Institute of Chartered Financial Analysts of India (ICFAI) University 2007 C.A Chartered Accountant Cost-Fm Solved - Question Paper

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

All questions are compulsory.

Working notes should form part of the answer wherever appropriate,

suitable assumpti ons should be made.

Question 1

Answer any five of the following:

(i ) Usi ng Tayl ors differential piece rate system, find the earning of A from the following

particulars:

Standard time per piece

12 minutes

Normal rate per hour (in a 8 hours day) Rs. 20

A produced

37 Uni ts

(i i) Briefly discuss, how the synergetic effect help in reducti on in costs.

(i ii) Explain in brief the expli cit cost with examples.

(i v) Explain briefly the conditions when supplementary rates are used.

(v) The average annual consumption of a material is 18,250 units at a price of Rs. 36.50 per

unit. The stor age cost is 20% on an average inventory and the cost of pl acing an or der is

Rs. 50. How much quantity is to be purchased at a time?

(vi) Enumerate the various methods of Time booking. (5 2 = 10 Marks)

Answer

60

8

(i) Standard output per day units

40

12

Actual output = 37 units

Effici ency percentage 92.5%

100

40

37

Under this method lower rate i s 83% of the normal piece rate and is applicable i f

effici ency of wor ker is below 100%.

Earning rate per unit = 83% of unit

per

3.32

or

5

20

*

Earning = 37 3.32 = Rs. 122.84

minutes

60

* In one hour, pr oducti on wi ll be =

units

5

minutes

12

i.e.

peice,

per

time

standard

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

4

(ii) Two or more products are produced and managed together.

The result of combined efforts are higher than sum of the r esults of individual pro ducts.

Analysis of synergetic effect is helpful in cost control.

(iii) Out of pocket cost, involving immediate payment of Cash. Salaries, Wages, Postage and

Telegram, Pri nting and Stationery, Interest on Loan are some examples of Explicit Costs.

(iv) When the amount of under absorbed and over absorbed overhead is si gni ficant or l arge,

because of differences due to wrong esti mati on, then the cost of product needs to be

adjusted by using supplementary rates (under and over absorption/actual overhead) to

avoid misleading i mpression.

(v) Quantity to be purchased

50

18,250

2

units

500

2,50,000

36.50

of

20%

(vi) The various methods of time booking are:

(a) Job ticket.

(b) Combined time and job ti cket.

(c) Dail y time sheet.

(d) Piece work card.

(e) Clock card.

Question 2

A company has three production departments (M1 , M2 and A1 ) and three service department,

one of whi ch Engineering service department, servicing the M1 and M2 only. The rel evant

informations are as follows:

Product X Product Y

M1 10 Machine hours 6 Machine hours

M2 4 Machine hours 14 Machine hours

A1 14 Direct Labour hours 18 Direct Labour hours

The annual budgeted overhead cost for the year are

Indirect Wages Consumabl e Supplies

(Rs.)

( Rs.)

46,520

12,600

M1

41,340

18,200

M2

16,220

4,200

A1

Stores

8,200

2,800

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 5

Engineering Servi ce 5,340

4,200

General Service 7,520

3,200

Rs.

Depreci ation on Machinery 39,600

Insurance of

7,200

Machinery

Insurance of Building 3,240 (Total building insurance cost for

M1 i s one third of annual premium

Power

6,480

Light

5,400

12,675 (The general servi ce deptt. is

Rent

l ocated in a building owned by

the company. It is val ued at Rs.

6,000 and is charged into cost at

notional value of 8% per annum.

This cost i s additional to the re nt

shown above)

The value of issues of materials to the production departments are i n the

same propor tion as shown above for the Consumable suppli es.

The followi ng data are also avail abl e:

Department Book value

Area

Effective

Production

Capacity

Machinery

(Sq. ft.)

H.P. hours %

Direct

Machi ne

(Rs.)

Labour

hour

hour

M1 1,20,000 5,000 50 2,00,000 40,000

M2 90,000 6,000 35 1,50,000 50,000

A1 30,000 8,000 05 3,00,000

Stores 12,000 2,000

Engg. Service 36,000 2,500 10

General Service 12,000 1,500

Required:

(i ) Prepare a overhead analysis sheet, showing the bases of apportionment of overhead to

departments.

