P1 Class Notes by Sir Rafiqul Islam FCMA

Class notes on Performance Operations (P1) by Rafiqul Islam, FCMA
Preamble
Rafiqul Islam, FCMA
Hello Students!!
I hope you are doing fine. I will be with you for next 45 hours and talking about how to study
Performance Operations and be successful in the exam!!
Your broad syllabus is as follows:

SL Broad Topics % of weight Study hours
1 Cost Accounting Systems 30% 15.00 hours
2 Forecasting and Budgeting Techniques 10% 6.00 hours
3 Project Appraisal 25% 9.00 hours
4 Dealing with uncertainty in analysis 15% 6.00 hours
5 Managing Short Term Finance 20% 9.00 hours
100% 45 hours
Class Distribution
Class Topics
Class 1 Introduction to Cost Accounting, Cost concepts, determination of a costs of a
product or service
Class 2 Variable Costing vs. Absorption Costing
Class 3 CPV Analysis
Class 4 Traditional Costing vs. Activity Based Costing
Class 5 Traditional Costing vs. Activity Based Costing
Class 6 Costing for Decision Making
Class 7 Costing for Decision Making
Class 8 Budgeting: Flexible Budgeting vs. Static Budgeting
Class 9 Budgeting: Flexible Budgeting vs. Static Budgeting
Class 10 Budgeting: Variance Analysis
Class 11 Budgeting: Variance Analysis
Class 12 Class Test
Class 13 Cash Flow Forecasting and Time Value of Money
Class 14 Project Appraisal: Capital Budgeting
Class 20 Working Capital Management
Class 24 Making Decision under Risk and Uncertainty
Class 28 Class Test
Class 29 Review Class
Class 30 Review Class
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Curiosity to know the subject is pre-condition to success in the exam in first attempt.
These are essentials:
 Your knowledge in Fundamental to Management Accounting will be an added advantage.
 Reading as much as books on subject topic will make you gorgeous for the exam!!
 Solving as many as problems on particular topic will make you perfect.
Materials for study:

1. CIMA official study [ Must Read]
2. Managerial Accounting ---Garrison and Noreen
3. Introduction to Cost Accounting- Managerial Approach – Horngren
4. Cost Accounting Planning and Control – MatzUsry
5. Management & Cost Accounting – Collin Drury
6. Corporate Finance – Stephen A Ross
7. Financial Management Theory and Practice- Eugence F. Bringham & Michael C.
Ehrhardt
Hey don’t get upset!!

Just Read a topic unless you understand the full concept? Its necessity, its reasons, its impact on
bottom figures etc.
Solve some end of chapters’ problem
ICMAB previous questions on Management Accounting, Cost Accounting, Advanced Cost
Accounting, and Financial Management well help you.
Your instructor will solve many problems in the class!! Follow him. Try those problems home.
Try more if possible!!!
Special Note:
This class note contain only some mathematical problems to exercise and make proper
understating of concepts. It is desired that students will study core concepts and make themselves
very proficient in concepts. If they hold right amount of knowledge on concepts, they can solve
any mathematical problems. Practicing mathematical problems will save time in examination.
Try to think Try to link Try to implement
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Chapter ONE
1. Cost Concepts:
Variable costs Direct Materials Direct Costs/ Products Costs/ Inventorial

Prime Costs be Costs/Manufacturing
Costs
Variable costs Direct Labors
Variable costs & Manufacturing Overhead Indirect costs/
Fixed Costs Conversion Costs
Fixed Cost Administrative Overhead Non- Period Costs
manufacturing
costs
Variable costs & Selling Marketing and Non-
Fixed Costs Distributions manufacturing
costs
Purpose of Cost Classification Cost Classifications

Preparing external financial statements  Product costs (Inventoriable)
Direct materials
Direct labor
Manufacturing overhead
 Period Costs (expensed)
Non-manufacturing costs
Marketing or selling costs
Administrative costs
Predicting cost behavior in response to  Variable cost (proportional to activity)

change in activity  Fixed cost (constant in total)
Assigning costs to cost objects such as  Direct Costs (can be easily traced)
departments or products  Indirect cost (cannot be easily traced, must
be allocated)
Making decisions  Differential cost (differs between
alternatives)
 Sunk Cost (past cost not affected by a
decision)
 Opportunity cost (foregone benefit)
Cost of quality  Prevention costs
 Appraisal Costs
 Internal Failure costs
 External Failure costs
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Do you know!!
 Contributions Margin? Break Even Sales, Margin of Safety,
 Traceable Costs?
 Allocation, apportionment, and absorption of costs?
 Under-absorption, over-absorption of costs
 Relevant Costs for decision making?
Simple Statement of Cost of Goods Sold

(Manufacturing Concern)
Particulars Taka Taka

Direct Materials (A) Opening Inventory
Add: Purchase
Less: Indirect Materials Used
Less: Ending Inventory
Direct Labor (B)

Factory Overhead (C) Indirect Materials
Indirect Labors
Tax expenses for Factory labors
Depreciation on Factory Machinery,
Building, Plant
Insurance
General Factory Overhead
Total Manufacturing Costs (A+B+C=D)
Add: Beginning Work in process (WIP)
Less: Ending Work in process (WIP)
Cost of Goods Manufactured (E)
Add: Beginning Finished Goods
Goods available for Sale(F)
Less: Ending Finished Goods
Cost of Goods Sold (G)
Simple Statement of Cost of Goods Sold

(Trading Concern/Merchandising Company)
Particulars Taka
Opening Inventory (Trading Items)
Add: Purchase of Trading Items
Add: Freight In
Less: Returns of Trading Items
Less: Ending Inventory (Trading Items)
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Income Statement
(Manufacturing Concern/Trading Concern)
Sales Revenue/Service Revenue

Less: Cost of Goods Sold/ Cost of Sales
Gross Profit
Less:
Operating Expense
Selling Expense
Administrative expenses
Less/Add: (under-absorption)/over absorption costs
Operating Profit
Less: Finance Expense
Profit Before Tax
Less: Tax Expenses
Net Profit
2. Traditional Costing:
Absorption costing/full costing (Format)
Sales Taka Taka

Less: Cost of Sales
Opening Stock
Add: Production costs
Less: Closing Stock
Less/Add: (under-absorption)/over absorption costs
Gross Profit
Less: Selling, distribution, and admin costs
Variable
Fixed
Net Profit/ (Loss)
Marginal Costing/ Direct Costing
Sales Taka Taka

Less: Variable Cost of Sales
Opening Stock
Add: Variable Production costs
Less: Closing Stock
Less: Variable Selling, distribution, and admin costs
Contributions
Less: Fixed Selling, distribution, and admin costs
Net Profit/ (Loss)
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Reconciliation of Profits under absorption costing and Marginal costing
Particulars Taka
Absorption Costing Profit
(Increase)/decrease in stock X Fixed Overheads Per Unit
Marginal Costing Profit
Problem #1
A summary of a manufacturing company’s budgeted profit statement for its next financial year,
when it expects to be operating at 75% capacity, is given below:
Taka Taka
Sales 9000 units at Tk. 32 288000
Less:
Direct Materials 54000
Direct Wages 72000
Production Overhead- Fixed 42000
Production Overhead- Variable 18000
186000
Gross Profit 102000
Less: admin, selling and distribution costs
Variable 36000
Fixed 27000
63000
Net Profit 39000
It has been estimated that,

i. If the selling price per unit were reduced to Tk.28, the increased demand would utilize 90
percent of the company’s capacity without any additional advertising expenditure;
ii. To attract sufficient demand to utilize full capacity would require a 15 percent reduction
in the current selling price and a Tk. 5000 special advertising campaign.
Required
a. Calculate break even points in units based on original budget;
b. Calculate the profits and breakeven points which would result from each of the two alternatives
c. The company decided to proceed with the original budget has asked you to calculate how many
units must be sold to achieve a profit of 45,500.
Solution hints
Requirement: (a)
Total Fixed Costs = (42000 +27000) = 69000
Per unit variable cost = Tk. 20 (180,000/9000)
CM ratio = 20/32 = 0.63
Break Even = (69000/ 0.63)

= 109523.81
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Requirement: (b): Alternative one
Taka Taka
Sales 10800 units at Tk. 28 302400
[(9000/0.75)x0.90]
Less: variable expenses 216000
(20X10800)
CM 86,400
Fixed Costs 69000
Net Profit 17400
Requirement: (b): alternative two

Taka Taka
Sales 12000 units at Tk. 27.20 326,400
[(9000/0.75)x1]X 32X0.85
Less: variable expenses 240,000
(20X12000)
CM 86,400
Less: Fixed Costs (69000+5000) (74000)
Net Profit 12,400
Requirement: (c)
Total Fixed Costs = (42000 +27000) = 69000

Per unit variable cost = Tk. 20 (180,000/9000)
CM ratio = 20/32 = 0.63
Break Even = (69000+45500/ 0.63)

= 181,746
Problem no. 02
MEMOFAX inc produces memory enhancement kits for fax machines. Sales have been very
erratic with some months showing a profit and some months showing a loss. The company’s
income statement for the most recent month is given below:
Sales Tk. 270000

