Paper - 3: Cost Accounting and Financial Management: © 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
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
Assets
Amount (`)
40,00,000 Fixed Assets (Net)
1,28,00,000
Amount (`)
Equity share capital of ` 10 each

Reserve & Surplus
8,00,000 Current Assets
15% Debentures
80,00,000
Current Liabilities
32,00,000
1,60,00,000
32,00,000
1,60,00,000
The additional information given is as under:

Fixed cost per annum (excluding interest)
` 32,00,000
Variable operating cost ratio

Total assets turnover ratio
70%
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
48
INTERMEDIATE (IPC) EXAMINATION: MAY, 2016
(ii) Depreciation per annum =
` 10,000 - ` 1,000
= ` 900
10 years
(iii) Chemical solution cost per annum = ` 20 50 weeks = ` 1,000

(iv) Wages of attendants (per annum) =
` 120 50 weeks
= ` 1,000
6 machines
Calculation of Machine hour rate

Particulars
Amount
(per annum)
Amount
(per hour)
A. Standing Charge
(i)
Wages of attendants
1,000
(ii) Departmental and general works overheads
2,000
Total Standing Charge
3,000
1.5
3,000
2,000
Standing Charges per hour
B. Machine Expense
(iii) Depreciation
900
0.45
1.37
(v) Chemical solution
1,000
0.50
(vi) Maintenance cost
1,200
0.60
(iv) Electricity
` 0.0916units1,900hours
2,000hours
Machine operating cost per hour (A + B)
4.42
(b) Working Notes:

Particulars
Fixed Cost
Variable Cost
2015 (`)
72,00,000
2016 (`)
79,20,000
(` 60 1,20,000 units)
(110% of ` 72,00,000)
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.
49
(`)
Total Contribution required to recover total fixed cost in

2016 and to reach break-even volume.
79,20,000
Less: Contribution from opening stock
24,00,000
Balance Contribution to be recovered
55,20,000
{20,000 units (` 300 ` 180)}
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
7.336
CVFA (8%,6 years)
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
50
(d) Workings:
Total Assets Turnover Ratio i.e.
Sales
= 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
(i)
Operating Leverage
Contribution
` 1,20,00,000
=
= 1.36
EBIT
` 88,00,000
(ii)
Financial Leverage
EBIT
EBT
Contribution ` 1,20,00,000
=
= 1.58
` 76,00,000
EBT
(iii) Combined Leverage
` 88,00,000
= 1.16
` 76,00,000
Or
Combined Leverage
= Operating Leverage Financial Leverage

= 1.36 1.16 = 1.58
(iv) Earning per share =
PAT / EAT
` 53,20,000
=
= ` 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:
(a) Opening Balance of Creditors Account

(b) Closing Balance of Creditors Account
(c)
Payment made to Creditors
(d) Opening Balance of Stores Ledger Control Account

(e) Closing Balance of Stores Ledger Control Account
(f)
Wages paid (for 8000 hours) 20% relate to indirect workers
(g) Various indirect expenses incurred

(h) Opening balance of WIP control account
51
` 25,000
` 40,000
` 5,80,000
` 40,000
` 65,000
` 4,00,000
` 60,000
` 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
`4,00,000
Closing Stock
Stock turnover ratio
10
Gross profit ratio

Net profit ratio
25 percent
20 percent
Net profit to capital

Capital to total liabilities
1/5
1/2
Fixed assets to capital

Fixed assets/Total current assets
5/4
5/7
(8 Marks)
Answer
(a)
Creditors A/c
Dr.
Particulars
To Bank A/c
Cr.
(`)
Particulars
5,80,000 By Balance b/d
(`)
25,000
52
To Balance c/d
40,000 By Stores ledger control A/c
(Materials purchased)(Bal. figure)
6,20,000
5,95,000
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
(Materials purchased)
65,000
6,35,000
6,35,000
Work-in-Process Control A/c

Dr.
Cr.
Particulars
To Balance b/d
(`) Particulars
50,000 By Finished goods control A/c