(i i) Allocate service department overheads to production department ignoring the

apportionment of service department costs among servi ce departments.

(i ii) Calculate suitable overhead absorpti on rate for the production departments.

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

6

(i v) Calculate the overheads to be absorbed by two products, X and Y.

(6 + 4 + 3 + 2 = 15 Marks)

Answer

(i)

Summary of Apportionment of Overheads

(Rs.)

Produc tion Deptt. Service Deptt.

Basis of

Apportionment

Total

Amount M 1 M2 A1 Store

Items

Engineering

General

Service

Service

Service

In direct

wages

Allocation given 1,25, 140 46,520 41,340 1 6,220 8,200 5,340 7, 520

Consu mable

stores

Allocation given 45,20 0 12,600 18,200 4,200 2,800 4,200 3, 200

Depreciation Capital value of

39,60 0 15,840 11,880 3,960 1,584 4,752 1, 584

machine

In surance of

Machine

Capital value of

machine

7,20 0 2,880 2,160 720 288 864 288

In surance

on Building 3

3,24 0 1,080 648 864 216 270 162

1 to MI

Balance area

basis

Power HP Hr% 6,48 0 3,240 2,268 324 648

Light Area 5,40 0 1,080 1,296 1,728 432 540 324

Rent Area 12,67 5 2,535 3,042 4,056 1,014 1,268 760

Rent of

gen eral

service

Direct 8% of

6,000

48 0

480

_______ ______ ______ ______ ______ ______

_ _____

Tota l 2,45, 415 85,775 80,834 3 2,072 14,534 17,882 14, 318

(ii) Allocation of service department s overheads

Production Deptt. Service Deptt.

Basis of

Apportionment M1 M2 A1 Store

Service Deptt.

Engineering

General

Service

Service

Service

Store Ratio of

consumable value

(126 :182 : 42)

5,232 7,558 1,744 (14,534)

Engineering

service

In Machine hours

Ratio of M1 and

M2 (4 : 5) 7,948 9,934 (17,882)

General

service

LHR Basis

20 : 15 : 30 4,406 3,304 6,608

(14,318)

Production

Department

allocated in (i) _______ 85,775 80,834 32,072

Total 2,45,415 1,03,361 1,01,630 40,424

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 7

(iii)

Overhead Absorpt ion rate

M1 M2 A1

Total overhead all ocated 1,03,361 1,01,630 40,424

Machi ne hours

40,000 50,000

Labour hours

3,00,000

Rate per MHR

2.584 2.033

Rate per Direct labour

.135

(iv) Statement showing overhead absorption for Product X and Y

Machine

Absorpti on

Product X

Product Y

Deptt.

Rate

Hours Rs.

Hours Rs.

M1 2.584 10 25.84 6 15.50

M2 2.033 4 8.13 14 28.46

A1 .135 14 .54 18 2.43

34.51

46.39

Question 3

(a) AKP Builders Ltd. Commenced a contract on Apri l 1, 2005. The total contract was for Rs.

5,00,000. Actual expendi ture for the period April 1, 2005 to March 31, 2006 and

estimated expenditure for April 1, 2006 to December 31, 2006 are given below:

2005-06

2006-07 (9 months)

(Actuals)

(Estimated)

Rs.

Rs.

Mater ial Issued

90,000 85,750

Labour : Paid

75,000 87,325

Outstanding at the end

6,250 8,300

Plant

25,000

Sundry Expenses : Paid 7,250 6,875

Prepaid at the end

625

Establishment charges

14,625

A part of the material was unsuitabl e and was sold for Rs. 18,125 (Cost bei ng Rs.

15,000) and a part of plant was scrapped and disposed of for Rs. 2,875. The val ue of

plant at site on 31 March, 2006 was Rs. 7,750 and the value of material at site was Rs.

4,250. Cash received on account to date was Rs. 1,75,000, representing 80% of the

work certified. The cost of work uncertified was val ued at Rs. 27,375.

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

8

The contractor estimated further expendi ture that would be incurred i n completion of the

contract:

The contract would be completed by 31st December, 2006.

A further sum of Rs. 31,250 would have to be spent on the plant and the residual

val ue of the pant on the completi on of the contract would be Rs. 3,750.