Less: Variable Expenses Tk. 189,000
Contribution margin Tk.81,000
Less: Fixed expenses Tk.90,000
Net Operating Loss Tk. (9000)
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Required
1. Compute the company’s CM ratio and its break-even point in both units and dollars
2. The sales manager feels that an Tk.8000 increase in the monthly advertising budget,
combined with an intensified effort by the sales staff, will result in a Tk.70,000 increase
in monthly sales. If the sales manager is right, what will be the effect on the company’s
monthly net operating income or loss?
3. The president convinced that a 10% reduction in the selling price, combined with an
increase of Tk.35000 in the monthly advertising budget, will cause the unit sales to
double. What will the new income statement look like if these changes are adopted?
4. Refer to original data. The company’s advertising agency thinks that a new package
would help sales. The new package being proposed would increase packaging costs by
Tk.0.60 per unit. Assuming no other changes. How many units would have to be sold
each month to earn a profit of Tk.4500?
5. Refer to original data, by automating certain operations, the company could slash its
variable expenses in half. However, fixed costs would increase by Tk.118,000 per month.
a. Compute new CM ratio and the new break-even point in both units and dollars
b. Assume that the company expects to sell 20,000 units next month. Prepare two
income statements, one assuming that operations are not automated and one assuming
that they are.
c. Would you recommend that the company automate its operations? Explain.
Solution
1. CM ratio is 30%.
Total Per unit percentage

Sales 2,70,000 20 100%
Less Variable expense 189,000 14 70%
Contribution margin 81,000 6 30%
Break-even point in sales units = Fixed costs/unit contribution margin

=90000/6
= 15000 units
Break-even point in sales Dollars = Fixed costs/CM Ratio

= 90000/0.30
= USD 3,00,000
2. Incremental contribution margin
Increased CM (70000 increased sales x 30% CM ratio) 21000

Less: Increased Fixed costs 8000
Increase in monthly net operating income 13,000
Since the company presently has a loss of 9000 per month, if the changes are adopted, loss will
turn into a profit of 4000 per month.
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3.
Sales (27000x18 per unit) 4,86,000

Less: variable expense 3,78,000
CM 108000
Less: fixed costs 125000
Net operating loss (17000)
4. Units sales to attain target profit
(Fixed Costs+ Target profit)/ CM per unit
= (90000 + 4500)/ 5.40 per unit

= 17500 units
5. The new CM ratio would be = 13/20 = 65%
New break even sales = Fixed costs/Unit Contribution

= 208000/13 per unit = 16000 units
Breakeven point in sales dollars = Fixed costs/CM ratio

= 208000/0.65
= 320000 sales
Comparative income statement follow
Not automated Automated

Total Per unit % Total Per unit %
Sales (20000 units) 400000 20 100 400000 20 100
Less: Variable expenses 280000 14 70 140000 7 35
Contribution margin 120000 6 30 260000 13 65
Less: Fixed costs 90000 208000
Net operating profit 30000 52000
Problem no. 3
Marlin Company has been operating for only a few months. The company sells three products:
Sinks, Mirrors, and vanities. Budgeted sales by product and in total for the coming month are
shown below:
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Sinks Mirrors Vanities Total

% of total Sales 48% 20% 32% 100%
Sales 240,000 100% 100000 100% 160000 100% 500000 100%
Less: Variable 72000 30% 80000 80% 88000 55% 240000 48%
Expenses
Total Contribution 168000 70% 20000 20% 72000 45% 260000
Margin
Less: Fixed 223,600
expenses
Net Operating 36,400
Income
Break-even point in dollar sales = Fixed Expense / CM ratio = 223600/0.52 = 430,000

As shown by these data, net operating income is budgeted at 36,400 for the month and break
even sales at 430,000.00
Assume that actual sales for the month total 500,000 as planned. Actual sales by product are:
Sinks – 160000, mirrors – 200,000 and vanities – 140000
Required
1. Prepare a contribution income statements for the month based on actual sales data.
Present the income statement in the format shown above
2. Compute the break-even sales for the month based on your actual data
3. Considering the fact that the company met its 500000 sales budget for the month, the
president is shocked at the results shown on your income statement in (1) above. Prepare
a brief memo for the president explaining why both the operating results and break even
sales are different from what was budgeted.
Solution
1. Income statement
Sinks Mirrors Vanities Total
Percentage of total sales 32% 40% 28% 100%
Sales 160000 100% 200000 100% 140000 100 500000 100
Less: variable expense 48000 30 160000 80 77000 55 285000 57
Contribution margin 112000 70% 40000 20% 63000 45% 215000 43
Less: Fixed costs 223,600
Net operating income (8600)
2. Break-even point in total dollar sales = Fixed expenses/CM ratio

= 223,600/0.43
= 520000 in sales
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3. Memo to the president
Although the company met its sales budget of usd 500000 for the month, the mix of products
sold changed substantially from that budgeted. This is the reason the budgeted net operating
income was not met, the reason the break even sales were greater than budgeted. The company’s
sales mix was planned at 48% sinks, 20% mirrors, and 32% vanities. The actual sales mix was
32% sinks, 40% mirrors, and 28% vanities.
As shown by these data, sales shifted away from sinks, which provides our greatest contribution
per dollar of sales and shifted strongly toward Mirrors, which provide our least contribution per
dollar of sales. Consequently, although the company met its budgeted level of sales, these
provided considerably less contribution margin that we had planned, with a resulting decrease in
net operating income.
Problem #4
The following information has been taken from the accounting records of Klear Seal Company
for last year:
Taka
Selling Expense 140,000
Raw Materials Inventory, Jan 1 90,000
Raw Materials Inventory, Dec 31 60,000
Utilities, factory 36,000
Direct Labor Costs 150,000
Depreciation, factory 162,000
Purchase of Raw Materials 750,000
Sales 2,500,000
Insurance, factory 40,000
Supplies, factory 15,000
Administrative expenses 270,000
Indirect labor 300,000
Maintenance, factory 87,000
Work in process inventory, Jan 1 180,000
Work in process inventory, Dec 31 100,000
Finished goods inventory, Jan 1 260,000
Finished goods inventory, Dec 31 210,000
Management wants these data organized in a better format so that financial statements can be
prepared for the year.
Required:
i. Prepare a schedule of cost of goods manufactured.

ii. Compute the cost of goods sold.
iii. Using data as needed from (1) and (2) above, prepare an income statement.
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Basic Problem #5
This makes no sense at all,” said H.M. Nahiyan, President of Keya Company. “We sold the same number
of units this year as we did last year, yet our profits have more than doubled. Who made the goof – the
compute or the people who operate it?” The statements to which Mr. Nahiya was referring are shown
below (absorption costing basis):
Particulars Year 1 Taka Year 2Taka

Sales (20000 units each year) 700,000 700,000
Less: Cost of Goods sold 460,000 400,000
Gross Profit 240,000 300,000
Less selling and administrative expenses 200,000 200,000
Net Operating Income 40,000 100,000
The statements above show the results of the first two years of operations. In the first year, the company
produced and sold 20000 units. In the second year, the company again sold 20000 units, but it increased
production as shown below:
Year 1 Year 2
Production in units 20000 units 25000 units
Sales in units 20000 units 20000 units
Variable manufacturing cost per unit produced Tk. 8 Tk. 8
Variable selling and administrative expense per unit sold Tk. 1 Tk. 1
Fixed manufacturing overhead costs (total) Tk. 300,000 Tk. 300,000
Keya Company applies fixed manufacturing overhead costs to its only product on the basis of each year’s
production
Required:
a) Compute the unit product cost for each year under:

i. Absorption costing
ii. Variable Costing
b) Prepare a variable costing income statement for each year, using contribution approach.
c) Reconcile the variable costing and absorption costing net operating income figures for each year.
Solution Hints
Calculation of Unit Product cost

Absorption Costing Variable Costing
Year 1 Year 2 Year 1 Year 2
Variable product Tk. 8 Tk. 8 Tk. 8 Tk. 8
costs
Fixed Tk. 15 Tk. 12.00
Manufacturing (300,000/20000) (300,000/25000)
costs
Unit Product cost Tk. 23.00 Tk. 20.00 Tk. 8 Tk. 8
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Variable Costing Income statement

Year 1 Year 2
Taka Taka
Sales 700,000 700,000
Opening Stock 0.00 0.00
Add: Variable Production costs 160,000 200,000
Less: Closing Stock 0.00 (40,000)
160,000 160,000
Less: Variable Selling, distribution, and 20,000 20,000
admin costs
Contributions 520,000 520,000
Fixed Manufacturing overhead costs 300,000 300,000
Less: Fixed Selling, distribution, and admin 180,000 180,000
costs
(480,000) (480,000)
Net operating Income 40,000 40,000
Reconciliation of net operating income

Year 1 Year 2
Net operating Income under variable costing 40,000 40,000
Add: Fixed manufacturing overhead costs deferred with closing --- 60,000
inventory year 2 (5000 units x 12)
Less: Fixed manufacturing overhead costs released with opening --- ---
inventory
Absorption costing net operating profit 40,000 100,000
Problem #6
RFL makes a plastic ring for large plastic injection molding machines. Each machine requires four new
rings a year. In 2013 and 2014, the company had the following standard costs for production of rings.
Basic production data at standard cost

Direct Material 20
Direct Labor 25
Var. Manu. Overhead 5
Standard variable cost per unit 50
The annual budget for fixed manufacturing overhead is Tk. 20 lacs. Budgeted production is 2 lac rings per
year. Sales price is Tk.75. The single cost driver for the Tk.5.00 per ring variable manufacturing overhead
is rings produced. Both budgeted and actual selling and administrative expenses are Tk.6.75 lacs yearly
fixed cost plus sales commission at 5% of sales. Actual product quantities are:
2013 2014
Opening Inventory (units) -- 30000
Production 170,000 140,000
sales 140000 160000
Ending Inventory 30000 10000
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There are no variances from the standard variable manufacturing costs, and the actual fixed
manufacturing overhead incurred is exactly Tk.20 lacs each year.
Required:
1. Prepare income statement for 2013 and 2014 under variable costing
2. Prepare income statement for 2013 and 2014 under absorption costing
3. Show a reconciliation of difference in operating income for 2013, 2014 and the two years.
Solution Hints
Variable Costing Income statement 2013 2014
Taka (000) Taka (000)
Sales 10500 12000
Opening Stock 0.00 1500
Add: Variable Production costs 8500 7000
Less: Closing Stock (1500) (500)
(7000) (8000)
Less: Variable Selling expenses at 5% of sale (525) (600)
(10500x5%), (12000x5%)
Contributions 2975 3400
Fixed Manufacturing overhead costs 2000 2000
Less: Fixed Selling, distribution, and admin costs 675 675
(2675) (2675)
Net operating Income 300 725
Absorption Costing Income statement

