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 company manufactures a product from a raw material which is purchased at ` 96 per
kg. The company incurs a handling and freight cost of ` 1,500 per order. The incremental
carrying cost of inventory of raw material is ` 7.50 per kg per quarter. The annual
production of the product is 2,00,000 units and 5 units are obtained from one kg. of raw
material.
You are required to:
(i) Calculate the Economic Order Quantity of raw materials.
(ii) If the company proposes to rationalize placement of order on yearly basis, what
percentage of discount in the price of raw materials should be negotiated?
(b) XYZ Ltd. has provided the following information:
Year 2019 Year 2020
Sales ` 5,00,000 ?
Profit/Volume Ratio (P/V ratio) 40% 25%
Margin of Safety sales as a % of total 20% 15%
sales
There is no change in sales quantity level of year 2019 and year 2020, however, there
was reduction in selling price in the year 2020. XYZ Ltd. has done restructuring of
business and this has resulted in substantial savings in Fixed Cost in the year 2020.
You are required to calculate the following:
(i) Variable Cost in Rupees for year 2019 and year 2020
(ii) Sales for year 2020 in Rupees
(iii) Break-even sales for year 2020 in Rupees
(iv) Fixed cost for year 2020.

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 2 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(c) PQR Limited is considering investing in a project which requires a funding of ` 150
Crores. Finance Manager of the company has presented two financing plans for which
information is as follows:
Plan - A: Equity-20%, Debt-80%
Plan - B: Equity-60%, Preference Shares-40%
The Cost of debt is 10% and the Cost of preference shares is also 10%. Tax rate is 25%.
Equity shares of the face value of ` 100 each will be issued at a premium of ` 50 per
share. The Expected EBIT is ` 60 Crores.
You are required to determine: -
(i) Earnings Per Share (EPS) for Plan A and Plan B
(ii) The Financial Break-Even Point for Plan A and Plan B
(d) 'X' Limited has provided the following information for the year ended on 31.03.2019.
Net profit before taking into account Income tax but after taking into account the following
items was ` 20 lakhs:
(i) Depreciation on Fixed Assets is ` 5 lakhs.
(ii) Discount on issue of Debentures written off is ` 30,000.
(iii) Interest on Debentures paid is ` 3,50,000.
(iv) Book value of investments is ` 3 lakhs (Sale of Investments for ` 3,20,000).
(v) Interest received on investments is ` 60,000.
(vi) Income tax paid during the year is ` 10,50,000.
Current assets and current liabilities in the beginning and at the end of the years are as
detailed below:
As on 31.03.2018 As on 31.03.2019
` `
Stock 12,00,000 13,18,000
Sundry Debtors 2,08,000 2,13,100
Bills receivable 50,000 40,000
Bills payable 45,000 40,000
Sundry Creditors 1,66,000 1,71,300
Outstanding expenses 75,000 81,800
You are required to calculate Net Cash Flow from Operating Activities accord ing to
Indirect Method as per AS-3 (Revised) for the year ended 31.03.2019. (4 x 5 = 20 Marks)

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 3

Answer
2,00,000units
(a) Annual requirement of raw material in kg. (A) = = 40,000kg.
5unitsper kg.

Ordering Cost (Handling & freight cost) (O) = ` 1,500

Carrying cost per unit per annum = (` 7.5 × 4) = ` 30 per kg.
2  40,000kgs.  ` 1500
(i) E.O.Q. = = 2,000 kg.
` 30

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

Particulars Yearly order EOQ
Size of the order 40,000 kg. 2,000 kg.
No. of orders 1 20
Cost of placing orders ` 1,500 ` 30,000
(1 order × ` 1500) (20 orders × ` 1500)
Inventory carrying cost ` 6,00,000 ` 30,000
(40,000 kg. × ½ × ` 30) (2,000 kg. × ½ × ` 30)
Total Cost ` 6,01,500 ` 60,000
When order is placed on yearly basis, the ordering cost and carrying cost increased
by ` 5,41,500 (` 6,01,500 - ` 60,000). This increase in total cost should be
compensated by reduction in purchase price per kg. to make yearly order placement
rational.
Reduction per kg. in the purchase price of raw material:
Increased in total cost ` 5,41,500
= = = ` 13.54 per kg.
Annual requirement 40,000kg
` 13.54
Discount in the price of raw material to be negotiated = = 14.10%
` 96
(b) (i) Variable cost in Rupees for year 2019 and 2020
In 2019, PV ratio = 40%
Variable cost ratio = 100% - 40% = 60%
Variable cost in 2019 = ` 5,00,000  60% = ` 3,00,000