Establishment charges would cost the same amount per month as in the previous

year.

Rs. 10,800 would be sufficient to provi de for conti ngencies.

Required:

Prepare Contract account and calculate estimated total profit on this contract. Profit

transferrable to Profit and Loss account is to be calculated by reducing estimated Profit

in proportion of work certified and contract price.

(8 Marks)

(b) A Company produces two joint products P and Q in 70 : 30 ratio from basic raw materi al s

in department A. The input output ratio of department A is 100 : 85. Product P can be

sold at the split of stage or can be processed further at department B and sol d as pr oduct

AR. The i nput output ratio is 100 : 90 of department B. The department B i s created to

process product A only and to make it product AR.

The selli ng prices per kg. are as under:

Product P Rs. 85

Product Q Rs. 290

Product AR Rs. 115

The production will be taken up in the next month.

Raw materials 8,00,000 Kgs.

Purchase price Rs. 80 per Kg.

Deptt. A Deptt. B

Rs. Lacs Rs. Lacs

Direct materials

35.00 5.00

Direct labour

30.00 9.00

Variable overheads

45.00 18.00

Fixed overheads

40.00 32.00

Total

150.00 64.00

Selling Expenses:

Rs. in Lacs

Product P

24.60

Product Q

21.60

Product AR

16.80

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 9

Required:

(i) Prepare a statement showing the apportionment of j oint costs.

(ii) State whether it is advisable to produce product AR or not. (8 Marks)

Answer

(a)

AKP Builders Lt d.

Contract Account (20052006)

Particulars

Rs. Par ticulars Rs.

To Material issued 90,000 By Materi al (sold) 18,125

To Labour 75,000 By Plant (sold) 2,875

Add: Outstanding 6,250 81,250 By Plant at si te 7,750

To Plant

25,000 By Materi al at site 4,250

To Sundry Expenditure 7,250

Less: Pre-paid 625 6,625

To Establishment charges 14,625 By Bal ance c/d 1,87,625

To Profit and Loss A/c

(Profit on sale of

material)

3,125

_______

2,20,625

2,20,625

To Balance b/d

1,87,625 By Work in progress

To Balance c/d

58,500 Certi fied 2,18,750

_______ Uncertified 27,375

2,46,125

2,46,125

To Profit and Loss A/c* 29,960.55 By Bal ance 58,500

To Work i n progress 28,539.45

_______

58,500

58,500

certified

Work

* Profit to Profit and Loss A/c =

Profit

Estimated

price

Contract

29,960.55

Rs.

68,481.25

5,00,000

2,18,750

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

10

Memorandum Contract Account (9 months)

Particulars Rs. Rs. Particulars Rs.

To Material

By Contractees A/c 5,00,000

(90,000 + 3,125

18,125)

75,000

Add: New Addition 85,750 1,60,750

To Plant (25,000 2,875) 22,125

Add: New (+) 31,250

Less: Closing ( ) 3,750 49,625

To Es tablishment charges 14,625

Add: For nine months

14,625 10,968.75 25,593.75

9

12

To Sundry Expenditure 6,625

Add: New (+) 6,875

Previous prepaid (+) 625 14,125.00

To Labour 81,250

Add: (87,325 6,250) (+) 81,075

Outstanding (+) 8,300 1,70,625

To Reserve for

10,800

contingencies

To Es timated Profit 68,481.25

_______

5,00,000

5,00,000

(b) Input in Deptt. A 80,000 kgs.

Yield 85%

Therefore Output = 85% of 8,00,000 = 6,80,000 kgs.

Ratio of output for P and Q = 70 : 30.

Product of P = 70% of 6,80,000 = 4,76,000 kgs.

Product of Q = 30% of 6,80,000 = 2,04,000 kgs.

Statement showing apportionment of joint cost

P Q Total

Product kgs.

4,76,000 2,04,000

Selling pr ice per kg. Rs. 85.00 290.00

Rs. l akhs Rs. lakhs Rs. l akhs

Sales

404.60 591.60 996.20

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 11

Less: Selling expenses

24.60 21.60 46.20

Net sales

380 570 950

Ratio

40% 60% 100%

Rs. lakhs

Raw materials (8,00,000 kgs. Rs. 80)

640

Process cost of department A

150

790

Apportionment of Joint Cost

(In the rati o of Net Sales i.e. P : Q., 40% : 60%.