2013 2014
Taka Taka (000)
(000)
Sales 10500 12000
Less: Cost of Sales
Opening Stock 1800
Add: Production costs 10200 8400
Less: Closing Stock (1800) (600)
Less/Add: (under-absorption)/over absorption 8400 9600
costs 300 600
Gross Profit 1800 1800
Less: Selling, distribution, and admin costs 1200 1275
Variable -525
Fixed- 675
Net Profit/ (Loss) 600 525
Reconciliation of net operating income

Year 1 Year 2
Net operating Income under variable costing 300 725
Add: Fixed manufacturing overhead costs deferred with closing 300 100
inventory
Less: Fixed manufacturing overhead costs released with opening -- (300)
inventory
Absorption costing net operating profit 600.00 525
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Chapter Two
Costing for Decision Making
Problem# 1
WRX manufactures three products using different quantities of the same resources. Details of
these products are as follows:
Product W R X
TK/unit TK/unit TK/unit
Market Selling price 90 126 150
Direct Labor (Tk.7/hour) 14 28 35
Materials A (Tk.3/kg) 15 12 21
Materials B (Tk.6/kg) 24 36 30
Variable overhead (Tk.4/hour) 8 16 20
Fixed Overhead 12 7 12
Total cost 73 99 118
Profit 17 27 32
The management of WRX has predicted the demand for these products for july as follows:
W R X
500 units 800 units 1600 units
These demand estimates do NOT include an order from a major customer to supply 400 units per
month of each of the three products, at a discount of TK.10 per unit from the market selling
price.
During July the management of WRX anticipates that there will be a shortage of Materials B,
and that only 17500 kgs will be available.
It is not possible for WRX to hold inventory of any raw materials, WIP or finished products.
Required
Prepare calculations to show the optimum product mix to maximize WRX’s profit for July,
assuming that the order with the major customer is supplied in full.
Solution
Product W R X
TK/unit TK/unit TK/unit
Market Selling price 90 126 150
Variable Costs 61 92 106
Contribution 29 34 44
Kgs of Materials B 4 kg (24/6) 6 kg (36/6) 5 kg (30/6)
Contribution per Kg of Material B Tk. 7.35 Tk. 5.67 Tk. 8.80
Ranking 2nd 3rd 1st
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The major customer order is for 400 units of each of W, R, and X and therefore uses 6000 kgs of
Material B (400X4+400x6+400x5). This leaves 11,500 kgs of Material B to be used for other
sales.
Production Plan:
Make units (Demand) 500 (units) 2500 units 1600 units
Usages of Material B (3500- 500x4kg)=1500 (1500/6 kg)= 1500 (11500 –
kg kg 1600x5)=3500
Problem # 2
There are 20000 hours of labor available and 18000 machines hours. Variable Overheads
represent the direct cost of running the machinery. The fixed costs are allocated on basis of labor
hours.
Product X Product Y
Expected Demand/Budgeted output (units) 20,000 10,000
Selling price per unit (Tk.) 150 200
Materials cost per unit 50 60
Labor cost per unit @ Tk.20 per hour 10 15
Variable overhead cost per unit @Tk.50 per hour 25 50
Fixed overhead cost per unit @ Tk.80 per hour 40 60
The company operates a back flush accounting system using two triggers points: purchase of raw
materials and completion of goods.
Required:
i. What is the throughput per unit of product X and product Y
ii. Which of labor or machinery is the bottleneck resource
iii. What is the return per factory hour for product X and product Y
iv. To which product priority be given?
v. What is the cost per factory hour?
vi. What throughput accounting ratio for product X and product Y
vii. Which product has an acceptable TAR?
viii. At the end of a period there are 100 units half-finished of each of product X and product
Y on the production line. What is the valuation of these units in the costing records?
Solution
Requirement #i
Product X Product Y
Selling price per unit (Tk.) 150 200
Throughput per unit Tk.100 Tk.140
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Requirement #ii
Labor Hours Machine Hours

Hours Required 17500 hrs 20000 hrs
(20000X0.5+10000x0.75) (20000X0.5+10000x1)
Hours Available 20000 hrs 18000 hrs
Surplus/ (Deficit) Hours 2500 Hours (2000) hrs
So Machine hours are bottleneck resources.
Requirement #iii
Return per factory hour = (throughput per unit/Bottleneck hour per unit)
Product X Product Y
Throughput per unit Tk.100 Tk.140
Bottleneck hour per unit 0.50 hr 1 hr
Return per factory hour Tk.200 per hour Tk.140 per hour
Requirement # iv
Product X (higher return per factory hour)
Requirement # v
Total Factory costs (other than materials) = Labor: 400000
Labor (17500hrs @20tk) 3,50,000.00

Variable overhead costs (18000 hrs @50) 9,00,000.00
Fixed Cost (17500 hrs @80tk) 14,00,000.00
Total 27,50,000.00
Total machine hours 18000hrs
Cost per factory hour 152.80
Or this can be calculated in the following manner= 27,50,000.00
Products X : 20000 units @ tk. 75(10+25+40) = 1500,000

Product Y : 10000 units @ tk.125.00 (15+50+60) = 1250000
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Requirement # vi
Throughput accounting ratio
Product X Product Y
Return per factory hour Tk.200 per hour Tk.140 per hour
Cost per factory hour 152.80
TAR 1.30 0.90
Requirement # vii
Product X is acceptable. Which TAR is greater than 1.

Requirement # viii
Product X Product Y
Material units 100 100
5000 6000
Ending WIP 11000 tk.
Problem #3
Kiran Company has a single product called a Dak. The company normally produces and sells
60,000 Dals each year at a selling price of Tk.32 per unit. The company’s unit costs at this level
of activity are given below:
Direct Materials Tk.10

Direct Labor 4.50
Variable Manufacturing overhead 2.30
Fixed Manufacturing overhead 5.00 (Tk.300,000 total)
Variable selling expenses 1.20
Fixed Selling expenses 3.50 (Tk.210000 total)
Total cost per unit Tk.26.50
A number of questions relating to the production and sale of Daks follow. Each question is
independed.
A) Assume that Kiran Company has sufficient capacity to produce 90000 Daks each year without
increase in fixed manufacturing overhead costs. The company could increase its sales by 25%
above the present 60000 units each year if it were willing to increase the fixed selling expenses
by Tk.80000. would the increased fixed selling expense be justified?
B) Assume again that kiran Company has sufficient capacity to produce 90,000 Daks each year. A
customer in a foreign market wants to purchase 20,000 Daks. Import duties on the Daks would be
tk. 1.70 per unit, and costs for permits and licenses would be TK. 9,000. The only selling costs
that would be associated with the order would be TK. 3.20 per unit shipping cost. Compute the
per unit break-even price on this order.
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C) The company has 1,000 Daks on hand that have some irregularities and are therefore
considered to be “seconds”. Due to the irregularities, it will be impossible to sell these
units at the normal price through regular distribution channels. What unit cost figure is
relevant for setting a minimum selling price? Explain.
D) Due to a strike in its supplier’s plant, kiran Company is unable to purchase more material
for the production of Daks. The strike is expected to last for two months. Kiran
Company has enough material on hand to operate at 30% of normal levels for the two-
month period. As an alternative, kiran could close its plant down entirely for the two
months. If the plant were closed, fixed manufacturing overhead costs would continue at
60% of their normal level during the two-month period and the fixed selling expenses
would be reduced by 20%. What would be the impact on profits of closing the plant for
the two-month period?
E) An outside manufacturer has offered to produce Daks and ship them directly to kiran’s
customers. If kiran Company accepts this offer, the facilities that it uses to produce Daks
would be idle; however, fixed manufacturing overhead costs would be reduced by 75%
since the outside manufacturer would pay for all shipping costs, the variable selling
expenses would be only two-thirds of their present amount. Compute the unit cost that is
relevant for comparison to the price quoted by the outside manufacture.
Solution
Requirement # A
Selling price per unit 32

Variable expense per unit 18 (10+4.5+2.30+1.20)
Contribution margin (CM) per unit 14
Increased sales in units (60000 units X25%) 15000 units

CM per unit 14 tk.
Incremental CM 2,10,000.00
Less: Incremental Fixed Costs 80000
Incremental net operating income 1,30,000.00
Yes, the increase in fixed selling expenses would be justified.
Requirement # B
Variable manufacturing cost per unit 16.80 (10+4.5+2.30)

Import duties per unit 1.70
Permits and license (90000/20000 units) 0.45
Shipping cost per unit 3.20
Break-even price per unit 22.15
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Requirement # C
The relevant cost is Tk.1.20 per unit, which is the variable selling expense per Dak. Since the
irregular units have already been produced, all production costs (including the variable
production costs) are sunk. The fixed selling expenses are not relevant since they will be incurred
whether or not irregular units are sold.
Depending on how the irregular units are sold, variable expense of Tk.1.20 per unit may not even
be relevant. For example, the units may be disposed of through a liquidator without incurring the
normal variable selling expense.
Requirement # D
If the plant operates at 30% of normal levels, then only 3000 units (60000/12X2X30%) will be
produced and sold during the two-month period.
Contribution Margin (3000x14) 42000

