,000

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

Add: Transfer to General Reserve 6,75,000

Provision for Tax 4,50,000
Proposed Dividend 9,10,000 20,35,000
Profit before Tax 24,10,000
Adjustment for Depreciation:
Land and Building (on building) 6,80,000
Plant and Machinery 15,02,400 21,82,400
Loss on Sale of Plant and Machinery 1,75,000
Goodwill written off 2,25,000
Interest on 13% Debentures 5,65,500
Premium on Redemption 1,45,000
Operating Profit before Working Capital Changes 57,02,900
Adjustment for Working Capital Changes:
Decrease in Stock 5,50,000
Increase in Debtors (11,75,000)
Increase in Current Liabilities 2,50,000 (3,75,000)
Cash generated from Operations 53,27,900
Income tax paid (225,000)
Net Cash Inflow from Operating Activities (a) 51,02,900
B. Cash flow from Investing Activities
Sale of Investment 4,50,000
Sale of Plant and Machinery 6,25,000
Purchase of Plant and Machinery (55,85,400)
Net Cash Outflow from Investing Activities (b) (45,10,400)
C. Cash Flow from Financing Activities
Issue of Equity Shares 27,50,000
Redemption of Debentures (14,50,000)
Redemption of Debentures at premium (1,45,000)
Dividend paid (7,50,000)
Interest paid to Debenture holders (5,65,500)
Net Cash Outflow from Financing Activities (c) (1,60,500)
Net increase in Cash and Cash Equivalents during the year 4,32,000

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

(a + b + c)
Cash and Cash Equivalents at the beginning of the year 14,93,000
Cash and Cash Equivalents at the end of the year 19,25,000
Working Notes:
1. Provision for the Tax Account
` `
To Bank (paid) 2,25,000 By Balance b/d 22,50,000
To Balance c/d 24,75,000 By Profit and Loss A/c 4,50,000
(Provision)
27,00,000 27,00,000

2. Investment Account
` `
To Balance b/d 25,00,000 By Bank A/c (bal. figure- 4,50,000
Sale)
To General Reserve A/c 75,000 By Balance c/d 21,25,000
(Profit on Sale)
25,75,000 25,75,000

3. Plant and Machinery Account

` `
To Balance b/d 75,12,000 By Bank (Sale) 6,25,000
To Bank A/c 55,85,400 By Profit and Loss A/c 1,75,000
(Purchase- Bal. figure) (Loss on sale)
By Profit and Loss A/c 15,02,400
(Depreciation)
By Balance c/d 1,07,95,000
1,30,97,400 1,30,97,400

4. Proposed Dividend Account

` `
To Bank (paid) 7,50,000 By Balance b/d 7,50,000
To Balance c/d 9,10,000 By Profit and Loss A/c 9,10,000
16,60,000 16,60,000

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

5. General Reserve Account

` `
By Balance b/d 42,50,000
By Profit & Loss 6,75,000
(transfer from)
To Balance c/d 50,00,000 By Investment (Gain on Sale) 75,000
50,00,000 50,00,000
Question 4
(a) The following information is furnished by ABC Company for Process - II of its
manufacturing activity for the month of April 2015:
(i) Opening Work-in-Progress - Nil
(ii) Units transferred from Process I – 55,000 units at ` 3,27,800
(iii) Expenditure debited to Process – II:
Consumables ` 1,57,200
Labour ` 1,04,000
Overhead ` 52,000
(iv) Units transferred to Process III – 51,000 units
(v) Closing WIP – 2,000 units (Degree of completion):
Consumables 80%
Labour 60%
Overhead 60%
(vi) Units scrapped - 2,000 units, scrapped units were sold at ` 5 per unit
(vii) Normal loss – 4% of units introduced
You are required to:
(i) Prepare a Statement of Equivalent Production.
(ii) Determine the cost per unit
(iii) Determine the value of Work-in-Process and units transferred to Process – III
(8 Marks)
(b) RST Ltd. is expecting an EBIT of ` 4 lakhs for F.Y. 2015-16. Presently the company is
financed entirely by equity share capital of ` 20 lakhs with equity capitalization rate of
16%. The company is contemplating to redeem part of the capital by introducing debt
financing. The company has two options to raise debt to the extent of 30% or 50% of the
total fund.

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

It is expected that for debt financing upto 30%, the rate of interest will be 10% and equity
capitalization rate will increase to 17%. If the company opts for 50% debt, then the
interest rate will be 12% and equity capitalization rate will be 20%.
You are required to compute value of the company; its overall cost of capital under
different options and also state which is the best option. (8 Marks)
Answer
(a) (i) Statement of Equivalent Production
Equivalent Production
Input Output Material- A* Consumables Labour &
Units Units
Details Particulars Overheads
% Units % Units % Units
Units 55,000 Units 51,000 100 51,000 100 51,000 100 51,000
transferre transferred
d from to Process-
Process-I III
Normal loss 2,200 - - - - - -
(4% of
55,000)
Closing 2,000 100 2,000 80 1,600 60 1,200
W-I-P
Abnormal (200) 100 (200) 100 (200) 100 (200)
Gain
55,000 55,000 52,800 52,400 52,000
*Material A represent transferred-in units from process-I
(ii) Determination of Cost per Unit
Particulars Amount (`) Units Per Unit (`)
(i) Direct Material (Consumables) :
Value of units transferred from Process-I 3,27,800
Less: Value of normal loss
(2,200 units × ` 5) (11,000)
3,16,800 52,800 6.00
(ii) Consumables added in Process-II 1,57,200 52,400 3.00
(iii) Labour 1,04,000 52,000 2.00
(iii) Overhead 52,000 52,000 1.00
Total Cost per equivalent unit 12.00

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

(iii) Determination of value of Work-in-Process and units transferred to Process-III

Particulars Units Rate (`) Amount (`)
Value of Closing W-I-P:
Material from Process-I 2,000 6.00 12,000
Consumables 1,600 3.00 4,800
Labour 1,200 2.00 2,400
Overhead 1,200 1.00 1,200
20,400
Value of units transferred to Process-III 51,000 12.00 6,12,000
(b) EBIT = ` 4,00,000
Equity Share Capital = ` 20,00,000
Equity Capitalization rate = 16%
100
At Present Value of the Company = ` 4,00,000× = ` 25,00,000
16
Computation of Value of the Company and Overall Cost of Capital under the two options:
Particulars Option I Option II
Debt 30% 50%
Equity (existing) ` 20,00,000 ` 20,00,000
Debt ` 6,00,000 ` 10,00,000
Equity capitalization rate 17% 20%
Interest on Debt 10% 12%
EBIT ` 4,00,000 ` 4,00,000
Less: Interest on Debt ` 60,000 ` 1,20,000
Earnings to equity share holders ` 3,40,000 ` 2,80,000
Market Value of equity ` 20,00,000 ` 14,00,000
100 100
(` 3,40,000 × ) (` 2,80,000× )
17 20
Value of Debt ` 6,00,000 ` 10,00,000
Value of the Company (Equity ` 26,00,000 ` 24,00,000
+Debt)
Overall Cost of Capital 15.38% 16.67%

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

` 4,00,000 ` 4,00,000
( ×100 ) ( ×100 )
` 26,00,000 ` 24,00,000

Since in Option I value of the Company is more and overall cost of Capital is less compared
to Option II, hence Option I is better.
Question 5
(a) State the method of costing and also the unit of cost for the following industries:
(i) Hotel
(ii) Toy-making
(iii) Steel
(iv) Ship Building
(b) How would you account for idle capacity cost in Cost Accounting?
(c) Distinguish between Net Present Value (NPV) and Internal Rate of Return (IRR) methods
for evaluating projects.
(d) What is meant by venture capital financing? State its various methods.
(4 × 4 = 16 Marks)
Answer
(a)
Industry Method of Costing Unit of Cost
(i) Hotel Operating Costing Room day/ per bed
(ii) Toy Making Batch Costing Units/ Batch
(iii) Steel Process Costing/ Single Costing Per Tonne/ Per MT
(iv) Ship Building Contract Costing Project/ Unit
(b) Idle capacity costs are treated in the following ways in Cost Accounts:
(i) If the idle capacity cost is due to unavoidable reasons: A supplementary
overhead rate may be used to recover the idle capacity cost. In this case, the costs
are charged to the production capacity utilised.
(ii) If the idle capacity cost is due to avoidable reasons: Such as faulty planning,
etc. the cost should be charged to Costing Profit and Loss Account.
(iii) If the idle capacity cost is due to trade depression, etc.,: Being abnormal in
nature the cost should also be charged to the Costing Profit and Loss Account.

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

(iv) If the idle capacity cost is due to seasonal factors, then the cost should be
charged to cost of production by inflating overhead rate.
(c) Distinguish between Net Present Value (NPV) and Internal Rate of Return (IRR)
NPV and IRR methods differ in the sense that the results regarding the choice of an
asset under certain circumstances are mutually contradictory under two methods. In case
of mutually exclusive investment projects, in certain situations, they may give
contradictory results such that if the NPV method finds one proposal acceptable, IRR
favours another. The different rankings given by the NPV and IRR methods could be due
to size disparity problem, time disparity problem and unequal expected lives.
The net present value is expressed in financial values whereas internal rate of return
(IRR) is expressed in percentage terms.
In the net present value cash flows are assumed to be re-invested at cost of capital rate.
In IRR reinvestment is assumed to be made at IRR rates.
(d) Meaning of Venture Capital: The venture capital financing refers to financing and
funding of the small scale enterprises, high technology and risky ventures.
Methods of Venture Capital financing: Some common methods of venture capital
financing are as follows:
(i) Equity financing: The venture capital undertakings generally requires funds for a
longer period but may not be able to provide returns to the investors during the
initial stages. Therefore, the venture capital finance is generally provided by way of
equity share capital..
(ii) Conditional Loan: A conditional loan is repayable in the form of a royalty after the
venture is able to generate sales. No interest is paid on such loans. In India Venture
Capital Financers charge royalty ranging between 2 to 15 per cent; actual rate
depends on other factors of the venture such as gestation period, cash flow
patterns, riskiness and other factors of the enterprise.
(iii) Income Note: It is a hybrid security which combines the features of both
conventional loan and conditional loan. The entrepreneur has to pay both interest
and royalty on sales but at substantially low rates
(iv) Participating Debenture: Such security carries charges in three phases- in the start-
up phase, no interest is charged, next stage a low rate of interest is charged upto a
particular level of operations, after that, a high rate of interest is required to be paid.
Question 6
(a) PVK Constructions commenced a contract on 1st April, 2014. Total contract value was
` 100 lakhs. The contract is expected to be completed by 31st December, 2016. Actual

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

expenditure during the period 1st April, 2014 to 31st March, 2015 and estimated
expenditure for the period 1st April, 2015 to 31st December, 2016 are as follows:
Actual (`) Estimated (`)
1st April, 2014 to 31st 1st April, 2015 to 31st
March, 2015 Dec. 2016
Material issued 15,30,000 21,00,000
Direct Wages paid 10,12,500 12,25,000
Direct Wages outstanding 80,000 1,15,000
Plant purchased 7,50,000 -
Expenses paid 3,25,000 5,40,000
Prepaid Expenses 68,000 -
Site office expenses 3,00,000 -
Part of the material procured for the contract was unsuitable and was sold for ` 2,40,000
(cost being ` 2,55,000) and a part of plant was scrapped and disposed of for ` 80,000.
The value of plant at site on 31st March, 2015 was ` 2,50,000 and the value of material at
site was ` 73,000. Cash received on account to date was ` 36,00,000, representing 80%
of the work certified. The cost of work uncertified was valued at ` 5,40,000.
Estimated further expenditure for completion of contract is as follows:
• An additional amount of ` 4,62,500 would have to be spent on the plant and the
residual value of the plant on the completion of the contract would be` 67,500.
• Site office expenses would be the same amount per month as charged in the
previous year.
• An amount of ` 1,57,500 would have to be incurred towards consultancy charges.
Required:
Prepare Contract Account and calculate estimated total profit on this contract. (8 Marks)
(b) A firm has a total sales of ` 200 lakhs of which 80% is on credit. It is offering credit terms
of 2/40, net 120. Of the total, 50% of customers avail of discount and the balance pay in
120 days. Past experience indicates that bad debt losses are around 1% of credit sales.
The firm spends about ` 2,40,000 per annum to administer its credit sales. These are
avoidable as a factor is prepared to buy the firm's receivables. He will charge 2%
commission. He will pay advance against receivables to the firm at an interest rate of
18% after withholding 10% as reserve.
(i) What is the effective cost of factoring? Consider year as 360 days.
(ii) If bank finance for working capital is available at 14% interest, should the firm avail
of factoring service? (8 Marks)

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

Answer
(a) PVK Constructions
Contract Account for the year 2014-15
Particulars (`) Particulars (`)
To Materials issued 15,30,000 By Material sold 2,40,000
To Direct wages 10,12,500 By Costing P & L Account 15,000
(loss on sale of material)
Add: Outstanding 80,000 10,92,500 By Plant sold 80,000
To Plant purchased 7,50,000 By Plant at site 2,50,000
To Expenses 3,25,000 By Material at site 73,000
Less: Prepaid (68,000) 2,57,000 By Work-in-progress:
To Site office expenses 3,00,000 -Work certified 45,00,000
To Notional profit c/d 17,68,500 - Work uncertified 5,40,000 50,40,000
56,98,000 56,98,000
To Costing P&L A/c (transfer) 4,11,967* By Notional profit b/d 17,68,500
(Refer Working note)
To Work-in-progress (reserve) 13,56,533#
17,68,500 17,68,500
Calculation of Estimated Profit (April 2014 to December 2016)
Particulars Amount (`) Amount (`) Amount (`)
Total Value of the Contract (A) 1,00,00,000
(i) Materials Costs:
Materials Consumed in 2014-2015:
- Materials issued in 2014-15 15,30,000
- Less: Closing Materials at site (73,000)
- Less: Unsuitable Materials sold (2,55,000) 12,02,000
Add: Materials to be Consumed
- Materials to be issued 21,00,000
- Add: Opening materials at site 73,000 21,73,000 33,75,000
(ii) Direct Wages Cost:
Direct wages for 2014-15:
- Wages paid 10,12,500

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

- Add: Outstanding at closing 80,000 10,92,500

Direct wages to be incurred:
- Wages to be paid 12,25,000
- Less: Outstanding at opening (80,000)
- Add: Outstanding at closing 1,15,000 12,60,000 23,52,500
(iii) Plant Cost
Plant used during 2014-15:
- Plant purchased 7,50,000
- Less: Plant disposed off (80,000)
- Less: Closing plant at site (2,50,000) 4,20,000
Plant to be used
- Additional amount to be spent 4,62,500
- Add: Opening plant at site 2,50,000
- Less: Residual value of plant (67,500) 6,45,000 10,65,000
(iv) Expenses
Expenses incurred during 2014-15:
- Expenses paid 3,25,000
- Less: Prepaid at closing (68,000) 2,57,000
Expenses to be incurred
- Expenses to be paid 5,40,000
- Add: Prepaid at opening 68,000 6,08,000 8,65,000
(v) Site office expenses paid in 2014-15 3,00,000
- Add: To be paid {(3,00,000÷12) × 21 5,25,000 8,25,000
months}
(vi) Consultancy charges to be paid 1,57,500
Total Estimated Cost of the Contract 86,40,000
Estimated Profit (A – B) 13,60,000
* The profit to be transferred can be calculated using various formulae given in the
working note, however, in this solution following the conservative approach, the lowest
amount has been taken.
# Profit transferred to the reserve will vary depending upon the formula of profit
calculation adopted.

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

Workings:
Profit to be transferred to Costing Profit and Loss Account
Work certified Cash received
= Estimated Profit × ×
Contract price Work certified
` 45,00,000 ` 36,00,000
= ` 13,60,000 × × = ` 4,89,600
` 1,00,00,000 ` 45,00,000
Or
Cost of work to date Cash received
= Estimated Profit × ×
Estimated total cost Work certified
` 32,71,500 * ` 36,00,000
= ` 13,60,000 × × = ` 4,11,967
` 86,40,000 ` 45,00,000
Or
Cost of work to date ` 32,71,500 *
= Estimated Profit × = ` 13,60,000 × = ` 5,14,958.33
Estimated total cos t ` 86,40,000
Or
Value of Work Certified ` 45,00,000
= EstimatedPr ofit × = ` 13,60,000 × = ` 6,12,000
Value of Contract ` 1,00,00,000
*[ Material Consumed + Direct Wages + Plant used + Expenses + Site office expenses]
[` 12,02,000 + ` 10,92,500 + ` 4,20,000 + ` 2,57,000 + ` 3,00,000 = ` 32,71,500]

Since, in the question estimated cost information is given, hence, the profit to be
transferred in the Costing Profit & Loss account for the year 2014-15, will be on the basis
of estimated profit calculated as above.
Profit to be transferred in Costing Profit & Loss account for the year 2014-15 on
percentage of completion method as below:
1 CashRe ceived 1 ` 36,00,000
NotionalPr ofit × × = ` 17,68,500 × × = ` 4,71,600
3 Value of Work Certified 3 ` 45,00,000

The detailed calculations have been shown for better understanding of the students.
(b) Total Sales = ` 200 lakhs
Credit Sales (80%) =` 160 lakhs
Receivables for 40 days = ` 80 lakhs

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

Receivables for 120 days = ` 80 lakhs

Average collection period [(40 x 0.5) + (120 × 0.5)] = 80 days
Average level of Receivables (` 1,60,00,000 × 80/360) = ` 35,55,556
Factoring Commission (` 35,55,556 × 2/100) = ` 71,111
Factoring Reserve (` 35,55,556 × 10/100) = ` 3,55,556
Amount available for advance {` 35,55,556 - (3,55,556 + 71,111)} = ` 31,28,889
Factor will deduct his interest @ 18% :
` 31,28,889 ×18 × 80
Interest = = ` 1,25,156
100 × 360
Advance to be paid (` 31,28,889 – ` 1,25,156) = ` 30,03,733
(i) Calculation of Effective Cost of Factoring
Annual Cost of Factoring to the Firm: `
Factoring commission (` 71,111 × 360/80) 3,20,000
Interest charges (` 1,25,156 × 360/80) 5,63,200
Total (A) 8,83,200
Firm’s Savings on taking Factoring Service: `
Cost of credit administration saved 2,40,000
Bad Debts (` 160,00,000 x 1/100) avoided 1,60,000
Total (B) 4,00,000
Net Cost to the firm (A – B) (` 8,83,200 – ` 4,00,000) 4,83,200
` 4,83,200
Effective cost of factoring = × 100 = 16.09* %
` 30,03,733
* If cost of factoring is calculated on the basis of total amount available for advance,
then, it will be
` 4,83,200
= × 100 = 15.44%
` 31,28,889
(ii) If Bank finance for working capital is available at 14%, firm will not avail factoring
service as 14 % is less than 16.08% (or 15.44%)
Question 7
Answer any four of the following:
(a) Explain the treatment of over and under absorption of overheads in cost accounting.

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

(b) Describe the various steps involved in adopting standard costing system in an
organization.
(c) Evaluate the role of cash budget in effective cash management system.
(d) Discuss the risk-return considerations in financing current assets.
(e) Distinguish between the following:
(i) 'Scraps' and 'Defectives' in costing
(ii) Preference Shares and Debentures. (4 × 4 = 16 Marks)
Answer
(a) Treatment of over and under absorption of overheads are:-
(i) Writing off to costing P&L A/c:– Small difference between the actual and
absorbed amount should simply be transferred to costing P&L A/c, if difference is
large then investigate the causes and after that abnormal loss shall be transferred
to costing P&L A/c.
(ii) Use of supplementary Rate: Under this method the balance of under and over
absorbed overheads may be charged to cost of W.I.P., finished stock and cost of
sales proportionately with the help of supplementary rate of overhead.
(iii) Carry Forward to Subsequent Year: Difference should be carried forward in the
expectation that next year the position will be automatically corrected. This would
really mean that costing data of two years would be wrong.
(b) The Steps of standard costing is as below:
(i) Setting of Standards: The first step is to set standards which are to be achieved.
(ii) Ascertainment of actual costs: Actual cost for each component of cost is
ascertained. Actual costs are ascertained from books of account, material invoices,
wage sheet, charge slip etc.
(iii) Comparison of actual cost and standard cost: Actual costs are compared with
the standards costs and variances are determined.
(iv) Investigation of variances: Variances arises are investigated for further action.
Based on this performance is evaluated and appropriate actions are taken.
(v) Disposition of variances: Variances arise are disposed off by transferring it the
relevant accounts (costing profit and loss account) as per the accounting method
(plan) adopted.
(c) Cash Budget is the most significant device to plan for and control cash receipts and
payments. It plays a very significant role in effective Cash Management System. This
represents cash requirements of business during the budget period.
The various role of cash budgets in Cash Management System are:-

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

(i) Coordinate the timings of cash needs. It identifies the period(s) when there might
either be a shortage of cash or an abnormally large cash requirement;
(ii) It also helps to pinpoint period(s) when there is likely to be excess cash;
(iii) It enables firm which has sufficient cash to take advantage like cash discounts on its
accounts payable; and
(iv) Lastly it helps to plan/arrange adequately needed funds (avoiding excess/shortage
of cash) on favorable terms.
(d) The financing of current assets involves a trade off between risk and return. A firm can
choose from short or long term sources of finance. Short term financing is less expensive
than long term financing but at the same time, short term financing involves greater risk
than long term financing.
Depending on the mix of short term and long term financing, the approach followed by a
company may be referred as matching approach, conservative approach and aggressive
approach.
In matching approach, long-term finance is used to finance fixed assets and permanent
current assets and short term financing to finance temporary or variable current assets.
Under the conservative plan, the firm finances its permanent assets and also a part of
temporary current assets with long term financing and hence less risk of facing the
problem of shortage of funds.
An aggressive policy is said to be followed by the firm when it uses more short term
financing than warranted by the matching plan and finances a part of its permanent
current assets with short term financing.
(e) (i) Difference between Scrap and Defectives
Scrap Defectives
1. It is loss connected with output 1. This type of loss connected with
the output but it can be in the
input as well.
2. Scraps are not intended but 2. Defectives also are not intended
cannot be eliminated due to nature but can be eliminated through
of material or process itself. proper control.
3. Generally scraps are not used or 3. Defectives can be used after
rectified. rectification.
4. Scraps have insignificant 4. Defectives are sold at lower
recoverable value. value from that of good one.