Joint Cost of P = Rs. 316 lakhs

Joint Cost of Q = Rs. 474 lakhs

Statement showing the profitability of further processing of

product P and converted into product AR

Product AR

Output = 90% of 4,76,000 kgs. = 4,28,400 kgs.

Rs. l akhs

Joint costs

316.00

Cost of Department B

64.00

Selling expenses

16.80

396.80

492.66

Sales value (Rs. 115 4,28,400)

Profit (492.66 396.80)

95.86

If P is not processed profitability is as under.

Rs. l akhs

Sales

380.00

Less: Joint expense

316.00

Profit

64.00

Further pr ocessing of product P and converting into product AR is beneficial to the

company because the profi t increaser by Rs. 31.86 lakhs (95.86 64.00).

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

12

Question 4

Answer any three of the following:

(i ) Discuss the treatment of spoilage and defectives.

(i i) What items are general ly incl uded in good uniform costing manual?

(i ii) Oper ation costing is defined as r efinement of Process costing. Explain it.

(i v) Enumerate the factors which cause difference in profits as shown in Financial Accounts

and Cost Accounts.

(3 3 = 9 Marks)

Answer

(i) Treatment of spoilage and defecti ves:

Spoilage:

Normal spoilage are incl uded in cost either by charging the loss to the producti on order

or charging i t to production overhead. The cost of abnormal spoil age is charged to

costing profi t and loss account.

Defectives:

Normal defectives can be recovered : charged to good production

: charged to general overhead

: charged to department.

If defectives are abnormal and are due to causes beyond the control of organization then

they should be charged to profi t and loss account.

(ii) Uniform costi ng manual includes essential informations and instructions to implement

accounting procedures.

(a) Introduction: It includes objects and scope of the planning.

(b) Accounti ng procedure and pl anning includes rules, and general princi ple to be

followed.

(c) Cost accounting planning i ncludes methods of costing, relation between cost and

financial accounts and methods of integration.

(iii) Operation costing is concerned with the determination of the cost of each operation

rather than the process:

In the i ndustries where process consist of distinct operations, the operation costing

method is appl ied.

It offers better control and faci litates, the computati on of unit operation cost at the

end of each operation.

(iv) Causes of difference:

(a) Items included in financi al accounts but not in cost accounts such as:

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 13

Interest received on bank deposits, loss/profit on sale of fixed assets and

investments, dividend, rent recei ved.

(b) Items included in cost accounts on notional basis such as rent of owned buil ding,

interest on own capital etc.

(c) Items whose treatment is different in the two sets of accounts such as i nventory

val uation.

Question 5

Answer any five of the following:

(i ) Define Modi fied Internal Rate of Return method.

(i i) Explain the need of debt-service coverage ratio.

(i ii) Explain the term Ploughing back of Profi ts.

(i v) ABC Li mited has an average cost of debt at 10 per cent and tax rate is 40 per cent. The

Financial leverage ratio for the company is 0.60. Calculate Return on Equity (ROE) if its

Return on Investment (ROI) is 20 per cent.

(v) Explain in brief the assumptions of Modigli ani-Mil ler theory.

(vi) A person is required to pay four equal annual payments of Rs. 4,000 each in hi s Deposit

account that pays 10 per cent interest per year. Find out the future value of annuity at

the end of 4 years.

(5 2 = 10 Marks)

Answer

(i) Modified Internal Rate of Return (MIRR): There are several limitations attached with

the concept of the conventional Internal Rate of Return. The MIRR addresses some of

these deficiencies. For example, it eliminates multiple IRR rates; it addresses the

reinvestment rate issue and pr oduces results, which are consistent with the Net Present

Value method.

Under this method, all cash flows, apart from the initi al i nvestment, are brought to the

terminal val ue using an appropriate di scount rate(usually the cost of capital). Thi s

results in a single stream of cash infl ow in the terminal year. The MIRR is obtai ned by

assuming a single outflow in the zeroth year and the terminal cash in flow as mentioned

above. The di scount rate which equates the present value of the terminal cash in flow to

the zeroth year outfl ow i s called the MIRR.

