Cost and Management Accounting

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Certificate in Accounting and Finance Stage Examination

The Institute of 9 September 2021


Chartered Accountants 3 hours – 100 marks
of Pakistan Additional reading time – 15 minutes

Cost and Management Accounting


Instructions to examinees:
(i) Answer all SIX questions.
(ii) Answer in black pen only.

Q.1 White Limited (WL) had prepared five years’ projection for its then newly developed
product ‘Delta’. Based on the original estimates, the management was highly optimistic
regarding the performance of Delta. However, during the first two years, Delta could not
meet the expectations and had incurred heavy losses. Now, at the beginning of third year,
the management is considering two options; either to discontinue production of Delta or
continue to produce and sell Delta for three more years.
Following information is available in this respect:
Original estimates:
(i) Machinery would be purchased for Rs. 2,000,000 which would be depreciated at
25% reducing balance method. Tax depreciation would be calculated on the same
basis. The estimated residual value of machinery would be equal to its written down
value at the end of project life i.e. 5 years.
(ii) Quantity to be produced and sold would be 3000, 3500, 4800, 5500 and 6000 units
from year 1 to year 5 respectively.
(iii) Sales price for the first year would be Rs. 1,000 per unit subject to increase of
10% per annum.
(iv) Each Delta would require one unit of material A-4. The supplier of A-4 has offered a
discount of 20% for all annual orders of 3000 units or more.
(v) Variable cost for the first year would be Rs. 600 per unit after accounting for
20% discount from supplier. Variable cost would comprise of direct material, direct
labour and variable overhead in the proportion of 50:30:20.
(vi) The storage facility would be acquired on rent for 5 years. The rent for first year would
be Rs. 500,000 which would be subject to an annual increase of 10%. However, if the
agreement is terminated before 5 years, penalty equivalent to 6 months’ rent payable
in the year the termination takes place, would need to be paid.
(vii) Other fixed cost would amount to Rs. 500,000 per annum.
(viii) Tax rate applicable to WL is 30%. Tax is payable in the same year in which it arises.
(ix) WL’s weighted average cost of capital is 15%.
(x) All costs unless otherwise specified are subject to 5% inflation rate.
Option 1: Discontinue production of Delta
(i) The existing stock of 1500 units of Delta would be sold to an existing customer at
75% of price based on the original estimates.
(ii) Machinery would be sold for Rs. 1,500,000.
(iii) All other information would remain the same as per original estimates.
Option 2: Continue to produce and sell Delta for 3 more years
(i) WL would continue to sell Delta (including opening stock of 1500 units) at the
budgeted price based on original estimates. However, at that price, WL would only
be able to sell 80% of budgeted quantity including 5% units to be given away as free
under the promotional scheme.
(ii) Marketing campaign would be carried out at Rs. 500,000 per annum.
(iii) More stringent controls would be introduced to reduce variable overheads and other
fixed cost by 20%.
(iv) All other information would remain the same as per original estimates.
Cost and Management Accounting Page 2 of 5

Required:
Evaluate both options by using net present value method. Recommend the best course of
action that WL should follow. (20)
Notes:
 Net present value based on original estimates is not required.
 Assume that except where stated otherwise, all cash flows would arise at the end of the year.

Q.2 (a) Yellow Limited (YL) is engaged in manufacturing and selling of three products that
are Alpha, Beta and Gamma. YL has recently received an order from an overseas
customer for 3000, 4000 and 1000 kg of Alpha, Beta and Gamma respectively. This
order represents 25% of total demand for each of the three products. The management
has decided to consider this order as ‘high priority’ as it is expected that repeated
orders would be received if the customer is fully satisfied; therefore, this order would
be fulfilled before any other order.

The per unit details of sales price, costs and direct labour hours required for each
product are given below:
Alpha Beta Gamma
----------- Rupees ----------
Selling price 10,000 9,000 12,500

Specialized chemical 2,500 1,800 3,500


Direct labour 1,250 2,000 1,500
Variable production cost 250 200 500
*Fixed production cost 750 400 600
*Selling and administration
costs (30% variable) 250 200 300
----------- Hours ----------
Direct labour hours required 6 5 8
*Fixed costs are allocated on the basis of expected demand

Each product requires specialized imported chemical. YL has been allowed to import
that chemical maximum to Rs. 70 million per annum.

The management of YL is concerned over restrictions on import of specialised


chemical in the existing country of operation as any shortfall to meet demand cannot
be fulfilled. One of the proposals is to shut-down the existing plant and start
manufacturing in Country X.

Following information is relevant if YL considers to start manufacturing in


Country X:
(i) There is no import restriction on required chemical.
(ii) Direct labour hours required for manufacturing YL’s products are in short
supply and available up to 100,000 hours only.
(iii) Any shortfall in the units can be met by sub-contracting to an outside supplier.
The cost of buying each finished product of Alpha, Beta and Gamma would
be equivalent to Rs. 5000, Rs. 4500 and Rs. 7500 respectively. However, the
order considered as ‘high priority’ would be manufactured by YL itself.
(iv) All other information unless otherwise specified would remain the same for
Country X.

YL operates a just-in-time system and has no inventories of chemical or finished


goods.

