[paper - 4] cost accounti ng & financial management [paper ... dec pcc gr.2 4a-b.pdf · (i)...

1

[Paper - 4] Cost Accounting & Financial

Management

[Paper - 4A] Cost Accounting

Chapter - 1 : Basic Concepts

2008 - Nov [1] Answer the following :

(iv) State the method of costing that would be most suitable for :

(a) Oil refinery

(b) Bicycle manufacturing

(c) Interior decoration

(d) Airlines company (2 marks)

Answer :

(iv) The suitable method of costing for the following is :

(a) Oil Refinery : Process costing

(b) Bicycle manufacturing : Batch costing or Multiple costing

(c) Interior decoration : Job costing but if on a larger basis

then Contract costing

(d) Airlines company : Operating costing

Chapter - 2 : Material


(i) The annual carrying cost of material 'X' is Rs. 3.6 per unit and its total

carrying cost is Rs. 9,000 per annum. What would be the Economic

order quantity for material 'X', if there is no safety stock of material X?

(2 marks)

Answer :

(i) As per the given information :

C = Rs. 3.6 per unit per annum

Total carrying cost = Rs. 9,000 per annum.

Let the annual consumption of material ‘X’ for the year = A

PCC Group - II Paper 4 II-2

Then, total carrying cost = 3.6 × A

9000 = 3.6 × A

or A = = 2500 units

Total carrying cost =

9000 =

squaring bo th the sides, we get

8,10,00,000 = 18,000 O

O = = Rs. 4,500

Therefore, ordering cost per order i.e. O = Rs. 4,500

EOQ =

=

EOQ = 2500 units (2 marks)


(v) Differentiate between “scrap” and “defectives” and how they are

treated in cost accounting. (2 marks)

Answer :

(v) Distinction between ‘scrap’ and ‘defectives’ are as follows :

Basis Scrap Defectives

1. Meaning Scrap is the incidental residue

from cer ta in types o f

manufacture, usually of small

amount and low value,

recoverable without further

processing.

Defective work signifies

those units of production

which can be rectified and

turned out as good units by

t h e a p p l i c a t i o n o f

additional materials, labour

or other service.

2. Reason Scrap is inherent in nature. Defectives arise due to sub-

standard materials, bad-

superv i s ion , i m p roper

planning, poor workm-

a n s h i p i n ad e q u a t e

equipment and careless

inspection.


3. Avoidability Scrap, since inherent in

nature, cannot be avoided.

To some extent, defectives

may be unavoidable, but

with proper care it is

possible to avoid defects in

the goods produced.

4. Control The measures to control scrap

losses and obtain maximum

gainful utilisation of raw

material are :

(a) Proper product designing

by the Production Plann-

ing Department.

(b)U se of standardise d

m a t e r i a l s - ,

e q u i p m e n t s ,

personnel and

efficiency by

the Prod-uction

Dep-artment.

(c)Preparation of periodical

scrap, re-ports,

c o r r e c t i v e -

actions etc. by

the Cost Co-

ntrol Dept.

Control of defective may

cover the following two

areas :

(a)Control over defectives

produced

(b)Control over re-working

costs.

For exercising effective

control over defectives

produced and the cost of

re- working, standards for

normal percentage of

defectives and re-workings

should be established.

Chapter - 3 : Labour

2008 - Nov [3] (b) Describe briefly, how wages may be calculated under the

following systems:

(i) Gantt task and bonus system

(ii) Emerson's efficiency system

(iii) Rowan system

(iv) Halsey system

(v) Barth system. (9 marks)

Answer :

The various systems of wage payment have been discussed below :


(i) Gantt task and bonus system :

This system, like Emerson’s system, involves, measurement of

efficiency. It is a combination of time and piece work system.

According to this system a high standard or task is set on the basis of

careful time and motion study. The worker’s actual performance is

compared with the standard and efficiency determined.

Only time wages are paid to the worker for production below the

set standard. If the standards are achieved or exceeded, the payment to

the concerned worker is made at a higher piece rate. The piece rate fixed

under this system also includes an element of bonus to the extent of

20%. The figure of bonus to such workers is calculated over the time

rate of the workers.

Thus, the system consists of paying a worker on time basis if he

does not attain the standard and on piece basis if he does.

Wages payable to workers under this plan are calculated as under:

Output Payment

(i) Output below standard

(ii) Output at standard

(iii) Output above standard

Guaranteed time rate

Time rate plus bonus of 20%

(usually) of time rate

High piece rate on worker’s

whole output.

It is so fixed, so as to include a

bonus of 20% of the time rate.

(ii) Emerson’s Efficiency System :

Emerson was one of Taylor’s associates. He guaranteed time wages but

wanted to reward efficiency. Under this system, minimum time wages

are guaranteed. But beyond a certain level of efficiency, bonus in

addition to minimum day wages is given.

A worker who is able to attain efficiency, measured by his output

equal to 2/3rd of the standard efficiency, or above, is deemed to be an

efficient worker deserving encouragement. The scheme thus provides

for payment of bonus at a rising scale at various levels of efficiency,

ranging from 66.67% to 150%. For a performance below 66.67% only

time rate wages without any bonus are paid. Above 66.67% to 100%

efficiency, bonus varies between 0.01% and 20%. Above 100%

efficiency, bonus of 20% of basic wages plus 1% for each 1% increase

in efficiency is admissible.