If closed cost savings are: (20000)
Fixed Manu. Overhead costs (300000/12x2x40%) (7000)
Fixed selling cost (210000/12x2x20%)
Net advantages of running the factory 15000
Requirement # E
Relevant costs are those that can be avoided by purchasing from the outside manufacturer. These
costs are:
Variable manufacturing cost per unit 16.80 (10+4.5+2.30)
Fixed Manufacturing overhead costs 3.75
(300000X75%)/60000 units
Variable selling expense 0.40
Total avoidable cost 20.95
To be acceptable, the outside manufacturer’s quotation must be less than Tk.20.95 per unit.
Problem #4
Down south lures makes three fishing lures it its manufacturing facility in Alabama. Data
concerning three products appear below:
Frog Minnow Worm
Normal annual sales volume 1,00,000 200,000 300,000
Unit Selling Price 2.0 1.4 0.8
Variable cost per unit 1.2 0.8 0.5
Total fixed expense for the entire company are 282,000 per year.
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All three products are sold in highly competitive markets, so the company is unable to raise its
prices without losing unacceptable number of customers.
The company has no work in progress or finished goods inventories due to an extremely
effective just-in-time manufacturing system.
Required:
1. What is company’s overall break even in total sales dollars:
2. Of the total fixed costs of Tk. 2,82,000, Tk. 18,000 could be avoided if the Frog lure
product were dropped, 96,000 if the Minnow lure product were dropped, and 60,000 if
the Worm lure product were dropped. The remaining fixed costs of TK. 10,8000 consists
of common fixed costs such as administrative salaries and rent on the factory building
that could be avoided only by going out of business entirely.
a. What is break even quantity of each product?
b. If the company sells exactly the break even quantity of each product, what will be the
overall profit of the company? Explain this result.
Solution:
See solution from Garris-on Noreen Book Case No. 6-23 sixth edition.
Notes:
Please exercise problems as many as possible from CIMA book (Examples, Test for
Understanding, Questions KIT (previous year questions) and from other books.
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Chapter Three
i. What is activity based costing
ii. What are the benefits of activity based costing
iii. What are the drawbacks of activity based costing
iv. Understand: cost objects, cost driver, activity, cost pool, activity rates
v. Plant wide rate, departmental rate, activity rates.
vi. Cost distortion, mis-costing, under –costing, over costing, cross subsidization.
vii. Why activity based costing
Problem no.1
Advanced Products Corporation has supplied the following data from its activity based costing
system:
Overhead Costs
Wages and Salaries 300,000.00
Other Overhead Costs 100,000.00
Total Overhead Costs 400,000.00
Activity Cost Pool Activity Measures Total Activity for the year
Volume related No. of Direct Labor Hours 20000 DLH
Order related Number of Orders 400 orders
Customer Support Number of Customers 200 Customers
Other These costs are not allocated Not Applicable
to products or customers
Activity Cost Pool Distribution of Resource Consumption Across Activity Cost Pools
Volume Order Related Customer Other Total
Related Support
Wages and Salaries 40% 30% 20% 10% 100%
Other Overhead Costs 30% 10% 20% 40% 100%
During the year, Advanced Products completed one order for a new customer, Shenzhen
Enterprises. This customer did not order any other products during the year. Data concerning the
order follow:
Data Concerning the Shenzhen Enterprise Order
Units Ordered 10 units
Direct Labor Hours 2 DLHs per unit
Selling Price $300 per unit
Direct Materials $ 180 per unit
Direct Labor $ 50 per unit
Required
i. Prepare a report showing the first stage allocation of overhead costs to the activity cost
pools
ii. Compute the activity rates for the activity cost pools
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iii. Prepare a report showing the overhead costs for the order from Shenzhen Enterprises,
including a customer support costs
iv. Prepare a report showing customer margin for Shenzhen Enterprises
Solution:
Requirement no.i: first stage allocation of activity based costs
Activity Cost Distribution of Resource Consumption Across Activity Cost Pools

Pool Volume Order Related Customer Other Total
Related Support
Wages and 120000 90000 60000 30000 300,000
Salaries (300000x40%) (300000x30%) (300000x20%) (300000x10%) (100%)
Other Overhead 30000 10000 20000 40000 100000
Costs (100000x30%) (100000x10%) (100000x20%) (100000x40%) (100%)
Total 150,000 100,000 80,000 70,000 400,000
Requirement no.ii Computation of the activity rates for the activity cost pools
Activity Cost Amount of costs Activity Measures Total Activity Activity Rates
Pool (A) for the year (A/B)
(B)
Volume related 150,000 No. of Direct Labor 20000 DLH Tk. 7.50 per
Hours DLH
Order related 100,000 Number of Orders 400 orders Tk.250 per
order
Customer 80,000 Number of Customers 200 Tk.400 per
Support Customers customer
Other 70,000 These costs are not Not NA
allocated to products Applicable
or customers
Requirement No. iii

Allocation of overhead costs for the order from Shenzhen Enterprises, including a customer
support costs
Overhead costs Activity rates 10 units Overhead cost

allocated
Volume related Tk.7.50 per DLHJ 20 DLH Tk.150
(10 units x 2 DLHs
per unit)
Order related Tk.250 per order 1 order Tk.250
Customer Support Tk.400 per customer 1 customer Tk.400
Total Tk. 800
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Requirement no. iv
Calculation of customer margin: Shenzhen Enterprises
Data Concerning the Shenzhen Enterprise Order

Sales 3000.00
Materials cost (1800.00)
Direct Labor (500.00)
Overhead costs (from requirement no.iii) (800.00)
PROFIT/(LOSS) (100)
Problem no.02
GH produces three models of speedboat for sale to the retail market. GH currently operates a
standard absorption costing system. Budgeting information for next year is given below:
Model of speedboat Superior Deluxe Ultra Total

$000 $000 $000 $000
Sales 54,000 86,400 102,000 242,400
Direct material 17,600 27,400 40,200 85,200
Direct labour 10,700 13,400 16,600 40,700
Production overhead 69,600
Gross profit 46,900
Superior Deluxe Ultra

Production / sales (number of boats) 1,000 1,200 800
Machine hours per boat 100 200 300
The production overhead cost is absorbed using a machine hour rate.
GH is considering changing to an activity based costing system. The main activities and their
associated cost drivers and overhead cost have been identified as follows:
Activity Cost Driver Production overhead cost
$000
Machining Machine hours 13,920
Set up Number of set ups 23,920
Quality inspection Number of quality inspections 14,140
Stores receiving Number of component 6,840

deliveries
Stores issue Number of issues from stores 10,780
69,600
The analysis also revealed the following information:
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Superior Deluxe Ultra

Budgeted production (number of 1,000 1,200 800
boats)
Boats per production run 5 4 2
Quality inspections per production run 10 20 30
Number of component deliveries 500 600 800
Number of issues from stores 4,000 5,000 7,000
The machines are set up for each production run of each model.
Required:
(a) Calculate the total gross profit for each model of speedboat:
(i) using the current absorption costing system;
(ii) using the proposed activity based costing system.
(b) Explain why an activity based costing system may produce more accurate product costs than a
traditional absorption costing system.
(c) Explain the possible other benefits to the company of introducing an activity based costing
system. You should use the figures calculated in part (a) to illustrate your answer.
Solution
Requirement no.1:
Calculation of gross profit under traditional absorption costing system
$000 $000 $000 $000
Sales 54,000 86,400 102,000 242,400
Direct material 17,600 27,400 40,200 85,200
Direct labour 10,700 13,400 16,600 40,700
cost allocated @120 per 1,20,00 2,88,00 2,88,00 69,600
machine hour
Gross profit 13,700 16,800 16,400 46,900
Working no 1: Allocation of overhead cost under traditional absorption costing

Absorption rate = total overhead costs/total machine hours
= 69,600,000/580,000 hours
= 120 per machine hour
Working 2: calculation of total machine hours
Superior Deluxe Ultra Total
Production / sales (number of 1,000 1,200 800
boats)
Total 100,000 240,000 240,000 580,000 hours

Total machine hours 100,000 240,000 240,000 580,000 hours
cost allocated @120 per machine 1,20,00,000 2,88,00,000 2,88,00,000 69,600,000
hour
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Calculation of gross profit under activity based costing system

$000 $000 $000 $000
Sales 54,000 86,400 102,000 242,400
Direct material 17,600 27,400 40,200 85,200
Direct labour 10,700 13,400 16,600 40,700
Overhead cost allocated 13625 23505 32470 69,600
Gross profit 12075 22097 12730 46,900
Working 3: Allocation of overhead cost under activity based costing

Step 1: calculation of activity rates
Activity Cost Driver Production Activity Activity Rates
overhead measures(B) (A/B)
cost $000
(A)
Machining Machine hours 13,920 580000 24 per machine
hour
Set up Number of set ups 23,920 900 26578 per set up
Quality Number of quality 14,140 20000 707 per quality
inspection inspections inspection
Stores receiving Number of 6,840 1900 3600 per
component deliveries component delivery
Stores issue Number of issues 10,780 16000 674 per store issue
from stores
69,600
Working 3(i): Calculation of activity measures

Budgeted production (number of 1,000 1,200 800
boats)
Boats per production run 5 4 2
No of set up 200 300 400 900
(1000/5) (1200/4) (800/2)
Quality inspections per production 10 20 30
run
No of quality inspection 2000 6000 12000 20000
(200x10) (300x20) (400x30)
Number of component deliveries 500 600 800 1900
Number of issues from stores 4,000 5,000 7,000 16000
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Step 2: allocation of activity costs to cost object