© The Institute of Chartered Accountants of India

70 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2015

(ii) Difference between Preference Shares and Debentures

Basis of difference Preference shares Debentures
Ownership Preference Share Capital is a Debenture is a type of loan
special kind of share which can be raised from
the public
Payment of its holders enjoy priority both as It carries fixed percentage
Dividend/ Interest regard to the payment of a fixed of interest.
amount of dividend and also
towards repayment of capital in
case of winding up of a
company
Nature Preference shares are a hybrid Debentures are instrument
form of financing with some for raising long term capital
characteristic of equity shares with a period of maturity.
and some attributes of Debt
Capital.

© The Institute of Chartered Accountants of India

DISCLAIMER
The Suggested Answers hosted in the website do not constitute the basis for evaluation of the
students’ answers in the examination. The answers are prepared by the Faculty of the Board
of Studies with a view to assist the students in their education. While due care is taken in
preparation of the answers, if any errors or omissions are noticed, the same may be brought to
the attention of the Director of Studies. The Council of the Institute is not in anyway
responsible for the correctness or otherwise of the answers published herein.

© 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
(a) ABC Limited started its operations in the year 2013 with a total production capacity of
2,00,000 units. The following information, for two years, are made available to you:
Year Year
2013 2014
Sales (units) 80,000 1,20,000
Total Cost (`) 34,40,000 45,60,000
There has been no change in the cost structure and selling price and it is anticipated that
it will remain unchanged in the year 2015 also.
Selling price is ` 40 per unit.
Calculate :
(i) Variable cost per unit.
(ii) Profit Volume Ratio.
(iii) Break-Even Point (in units)
(iv) Profit if the firm operates at 75% of the capacity.
(b) X Y Z Limited is drawing a production plan for its two products - Product 'xml' and
'Product 'yml' for the year 2015-16. The company's policy is to maintain closing stock of
finished goods at 25% of the anticipated volume of sales of the succeeding month.
The following are the estimated data for the two products:
xml yml
Budgeted Production (in units) 2,00,000 1,50,000
Direct Material (per unit) ` 220 ` 280
Direct Labour (per unit) ` 130 ` 120
Direct Manufacturing Expenses ` 4,00,000 ` 5,00,000
The estimated units to be sold in the first four months of the year 2015-16 are as under:

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

April May June July

xmI 8,000 10,000 12,000 16,000
yml 6,000 8,000 9,000 14,000
Prepare:
(i) Production Budget (Month wise)
(ii) Production cost Budget (for first quarter of the year)
(c) A new customer has approached a firm to establish new business connection. The
customer require 1.5 month of credit. If the proposal is accepted, the sales of the firm will
go up by ` 2,40,000 per annum. The new customer is being considered as a member of
10% risk of non-payment group.
The cost of sales amounts to 80% of sales. The tax rate is 30% and the desired rate of
return is 40% (after tax).
Should the firm accept the offer? Give your opinion on the basis of calculations.
(d) Following information are related to four firms of the same industry :
Change in Operating Change in Earning
FIRM Change in Revenue
Income per Share
P 27% 25% 30%
Q 25% 32% 24%
R 23% 36% 21%
S 21% 40% 23%
Find out:
(i) degree of operating leverage, and
(ii) degree of combined leverage for all the firms. (4 × 5 = 20 Marks)
Answer
Change intotalcost
(a) (i) Variable Cost per unit =
Change insales volume
` 45,60,000  ` 34,40,000
=
1,20,000units  80,000units
` 11,20,000
= = ` 28
40,000units

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

Contributionper unit
(ii) Profit Volume Ratio = 100
Sellingprice per unit

` 40  ` 28
= 100 = 30%
` 40
Fixedcos t
(iii) Break-Even Point (in units) =
Contributionper unit

Fixed Cost = Total Cost in 2013 – Total Variable Cost in 2013

= ` 34,40,000 – (` 28 × 80,000 units)
= ` 34,40,000 – ` 22,40,000
= ` 12,00,000
` 12,00,000
Therefore, Break-Even Point = = 1,00,000 units
` 12

(iv) Profit if the firm operates at 75% of the capacity:

Number of units to be produced and sold = 2,00,000 units × 75% = 1,50,000 units
Profit = Total contribution – Fixed Cost
Or, = ` 12 × 1,50,000 units – ` 12,00,000
Or, = ` 18,00,000 – ` 12,00,000
Or, Profit = ` 6,00,000
(b) (i) Production Budget of Product ‘xml’ and ‘yml’ (monthwise in units)
April May June Total
xml yml xml yml xml yml xml yml
Sales 8,000 6,000 10,000 8,000 12,000 9,000 30,000 23,000
Add: Closing Stock 2,500 2,000 3,000 2,250 4,000 3,500 9,500 7,750
(25% of next month’s
sale)
Less: Opening Stock 2,000* 1,500* 2,500 2,000 3,000 2,250 7,500 5,750
Production units 8,500 6,500 10,500 8,250 13,000 10,250 32,000 25,000

* Opening stock of April is the closing stock of March, which is as per company’s policy 25% of
next month’s sale.

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(ii) Production Cost Budget (for first quarter of the year)

Rate (`) Amount (`)

Element of cost xml yml xml yml

(32,000 (25,000
units) units)
Direct Material 220 280 70,40,000 70,00,000
Direct Labour 130 120 41,60,000 30,00,000
Manufacturing Overhead
(` 4,00,000 ÷ 2,00,000 × 32,000) 64,000
(` 5,00,000 ÷ 1,50,000 × 25,000) 83,333
1,12,64,000 1,00,83,333
(c) Evaluation of Credit proposal to new business connection
Amount (`)
A. Calculation of profit on additional sales:
Increase in Sales 2,40,000
Less: Cost of Sales (1,92,000)
48,000
Less: Risk of non-payment (10% of ` 2,40,000) 24,000
Profit Before Tax 24,000
Tax (30% of ` 24,000) 7,200
Profit After Tax 16,800
B. Opportunity cost of Investment on Receivable
` 1,92,000 9,600
 40%
8*
C. Net Benefit (A – B) 7,200
12months
* Receivable Turnover = = 8 times
1.5months
Since estimated PAT on additional sales (i.e. ` 16,800) is more than the opportunity cost
of investment on receivable (i.e. ` 9,600), the firm should accept the offer.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

(d) Calculation of Degree of Operating leverage and Degree of Combined leverage

Firm Degree of Operating Leverage (DOL) Degree of Combined Leverage (DCL)
% change in OperatingIncome % change inEPS
= =
% change inRevenue % change inRevenue

25% 30%
P = 0.926 = 1.111
27% 27%
32% 24%
Q = 1.280 = 0.960
25% 25%
36% 21%
R = 1.565 = 0.913
23% 23%
40% 23%
S = 1.905 = 1.095
21% 21%

Question 2
(a) QS Limited has furnished the following information:
Standard overhead absorption rate per unit ` 20
Standard rate per hour ` 4
Budgeted production 12000 units
Actual production 15560 units
Actual working hours 74000
Actual overheads amounted to ` 2,95,000, out of which ` 62,500 are fixed. Overheads
are based on the following flexible budget:
Production (units) Total Overheads (` )
8,000 1,80,000
10,000 2,10,000
14,000 2,70,000
Calculate following overhead variances on the basis of hours :
(i) Variable overhead efficiency variance.
(ii) Variable overhead expenditure variance.
(ill) Fixed overhead efficiency variance.
(iv) Fixed overhead capacity variance.

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(b) SSR Ltd. has furnished the following ratios and information relating to the year ended
31st March, 2015.
Sales ` 60 Lacs
Return on Net worth 25%
Rate of Income tax 50%
Share Capital to reserves 7:3
Current Ratio 2
Net-Profit to Sales (after tax) 6.25%
Inventory Turnover 12
(Based on cost of goods sold and closing stock)
Cost of goods sold ` 18 Lacs
Interest on Debentures (@ 15%) ` 60,000
Sundry Debtors ` 2 Lacs
Sundry Creditors ` 2 Lacs
You are required to :
(i) Calculate the operating expenses for the year ended 31st March, 2015.
(ii) Prepare a Balance Sheet as on 31st March, 2015. (8 Marks)
Answer
(a) Workings:
(a) Variable Overhead rate per unit
Difference of Overheadat twolevel `2,10,000  `1,80,000
= =  `15
Difference inPr oductionunits 10,000units  8,000units

(b) Fixed Overhead = `1,80,000  (8,000 units  ` 15) = ` 60,000

Std.Overhead AbsorptionRate
(c) Standard hours per unit of production =
Std.Rate per hour
` 20
=  5hours
`4

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

VariableOverheadper unit
(d) Standard Variable Overhead Rate per hour =
Std.hour per unit

`15
=  `3
5hours

(e) Standard Fixed Overhead Rate per hour = ` 4 - ` 3 = ` 1

(f) Actual Variable Overhead = ` 2,95,000 – ` 62,500= ` 2,32,500
`2,32,500
(g) Actual Variable Overhead Rate per Hour=  ` 3.1419
74,000hours

(h) Budgeted hours = 12,000 units  5 hours = 60,000 hours

(i) Standard Hours for Actual Production= 15,560 units  5 hours = 77,800 hours
(i) Variable Overhead Efficiency Variance:
= Std. Rate per hour (Std. Hours – Actual Hours)
= ` 3 (77,800 hours  74,000 hours)
= ` 11,400 (F)
(ii) Variable Overhead Expenditure Variance:
= Actual Hours (Std. Rate - Actual Rate)
= 74,000 hours (` 3 - ` 3.1419)
= ` 10,500 (A)
(iii) Fixed Overhead Efficiency Variance:
= Std. Rate per Hour (Std. Hours-Actual Hours)
= ` 1(77,800 hours -74,000 hours)
= ` 3,800 (F)
(iv) Fixed Overhead Capacity Variance:
= Std. Rate per Hour (Actual Hours - Budgeted Hours)
= ` 1(74,000 hours – 60,000 hours)
= ` 74,000  ` 60,000 = ` 14,000 (F)
(b) Workings:
1. Net Profit = 6.25% of ` 60,00,000 = ` 3,75,000
100
2. Net worth = ` 3,75,000 × = ` 15,00,000
25

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

7
Share Capital = ` 15,00,000 × = ` 10,50,000
10
3
Reserve = ` 15,00,000 × = ` 4,50,000
10
100
Debentures = ` 60,000 × = ` 4,00,000
15
3. Sundry Creditors = ` 2,00,000
Current Assets
Current Ratio = =2
Current Liabilities
Current Assets = 2 Current Liabilities
= 2 × ` 2,00,000 (assumed creditors is the only current liabilities)
= ` 4,00,000
Cost of GoodsSold
4. Inventory Turnover = = 12
Clo singStock
` 18,00,000
Hence, Closing Stock = = ` 1,50,000
12
Calculation of Earnings Before Interest and Tax (EBIT)
Particulars Amount (`)
Net Profit 3,75,000
Tax @50% 3,75,000
Profit Before Tax 7,50,000
Add: Interest on Debentures 60,000
Earnings Before Interest and Tax (EBIT) 8,10,000
(i) Calculation of Operating Expenses for the year ended 31st March 2015
Particulars Amount (`) Amount (`)
Sales 60,00,000
Less: Cost of Goods Sold 18,00,000
EBIT 8,10,000 26,10,000
Operating Expenses 33,90,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

(ii) Balance Sheet as on 31st March, 2015

Liabilities Amount Amount Assets Amount Amount
(`) (`) (`) (`)
Share capital 10,50,000 Fixed Assets 17,00,000
(balancing
figure)
Reserve 4,50,000 Current Assets:
Debentures 15% 4,00,000 Closing stock 1,50,000
Sundry Creditors 2,00,000 Debtors 2,00,000
Cash 50,000 4,00,000
21,00,000 21,00,000

Question 3
(a) A mini-bus, having a capacity of 32 passengers, operates between two places - 'A' and
'B'. The distance between the place 'A' and place 'B' is 30 km. The bus makes 10 round
trips in a day for 25 days in a month. On an average, the occupancy ratio is 70% and is
expected throughout the year.
The details of other expenses are as under:
Amount (`)
Insurance 15,600 Per annum
Garage Rent 2,400 Per quarter
Road Tax 5,000 Per annum
Repairs 4,800 Per quarter
Salary of operating staff 7,200 Per month
Tyres and Tubes 3,600 Per quarter
Diesel: (one litre is consumed for every 5 km) 13 Per litre
Oil and Sundries 22 Per 100 km run
Depreciation 68,000 Per annum
Passenger tax @ 22% on total taking is to be levied and bus operator requires a profit of
25% on total taking.
Prepare operating cost statement on the annual basis and find out the cost per
passenger kilometer and one way fare per passenger. (8 Marks)

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(b) Given below are the data on a capital project 'M'.

Annual cash inflows ` 60,000
Useful life 4 years
Internal rate of return 15%
Profitability index 1.064
Salvage value 0
You are required to calculate for this project M :
(i) Cost of project
(ii) Payback period
(iii) Cost of capital
(iv) Net present value
PV factors at different rates are given below:
Discount factor 15% 14% 13% 12%
1 year 0.869 0.877 0.885 0.893
2 year 0.756 0.769 0.783 0.797
3 year 0.658 0.675 0.693 0.712
4 year 0.572 0.592 0.613 0.636
(8 Marks)
Answer
(a) Operating Cost Statement
Particulars Total Cost Per
annum (`)
A. Fixed Charges:
Insurance 15,600
Garage rent (` 2,400 × 4 quarters) 9,600
Road Tax 5,000
Salary of operating staff (` 7,200 × 12 months) 86,400
Depreciation 68,000
Total (A) 1,84,600
B. Variable Charges:
Repairs (` 4,800 × 4 quarters) 19,200

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

Tyres and Tubes (` 3,600 × 4 quarters) 14,400

Diesel {(1,80,000 km. ÷ 5 km.) × `13} 4,68,000
Oil and Sundries {(1,80,000 km. ÷ 100 km.) × `22} 39,600
Total (B) 5,41,200
Total Operating Cost (A+B) 7,25,800
Add: Passenger tax (Refer to WN-1) 3,01,275
Add: Profit (Refer to WN-1) 3,42,359
Total takings 13,69,434
Calculation of Cost per passenger kilometre and one way fare per passenger:
TotalOperatingCost
Cost per Passenger-Km. =
TotalPassenger  Km.

` 7,25,800
= = ` 0.18
40,32,000Passenger  Km.

TotalTakings
One way fare per passenger =  30Km.
TotalPassenger  Km.

` 13,69,434
=  30km = ` 10.20
40,32,000Passenger  Km.

Working Notes:
1. Let total taking be X then Passenger tax and profit will be as follows:
X = ` 7,25,800 + 0.22 X + 0.25X
X – 0.47 X = ` 7,25,800
`7,25,800
X= = ` 13,69,434
0.53

Passenger tax = ` 13,69,434 × 0.22 = ` 3,01,275

Profit = ` 13,69,434 × 0.25 = ` 3,42,359
2. Total Kilometres to be run during the year
= 30 km.× 2 sides × 10 trips × 25 days × 12 months = 1,80,000 Kilometres
3. Total passenger Kilometres
= 1,80,000 km. × 32 passengers × 70% = 40,32,000 Passenger- km.

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(b) (i) Cost of Project ‘M’

At 15% internal rate of return (IRR), the sum of total cash inflows = cost of the
project i.e initial cash outlay
Annual cash inflows = ` 60,000
Useful life = 4 years
Considering the discount factor table @ 15%, cumulative present value of cash
inflows for 4 years is 2.855 (0.869 + 0.756 + 0.658 + 0.572)
Hence, Total Cash inflows for 4 years for Project M is
` 60,000 × 2.855 = ` 1,71,300
Hence, Cost of the Project = ` 1,71,300
(ii) Payback Period
Cost of the Project
Payback period =
Annual Cash Inflows
` 1,71,300
= = 2.855 years
` 60,000
(iii) Cost of Capital
Sum of Discounted Cash inflows
Profitability index =
Cost of the Project
Sum of Discounted Cash inflows
1.064 
` 1,71,300
 Sum of Discounted Cash inflows = ` 1,82,263.20
Since, Annual Cash Inflows = ` 60,000
` 1,82,263.20
Hence, cumulative discount factor for 4 years =
` 60,000
From the discount factor table, at discount rate of 12%, the cumulative discount
factor for 4 years is 3.038 (0.893 + 0.797 + 0.712 + 0.636)
Hence, Cost of Capital = 12%
(iv) Net Present Value (NPV)
NPV = Sum of Present Values of Cash inflows – Cost of the Project
= ` 1,82,263.20 – ` 1,71,300 = ` 10,963.20
Net Present Value = `10,963.20

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

Question 4
(a) A company manufactures one main product (M 1) and two by-products B1 and B2. For the
month of January 2015, following details are available:
Total cost upto separation point ` 2,12,400.
M1 B1 B2
Cost after separation - ` 35,000 ` 24,000
No. of Units produced 4,000 1,800 3,000
Selling Price per unit ` 100 ` 40 ` 30
Estimated net profit as percentage to
Sales Value - 20% 30%
Estimated selling expenses as 20% 15% 15%
percentage to Sales Value
There are no opening or closing inventories.
Prepare statement showing:
(i) Allocation of Joint Cost; and
(ii) Product-wise and overall profitability of the company for January, 2015. (8 Marks)
(b) A Ltd. wishes to raise additional finance of ` 30 lakhs for meeting its investment plans.
The company has ` 6,00,000 in the form of retained earnings available for investment
purposes.
The following are the further details:
 Debt equity ratio - 30 : 70
 Cost of debt - at the rate of 11 % (before tax) upto ` 3,00,000 and 14% (before tax)
beyond that.
 Earnings per share - ` 15.
 Dividend payout - 70% of earnings.
 Expected growth rate in dividend - 10%.
 Current market price per share - ` 90.
 Company's tax rate is 30% and shareholder's Personal tax rate is 20%.
You are required to :
(i) Calculate the post tax average cost of additional debt.
(ii) Calculate the cost of retained earnings and cost of equity.
(iii) Calculate the overall weighted average (after tax) cost of additional finance.
(8 Marks)

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

Answer
(a) (i) Statement showing allocation of Joint Cost
Particulars B1 B2
No. of units Produced 1,800 3,000
Selling Price Per unit (`) 40 30
Sales Value (`) 72,000 90,000
Less:Estimated Profit (B1 -20% & B2 -30%) (14,400) (27,000)
Cost of Sales 57,600 63,000
Less: Estimated Selling Expenses (B1 -15% & B2 -15%) (10,800) (13,500)
Cost of Production 46,800 49,500
Less:Cost after separation (35,000) (24,000)
Joint Cost allocated 11,800 25,500

(ii) Statement of Profitability

Particulars M1 (`) B1 (`) B2 (`)
Sales Value (A) 4,00,000 72,000 90,000
(4,000 × `100)
Less:- Joint Cost 1,75,100 11,800 25,500
(2,12,400 -11,800
- 25,500)
- Cost after separation - 35,000 24,000
- Selling Expenses 80,000 10,800 13,500
(M1- 20%, B1-15% & B2-15%)
(B) 2,55,100 57,600 63,000
Profit (A –B) 1,44,900 14,400 27,000
Overall Profit = `1,44,900 + `14,400 + ` 27,000 = ` 1, 86,300
(b)
Pattern of raising capital = 0.30  30,00,000
Debt = 9,00,000
Equity = 21,00,000
Equity fund (` 21,00,000)
Retained earnings = ` 6,00,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

Equity (additional) = `15,00,000

Total = ` 21,00,000
Debt fund (` 9,00,000)
11% debt = ` 3,00,000
14% debt = ` 6,00,000
Total = ` 9,00,000
TotalInterest (1  t)
(i) Kd = 100
` 9,00,000
(` 33,000  ` 84,000)(1  0.3)
=  100
` 9,00,000

` 81,900
or = 100 = 9.10%
` 9,00,000

 (EPS  Payout)(1  g)   ( `15  0.7)  1.1 

(ii) Ke* =  100   g =  100  10%
 Mp   ` 90 

 ` 11.55 
=  100   10% = 22.83%
 ` 90 
Kr = Ke (1 – t p) = 22.83%(1  0.2) = 18.26%
(iii) Weighted average cost of capital
Weighted Cost
Sources of Capital Amount (`) Weight After tax Cost
(in percentage)
Equity Capital 15,00,000 0.5 22.83% 11.415
Retained earning 6,00,000 0.2 18.26% 3.652
Debt 9,00,000 0.3 9.10% 2.730
Total 30,00,000 1.00 17.797
* Ke is calculated based on dividend growth model
Kd = Cost of capital; Ke = Cost of equity; Kr = Cost of retained earnings; Mp = Market
price; g = growth; tp = Shareholder’s personal tax; Ko = Cost of overall capital

Note: Cost of retained earnings(Kr ) and Cost of equity (Ke) can also be calculated in the
same way without considering shareholder’s personal tax. In that case Ke and Kr will be
same and accordingly Ko can be calculated.