It can be summarised as below :

Less than 66b% -only time wages

66b% to 100% -Basic (100%) + Bonus (0.01% to

20%)

100% - above - B a s i c ( 1 0 0 % ) + B o n u s

(20%)+1% for each 1% increase in

efficiency.

This system does not pre-suppose a high degree of average

performance. Wages on time basis are guaranteed.

(iii) Rowan System :

In it essence, the plan is similar to the Halsey Plan wages at the ordinary

rate for actual time put in by a worker are guaranteed and a bonus given,

if the worker saves time out of the standard time, set for him. According

to this plan, the bonus is that proportion of wages of actual time taken

which time saved bears to the standard time.

Formula for calculating wages under Rowan system:

× Time taken × Rate per hour.

(iv) Halsey system :

Under this method, standard time for doing a job is determined and

workers are encouraged to do the job in less than the standard time. A

standard is fixed for each job or process. If there is no saving on this

standard time allowance, the worker is paid only his day rate. He gets

his time rate even if he exceeds the standard time limit, since his day

rate is guaranteed. If, however, he does the job in less than the standard

time, he gets a bonus equal to 50 percent of wages of time saved; the

employer benefits by the other 50 percent. The scheme also is

sometimes referred to as the Halsey fifty percent plan.

Formula for claculating wages under Halsey system :

= Time taken × T ime Rate + 50% of time saved × Time Rate

The Halsey Weir system is the same as the Halsey system except that

the bonus paid to workers is 30% of time saved. This system is useful

for capital intensive industry.

(v) Barth System :

Barth system is particularly suitable for trainees and beginners and also

for unskilled workers. The reason is that for low production efficiency,

the earnings are higher than in the piece work system but as the

efficiency increases, the rate of increase in the earnings falls.

Formula for calculating the remuneration under Barth Plan :

Earnings = Hourly Rate ×


Chapter - 4 : Overheads


(ii) A machinery was purchased from a manufacturer who claimed that his

machine could produce 36.5 tonnes in a year consisting of 365 days.

Holidays, break-down, etc., were normally allowed in the factory for 65

days. Sales were expected to be 25 tonnes during the year and the plant

actually produced 25.2 tonnes during the year. You are required to state

the following figures :

(a) rated capacity

(b) practical capacity

(c) normal capacity

(d) actual capacity (2 marks)

Answer :

(ii) Rated Capacity :

(a) Rated capacity or ideal capacity is the maximum number of

operating hours that could be available ignoring the stoppages due

to down time, repairs, etc.

Therefore, as per the information provided in the question,

Rated capacity = 36.5 tonnes.

(b) Practical Capacity :

This measure represents the maximum level at which a company

can realistically operate at full efficiency. This allows for

unavoidable operating interruptions which means that practical

capacity is less than ideal capacity.

Therefore,

Number of working days in a year = 365 ! 65 = 300 days

Practical capacity = = 30 tonnes.

Practical capacity ranges from 75% to 85% of rated capacity

(Like here it is = 82.19%)

(c) Normal Capacity :

It is the rate of activity needed to meet average sales demand over

a period that is sufficiently long to cover seasonal, cyclical and

trend variations in the pattern of demand for company’s products.

Normal capacity represents 75% to 90% of practical capacity.

Therefore, in the given question, normal capacity is Rs. 25 tonnes.


Normal Capacity in % = ×100 = 68.49%

(d) Actual Capacity :

Actual capacity represents the actual activity which has been

performed like, in the given question.

Actual Capacity = 25.2 tonnes.

Actual Capacity in % = ×100 = 69.10%

Chapter - 5 : Non-Integrated Accounts & Integrated

Accounts

2008 - Nov [2]As of 31st March, 2008, the following balances existed in a

firm's cost ledger, which is maintained separately on a double entry basis :

Debit Credit

Rs. Rs.

Stores Ledger Control A/c 3,00,000 )

Work-in-progress Control A/c 1,50,000 )

Finished Goods Control A/c 2,50,000 )

Manufacturing Overhead Control A/c 15,000

Cost Ledger Control A/c 6,85,000

7,00,000 7,00,000

During the next quarter, the following items arose :

Rs.

Finished Product (at cost) 2,25,000

Manufacturing overhead incurred 85,000

Raw material purchased ,25,000

Factory wages 40,000

Indirect labour 20,000

Cost of sales 1,75,000

Materials issued to production 1,35,000

Sales returned (at cost) 9,000

Materials returned to suppliers 13,000

Manufacturing overhead charged to production 85,000

You are required to prepare the Cost Ledger Control A/c, Stores Ledger

Control A/c, Work-in-progress Control A/c, Finished Stock Ledger Control

A/c, Manufacturing Overhead Control A/c, Wages Control A/c, Cost of Sales

A/c and the Trial Balance at the end of the quarter. (15 marks)


Answer :

Cost Ledger Control Account

Particulars Amount Particulars Amount

To Stores ledger

(Control A/c Mat.

returned to

suppliers)

To Balance c/d

(Bal. fig.)

13,000

9,42,000

By Balance b/d

By Stores ledger control

A/c (M at. pur.)

By Manufacturing

Overhead Control

A/c (overhead

incurred)

By Wages Control A/c

(40,000% 20,000)

6,85,000

1,26,000

85,000

60,000

9,55,000 9,55,000

Stores Ledger Control Account


To Balance b/d

To Cost ledger control

A/c (M at. pur.)