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 4 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

In 2020, sales quantity has not changed. Thus, variable cost in 2020 is ` 3,00,000.
(ii) Sales for year 2020 in Rupees
In 2020, P/V ratio = 25%
Thus, Variable cost ratio = 100% − 25% = 75%
` 3,00,000
Thus, sales in 2020 = = ` 4,00,000
75%
(iii) Break even sales for year 2020 in Rupees
At break-even point, fixed cost is equal to contribution.
In 2020, Break-even sales = 100% − 15% = 85%
Break-even sales = ` 4,00,000  85% = ` 3,40,000
(iv) Fixed Cost for year 2020
Fixed cost = B.E. sales  P/V ratio
= ` 3,40,000  25% = ` 85,000
(c) Capital Structure under plan A and Plan B
Financing Plans Plan A Plan B
Equity Shares ` 30 crores ` 90 crores
(` 150 crores x 20%) (` 150 crores x 60%)
Debt ` 120 crores --
(` 150 crores x 80%)
Preference Shares -- ` 60 crores
(` 150 crores x 40%)
Total ` 150 crores ` 150 crores
(i) Computation of Earnings per Share (EPS)
Particulars Plan A Plan B
(` Crores) (` Crores)
Earnings before interest & tax (EBIT) 60 60
Less: Interest charges (10% of ` 120 crores) (12) -
Earnings before tax (EBT) 48 60
Less: Tax @ 25% 12 15
Earnings after tax (EAT) 36 45

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 5

Less: Preference share dividend (10% of ` 60 - 6

crores)
Earnings available for equity shareholders (A) 36 39
No. of equity shares (B) 0.20 0.60
Plan A = ` 30 Crores / ` 150
Plan B = ` 90 Crores / ` 150
E.P.S (in `) (A  B) 180 65
(ii) Computation of Financial Break-even Points
Financial Break-even point = Interest + Preference dividend/(1 - tax rate)
Plan A = ` 12 Crores (Interest charges)
Plan B = Earnings required for payment of preference share dividend
= ` 6 crores  (1 - 0.25) = ` 8 crores
(d) Statement of Cash Flow for the year ended 31 st March, 2019 [As per AS-3 (Revised)]
(`) (`)
Cash flow from Operating Activities
Profit before taxation 20,00,000
Adjustments:
Add: Depreciation on fixed assets 5,00,000
Add: Discount on issue of debentures written-off 30,000
Add: Interest on debentures paid 3,50,000 8,80,000
Less: Profit on sale of investment (` 3,20,000 – (20,000)
` 3,00,000)
Less: Interest received on investments (60,000) (80,000)
Operating profit before working capital changes 28,00,000
Decrease in Bills receivables (` 50,000 – ` 40,000) 10,000
Increase in Sundry creditors (` 1,71,300 – ` 1,66,000) 5,300
Increase in Outstanding expenses (` 81,800 – ` 75,000) 6,800 22,100
Increase in Stock (` 13,18,000 – ` 12,00,000) (1,18,000)
Increase in Sundry debtors (` 2,13,100 – ` 2,08,000) (5,100)
Decrease in Bills payables (` 45,000 – ` 40,000) (5,000) (1,28,100)
Cash generated from operations 26,94,000

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 6 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

Less: Income tax paid (10,50,000)

Net Cash flow from Operating Activities 16,44,000
Question 2
(a) PQR Ltd. has provided the following information for Departments A and B of its factory:
Preliminary Estimates of expenses (Per Annum)
Total (`) Dept A (`) Dept B (`)
Power 15,000 - -
Spare parts 8,000 3,000 5,000
Consumable stores 5,000 2,000 3,000
Depreciation on machinery 30,000 10,000 20,000
Insurance on machinery 3,000 1,000 2,000
Indirect labour 40,000 - -
Building maintenance 7,000 - -
The final estimates of expenses are to be prepared on the basis of above figures after
taking into consideration the following factors:
(a) An increase of 10 per cent in the price of spare parts.
(b) An increase of 20 per cent in the consumption of spare parts for Department B only.
(c) Increase in the straight line method of depreciation from 10 per cent on the original
value of machinery to 12 per cent.
(d) 15 per cent increase in wage rates of Indirect Labour.
The following information is also available:
Dept. A Dept. B
Estimated Direct Labour hours 80,000 1,20,000
Ratio of K.W. Rating 3 2
Floor space (sq. ft.) 15,000 20,000
There are 12 holidays besides Sundays in the year. The manufacturing department
works 8 hours in a day. All machines work at 90% capacity throughout the year.
(Assume 365 days in a year).
You are required to work out the Machine Hour rates for Departments A and B. (8 Marks)
(b) A Company is capitalized as follows:
7% Preference Shares ` 1 each. ` 6,00,000