(ii) Debt Service Coverage Ratio: Lenders are i nterested in this rati o to judge the fi rms

ability to pay off current interest and installments.

service

debt

for

available

Earnings

ratio

coverage

service

Debt

Instalment

Interest

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

14

Where,

Earning for debt service = Net profit

+ Non- cash operating expenses li ke depreciation and other

amortizations

+ Non-operating adjustments li ke loss on sale of

+ Fi xed assets + Interest on Debt Fund.

(iii) Ploughing back of Profits: Retained earni ngs means retention of profit and reinvesting

it in the company as long term funds. Such funds belong to the or di nary shareholders

and increase the net worth of the company. A publi c li mited company must plough back a

reasonable amount of profit every year keeping i n view the legal requirements in thi s

regard and its own expansion plans. Such funds also entai l almost no risk. Further,

control of pr esent owners i s also not diluted by retaining profits.

(iv) ROE = [ROI + {(ROI r) D/E}] (1 t)

= [0.20 + {(0.20 0.10) 0.60}] (1 0.40)

=[ 0.20 + 0.06] 0.60 = 0.1560

ROE = 15.60%

(v) Assumptions of Modigliani Miller Theory

(a) Capital markets are perfect. All information is freely available and there is no

transaction cost.

(b) All investors ar e rational.

(c) No existence of corporate taxes.

(d) Fi rms can be grouped into Equivalent risk classes on the basis of thei r business

risk.

1

i)

(1

(vi) i

A

FVA n

1

.10)

(1

4,000 n

.10

4,000 4.641 = Rs. 18,564

Future Value of Annuity at the end of 4 years = Rs. 18,564

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 15

Question 6

The Balance Sheet of JK Li mited as on 31st March, 2005 and 31st March, 2006 are given

below:

Balance Sheet as on

(Rs. 000)

Liabi liti es 31.03.05 31.03.06 Assets 31.03.05 31.03.06

Share Capital 1,440 1,920 Fixed Assets 3,840 4,560

Capital Reserve

48 Less: Depreci ation 1,104 1,392

General Reserve 816 960

2,736 3,168

Profit and Loss

Account

288 360 Investment 480 384

9% Debenture 960 672 Cash 210 312

Current Liabilities 576 624 Other Current

Assets

Proposed Dividend 144 174 (including Stock) 1,134 1,272

Provisi on for Tax 432 408 Preliminary

96 48

Expenses

Unpaid Dividend 18

_____ _____

4,656 5,184

4,656 5,184

Additional Informations:

(i ) During the year 2005-2006, Fixed Assets with a book value of Rs. 2,40,000 ( accumulated

depreciation Rs. 84,000) was sold for Rs. 1,20,000.

(i i) Provided Rs. 4,20,000 as depreciation.

(i ii) Some investments are sol d at a profit of Rs. 48,000 and Profit was credited to Capital

Reserve.

(i v) It decided that stocks be valued at cost, whereas previously the practice was to value

stock at cost less 10 per cent. The stock was Rs. 2,59,200 as on 31.03.05. The stock as

on 31.03.06 was cor rectly valued at Rs. 3,60,000.

(v) It decided to write off Fixed Assets costing Rs. 60,000 on which depreciati on amounting

to Rs. 48,000 has been provided.

(vi) Debentures are redeemed at Rs. 105.

Required:

Prepare a Cash Flow Statement.

(15 Marks)

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

16

Answer

Cash flow Statement (31s t March, 2006)

(A) Cashflows from Operating Activities

Profit and Loss A/c

(3,60,000 (2,88,000 + 28,800)

43,200

Adjustments:

Increase in General Reserve 1,44,000

Depreciati on

4,20,000

Provi sion for Tax

4,08,000

Loss on Sale of Machi ne 36,000

Premium on Redemption of

14,400

Debenture

Proposed Dividend 1,74,000

Preliminary Exp. w/o 48,000

Fi xed Assets w/o

12,000 12,56,400

Funds from Operation

12,99,600

Increase in Sundry Current Liabilities

48,000

Increase in Current Assets

12,72,000 (11,34,000 + 28,800)

(1,09,200)

Cash before Tax

12,38,400

Tax paid

4,32,000

Cash from Operating Activities

8,06,400

(B) Cash from Investing Activities

Purchases of fixed assets

(10,20,000)

Sale of Investment

1,44,000

Sale of Fixed Assets

1,20,000 (7,56,000)

(C) Cash from Financing Activities

Issue of Share Capital

4,80,000

Redemption of Debenture

(3,02,400)

Dividend paid

(1,26,000) 51,600

Net increase in Cash and Cash

equivalents

1,02,000

Openi ng Cash and Cash equivalents

2,10,000

Closing Cash

3,12,000

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 17

Fixed Assets Account

Particulars

Rs. Particul ars Rs.