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

Question 5
(a) Explain 'Sunk Cost' and 'Opportunity Cost'.
(b) Write notes on 'Escalation Clause'.
(c) Explain 'Sales and Lease Back'.
(d) Explain 'Miller-Orr Cash Management model'. (4 x 4 = 16 Marks)
Answer
(a) Sunk cost: Historical costs or the costs incurred in the past are known as sunk cost.
They play no role in the current decision making process and are termed as irrelevant
costs. For example, in the case of a decision relating to the replacement of a machine,
the written down value of the existing machine is a sunk cost, and therefore, not
considered.
Opportunity cost: It refers to the value of sacrifice made or benefit of opportunity
foregone in accepting an alternative course of action. For example, a firm financing its
expansion plan by withdrawing money from its bank deposits. In such a case the loss of
interest on the bank deposit is the opportunity cost for carrying out the expansion plan.
(b) Escalation Clause: This clause is usually provided in the contracts as a safeguard
against any likely changes in the price or utilization of material and labour. If during the
period of execution of a contract, the prices of materials or labour rise beyond a certain
limit, the contract price will be increased by an agreed amount. Inclusion of such a term
in a contract deed is known as an 'escalation clause'.
An escalation clause usually relates to change in price of inputs, it may also be extended
to increased consumption or utilization of quantities of materials, labour etc (where it is
beyond the control of the contractor). In such a situation the contractor has to satisfy the
contractee that the increased utilization is not due to his inefficiency.
(c) Sales and Lease Back: Under this type of lease, the owner of an asset sells the asset to
a party (the buyer), who in turn leases back the same asset to the owner in consideration
of a lease rentals. Under this arrangement, the asset is not physically exchanged but it
all happen in records only. The main advantage of this method is that the lessee can
satisfy himself completely regarding the quality of an asset and after possession of
the asset convert the sale into a lease agreement.
(d) Miller – Orr Cash Management Model: According to this model the net cash flow is
completely stochastic. When changes in cash balance occur randomly, the application of
control theory serves a useful purpose. The Miller – Orr model is one of such control limit
models. This model is designed to determine the time and size of transfers between an
investment account and cash account. In this model control limits are set for cash balances.
These limits may consist of ‘h’ as upper limit, ‘z’ as the return point and zero as the lower
limit.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

h
Upper Control Limit
Cash Balance (Rs.)

Z
Return Point

0
Time Lower Control Limit

MILLER-ORR CASH MANAGEMENT MODEL

When the cash balance reaches the upper limit, the transfer of cash equal to ‘h – z’ is
invested in marketable securities account. When it touches the lower limit, a transfer from
marketable securities account to cash account is made. During the period when cash balance
stays between (h, z) and (z, 0) i.e. high and low limits, no transactions between cash and
marketable securities account is made. The high and low limits of cash balance are set up on
the basis of fixed cost associated with the securities transaction, the opportunities cost of
holding cash and degree of likely fluctuations in cash balances. These limits satisfy the
demands for cash at the lowest possible total costs.
Question 6
(a) A machine shop cost centre contains three machines of equal capacities. Three
operators are employed on each machine, payable ` 20 per hour each. The factory
works for 48 hours in a week which includes 4 hours set up time. The work is jointly done
by operators. The operators are paid fully for the 48 hours. In addition, they are also paid
a bonus of 10% of productive time. Costs are reported for this company on the basis of
thirteen, four-weekly period.
The company, for the purpose of computing machine hour rate includes the direct wages
of the operator and also recoups the factory overheads allocated to the machines. The
following details of factory overheads applicable to the cost centres are available:
Original Cost of each machine - ` 52,000
Depreciation on the original cost of the machine -` 10% p.a.
Maintenance & Repair per week per machine - ` 60
Consumable Stores per week per machine - ` 75
Power: 20 units per hour per machine - 80 paise per unit

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

Apportionment to the cost centre:

Rent per annum ` 5,400
Heat and Light per annum ` 9,720
Foreman's Salary per annum ` 12,960
Calculate:
(i) the cost of running one machine for a four week period.
(ii) machine hour rate. (8 Marks)
(b) The following information is provided by the DVP Ltd. for the year ending 31 st March, 2015.
Raw Material storage period 50 days
Work in progress conversion period 18 days
Finished Goods storage period 22 days
Debt Collection period 45 days
Creditors' payment period 55 days
Annual Operating Cost ` 21 Lacs
(Including depreciation of ` 2,10,000)
(1 year = 360 days)
You are required to calculate:
(i) Operating Cycle period.
(ii) Number of Operating Cycles in a year.
(iii) Amount of working capital required for the company on a cash cost basis.
(iv) The company is a market leader in its product, there is virtually no competitor in the
market. Based on a market research, it is planning to discontinue sales on credit
and deliver products based on pre-payments. Thereby, it can reduce its working
capital requirement substantially. What would be the reduction in working capital
requirement due to such decision? (8 Marks)
Answer
(a) Effective Machine hour for four-week period
= Total working hours – unproductive set-up time
= {(48 hours × 4 weeks) – {(4 hours × 4 weeks)}
= (192 – 16) hours ) =176 hours.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

(i) Computation of cost of running one machine for a four week period
(`) (`)
(A) Standing charges (per annum)
Rent 5,400.00
Heat and light 9,720.00
Forman’s salary 12,960.00
Standing charges (per annum) 28,080.00 720.00
Total expenses for one machine for four week
 ` 28,080 
period  
 3machines  13 four  week period 
Wages (48 hours × 4 weeks × ` 20 × 3 operators) ÷ 3 3,840.00
machines)
Bonus (176 hours × ` 20 × 3 operators) ÷ 3 352.00
machines) 10%
Total standing charges 4,912.00
(B) Machine Expenses
Depreciation
 1  400.00
=  ` 52,000 × 10% × 
 13 four - week period 

Repairs and maintenance (`60  4 weeks) 240.00

Consumable stores (` 75  4 weeks) 300.00
Power (176 hours  20 units  ` 0 .80) 2,816.00
Total machine expenses 3,756.00
(C) Total expenses (A) + (B) 8,668.00
` 8,668
(ii) Machine hour rate =  `49.25
176hours

If we assume that there are three different operators for three machines i.e. 9
operators, in that case Wages will be `11,520 (48 hours × 4 weeks × ` 20 × 3
operators), Bonus will be `1,056 (176 hours × ` 20 × 3 operators 10%) and
`17,052
accordingly the Machine hour rate will be = ` 96.89
176hours

© The Institute of Chartered Accountants of India

70 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

(b) (i) Calculation of Operating Cycle Period

Operating Cycle Period = R + W + F + D – C
= 50 + 18 + 22 + 45 – 55 = 80 days
(ii) Number of Operating Cycle in a Year
360
=
Operating Cycle Period

360
= = 4.5
80
(iii) Amount of Working Capital Required
Annual Operating Cost (` 21,00,000  ` 2,10,000)
= =
Number of Operating Cycle 4.5

18,90,000
= = 4,20,000
4.5
(iv) Reduction in Working Capital
Operating Cycle Period = R + W + F – C
= 50 + 18 + 22 – 55= 35 days
18,90,000
Amount of Working Capital Required = × 35 = 1,83,750
360
Reduction in Working Capital = 4,20,000 – 1,83,750 = 2,36,250
Question 7
Answer any four of the following:
(a) Define 'Cost Centre' and state its types.
(b) State benefits of Integrated Accounting.
(c) Differentiate between 'Factoring' and 'Bill discounting'.
(d) Discuss the conflicts in Profit versus Wealth maximization principle of the firm.
(e) Define 'Present Value' and 'Perpetuity'. (4 x 4 = 16 Marks)
Answer
(a) It is defined as a location, person or an item of equipment (or group of these) for which
cost may be ascertained and used for the purpose of Cost Control.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 71

Cost Centres are of two types,

 Personal Cost Centre: It consists of a person or group of persons e.g. Mr. X,
supervisor, foreman, accountant, engineer, process staffs, mining staffs, doctors
etc.
 Impersonal Cost Centre: It consists of a location or an item of equipment (or group
of these) e.g. Ludhiana branch, boiler house, cooling tower, weighing machine,
canteen, and generator set etc.
In a manufacturing concern there are two types of cost centres viz., Production and
Service cost centres.
(b) The main advantages of Integrated Accounting are as follows:
 No need for Reconcilation: The question of reconciling costing profit and financial
profit does not arise, as there is only one figure of profit.
 Less efforts: Due to use of one set of books, there is significant saving in efforts
made.
 Less time consuming: No delay is caused in obtaining information provided in
books of original entry.
 Economical Process: It is economical also as it is based on the concept of
‘Centralization of Accounting Function’
(c) Differentiation between Factoring and Bills Discounting
The differences between Factoring and Bills discounting are:
(a) Factoring is called as “Invoice Factoring’ whereas Bills discounting is known as
‘Invoice discounting.”
(b) In Factoring, the parties are known as the client, factor and debtor whereas in Bills
discounting, they are known as drawer, drawee and payee.
(c) Factoring is a sort of management of book debts whereas bills discounting is a sort
of borrowing from commercial banks.
(d) For factoring there is no specific Act, whereas in the case of bills discounting, the
Negotiable Instruments Act is applicable.
(d) Conflict in Profit versus Wealth Maximization Principle of the Firm: Profit
maximisation is a short-term objective and cannot be the sole objective of a company. It
is at best a limited objective. If profit is given undue importance, a number of problems
can arise like the term profit is vague, profit maximisation has to be attempted with a
realisation of risks involved, it does not take into account the time pattern of returns and
as an objective it is too narrow.
Whereas, on the other hand, wealth maximisation, as an objective, means that the
company is using its resources in a good manner. If the share value is to stay high, the

© The Institute of Chartered Accountants of India

72 INTERMEDIATE (IPC) EXAMINATION: MAY, 2015

company has to reduce its costs and use the resources properly. If the company follows
the goal of wealth maximisation, it means that the company will promote only those
policies that will lead to an efficient allocation of resources.
(e) Present Value: Present Value” is the current value of a “Future Amount”. It can also be
defined as the amount to be invested today (Present Value) at a given rate over specified
period to equal the “Future Amount”.
Perpetuity: Perpetuity is an annuity in which the periodic payments or receipts begin on
a fixed date and continue indefinitely or perpetually. Fixed coupon payments on
permanently invested (irredeemable) sums of money are prime examples of perpetuities.

© The Institute of Chartered Accountants of India

DISCLAIMER
The Suggested Answers hosted in the website do not constitute the basis for evaluation of the
students’ answers in the examination. The answers are prepared by the Faculty of the Board
of Studies with a view to assist the students in their education. While due care is taken in
preparation of the answers, if any errors or omissions are noticed, the same may be brought to
the attention of the Director of Studies. The Council of the Institute is not in anyway
responsible for the correctness or otherwise of the answers published herein.

© The Institute of Chartered Accountants of India

PAPER – 3: COST ACCOUNTING AND FINANCIAL MANAGEMENT
Question No. 1 is compulsory.
Answer any five questions from the remaining six questions.
Working notes should form part of the answers.
Question 1
Answer the following:
(a) Following details are related to a manufacturing concern:
Re-order Level 1,60,000 units
Economic Order Quantity 90,000 units
Minimum Stock Level 1,00,000 units
Maximum Stock Level 1,90,000 units
Average Lead Time 6 days
Difference between minimum lead time and Maximum lead time 4 days
Calculate:
(i) Maximum consumption per day
(ii) Minimum consumption per day
(b) Zed Limited sells its product at ` 30 per unit. During the quarter ending on 31st March,
2014, it produced and sold 16,000 units and suffered a loss of ` 10 per unit. If the
volume of sales is raised to 40,000 units, it can earn a profit of ` 8 per unit.
You are required to calculate:
(i) Break Even Point in Rupees.
(ii) Profit if the sale volume is 50,000 units.
(iii) Minimum level of production where the company needs not to close the production if
unavoidable fixed cost is ` 1,50,000.
(c) Alpha Limited requires funds amounting to ` 80 lakhs for its new project. To raise the
funds, the company has following two alternatives:
(i) to issue Equity Shares (at par) amounting to ` 60 lakhs and borrow the balance
amount at the interest of 12% p.a.; or
(ii) to issue Equity Shares (at par) and 12% Debentures in equal proportion.
The Income-tax rate is 30%.
Find out the point of indifference between the available two modes of financing and state
which option will be beneficial in different situations.

© The Institute of Chartered Accountants of India

(d) 'A' Ltd. and 'B' Ltd. are identical in every respect except capital structure. 'A' Ltd. does
not employ debts in its capital structure whereas 'B' Ltd. employs 12% Debentures
amounting to ` 10 lakhs. Assuming that :
(i) All assumptions of M-M model are met;
(ii) Income-tax rate is 30%;
(iii) EBIT is ` 2,50,000 and
(iv) The Equity capitalization rate of ‘A' Ltd. is 20%.
Calculate the value of both the companies and also find out the Weighted Average Cost
of Capital for both the companies. (4 x 5 = 20 Marks)
Answer
(a) Difference between Minimum lead time Maximum lead time = 4 days
Max. lead time – Min. lead time = 4 days
Or, Max. lead time = Min. lead time + 4 days.............................................(i)
Average lead time is given as 6 days i.e.
Max.lead time + Min.lead time
= 6 days.......................................................(ii)
2
Putting the value of (i) in (ii),
Min. lead time + 4 days + Min.lead time
= 6 days
2
Or, Min. lead time + 4 days + Min. lead time = 12 days
Or, 2 Min. lead time = 8 days
8days
Or, Minimum lead time = = 4 days
2
Putting this Minimum lead time value in (i), we get
Maximum lead time = 4 days + 4 days = 8 days
(i) Maximum consumption per day:
Re-order level = Max. Re-order period × Maximum Consumption per day
1,60,000 units = 8 days × Maximum Consumption per day
1,60,000units
Or, Maximum Consumption per day = = 20,000 units
8days
(ii) Minimum Consumption per day:
Maximum Stock Level =

© The Institute of Chartered Accountants of India

Re-order level + Re-order Quantity – (Min. lead time × Min. Consumption per day)
Or, 1,90,000 units = 1,60,000 units + 90,000 units – (4 days × Min. Consumption per day)
Or, 4 days × Min. Consumption per day = 2,50,000 units – 1,90,000 units
60,000 units
Or, Minimum Consumption per day = = 15,000 units
4 days
(b)
Units sold Sales value (`) Profit/ (loss) (`)
16,000 units 4,80,000 (1,60,000)
(` 30 × 16,000 units) (` 10 × 16,000 units)
40,000 units 12,00,000 3,20,000
(` 30 × 40,000 units) (` 8 × 40,000 units)

Change inprofit ` 3,20,000 − ( − ` 1,60,000)

P/V Ratio = ×100 = ×100
Change insales value ` 12,00,000 −` 4,80,000
` 4,80,000
= ×100 = 66.67%
` 7,20,000
Total Contribution in case of 40,000 units = Sales Value × P/V Ratio
= ` 12,00,000 × 66.67%
= ` 8,00,000
So, Fixed cost = Contribution – Profit
= ` 8,00,000 – ` 3,20,000
= ` 4,80,000
FixedCost
(i) Break-even Point in Rupees =
P / V Ratio

` 4,80,000
= = ` 7,20,000
66.67%
(ii) If sales volume is 50,000 units, then profit = Sales Value × P/V Ratio – Fixed Cost
= (50,000 units× ` 30×66.67% - ` 4,80,000)
= ` 5,20,000
(iii) Minimum level of production where the company needs not to close the production,
if unavoidable fixed cost is ` 1,50,000:

© The Institute of Chartered Accountants of India

Avoidable fixedcos t
=
Contributionper unit
Totalfixedcos t − Unavoidable fixedcos t
=
Contributionper unit
` 4,80,000 −` 1,50,000
=
` 30 × 66.67%
` 3,30,000
= = 16,500 units.
` 20

At production level of ≥ 16,500 units, company needs not to close the production.
(c) (i) (Note: The par value of equity share is assumed to be `100)
Amount = ` 80 Lakhs
Plan I = Equity of ` 60 lakhs + Debt of ` 20 lakhs
Plan II = Equity of ` 40 lakhs + Debentures of ` 40 Lakhs.
Plan I: Interest Payable on Loan
= 0.12 x 20,00,000 = 2,40,000
Plan II: Interest Payable on Debentures
= 0.12 x 40,00,000 = 4,80,000
Computation of Point of Indifference

(EBIT - I) (I - t ) = (EBIT - I ) (I - t )
2

E E
1 2

(EBIT - 2,40,000 ) (1- 0.3 )

=
(EBIT - 4,80,000 ) (I - 0.3 )
60,000 40,000
2 (EBIT – 2,40,000) = 3(EBIT – 4,80,000)
2 EBIT – 4,80,000 = 3 EBIT – 14,40,000
2 EBIT – 3 EBIT = -14,40,000 + 4,80,000
EBIT = 9,60,000

© The Institute of Chartered Accountants of India

(ii) Earnings per share (EPS) under Two Situations for both the Plans
Situation A (EBIT is assumed to be ` 9,50,000)
Particulars Plan I Plan II
EBIT 9,50,000 9,50,000
Less: Interest @ 12% 2,40,000 4,80,000
EBT 7,10,000 4,70,000
Less: Taxes @ 30% 2,13,000 1,41,000
EAT 4,97,000 3,29,000
No. of Equity Shares 60,000 40,000
EPS 8.28 8.23
Comment: In Situation A, when expected EBIT is less than the EBIT at indifference
point then, Plan I is more viable as it has higher EPS. The advantage of EPS would be
available from the use of equity capital and not debt capital.
Situation B (EBIT is assumed to be ` 9,70,000)
Particulars Plan I Plan II
EBIT 9,70,000 9,70,000
Less: Interest @ 12% 2,40,000 4,80,000
EBT 7,30,000 4,90,000
Less: Taxes @ 30% 2,19,000 1,47,000
EAT 5,11,000 3,43,000
No. of Equity Shares 60,000 40,000
EPS 8.52 8.58
Comment: In Situation B, when expected EBIT is more than the EBIT at indifference
point then, Plan II is more viable as it has higher EPS. The use of fixed-cost source of
funds would be beneficial from the EPS viewpoint. In this case, financial leverage would
be favourable.
(Note: The problem can also be worked out assuming any other figure of EBIT
which is more than 9,60,000 and any other figure less than 9,60,000. Alternatively,
the answer may also be based on the factors/governing the capital structure like the
cost, risk, control, etc. Principles).
(d) (i) Calculation of Value of Firms ‘A Ltd.’ and ‘B Ltd’ according to MM Hypothesis
Market Value of ‘A Ltd’ (Unlevered)
EBIT (1 - t )
Vu =
K
e

© The Institute of Chartered Accountants of India

2,50,000 (1 - 0.30 )
=
20%
1,75,000
= = ` 8,75,000
20%
Market Value of ‘B Ltd.’ (Levered)

V E = V u + DT
= 8,75,000 + (10,00,000 x 0.30)
= 8,75,000 + 3,00,000 = ` 11,75,000
(ii) Computation of Weighted Average Cost of Capital (WACC)
WACC of ‘A Ltd.’ = 20% (Ke =Ko)
WACC of ‘B Ltd.’
B Ltd.
EBIT 2,50,000
Interest to Debt holders (1,20,000)
EBT 1,30,000
Taxes @ 30% (39,000)
Income available to Equity Shareholders 91,000
Total Value of Firm 11,75,000
Less: Market Value of Debt (10,00,000)
Market Value of Equity 1,75,000
Ke = 91,000 / 1,75,000 0.52
For Computation of WACC B. Ltd
Component of Costs Amount Weight Cost of Capital WACC
Equity 1,75,000 0.149 0.52 0.0775
Debt 10,00,000 0.851 0.084* 0.0715
11,75,000 WACC 0.1490
Kd= 12% (1- 0.3) = 12% x 0.7 = 8.4%
WACC = 14.90%
Question 2
(a) Z Limited obtained a contract No. 999 for ` 50 lacs. The following details are available in
respect of this contract for the year ended March 31, 2014:

© The Institute of Chartered Accountants of India

`
Materials purchased 1,60,000
Materials issued from stores 5,00,000
Wages and salaries paid 7,00,000
Drawing and maps 60,000
Sundry expenses 15,000
Electricity charges 25,000
Plant hire expenses 60,000
Sub-contract cost 20,000
Materials returned to stores 30,000
Materials returned to suppliers 20,000
The following balances relating to the contract No. 999 for the year ended on March 31,
2013 and March 31, 2014 are available:
as on 31st March, 2013 as on 31st March, 2014
Work certified 12,00,000 35,00,000
Work uncertified 20,000 40,000
Materials at site 15,000 30,000
Wages outstanding 10,000 20,000
The contractor receives 75% of work certified in cash.
Prepare Contract Account and Contractee's Account. (8 Marks)
(b) Balance Sheets of Star Ltd. are as under:
Balance Sheet (in lakh `)
Liabilities 31/03/13 31/03/1 Assets 31/03/13 31/03/14
` 4` ` `
Share Capital 24.00 30.00 Plant & Machinery 15.00 21.00
Reserve 4.50 6.00 Buildings 12.00 18.00
Profit & Loss A/c 1.80 3.00 Investments - 3.00
Debentures - 6.00 Sundry Debtors 21.00 15.00
Provision for Taxation 2.10 3.00 Stock 6.00 12.00
Proposed Dividend 3.00 6.00 Cash in hand/Bank 6.00 6.00
Sundry Creditors 24.60 21.00
Total 60.00 75.00 60.00 75.00

© The Institute of Chartered Accountants of India

With the help of following additional information, prepare Cash Flow Statement:
(i) Depreciation on plant and machinery was charged @ 25% on its opening balance
and on building @ 10% on its opening balance.
(ii) During the year an old machine costing ` 1,50,000 (written down value ` 60,000)
was sold for ` 1,05,000.
(iii) ` 1,50,000 was paid towards Income-tax, during the year. (8 Marks)
Answer
(a) Contract No. 999 Account for the year ended 31st March, 2014
Dr. Cr.
Particulars Amount (`) Particulars Amount (`)
To Work in progress b/d: By Material returned to store 30,000
- Work certified 12,00,000 By Material returned to 20,000
suppliers
- Work uncertified 20,000 By Stock (Material) c/d 30,000
To Stock (Materials) b/d 15,000 By Work in progress c/d:
To Material purchased 1,60,000 - Work certified 35,00,000
To Material issued 5,00,000 - Work uncertified 40,000
To Wages paid 7,00,000
Less: Opening O/s (10,000)
Add: Closing O/s 20,000 7,10,000
To Drawing and maps* 60,000
To Sundry expenses 15,000
To Electricity charges 25,000
To Plant hire expenses 60,000
To Sub- contract cost 20,000
To Notional profit c/d
(balancing figure) 8,35,000
36,20,000 36,20,000
To Costing P& L A/c (W.N.-1) 4,17,500 By Notional profit b/d 8,35,000
To WIP Reserve (balancing figure) 4,17,500
8,35,000 8,35,000
*Assumed that expenses incurred for drawing and maps are used exclusively for this contract
only.