3,00,000

1,25,000

By WIP control A/c

(Mat. issued)

By Cost Ledger Control

A/c (M at.

received. to

supplier)

By Balance c/d

(bal. fig.)

1,35,000

13,000

2,77,000

4,25,000 4,25,000

Work in Progress Control Account


To Balance b/d

To Wages Control A/c

(direct wages)

To Stores Ledger

1,50,000

40,000

By Finished stock

(ledger control A/c

(finished product at

cost)

2,25,000


Control A/c

(Mat. issued)

To Manufacturing over-

head control

A/c

(O.H. charged to

production)

1,35,000

85,000

By Balance c/d

(bal. fig.)

1,85,000

4,10,000 4,10,000

Finished Stock Ledger Control Account


To Balance b/d

To WIP Control A/c

(finished prod. at cost)

To Cost of Sales A/c

(Sales return-at cost)

2,50,000

2,25,000

9,000

By Cost of Sales A/c

By Balance c/d

(Bal. fig.)

1,75,000

3,09,000

4,84,000 4,84,000

Manufacturing Overhead Control Account


To Wages Control A/c

(Indirect Labour)

To Cost ledger control

A/c (Overhead

incurred)

20,000

85,000

By Balance b/d

By WIP Control A/c

(Overhead charges to

production)

By Balance c/d

15,000

85,000

5,000

1,05,000 1,05,000

Wages Control Account


To Cost Ledger control 60,000 By WIP Contract A/c 40,000


A/c (40,000%20,000) (Direct wages)

By Manufacturing over-

head contro l A/c

(indirect labour)

20,000

60,000 60,000

Cost of Sales Account


To Finished Stock

ledger control A/c

1,75,000 By Finished Stock

Ledger Control A/c

(Sales- return at cost)

By Balance c/d

9,000

1,66,000

1,75,000 1,75,000

TRIAL BALANCE

For the year ending 31st March, 2008

ParticularsAmount

Debit

Amount

Credit

Cost Ledger Control Account

Stores Ledger Control Account

Work-in-Progress Control Account

Finished Stock Ledgers Control Account

Manufacturing Overhead Control Account

Cost of Sales Account

2,77,000

1,85,000

3,09,000

5,000

1,66,000

9,42,000

Total 9,42,000 9,42,000

Chapter - 8 : Contract Costing

2008 - Nov [4] Answer the following

(iii) A contract expected to be completed in year 4, exhibits the following

information :


End of Value of Cost of Cost of Cash Cash

Year work work work received

certified to date not yet

certified

(Rs.) (Rs.) (Rs.) (Rs.)

1. 0 50,000 50,000 0

2. 3,00,000 2,30,000 10,000 2,75,000

3. 8,00,000 6,60,000 20,000 7,50,000

The contract price is Rs. 10,00,000 and the estimated profit is 20%.

You are required to calculate, how much profit should have been

credited to the Profit and Loss A/c by the end of years 1, 2, and 3.

(3 marks)

Answer :

(iii) At the end of year - 1

Since percentage completion of contract is 0, therefore, no profit will

be recognised in the Profit & Loss Account.

At the end of year - 2

Notional Profit

= Value of work certified - (cost of work to date - cost of work not yet

certified)

= Rs.3,00,000 ! (Rs. 2,30,000 ! Rs. 10,000)

= Rs. 80,000

Percentage completion = ×100

= ×100 = 30%

Since percentage completion ranges between 25% to 50%.

Therefore, estimated profit to be transferred to Profit & Loss A/c (at

the end of year 2)

= × Notional Profit ×

= × 80,000 ×

= Rs. 24,444.44

At the end of year - 3

Notional Profit :

= Value of work certified ! (cost of work to date ! cost of work not

yet certified )


= Rs. 8,00,000 ! (Rs. 6,60,000 ! Rs. 20,000)

= Rs. 1,60,000

Percentage completion = ×100

×100 = 80%

Since, percentage completion is in the range between 50% to 90%.

Therefore, estimated profit to be transferred to Profit & Loss A/c (at

the end of year - 3)

× Notional Profit ×

= × 1,60,000 ×

= Rs. 1,00,000

Chapter - 9 : Operating Costing and Multiple Costing


(iii) State the unit of cost for the following industries :

(a) Transport

(b) Power

(c) Hotel

(d) Hospital (2 marks)

Answer :

(iii) The unit of cost for various industries are as follows :

Industry Unit of Cost

(a) Transport (i) Goods - Per ton km. or per quintal km.

(ii) Passengers - Per passenger km.

(b) Power Per kilo-watt hour (Kwh) or Horse Power (HP)

(c) Hotel Per Room-day or Per Service-day

(d) Hospital Per Patient-day or Per Bed-day or per

Operation


Chapter - 10 : Process Costing


(i) A product passes from Process I and Process II. M aterials issued to

Process I amounted to Rs. 40,000, Labour Rs. 30,000 and

manufacturing overheads were Rs. 27,000. Normal loss was 3% of

input as estimated. But 500 more units of output of Process I were

lost due to the carelessness of workers. Only 4,350 units of output

were transferred to Process II. There were no opening stocks. Input

raw material issued to Process I were 5,000 units. You are required to

show Process I account. (3 marks)

Answer :

(i)

Particulars Units Amount Particulars Units Amount

To MaterialTo LabourTo Manufacturing

overheads

5,000 40,00030,00027,000

By Normal loss(5000×8%)

By Abnormal loss(@ Rs. 20 p.u.)