To Balance b/d 27,36,000 By Cash 1,20,000

To Purchases (Balance) 10,20,000 By Loss on sales 36,000

By Depr eciation 4,20,000

By Assets w/o 12,000

________ By Balance 31,68,000

37,56,000

37,56,000

Depreciation Account

Particulars

Rs. Particul ar s Rs.

To Fixed Assets (on sales) 84,000 By Balance b/d 11,04,000

To Fixed Assets w/o 48,000 By Profit and Loss a/c 4,20,000

To Balance

13,92,000

________

15,24,000

15,24,000

Question 7

(a) The following details of RST Limited for the year ended 31March, 2006 are given below:

Operating leverage

1.4

Combined leverage

2.8

Fixed Cost (Excluding interest)

Rs. 2.04 l akhs

Sales

Rs. 30.00 l akhs

12% Debentures of Rs. 100 each

Rs. 21.25 l akhs

Equity Share Capital of Rs. 10 each

Rs. 17.00 l akhs

Income tax rate

30 per cent

Required:

(i) Calculate Financial lever age

(ii) Calculate P/V ratio and Earning per Share (EPS)

(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a

high or low assets leverage?

(iv) At what l evel of sal es the Earning before Tax (EBT) of the company will be equal to

zero?

(b) The turnover of PQR Ltd. is Rs. 120 lakhs of whi ch 75 per cent is on credit. The variable

cost ratio is 80 per cent. The credit terms are 2/10, net 30. On the current level of sales,

the bad debts are 1 per cent. The company spends Rs. 1,20,000 per annum on

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

18

administering its credit sales. The cost includes salaries of staff who handle credi t

checking, collection etc. These are avoidable costs. The past experience indicates that

60 per cent of the customers avail of the cash di scount, the remaining customers pay on

an average 60 days after the date of sale.

The Book debts (receivable) of the company are presently being financed in the ratio of

1 : 1 by a mix of bank borrowings and owned funds which cost per annum 15 per cent

and 14 per cent respectively.

A factoring firm has offered to buy the fi rms recei vables. The main el ements of such

deal structured by the factor are:

(i) Factor reserve, 12 per cent

(ii) Guaranteed payment, 25 days

(iii) Interest charges, 15 per cent, and

(iv) Commission 4 per cent of the value of receivables.

Assume 360 days i n a year.

What advise would you give to PQR Ltd. - whether to conti nue with the in house

management of receivabl es or accept the factoring firms offer? (8 + 8 = 16 Marks)

Answer

(a) (i) Financial leverage

Combined Leverage = Operati ng Leverage (OL) Financial Leverage (FL)

2.8 = 1.4 FL

FL = 2

Fi nancial Leverage = 2

(ii) P/V Ratio and EPS

P/V ratio = 100

S

C

C

Operating leverage = 100

F

C

C

1.4

2,04,000

C

1.4 (C 2,04,000) = C

1.4 C 2,85,600 = C

2,85,600

C

0.4

C = 7,14,000

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 19

7,14,000

P/V = 23.8%

100

30,00,000

Therefore, P/V Ratio = 23.8%

tax

after

Profit

EPS = shares

equity

of

No.

EBT = Sales V FC Interest

= 30,00,000 22,86,000 2,04,000 2,55,000

= 2,55,000

PAT = EBT Tax

= 2,55,000 76,500 = 1,78,500

EPS 1.05

1,70,000

1,78,500

(iii) Assets turnover

Sales

Assets turnover =

.784

0

38,25,000

30,00,000

Assets

Total

0.784 < 1.5 means lower than industry turnover.