© The Institute of Chartered Accountants of India

Dr. Contractee’s Account Cr.
Particulars Amount (`) Particulars Amount (`)
To Balance c/d 26,25,000 By Balance b/d 9,00,000
(` 35,00,000 × 75%) (75% of ` 12,00,000)
By Bank A/c 17,25,000
26,25,000 26,25,000
Working Note:
1. Profit to be Transferred to Costing Profit & Loss account:
Work certfied
(a) Percentage of completion = x100
Value of contract
` 35,00,000
= x100 = 70%
` 50,00,000
(b) Profit to be transferred to Costing Profit & Loss Account
2 Cash received
= × Notional profit ×
3 Work certified
2 75
= × ` 8,35,000 × = ` 4,17,500
3 100
(b) Cash Flow Statement for the year ending on March 31, 2014
` in lakhs ` in lakhs
I. Cash flows from Operating Activities
Net profit made during the year (W.N.1) 8.70
Provision for taxation made during the year 2.40
Profit on sale of machinery (0.60)
Adjustment for depreciation on Machinery (W.N.2) 3.75
Adjustment for depreciation on Land & Building 1.20
Operating profit before change in Working Capital 15.45
Increase in inventory (6.00)
Decrease in Debtors 6.00
Decrease in Creditors (3.60)
Cash generated from operations 11.85
Income-tax paid (1.50)
Net cash from operating activities 10.35

© The Institute of Chartered Accountants of India

II. Cash flows from Investing Activities
Purchase of Machinery (10.20)
Sale of Machinery 1.05
Purchase of Building (7.20)
Purchase of investments (3.00)
(19.35)
III. Cash flows from Financing Activities
Issue of shares 6.00
Issue of debentures 6.00
Dividend paid (3.00) 9.00
Net increase in cash and cash equivalent Nil
Cash and cash equivalents at the beginning of the period 6.00
Cash and cash equivalents at the end of the period 6.00
Working Notes:
(i) Net Profit made during the year ended 31.3.2014
` in lakhs
Increase in P & L (Cr.) Balance 1.20
Add: Transfer to general reserve 1.50
Add: Provided for proposed dividend during the year 6.00
8.70
(ii) Plant & Machinery Account
` in lakhs ` in lakhs
To Balance b/d 15.00 By Depreciation 3.75
(Bal. Fig.)
[25% of 15 ]
To P& L A/c 0.60 By Cash/Bank A/c 1.05
[1.05 less 0.45 (0.60
less depreciation
0.15)]
To Cash/Bank 10.20 By Balance c/d 21.00
(balancing fig.)
25.80 25.80

© The Institute of Chartered Accountants of India

(iii) Provision for Taxation Account
` in lakhs ` in lakhs
To Cash/Bank (Bal. Fig.) 1.50 By Balance b/d 2.10
To Balance c/d 3.00 By P & L A/c 2.40
4.50 4.50
(iv) Proposed Dividend Account
` in lakhs ` in lakhs
To Bank 3.00* By Balance b/d 3.00
To Balance c/d 6.00 By P & L A/c (Bal. Fig.) 6.00
9.00 9.00
* last year proposed dividend assumed to be paid this year.
(v) Building Account
` in lakhs ` in lakhs
To Balance b/d 12.00 By Depreciation 1.20
To Bank A/c (Purchase) 7.20
By Balance c/d 18.00
19.20 19.20
Question 3
(a) RST Limited is presently operating at 50% capacity and producing 30,000 units. The
entire output is sold at a price of ` 200 per unit. The cost structure at the 50% level of
activity is as under:
`
Direct Material 75 per unit
Direct Wages 25 per unit
Variable Overheads 25 per unit
Direct Expenses 15 per unit
Factory Expenses (25% fixed) 20 per unit
Selling and Distribution Exp. (80% variable) 10 per unit
Office and Administrative Exp. (100% fixed) 5 per unit
The company anticipates that the variable costs will go up by 10% and fixed costs will go
up by 15%.

© The Institute of Chartered Accountants of India

You are required to prepare an Expense budget, on the basis of marginal cost for the
company at 50% and 60% level of activity and find out the profits at respective levels.
(8 Marks)
(b) From the following information, prepare Balance Sheet of a firm:
Stock Turnover Ratio (based on cost of goods sold) - 7 times
Rate of Gross Profit to Sales - 25%
Sales to Fixed Assets - 2 times
Average debt collection period - 1.5 months
Current Ratio - 2
Liquidity Ratio - 1.25
Net Working Capital - ` 8,00,000
Net Worth to Fixed Assets - 0.9 times
Reserve and Surplus to Capital - 0.25 times
Long Term Debts - Nil
All Sales are on credit basis. (8 Marks)
Answer
(a) Expense Budget of RST Ltd. for the period
Per unit 30,000 units 36,000 units
(`) Amount (`) Amount (`)
Sales (A) 200.00 60,00,000 72,00,000
Less: Variable Costs:
- Direct Material 82.50 24,75,000 29,70,000
- Direct Wages 27.50 8,25,000 9,90,000
- Variable Overheads 27.50 8,25,000 9,90,000
- Direct Expenses 16.50 4,95,000 5,94,000
- Variable factory expenses 16.50 4,95,000 5,94,000
(75% of ` 20 p.u.)
- Variable Selling & Dist. exp. 8.80 2,64,000 3,16,800
(80% of ` 10 p.u.)
Total Variable Cost (B) 179.30 53,79,000 64,54,800
Contribution (C) = (A – B) 20.70 6,21,000 7,45,200

© The Institute of Chartered Accountants of India

Less: Fixed Costs:
- Office and Admin. exp. (100%) -- 1,72,500 1,72,500
- Fixed factory exp. (25%) -- 1,72,500 1,72,500
- Fixed Selling & Dist. exp. (20%) -- 69,000 69,000
Total Fixed Costs (D) -- 4,14,000 4,14,000

Profit (C – D) -- 2,07,000 3,31,200

(b) Working Notes;
1. Net Working Capital = Current Assets – Current Liabilities
=2-1=1
Net Working Capital × 2
Current Assets =
1
8,00,000 × 2
=
1
Current Assets =16,00,000
Current Liabilities = 16,00,000 – 8,00,000 = 8,00,000
Liquid Assets
2. Liquid Ratio =
Current Liabilities
Current Assets - Stock
1.25 =
Current Liabilities
16,00,000 - Stock
1.25 =
8,00,000
1.25 x 8,00,000 = 16,00,000 – Stock
10,00,000 = 16,00,000 – Stock
Stock = 6,00,000
Liquid Assets = 1.25 x 8,00,000 = 10,00,000
COGS
3. Stock Turnover Ratio =
Stock
COGS
7=
6,00,000
COGS = 42,00,000

© The Institute of Chartered Accountants of India

4. Sales – Gross Profit = COGS
Gross Profit
= 25%
Sales
Gross Profit = 25% Sales
Sales – 25% Sales = COGS
42,00,000
Sales = = 56,00,000
0.75
12
5. Debtors turnover Ratio = =8
1.5
Credit Sales
Debtors =
Debtors Turnover
56,00,000
= = 7,00,000
8
Sales
6. =2
Fixed Assets
56,00,000
Fixed Assets = = 28,00,000
2
7. Net worth = Fixed Assets + Current Assets – Long-term Debt – Current Liabilities
= 28,00,000 + 16,00,000 – 0 – 8,00,000
= 36,00,000
Reserves & Surplus
8. = 0.25
Capital
Net worth = Reserves and Surplus + Capital
36,00,000
Capital = = 28,80,000
1.25
Reserves and Surplus = 0.25 x 28,80,000
= 7,20,000

9. Cash = Liquid Assets – Debtors

= 10,00,000 – 7,00,000 = 3,00,000
10. Long Term Debts = Nil

© The Institute of Chartered Accountants of India

Draft Balance Sheet
Liabilities ` Assets `
Share Capital 28,80,000 Fixed Assets 28,00,000
Reserves and Surplus 7,20,000 Current Assets:
Long Term Debts - Stock 6,00,000
Current Liabilities 8,00,000 Debtors 7,00,000
- Cash 3,00,000
44,00,000 44,00,000
(Note: The above solution has been worked out by ignoring the Net worth to Fixed
assets ratio given in the question in order to match the total of assets and liabilities in the
Balance Sheet).
Question 4
(a) Following information have been extracted from the cost records of XYZ Pvt. Ltd:
`
Stores:
Opening balance 54,000
Purchases 2,88,000
Transfer from WIP 1,44,000
Issue to WIP 2,88,000
Issue for repairs 36,000
Deficiency found in stock 10,800

Work-in-progress: `
Opening balance 1,08,000
Direct wages applied 1,08,000
Overheads charged 4,32,000
Closing balance 72,000

Finished Production: `
Entire production is sold at a profit of 15% on cost at WIP
Wages paid 1,26,000
Overheads incurred 4,50,000
Draw the Stores Ledger Control Account, Work-in-Progress Control Account, Overheads
Control Account and Costing Profit and Loss Account. (8 Marks)

© The Institute of Chartered Accountants of India

(b) The Capital structure of RST Ltd. is as follows:
`
Equity Share of ` 10 each 8,00,000
10% Preference Share of ` 100 each 5,00,000
12% Debentures of ` 100 each 7,00,000
20,00,000
Additional Information:
- Profit after tax (Tax Rate 30%) are ` 2,80,000
- Operating Expenses (including Depreciation ` 96,800) are 1.5 times of EBIT
- Equity Dividend paid is 15%
- Market price of Equity Share is ` 23
Calculate:
(i) Operating and Financial Leverage
(ii) Cover for preference and equity dividend
(iii) The Earning Yield Ratio and Price Earning Ratio
(iv) The Net Fund Flow
Note: All operating expenses (excluding depreciation) are variable. (8 Marks)
Answer
(a) Stores Ledger Control A/c
Particulars (`) Particulars (`)
To Balance b/d 54,000 By Work in Process A/c 2,88,000
To General Ledger 2,88,000 By Overhead Control A/c 36,000
Adjustment A/c By Overhead Control A/c 10,800*
To Work in Process A/c 1,44,000 (Deficiency)
By Balance c/d 1,51,200
4,86,000 4,86,000
*Deficiency assumed as normal (alternatively can be treated as abnormal loss)

© The Institute of Chartered Accountants of India

Work in Progress Control A/c
Particulars (`) Particulars (`)
To Balance b/d 1,08,000 By Stores Ledger Control a/c 1,44,000
To Stores Ledger Control A/c 2,88,000 By Costing P/L A/c 7,20,000
To Wages Control A/c 1,08,000 (Balancing figures being Cost
To Overheads Control a/c 4,32,000 of finished goods)
By Balance c/d 72,000
9,36,000 9,36,000
Overheads Control A/c
Particulars (`) Particulars (`)
To Stores Ledger Control A/c 36,000 By Work in Process A/c 4,32,000
To Stores Ledger Control A/c 10,800 By Balance c/d 82,800
To Wages Control A/c 18,000 (Under absorption)
(`1,26,000- `1,08,000)
To Gen. Ledger Adjust. A/c 4,50,000
5,14,800 5,14,800
Costing Profit & Loss A/c
Particulars (`) Particulars (`)
To Work in progress 7,20,000 By Gen. Ledger Adjust. A/c 8,28,000
To Gen. Ledger Adjust. A/c 1,08,000 (Sales) (` 7,20,000 × 115%)
(Profit)
8,28,000 8,28,000
(b) Working Notes:
`
Net Profit after Tax 2,80,000
Tax @ 30% 1,20,000
EBT 4,00,000
Interest on Debentures 84,000
EBIT 4,84,000
Operating Expenses (1.5 times of EBIT) 7,26,000
Sales 12,10,000

© The Institute of Chartered Accountants of India

(i) Operating Leverage
Contribution
=
EBIT
(12,10,000 - 6,29,200)
=
4,84,000
5,80,800
= =1.2 times
4,84,000
EBIT
Financial Leverage =
EBT
4,84,000
=
4,00,000
= 1.21 times
OR
EBIT
Financial Leverage =
 Preference Dividend 
EBT -  
 1- t 
4,84,000
=
 50,000 
4,00,000 -  
 1- 0.30 
4,84,000
=
4,00,000 - 71,428.57
4,84,000
= =1.47 times
3,28,571
(ii) Cover for Preference Dividend
PAT
=
Preference Share Dividend
2,80,000
= = 5.6 times
50,000

© The Institute of Chartered Accountants of India

Cover for Equity Dividend
(PAT - Preference Dividend)
=
Equity Share Dividend

(2,80,000 - 50,000)
=
1,20,000
2,30,000
= = 1.92 times
1,20,000
(iii) Earning Yield Ratio
EPS
= × 100
Market Price

 
 2,30,000 
= × 100 
80,000
 
 23 
2.875
= × 100 =12.5%
23
Price – Earnings Ratio (PE Ratio)
Market Price 23
= =
EPS 2.875
= 8 times
(iv) Net Funds Flow
= Net PAT + Depreciation-Total Dividend
= 2,80,000 + 96,800 – (50,000 + 1,20,000)
= 3,76,800 – 1,70,000
Net Funds Flow = 2,06,800
Question 5
(a) Identify the methods of costing for the following:
(i) Where all costs are directly charged to a specific job.
(ii) Where all costs are directly charged to a group of products.

© The Institute of Chartered Accountants of India

(iii) Where cost is ascertained for a single product.
(iv) Where the nature of the product is complex and method can not be ascertained.
(b) Explain the treatment of over and under absorption of overheads in cost accounts.
(c) Explain four kinds of float with reference to management of cash.
(d) Distinguish between ‘Operating Lease’ and ‘Financial Lease’. (4 x 4 = 16 Marks)
Answer
(a)
Sl. No. Method of Costing
(i) Job Costing
(ii) Batch Costing
(iii) Unit Costing or Single or Output Costing
(iv) Multiple Costing
(b) Treatment of over and under absorption of overheads are:-
(i) Writing off to costing P&L A/c:– Small difference between the actual and absorbed
amount should simply be transferred to costing P&L A/c, if difference is large then
investigate the causes and after that abnormal loss/ gain shall be transferred to
costing P&L A/c.
(ii) Use of supplementary Rate: Under this method the balance of under and over
absorbed overheads may be charged to cost of W.I.P., finished stock and cost of
sales proportionately with the help of supplementary rate of overhead.
(iii) Carry Forward to Subsequent Year: Difference should be carried forward in the
expectation that next year the position will be automatically corrected.
(c) Four Kinds of Float with reference to Management of Cash
The four kinds of float are:
(i) Billing Float: The time between the sale and the mailing of the invoice is the billing
float.
(ii) Mail Float: This is the time when a cheque is being processed by post office,
messenger service or other means of delivery.
(iii) Cheque processing float: This is the time required for the seller to sort, record and
deposit the cheque after it has been received by the company.
(iv) Bank processing float: This is the time from the deposit of the cheque to the
crediting of funds in the seller’s account.

© The Institute of Chartered Accountants of India

(d) Difference between Financial Lease and Operating Lease
S.No. Finance Lease Operating Lease
1. The risk and reward incident to The lessee is only provided the use
ownership are passed on the of the asset for a certain time. Risk
lessee. The lessor only remains the incident to ownership belongs only
legal owner of the asset. to the lessor.
2. The lessee bears the risk of The lessor bears the risk of
obsolescence. obsolescence.
3. The lease is non-cancellable by The lease is kept cancellable by the
either party under it. lessor.
4. The lessor does not bear the cost of Usually, the lessor bears the cost of
repairs, maintenance or operations. repairs, maintenance or operations.
5. The lease is usually full payout. The lease is usually non-payout.
(Note: Students may answer any four of the above differences)
Question 6
(a) PQR Ltd. having an annual sales of ` 30 lakhs, is re-considering its present collection
policy. At present, the average collection period is 50 days and the bad debt losses are
5% of sales. The company is incurring an expenditure of ` 30,000 on account of
collection of receivables.
The alternative policies are as under:
Alternative I Alternative II
Average Collection Period 40 days 30 days
Bad Debt Losses 4% of sales 3% of sales
Collection Expenses ` 60,000 ` 95,000
Evaluate the alternatives on the basis of incremental approach and state which
alternative is more beneficial. (8 Marks)
(b) The following information relate to Process A:
(i) Opening Work-in-Progress 8,000 units at ` 75,000
Degree of Completion:
Material 100%
Labour and Overhead 60%
(ii) Input 1,82,000 units at ` 7,37,500
(iii) Wages paid ` 3,40,600
(iv) Overheads paid ` 1,70,300

© The Institute of Chartered Accountants of India

(v) Units scrapped 14,000
Degree of Completion:
Material 100 %
Wages and Overheads 80%
(vi) Closing Work - in- Progress 18,000 units
Degree of Completion:
Material 100%
Wages and Overheads 70%
(vii) Units completed and transferred 1,58,000 to next process
(viii) Normal loss 5% of total input including opening WIP
(ix) Scrap value is ` 5 per unit to be adjusted out of direct material cost
You are required to compute on the basis of FIFO basis:
(i) Equivalent Production
(ii) Cost Per Unit
(iii) Value of Units transferred to next process. (8 Marks)
Answer
(a) Evaluation of Alternative Collection Programmes
Present Policy Alternative I Alternative II
` ` `
Sales Revenues 30,00,000 30,00,000 30,00,000
Average Collection Period (ACP) (days) 50 40 30
Receivables 4,16,667 3,33,333 2,50,000
 ACP 
(`)  Sales × 
 360 
Reduction in Receivables from Present
Level (`) − 83,334 1,66,667
Savings in Interest @ 10% p.a. (A) − ` 8,333 ` 16,667
% of Bad Debt Loss 5% 4% 3%
Amount (`) 1,50,000 1,20,000 90,000
Reduction in Bad Debts from Present
Level (B) − 30,000 60,000

© The Institute of Chartered Accountants of India

Incremental Benefits from Present
Level (C) = (A) + (B) − 38,333 76,667
Collection Expenses (`) 30,000 60,000 95,000
Incremental Collection Expenses from
Present Level (D) − 30,000 65,000
Incremental Net Benefit (C – D) − ` 8,333 ` 11,667
Conclusion: From the analysis it is apparent that Alternative I has a benefit of ` 8,333
and Alternative II has a benefit of ` 11,667 over present level. Alternative II has a benefit
of ` 3,334 more than Alternative I. Hence Alternative II is more viable.
(Note: In absence of Cost of Sales, sales has been taken for purpose of calculating
investment in receivables. Cost of Funds has been assumed to be 10%. 1 year = 360 days.)
(b) (i) Statement of Equivalent Production
(FIFO Method)
Input Output Equivalent Production
Particulars Units Particulars Units Material Labour & Overheads
(%) Units (%) Units
Opening WIP 8,000 Transfer to next Process :
Introduced 1,82,000 Opening WIP completed 8,000 -- -- 40 3,200
Introduced & completed 1,50,000 100 1,50,000 100 1,50,000
Normal loss 9,500 -- -- -- --
5% (8,000 + 182,000)
Abnormal loss 4,500 100 4,500 80 3,600
Closing WIP 18,000 100 18,000 70 12,600
1,90,000 1,90,000 1,72,500 1,69,400

(ii) Computation of Cost per unit

Particulars Materials Labour Overhead
(`) (`) (`)
Input of Materials 7,37,500 -- --
Expenses -- 3,40,600 1,70,300
Total 7,37,500 3,40,600 1,70,300
Less : Sale of Scrap (9,500 units x ` 5 ) (47,500) -- --
Net cost 6,90,000 3,40,600 1,70,300
Equivalent Units 1,72,500 1,69,400 1,69,400
Cost Per Unit 4.0000 2.0106 1.0053
Total cost per unit = ` (4.0000 + 2.0106 + 1.0053) = ` 7.0159

© The Institute of Chartered Accountants of India

(iii) Value of units transferred to next process:
Amount (`) Amount (`)
Opening W-I-P 75,000
Add: Labour (3,200 units × ` 2.0106) 6,434
Overhead (3,200 units × ` 1.0053) 3,217 84,651
New introduced (1,50,000 units × ` 7.0159) 10,52,385
11,37,036
Question 7
Answer any four of the following:
(a) Why money in the future is worth less than similar money today? Give the reasons and
explain.
(b) Distinguish between 'Business Risk' and 'Financial Risk'.
(c) What is 'Internal Rate of Return'? Explain.
(d) State the different types of Packing Credit.
(e) Define ‘Labour Turnover’. How is it measured? Explain. (4 x 4 = 16 Marks)
Answer
(a) Money in the Future is worth less than the Similar Money Today due to several reasons:
 Risk − There is uncertainty about the receipt of money in future.
 Preference For Present Consumption − Most of the persons and companies in
general, prefer current consumption over future consumption.
 Inflation − In an inflationary period a rupee today represents a greater real
purchasing power than a rupee a year hence.
 Investment Opportunities − Most of the persons and companies have a
preference for present money because of availabilities of opportunities of
investment for earning additional cash flow.
(b) Business Risk and Financial Risk: Business risk refers to the risk associated with the
firm’s operations. It is an unavoidable risk because of the environment in which the firm
has to operate and the business risk is represented by the variability of earnings before
interest and tax (EBIT). The variability in turn is influenced by revenues and expenses.
Revenues and expenses are affected by demand of firm’s products, variations in prices
and proportion of fixed cost in total cost.
Whereas, Financial risk refers to the additional risk placed on firm’s shareholders as a
result of debt use in financing. Companies that issue more debt instruments would have

© The Institute of Chartered Accountants of India

higher financial risk than companies financed mostly by equity. Financial risk can be
measured by ratios such as firm’s financial leverage multiplier, total debt to assets ratio
etc.
(c) Internal Rate of Return: It is that rate at which discounted cash inflows are equal to the
discounted cash outflows. It can be stated in the form of a ratio as follows:
Cash inflows
=1
Cash Outflows
This rate is to be found by trial and error method. This rate is used in the evaluation of
investment proposals. In this method, the discount rate is not known but the cash
outflows and cash inflows are known.
In evaluating investment proposals, internal rate of return is compared with a required
rate of return, known as cut-off rate. If it is more than cut-off rate the project is treated as
acceptable; otherwise project is rejected.
(d) Different Types of Packing Credit
Packing credit may be of the following types:
(i) Clean Packing credit: This is an advance made available to an exporter only on
production of a firm export order or a letter of credit without exercising any charge
or control over raw material or finished goods. It is a clean type of export advance.
Each proposal is weighted according to particular requirements of the trade and
credit worthiness of the exporter. A suitable margin has to be maintained. Also,
Export Credit Guarantee Corporation (ECGC) cover should be obtained by the
bank.
(ii) Packing credit against hypothecation of goods: Export finance is made available
on certain terms and conditions where the exporter has pledgeable interest and the
goods are hypothecated to the bank as security with stipulated margin. At the time
of utilising the advance, the exporter is required to submit alongwith the firm export
order or letter of credit, relative stock statements and thereafter continue submitting
them every fortnight and whenever there is any movement in stocks.
(iii) Packing credit against pledge of goods: Export finance is made available on
certain terms and conditions where the exportable finished goods are pledged to the
banks with approved clearing agents who will ship the same from time to time as
required by the exporter. The possession of the goods so pledged lies with the bank
and is kept under its lock and key.
(iv) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture,
processing, purchasing, or packing of goods meant for export against a firm order
qualifies for the packing credit guarantee issued by Export Credit Guarantee
Corporation.