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 7

Ordinary Shares, ` 1 Each ` 16,00,000

Total ` 22,00,000
The following information is relevant as to its financial year just ended:
Profit (after Taxation @ 50%) ` 5,42,000
Ordinary Dividend paid 20%
Market Price of each Ordinary Share `4
Depreciation ` 2,20,000
You are required to calculate the following, showing the necessary workings:
(i) Dividend Yield on the Ordinary Shares
(ii) Preference Dividend Coverage Ratio
(iii) Ordinary Dividend Coverage Ratio
(iv) Earnings Yield
(v) Price-earnings (P/E) Ratio
(vi) Amount transferred to Reserve and Surplus
(vii) Net Cash Flow (8 Marks)
Answer
(a) Computation of Machine Hour Rate

Basis of Total Department

apportionment (`) A (`) B (`)
(A) Standing Charges
Insurance Direct 3,000 1,000 2,000
Indirect Labour Direct Labour 46,000 18,400 27,600
(2:3)
Building maintenance Floor Space 7,000 3,000 4,000
expenses (3:4)
Total standing charges (A) 56,000 22,400 33,600
Hourly rate for standing charges (H1) 10.33 15.50
(B) Machine Expenses:
Power K.W. rating (3:2) 15,000 9,000 6,000
Spare parts Final estimates 9,900 3,300 6,600

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 8 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

Consumable Stores Direct 5,000 2,000 3,000

Depreciation on Final estimates 36,000 12,000 24,000
machinery
Total Machine expenses (B) 65,900 26,300 39,600
Hourly Rate for Machine expenses (H2) 12.13 18.27
Total Cost (A + B) 1,21,90 48,700 73,200
0
Machine Hour rate* (H1+H2) 22.46 33.76
*Alternatively, Machine Hour rate can be calculated as total Cost  total effective hours.
Working Notes:
(i) Calculation of effective working hours:
No. of off-days = No. of Sundays + No. of holidays
= 52 + 12 = 64 days
No. of working days = 365 days – 64 days = 301 days
Total working Hours = 301 days × 8 hours
= 2,408 hours
Total effective hours = Total working hours × 90%
= 2,408 hours × 90%
= 2,167.2 or Rounded up to 2,168 hours
(ii) Amount of Indirect Labour is calculated as under:
Particulars (`)
Preliminary estimates 40,000
Add: Increase in wages @ 15% 6,000
Estimated total cost of Indirect labour 46,000
(iii) Amount of spare parts is calculated as under:
Particulars A (`) B (`)
Preliminary estimates 3,000 5,000
Add: Increase in price @ 10% 300 500
3,300 5,500

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 9

Add: Increase in consumption @ 20% − 1,100

Estimated cost of spare parts 3,300 6,600
(iv) Amount of Depreciation of machinery is calculated as under:
Particulars A (`) B (`)
Preliminary estimates 10,000 20,000
Add: Increase in depreciation 2000 4000
{` 10,000 x 2 (12-10) /10}
Estimated Depreciation 12,000 24,000
(Current depreciation x 12/10)

(b) (i) Dividend yield on the ordinary shares

Dividend per share ` 0.20 (0.20 x ` 1)
= x 100 = x 100 = 5%
Market price per share `4
(ii) Preference Dividend coverage ratio
Profit after taxes
=
Diviend payable to preference shareholders

` 5,42,000
= = 12.9 times
` 42,000 (0.07 × ` 6,00,000)
(iii) Ordinary Dividend coverage ratio
Profit after taxes - Preference share dividend
=
Dividend payable to equity shareholders at current rate of ` 0.20 per share

` 5,42,000 - ` 42,000
= = 1.56 times
` 3,20,000 (16,00,000 shares × ` 0.2)
(iv) Earnings Yield
EPS * ` 0.31
= = = 7.75%
Market price per shares 4
*Earnings per share (EPS)
Earnings available to equity shareholders ` 5,00,000
= = = ` 0.31 per share
Number of equity shares outstanding 16,00,0000 shares

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 10 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(v) Price-earnings (P/E) ratio