By Transfer to Process-II A/c(@ Rs. 20 per units)

150

500

4,350

G

10,000

87,000

5,000 97,000 5,000 97,000

Working Notes :

Calculation of rate :

= =

= Rs. 20 per unit

Note: In the absence of any information, it is assumed that normal loss is not

sold as scrap.

Chapter - 12 : Standard Costing


(iv) UV Ltd. presents the following information for November, 2008 :

Budgeted production of product P = 200 units.

Standard consumption of Raw materials = 2 kg per unit of P.

Standard price of material A = Rs. 6 per kg.

Actually, 250 units of P were produced and material A was purchased

at Rs. 8 per kg and consumed at 1.8 kg. per unit of P. Calculate the

material cost variances. (3 marks)


Answer :

250 units of P were produced from material A.

For one units of P = 1.8 kg of material A is required, so for 250 units of P =

250 × 1.8 = 450 kg of material A is required.

Total Actual cost of output P produced 250 units

Actual cost = 250 × 1.8 × 8 = Rs. 3,600

Standard cost = For Actual output produced i.e.; 250 units of P, raw material

A will be required as in standard consumption ratio of 2 kg. per unit of P.

So for 250 units, standard raw material A required = 250 × 2 = 500 kg.

Standard cost per unit of X = Rs. 6 per kg.

So that standard cost = 500 × 6 = Rs. 3,000

Material cost variance = Standard cost ! Actual cost

= 3000 ! 3600 = 600 (A)

Material price variance = 2700 ! 3600 = 900 (A)

Material mix variance = Nil

Material yield variance = 3000 ! 2700 = 300 (F)

Material Usages variance = 3000 ! 2700 = 300 (F)

Chapter - 13 : Marginal Costing


(ii) PQ Ltd. reports the following cost structure at two capacity levels :

(100% capacity)

2,000 units 1,500 units

Production overhead I Rs. 3 per unit Rs. 4 per unit

Production overhead II Rs. 2 per unit Rs. 2 per unit.

If the selling price, reduced by direct material and labour is Rs. 8 per

unit, what would be its break-even po int ? (3 marks)


Answer :(ii) Production overhead I is fixed overhead.

In case of 2000 units & 2000 × 3 = 6,000In case of 1500 units & 1500 × 4 = 6,000Hence, Fixed Production Overhead = Rs. 6,000Variable Production Overhead = Rs. 2 per unitContribution : Rs. per unitSelling price reduced by material & labour 8Less : Variable production overhead 2

Contribution 6� Contribution = Rs. 6 per unit

BEP (in units) :

=

= = 1000 units

Chapter - 14 : Budgets & Budgetary Control


(vi) Explain briefly the concept of 'flexible budget'. (2 marks)

Answer :

(vi) Flexible Budgets show the expected results of a responsibility centre

for several activity levels. It is a budget which by recognising the

difference between fixed, semi-variable and variable costs is designed

to change in relation to level of activity attained. It is not rigid as it can

be recasted on the basis of activity level to be achieved. It consists of

services of static budgets for different levels of activity. Variance

analysis through flexible budget provides useful information as each

cost is analysed according to its behaviour.

It facilitates the ascertainment of cost, fixation of selling price

and submission of quotations. Flexible budgets provide a meaningful

basis of comparison of the actual performance with the budgeted

targets.

Such budgets are especially useful in estimating and controlling

factory costs and operating expenses.

Flexible Budgeting may be resorted to in the follow ing situations:

(a) New Business :

In case of new business venture, due to its typical nature, it may

be difficult to forecast the demand of a product accurately.

(b) Uncertain Environment :

Where the business is dependent upon the mercy of nature.


(c) Factor M arket Conditions :

In the case of Labour intensive industry where the production of

the concern is dependent upon the availability of labour.

Chapter - 15 : Product Cost Sheet

2008 - Nov [3] (a) ABC Ltd. can produce 4,00,000 units of a product per

annum at 100% capacity. The variable production costs are Rs. 40 per unit and

the variable selling expenses are Rs. 12 per sold unit. The budgeted fixed

production expenses were Rs. 24,00,000 per annum and the fixed selling

expenses were Rs. 16,00,000. During the year ended 31st March, 2008, the

company worked at 80% of its capacity. The operating data for the year are as

follows :

Production 3,20 ,000 units

Sales @ Rs. 80 per unit 3,10 ,000 units

Opening stock of finished goods 40,000 units

Fixed production expenses are absorbed on the basis of capacity and fixed

selling expenses are recovered on the basis of period.

You are required to prepare Statements of Cost and Profit for the year

ending 31st March, 2008 :

(i) On the basis of marginal costing

(ii) On the basis of absorption costing. (7 marks)

Answer 4 :

Production Overhead absorption rate =

=

= Rs. 6 per unit.

Closing Stock (in units)

= Op. Stock % Production ! Units so ld

= 40,000 % 3,20,000 ! 3,10,000

= 50,000 units.