Required
Recommend whether YL should continue manufacturing in the existing country or
start manufacturing from Country X. Your recommendation should be based on
profit maximizing production schedules. (15)
Cost and Management Accounting Page 3 of 5

(b) Discuss the non-financial factors that management would need to consider before
deciding to sub-contract the manufacturing of its products. (04)

Q.3 Following information pertains to one of the products ‘Violet’ of Blue Limited (BL), for the
month of August 2021:

(i) Production for the month was budgeted at 12,000 units. The standard cost per unit of
Violet is as follows:
Rupees
Direct materials:
Alpha – 4 kg 800
Beta – 6 kg 900
Direct labour – 2 hours 300
*Production overheads – 2 direct labour hours 260
*Fixed production overheads were estimated at Rs. 1.2 million based
on budgeted direct labour hours

(ii) Direct materials are added at the beginning of the production process. BL accounts for
material price variance at the time of issuance of material to production and uses FIFO
method for inventory valuation. Following information has been extracted from the
stock cards of Alpha and Beta:
Alpha Beta
Date Description Cost per kg Cost per kg
kg kg
(Rs.) (Rs.)
2,000 220 4,000 140
1-Aug Opening balance
4,000 190 4,000 150
2-Aug Purchase returns (1,000) 190 - -
3-Aug Purchases 75,000 195 86,000 155
5-Aug Purchase returns - - (500) 140
7-Aug Issues to production (60,000) - (70,000) -

(iii) Conversion costs are incurred evenly throughout the process. Conversion costs
incurred for August 2021 are as under:
Rupees
Direct labour paid for 26,730 hours
(including 10% idle hours due to machine break-down) 4,000,000
Variable production overheads 2,000,000
Fixed production overheads 1,400,000

(iv) Actual sales for the month of August 2021 were 12,500 units. Details of opening and
closing inventories are hereunder:
Opening Closing
Finished goods 1,200 units 1,500 units
Work in process 1,000 units (60% complete) 500 units (80% complete)

(v) BL uses standard absorption costing system.

Required:
(a) Prepare a statement of equivalent production units. (02)
(b) Compute the following variances:
(i) Material price, mix and yield variances (09)
(ii) Variable production overhead rate and efficiency variances (04)
(iii) Fixed production overhead expenditure, efficiency and capacity variances (05)
Cost and Management Accounting Page 4 of 5

Q.4 Green Limited (GL) produces a chemical that passes through two processes before being
transferred to warehouse. Following information pertains to Process II for the month of
August 2021:

Production Cost
(kg) (Rs. in '000)
Opening work in process 7,500 3,000
Transferred from Process I 45,000 27,000
Material added in Process II 22,500 11,250
Conversion costs incurred in Process II - 1,500
Finished goods transferred to warehouse 60,000 -
Closing work in process 9,000 -

In Process II, material is added at start of the process and conversion costs are incurred
evenly throughout the process. Process loss is determined on inspection which is carried out
on 60% completion of the process. Process loss is estimated at 10% of the inspected quantity
and is sold for Rs. 200 per kg.

The details of opening and closing work in processes are as follows:

Opening work in process Closing work in process


kg Completion % kg Completion %
5,250 80% 5,400 70%
2,250 40% 3,600 30%

GL uses FIFO method for inventory valuation.

Required:
Prepare Process II account for the month of August 2021. (10)

Q.5 Red Limited (RL) manufactures and sells plastic chairs. The relevant details at different
demand levels are as follows:

Demand in units 16,000 14,000 11,800 9,300


--------------------- Rupees --------------------
Sale price (net of 3% distributor
commission) per unit 2,850 2,945 3,040 3,135
Material 20,520,000 18,900,000 15,930,000 12,555,000
Conversion cost 11,403,600 10,750,000 9,374,000 8,299,000
Operating expenses 3,500,000 3,500,000 3,500,000 3,500,000

The management is considering manufacturing either 14,000 chairs or 16,000 chairs. In the
above table, fixed conversion cost increases by 10% if number of chairs manufactured
exceeds 13,000. Further, material cost and variable conversion costs reduce by 5% and 3%
respectively, if number of chairs manufactured exceeds 15,000.

In order to achieve the desired level of sales, RL is also considering to offer 5% sale discount
on bulk order of 25 chairs and 10% sale discount on bulk order of 50 chairs. The sales mix
after introduction of discount is estimated to be in the ratio of 60:30:10 for normal sale,
5% sale discount and 10% sale discount respectively. It is estimated that introduction of
discount would result in increase in distributor commission by 1% on bulk sale of 25 chairs
and 2% on bulk sale of 50 chairs.

Required:
(a) Determine the breakeven revenue and margin of safety units at the demand level of
14,000 and 16,000 chairs. (14)
(b) Briefly discuss any conclusion which may be drawn from your calculation in (a)
above. (02)
Cost and Management Accounting Page 5 of 5

Q.6 (a) Identify any four situations under which the cost of inventories may exceed its
net realisable value. (02)

(b) Orange Limited (OL) manufactures four products. The information related to its
inventory of each product for the year ended 30 June 2021 is as follows:

A B C D
Closing inventory (units) 15,000 25,000 5,000 8,000
Cost per unit using weighted average method (Rs.) 800 700 900 1,275
Retail price per unit inclusive of 10% sales tax (Rs.) 1,144 990 1,320 1,980
Variable selling cost per unit (Rs.) 80 75 100 110
Defective units (included in closing inventory) 2,400 4,000 - -
Rework cost per defective unit (Rs.) 260 320 - -

Additional information:
 During physical inventory count of Product C, a discrepancy of 900 completed
units was observed. On investigation, it was found that 5,600 units supplied to a
customer were erroneously recorded as 6,500 units.
 The defective units can be sold in the market at 60% of the current retail price
without incurring any rework and selling costs.
 Due to decrease in raw material prices, the products similar to B and D, offered
by the competitors, are available in the market at a discount of 15% and 20%
respectively, of OL’s current retail price. OL would have to adjust its sales prices
accordingly.

Required:
(i) Prepare entries to record the adjustments that need to be incorporated for correct
valuation of inventory. (10)
(ii) Determine the adjusted value of inventory as at 30 June 2021. (03)

(THE END)

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