Final Examination (Transitional Scheme)

The Institute of 6 June 2018

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

Management Accounting
Q.1 (a) Explain the term Cost-Volume-Profit (CVP) analysis and describe any three
limitations of CVP analysis. (04)

(b) Alpha Enterprises (AE) suffered a loss of Rs. 10.5 million for the year ended
31 March 2018. In this respect, a report prepared by the Chief Financial Officer (CFO)
contains the following observations:

Despite spending Rs. 6 million during the year on overhauling of the plant, it could
achieve a capacity utilisation of only 75% against the planned utilisation of 96%.

Sales for the year amounted to Rs. 140 million which was 80% of the
break-even sales. Contribution margin on sales was 30%.
The report also contains the following views of the key executives:
Marketing manager: Sales was restricted due to severe market competition and it
can be increased by reducing selling price.
Production manager: The plant was damaged due to fire in January 2017 and have
not been able to perform satisfactorily since then.
On the advice of the Chief Executive Officer, the team consisting of CFO and both the
managers have worked together and submitted the following recommendations:
(i) Replace the old plant with a higher capacity plant.
(ii) Negotiate bulk purchases of raw material to obtain maximum discount.
(iii) Reduce selling price to gain competitive edge in the market.

Following data is available on the basis of a study carried out by the team and
information gathered internally:
(i) A new plant having 10% more capacity than full capacity of the existing plant
would cost Rs. 50 million and have estimated useful life of 12 years. For the first
year of operation, the maximum capacity utilisation would be 90%. The new
plant would improve product quality, reduce raw material consumption by 2%
and increase labour efficiency by 8%.

The existing plant was installed eight years ago at a cost of Rs. 35 million. It has
a remaining life of two years and could be sold at book value plus 10%. AE
depreciates its plants on straight line basis over their estimated useful life.

(ii) To run and maintain the plant, technical staff would be trained at a cost of
Rs. 0.5 million.
(iii) Funds for the new plant would be arranged through a long-term loan at a cost of
8% per annum.
(iv) Procurement manager has negotiated with the existing suppliers who have
agreed to offer bulk purchasing discount at 5%.
(v) Improved quality of the product and reduction in selling price by 5% would
enable AE to sell the entire production of the new plant.

Required:
Compute projected profit for the year ending 31 March 2019 and margin of safety,
assuming that existing variable cost ratio for direct material, direct labour and
overheads was 5:3:2 respectively. (13)
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Q.2 (a) Briefly describe the advantages of zero based budgeting. (03)

(b) Moon Industries Limited (MIL) is in the process of preparing its annual budget for the
year ending 30 June 2019. Following information has been extracted from MIL's
projected financial statements for the current year ending 30 June 2018:
(i) Extracts from current year's projected statement of profit or loss:
Rs. in million
Sales (51,600 units) 258
Cost of goods manufactured:
Raw material consumption 70
Direct labour 46
Factory overheads (including fixed overheads of Rs. 15 million) 35
Selling expenses (including fixed expenses of Rs. 7 million) 24
Administrative expenses (all fixed) 18

(ii) Extracts from current year's projected statement of financial position:

Rs. in million
Cash and bank balances (5)
Trade debtors 23
Trade creditors 16
Accruals and other liabilities 9
Closing inventory:
Raw material 8
Finished goods (5,000 units) 13
(iii) Opening raw material and finished goods (4,000 units) inventories amounted to
Rs. 7 million and Rs. 10 million respectively.
(iv) MIL uses marginal costing and follows FIFO method for valuation of inventory.
(v) Fixed costs as mentioned above include depreciation as under:
Rs. in million
Factory overheads 6
Selling expenses 2
Administrative expenses 4
Information and projections pertaining to the next year's budget:
(i) MIL plans to increase selling price by 5%. Sales volume is expected to increase
by 8%.
(ii) Raw material, direct labour and all other costs are estimated to increase by
8%, 10% and 6% respectively.
(iii) MIL plans to carry out balancing, modernization and replacement (BMR) of its
plant. The BMR is expected to complete by the end of the current year at a cost
of Rs. 35 million which include cost of new equipment of Rs. 30 million. The
equipment would be obtained on finance lease consisting of six equal annual
instalments of Rs. 6.26 million each, payable in advance, commencing from
1 July 2018. Interest rate implicit in the lease is 10% per annum.
Life of the equipment is estimated at 6 years. MIL depreciates such assets over its
useful life on a straight line basis.
Due to BMR, raw material wastage would reduce from 8% to 6% of input and
labour efficiency would increase by 5%.
(iv) Closing inventory and average collection/payment periods are estimated as under:
Raw material inventory Average 60 days' consumption
Finished goods Average 45 days' sales
Collection of trade debtors 35 days
Payment to trade creditors 40 days
Payment of expenses 25 days
(v) At the end of budget year, the quick ratio is estimated at 1.25:1
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Required:
Prepare working capital budget for the year ending 30 June 2019. Assume that except
stated otherwise, all transactions are evenly distributed over the year (360 days). (21)