(i) On the basis of marginal costing :

Statement of Cost and Profit

For the year ended 31st March, 2008

ParticularsAmount

Rs. ‘000

Amount

Rs. ‘000

Sales (3,10,000 × 80) 24,800


Less : Total variable cost

Opening stock (40,000 × 40)

Add : Variable Production O.H. (3,20,000 × 40)

Less : Closing stock (50,000 × 40)

Add : Variable selling OH (3,10,000 × 12)

1,600

12,800

14,400

2,000

12,400

3,720 16,120

Contribution :

Less : Total Fixed Overheads

Fixed production overhead (4,00,000 × 6)

Add : Fixed selling overhead

NET PROFIT

2,400

1,600

8,680

4,000

4,680

(ii) On the basis of Absorption Costing

Statement of Cost and Profit

For the year ended 31st March, 2008

ParticularsAmount

Rs. ‘000

Amount

Rs. ‘000

Sales (3,10,000 × 80)

Less : Cost of goods sold

Opening stock (40,000 × 46)

Add : Variable Production O.H. (320,000 × 40)

Add : Fixed Production O.H (320,000 × 6)

Less : Closing stock (50,000 × 46)

Less : Selling Overheads

Fixed selling O.H.

Variable Selling O.H. (310,000 × 12)

1,840

12,800

1,920

16,560

2,300

1,600

3,720

24,800

14,260

10,540

5,320

NET PROFIT 5,220


Working Notes :

Reconciliation of Net Profit under Absorption & M arginal Costing

ParticularsAmount

Rs. ‘000

Amount

Rs. ‘000

N.P. Under Absorption Costing

Less : Under absorption of O.H. (80,000×6)

(+) Over valuation of closing stock

(50,000 × 6)

(!) Over valuation of Op. stock

(40,000 × 6)

480

300

(240)

5,220

540

N.P. under Marginal Costing 4,680

[Paper - 4B] Financial Management

Chapter - 2:Time Value of Money


(i) A company offers a Fixed deposit scheme whereby Rs. 10,000 matures

to Rs. 12,625 after 2 years, on a half-yearly compounding basis. If the

company wishes to amend the scheme by compounding interest every

quarter, what will be the revised maturity value ? (3 marks)

Answer :

The future value of single Cashflow is defined as :

FV = PV (1 +r)n

FV = Future value n years hence

PV = Present value of Cashflow today.

r = Rate of interest per annum

n = No. of periods for which compounding is done.

Substituting values in the equation.

12,625 = 10,000 (1 + r)4

By solving through interpolation, we get the annual rate at 12% p.a.

Now if the Co. goes for quarterly compounding the maturity value will be

Quarterly Rate = 12% ÷ 4 = 3%

FV = 10,000 (1 + 0 .3) 8

FV = Rs. 12,668/-


Chapter - 3 : Financial Analysis and Planning


(v) How is return on capital employed calculated ? What is its

significance?

(vi) What is quick ratio ? What does it signify? (2 marks each)

Answer :

(v) Return on capital employed =

Return = Profit after tax

+ Tax

+ Interest

+ Non trading Expenses

! Non operating incomes

Capital employed = Equity share capital

+ preference share capital

+ Reserves & surplus + P & L (Cr. Bal.) + Long term loans

+ Debentures

! Non trading investment - Fictitious Assests

! P & L (Dr. Bal)

Significance of ratio “ Return on capital employed” :

1. Overall profitability of the business is highlighted

2. Comparison of “Return on capital employed with rate of interest

debt leads to financial leverage.

(vi) Quick ratio also termed as “acid test ratio” is one of the best measures

of liquidity

It is worked out as follows :

Quick Ratio =

In the above formula !Quick Assets = Current Assets ! Inventories

Quick liabilities = Current liabilities ! Bank!Overdraft ! Cash credit

Quick ratio of 1: 1 is an ideal ratio significance :

It indicates whether the firm is in a position to pay its current

liabilities within a month or immediately.

2008 - Nov [6]Balance Sheets of a company as on 31st March, 2007 and 2008

were as follows :Liabilities 31.3.07 31.3.08 Assets 31.3.07 31.3.08

Rs. Rs. Rs. Rs.Equity Share Capita l10,00,000 10,00,000 Goodwill 1,00,000 80,000


8% P.S. Capital 2,00,000 3,00,000 Land andGeneral Reserve 1,20,000 1,45,000 Building 7,00,000 6,50,000Securities Premium ) 25,000 Plant andProfit & Loss A/c 2,10,000 3,00,000 Machinery 6,00,000 6,60,00011% Debentures 5,00,000 3,00,000 InvestmentsCreditors 1,85,000 2,15,000 (non-trading) 2,40,000 2,20,000Provision for tax 80,000 1,05,000 Stock 4,00,000 3,85,000Proposed Dividend 1,36,000 1,44,000 Debtors 2,88,000 4,15,000

Cash and Bank 88,000 93,000Prepaid Expenses 15,000 11,000Premium onRedemptionof Debenture ) 20,000

24,31,000 25,34,000 24,31,000 25,34,000

Additional Information :

1. Investments were sold during the year at a profit of Rs. 15,000.

2. During the year an old machine cos ting Rs. 80,000 was sold for

Rs.36,000. Its written down value was Rs. 45,000.

3. Depreciation charged on Plants and Machinery @ 20 percent on the

opening balance.

4. There was no purchase or sale of Land and Building.

5. Provision for tax made during the year was Rs. 96,000.

6. Preference shares were issued for consideration of cash during the year.

You are required to prepare :

(i) Cash flow statement as per AS-3.

(ii) Schedule of changes in working capital. (15 marks)

Answer :

(a) Cash flow Statement for the year ending 31-3-07

Particulars Rs. Rs.