© The Institute of Chartered Accountants of India

(v) Forward exchange contract: Another requirement of packing credit facility is that if
the export bill is to be drawn in a foreign currency, the exporter should enter into a
forward exchange contact with the bank, thereby avoiding risk involved in a possible
change in the rate of exchange.
(Note: Students may answer any four of the above packing credits).
(e) Labour turnover in an organisation is the rate of change in the composition of labour
force during a specified period measured against a suitable index. The standard of usual
labour turnover in the industry or labour turnover rate for a past period may be taken as
the index or norm against which actual turnover rate should be compared.
The methods for measuring labour turnover are:
Replacement method: This method takes into consideration actual replacement of
labour irrespective of no. of workers leaving.
Number of employees replaced during the year
Replacement method = × 100
Average number of employees on roll during the year
Separation method: In this method labour turnover is measured by dividing the total no.
of separations during the period by average no. of workers on payroll during the same
period.
Number of employees separated during the year
Separation method = × 100
Average number of employees on roll during the year
Flux method: This method takes into account both the replacements as well as no. of
separations during the period.
 No.of employeesreplaced No.of employees separated 
 + 
duringthe year duringthe year
Flux method =   × 100
 Average number of employees on roll during the year 
 
 

© 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
(a) SHA Limited provides the following trading results:
Year Sale Profit
2012-13 ` 25,00,000 10% of Sale
2013-14 ` 20,00,000 8% of Sale
You are required to calculate:
(i) Fixed Cost
(ii) Break Even Point
(iii) Amount of profit, if sale is ` 30,00,000
(iv) Sale, when desired profit is ` 4,75,000
(v) Margin of Safety at a profit of ` 2,70,000
(b) A manufacturing company has disclosed net loss of ` 48,700 as per their cost accounting
records for the year ended 31st March, 2014. However their financial accounting records
disclosed net profit of ` 35,400 for the same period. A scrutiny of data of both the sets of
books of accounts revealed the following informations:
`
(i) Factory overheads under absorbed 30,500
(ii) Administrative overheads over absorbed 65,000
(iii) Depreciation charged in financial accounts 2,25,000
(iv) Depreciation charged in cost accounts 2,70,000
(v) Income-tax provision 52,400
(vi) Transfer fee (credited in financial accounts) 10,200
(vii) Obsolescence loss charged in financial accounts 20,700
(viii) Notional rent of own premises charged in cost accounts 54,000
(ix) Value of opening stock:
(a) in cost accounts 1,38,000
(b) in financial accounts 1,15,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

(x) Value of closing stock:

(a) in cost accounts 1,22,000
(b) in financial accounts 1,12,500
Prepare a Memorandum Reconciliation Account by taking costing loss as base.

(c) NOOR Limited provides the following information for the year ending 31st March, 2014:
Equity Share Capital `25,00,000
Closing Stock `6,00,000
Stock Turnover Ratio 5 times
Gross Profit Ratio 25%
Net Profit / Sale 20%
Net Profit / Capital 1
4
You are required to prepare:
Trading and Profit & Loss Account for the year ending 31st March, 2014.
(d) The following details are provided by the GPS Limited :
`
Equity Share Capital 65,00,000
12% Preference Share Capital 12,00,000
15% Redeemable Debentures 20,00,000
10% Convertible Debentures 8,00,000
The cost of equity capital for the company is 16.30% and Income Tax rate for the
company is 30%.
You are required to calculate the Weighted Average Cost of Capital (WACC) of the
company. (4 × 5 = 20 Marks)
Answer
(a) Workings:
Profit in year 2012-13 = ` 25,00,000 × 10% = ` 2,50,000
Profit in year 2013-14 = ` 20,00,000 × 8% = ` 1,60,000
Change inPr ofit
So, P/V Ratio = ×100
Change inSales

© The Institute of Chartered Accountants of India

50 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

` 2,50,000 − ` 1,60,000
= ×100
` 25,00,000 − ` 20,00,000
` 90,000
= ×100 = 18%
` 5,00,000
(i) Fixed Cost = Contribution (in year 2012-13) – Profit (in year 2012-13)
= (Sales × P/V Ratio) – ` 2,50,000
= (` 25,00,000 × 18%) – ` 2,50,000
= ` 4,50,000 – ` 2,50,000
= ` 2,00,000
FixedCost
(ii) Break-even Point (in Sales) =
P / V Ratio
` 2,00,000
= = ` 11,11,111 (Approx)
18%
(iii) Calculation of profit, if sale is ` 30,00,000
Profit = Contribution – Fixed Cost
= (Sales × P/V Ratio) – Fixed Cost
= (` 30,00,000 × 18%) - ` 2,00,000
= ` 5,40,000 – ` 2,00,000 = ` 3,40,000
So profit is ` 3,40,000, if Sale is ` 30,00,000.
(iv) Calculation of Sale, when desired Profit is ` 4,75,000
Contribution Required = Desired Profit + Fixed Cost
= ` 4,75,000 + ` 2,00,000 = ` 6,75,000
Contribution ` 6,75,000
Sales = = = ` 37,50,000
P / V Ratio 18%
Sales is ` 37,50,000 when desired profit is ` 4,75,000.
Pr ofit
(v) Margin of Safety =
P / V Ratio
` 2,70,000
= = ` 15,00,000
18%
So Margin of Safety is ` 15,00,000 at a profit of ` 2,70,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

(b) Memorandum Reconciliation Accounts

Dr. Cr.
Particulars Amount Particulars Amount
(`) (`)
To Net Loss as per Cost 48,700 By Administration overheads over 65,000
Accounts recovered in Cost Accounts
To Factory overheads under 30,500 By Depreciation overcharged in 45,000
absorbed in Cost Accounts Cost Accounts
(` 2,70,000 – ` 2,25,000)
To Provision for Income tax 52,400 By Transfer fees in Financial 10,200
Accounts
To Obsolescence loss 20,700 By Notional Rent of own premises 54,000
To Overvaluation of closing 9,500 By Overvaluation of Opening stock 23,000
stock in Cost Accounts** in Cost Accounts*
To Net Profit (as per Financial 35,400
Accounts)
1,97,200 1,97,200

* Overvaluation of Opening Stock as per Cost Accounts

= Value in Cost Accounts – Value in Financial Accounts
= ` 1,38,000 – ` 1,15,000 = ` 23,000.
** Overvaluation of Closing Stock as per Cost Accounts
= Value in Cost Accounts – Value in Financial Accounts
= ` 1,22,000 – ` 1,12,500 = ` 9,500.
(c) Working Notes:
Net Profit 1
(i) =
Capital 4
Net Profit 1
=
25,00,000 4
Net Profit = 6,25,000
Net Profit
(ii) = 20%
Sale
6,25,000
Sale = = 31,25,000
0.20

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

Gross Profit
(iii) Gross Profit Ratio = × 100
Sales
Gross Profit
25 = × 100
31,25,000
31,25,000 × 25
Gross Profit =
100
= 7,81,250
COGS
(iv) Stock Turnover =
Average Stock

⎛ 31,25,000 - 7,81,250 ⎞
5 = ⎜ ⎟
⎝ Average Stock ⎠
23,43,750
Average Stock =
5
= 4,68,750
Closing Stock + Opening Stock
(v) Average Stock =
2
6,00,000 + Opening Stock
4,68,750 =
2
Opening Stock = 9,37,500 – 6,00,000 = 3,37,500
Trading A/c for the year ending 31st March, 2014
` `
To Opening Stock 3,37,500 By Sales 31,25,000
To Purchases (Balancing figure) 26,06,250 By Closing Stock 6,00,000
To Gross Profit c/f to P&L A/c 7,81,250 -
37,25,000 37,25,000
Profit & Loss A/c for the year ending 31st March, 2014
` `
To Miscellaneous Expenses 1,56,250 By Gross Profit b/f 7,81,250
(balancing figure) from Trading A/c
To Net Profit 6,25,000 -
7,81,250 7,81,250

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

(d) Calculation of Weighted Average Cost of Capital (WACC)

Source Amount (`) Weight Cost of Capital WACC
after tax
Equity Capital 65,00,000 0.619 0.163 0.1009
12% Preference Capital 12,00,000 0.114 0.120 0.0137
15% Redeemable Debentures 20,00,000 0.190 0.105* 0.020
10% Convertible Debentures 8,00,000 0.076 0.07** 0.0053
Total 1,05,00,000 1.0000 0.1399
* Cost of Debentures (after tax) = 15 (1 – 0.30) = 10.5% = 0.105
** Cost of Debentures (after tax) = 10 (1 – 0.30) = 7% = 0.07
Weighted Average Cost of Capital = 0.1399 = 13.99%
(Note: In the above solution, the Cost of Debentures has been computed in the above
manner without considering the impact of special features i.e. redeemability and
convertibility in absence of requisite information.)
Question 2
(a) A company manufactures a product from a raw material, which is purchased at ` 80 per
kg. The company incurs a handling cost of ` 370 plus freight of ` 380 per order. The
incremental carrying cost of inventory of raw material is ` 0.25 per kg per month. In
addition, the cost of working capital finance on the investment in inventory of raw
material is ` 12 per kg per annum. The annual production of the product is 1,00,000 units
and 2.5 units are obtained from one kg. of raw material.
Required:
(i) Calculate the economic order quantity of raw materials.
(ii) Advise, how frequently company should order for procurement be placed.
(iii) If the company proposes to rationalize placement of orders on quarterly basis, what
percentage of discount in the price of raw materials should be negotiated?
Assume 360 days in a year. (8 Marks)
(b) A company had the following Balance Sheet as on 31st March, 2014:
Liabilities ` (In crores) Assets (` In crores)
Equity Share Capital (50 lakhs 5
shares of ` 10 each)
Reserves and Surplus 1 Fixed Assets (Net) 12.5
15% Debentures 10 Current Assets 7.5
Current Liabilities 4
20 20

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

The additional information given is as under:

Fixed cost per annum (excluding interest) ` 4 crores
Variable operating cost ratio 65%
Total assets turnover ratio 2.5
Income Tax rate 30%
Required:
Calculate the following and comment:
(i) Earnings Per Share
(ii) Operating Leverage
(iii) Financial Leverage
(iv) Combined Leverage (8 Marks)
Answer
(a) (i) Calculation of Economic Order Quantity (E.O.Q)
1,00,000units
Annual requirement (usage) of raw material in kg. (A) = = 40,000kg.
2.5unitsper kg.
Ordering Cost (Handling & freight cost) (O) = ` 370 + ` 380 = ` 750
Carrying cost per unit per annum (C) i.e. inventory carrying cost + working capital cost
= (`0.25 × 12 months) + ` 12
= `15 per kg.
2AO 2 × 40,000kg. × ` 750
E.O.Q. = = = 2,000 kg.
C `15

(ii) Frequency of placing orders for procurement:

Annual consumption (A) = 40,000 kg.
Quantity per order (E.O.Q) = 2,000 kg.
A 40,000kg.
No. of orders per annum ( ) = = 20 orders
E.O.Q 2,000kg.
360days
Frequency of placing orders (in days) = = 18 days
20orders

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

(iii) Percentage of discount in the price of raw materials to be negotiated:

Particulars On Quarterly Basis On E.O.Q Basis
1. Annual Usage (in Kg.) 40,000 kg. 40,000 kg.
2. Size of the order 10,000 kg. 2,000 kg.
3. No. of orders (1 ÷ 2) 4 20
4. Cost of placing orders or ` 3,000 ` 15,000
Ordering cost (4 order × ` 750) (20 orders × ` 750)
(No. of orders × Cost per order)
5. Inventory carrying cost ` 75,000 ` 15,000
(Average inventory × Carrying cost (10,000 kg. × ½ × ` (2,000 kg. × ½ × `
per unit) 15) 15)
6. Total Cost (4 + 5) ` 78,000 ` 30,000
When order is placed on quarterly basis the ordering cost and carrying cost increased by
` 48,000 (`78,000 - `30,000).
So, discount required = ` 48,000
Total annual purchase = 40,000 kg. × ` 80 = ` 32,00,000
` 48,000
So, Percentage of discount to be negotiated = ×100 = 1.5%
` 32,00,000

(b) Total Assets = ` 20 crores

Total Asset Turnover Ratio = 2.5
Hence, Total Sales = 20 × 2.5 = ` 50 crores
Computation of Profit after Tax (PAT)
(` in crores)
Sales 50.00
Less: Variable Operating Cost @ 65% 32.50
Contribution 17.50
Less: Fixed Cost (other than Interest) 4.00
EBIT 13.50
Less: Interest on Debentures (15% × 10) 1.50
PBT 12.00
Less: Tax @ 30% 3.60
PAT 8.40

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(i) Earnings per Share

8.40 crores
EPS =
Number of Equity Shares
8.40 crores
= = ` 16.80
50,00,000
It indicates the amount the company earns per share. Investors use this as a guide
while valuing the share and making investment decisions. It is also a indicator used
in comparing firms within an industry or industry segment.
(ii) Operating Leverage
Contribution
Operating Leverage =
EBIT
17.50
=
13.50
= 1.296
It indicates the choice of technology and fixed cost in cost structure. It is level
specific. When firm operates beyond operating break-even level, then operating
leverage is low. It indicates sensitivity of earnings before interest and tax (EBIT) to
change in sales at a particular level.
(iii) Financial Leverage
EBIT
Financial Leverage =
PBT
13.50
= = 1.125
12.00
The financial leverage is very comfortable since the debt service obligation is small
vis-à-vis EBIT.
(iv) Combined Leverage
Contribution EBIT
Combined Leverage = ×
EBIT PBT
Or, = Operating Leverage × Financial Leverage
= 1.296 × 1.125 = 1.458
The combined leverage studies the choice of fixed cost in cost structure and choice
of debt in capital structure. It studies how sensitive the change in EPS is vis-à-vis

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

change in sales. The leverages − operating, financial and combined are measures
of risk.
Question 3
(a) M J Pvt. Ltd. produces a product "SKY" which passes through two processes, viz.
Process-A and Process-B. The details for the year ending 31st March, 2014 are as follows:
Process A Process - B
40,000 Units introduced at a cost of ` 3,60,000 -
Material Consumed ` 2,42,000 2,25,000
Direct Wages ` 2,58,000 1,90,000
Manufacturing Expenses ` 1,96,000 1,23,720
Output in Units 37,000 27,000
Normal Wastage of Input 5% 10%
Scrap Value (per unit) ` 15 20
Selling Price (per unit) ` 37 61
Additional Information:
(a) 80% of the output of Process-A, was passed on to the next process and the balance
was sold. The entire output of Process- B was sold.
(b) Indirect expenses for the year was ` 4,48,080.
(c) It is assumed that Process-A and Process-B are not responsibility centre.
Required:
(i) Prepare Process-A and Process-B Account.
(ii) Prepare Profit & Loss Account showing the net profit I net loss for the year.
(8 Marks)
(b) FH Hospital is considering to purchase a CT-Scan machine. Presently the hospital is
outsourcing the CT -Scan Machine and is earning commission of `15,000 per month (net
of tax). The following details are given regarding the machine:
`
Cost of CT -Scan machine 15,00,000
Operating cost per annum (excluding Depreciation) 2,25,000
Expected revenue per annum 7,90,000
Salvage value of the machine (after 5 years) 3,00,000
Expected life of the machine 5 years

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

Assuming tax rate @ 30%, whether it would be profitable for the hospital to purchase the
machine?
Give your recommendation under:
(i) Net Present Value Method, and
(ii) Profitability Index Method.
PV factors at 12% are given below:
Year 1 2 3 4 5
PV factor 0.893 0.797 0.712 0.636 0.567
(8 Marks)
Answer
(a) (i) Process- A Account
Particulars Units Amount Particulars Units Amount
(`) (`)
To Input 40,000 3,60,000 By Normal wastage 2,000 30,000
(2,000 units × ` 15)
To Material --- 2,42,000 By Abnormal loss A/c 1,000 27,000
(1,000 units × ` 27)
To Direct wages --- 2,58,000 By Process- B 29,600 7,99,200
(29,600 units × ` 27)
To Manufacturing Exp. --- 1,96,000 By Profit & Loss A/c 7,400 1,99,800
(7,400 units × ` 27)
40,000 10,56,000 40,000 10,56,000
` 10,56,000 − ` 30,000
Cost per unit = = ` 27 per unit
40,000units − 2,000units
Normal wastage = 40,000 units × 5% = 2,000 units
Abnormal loss = 40,000 units – (37,000 units + 2,000 units) = 1,000 units
Transfer to Process- B = 37,000 units × 80% = 29,600 units
Sale = 37,000 units × 20% = 7,400 units
Process- B Account
Particulars Units Amount Particulars Units Amount
(`) (`)
To Process- A A/c 29,600 7,99,200 By Normal wastage 2,960 59,200
(2,960 units × ` 20)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

To Material --- 2,25,000 By Profit & Loss A/c 27,000 12,96,000

(27,000 units × ` 48)
To Direct Wages --- 1,90,000
To Manufacturing Exp. --- 1,23,720
To Abnormal Gain A/c 360 17,280
(360 units × ` 48)
29,960 13,55,200 29,960 13,55,200
`13,37,920 − `59,200
Cost per unit = = ` 48 per unit
29,600units − 2,960units
Normal wastage = 29,600 units × 10% = 2,960 units
Abnormal gain = (27,000 units + 2,960 units) – 29,600 units = 360 units
(ii) Profit & Loss Account
Particulars Amount Particulars Amount
(`) (`)
To Process- A A/c 1,99,800 By Sales:
To Process- B A/c 12,96,000 - Process-A 2,73,800
(7,400 units × ` 37)
To Abnormal loss A/c 12,000 - Process- B 16,47,000
(27,000 units × ` 61)
To Indirect Expenses 4,48,080 By Abnormal gain 10,080
By Net loss 25,000
19,55,880 19,55,880
Working Notes:
Normal wastage (Loss) Account
Particulars Units Amount (`) Particulars Units Amount (`)
To Process- 2,000 30,000 By Abnormal Gain A/c 360 7,200
A A/c (360 units × ` 20)
To Process- 2,960 59,200 By Bank (Sales) 4,600 82,000
B A/c
4,960 89,200 4,960 89,200
Abnormal Loss Account
Particulars Units Amount Particulars Units Amount
(`) (`)
To Process- 1,000 27,000 By Bank A/c 1,000 15,000
A A/c (1,000 units × ` 15)

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

By Profit & Loss A/c --- 12,000

1,000 27,000 1,000 27,000
Abnormal Gain Account
Particulars Units Amount Particulars Units Amount
(`) (`)
To Normal loss A/c 360 7,200 By Process- B A/c 360 17,280
(360 units × ` 20)
To Profit & Loss A/c 10,080
360 17,280 360 17,280
(b) Advise to the Hospital Management
Determination of Cash inflows `
Sales Revenue 7,90,000
Less: Operating Cost 2,25,000
5,65,000
Less: Depreciation (15,00,000 – 3,00,000)/5 2,40,000
Net Income 3,25,000
Tax @ 30% 97,500
Earnings after Tax (EAT) 2,27,500
Add: Depreciation 2,40,000
Cash inflow after tax per annum 4,67,500
Less: Loss of Commission Income 1,80,000
Net Cash inflow after tax per annum 2,87,500
In 5th Year :
New Cash inflow after tax 2,87,500
Add: Salvage Value of Machine 3,00,000
Net Cash inflow in year 5 5,87,500
Calculation of Net Present Value (NPV)
Year CFAT PV Factor @10% Present Value of Cash inflows
1 to 4 2,87,500 3.038 8,73,425.00
5 5,87,500 0.567 3,33,112.50
12,06,537.50
Less: Cash Outflows 15,00,000.00
NPV (2,93,462.50)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

Sum of discounted cash inflows 12,06,537.50

Profitability Index = = = 0.804
Present value of cash outflows 15,00,000
Advise: Since the net present value is negative and profitability index is also less than
1, therefore, the hospital should not purchase the CT-Scan machine.
Question 4
(a) XYZ Co. Ltd. provides the following information:
Standard Actual
Production 4,000 Units 3,800 Units
Working Days 20 21
Fixed Overhead ` 40,000 ` 39,000
Variable Overhead ` 12,000 ` 12,000
You are required to calculate following overhead variances:
(a) Variable Overhead Variance
(b) Fixed Overhead Variances
(i) Expenditure Variance
(ii) Volume Variance (8 Marks)
(b) The Balance Sheets of Z Ltd. as on 31st March, 2013 and 31st March, 2014 are as under:
Liabilities 2013 2014 Assets 2013 2014
` ` ` `
Equity share capital 15,00,000 20,00,000 Goodwill 5,75,000 4,50,000
12% Redeemable 7,50,000 5,00,000 Land & 10,00,000 8,50,000
pref. share cap. Building
General Reserve 2,00,000 3,50,000 Plant 4,00,000 10,00,000
Profit & Loss A/c 1,50,000 2,40,000 Debtors 8,00,000 12,60,000
Creditors 2,75,000 4,15,000 Stock 4,85,000 4,35,000
Outstanding 1,00,000 80,000 Marketable 75,000 50,000
Expenses Securities
Provision for Tax 2,00,000 2,50,000 Cash and 50,000 40,000
Bank
Proposed Dividend 2,10,000 2,50,000
33,85,000 40,85,000 33,85,000 40,85,000
Additional Information:
(i) Depreciation charged on Plant and Land & Buildings during the year was ` 50,000
and ` 1,00,000 respectively.