Activity Cost Driver Activity Superior deluxe Ultra
Rates
(A/B)
Machining Machine hours 24 per 2400 5760 5760
machine (100000x24) (240000x24) (240000x24)
hour
Set up Number of set 26578 per set 5315 7973 10631
ups up (200x26578) (300x26578) (400x26578)
Quality Number of 707 per 1414
inspection quality quality (2000x707) 4242 8484
inspections inspection (6000x707) (12000x707)
Stores receiving Number of 3600 per 1800 2160 2880
component component (500x3600) (600x3600) (800x3600)
deliveries delivery
Stores issue Number of 674 per store 2696 3370 4718
issues from issue (4000x674) (5000x674) (7000x674)
stores
Total 13625 23503 32470
Requirement no.ii: Why ABC provides more accurate costs:

Under traditional costing system, only one cost driver was used that is machine hour. But we
know that only machine hours do not drive all overhead or support costs. That is there is no
cause and effect analysis under traditional costing which lead to mis-costing (under-costing or
over costing) or cost distortion in many cases.
But under ABC, all overhead or support costs are pooled under different activities which drive
the costs as per cause and effect analysis. Then costs under the cost pool (activities) are allocated
to cost object as per activity rates and amount of activity each products consumed or caused or
drive to happen. Therefore, there is less possibility for cost distortion.
Requirement no.iii: Other benefits of ABC
Cost drivers identified under ABC system provide information to management to identify which
products or services are more profitable and which ones are less profitable (even loss maker). It
helps management to discontinue loss making products or services and provide more
concentration on more profitable products. Thus it leads to improve overall profitability of the
company.
i. ABC helps to avoid mispricing of the products. While under traditional costing a product
may be overcharged with overhead costs compared to another products which actually
consumed more overhead costs. If pricing is done on cost of the product, a less costly
products may be overpriced and vice versa due to cost distortion. Mispricing may lead to
decrease in sales of a good product while increasing a sale of product which is not really
profitable for the company.
ii. From the above problem and as detailed in the below table, we see that while under
traditional costing, superior is shown to be the highest margin (25.37%) maker product of the
company, but under ABC, Deluxe proved to be really the highest margin earning product of
the company.
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Comparison of gross profit under two methods

$000 $000 $000 $000
Gross profit under 13,700 16,800 16,400 46,900
traditional absorption
costing
Gross profit margin 25.37% 19.44% 16.08% 19.35%
(13700/54000) (16800/86400) (16400/102000) (46900/242,40
0)
Gross profit under 12075 22097 12730
absorption costing
Gross profit margin 22.36% 25.57% 12.48% 19.35%
(12075/54000) (22097/86400) (12730/102000) (46900/242,40
0)
Problem no.03
Tarquine’s trophies makes trophies and plaques and operates at capacity. Tarquine dose large
custom orders, such as the participant trophies for the mishawake little league. The controller has
asked you to compare plant-wide, department, and capacity-based cost allocation.
Tarquine’s Trophies
Budgeted information
For the year ended November 30, 2011
Forming department Trophies Plaques Total

Direct materials $ 13,000 $ 11,250 $24,250
Direct labor 15,600 9,000 24600
Overhead costs
Setup 12,000
supervision 10,386
Assembly department Trophies Plaques Total

Direct materials $ 2,600 $ 9,375 $11,975
Direct labor 7800 10,500 18300
Overhead costs
Setup 23,000
supervision 10,960
Other information follows:

Setup costs vary with the number of batches processed in each department. The budgeted
number of batches for each product line in each department in as follows:
Trophies Plaques
Forming department 40 116
Assembly department 43 103
Supervision costs vary with direct labor costs in each department.
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Required:
1. Calculate the budgeted cost per unit for trophies and plaques based on a single plant wide
overhead rate, if total overhead is allocated based on total direct costs.
2. Calculate the budgeted cost per unit for trophies and plaques, where forming department
overhead costs are allocated based on direct labor costs of the forming department and
assembly department overhead costs allocated based on total direct costs of assembly
department.
3. Calculate the budgeted cost per unit for trophies and plaques if Tarquine allocates
overhead costs in each department using activity-based costing.
4. Explain how disaggregation of information could improve or reduce decision quality.
Solution
Tropies Plaques Total
Direct materials 15,600 20,625 36225
(13000+2600) (11250+9375)
Direct labor 23,400 19,500 42,900
(15600+7800) (9000+10500)
79125
Budgeted overhead = [(12000+10386+23000+10960)/79,125] = 0.712 per dollar of direct labor

cost

(13000+2600) (11250+9375)
Direct labor 23,400 19,500 42,900
(15600+7800) (9000+10500)
Total direct costs 39,000 40,125 79125
Allocated overhead 27,772 28,574 56,346
(39000x0.712) (40,125x0.712)
Total 66,772 68,699 135,471
Requirement 2
Budgeted overhead rate (Forming department)

= Budgeted forming department overhead costs/budgeted forming department direct labor cost
= (12000+10386)/ (15600+9000)
= 0.91 per forming department direct labor cost
Budgeted overhead rate (Assembly Department)

= Budgeted assembly department overhead costs/Budgeted Assembly department Direct Costs
= (23000+10960) / (2600+9375+7800+10500)= 33,960/30,275

= 1.1217 per Assembly department Direct Cost
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(13000+2600) (11250+9375)
Direct labor 23,400 19,500 42,900
(15600+7800) (9000+10500)
Forming depta 11,666 22,294
Assembly deptb
Total 64,862 70,609 135,471

a
Forming Department
Direct Labor costs 15600 9000 24,600
(0.91x15,600) (0.91x15,600)
b
Assembly
Department
Direct Costs 10,400 19,875 30,275
(2600+7800) (9375+10500)
(1.1217x10,400) (0.1.1217x19875)
Requirement 3
Calculation of Activity Rates
Forming department
Budgeted set up rate = 12000/156 batches = 76.92 per batch
Budgeted supervision rate = 10,386/24,600 = 0.422 per direct labor cost
Assembly Department
Budgeted set up rate = 23000/146 batches = 157.53 per batch
Budgeted supervision rate = 10,960/18,300 = 0.5989 per direct labor cost

(13000+2600) (11250+9375)
Direct labor 23,400 19,500 42,900
(15600+7800) (9000+10500)
Allocated overhead
Forming dept
Set up 3077 (76.92x40) 8923 (76.92x116) 12000
Supervision 6586 (0.422x15600) 3800 (0.422x9000) 10,386
Assembly dept
Set up 6,774 16,226 23,000
Supervision 4,671 6,289 10,960
Total 60,108 75,363 135,471
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Requirement 4.
Tarquin uses more refined cost pools the costs of tropies decreases and costs of plaque
increases. This is because plaques use a higher proportion of cost drivers (batches of set ups
and direct manufacturing labor costs) than tropies whereas the direct costs (the allocation
base used in the simple costing system) are slightly smaller for plaques compared to trophies.
This results in plaques being under-costed and trophies over-costed in the simple costing
system.
Department costing systems increases the costs of plaques relative to trophies because the
forming department costs are allocated based on direct manufacturing labor costs in the
forming department and plaques use more direct manufacturing labor in this department
compared to trophies.
Disaggregated information can improve decisions by allowing managers to see the details
which helps them understand how different aspects of cost influence total cost per unit.
Managers can also understand the drivers of different cost categories and use this
information for pricing and product mix decisions, cost reduction and process improvement
decisions, design decisions and to plan and manager activities. However, too much detail can
overload managers who don’t understand the data or what it means. Also, managers looking
at per unit data may be misled when considering costs that are not unit level costs.
Problem No: 4
Allens Aero Toys makes two models of toy air planes, fighter jet and cargo planes. The
fighter jets are more detailed and require smaller batch sizes. The controller has asked you to
compare plant-wide, departmental, and activity based cost allocations
Allen’s Aero Toys
Budgeted information per unit
For the year ended 30 November 2010
Assembly Department Fighters Cargo Total
Direct Materials 2.50 3.75 6.25
Direct Manufacturing Labor 3.50 2.00 5.50
Total Direct Cost per unit 6.00 5.75 11.75
Painting Department Fighters Cargo Total

Direct Materials 0.50 1.00 1.50
Direct Manufacturing Labor 2.25 1.50 3.75
Total Direct Cost per unit 2.75 2.50 5.25
Fighters Cargo Total

Number of unit produced 800 740
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The budgeted overhead cost for each department is as follows:
Assembly Painting Total

Department Department
Materials handling $ 1,700 $ 900 $ 2,600
Quality inspection 2750 1150 3900
Utilities 2,580 2,100 4,680
$7,030 $4,150 $11,180
Other information follows:

Materials handling and quality inspection costs vary with the number of batches processed in
each department. The budgeted number of batches for each product line in each department
in as follows:
Fighters Cargo total
Assembly 150 48 198
department
Painting department 100 32 132
total 250 80 330
Utilities costs vary with direct manufacturing labor costs in each department.
Required:
1. Calculate the budgeted cost per unit for fighter jets and cargo planes based on a single
plant wide overhead rate, if total overhead is allocated based on total direct costs.
2. Calculate the budgeted cost per unit for fighter jets and cargo planes based on
departmental overhead rates, where assembly department overhead costs are allocated
based on direct manufacturing labor costs of the assembly department and painting
department overhead costs allocated based on total direct costs of painting
department.
3. Calculate the budgeted cost per unit for fighter jets and cargo planes if allen’s aero
toys allocates overhead costs using activity-based costing.
4. Explain how activity-based costing could improve or reduce decision quality.
Solution
Follow question problem no.3
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Chapter Four: Budgeting
Problem no. 01
A company produces two products, A1 and A2 that are sold to retailers. The budgeted sales volumes for
the next quarter are as follows:
Product Units A1 32,000 kg A2 56,000 kg
The inventory of finished goods is budgeted to increase by 1,000 units of A1 and decrease by 2,000 units
of A2 by the end of the quarter.
Materials B3 and B4 are used in the production of both products. The quantities required of each material
to produce one unit of the finished product and the purchase prices are shown in the table below:
B3 B4
A1 8 kg 4 kg
A2 4 kg 3 kg
Purchase Price per kg $1.25 $3 kg
Budgeted opening inventory 30,000 kg 20,000 kg
The company plans to hold inventory of raw materials, at the end of the quarter, of 5% of the quarter’s
material usage budget.
Required: Prepare the following budgets for the quarter: (i) The production budget (in units) (ii) The
material usage budget (in kg) (iii) The material purchases budget (in kg and $) (CIMA Sep, 2014 Exam)
Solution:
(i)
Product A1 B1
sales 32000 56000
Increase / (decrease) in inventory 1000 (2000)
Production budget (units) 33000 54000
Materials B3 B4
A1 A2 Total A1 A2 Total
Production 33000 54000 87000 33000 54000 87000
budget
Kg per unit 8 4 4 3
264000 216000 480000 132000 162000 294000
B2 B3
Material usage 480000 kg 294,000 kg
Less: opening inventory (30000) (20000)
Plus: closing inventory 24000 14700
Materials purchase 474000 288,700
Price per kg 1.25 1.80
Material purchase 5,92,500 5,19,660
33 | P a g e
Problem no. 02
AB is preparing its purchases budget for raw material C for the forthcoming year. The opening
inventory of raw material C is expected to be 2,000kg and the price is expected to be $8 per kg.
Raw material C is used only in the production of Product D. Each unit of Product D requires two kg
of material C. Budgeted sales of Product D for the forthcoming year and for the following year are
36,000 units in each year. Sales will occur evenly throughout each year. The opening inventory is
expected to be 6,000 units.
AB will implement a new inventory policy from the first month of the forthcoming year. The closing
inventory that will be required at the end of the forthcoming year is as follows:
Raw material inventory: one month's production requirements
Finished goods inventory: one month's sales requirements
Required:
Calculate the material purchases budget for the forthcoming year
Problem # 3
FG is preparing its cash budgets for January, February and March. Budgeted data are as follows:
Nov Dec Jan Feb Mar
Sales (units) 750 800 800 850 900
Production 800 800 850 900 950
Direct Labor 48000 48000 51000 54000 56000
&
Variable
Overhead
Fixed Costs 20000 20000 20000 20000 20000
(excluding
depreciation)
The selling price per unit is $200. The purchase price per kg of raw material is $25. Each unit of
finished product requires 2 kg of raw materials which are purchased on credit in the month before
they are used in production. Suppliers of raw materials are paid one month after purchase.
All sales are on credit. 80% of customers, by sales value, pay one month after sale and the remainder
pay two months after sale.
The direct labour cost, variable overheads and fixed overheads are paid in the month in which they
are incurred.
Machinery costing $100,000 will be delivered in February and paid for in March.
Depreciation, including that on the new machinery, is as follows:
Machinery and equipment $3,500 per month
Motor vehicles $800 per month
The opening cash balance at 1 January is estimated to be $15,000.
Required: Prepare a cash budget for each of the three months January, February and March.
: See: (Cima Nov 2014)
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Problem no.4
Minded Company is a wholesale distributor of premium European Chocolates. The Company
balance sheet as on 30 April is given below:
Assets
Cash 9000
Debtors, Customers 54000
Stock 30,000
Building and equipment, net of depreciation 207,000
Total Assets 3,00,000
Liabilities and shareholders’ equity
Creditors, suppliers 63,000
Note payable 14,500
Capital stock, no par 180,000
Retained earnings 42,500
Total liabilities and shareholders’ equity 3,00,000
The company is in process of preparing budget data for May. A number of budget items have
already been prepared, as stated below:
i. Sales are budgeted at tk.2,00,000 for May. Of these sales, Tk.60,000 will be for cash; the
remainder will be credit sales. One-half of a month’s credit sales are collected in the
month of sales are made, and the remainder is collected in the following month. All of the
30 April receivables will be collected in May.
ii. Purchase of stock are expected to total Tk.120,000 during May. These purchase will all
be on account: 40% of all purchases are paid for in the month of purchase; the remainder
is paid in the following month. All of the 30 April creditors to supplier will be paid
during May.
iii. The 31 May stock balance is budgeted at tk.40,000.
iv. Operating expenses for May are budgeted at TK.72000, exclusive of depreciation. These
expenses will be paid in cash. Depreciation is budgeted at Tk.2000 for the month.
v. The note payable on the 30 April balance sheet will be paid during May, with Tk.100 in
interest for May month only.
vi. New Refrigerating equipment costing Tk.6500 will be purchased for cash during May.
vii. During May, the company will borrow Tk.20,000 from its bank by giving a new note
payable to the Bank for that amount. The new note payable will be due in one year.
Required
v. Prepare a cash budget for May. Support your budget with schedules showing budgeted
cash receipts from sales and budgeted cash payments for stock purchase.
vi. Prepare a budgeted profit and loss account for May. Use the traditional profit and loss
account format.
vii. Prepare a budgeted balance sheet as of 31 May.
Solution:
Solved in the class
35 | P a g e
Problem #5
Auxiliary Ltd. a manufacturing company, having a capacity of 7,00,000 units has prepared the
following cost sheet:
Per unit $
Direct Material 30
Direct Wages 12
Factory Overhead (50% variable) 30
Selling and Administrative Overheads (2/3rd 18
Fixed)
Selling Price 120
During the year 2013-14, the sales volume achieved by the company was 6,00,000 units. The
company has launched an expansion program, the details of which are as under:
i. The capacity will be increased to 1,200,000 units

ii. The additional fixed overheads will amount to $5,000,000 up to 1,000,000 units and will
be increase by $2,500,000 more beyond 1,000,000 units.
iii. The cost of investment of expansion is $10,000,000 which is proposed to be financed
through Bank borrowings carrying interest 15% p.a.
iv. The average depreciation rate on the new investment is 15% based on straight line
method.
After expansion is put through, the company has two alternatives for operations:
i. Sales can be increased up to 1,000,000 units by spending & 1,000,000 on special

advertisement campaign to explore new market. Or
ii. Sales can be increased to 1,200,000 units subject to the following:
 By an overall reduction $ 10 per unit on all units are sold

 By increasing the variable selling and administrative expense by 8%.
 The direct material costs would go down by 1.5% due to discount on bulk purchasing.
Required
(a) Construct a flexible budget at the level of 600,000, 1,000,000 and 1,200,000 unit of
production
(b) Calculate break-even point before and after expansion
(c) Advise the optimum level of output for expansion.
Solution:
Solved in the class. Solution is also available in previous year question (CMA June 2016
Exam)
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Problem SIX
GH manufactures and sells a single product. The company operates a standard absorption
costing system and absorbs overheads on the basis of direct labour hours.
The standard selling price and standard costs for one unit of the product are as follows: $
per unit
Selling price 300
Direct material 15 metres @ $9 per metre 135
Direct labour 5 hours @ $12 per hour 60
Variable production 5 hours @ $6 per hour 30
overheads
Fixed production overheads 5 hours @ $3 per hour 15
Gross profit 60
The budgeted production and sales for February were 1,000 units. The fixed overhead
absorption rate has been calculated based on budgeted production for the month.
Actual results for February were as follows:
Production 1,400 units
Sales 1,200 units
Selling price $306 per unit
Direct materials 22,000 metres @ $12 per metre
Direct labour 6,800 hours @ $15 per hour
Variable production overheads $33,000
Fixed production overheads $18,000
No materials inventories are held.
Prepare a statement that reconciles the budgeted gross profit with the actual gross profit
for February. Your statement should show the variances in as much detail as possible
The Production Director when questioned about the variances explained that, in an
attempt to improve the quality of the product, better quality material was used and some
of the semi-skilled labour was replaced with skilled labour. The Production Director
believed that the improvement in the quality of the product would enable the company to
increase the price of the product and would also result in increased sales volumes.
Discuss, using the variances calculated in part (a), the effect on performance of the
decisions taken by the Production Director
Explain why a standard costing system may not be considered appropriate in a modern
manufacturing environment
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Solution
Amount Amount
Budgeted gross profit (1,000 60000
units x $60)
Sales volume profit variance 12000F
(1,200 units - 1,000 units) x
$60
Sales price variance 1,200 7200F
units x ($306 - $300)
Direct material price variance 66000A
22,000 mtrs x ($9 - $12)
Direct material usage variance 9000A
((1,400 x 15 mtrs) – 22,000
mtrs) x $9
Direct labour rate variance 20400A
6,800 hours x ($12 - $15)
Direct labour efficiency 2400F
variance ((1,400 x 5 hrs) –
6,800) x $12
Variable overhead expenditure 7800F
variance (6,800 x $6) –
$33,000
Variable overhead efficiency 1200F
variance ((1,400 x 5 hrs) –
6,800) x $6
Fixed overhead expenditure 3000A
variance (1,000 x $15) -
$18,000
Fixed overhead expenditure 6000F
variance (1,000 x $15) -
$18,000
Actual gross profit /(loss) (1800)
Workings:
Amount
Sales 1,200 units x $306 367,200
Direct Materials 22,000 metres x $12 264000
Direct Labor 6,800 hours x $15 102000
Variable production overhead 33000
Fixed production overhead 18000
Closing Stock 200 units x $240 (48000)
Actual Gross Profit (1800)
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(b)
The Production Director’s decision has resulted in a favourable sales volume variance of
$12,000 and a favourable sales price variance of $7,200 F which may at least partly be as a
result of the improved quality of the product. However, the favourable sales variances have
been achieved at a very high cost in terms of material and labour.
The Production Director’s decision has resulted in a total material cost variance of $75,000 A
and a total labour cost variance of $18,000 A. The material price variance is adverse due to
the purchase of higher quality materials. However, there is also an adverse material usage
variance which may be because the labour force was unfamiliar with handling the new
material. The decision to use higher skilled labour has resulted in an adverse labour rate
variance which has been only partially offset by a favourable labour efficiency variance.
(c)
In a JIT environment measuring standard costing variances may encourage dysfunctional