A. Cash flow from operating activities. Net

profit before tax and extraordinary items

(3,00,000!2,10,000)

Adjustments :

Add :

General reserve

Provision for tax [W.N.-1]

Loss on sale of Machinery [W.N.-2]

Depreciation on Machinery [W.N.-2]

Depreciation on land and building

Provision for proposed dividend[W.N.4]

Goodwill written off

25,000

96,000

9,000

1,20,000

50,000

1,44,000

20,000

90,000


Loss :

Profit on sale of investment [W.N.-3]

Operating profit before working Capital

changes

Adjustment for working capital changes

Add :

Decrease in stock

Decrease in prepaid expenses

Increase in creditors

Less :

Increase is debtors

(15,000)

15,000

4,000

30,000

(1,27,000)

5,39,000

Operating Profit afters adjustment of

working capital changes

(-) income tax paid

4,61,000

71,000

Net cash flow from operating activities 3,90,000 3,90,000

B. Cash flow from investing activities

Sale of investment [WN-3]

Sale of plant and machinery [WN.-2]

Purchase of plant [W.N-2]

35,000

36,000

(2,25,000)

Net Cash flow from investing activities 1,54,000

C. Cash flow from financing activities

Issue of 8% preference shares

Premium on issue of preference shares

Redemption of debentures

Dividend paid

1,00,000

25,000

(2,20,000)

(1,36,000)

Net cash flow from financing activity (2,31,000)

Net increase in Cash and Cash

equivalents during the year

Add : Cash and cash equivalents at the

beginning of the year

Cash and cash equivalents at the end of

the year.

5,000

88,000

93,000


working notes :

Tax A/c

To bank (bal fig)

(paid during year)

To bal c/d

71,000

1,05,000

By bal b/d

By P & L

(prov. made)

80,000

96,000

1,76,000 1,76,000

2. Plant and M achinery A/c

To bal b/d.

To B ank (bal. fig)

(machinery purchased)

6,00,000

2,25,000

By Depreciation

By Bank (sale of machinery)

By P & L (loss on sale of

mach.)

By bal c/d

1,20,000

36,000

9,000

6,60,000

8,25,000 8,25,000

3. Investments A/c

To bal b/d

To P & L (Profit on sale of

investment)

2,40,000

15,000

By bank (sale of

investments)

By bal c/d.

35,000

2,20,000

2,55,000 2,55,000

4. It has been assumed that last year's proposed dividend has been paid and

a provision of current years dividend has been made out of the profits.

(b) Schedule of Changes in Working Capital

Particulars As on31-3-07

As on31-3-08

Increasein WorkingCapital

Decrease inWorkingCapital

A. Current Assets :StockDebtorsCash and BankPrepaid expenses

4,00,0002,88,000

88,00015,000

3,85,0004,15,000

93,00011,000

1,27,0005,000

15,000

4,000


7,91,000 9,04,000

B. Current liabilities :Creditors 1,85,000 2,15,000 30,000

1,85,000 2,15,000

Working Capital (A-B)Increase in workingCapital

6,06,000 6,89,000

1,32,000(83,000)1,32,000

Ans : Increase in working Capital Rs. 82,000

Note :Proposed dividend is not treated as current liability.

2008 - Nov [8]Answer the following :

(iii) What do you mean by Stock Turnover ratio and Gearing ratio ?

(3 marks)

Answer :

Inventory/ Stock turn over ratio

It establishes the relationship between the cost of goods sold during the

year and average inventory held during the year.

It is calculated as follows :

Inventory/Stock turnover Ratio =

In above formula :

Average inventory =

This ratio indicates that how fast inventory is sold.

A high ratio is good from the view point of liquidity and a low ratio would

indicate that inventory is not sold and remains in godown for a long time.

Note : Turnover is generally taken as cost of goods sold.

Gearing Ratio :

It is also called as “Capital Gearing Ratio”. It shows the proportion of

fixed interest (d ividend) bearing capital to funds belonging to equity share-

holders funds.

It is calculated as follows :

Capital Gearing Ratio = Preference Capital +

This ratio helps to judge the long term solvency position of a firm.


Chapter - 4 : Cost of Capital & Capital Structure


(iii) Discuss the concept of ''Optimal Capital Structure.'' (2 marks)

Answer 5 : Refer Para No. 5 & 6 of the Notes Zone on page no. 560.

Chapter - 5 : Business Risk, Financial Risk & Leverage


(ii) A company operates at a production level of 1,000 units . The

contribution is Rs. 60 per unit, operating leverage is 6, combined

leverage is 24. If tax rate is 30%, what would be its earnings after tax?

(3 marks)

Answer :

Contribution = 1000 units @ Rs. 60 per unit

= Rs. 60,000

Operating leverage = 6

Operating leverage =

6 =

EBIT =

Combined leverage = 24

Combined leverage = Operating leverage ×Financial leverage

24 = 6 × FL

Financial leverage = 4

Financial Leverage =

4 =

� EBT = Rs. 2,500

Earnings before tax = Rs. 2,500

(!) tax @ 30% = Rs. 750

Earnings after tax (EAT) = Rs 1750


Chapter - 6 : Typing of Financing


(i) Write a short note on “Deep Discount Bonds”. (2 marks)

Answer :

Deep Discount Bonds :

Deep discount bonds are a form of zero interest bonds. These bonds are

sold at a discounted value and an maturity face value is paid to the investors.

In such bonds, there is no interest payout during lock in period. When such

bonds are sold in the stock market, the difference realised between face value

and market price is the capital gain DBI was the first to issue deep discount

bonds.