Market price per share `4
= = = 12.90 times
Equity per share ` 0.31
(vi) Amount transferred to Reserve and Surplus
= Earnings available for ordinary shareholders – Dividend paid to ordinary
shareholders
= ` 5,00,000 - ` 3,20,000 = ` 1,80,000
(vii) Net Cash Flow
= Profit after tax + Depreciation – Dividend paid to Preference shareholders –
Dividend paid to ordinary shareholders
= ` 5,42,000 + ` 2,20,000 - ` 42,000 - ` 3,20,000 = ` 4,00,000
Question 3
(a) A company is considering four alternative proposals for a new toy manufacturing
Machine launched in the market. New machine is expected to produce approximately
25,000 toys every year. The proposals are as follows:
(i) Purchase and maintain the new toy manufacturing Machine and bear all related
costs. These machines will run on fuel. The average cost of a Machine is
` 10,00,000. Life of the machine is 4 years with annual production of 25,000 toys
and the Resale value is ` 2,00,000 at the end of the fourth year.
(ii) Hire from Agency-A: It can hire the machine from the Agency-A and pay hire
charges at the rate of ` 20 per toy and bear no other cost.
(iii) Hire from Agency-B: It can hire the machine from the Agency-B and pay hire
charges at the rate of ` 12 per toy and also bear insurance costs. All other costs will
be borne by Agency-B.
(iv) Hire from Agency-C: Hire machine from Agency-C at ` 2,50,000 per year. These
machines are more advanced and run on electricity and therefore, the running cost
is considerably low. The company will have to bear costs of electricity, licensing
fees and spare parts. However, Repairs and maintenance and Insurance cost are
borne by Agency-C.
The following further details are available:
The cost of Fuel is ` 8 per toy, the cost of spare parts is ` 0.20 per toy and the cost of
electricity is ` 2 per toy. Further, the cost of Repairs and maintenance is ` 0.25 per toy,
the amount of licensing fees to be paid is ` 5,000 per machine per annum and the cost of
Insurance to be paid is ` 25,000 per machine per annum. Consider no taxes.

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You are required to:

(i) Calculate the relative costs of four proposals on cost per toy basis.
(ii) Rank the proposals on the basis of total cost for 25,000 toys per year.
(iii) Recommend the best proposal to company in view of (ii) above. (8 Marks)
(b) KLM Ltd., has an operating profit of ` 46,00,000 and has employed Debt (Total Interest
Charge of ` 10,00,000). The existing Cost of Equity and Cost of Debt to the firm are 18%
and 10% respectively. The firm has a proposal before it requiring funds of ` 100 Lakhs
(to be raised by issue of additional debt @ 10%) which is expected to bring additional
profit of ` 19,00,000. Assume no Tax.
You are required to find out the
(i) Existing Weighted Average Cost of Capital (WACC)
(ii) New Weighted Average Cost of Capital (WACC) (8 Marks)
Answer
(a) Calculation of relative costs of proposals

Proposals
Particulars Purchase of Hire Agency- Hire Agency- Hire Agency-
machine A B C
(`) (`) (`) (`)
Depreciation of 2,00,000 - - -
machine (Working
note 1)
Hire charges - 5,00,000 3,00,000 2,50,000
(` 20 × 25,000) (` 12 × 25,000)
Cost of fuel 2,00,000 - - -
(` 8 × 25,000)
Cost of spare parts 5,000 - - 5,000
(` 0.2 × 25,000) (` 0.2 × 25,000)
Cost of electricity - - - 50,000
(` 2 × 25,000)
Repair & 6,250 - - -
maintenance (` 0.25 × 25,000)
Licencing fees 5,000 - - 5,000

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 12 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

Insurance cost 25,000 - 25,000 -

Total Cost (A) 4,41,250 5,00,000 3,25,000 3,10,000
No. of toys (units) 25,000 25,000 25,000 25,000
(B)
(i) Cost per toy 17.65 20.00 13.00 12.40
(A/B)
(ii) Ranking of III IV II I
proposals
(iii) Recommendation: Proposal of Hire machine from Agency-C is acceptable as the
cost of manufacturing toys is lowest.
Working Notes:
(1) Depreciation per year:
Cost of machine -Resale value ` 10,00,000 - ` 2,00,000
= = ` 2,00,000
Life of machine 4 years
(b) Workings:
Interest
Value of Debt =
Cost of debt (K )
d
` 10,00,000
= = ` 1,00,00,000
0.10
Operating profit -Interest
Value of equity capital =
Cost of equity (K e )

` 46,00,000 − ` 10,00,000
= = ` 2,00,00,000
0.18
Total capital = ` 1,00,00,000 + ` 2,00,00,000 = ` 3,00,00,000
(i) Computation of Existing Weighted Average Cost of Capital (WACC):
Sources Amount (`) Proportion Cost of Capital WACC
Equity 2,00,00,000 0.667 0.18 0.1200
Debt 1,00,00,000 0.333 0.10 0.0333
Total 3,00,00,000 1 0.1533 or 15.33%