behaviour. A JIT production environment relies on producing small batch sizes economically
by reducing set up times. Performance measures that benefit from large batch sizes or
producing for inventory should therefore be avoided.
In an AMT environment the major costs are those related to the production facility rather
than production volume related costs such as materials and labour, which standard costing is
essentially designed to plan and control. Fixed overhead variances don’t necessarily reflect
under or overspending but may simply reflect differences in production volume. An activity
based cost management system may be more appropriate, focusing on the activities that drive
the cost.
In a total quality environment, standard costing variance measurement places an emphasis on

cost control to the detriment of quality. Cost control may be achieved at the expense of
quality and competitive advantage.
A continuous improvement environment requires a continual effort to do things better rather

than achieve an arbitrary standard based on prescribed or assumed conditions. In today’s
competitive environment cost is market driven and is subject to considerable downward
pressure. Cost management must consist of both cost maintenance and continuous cost
improvement.
In a JIT/AMT/TQM environment the workforce is usually organised into empowered,

multiskilled teams controlling operations autonomously. The feedback they require is real
time. Periodic financial reports are neither meaningful nor timely enough to facilitate
appropriate control action.
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Exercise #1
GH manufactures and sells a single product. The company uses a just-in-time purchasing and
production system and as a result holds no inventory of raw materials or finished goods.
The standard selling price and standard variable costs of the product are as follows:
Selling price per unit 400

Variable costs per unit: 8kg of material @ $20 per kg 160
6 hours of labour @ $14 per hour 84
The following information is available for April:
(i) Budgeted production and sales were 2,500 units. Actual production and sales were 2,850 units
at a selling price of $385.
(ii) Actual usage of material was 24,900 kg at $18 per kg.
(iii) 18,800 hours were worked and paid for at a rate of $15.50 per hour.
Required:
(a) Prepare a statement that reconciles the budgeted contribution with the actual contribution.
Your statement should show the variances in as much detail as possible.
The management accountant has decided that it would be more useful to show separately the
variances that relate to planning differences and those that relate to operational changes. The
following additional information is available:
The material normally used was unavailable throughout April and the company had to use a
substitute material. Due to the nature of the substitute material it was expected that 9.25kg of
material would be required per unit of the product. The cost of the substitute material was
expected to be $20 per kg.
(b) Prepare calculations that show the total material usage variance separated into planning
and operational variances. (4 marks)
(c) Explain why planning and operational variances provide better information for planning
and control purposes. (6 marks)
(d) Explain TWO factors that a company should consider before deciding whether to
investigate a variance.
Solution: See CIMA May 2013
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Chapter Four: Variance Analysis

Problem 01
Nitol Corporation manufactures and sells a single product, using a standard cost system. The
standard cost per product is:
Materials: 1 pound of plastic @Tk.2 Tk.2

Direct Labor: 1.6 hours@ Tk.4 Tk.6.40
Variable factory overhead cost per unit Tk. 3.00
Fixed factory overhead cost per unit Tk. 1.45
Tk.12.85
The factory overhead cost per unit was calculated from the following annual overhead cost
budget for a 60,000 unit volume:
Variable factory overhead cost:

Indirect labor (30,000 hours @ Tk.4.00) Tk.120,000
Supplies (Oil 60000 gallons @tk.0.50) Tk.30,000
Allocated variable service department costs Tk. 30,000
Total Variable factory overhead cost Tk. 1,80,000
Fixed factory overhead cost:
Supervision Tk.27,000
Depreciation Tk.45,000
Other fixed costs Tk. 15,000
Total Fixed factory overhead cost Tk. 87,000
Total budgeted annual factory overhead cost 2,67,000

for 60,000 units
The charges to the Manufacturing Department for November, when 5000 units produced, were
Materials: 5300 pounds of plastic @Tk.2 Tk.10,600

Direct Labor: 8200 hours@ Tk.4.10 Tk.33,620
Indirect Labor: 2400 hours@ Tk.4.10 Tk.9,840
Supplies (Oil 6000 gallons @tk.0.55) Tk.3,300
Allocated variable service department costs Tk. 3,200
Supervision Tk.2,475
Depreciation Tk.3,750
Other fixed costs Tk. 1,250
Total Tk.68,035
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The purchasing department normally buys about the same quantity of plastic as is used in
production during a month. In November, 5300 pounds were purchased at a price of Tk.2.10 per
pound.
The company has divided its responsibility so that the purchasing department is responsible for
the price at which materials and supplies are purchased, while the Manufacturing Department is
responsible for the quantities of materials used.
The Manufacturing Department manager performs the time keeping function and, at various
times, an analysis of factory overhead and direct labor variances has shown that the manager has
deliberately misclassified labor hours (e.g., direct labor hours might be classified as indirect
labor hours and vice versa), so that only one of the two labor variances in unfavorable. It is not
economically feasible to hire a separate timekeeper.
Required:
(i) Calculate these variances from standard costs for the data given: (a) materials
purchase price variance; (b) materials quantity variance; (c) direct labor rate variance;
(d) direct labor efficiency variance, factory overhead controllable and (f) volume
variance.
(ii) Explain whether the division of responsibilities should solve the conflict between
price and quantity variances.
Solution
Computation of total variance
Actual Standard variance

Material purchase (5,300 X 11,130 (5,300 x 2) 10600 Tk. 530 UF
2.10)
1 Material used 5,300 X 10,600 (5,000 x 2) 1000 600 UF
2.00
2 Labor(HR X (8,200 X 33,620 (8000 x 4) 32000 1620 UF
RATE) 4.10)
3 Variable F.O.H 16,340 5000 X 3 15000 1340 UF
4 Fix overhead 7475 (5000 x 1.45) 225 UF
Tk. 3785
Variance analysis
R (a) material price variance
Actual Qty X actual price = 5300 x 2,10 Tk. 11,130

Actual Qty X standard price= 5200 x 2.00 10,400
Price variance 530 UF
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R (B) material quantity variance:
Actual Qty used x standard price = 5300 x 10,600

2.10
Standard Qty x standard price = 5,000 x 2.00 10,000
Quantity variance 600 UF
R (c) labour rate variance
Actual labour hours x actual rate = 8,200 x 33,620

4.10
Actual labour hours x standard rate = 8,200 x 32,800
4.00
Labour rate variance 820 UF
R (D) labour efficiency variance:
Actual labour hours x standard rate = 8,200 x 32,800

4.00
standard labour hours x standard rate = 8,000 32,000
x 4.00
labour efficiency variance 800 UF
R (e) factory overhead controllable variance
Actual overhead cost : variable – 16,340 23,815

Fixed – 7,475
Budgeted allowance based on actual output:
Variable = 5,000 x 3.00 15,000

fixed = 5000 x 1.45 7,250 22,250
Controllable 1565 UF
variance
R (e) Volume Variance:
Budgeted allowance based on actual output 22,250

Budgeted allowance based on standard output 22,250
(5000 x 4.45)
Volume variance Nil
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Re-capitulation
Total variance of 5,000 of units produced as computed in w-I tk. 3,785 UF
1 Material quantity variance Tk. 600 UF

2 Labor rate variance 820 UF
3 Labor efficiency variance 800 UF
4 Factory O.H controllable variance 1556 UF
5 Factory O.H volume variance 0
total Tk. 3,785 UF
Requirement (2)
Clearly indicating where the responsibilities for price and quantity variances to the
department with initial responsibility reduces the conflict but does not eliminate it.
The specific causes of the variance needs to be determined before there can be certainty that
the proper department is changed. For example if materials were purchased at higher than
standard price because the manufacturing dept. required a rush order, then the price variance
is the responsibility of the manufacturing dept. if the material provided by the purchasing
dept. were slightly lower quality than specifications required, due to careless purchasing the
excess quantity used by manufacturing is the purchasing dept. is responsibility.
Even if the variances are properly charged to the two departments. It can he argued that the
purchasing dept’s variance is influenced by the excess Qty required by manufacturing. In this
case, the extra 300 pounds will increase the purchasing dept.’s variance (accumulated over
several periods) tk. 30 (300ib x .10) i.g. the Tk. 30 is the joint responsibility of the two
departments.
Problem no .2
Beximco produces two products, Product B and Product C. the company uses a standard
absorption costing system that absorbs overhead on the basis of direct labor hours. The
company operates a just-in-time purchasing and production system and no inventory of raw
materials and finished goods is held.
Standard selling price are determined by adding a 100% mark-up to total production costs
per unit. The following budget and actual data relate to August, 2016.
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Budgeted Data:
Product B Product C
Production and sales 2,200 units 1,800 units
Standard production costs per unit: Taka Taka
Direct Materials (Tk.5 per kg) 25.00 35.00
Direct Labor (Tk.7 per hour) 14.00 10.50
Variable overhead 3.00 2.25
Fixed Overhead 8.00 6.00
Actual Data
Product B Product C
Production and sales 3,000 units 1,500 units
Selling Price Per Unit Tk. 110.00 Tk. 105.00
Production costs
Direct Materials Tk.124,800.00 (25,600 kg)
Direct Labor Tk. 67,980.00 (9,140 hours)
Variable overhead Tk. 14,300.00
Fixed Overhead Tk. 27,000.00
The company produces a monthly variance analysis report which has previously included the
calculation of the sales volume profit variance. The management accountant has decided to
extend this analysis and replace the sales volume profit variance with the sales mix profit margin
variance and the sales quantity profit variance.
Required
a. Prepare a statement that reconciles the budgeted gross profit and actual gross profit for
August, 2016. The variance should at least include the following variances:
i. Materials price variance
ii. Materials usage variance
iii. Direct Labor Rate Variance
iv. Direct Labor Efficiency Variance
v. Variable Overhead Expenditure Variance
vi. Variable Overhead Efficiency Variance
vii. Fixed Overhead Expenditure Variance
viii. Fixed Overhead Volume Variance
ix. Sales mix profit margin variance
x. Sales quantity profit variance
xi. Sales Price Variance
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Details Working
i Material price variance
Standard price (tk) 5.00
Actual Price (tk) 4.88
Difference 0.13
Actual Quantity (kg) 25600.00
3200.00 F
ii Material Usage Variance
Standard Quantity (kg) 25500.00
Actual Quantity (kg) 25600.00
Difference -100.00
Standard Price 5.00
variance -500.00 UF
iii Direct Labor Rate Variance