(iv) EBT zero means 100% reduction in EBT. Since combined leverage is 2.8, sales

have to be dropped by 100/2.8 = 35.71%. Hence new sales will be

30,00,000 (100 35.71) = 19,28,700.

Therefore, at 19,28,700 level of sales, the Earnings before Tax of the company will

be equal to zero.

(b) In-house Decision

Rs.

1,08,000

Cash discount (Rs. 90 lakhs .60 .02)

Bad debts losses (90,00,000 .01)

90,000

Administration cost

1,20,000

Cost of funds in recei vables*

1,08,750

4,26,750

*Average collection period (10 .6) + (60 days .40) = 30 days

Average investments in debtors = lakhs

7.5

12

90

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

20

Cost of Bank funds .15

7.5

Rs.

2

1

56,250

1

Cost of Owned funds .14

7.5

Rs.

2

52,500

1,08,750

Offer Alternative

3,60,000

Factoring commissi on (Rs. 90 lakhs .04)

25 79,200

Interest charges .88(90 lakhs 3,60,000) = 76,03,200 .15

360

Cost of owned funds invested i n receivables

25

(90,00,000 76,03,200) .14 360

13,580

4,52,780

Decision: PQR should not go for the factori ng al ternative as the cost of factoring is

more.

Cost of In-house Deci sion

4,26,750

Cost of Factoring Firm

4,52,780

Net l oss

(26,030)

Question 8

Answer any three of the following:

(i ) Differentiate between Business ri sk and Financial ri sk.

(i i) Diagrammatically present the DU PONT CHART to calcul ate return on equity.

(i ii) What are the main responsi bilities of a Chief Fi nancial Officer of an organisation?

(i v) Explain in brief the features of Commercial Paper. (3 3 = 9 Marks)

Answer

(i) Business Risk and Financial Risk

Business risk refers to the ri sk associated with the firms operations. It is uncertainty

about the future operating income, i.e. how wel l can the operating income be predicted?

It can be measured by standard deviation of basic earni ng power rati o.

Whereas, Financial risk refers to the additional risk pl aced on firms shareholders as a

result of debt use in financi ng. Companies that issue mor e debt instruments would have

higher financi al ri sk than companies financed mostly by equity. Financial risk can be

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 21

measured by ratios such as firms financial leverage mul tiplier, total debt to assets ratio

etc.

(ii) Du Pont Chart

There are three components in the calculati on of return on equity using the traditional

DuPont model- the net profit margin, asset turnover, and the equi ty multiplier. By

exami ning each input indivi dual ly, the sour ces of a company's return on equity can be

discovered and compared to its competitors.

Return on Equi ty = (Net Profit Margin) (Asset Turnover) (Equi ty Multipl ier)

Profit Margin =

EBIT Sales

Return on Net Assets

(RONA) = EBIT NA

Assets Turnover =

Sales NA

Financial Leverage (Income)

= PAT E BIT

Return on Equity

(ROE) = PAT NW

Financial Leverage (Balance

Sheet) = NA NW

Du Pont Chart

(iii) Responsibilities of Chief Financial Officer (CFO)

The chief financial officer of an organisati on plays an impor tant role in the company s

goals, poli cies, and financi al success. His main responsib ilities incl ude:

(a) Fi nancial analysis and planning: Determining the proper amount of funds to be

employed in the firm.

(b) Investment decisions: Efficient al location of funds to specific assets.

(c) Fi nancial and capital structure decisions: Raising funds on favourable terms as

possible, i.e., determining the composition of liabil ities.

(d) Management of financial resources (such as working capital).

(e) Risk Management: Protecting assets.

(iv) Features of Commercial Paper (CP)

A commercial paper is an unsecured money market instrument issued in the form of a

promissory note. Since the CP represents an unsecured borrowing i n the money market,

PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007

22

the regulation of CP comes under the purview of the Reserve Bank of India which issued

guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group.

These guidelines were aimed at:

(i) Enabling the highly rated corporate borrowers to di versify thei r sources of short term

borrowings, and

(ii) To provi de an additional instrument to th e shor t term investors.

It can be issued for maturi ties between 7 days and a maximum upto one year from the

date of issue. These can be issued in denominati ons of Rs. 5 lakh or multipl es therefore.

All el igible i ssuers are required to get the credit rati ng from credi t rating agencies.