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 13

(ii) Computation of New Weighted Average Cost of Capital (WACC):

Cost of equity (Ke) = Increased Operating profit -Interest on Increased debt
Equity capital

( ` 46,00,000 + ` 19,00,000) − ( ` 10,00,000 + ` 10,00,000)

=
` 2,00,00,000
` 65,00,000 − ` 20,00,000 ` 45,00,000
= =
` 2,00,00,000 ` 2,00,00,000

= 0.225 or 22.5%
Calculation of New Weighted Average Cost of Capital (WACC)
Sources Amount (`) Proportion Cost of Capital WACC
Equity 2,00,00,000 0.50 0.225 0.1125
Debt 2,00,00,000 0.50 0.100 0.0500
Total 4,00,00,000 1 0.1625 or 16.25%
Note: It is assumed that in the new situation Cost of Debt is constant and value of Equity
is unchanged, then Cost of Equity will change. If we assume, Cost of Debt and Cost of
Equity is constant, then value of equity will change. Accordingly, the value of equity will
be ` 2,50,00,000 and the new Weighted Average Cost of capital (WACC) will be
14.45%.
Question 4
(a) XYZ Ltd. has provided following information in respect of Process 'P' from its Cost
Records :
Work-in-process as at start of period (`)
- Materials 10,000
- Labour 5,000
- Overhead 5,000
Total 20,000
Cost during the period
- Materials 50,000
- Labour 22,500
- Overhead 22,500
Total 95,000

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 14 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

The following information is available from its Production Records:

Units in process as at start of period 5,000
(Degree of completion for Materials is 100% and for
Labour and Overhead is 50%)
New units introduced 25,000
Units completed 19,000
Units in process as at end of period 10,000
(Degree of completion for Materials is 100% and for
Labour and Overhead is 75%)
The degree of completion for scrapped units is 100% for Materials as well as for Labour
and Overhead and units scrapped do not fetch any value. There is no normal loss in the
Process 'P'.
You are required to prepare following, presuming that Average Method of inventory is
used:
(i) Statement of Equivalent Production
(ii) Statement of Cost
(iii) Statement of Distribution of Cost
(iv) Process Account for Process 'P' (8 Marks)
(b) A chemical company is presently paying an outside firm ` 1 per gallon to dispose off the
waste resulting from its manufacturing operations. At normal operating capacity, the
waste is about 50,000 gallons per year.
After spending ` 60,000 on research, the company discovered that the waste could be
sold for ` 10 per gallon if it was processed further. Additional processing would, however,
require an investment of ` 6,00,000 in new equipment, which would have an estimated
life of 10 years with no salvage value. Depreciation would be calculated by straight line
method.
Except for the costs incurred in advertising ` 20,000 per year, no change in the present
selling and administrative expenses is expected, if the new product is sold. The details of
additional processing costs are as follows:
Variable : ` 5 per gallon of waste put into process.
Fixed : (Excluding Depreciation) ` 30,000 per year.
There will be no losses in processing, and it is assumed that the total waste processed in
a given year will be sold in the same year. Estimates indicate that 50,000 gallons of the
product could be sold each year.

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 15

The management when confronted with the choice of disposing off the waste o r
processing it further and selling it, seeks your advice. Which alternative would you
recommend? Assume that the firm's cost of capital is 15% and it pays on an average
50% Tax on its income.
You should consider Present value of Annuity of ` 1 per year @ 15% p.a. for 10 years as
5.019. (8 Marks)
Answer
(a) (i) Statement of Equivalent Production
Particulars Input Particulars Output Equivalent Production
Units Units Material Labour & O.H.
% Units % Units
Opening WIP 5,000 Completed and 19,000 100 19,000 100 19,000
transferred to
next Process
Units introduced 25,000 Abnormal loss 1,000 100 1,000 100 1,000
(Balancing
figure)
Closing WIP 10,000 100 10,000 75 7,500
30,000 30,000 30,000 27,500
(ii) Statement showing cost for each element
Particulars Materials Labour Overhead Total
(`) (`) (`) (`)
Cost of opening work-in-progress 10,000 5,000 5,000 20,000
Cost incurred during the month 50,000 22,500 22,500 95,000
Total cost: (A) 60,000 27,500 27,500 1,15,000
Equivalent units: (B) 30,000 27,500 27,500 -
Cost per equivalent unit: (C) = 2 1 1 4
(A ÷ B)
(iii) Statement of Distribution of cost
Particulars Amount (`) Amount (`)
Value of units completed and transferred 76,000