(Balancing figure)
To Stores ledger control A/c
5,70,000 By Balance c/d:
To Wages control A/c
3,20,000 -
(80% of ` 4,00,000)
Material
35,000
Labour
20,000
(` 50* 400 hours)
Factory Oh
(` 20** 400 hours)
To Factory Overhead control

A/c
(`)
10,05,000
8,000
63,000
1,28,000
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
To Bank A/c
(`)
Particulars
4,00,000 By WIP control A/c
(80% of ` 4,00,000)
(`)
3,20,000
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
To Bank A/c
60,000 By Balance c/d
(` 20 6,400 hours)
(Indirect expenses)
1,40,000
(`)
1,28,000
12,000
1,40,000
(b) Workings:
(i)
Fixed Assets
5
=
TotalCurrent Assets 7
Or, Total Current Assets =
` 40,00,000 7
= ` 56,00,000
5
(ii)
Fixed Assets 5
=
Capital
4
Or, Capital =
(iii)
Capital
1
=
TotalLiabilities * 2
Or, Total liabilities = ` 32,00,000 2 = ` 64,00,000
` 40,00,000 4
= ` 32,00,000
5
*It is assumed that Total liabilities does not include capital.

(iv)
Net Pr ofit 1
=
Capital
5
Or, Net Profit = ` 32,00,000 1/5 = ` 6,40,000
(v)
Net Pr ofit 1
=
Sales
5
Or, Sales = ` 6,40,000 5 = ` 32,00,000
(vi) Gross Profit
= 25% of ` 32,00,000 = ` 8,00,000
(vii) Stock Turnover
Cost of GoodsSold(i.e.Sales Grossprofit)

= 10
Average Stock
`32,00,000 ` 8,00,000
= 10
Average Stock
54
Or, Average Stock
= ` 2,40,000 Or,
Or, Opening Stock
= ` 80,000
OpeningStock + ` 4,00,000
= ` 2,40,000
2
Trading Account
Particulars
(`)
To Opening Stock
To Manufacturing
Purchase
Particulars
80,000 By Sales
exp./
(`)
32,00,000
27,20,000
(Balancing figure)
To Gross Profit b/d
8,00,000 By Closing Stock

36,00,000
4,00,000
36,00,000
Profit and Loss Account

Particulars
(`)
Particulars
To Operating Expenses
1,60,000 By Gross Profit c/d
To Net Profit
6,40,000
(Balancing figure)
8,00,000
(`)
8,00,000
8,00,000
Balance Sheet
Capital and Liabilities
(`)
Assets
Capital
32,00,000 Fixed Assets
Liabilities
64,00,000 Current Assets:

Closing Stock
Other Current Assets
(Bal. figure)
96,00,000
(`)
40,00,000
4,00,000
52,00,000
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
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.
March 31
Return started in March

Return-in-process (80% complete)
825 Nos
125 Nos
Return-in-process labour
` 12,000
` 5,000
Cost Data:
March 1
- Overheads
March 1 to 31
Labour : 4,000 hours
` 1,78,000
` 90,000
Overheads
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
Collection Period
Increase in Sales
Present default
anticipated
10 days
1.5%
II
30 days
III
45 days
` 21,000
`52,500
`63,000
3%
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)
56
Answer
(a) (a) Statement Showing Cost Elements Equivalent Units of Performance and the
Actual Cost per Equivalent Unit
Detail of Returns
Details
Detail of
Input
Units
Equivalent Units
Output
Units
Labour
Units
Overheads
Units
Returns in
Process at Start
200 Returns
Completed in
March
900
900
100
900
100
Returns Started in
March
825 Returns
in
Process at the
end of March
125
100
80
100
80
1,025
1,000
1,025
Costs:
1,000
(`)
(`)
12,000
5,000
During the month
1,78,000
90,000
Total Cost
1,90,000
95,000
190.00
95.00
From previous month
Cost per Equivalent Unit