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(ii) Income-Tax ` 1,75,000 was paid during the year 2013-14.

(iii) An Interim Dividend of ` 1,00,000 has been paid in 2013-14.
Prepare Cash Flow Statement. (8 Marks)
Answer
(a) Workings:
` 12,000
Standard Variable Overhead rate per unit = =`3
4,000units

` 40,000
Standard Fixed Overhead rate per unit = = ` 10
4,000units

(a) Variable Overhead Variance = Recovered Variable Overhead - Actual Variable overhead
= 3,800 units × ` 3 – ` 12,000
= ` 11,400 – `12,000 = ` 600 (Adverse)
(b) (i) Fixed Overhead Expenditure Variance = Budgeted Overhead – Actual Overhead
= ` 40,000 – ` 39,000
= ` 1,000 (Favourable)
(ii) Fixed Overhead Volume Variance = Recovered Overhead – Budgeted Overhead
= 3,800 units × ` 10 – ` 40,000
= ` 38,000 – ` 40,000
= ` 2,000 (Adverse)
(b) Cash Flow Statement for the year ending 31st March, 2014
` `
A. Cash flow from Operating Activities
Profit and Loss A/c as on 31.3.2014 2,40,000
Less: Profit and Loss A/c as on 31.3.2013 (1,50,000)
90,000
Add: Transfer to General Reserve 1,50,000
Provision for Tax 2,25,000
Interim Dividend paid during the year 1,00,000
Proposed Dividend 2,50,000 7,25,000
Profit before Tax 8,15,000
Adjustment for Depreciation:
Land and Building 1,00,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

Plant and Machinery 50,000 1,50,000

Goodwill written off 1,25,000
Operating Profit before Working Capital Changes 10,90,000
Adjustment for Working Capital Changes:
Decrease in Outstanding Expenses (20,000)
Decrease in Stock 50,000
Increase in Debtors (4,60,000)
Increase in Creditors 1,40,000 (2,90,000)
Cash generated from Operations 8,00,000
Income tax paid (1,75,000)
Net Cash Inflow from Operating Activities (a) 6,25,000
B. Cash flow from Investing Activities
Proceeds from Sale of Building 50,000
Purchase of Plant and Machinery (6,50,000)
Net Cash Outflow from Investing Activities (b) (6,00,000)
C. Cash Flow from Financing Activities
Proceeds from Issuance of Share Capital 5,00,000
Redemption of Preference Shares (2,50,000)
Interim Dividend Paid (1,00,000)
Final Dividend Paid (2,10,000)
Net Cash Outflow from Financing Activities (c) (60,000)
Net increase in Cash and Cash Equivalents during the year (a+b+c) (35,000)
Cash and Cash Equivalents at the beginning of the year 1,25,000
(Cash and Bank and Marketable Securities)
Cash and Cash Equivalents at the end of the year 90,000
Working Notes:
1. Provision for the Tax Account
` `
To Bank (paid) 1,75,000 By Balance b/d 2,00,000
To Balance c/d 2,50,000 By Profit and Loss a/c 2,25,000
4,25,000 4,25,000
2. Plant and Machinery Account
` `
To Balance b/d 4,00,000 By Depreciation 50,000

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

To Bank a/c (Purchases) 6,50,000 By Balance c/d 10,00,000

(Balancing figure)
10,50,000 10,50,000
3. Land and Building Account
` `
To Balance b/d 10,00,000 By Depreciation 1,00,000
By Bank a/c (Sales) 50,000
(Balancing figure)
By Balance c/d 8,50,000
10,00,000 10,00,000
(Note: In the above solution it has been assumed that marketable securities have
insignificant risk of changes in value.)
Question 5
(a) Distinguish between cost control and cost reduction.
(b) Explain the following:
(i) Explicit costs
(ii) Engineered costs
(c) Discuss emerging issues affecting the future role of Chief Financial Officer (CFO).
(d) State the main features of Global Depository Receipts (GDRs) and American Depository
Receipts (ADRs). (4 × 4 = 16 Marks)
Answer
(a) Difference between Cost Control and Cost Reduction
Cost Control Cost Reduction
1. Cost control aims at maintaining 1. Cost reduction is concerned with
the costs in accordance with the reducing costs. It challenges all
established standards. standards and endeavours to better
them continuously
2. Cost control seeks to attain 2. Cost reduction recognises no condition
lowest possible cost under as permanent, since a change will result
existing conditions. in lower cost.
3. In case of Cost Control, 3. In case of cost reduction it is on
emphasis is on past and present present and future.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

4. Cost Control is a preventive 4. Cost reduction is a corrective function.

function It operates even when an efficient cost
control system exists.
5. Cost control ends when targets 5. Cost reduction has no visible end.
are achieved
(b) (i) Explicit Costs - These costs are also known as out of pocket costs and refer to
costs involving immediate payment of cash. Salaries, wages, postage and telegram,
printing and stationery, interest on loan etc. are some examples of explicit costs
involving immediate cash payment.
(ii) Engineered Costs - These are costs that result specifically from a clear cause and
effect relationship between inputs and outputs. The relationship is usually
personally observable. Examples of inputs are direct material costs, direct labour
costs etc.
(c) Emerging Issues/Priorities Affecting the Future Role of Chief Financial Officer
(CFO)
(i) Regulation: Regulation requirements are increasing and CFOs have an increasingly
personal stake in regulatory adherence.
(ii) Globalisation: The challenges of globalisation are creating a need for finance leaders
to develop a finance function that works effectively on the global stage and that
embraces diversity.
(iii) Technology: Technology is evolving very quickly, providing the potential for CFOs to
reconfigure finance processes and drive business insight through ‘big data’ and
analytics.
(iv) Risk: The nature of the risks that organisations face is changing, requiring more
effective risk management approaches and increasingly CFOs have a role to play in
ensuring an appropriate corporate ethos.
(v) Transformation: There will be more pressure on CFOs to transform their finance
functions to drive a better service to the business at zero cost impact.
(vi) Stakeholder Management: Stakeholder management and relationships will become
important as increasingly CFOs become the face of the corporate brand.
(vii) Strategy: There will be a greater role to play in strategy validation and execution,
because the environment is more complex and quick changing, calling on the analytical
skills CFOs can bring.
(viii) Reporting: Reporting requirements will broaden and continue to be burdensome for
CFOs.
(ix) Talent and Capability: A brighter spotlight will shine on talent, capability and
behaviours in the top finance role.
(Note: Students may answer any four of the above issues)

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(d) Global Depository Receipts and American Depository Receipts

Global Depository Receipts (GDRs) are basically negotiable certificates denominated
in US dollars that represent a non-US company’s publicly traded local currency equity
shares. These are created when the local currency shares of Indian company are
delivered to the depository’s local custodian bank, against which the depository bank
issues Depository Receipts in US dollars.
American Depository Receipts (ADRs) are securities offered by non-US companies
who want to list on any of the US exchange. Each ADR represents a certain number of a
company's regular shares. ADRs allow US investors to buy shares of these companies
without the costs of investing directly in a foreign stock exchange. ADRs are issued by an
approved New York bank or trust company against the deposit of the original shares.
These are deposited in a custodial account in the US. Such receipts have to be issued in
accordance with the provisions stipulated by the SEC USA which are very stringent.
Question 6
(a) M/s ABID Constructions undertook a contract at a price of ` 171.00 lacs. The relevant
data for the year ended 31st March, 2014 are as under:
(`’000)
Material issued at site 7700
Direct Wages paid 3300
Site office cost 550
Material return to store 175
Work certified 12650
Work uncertified 225
Progress Payment Received 10120
Prepaid site office cost as on 31-03-2014 50
Direct wages outstanding as on 31-03-2014 100
Material at site as on 31-03-2014 110
Additional Information:
(a) A plant was purchased for the contract at ` 8,00,000 on 01-12-2013.
(b) Depreciation @ 15% per annum is to be charged.
(c) Material which cost ` 1,30,000 was destroyed by fire.
Prepare:
(i) Contract Account for the year ended 31st March, 2014 and compute the profit to be
taken to the Profit & Loss Account.
(ii) Account of Contractee.
(iii) Profit & Loss Account showing the relevant items.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 67

(iv) Balance Sheet showing the relevant items. (8 Marks)

(b) Black Limited has furnished the following cost sheet:
` / Per Unit
Raw Material 98
Direct Labour 53
Factory Overhead (Includes depreciation of ` 15 per unit at budgeted 88
level of activity)
Total Cost 239
Profit 43
Selling Price 282
Additional Information:
(i) Average raw material in stock 3 weeks
(ii) Average work-in-progress (% of completion with respect to 2 weeks
Material- 75% Labour & Overhead - 70%)
(iii) Finished goods in stock 4 weeks
(iv) Credit allowed to debtors 2½ weeks
(v) Credit allowed by creditors 3½ weeks
(vi) Time lag in payments of labour 2 weeks
(vii) Time lag in payments of factory overheads 1½ weeks
(viii) Company sells, 25% of the output against cash
(ix) Cash in hand and bank is desired to be maintained ` 2,25,000
(x) Provision for contingencies is required @ 4% of working capital
requirement including that provision.
You may assume that production is carried on evenly throughout the year and labour and
factory overheads accrue similarly.
You are required to prepare a statement showing estimate of working capital needed to
finance a budgeted activity level of 1,04,000 units of production. Finished stock, debtors
and overhead are taken at cash cost. (8 Marks)
Answer
(a) (i) M/s ABID Constructions
Contract Account
Particulars Amount Particulars Amount
(` in ‘000) (` in ‘000)
To Material issued 7,700 By Material returned 175

© The Institute of Chartered Accountants of India

68 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

To Direct wages 3,300 By Profit & Loss A/c 130

(Material Destroyed by fire)
Add: Outstanding 100 3,400 By W-I-P:
To Site Office Cost 550 - Work uncertified 225
Less: Prepaid 50 500 - Work certified 12,650 12,875
To Depreciation* 40 By Material at site 110
To Notional Profit 1,650
13,290 13,290
To Profit & Loss A/c 880 By Notional Profit 1,650
(Working Note -2)
To W-I-P (Reserve) 770
1,650 1,650
4 months
* Depreciation on plant = ` 8,00,000 × 15% × = ` 40,000
12 months
(ii) Contractee’s Account
Particulars Amount Particulars Amount
(` in ‘000) (` in ‘000)
To Balance c/d 10,120 By Bank A/c 10,120
10,120 10,120
(iii) Relevant items of Profit & Loss Account
Particulars Amount Particulars Amount
(` in ‘000) (` in ‘000)
To Contract A/c 130 By Contract A/c 880
(loss of material due to fire) (Profit on contract)
To Net Profit 750
880 880
(iv) Balance Sheet (Extracts) as on 31st March, 2014
(Amount in ‘000)
Liabilities Amount Amount Assets Amount Amount
(` ) (` ) (` ) (` )
Plant at cost 800
Add: Profit 750 Less: Dep. 40 760
Contract W-I-P:

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 69

Outstanding Wages 100 -Uncertified 225

-Certified 12,650
-Reserve (770)
Less: Advances (10,120) 1,985
Materials at site 110
Prepaid exp. 50
Working Notes:
Work Certified
1. Percentage of Completion = ×100
Value of ontract
` 1,26,50,000
= ×100
`1,71,00,000
= 73.98%
2. Profit from the incomplete contract
2 CashRe ceived
= Notional Profit × ×
3 Work Certified
2 ` 1,01,20,000
= ` 16,50,000 × ×
3 `1,26,50,000
= ` 8,80,000
(Note: The above figures calculated on traditional prudent basis followed in Contract
costing.)
(b) Statement of Estimation of Working Capital Needs
Current Assets `
I Investment in Inventory
3 5,88,000
(i) Raw material Inventory = 1,04,000 × × ` 98
52
(ii) Work-in-Process Inventory
2
Material = 1,04,000 × × 0.75 × 98 = 2,94,000
52
Labour and Overheads Cost (other than depreciation)
2 6,46,800
= 1,04,000 × × 0.70 × 126 = 3,52,800
52

© The Institute of Chartered Accountants of India

70 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(iii) Finished Goods Inventory (Cash Cost)

4 17,92 ,000
= 1,04,000 × × 224
52
II Investment in Debtors (Cash Cost) 8,40,000
2.5
= 1,04,000 × × 0.75 × 224
52
III Cash Balance 2,25 ,000
Investment in Current Assets 40,91,800

Current Liabilities and Deferred Payment `

3.5
(i) Creditors = 1,04,000 × × 98 6,86,000
52
2
(ii) Wages outstanding = 1,04,000 × × 53 2,12,000
52
1.5
(iii) Overheads outstanding (cash cost) = 1,04,000 × × 73 2,19,000
52
Total Deferred Payments 11,17,000
Net Working Capital (Current assets – Non-interest bearing current 29,74,800
liabilities) = 40,91,800 – 11,17,000
Add: Provision for Contingencies @ 4 percent (` 29,74,800 × 1/24) 1,23 ,950
Working Capital Requirement including Provision 30,98,750
(Note: For calculation purpose, 4 weeks maybe taken as equivalent to a month and 52
weeks in a year.)
Question 7
Answer any four of the following:
(a) Distinguish between allocation and apportionment of cost.
(b) Describe the salient features of budget manual.
(c) Explain the following:
(i) Concentration Banking
(ii) Lock Box System
(d) Comment on the Debt Service Coverage Ratio.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 71

(e) (i) Name any four financial instruments, which are related to international financial
market.
(ii) State the unit of cost for the followings:
(1) Transport
(2) Power
(3) Hotel
(4) Hospital (4 x 4 = 16 Marks)
Answer
(a) Distinguish between allocation and apportionment of cost.
Cost allocation: The term ‘allocation’ refers to assignment or allotment of an entire item
of cost to a particular cost centre or cost unit. It implies relating overheads directly to the
various departments. The estimated amount of various items of manufacturing overheads
should be allocated to various cost centres or departments. For example- if a separate
power meter has been installed for a department, the entire power cost ascertained from
the meter is allocated to that department.
Cost apportionment: There are some items of estimated overheads (like the salary of
the works manager) which cannot be directly allocated to the various departments and
cost centres. Such unallocable expenses are to be spread over the various departments
or cost centres on an appropriate basis. This is called apportionment.
(b) Salient features of Budget Manual
• Budget manual contains many information which are required for effective
budgetary planning.
• A budget manual is a collection of documents that contains key information for
those involved in the planning process.
• An introductory explanation of the budgetary planning and control process,
including a statement of the budgetary objective and desired results is included in
Budget Manual
• Budget Manual contains a form of organisation chart to show who is responsible for
the preparation of each functional budget and the way in which the budgets are
interrelated.
• In contains a timetable for the preparation of each budget.
• Copies of all forms to be completed by those responsible for preparing budgets,
with explanations concerning their completion is included in Budget Manual.

© The Institute of Chartered Accountants of India

72 INTERMEDIATE (IPC) EXAMINATION: MAY, 2014

(c) (i) Concentration Banking: In concentration banking the company establishes a

number of strategic collection centres in different regions instead of a single
collection centre at the head office. This system reduces the period between the
time a customer mails in his remittances and the time when they become spendable
funds with the company. Payments received by the different collection centers are
deposited with their respective local banks which in turn transfer all surplus funds to
the concentration bank of head office.
(ii) Lock Box System: Another means to accelerate the flow of funds is a lock box
system. The purpose of lock box system is to eliminate the time between the
receipts of remittances by the company and deposited in the bank. A lock box
arrangement usually is on regional basis which a company chooses according to its
billing patterns.
(d) Comment on Debt Service Coverage Ratio (DSCR)
Debt service coverage ratio indicates the capacity of a firm to service a particular level of
debt i.e. repayment of principal and interest. High credit rating firms target DSCR to be
greater than 2 in its entire loan life. High DSCR facilitates the firm to borrow at the most
competitive rates. Lenders are interested in this ratio to judge the firm’s ability to pay off
current interest and installments.
The debt service coverage ratio can be calculated as under:
Earnings available for debt service
Debt Service Coverage Ratio =
Interest + Installments
EBITDA
Or, Debt Service Coverage Ratio =
Principal Repayment Due
Interest +
1 − Tc
(e) (i) Financial Instruments in the International Market
Some of the various financial instruments dealt with in the international market are:
(a) Euro Bonds
(b) Foreign Bonds
(c) Fully Hedged Bonds
(d) Medium Term Notes
(e) Floating Rate Notes
(f) External Commercial Borrowings
(g) Foreign Currency Futures

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 73

(h) Foreign Currency Option

(i) Euro Commercial Papers.
(Note: Students may answer any four of the above financial instruments)
(ii)
Industry Unit of Cost
1. Transport Per passenger k.m. or per tonne k.m.
2. Power Per Kilo – watt (kw) hour
3. Hotel Per room day / or per meal
4. Hospital Per Patient – day / or per bed/day

© The Institute of Chartered Accountants of India

DISCLAIMER
The Suggested Answers hosted in the website do not constitute the basis for evaluation of the
students’ answers in the examination. The answers are prepared by the Faculty of the Board
of Studies with a view to assist the students in their education. While due care is taken in
preparation of the answers, if any errors or omissions are noticed, the same may be brought to
the attention of the Director of Studies. The Council of the Institute is not in anyway
responsible for the correctness or otherwise of the answers published herein.

© 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

© The Institute of Chartered Accountants of India

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 :
N S D
Production (in units) 17,500 6,700 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 -
Preference Shares of ` 100 each - 2,00,000
` 6,00,000 6,00,000

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)
2×Annual requirement of 'Rex' × Ordering cost per order
=
Annual carrying cost per unit per annum

2 × 60,000units × ` 800 9,60,00,000

= =
` 10 ×15% ` 1.5

= 8,000 units
(ii) Re-order Level = Safety Stock + (Normal daily Usage × Re-order period)
60,000units
= 600 + ( × 10 days)
300days

= 600 + 2,000
= 2,600 units

© The Institute of Chartered Accountants of India

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
1
(iv) Average Stock Level = Minimum Stock level + Re-order Quantity
2
1
= 600* + 8,000 units
2
= 4,600 units
OR
MaximumStock level + MinimumStock level
Average Stock Level =
2
8,600units + 600units
=
2
= 4,600 units
* Minimum Stock Level = Re-order level – (Normal daily usage × Re-order period)
60,000units
= 2,600 – ( × 10 days)
300days
= 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 4,40,000
(Being issue of Direct and Indirect materials)

© The Institute of Chartered Accountants of India

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 1,75,000
(Being transfer of under absorption of
Administration overhead)
(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. 2,00,000
To Sundry Debtors A/c 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 Firm S Firm D
Output (Units) 17,500 6,700 31,800
Selling Price/Unit 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

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 45

C 8,22,500 5,86,250 7,95,000

DOL =
EBIT 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
DFL=
PBT 2,97,500 1,61,250 5,45,000
= 1.42 = 1.47 = 1.00
DCL = OL x FL 1.95 x 1.42 2.48 x 1.47 1.46 x 1
OR = 2.77 = 3.65 = 1.46

Contribution 8,22,500 5,86,250 7,95,000

DCL = = 2.76 = 3.64 = 1.46
PBT 2,97,500 1,61,250 5,45,000

(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
Preference Dividend 16,800
Rate of Dividend = x 100 = x 100 = 8.4%
Preference Share Capital 2,00,000
Question 2
(a) The following information relates to a bus operator:
Cost of the bus ` 18,00,000
Insurance charges 3% p.a.
Manager-cum accountant's salary ` 8,000 p.m.