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 16 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(19,000 units × ` 4)
Value of Abnormal Loss:
- Materials (1,000 units × ` 2) 2,000
- Labour (1000 units × ` 1) 1,000
- Overheads (1000 units × ` 1) 1,000 4,000
Value of Closing W-I-P:
- Materials (10,000 units × ` 2) 20,000
- Labour (7,500 units × ` 1) 7,500
- Overheads (7,500 units × ` 1) 7,500 35,000
(iv) Process P A/c
Particulars Units (`) Particulars Units (`)
To Opening W.I.P: By Abnormal loss 1,000 4,000
- Materials 5,000 10,000 By Completed 19,000 76,000
units
- Labour -- 5,000 By Closing WIP 10,000 35,000
- Overheads -- 5,000
To Materials 25,000 50,000
introduced
To Direct Labour -- 22,500
To Overheads -- 22,500
30,000 1,15,000 30,000 1,15,000

(b) Evaluation of Alternatives:

Savings in disposing off the waste

Particulars (`)
Outflow (50,000 × ` 1) 50,000
Less: tax savings @ 50% 25,000
Net Outflow per year 25,000

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 17

Calculation of Annual Cash inflows in Processing of waste Material

Particulars Amount (`) Amount (`)
Sale value of waste 5,00,000
(` 10 × 50,000 gallon)
Less: Variable processing cost 2,50,000
(` 5 × 50,000 gallon)
Less: Fixed processing cost 30,000
Less: Advertisement cost 20,000
Less: Depreciation 60,000 (3,60,000)
Earnings before tax (EBT) 1,40,000
Less: Tax @ 50% (70,000)
Earnings after tax (EAT) 70,000
Add: Depreciation 60,000
Annual Cash inflows 1,30,000
Total Annual Benefits = Annual Cash inflows + Net savings(adjusting tax) in disposal cost
= ` 1,30,000 + ` 25,000 = ` 1,55,000
Calculation of Net Present Value
Year Particulars Amount (`)
0 Investment in new equipment (6,00,000)
1 to 10 Total Annual benefits × PVAF (10 years, 15%)
` 1,55,000 × 5.019 7,77,945
Net Present Value 1,77,945
Recommendation: Processing of waste is a better option as it gives a positive Net
Present Value.
Note- Research cost of ` 60,000 is not relevant for decision making as it is sunk cost.
Question 5
(a) Define the following terms in Cost Accounting:
(i) Conversion Cost
(ii) Sunk Cost
(iii) Opportunity cost

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 18 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(iv) Cost Centre

(b) Differentiate between Fixed Budget and Flexible Budget.
(c) Explain any four factors that a Venture Capitalist should consider before financing any
risky project.
(d) What is Factoring? What do you understand by Recourse basis factoring and Non-
recourse basis factoring? Explain the advantages of Factoring in brief. (4 x 4 = 16 Marks)
Answer
(a) (i) Conversion cost: It is the cost incurred to convert raw materials into finished
goods. It is the sum of direct wages, direct expenses and manufacturing overheads.
(ii) 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.
(iii) 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.
(iv) 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.
(b) Difference between Fixed and Flexible Budgets
Fixed Budget Flexible Budget
1. It does not change with actual volume of It can be re-casted on the basis of
activity achieved. Thus it is rigid. activity level to be achieved. Thus it
is not rigid.
2. It operates on one level of activity and It consists of various budgets for
under one set of conditions. different level of activity.
3. If the budgeted and actual activity levels It facilitates the cost ascertainment
differ significantly, then cost and price fixation at different levels
ascertainment and price fixation do not of activity.
give a correct picture.
4. Comparisons of actual and budgeted It provided meaningful basis of
targets are meaningless particularly comparison of actual and budgeted
when there is difference between two targets.
levels.

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 19

(c) Factors to be considered by a Venture Capitalist before financing any Risky

Project:
(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 Bo ard of
Directors to have a say on all significant matters affecting the business.
(d) Factoring: Factoring involves provision of specialized services relating to credit
investigation, sales ledger management purchase and collection of debts, credit
protection as well as provision of finance against receivables and risk bearing. In
factoring, accounts receivables are generally sold to a financial institution (a subsidiary of
commercial bank – called “factor”), who charges commission and bears the credit risks
associated with the accounts’ receivables purchased by it.
Types of factoring - Recourse and Non-recourse:
A non-recourse basis factoring is the arrangement where in the event of default the loss
is borne by the factor.
However, in a factoring arrangement with recourse, the accounts receivables will be
turned back to the firm by the factor for resolution.
Advantages of Factoring: The main advantages of factoring are-
(i) The firm can convert accounts receivables into cash without bothering about
repayment.
(ii) Factoring ensures a definite pattern of cash inflows.
(iii) Continuous factoring virtually eliminates the need for the credit department.
(iv) 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 from a considerable part of cash management.