(b) Actual cost of returns in process on March 31:
Numbers
Stage of
Completion
Rate per
Return (`)
Total
(`)
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
Overhead
5 Hrs ` 40 per hour = ` 200

5 Hrs ` 20 per hour = ` 100
` 300
Budgeted volume for March = ` 98,000 / 1000 = 980 Returns
Actual labour rate
= ` 178000 / 4000 = `44.50
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
(b) A.
Recovered/Absorbed Overhead Budgeted Overhead
950 Units 5 hrs. `20 ` 98,000 = ` 3,000(A)
Statement showing the Evaluation of Debtors Policies (Total Approach)
Particulars
Present Policy
(30 days)
Proposed
Policy I
(40 days)
Proposed
Policy II
(60 days)
Proposed
Policy III
(75 days)
(`)
(`)
(`)
(`)
4,20,000
4,41,000
4,72,500
4,83,000
A. Expected Profit:
(a) Credit Sales
(b) Total Cost (other than
58

Bad Debts)
(i) Variable Costs
2,80,000
2,94,000
3,15,000
3,22,000
(ii) Fixed Costs (W.N.
35,000
35,000
35,000
35,000
Total Cost (Variable Cost
3,15,000
3,29,000
3,50,000
3,57,000
6,615
14,175
19,320
[Sales x ` 2/` 3]
1)
+ Fixed Cost)
(c) Bad Debts
4,200
(d) Expected Profit [(a)

(b) (c)]
B. Opportunity Cost of
Investments
in
Receivables *
(1% of
4,20,000)
(1.5% of
4,41,000)
(3% of
4,72,500)
(4% of
4,83,000)
1,00,800
1,05,385
1,08,325
1,06,680
7,311
11,667
14,875
5,250
(3,15,000x
C. Net Benefits (A B)
30
20
40
20
x ) (3,29,000x
x
)
360 100
360 100
95,550
(3,50,000x
98,074
60
20
x )
360 100
96,658
(3,57,000x
75 20
x )
360 100
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

Opportunity Cost = Total Cost
Collectionperiod Rate of return
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:
Material
59
` 5,000
` 3,000
` 2,000
` 10,000
Labour
Overhead
Subsequent cost in ` are given below:

A
Material
3,000
1,500
Labour
1,400
1,000
600
500
5,000
3,000
Overhead
Selling prices are
` 16,000
` 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
Profitability index
4 years
1.0417
Internal rate of return

Salvage value
15%
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
60
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
Selling Price
Less: Estimated profit
A (`)
B (`)
16,000
8,000
4,000
(20% of ` 8,000)
12,000
6,400
Cost of sales
Less: Selling & Distribution exp.
1,600
(25% of `16,000)
267
(Refer working note)
133
(` 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
Material
Labour
Overheads
Joint Cost
A
B
3,367
2,020
1,346
1,633
980
654
Subsequent Cost
A
B
3,000
1,500
1,400
1,000
600
500
Cost of production
Total Cost
A
B
6,367
3,420
1,946
11,733
3,133
1,980
1,154
6,267
Working Note:
Calculation of Selling and Distribution Expenses
Particulars
Total Sales Revenue (` 16,000 + ` 8,000)

Less: Estimated Profit (` 4,000 + ` 1,600)
Cost of Sales
Less: Cost of production:
- Joint Costs
- Subsequent costs (` 5,000 + ` 3,000)
Selling and Distribution expenses (Balancing figure)
(`)
24,000
(5,600)
18,400
(10,000)
(8,000)
400
(b) (i)
61
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
Hence, Annual Cash flow =
` 2,28,400
= ` 80,000
2.855
(ii) Cost of Capital:

Profitability index =
1.0417 =
Sum of Discounted Cash inflows

Cost of the Project
Sum of Discounted Cash inflows

` 2,28,400
Sum of Discounted Cash inflows = ` 2,28,400 1.0417 = ` 2,37,924.28

Since, Annual Cash Inflows = ` 80,000
Hence, cumulative discount factor for 4 years =
` 2,37,924.28
= 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
flow
PV of Re.1 @
13%
PV of Cash
flow
Cumulative PV of
Cash inflow
80,000
0.885
70,800
70,800
62
80,000
0.783
62,640
1,33,440
80,000
0.693
55,440
1,88,880
80,000
0.613
49,040
2,37,920
39,520
= 3.8059 years
49,040
Discounted Payback Period
= 3+
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
maintaining the costs in
accordance
with
the
established standards.
1.
Cost reduction is concerned with

reducing costs. It challenges all
standards and endeavours to better
them continuously.
2.
Cost control seeks to attain

lowest possible cost under
existing conditions.
2.
Cost reduction recognises no condition as

permanent, since a change will result in
lower cost.
3.
In case of Cost Control,

emphasis is on past and
present.
3.
In case of cost reduction it is on present

and future.
4.
Cost Control is a preventive

function.
4.
Cost reduction is a corrective function. It

operates even when an efficient cost
control system exists.
5.
Cost control ends when targets

are achieved.
5.
Cost reduction has no visible end.
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
(iv)
Commission
brokerage paid
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.
or Commission or brokerage paid is added with the

cost of purchase.
(c) Distinguish between Operating Lease and Financial Lease

Point
Operating Lease
Finance Lease
Ownership
The lessee is only provided the

use of the asset for a certain
time. Risk incident to ownership
belongs only to the lessor.
The risk and reward incidental to

ownership are passed on to the
lessee. The lessor only remains the
legal owner of the asset.
Bearing
risk
The lessor bears the risk of The lessee bears the risk of
obsolescence.
obsolescence.
Purchase
option
The lessee does not have any It allows the lessee to have a
option to buy the asset during purchase option during the lease
the lease period.
period.
Expenses
borne
Usually, the lessor bears the cost The lessor does not bear the cost of
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.
64
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
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
Total fixed costs per year
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 companys 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
2008
1.21
2013
1.95
2009
1.33
2014
2.15
2010
1.46
2015
2.36
65
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
8.00
6.00
32,00,000
24,00,000
Contribution per unit

Total Contribution
(` 8 4,00,000)
(` 6 4,00,000)
30,00,000
21,00,000
Profit
2,00,000
3,00,000
*Capacity (units)
4,30,000
5,00,000
Less: Total fixed costs
Total Contribution at full capacity

Fixed Cost
Profit
34,40,000
30,00,000
(` 8 4,30,000)
(` 6 5,00,000)
30,00,000
21,00,000
4,40,000
9,00,000
Process- B should be chosen as it gives more profit.

(2)
Particulars
*Capacity (units)
Process- A (`)
Process- B (`)
6,00,000
5,00,000
66
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
(b) (i)
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.
Calculation of after tax cost of the followings:

(a) New Debentures (Kd) =
I(1- t) `16 (1-0.5)

x 100 = 8.33%
=
` 96
NP
New Preference Shares (Kp)
Preference Dividend
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 )
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
(a)
After tax Cost of

capital (%)
(b)
Weighted Average Cost of

Capital [WACC (%)]
(a) (b)
Debenture
0.15
8.33%
1.25
Preference
shares
0.05
11.96%
0.60
Equity shares
0.80
15.00%
12.00
Marginal cost of
capital
13.85
(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
68
= 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:
Ke=
Expecteddividend(D1 )
50% of `2.36
+ 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 (%)
(a)
(b)
Weighted Average Cost of

Capital [WACC (%)]
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
(a) (b)
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.
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
(44 =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.
70
(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
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.

Paper - 3: Cost Accounting and Financial Management: © The Institute of Chartered Accountants of India

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Paper - 3: Cost Accounting and Financial Management: © The Institute of Chartered Accountants of India

Uploaded by

Copyright:

Available Formats

PAPER 3 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

Question No. 1 is compulsory.

The Institute of Chartered Accountants of India