Q.3 Glacier Electronics (GE) produces various components for chillers. Production overheads
are allocated to products at a rate computed using activity based costing. In this respect,
following information for the month of May 2018 has been extracted from the cost records:

(i) Total actual overheads for the month:

Rs. in ‘000
Production department 5,000
Procurement department 1,200
Shipment department 1,000
Quality control & testing department (QCT) 1,800
Maintenance department 1,500
Total 10,500

(ii) Details of total hours worked by QCT and Maintenance departments:

QCT Maintenance
Number of hours
Production department 450 2,800
Procurement department 300 640
Shipment department 150 560
QCT 4,200 -
Maintenance department 900 -
6,000 4,000

(iii) Total activities carried out during the month:

8,000 machine hours were worked by production department

Quality inspection is carried out at the completion of each batch. 100 batches
were completed during the month.

120 purchase orders were placed and processed

80 sales orders were delivered

(iv) GE produces a number of components. Following information pertains to two of its

main products Bee and Zee:
Bee Zee
Opening inventory – Finished goods units 350 200
Units sold 4,750 3,900
Closing inventory: Finished goods units 400 300
WIP units – 50% to conversion 400 -
Batch size in units 200 250
Machine hours per batch 60 50
No. of sales orders dispatched 8 10
Direct material cost Rs. in ‘000 1,200 1,440
Average size of a purchase order Rs. in ‘000 150 120

Required:
Compute actual production overheads for Bee and Zee using activity based costing. (15)
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Q.4 Hatim Processing Limited (HPL) produces a product through two processes. Following
data pertains to process 2 for the month of May 2018:
Production Cost
(Units) (Rs. in '000)
Opening work in process (100% complete
to material and 80% to conversion) 5,000 1,300
Transfers from process 1 65,000 28,000
Cost incurred in process 2:
− Material 15,000
− Direct labour 9,000
− Production overheads 7,000
Completed units 60,000
Closing work in process (100% complete
to material and 60% to conversion) 6,000

Wastage of material occurs in the early stage of process 2 after all materials have been
added. Normal loss is estimated at 5% of input.

Required:
Prepare the process 2 account for the month of May 2018 using first-in-first-out method. (13)

Q.5 Ravi Limited (RL) is a manufacturing concern. Its products have strong acceptability in the
market and its Sales Manager is confident that the sales can be increased by 40%. However,
presently RL has already utilised all the available financing facilities and it would require
funding for any consequential increase in the working capital requirements.

Following information pertains to its existing working capital:

Entire sale is on 50 days credit. RL's average cost of collection from debtors and bad
debts is 1% and 2% of sales respectively.

Average finished goods inventory of approximately 60 days is maintained.

Credit period of 30 days is available for all purchases.

Bank borrowings amount to Rs. 20 million.

A cash balance of Rs. 0.5 million is maintained to meet the day to day cash
requirements.

The existing annual sale is Rs. 700 million. Any increase in sale would require a
proportionate increase in working capital. In this respect, following options are under
consideration:
(i) Introduction of cash sales at a discount of 5% on existing prices. It is estimated that
20% of the customers would opt to purchase in cash.
(ii) Major suppliers who meet 80% of the raw material requirement have offered to
increase credit period by 20 days in return for a price increase of 1.5%.
(iii) Factoring facility is available from a factor who has offered following terms and
conditions:

The factor would make collections from debtors. Bad debts, if any, would be to
his account.

Amount equal to 70% of the invoices submitted would be paid immediately by the
factor for which 16% interest per annum would be charged. The balance would be
paid within the normal credit period of 50 days.

Factoring fee would be 3% of credit sales.

(iv) Additional borrowing facility of Rs. 15 million has been offered by a bank at a markup
of 14% per annum.

RL’s profit margin is 30% of production cost. Raw material cost is 60% of the total
production cost
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Required:
Advise RL how additional working capital may be arranged in the above situation. (Assume
360 days in a year) (15)

Q.6 ABC Limited produces two products X and Y from different quantities of the same
resources. The selling price and resource requirement per unit of each of these two products
are as follows.
X Y
----- Rs. per unit -----
Selling price 15,000 9,870
Material cost 8,800 4,400
Direct labour cost at Rs. 250 per hour 1,000 1,250
Machine hours cost at Rs. 410 per hour 2,460 1,640
Variable overheads 690 460
Fixed overheads 450 300

ABC is preparing its production plan for the quarter ending 30 September 2018. In this
respect following information is available:
(i) X can only be sold in combination with Y in the ratio of 4:1 respectively. Y can be
sold separately also.
(ii) X has maximum demand of 6,000 units whereas Y has unlimited demand.
(iii) Procurement and production departments have advised the availability of resources
as under:

Direct labour 40,000 hours

Machine time 45,000 hours

Required:
Determine the optimal production plan for the quarter ending 30 September 2018 and the
contribution that would result from adopting the plan. (16)

(THE END)