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 20 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

Question 6
(a) The following data has been collected from the cost records of Nee Ltd. for computing
the variances for a period:-
Particulars Budget Actual
Output (units) 50,000 54,000
Hours 25,000 28,000
Fixed overhead ` 65,000 ` 54,000
Working days 25 26
You are required to calculate :
(i) Fixed Overhead Cost Variance
(ii) Fixed Overhead Expenditure Variance
(iii) Fixed Overhead Volume Variance
(iv) Fixed Overhead Efficiency Variance
(v) Fixed Overhead Capacity Variance
(vi) Fixed Overhead Calendar Variance (8 Marks)
(b) XYZ Ltd. has started business in the year 2020-21 and has provided the under
mentioned Projected Profit & Loss Account:
` `
Sales 10,00,000
Less: Cost of Goods Sold 6,12,000
Gross profit 3,88,000
Administration Expenses 72,000
Selling Expenses 60,000 1,32,000
Net Profit 2,56,000
The Cost of Goods Sold has been arrived at as under:
Materials Consumed 3,60,000
Wages & Manufacturing Expenses 2,40,000
Depreciation 1,20,000
7,20,000
Less: Stock of Finished Goods (15%
of goods produced not yet sold) 1,08,000
Cost of Goods Sold 6,12,000

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 21

There is no Work in progress and no opening stock of Raw material and Finished goods.
The company believes in keeping materials equal to three month's consumption in stock.
All expenses will be paid one month in arrear, suppliers of material will extend two
months credit, sales will be 50% for cash and the rest at one month credit. The company
wishes to keep ` 50,000 in cash.
You are required to prepare an estimate of the Requirements of Working Capital on the
basis of Estimates on Cash Cost Basis. Assume no Taxes. (8 Marks)
Answer
(a) Basic Calculations:
Budgeted hours 25,000
Standard hours per unit = = = 0.50 hr.
Budgeted units 50,000

Std. hrs. for actual output = 54,000 units × 0.50 hr = 27,000 hrs.
Budgeted overhead
Standard overhead rate per hour =
Budgeted hours
65,000
For fixed overhead = = ` 2.60 per hr.
25,000

Std. F.O. rate per day = ` 65,000 ÷ 25 days = ` 2,600

Recovered overhead = Std. hrs. for actual output × Std. rate
= 27,000 hrs. × ` 2.60 = ` 70,200
Standard overhead = Actual hours × Std. rate
For fixed overhead = 28,000 hrs. × ` 2.60 = ` 72,800
Budgeted hours
Revised budgeted hours = × Actual days
Budgeted days
25,000
=  26 = 26,000 hrs.
25

Revised budgeted overhead (for fixed overhead) = 26,000 hrs. × ` 2.60 = ` 67,600
Calculation of variances
(i) F.O. Cost Variance = Recovered Overhead – Actual Overhead
= ` 70,200 – ` 54,000 = ` 16,200 (F)

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 22 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(ii) F.O. Expenditure Variance = Budgeted Overhead – Actual Overhead

= ` 65,000 – ` 54,000 = ` 11,000 (F)
(iii) F.O. Volume Variance = Recovered Overhead – Budgeted Overhead
= ` 70,200 – ` 65,000 = ` 5,200 (F)
(iv) F.O. Efficiency Variance = Recovered Overhead – Standard Overhead
= ` 70,200 – ` 72,800 = ` 2,600 (A)
(v) F.O. Capacity Variance = Standard Overhead – Revised Budgeted Overhead
= ` 72,800 – ` 67,600 = ` 5,200 (F)
 Actual Budgeted 
(vi) F.O. Calendar Variance =  −  × Std. rate per day.
 Days Days 
= (26 – 25) × ` 2,600 = ` 2,600 (F)
(b) Statement showing the requirements of Working Capital
Particulars (`) (`)
A. Current Assets:
Inventory:
Stock of Raw material (` 3,60,000 × 3/12) 90,000
Stock of Finished goods (` 6,00,000 × 15/100) 90,000
Receivables (Debtors) (` 3,21,000 × 1/12) 26,750
Cash in Hand 50,000
Gross Working Capital 2,56,750 2,56,750
B. Current Liabilities:
Payables for Raw materials (` 4,50,000 × 2/12) 75,000
Outstanding Expenses:
Wages & Mfg. Expenses (` 2,40,000 × 1/12) 20,000
Administration expenses (` 72,000 × 1/12) 6,000
Selling Expenses (` 60,000 × 1/12) 5,000
Total Current Liabilities 1,06,000 1,06,000
Net Working Capital requirements (A – B) 1,50,750