(ii) Explain the methods of venture capital financing. (2 marks)

Answer : Refer Para No. 12 of the Notes Zone on page no. 631.

Chapter - 7: International Financing


(iv) Name the various financial instruments dealt with in the international

market. (2 marks)

Answer :

Some of the various financial instruments dealt with in the international market

are discussed below :

1. Euro Issue : An Euro issue is a issue listed on a foreign stock exchange.

It is an instrument which raises foreign currency in the international

market. through the issue of :

(i) Depository Receipts-ADR & GDR

(ii) Foreign Currency convertible bonds

2. Euro Bonds : Euro bonds are long term loans raised by entities enjoying

an excellent credit rating.

These bonds are issued for a period ranging between 3 to 20 years.

3. Foreign Bonds : Foreign Bonds are debt instrument denominated in a

currency which is foreign to the borrower and is sold in the country of

that currency.

4. Fully Hedged Bonds : Fully hedged bonds are the foreign bonds devoid

of the risk of currency fluctuation.

It eliminates the risk by selling the entire streams of principal and

interest payment in forward market.


5. Floating Rate Note : The floating Rate Notes provide foreign currency

at a rate lower than foreign loans. They are issued for a period upto 7

years.

The interest rates are adjusted to reflect the prevailing exchange

rate.

6. Euro Commercial Paper : Euro commercial papers are promissory notes

with a maturity period of less than one year. These are unsecured

instruments issued by a corporate body. The main investors are banks

insurance companies, fund managers etc.

7. Foreign Currency option : Foreign currency option is a right to buy or

sell a sum of foreign currency at a predetermined rate on a future date.

8. Foreign Currency Futures : A foreign currency future is a right to by

or sell a sum of foreign currency at a fixed exchange rate on a specific

future date.

It is an alternative to forward contract for hedging of exchange risk

.

Chapter - 8: Capital Budgeting

2008 - Nov [7] (b) A company wants to invest in a machinery that would cost

Rs. 50,000 at the beginning of year 1 . It is estimated that the net cash inflows

from operations will be Rs. 18,000 per annum for 3 years, if the company opts

to service a part of the machine at the end of year 1 at Rs. 10,000 and the scrap

value at the end of year 3 will be Rs. 12,500. However, of the company decides

not to services the part, it will have to be replaced at the end of year 2 at

Rs.15,400. But in this case, the machine will work for the 4th year also and get

operational cash inflow of Rs. 18,000 for the 4 th year. It will have to be

scrapped at the end of year 4 at Rs. 9,000. Assuming cost of capital at 10% and

ignoring taxes, will you recommend the purchase of this machine based on the

net present value of its cash flows?

If the supplier gives a discount of Rs. 5,000 for purchase, what would be

your decision? (The present value factors at the end of years 0, 1, 2, 3, 4, 5 and

6 are respectively 1, 0.9091, 0.8264, 0.7513, 0.6830, 0.6209 and 0.5644).

(7 marks)


Answer :

Option - I (Part of the Machine is serviced)

Year Cash inflows PV Factor PV of Cash flow

0

1

2

3

3

(50,000)

1 8 , 0 0 0 ! 1 0 , 0 0 0

18,000

18,000

12,500

1.00

.9091

.8264

.7513

.7513

(50,000)

7272.8

14,875

13,523

9,391

P.V of inflows = Rs. 45,062

P.V of outflows = Rs. 50,000

Net present value = P.V of inflows - P.V. of outflows

= 45,062 ! 50,000

= Rs. (4,938)

Since the options have unequal lives, Equivalent Annuity value (EAV) is

calculated as follows :

EAV. =

= = Rs. (1986)

Option -II (Part of the machine is replaced)

Year Cash inflows PV Factor PV of Cash flows

0

1

2

3

4

4.

(50,000)

18,000

18,000!15,400

18,000

18,000

9,000

1.00

.9091

.8264

.7513

.6830

.6830

(50,000)

16,364

2,149

13,523

12,294

6,147


P.V of outflow = Rs. 50,000

Net present value (NP V) = P.V. of inflows ! P.V of outflows

NPV = Rs. 50,477- Rs. 50,000

= Rs. 477

EAV =

= Rs. 150

Option I has a negative EAV (i.e. of Rs. 1986) whereas option II has a positiveEAV of Rs. 150. Therefore, option II shall be opted.


If the Co. decides to service the part, then it is not viable to purchase themachine but if it decides to replace it then machine may be recommended forpurchase although the Cash flows are very minimal.

If the supplier gives a discount of Rs. 5,000 for purchases : Outflow = 50,000!5,000

= Rs. 45,000

Option I

Year Cash inflows PV Factor PV of Cash flows

0

1

2

3

3

(45,000)

18,000!10,000

18,000

18,000

12,500

1.00

.9091

.8264

.7513

.7513

(45,000)

7,273

14,875

13,523

9,391


P.V. of outflows = Rs. 45,000

N.P .V = P.V. of inflows !P.V. of outflows

= Rs. 45,062 !Rs. 45,000

= Rs. 62

EAV =

= = Rs. 24.93

Option-II

Year Cash inflows PV Factor PV of Cash flow

0

1

2

3

4

4

(45,000)

18,000

18,000!15,400

18,000

18,000

9,000

1.00

.9091

.8264

.7513

.6830

.6830

(45,000)

16,364

2,149

13,523

12,294

6,147


P.V of outflows = Rs. 45,000

NPV = Rs. 50,177!Rs. 45,000 = Rs. 5,477

EAV =

= = Rs. 1,728

NPV of both the options are positive but since Option-II has a higher NPV than

option I hence, option II shall be adopted. In this case, the NPV as well as


equivalent Annuity is better in replacing the part of the machine, hence

machine may be recommended for purchase.