© The Institute of Chartered Accountants of India

46 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

Annual Tax ` 50,000

Garage Rent ` 2,500 p.m.
Annual repair & maintenance ` 1,50,000
Expected life of the bus 15 years
Scrap value at the end of 15 years ` 1,20,000
Driver's salary ` 15,000 p.m.
Conductor's salary ` 12,000 p.m.
Stationery ` 500 p.m.
Engine oil, lubricants (for 1200 kms.) ` 2,500
Diesel and oil (for 10 kms.) ` 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 (8 Marks)

© The Institute of Chartered Accountants of India

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.
` 1,12,000
Depreciation per month = = ` 9,333.33
12months
(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)
Totaldistance travelled
Engine oil & lubricants = × ` 2,500
1,200 K.m.

3,000K.m.
= × ` 2,500
1,200 K.m.
= ` 6,250
Totaldistance travelled
Diesel and Oil = × ` 52
10 K.m.

3,000K.m.
= × ` 52 = ` 15,600
10 K.m.
Statement showing the Operating Cost per Passenger-km.
` `
(i) Standing Charges:
Depreciation {Working Note- (i)} 9,333.33

© The Institute of Chartered Accountants of India

48 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

Insurance Charge  
` 18,00,000 4,500
× 3% 
 12 
Manager-cum-accountant’s salary 8,000

Annual Tax (p.m.) 

` 50,000  4,166.67

 12 
Garage Rent 2,500 28,500
(ii) Maintenance Charges:

Repair & Maintenance per month 

` 1,50,000  12,500

 12 
(iii) Running Cost:
Driver’s Salary 15,000
Conductor’s 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 49,350 49,350
driver and conductor
Total cost excluding commission to driver and
conductor 90,350
Driver’s commission on collection* 6,023.34
Conductor’s 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
` 90,350
So, Total collection = ×100 = ` 1,20,466.67
75
*Total Commission on collection = 10% × ` 1,20,466.67 = ` 12,046.67

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

Driver’s share = 50% × ` 12,046.67 = 6,023.34

Conductor’s share = 50% × ` 12,046.67 = 6,023.33
** Profit on collection = ` 1,20,466.67 × 15% = ` 18,070
Total Collection
Fare per Passenger-km. =
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 1.5
=
CL 1
∴ CA = 1.5CL
CA - CL = 1,50,000
1.5 CL- CL = 1,50,000
0.5 CL = 1,50,000
1,50,000
CL = = 3,00,000
0.5
CA = 1.5 x 3,00,000 = 4,50,000
2. Computation of Bank Credit (BC) and Other Current Liabilities (OCL)
Bank Credit 2
=
Other CL 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

50 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

3. Computation of Inventory
Quick Assets
Quick Ratio =
Current Liabilities
Current Assets - Inventories
=
Current Liabilities
4,50,000 - Inventories
0.8 =
3,00,000
0.8 × 3,00,000 = 4,50,000 – Inventories
Inventories = 4,50,000 – 2,40,000 = 2,10,000
4. Computation of Debtors
Inventory Turnover = 5 times
COGS
Average Inventory =
Inventory Turnover
COGS = 2,10,000 × 5 = 10,50,000
Average Collection Period (ACP) = 1.5 months = 45 days
360 360
Debtors Turnover = = =8
ACP 45
Sales - COGS
×100 = 25%
Sales
25×Sales
Sales - COGS =
100
Sales – 0.25 Sales = COGS
0.75 Sales = 10,50,000
10,50,000
Sales = = 14,00,000
0.75
Sales
Debtors =
Debtors Turnover
14,00,000
= = 1,75,000
8
5. 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 51

6. Computation of Reserves & Surplus

Reserves & Surplus
=4
Bank & Cash
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 6,85,000
Reserves & Surplus 2,60,000 Current Assets:
Current Liabilities: Inventories 2,10,000
Bank Credit 2,00,000 Debtors 1,75,000
Other Current Liabilities 1,00,000 Bank & Cash 65,000
11,35,000 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%.

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

The present value factors at 10% are :

Year t1 t2 t3
PVIF0.10,t 0.9091 0.8264 0.7513
PVIFA0.10,2 = 1.7355
PVIFA0.10,3 = 2.4868
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
5 40
Or, =
100 Average no. of workers on roll
Or, Average no. of workers on roll = 800
(ii) Labour Turnover Rate (Replacement method)
No. of workers replaced
=
Average no. of workers on roll

8 No. of workers replaced

Or, =
100 800
Or, No. of workers replaced = 64
(iii) Labour Turnover Rate (Flux Method)
No. of Separations + No. of accession (new recruitments)
=
Average No. of workers on roll

13 40 + No. of accessions (New recruitments)

Or, =
100 800
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’
Wor ker s at the begining + Wor ker s at the end
Average no. of workers on roll =
2

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

X + ( X + New accessions − Separations)

800 =
2
X + ( X + 64 − 40)
800 =
2
X + ( X + 24 )
800 =
2
2X = 1,600 – 24
X = 788 workers
(b) Statement Showing Evaluation of Two Machines
Particulars Machine A Machine B
Purchase Cost (`) : (i) 8,00,000 6,00,000
Life of Machines (in years) 3 2
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
Present Value of Running Cost of Machines (`): 3,23,284 4,33,875
(v) = [(ii) x (iii)]
Cash Outflow of Machines (`) : (vi) = (i) + (v) 11,23,284 10,33,875
Equivalent Present Value of Annual Cash Outflow 4,51,698.57 5,95,721.69
[(vi) ÷ (iii)] Or 4,51,699 Or 5,95,722

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 80
Fixed Overhead 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 1,20,000 1,50,000
(Long-term)
Bills Payable 20,000 30,000 Stock 3,00,000 2,30,000
Provision for Tax 1,60,000 1,80,000 Debtors 1,80,000 2,00,000
Cash & Bank 66,000 1,52,000
14,51,000 16,27,000 14,51,000 16,27,000
Additional Information:
(1) Depreciation charged during the year 2012-13:

© The Institute of Chartered Accountants of India

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)
9,000
= ` 50 ( × 8hours – 7,000 hrs.)
10
= ` 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)

© The Institute of Chartered Accountants of India

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 Working Capital
2012 2013 Increase Decrease
(`) (`) (`) (`)
(A) Current Assets
Stock 3,00,000 2,30,000 - 70,000
Debtors 1,80,000 2,00,000 20,000 -
Cash & Bank 66,000 1,52,000 86,000 -
Total (A) 5,46,000 5,82,000
(B) Current Liabilities
Sundry Creditors 1,71,000 1,67,000 4,000 -
Bills Payable 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
Increase in Working Capital 30,000 - - 30,000
Total 3,85,000 3,85,000 1,10,000 1,10,000
Funds Flow Statement as on 31st March, 2013
Sources of Fund ` Application of Fund `
Funds from Operation 5,13,596 Increase in Working Capital 30,000
Interim Dividend 80,000

© The Institute of Chartered Accountants of India

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 By Funds from Operations 5,13,596
Building 40,000 80,000
To Goodwill -
To Interim Dividend 80,000
To Corporate Dividend 13,596
Tax
To Provision for Tax 1,90,000
To Net Profit for 2013 2,70,000
6,73,596 6,73,596
Provision for Tax A/c
Particulars ` Particulars `
To Bank A/c (Tax Paid) 1,70,000 By Bal. b/d 1,60,000
To Balance b/d 1,80,000 By P&L A/c 1,90,000
3,50,000 3,50,000
Plant & Machinery A/c
Particulars ` Particulars `
To Bal. b/d 3,70,000 By Depreciation 40,000
To Bank 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.)

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

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 trans-
ferred 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 inter-
process 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.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

(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”.

© The Institute of Chartered Accountants of India

60 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
Annual Credit Sales (`) 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
Note: Return on investment in new accounts receivable is based on cost of investment in
debtors.
Which option would you recommend? (8 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

Answer
(a) Computation of Machine Hour Rate
Setting-up time Setting-up
is time is
‘Unproductive’ ‘Productive’
Particulars (Machine hour- (Machine
2,407*) hour- 2,600)
` `
Fixed Charges (Standing Charges):
Overhead Chargeable ` 18,000 × 12 = ` 2,16,000 89.74 83.08
 Rs` 2,16,000   Rs` 2,16,000 
 2,407 hours  ;  2,600 hours 
   
Operator’s Salary:
R̀ 18,500 × 12 × 2 Operators
= ` 1,11,000
4 machines
 R̀ 1,11,000   R̀ 1,11,000  46.12 42.69
 2,407 hours  ;  2,600 hours 
   
Insurance: 2% of `25,00,000 = `50,000 20.77 19.23
156.63 145.00
Variable Expenses (Machine Expenses) per hour
` 25,00,000 − ` 1,25,000 95.00 95.00
Depreciation :
25,000 hours
Power: ( 25 units × ` 5) 125.00 125.00
Repairs and Maintenance : 10.80 10.00
 ` 26,000   ` 26,000 
 2,407 hours  ;  2,600 hours 
   
 Rs` 2,600 × 12   Rs` 2,600 × 12  12.96 12.00
Chemical :   ; 
 2,407 hours   2,600 hours 
Machine Hour Rate 400.39 387.00

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2013

* (Hours)
Working Hours 3,000
Less: Maintenance hours 400
2,600
Less: Setting-up hours 193
2,600hours 2,407
Actual working hours ( ×100)
108

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 setting-
up 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 setting-
up 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)
Present Policy Policy
Policy Option I Option II
Sales Revenue 30,00,000 42,00,000 4,50,0000
Less: Variable Cost @70% 21,00,000 29,40,000 31,50,000
Contribution 9,00,000 12,60,000 13,50,000
Less: Other Relevant Costs
Bad Debt Losses (90,000) (2,10,000) (2,70,000)
Investment Cost (1,05,000) (1,96,000) (2,62,500)
(VC ÷ DTR) × 20%
Profit 7,05,000 8,54,000 8,17,500
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

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 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 reve-
nue 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.

© The Institute of Chartered Accountants of India

64 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 firm’s 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.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

(e) (i) 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”

© The Institute of Chartered Accountants of India

DISCLAIMER
The Suggested Answers hosted in the website do not constitute the basis for evaluation of the
students’ answers in the examination. The answers are prepared by the Faculty of the Board
of Studies with a view to assist the students in their education. While due care is taken in
preparation of the answers, if any errors or omissions are noticed, the same may be brought to
the attention of the Director of Studies. The Council of the Institute is not in anyway
responsible for the correctness or otherwise of the answers published herein.

© 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 answer”.
Question 1
Answer the following:
(a) Following are the details of the product Phomex for the month of April 2013:
Standard quantity of material required per unit 5 kg
Actual output 1000 units
Actual cost of materials used ` 7,14,000
Material price variance ` 51,000 (Fav)
Actual price per kg of material is found to be less than standard price per kg of material
by ` 10.
You are required to calculate:
(i) Actual quantity and Actual price of materials used.
(ii) Material Usage Variance
(iii) Material Cost Variance
(b) MFN Limited started its operation in 2011 with the total production capacity of 2,00,000
units. The following data for two years is made available to you:
2011 2012
Sales units 80,000 1,20,000
Total cost (`) 34,40,000 45,60,000
There has been no change in the cost structure and selling price and it is expected to
continue in 2013 as well. Selling price is ` 40 per unit.
You are required to calculate:
(i) Break-Even Point (in units)
(ii) Profit at 75% of the total capacity in 2013
(c) A company issued 40,000, 12% Redeemable Preference Share of ` 100 each at a
premium of ` 5 each, redeemable after 10 years at a premium of ` 10 each. The
floatation cost of each share is ` 2.
You are required to calculate cost of preference share capital ignoring dividend tax.
(d) The following information relates to Beta Ltd. for the year ended 31st March 2013:

© The Institute of Chartered Accountants of India

44 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Net Working Capital ` 12,00,000

Fixed Assets to Proprietor’s Fund Ratio 0.75
Working Capital Turnover Ratio 5 Times
Return on Equity (ROE) 15%
There is no debt capital.
You are required to calculate:
(i) Proprietor’s Fund
(ii) Fixed Assets
(iii) Net Profit Ratio. (4 x 5 = 20 Marks)
Answer
1. (a) (i) Actual Quantity and Actual Price of material used
Material Price Variance = Actual Quantity (Std. Price – Actual Price) = `51,000
Or, AQ (SP – AP) = ` 51,000
Or, 10 AQ = ` 51,000
Or, AQ = 5,100 kgs
Actual cost of material used is given i.e. AQ x AP = ` 7,14,000
or, 5,100 AP = ` 7,14,000
AP = ` 140
 Actual price is less by ` 10
So, Standard Price = ` 140 + ` 10 = ` 150 per kg
Actual Quantity = 5,100 kgs
Actual Price = ` 140/kg
(ii) Material Usage Variance
Std. Price (Std. Quantity – Actual Quantity)
Or, SP (SQ – AQ)
= ` 150 (1,000 units x 5 kg – 5,100 kg)
= ` 15,000 (A)
(iii) Material Cost Variance = Std. Cost – Actual Cost
= (SP x SQ) – (AP x AQ)
= ` 150 x 5,000 – ` 140 x 5,100

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 45

= ` 7,50,000 – ` 7,14,000
= ` 36,000 (F)
OR
Material Price Variance + Material Usage Variance
` 51,000 (F) + ` 15,000 (A)
= ` 36,000 (F)
(b)
2011 2012 Difference
Sales Units 80,000 1,20,000 40,000
Sale Value @ ` 40 32,00,000 48,00,000 16,00,000
Total Cost ` 34,40,000 45,60,000 11,20,000
Variable Cost per unit 11,20,000/40,000
(change in total = ` 28
cost/change in sales
volume)
Total Fixed Cost (`) 45,60,000 –
1,20,000 x 28 =
` 12,00,000
Or
34,40,000 –
80,000 x 28 =
` 12,00,000
Break-even point in Fixed Cost/Contribution per unit = ` 12,00,000/ ` (40-28)
units = 12,00,000/12 = 1,00,000 units
Capacity at 75% 1,50,000 units (2,00,000 x 75%)
Contribution per unit ` 12
Contribution (`) 1,50,000 x ` 12 = ` 18,00,000
Fixed Cost ` 12,00,000
Profit Contribution – Fixed Cost = ` 18,00,000 – 12,00,000
= ` 6,00,000
(c) Calculation of Cost of Preference Shares (Kp)
Preference Dividend (PD) = 0.12 x 40,000 x 100
= 4,80,000
Floatation Cost = 40,000 x 2 = ` 80,000
Net Proceeds (NP) = 42,00,000 – 80,000 = 41,20,000

© The Institute of Chartered Accountants of India

46 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Redemption Value (RV) = 40,000 x 110 = 44,00,000

PD + (RV - NP) / N
Cost of Redeemable Preference Shares =
RV + NP
2
4,80,000 + (44,00,000 - 41,20,000)/10
Kp =
44,00,000 + 41,20,000
2
4,80,000 + (2,80,000)/10
=
85,20,000/2
4,80,000 + 28,000 5,08,000
= =
42,60,000 42,60,000
= 0.1192
Kp = 11.92%
(Note: Kp may be computed alternatively by taking the RV and NP for one unit of
preference shares. Final figure would remain unchanged).
(d) (i) Calculation of Proprietor’s Fund
Since Ratio of Fixed Assets to Proprietor’s Fund = 0.75
Therefore, Fixed Assets = 0.75 Proprietor’s Fund
Net Working Capital = 0.25 Proprietor’s Fund
12,00,000 = 0.25 Proprietor’s Fund
12,00,000
Therefore, Proprietors Fund =
0.25
= 48,00,000
(ii) Calculation of Fixed Assets
Fixed Assets = 0.75 Proprietor’s Fund
= 0.75 x 48,00,000
= 36,00,000
(iii) Calculation of Net Profit Ratio
Net Working Capital = 0.25 x 48,00,000
= 12,00,000

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 47

Sales
Working Capital Turnover Ratio =
Working Capital
∴ Sales = 60,00,000
PAT
ROE =
Equity
PAT
0.15 =
48,00,000
PAT = 7,20,000
Net Profit
Net Profit Ratio = x100
Sales
7,20,000
= x 100
60,00,000
Net Profit Ratio = 12%
[Note: Fixed Assets may be computed alternatively by (Net Working Capital × Fixed Assets
to Proprietor’s Fund Ratio) and Proprietor’s Fund by (Fixed Assets + Net Working Capital)].
Question 2
(a) The summarized Balances Sheets of MPS Limited as on 31-3-2012 and 31-3-2013 are as
under:
Liabilities 31-3-2012 31-3-2013 Assets 31-3-2012 31-3-2013
` ` `
Equity share 40.00 50.00 Land & 27.00 25.00
capital Building
Securities - 1.00 Plant & 25.00 34.00
Premium Machinery
Account
General 8.00 11.00 Investments 3.00 8.00
Reserve (Long Term)
Profit & Loss 10.30 12.70 Stock 7.50 9.80
Account
10% Debentures 5.00 3.00 Debtors 9.25 11.15
Sundry Creditors 4.90 6.20 Bills 1.77 1.65
Receivable
Provision for Tax 5.00 7.00 Cash & Bank 4.50 7.70

© The Institute of Chartered Accountants of India

48 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Balance
Proposed 4.80 6.00 Preliminary 0.80 0.62
Dividend Expenses
Corporate 0.82 1.02
Dividend Tax
78.82 97.92 78.82 97.92
Additional Information:
(i) On 1.4.2012, the company redeemed debentures of ` 2,00,000 at par.
(ii) During 2012-13 the company has issued equity shares for cash at a premium of
10%.
(iii) Provision for tax made during the year 2012-13 for ` 6,80,000.
(iv) Dividend received on investment ` 50,000 in July 2012.
(v) A machine costing ` 8,00,000 (WDV ` 1,20,000) was sold for ` 50,000 during the
year 2012-13.
(vi) Depreciation for 2012-13 charged on plant & machinery ` 3,30,000 and ` 2,00,000
on land and building.
(vii) Proposed Dividend and Corporate Dividend Tax of 2011-12 paid during the year
2012-13.
Prepare a Cash Flow Statement as per Accounting Standard (AS)-3. (10 Marks)
(b) A skilled worker is paid a guaranteed wage rate of ` 120 per hour. The standard time
allowed for a job is 6 hour. He took 5 hours to complete the job. He is paid wages under
Rowan Incentive Plan.
(i) Calculate his effective hourly rate of earnings under Rowan Incentive Plan.
(ii) If the worker is placed under Halsey Incentive Scheme (50%) and he wants to
maintain the same effective hourly rate of earnings, calculate the time in which he
should complete the job. (6 Marks)
Answer
(a) Cash Flow Statement
(` in (` in
lakhs) lakhs)
(A) Cash Flow from Operating Activities
Profit and Loss A/c (12.70 – 10.30) 2.40
Add: General Reserves (11.00 – 8.00) 3.00
5.40

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 49

Add: Provision for tax 6.8

12.20
Add: Proposed dividend 6.00
Corporate dividend tax 1.02
Profit before tax 19.22
Add: Interest on debentures 0.30
Loss on Sale of Machinery 0.70
Depreciation on Plant & Machinery 3.30
Depreciation on Land & Building 2.00
Preliminary Expenses written off 0.18
25.70
Less: Dividend received on Investment (0.50)
Cash flow before W/C adjustments 25.20
Less:Increase in Current Assets
Stock (2.30)
Debtors (1.90)
21.00
Add: Decrease in Current Assets
Bills receivables 0.12
Add: Increase in Current Liabilities
Sundry Creditors 1.30
Cash Generated from Operations 22.42
Less:Income tax paid
[(5.00+6.80) – 7.00] (4.80)
Cash Flow from Operating Activities 17.62
(B) Cash Flow from Investing Activities
Sale of Plant & Machinery 0.50
Purchase of Plant & Machinery (13.50)
Purchase of Investment (5.00)
Dividend Received on Investment 0.50
Cash Flow from Investing Activities (17.50)
(C) Cash Flow from Financing Activities

© The Institute of Chartered Accountants of India

50 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Issue of Share Capital 10.00

Securities Premium 1.00
Redemption of Debentures (2.00)
Interest on debentures (0.30)
Proposed Dividend (4.80)
Corporate dividend tax (0.82)
Cash flow from Financing Activities 3.08
Net increase in Cash and Cash Equivalent (A+B+C) 3.20
Cash and Cash equivalent at beginning of year 4.50
Cash and Cash Equivalent at end of year 7.70
Working Notes:
Provision for Tax A/c
Particulars Amount (`) Particulars Amount (`)
To Cash b/f 4.80 By Bal. b/d 5.00
To Balance c/d 7.00 By P/L 6.80
11.80 11.80
Land & Building A/c
Particulars Amount (`) Particulars Amount (`)
To Bal. b/d 27.00 By Depreciation 2.00
By Balance c/d 25.00
27.00 27.00
Plant & Machinery A/c
Particulars Amount (`) Particulars Amount (`)
To Balance b/d 25.00 By Bank 0.50
To Bank b/f 13.50 By P/L 0.70
By Depreciation 3.30
By Balance c/d 34.00
38.50 38.50