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 23

Working Notes:
(i) Calculation of Stock of Finished Goods and Cost of Sales
Particulars (`)
Direct material Cost 3,60,000
Wages & Mfg. Expenses 2,40,000
Depreciation -
Gross Factory Cost 6,00,000
Less: Closing W.I.P. -
Cost of goods produced 6,00,000
Less: Closing stock 90,000
5,10,000
Add: Administration Expenses 72,000
Cost of Goods Sold 5,82,000
Add: Selling Expenses 60,000
Total Cash Cost of Sales 6,42,000
Debtors (50% of cash cost of sales) 3,21,000
(iii) Calculation of Credit Purchase
Particulars (`)
Raw material consumed 3,60,000
Add: Closing Stock 90,000
Less: Opening Stock -
Credit Purchases 4,50,000
Question 7
Answer any four of the following:
(a) List out the assumptions underlying Cost-Volume-Profit Analysis.
(b) Define Integrated Accounting System in brief. State any three essential pre-requisites of
this system.
(c) (i) List out two objectives each of Time-keeping and Time-Booking in Cost Accounting.
(ii) Money in the future is 'Worth Less' than similar Money 'Today'. Provide any 2
reasons in support of this statement.

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 24 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(d) Explain the following:

(i) Inter Corporate Deposits.
(ii) Certificate of Deposit.
(e) Explain the term 'Over-Capitalisation'. Also explain any two causes, two consequences,
and two remedies of/for Over-Capitalisation. (4 x 4 = 16 Marks)
Answer
(a) Assumptions underlying CVP Analysis:
(i) Changes in the levels of revenues and costs arise only because of changes in the
number of products (or service) units produced and sold.
(ii) Total cost can be separated into two components: Fixed and variable.
(iii) Graphically, the behaviour of total revenues and total cost are linear in relation to
output level within a relevant range.
(iv) Selling price, variable cost per unit and total fixed costs are known and constant.
(v) All revenues and costs can be added, sub traded and compared without taking into
account the time value of money.
(b) Integrated Accounting System: It is a system of accounting where both costing and
financial transactions are recorded in the same set of books.
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.
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.
(c) (i) Time keeping has the following two objectives-
(i) Preparation of Payroll: Wage bills are prepared by the payroll department on
the basis of information provided by the time keeping department.
(ii) Computation of Cost: Labour cost of different jobs, departments or cost
centers are computed by costing department on the basis of information
provided by the time keeping department.

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 PAPER – 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 25

The objectives of time booking are as follows:

(i) To ascertain the labour time spent on a job and the idle labour hours.
(ii) To ascertain labour cost of various jobs and products.
(iii) To calculate the amount of wages and bonus payable under the wage
incentive scheme.
(iv) To compute and determine overhead rates and absorption of overheads under
the labour and machine hour method.
(v) To evaluate the performance of labour by comparing actual time booked with
standard or budgeted time.
(ii) Money in the future is 'Worth Less' than 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.
(d) (i) Inter Corporate Deposits: The companies can borrow funds for a short period say
6 months from other companies which have surplus liquidity. The rate of interest on
inter corporate deposits varies depending upon the amount involved and time
period.
(ii) Certificate of Deposit (CD): The certificate of deposit is a document of title similar
to a time deposit receipt issued by a bank except that there is no prescribed interest
rate on such funds.
(e) Over-capitalization: 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.

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 26 INTERMEDIATE (IPC) EXAMINATION: NOVEMBER, 2020

(iv) Improper provision for depreciation, replacement of assets and distribution of

dividends at a higher rate.
(v) Wrong estimation of earnings and capitalization.
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”.
(iv) Some companies may opt for reorganization. However, sometimes the matter gets
worse and the company may go into liquidation.
Remedies for Over-Capitalisation: Following steps may be adopted to avoid the
negative consequences of over-capitalisation:
(i) Company should go for thorough reorganization.
(ii) Buyback of shares.
(iii) Reduction in claims of debenture-holders and creditors.
(iv) Value of shares may also be reduced. This will result in sufficient funds for the
company to carry out replacement of assets.

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