(iv) Explain the concept of multiple Internal rate of Return. (3 marks)

Answer :

Multiple Internal Rate of Return :

In cases where project cash flows change signs or reverse during the life

of a project, there may be more that one IRR. These are called Multiple

Internal Rate of Return

The most common drawback in using the internal rate of return to

evaluate deterministic cash flow streams is the possibility of multiple

conflicting internal rates, or no internal rate at all. We claim, however, that

contrary to current consensus, multiple or nonexistent internal rates are not

contradictory, meaningless or invalid as rates of return. There is, moreover, no

need to carefully examine a cash flow stream to rule out the possibility of

multiple internal rates, or to throw out or ignore “unreasonable” rates. What we

show is that when there are multiple (or even complex-valued) internal rates,

each has a meaningful interpretation as a rate of return on its own underlying

investment stream.

Some of the advantages of MIRR are :

1. This method makes use of concept of time value of money.

2. All the Cash flows in the project are considered.

Some of the limitations of MIRR are :

1. Calculation process is tedious

2. The IRR approach creates a peculiar situation if we compare two projects

with different inflow/outflow patterns.

3. In case of mutually exclusive projects decision based only on IRR may

not be correct.

Chapter - 9: Meaning, Concept & Policies of Working

Capital

2008 - Nov [7] (a) MN Ltd. is commencing a new project for manufacture of

electric toys. The following cost information has been ascertained for annual

production of 60,000 units at full capacity :

Amount per unit

Rs.

Raw materials 20

Direct labour 15

Manufacturing overheads :

Rs.


Variable 15

Fixed 10 25

Selling and Distribution overheads :

Rs.

Variable 3

Fixed 1 4

Total cost 64

Profit 16

Selling price 80

In the first year of operations expected production and sales are 40,000

units and 35,000 units respectively. To assess the need of Working capital, the

following additional information is available :

(i) Stock of Raw materials ............. 3 months consumption.

(ii) Credit allowable for debtors .............. 1 months.

(iii) Credit allowable by creditors ............. 4 months.

(iv) Lag in payment of wages ............. 1 month.

(v) Lag in payment of overheads ............... month.

(vi) Cash in hand and Bank is expected to Rs. 60,000.

(vii) Provision for contingencies is required @ 10% of W orking capital

requirement including that provision.

You are required to prepare a projected statement of Working capital

requirement for the first year of operations. Debtors are taken at cost.

(9 marks)

Answer :

MN Ltd.

Projected Statement of Working Capital Requirement

for the first year of operations

CURRENT ASSETS Rs.

Stock of Materials (W.N.1) 2,00,000

Debtors (W.N.3) 3,05,000

Finished goods (W.N.4) 3,25,000

Cash (Given) 60,000

Total Current Assets (A) 8,90,000

CURRENT LIABILITIES

Creditors for supply of materials 3,33,333

Creditors for wages [W.N.2(a)] 50,000

Creditors for Overheads [W.N.2(b)] 56,875


Total Current Liabilities (B) 4,40,208

Estimated W orking Capital Requirement 4,49,792

Add: Provision for Contingencies 49,976

(10% of total working capital requirement)

Total Working Capital Requirement

4,99,768

Working Notes:

1. Calculation of Creditors for supply of materials:

Materials consumed during the year 8,00,000

Add: Closing Stock of Raw M aterials

(8,00,000 x 3/12) 2,00,000

Total Purchases made during the year 10,00,000

Average Creditors (based on 4 months credit period)

[10,00,000 x 4/12] 3,33,333

2. Calculation of Creditors for Expenses:

(a) Creditors for Wages

Total wages paid 6,00,000

Average Creditors [6,00,000 x 1/12] 50,000

(b) Creditors for Overheads

Total Manufacturing Overhead 12,00,000

Total Selling and Distribution Overhead 1,65,000

13,65,000

Average Creditors [13,65,000 x 0.5/12] 56,875

3. Calculation of Average Debtors at Cost of Sales

Average Debtors (At Cost) [24,40,000 x 1.5/12] 3,05,000

4.

MN Ltd.

Projected Statement of Profit / Loss

(Ignoring Taxation)

Production (units) 40,000

Sales (units) 35,000

Sales Revenue @ Rs.80 per unit (A) 28,00,000

Cost of Production:

Materials @ Rs.20 per unit 8,00,000

Direct Labour @ Rs.15 per unit 6,00,000

Manufacturing Overheads:

Variable [40,000 x 15] 6,00,000

Fixed [60,000 x 10] 6,00,000 12,00,000

Cost of goods available for sale 26,00,000


[For 40 ,000 units]

Less: Closing Stock at average cost 3,25,000

[26,00,000 x 5,000/40,000]

Cost of goods sold [of 35000 units] 22,75,000

Add: Selling & Distribution Overheads:

Variable [35,000 x 3] 1,05,000

Fixed [60,000 x 1] 60,000 1,65,000

Cost of Sales (B) 24,40,000

Profit [A - B] 3,60,000

Shuchita Prakashan (P) Ltd.25/19, L.I.C. Colony, Tagore Town,

ALLAHABAD- 211002

Visit us : www.shuchita.com

�

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