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 51

(b) (i) Effective hourly rate of earnings under Rowan Incentive Plan
Earnings under Rowan Incentive plan =
Time Saved
(Actual time taken × wage rate) + × Time taken × Wage rate
Time Allowed
 1 hour 
= (5 hours × `120) +  × 5 hours ×` 120 
 6 hours 
= ` 600 + `100 = `700
Effective hourly rate = `700/5 hours = ` 140 /hour
(ii) Let time taken = X
Earnings under Halsay Scheme
∴ Effective hourly rate =
Time Taken
Or, Effective hourly rate under Rowan Incentive plan =
(Time taken × Rate) + 50% Rate × (Time allowed − Time taken)
TimeTaken
(X ×` 120) + 50% `120 × (6 − X)
Or, `140 =
X
Or, 140X = 120X + 360 – 60X
Or, 80X = 360
360
Or, X= = 4.5 hours
80
Therefore, to earn effective hourly rate of `140 under Halsey Incentive Scheme
worker has to complete the work in 4.5 hours
Question 3
(a) ABX Company Ltd. provides the following information relating to Process-B:
(i) Opening Work-in-progress - NIL
(ii) Units Introduced - 45,000 units @ ` 10 per unit
(iii) Expenses debited to the process:
Direct material - ` 65,500
Labour - ` 90,800
Overhead - ` 1,80,700
(iv) Normal loss in the process - 2% of Input

© The Institute of Chartered Accountants of India

52 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

(v) Work-in progress - 1800 units

Degree of completion
Materials - 100%
Labour - 50%
Overhead - 40%
(vi) Finished output - 42,000 units
(vii) Degree of completion of abnormal loss:
Materials - 100%
Labour - 80%
Overhead - 60%
(viii) Units scrapped as normal loss were sold at ` 5 per unit.
(ix) All the units of abnormal loss were sold at ` 2 per unit.
You are required to prepare:
(a) Statement of equivalent production.
(b) Statement showing the cost of finished goods, abnormal loss and closing balance of
work-in-progress.
(c) Process-B account and abnormal loss account. (10 Marks)
(b) The following information related to XL Company Ltd. for the year ended 31 st March,
2013 are available to you:
Equity share capital of ` 10 each ` 25 lakh
11% Bonds of ` 1000 each ` 18.5 lakh
Sales ` 42 lakh
Fixed cost (Excluding Interest) ` 3.48 lakh
Financial leverage 1.39
Profit-Volume Ratio 25.55%
Income Tax Rate Applicable 35%
You are required to calculate:
(i) Operating Leverage;
(ii) Combined Leverage; and
(iii) Earning per Share. (6 Marks)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 53

Answer
(a) Statement of Equivalent Production
Equivalent Production
Input Output
Units Units Material Labour Overhead
Details Particulars
% Units % Units % Units
Unit 45,000 Finished 42,000 100 42,000 100 42,000 100 42,000
Introduced output
Normal 900 - - - - - -
loss (2%
of 45,000)
Abnormal 300 100 300 80 240 60 180
loss
Closing 1,800 100 1,800 50 900 40 720
W-I-P
45,000 45,000 44,100 43,140 42,900
(b) Statement of Cost
Particulars Units Rate (`) Amount Amount (`)
(`)
(i) Finished goods 42,000 17.9042 7,51,976.40
(ii) Abnormal Loss
Material 300 11.5873 3,476.19
Labour 240 2.1048 505.15
Overhead 180 4.2121 758.18 4,739.52
(iii) Closing W-I-P:
Material 1,800 11.5873 20,857.14
Labour 900 2.1048 1,894.32
Overhead 720 4.2121 3,032.71 25,784.17

Cost per Unit

Particulars Amount (`) Units Per Unit (`)
(i) Direct Material :
Unit Introduced 4,50,000
Add: Material 65,500

© The Institute of Chartered Accountants of India

54 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

5,15,500
Less: Value of normal loss
(900 units × `5) (4,500)
5,11,000 44,100 11.5873
(ii) Labour 90,800 43,140 2.1048
(iii) Overhead 1,80,700 42,900 4.2121
17.9042
(c) Process – B A/c
Particulars Units Amount Particulars Units Amount
(`) (`)
To Input 45,000 4,50,000 By Normal loss 900 4,500
To Direct Material - 65,500 By Abnormal loss 300 4,740
To Labour - 90,800 By Finished goods 42,000 7,51,976
To Overhead 1,80,700 By Closing W-I-P 1,800 25,784
45,000 7,87,000 45,000 7,87,000
Abnormal Loss A/c
Particulars Units Amount Particulars Units Amount
(`) (`)
To Process-B A/c 300 4,740 By Cost ledger control A/c 300 600
or Bank A/c
By Costing Profit & loss A/c - 4,140
300 4,740 300 4,740
Contribution
(b) Profit – Volume Ratio =
Sales
Contribution
25.55 = x 100
42,00,000
Contribution = 10,73,100
Contribution
(i) Operating Leverage =
Contribution - Fixed Cost
10,73,100
=
10,73,100 - 3,48,000
10,73,100
=
7, 25,100

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 55

= 1.48
(ii) Combined Leverage = Operating Leverage x Financial Leverage
= 1.48 x 1.39 = 2.06
(iii) Earnings per Share (EPS)
Number of Equity Shares = 2,50,000
Earnings before Tax (EBT) = Sales – Variable Cost – Fixed Cost – Interest
= 42,00,000 – 31,26,900 – 3,48,000 – 2,03,500
EBT = 5,21,600
Profit after Tax (PAT) = EBT – Tax
= 5,21,600 – 1,82,560
= 3,39,040
3,39,040
EPS = = 1.3561
2,50,000
EPS = 1.36
Question 4
(a) A company manufactures one main product (M1) and two by-products B1 and B2. For the
month of January 2013, following details are available:
Total Cost upto separation Point ` 2,12,400
M1 B1 B2
Cost after separation - ` 35,000 ` 24,000
No. of units produced 4,000 1,800 3,000
Selling price per unit ` 100 ` 40 ` 30
Estimated net profit as percentage to - 20% 30%
sales value
Estimated selling expenses as 20% 15% 15%
percentage to sales value
There are no beginning or closing inventories.
Prepare statement showing:
(i) Allocation of joint cost; and
(ii) Product-wise and overall profitability of the company for January 2013. (8 Marks)
(b) The following information is provided by the DPS Limited for the year ending 31st March,
2013.

© The Institute of Chartered Accountants of India

56 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Raw material storage period 55 days

Work-in-progress conversion period 18 days
Finished Goods storage period 22 days
Debt collection period 45 days
Creditors’ payment period 60 days
Annual Operating cost ` 21,00,000
(Including depreciation of ` 2,10,000)
[1 year = 360 days]
You are required to calculate:
(i) Operating Cycle period.
(ii) Number of Operating Cycle in a year.
(iii) Amount of working capital required for the company on a cash cost basis.
(iv) The company is a market leader in its product, there is virtually no competitor in the
market. Based on a market research it is planning to discontinue sales on credit
and deliver products based on pre-payments. Thereby, it can reduce its working
capital requirement substantially.
What would be the reduction in working capital requirement due to such decision?
(8 Marks)
Answer
(a) (i) Statement showing allocation of Joint Cost
Particulars B1 B2
No. of units Produced 1,800 3,000
Selling Price Per unit (`) 40 30
Sales Value (`) 72,000 90,000
Less:Estimated Profit (B1 -20% & B2 -30%) (14,400) (27,000)
Cost of Sales 57,600 63,000
Less: Estimated Selling Expenses (B1 -15% & B2 - (10,800) (13,500)
15%)
Cost of Production 46,800 49,500
Less:Cost after separation (35,000) (24,000)
Joint Cost allocated 11,800 25,500

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 57

(ii) Statement of Profitability

Particulars M1 (`) B1 (`) B2 (`)
Sales Value (A) 4,00,000 72,000 90,000
(4,000x `100)
Less:- Joint Cost 1,75,100 11,800 25,500
(2,12,400 -11,800 -
25,500)
- Cost after separation - 35,000 24,000
- Selling Expenses 80,000 10,800 13,500
(M1- 20%, B1-15% & B2-15%)
(B) 2,55,100 57,600 63,000
Profit (A –B) 1,44,900 14,400 27,000
Overall Profit = 1,44,900 + 14,400 + 27,000 = ` 1,86,300
(b) (i) Calculation of Operating Cycle Period
Operating Cycle Period = R + W + F + D – C
= 55 + 18 + 22 + 45 – 60
= 80 days
(ii) Number of Operating Cycle in a Year
360
=
Operating Cycle Period
360
= = 4.5
80
(iii) Amount of Working Capital Required
Annual Operating Cost
=
Number of Operating Cycle
18,90,000
= = 4,20,000
4.5
(iv) Reduction in Working Capital
Operating Cycle Period = R + W + F – C
= 55 + 18 + 22 – 60
= 35

© The Institute of Chartered Accountants of India

58 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

18,90,000
Amount of Working Capital Required = × 35
360
= 1,83,750
Reduction in Working Capital = 4,20,000 – 1,83,750
= 2,36,250
Question 5
(a) Cost of a product or service is required to be expressed in suitable cost unit. State the
cost units for the following industries:
(i) Steel
(ii) Automobile
(iii) Transport
(iv) Power
(b) Distinguish between cost allocation and cost absorption.
(c) What is debt securitization? And also state its advantages.
(d) Distinguish between factoring and bill-discounting. (4x4=16 Marks)
Answer
(a)
Industry Cost Unit
(i) Steel Tonne
(ii) Automobile Numbers
(iii) Transport Passenger Kilo-meter/ Tonne Kilo-meter
(iv) Power Kilo-watt hour (Kwh)
(b) Distinguish between Cost allocation and Cost absorption:
Cost allocation is the allotment of whole item of cost to a cost centre or a cost unit. In
other words, it is the process of identifying, assigning or allowing cost to a cost centre or
a cost unit.
Cost absorption is the process of absorbing all indirect costs or overhead costs allocated
or apportioned over particular cost centre or production department by the units
produced.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 59

(c) Debt Securitisation and its Advantages

Debt securitisation is a method of recycling of funds and is especially beneficial to
financial intermediaries to support lending volumes. Under debt securitisation a group of
illiquid assets say a mortgage or any asset that yields stable and regular cash flows like
bank loans, consumer finance, and credit card payment are pooled together and sold to
intermediary. The intermediary then issues debt securities.
The advantages of debt securitisation to the originator are the following:
(i) The asset is shifted off the Balance Sheet, thus giving the originator recourse to off
balance sheet funding.
(ii) It converts illiquid assets to liquid portfolio.
(iii) It facilitates better balance sheet management; assets are transferred off balance
sheet facilitating satisfaction of capital adequacy norms.
(iv) The originator’s credit rating enhances.
(Note: Students may answer any two of the above advantages)
(d) Differentiation between Factoring and Bills Discounting
The differences between Factoring and Bills discounting are:
(i) Factoring is called as “Invoice Factoring’ whereas Bills discounting is known as
‘Invoice discounting.”
(ii) In Factoring, the parties are known as the client, factor and debtor whereas in Bills
discounting, they are known as drawer, drawee and payee.
(iii) Factoring is a sort of management of book debts whereas bills discounting is a sort
of borrowing from commercial banks.
(iv) For factoring there is no specific Act, whereas in the case of bills discounting, the
Negotiable Instruments Act is applicable.
Question 6
(a) Pentax Limited has prepared its expense budget for 20,000 units in its factory for the
year 2013 as detailed below:
` per unit
Direct Materials 50
Direct Labour 20
Variable Overhead 15
Direct Expenses 6
Selling Expenses (20% fixed) 15

© The Institute of Chartered Accountants of India

60 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Factory Expenses (100% fixed) 7

Administration expenses (100% fixed) 4
Distribution expenses (85% variable) 12
Total ` 129
Prepare an expense budget for the production of 15,000 units and 18,000 units.
(7 Marks)
(b) PQR Company Ltd. Is considering to select a machine out of two mutually exclusive
machines. The company’s cost of capital is 12 per cent and corporate tax rate is 30 per
cent. Other information relating to both machines is as follows:
Machine – I Machine – II
Cost of Machine ` 15,00,000 ` 20,00,000
Expected Life 5 Yrs. 5 Yrs.
Annual Income (Before Tax and Depreciation) ` 6,25,000 ` 8,75,000
Depreciation is to be charged on straight line basis:
You are required to calculate:
(i) Discounted Pay Back Period
(ii) Net Present Value
(iii) Profitability Index
The present value factors of ` 1 @ 12% are as follows:
Year 01 02 03 04 05
PV factor @ 12% 0.893 0.797 0.712 0.636 0.567 (9 Marks)
Answer
(a) Expense Budget of M/s Pentax Ltd.
Particulars 20,000 Units (`) 15,000 Units (`) 18,000 Units
(`)
Direct Material 10,00,000 7,50,000 9,00,000
(20,000 x 50) (15,000 x 50) (18,000 x 50)
Direct Labour 4,00,000 3,00,000 3,60,000
(20,000 x 20) (15,000 x 20) (18,000 x 20)
Variable Overhead 3,00,000 2,25,000 2,70,000
(20,000 x 15) (15,000 x 15) 18,000 x 15)
Direct Expenses 1,20,000 90,000 1,08,000
(20,000 x 6) (15,000 x 6) 18,000 x 6)

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 61

Selling Expenses (Variable)* 2,40,000 1,80,000 2,16,000

(20,000 x 12) (15,000 x 12) (18,000 x 12)
Selling Expenses (Fixed)* 60,000 60,000 60,000
(3 x 20,000)
Factory Expenses (Fixed) 1,40,000 1,40,000 1,40,000
(7 x 20,000)
Administration Expenses (Fixed) 80,000 80,000 80,000
(4 x 20,000)
Distribution Expenses (Variable)** 2,04,000 1,53,000 1,83,600
(10.20 x 20,000) (10.20 x 15,000) (10.20 x
18,000)
Distribution Expenses (Fixed)** 36,000 36,000 36,000
(1.80 x 20,000)
25,80,000 20,14,000 23,53,600
*Selling Expenses: Fixed cost per unit = `15 x 20% = `3
Fixed Cost = `3 x 20,000 units = `60,000
Variable Cost Per unit = `15 – `3 = `12
**Distribution Expenses: Fixed cost per unit = `12 x 15% = `1.80
Fixed Cost = `1.80 x 20,000 units = `36,000
Variable cost per unit = `12 – `1.80 = `10.20
(b) Working Notes:
15,00,000
Depreciation on Machine – I = = ` 3,00,000
5
20,00,000
Depreciation on Machine – II = = ` 4,00,000
5
Particulars Machine-I (`) Machine – II (`)
Annual Income (before Tax and Depreciation) 6,25,000 8,75,000
Less: Depreciation 3,00,000 4,00,000
Annual Income (before Tax) 3,25,000 4,75,000
Less: Tax @ 30% 97,500 1,42,500
Annual Income (after Tax) 2,27,500 3,32,500
Add: Depreciation 3,00,000 4,00,000
Annual Cash Inflows 5,27,500 7,32,500

© The Institute of Chartered Accountants of India

62 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

Machine – I Machine - II
Year PV of Re Cash PV Cumulative Cash PV Cumulative
1 @ 12% flow PV flow PV
1 0.893 5,27,500 4,71,058 4,71,058 7,32,500 6,54,123 6,54,123
2 0.797 5,27,500 4,20,418 8,91,476 7,32,500 5,83,803 12,37,926
3 0.712 5,27,500 3,75,580 12,67,056 7,32,500 5,21,540 17,59,466
4 0.636 5,27,500 3,35,490 16,02,546 7,32,500 4,65,870 22,25,336
5 0.567 5,27,500 2,99,093 19,01,639 7,32,500 4,15,328 26,40,664
(i) Discounted Payback Period
Machine – I
(15,00,000 − 12,67,056)
Discounted Payback Period = 3 +
3,35,490
2,32,944
=3+
3,35,490
= 3 + 0.6943
= 3.69 years or 3 years 8.28 months
Machine – II
(20,00,000 − 17,59,466)
Discounted Payback Period = 3+
4,65,870
2,40,534
=3+
4,65,870
= 3 + 0.5163
= 3.52 years or 3 years 6.24 months
(ii) Net Present Value (NPV)
Machine – I
NPV = 19,01,639 -15,00,000 = ` 4,01,639
Machine – II
NPV = 26,40,664 – 20,00,000 = ` 6,40,664

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 63

(iii) Profitability Index

Machine – I
19,01,639
Profitability Index = = 1.268
15,00,000
Machine – II
26,40,664
Profitability Index = = 1.320
20,00,000
Conclusion:
Method Machine - I Machine - II Rank
Discounted Payback Period 3.69 years 3.52 years II
Net Present Value `4,01,639 `6,40,664 II
Profitability Index 1.268 1.320 II
Question 7
Answer any four of the following: (4x4=16 Marks)
(a) “Perpetual inventory system comprises Bin Card and Stores Ledger, but the efficacy of
the system depends on continuous stock taking.” Comment.
(b) “Is reconciliation of cost accounts and financial accounts necessary in case of integrated
accounting system?”
(c) “Operating risk is associated with cost structure, whereas financial risk is associated with
capital structure of a business concern.” Critically examine this statement.
(d) What is venture capital financing? State the factors which are to be considered in
financing any risky project.
(e) State the advantage of Electronic Cash Management System.
Answer
(a) Perpetual Inventory system represents a system of records maintained by the stores
department. Records comprise of (i) Bin Cards and (ii) Stores Ledger. Bin Card
maintains a quantitative record of receipts, issues and closing balances of each item of
stores. Like a bin card, the Stores Ledger is maintained to record all receipt and issue
transactions in respect of materials. It is filled up with the help of goods received note
and material requisitions. But a perpetual inventory system’s efficacy depends on the
system of continuous stock taking. Continuous stock taking means the physical checking
of the records i.e. Bin cards and store ledger with actual physical stock. Perpetual
inventory is essentially necessary for material control. It incidentally helps continuous
stock taking.

© The Institute of Chartered Accountants of India

64 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

The main advantages of continuous stock taking are as follows:

(1) Physical stocks can be counted and book balances adjusted as and when desired
without waiting for the entire stock-taking to be done.
(2) Quick compilation of Profit and Loss Accounts (for interim period) due to prompt
availability of stock figures.
(3) Discrepancies are easily located and thus corrective action can be promptly taken
to avoid their recurrence.
(4) A systematic review of the perpetual inventory reveals the existence of surplus,
dormant, obsolete and slow-moving materials, so that remedial measures may be
taken in time.
(5) Fixation of the various levels and check of actual balances in hand with these levels
assist the Storekeeper in maintaining stocks within limits and in initiating purchase
requisitions for correct quantity at the proper time.
(b) In integrated accounting system cost and financial accounts are kept in the same set of
books. Such a system will have to afford full information required for Costing as well as
for Financial Accounts. In other words, information and data should be recorded in such
a way so as to enable the firm to ascertain the cost (together with the necessary
analysis) of each product, job, process, operation or any other identifiable activity. It also
ensures the ascertainment of marginal cost, variances, abnormal losses and gains. In
fact all information that management requires from a system of Costing for doing its work
properly is made available. The integrated accounts give full information in such a
manner so that the profit and loss account and the balance sheet can be prepared
according to the requirements of law and the management maintains full control over the
liabilities and assets of its business.
Since, only one set of books are kept for both cost accounting and financial accounting
purpose so there is no necessity of reconciliation of cost and financial accounts.
(c) “Operating risk is associated with cost structure whereas financial risk is
associated with capital structure of a business concern”.
Operating risk refers to the risk associated with the firm’s operations. It is represented
by the variability of earnings before interest and tax (EBIT). The variability in turn is
influenced by revenues and expenses, which are affected by demand of firm’s products,
variations in prices and proportion of fixed cost in total cost. If there is no fixed cost,
there would be no operating risk. Whereas financial risk refers to the additional risk
placed on firm’s shareholders as a result of debt and preference shares used in the
capital structure of the concern. Companies that issue more debt instruments would
have higher financial risk than companies financed mostly by equity.

© The Institute of Chartered Accountants of India

PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 65

(d) Venture Capital Financing and Factors to be considered in financing any Risky
Project
Under venture capital financing, venture capitalist makes investment to purchase debt or
equity from inexperienced entrepreneurs who undertake highly risky ventures with
potential of success. The factors to be considered in financing any risky project are:
(i) Quality of the management team is a very important factor to be considered. They
are required to show a high level of commitment to the project.
(ii) The technical ability of the team is also vital. They should be able to develop and
produce a new product / service.
(iii) Technical feasibility of the new product / service should be considered.
(iv) Since the risk involved in investing in the company is quite high, venture capitalists
should ensure that the prospects for future profits compensate for the risk.
(v) A research must be carried out to ensure that there is a market for the new product.
(vi) The venture capitalist himself should have the capacity to bear risk or loss, if the
project fails.
(vii) The venture capitalist should try to establish a number of exit routes.
(viii) In case of companies, venture capitalist can seek for a place on the Board of
Directors to have a say on all significant matters affecting the business.
(Note: Students may answer any two of the above factors)
(e) Advantages of Electronic Cash Management System
(i) Significant saving in time.
(ii) Decrease in interest costs.
(iii) Less paper work.
(iv) Greater accounting accuracy.
(v) More control over time and funds.
(vi) Supports electronic payments.
(vii) Faster transfer of funds from one location to another, where required.
(viii) Speedy conversion of various instruments into cash.
(ix) Making available funds wherever required, whenever required.
(x) Reduction in the amount of ‘idle float’ to the maximum possible extent.

© The Institute of Chartered Accountants of India

66 INTERMEDIATE (IPC) EXAMINATION: MAY, 2013

(xi) Ensures no idle funds are placed at any place in the organization.
(xii) It makes inter-bank balancing of funds much easier.
(xiii) It is a true form of centralised ‘Cash Management’.
(xiv) Produces faster electronic reconciliation.
(xv) Allows for detection of book-keeping errors.
(xvi) Reduces the number of cheques issued.
(xvii) Earns interest income or reduce interest expense.
(Note: Students may answer any four of the above advantages).

© The Institute of Chartered Accountants of India