Standard rate (tk) 7.00
Actual Rate 7.44
Difference -0.44
Actual Hours (hrs) 9140
-4000.00 UF
iv. Direct Labor Efficiency Variance

Standard hours 8250
Actual Hours 9140
Difference -890
Standard Rate 7.00
-6230.00 UF
v Var. O/H Expenditure Var.
Standard rate (tk) 1.50
Actual Rate (14300 tk/9140hrs) 1.56
Difference -0.06
Actual Hours (hrs) 9140
-590.00 UF
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vi. Var. O/H Efficiency Var.
Standard hours (3000 unitsX2

hrs+1500unitsX1.5 hrs) 8250
Actual Hours 9140
Difference -890
Standard Rate 1.50
-1335.00 UF
vii Fixed O/H Expenditure Var.
Standard Fixed O/H costs

(2200X 8tk. +1800UnitsX6tk.) 28400.00
Actual Fixed Overhead costs 27000.00
Expenditure Variance 1400.00 Fav.
viii
. Fixed O/H Volume Variance B C
Budgeted Volume 2200.00 1800
Actual Volume 3000.00 1500
Difference 800.00 -300.00
budged fixed cost per unit 8.00 6
-
1800.0
6400.00 0
Variance 4600.00
Sales mix profit margin

ix. variance
Actual
sales Standar
at standard Actual Differen d
mix Sales ce Profit Variance
2625
Product B (2200/4000*4500) 2475.00 3000 525.00 50 0
-
2821
Product C (1800/4000*4500) 2025.00 1500 -525.00 53.75 9
Unfa
4500.00 -1969 v.
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x sales Quantity profit variance
Actual sales
at standard Budget Differen Standard
mix ed sales ce Profit Variance
2475.00 2200 275.00 50 13750
2025.00 1800 225.00 53.75 12094
25844 Fav.
Standard Actual Differen Actual
xi. Sales Price variance Price Price ce Qty
Product B 100.00 110 10.00 3000 30000 Fav.
Product C 107.50 105 -2.50 1500 -3750 Unf.
26250 Fav.
Solution Summary
Budgeted Profit
Product B Product C Total
Unit budgeted (A) 2200 1800
Target profit per unit (B) 50 53.75
Budgeted Profit (AxB) 110000 96750 206750
W1 Standard Cost per unit 50 53.75

Mark Up @ 100% on cost 50 53.75
Statement of Reconciliation
Budgeted profit 206750
sales mix profit margin var -1969 A
sales quantity profit var. 25844 F
sales price variance 26250 F
cost variances
material price 3200.00
material usage -500.00
DL rate Var -4000.00
DL Effi. Var -6230.00
Var. f/OH exp. Var -590.00
VAr. f/OH eff. Var -1335.00
Fixed O/H exp. Var 1400.00
Fixed O/H volume. Var 4600.00
Total Cost Variances -3455.00 -3455.00
Actual Profit 253420
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Q. No. 4
DANISH Food Ltd manufactures condensed milk at its Narayanganj Plant. The plant has been
experiencing problems as shown by its June contribution format income statement below:
Budgeted Actual
Sales (15,000 containers) Tk.450,000 Tk.450,000
Variable Expense
Variable cost of goods sold 180,000 196,290
[Direct Materials, Direct labor, and variable
manufacturing overhead)
Variable selling expenses 20,000 20,000
Total variable expenses 200,000 216,290
Contribution margin 250,000 233,710
Fixed Expenses:
Manufacturing Overhead 130,000 130,000
Selling and administrative 84,000 84,000
Total Fixed Expenses 214,000 214,000
Net Operating Income 36,000 19,710
Mr. Mahmud, who has just been appointed general manager of the Plant, has been given
instructions to “get things under control”. Upon reviewing the plant’s income statement, Mr.
Mahmud has concluded that the major problem lies in the variable cost of goods sold. He has
been provided with the following standard cost per Milk Container:
Standard Quantity Standard Price or Standard Cost

or Hours rate
Direct Materials 0.30 pounds Tk.20.00 Tk.6.00
Direct Labor 0.20 hours Tk.24.00 Tk.4.80
Variable Manufacturing Overhead 0.10 hours* Tk.12.00 Tk.1.20
Total Standard Variable Cost Tk.12.00
*based on machine hours
Mr. Mahmud has determined that during the June the plant produced 15000 containers of
condensed milk and incurred the following costs:
a. Purchased 6000 pounds of materials at a cost of Tk.19.50 per pound.
b. Used 4920 pounds of materials in production. (Finished goods and work in process
inventories are insignificant and can be ignored).
c. Worked 2950 direct labor hours at a cost of at a cost of Tk.28 per hour.
d. Incurred variable manufacturing overhead cost totaling Tk.18,290 for the month. A total
1475 machine hours were recorded.
It is the company’s policy to close all variances to cost of goods sold on a monthly basis.
49 | P a g e
Required:
1. Compute the following variances for June:
a. Direct materials price and quantity variances.
b. Direct labor rate and efficiency variances.
c. Variable overhead spending and efficiency variances.
2. Summarize the variances that you computed in (1) above by showing the net overall
favorable or unfavorable variance for the month. What impact did this figure have on the
company’s income statement?
3. Pick out two most significant variances that you computed in (1) above. Explain to Mr.
Mahmud possible causes of these variances.
Solution
Req#01
Direct Material
Direct Materials Price Variance = (Tk.20-Tk.19.50)*6000 = 3000 (F)
Materials Quantity Variance = (4500-4920)*Tk.20 = 8400 (UF)
Direct Labor
Direct Labor Rate Variance = (Tk.24-Tk.28)*2950 = (11800) (UF)
Direct Labor Efficiency Variance = (3000-2950)*Tk.24 = 1200
Variable Manufacturing Overhead

Spending Variance = (Tk.12-Tk.12.40)*1475 = 590 (UF)
Efficiency Variance = (1500-1475)*Tk.12 = 300 (F)
Req#02 Summary of variances
Tk. Favorable/(unfavorable)
Direct Materials Price Variance 3000 F
Materials Quantity Variance (8400) F
Direct Labor Rate Variance (11800) (UF)
Direct Labor Efficiency Variance 1200 (F)
Spending Variance (590) (UF)
Efficiency Variance 300 F
Net Variances (16290) (UF)
The net unfavorable variances of TK.16290 for the month caused the plant’s variable cost of
goods sold to increase from the budgeted level of tk. 200,000 to Tk. 216290. Thereby net
operating profit also decreased by Tk. 16290 (from Tk.36000 to Tk.19710).
3. Two most significant variances are the materials quantity variance and the labor rate variance.
Possible causes of the variances include:
50 | P a g e
Materials quantity variance:

 Poor quality of materials
 Low Priced materials
 Faulty materials, Untrained workers and supervision.
Labor rate variance:
 Skilled workers with high hourly rate due to scarcity of labor
 Excess payment for overtime (due to lack of required labor)
 Regulation may change to rise in higher wages
Problem no.5
A company manufactures Product P by mixing three materials. The standard material quantity and
materials cost per unit of product P are as follows:
Material W 12 kg @ Tk.5.00 60
Material X 18 kg @ Tk.6.00 108
Material Y 20 kg @ 8.00 160
328
In February, the actual mix used was as follows:

Material W 970 kg 4,947
Material X 1230 kg 7,134
Material Y 1400 kg 11,060
The actual output was 76 units of Product P.
Required:
Calculate the following variances for February
i. The total material mix variance
ii. The material yield variance
Solution
See CIMA Book or CIMA Exam KIT
Problem no.5
The following data are available for Product A, B and C [CIMA NOV 12]
Budget
Product A Product B Product C
Sales units 6000 8400 9600
Selling price per unit 150 160 70
Variable cost per unit 75 90 45
Actual
Sales units 6400 9200 8700
Selling price per unit 142 168 77
Variable cost per unit 69 92 48
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Required:
i. Calculate the total sales mix contribution variance
ii. Calculate the total sales quantity contribution variance
Solution:
Sales mix contribution variance
Product Actual Sale Qty Actual sales Difference Contribution Variance
at budget mix
A 6000 6075 75 F 75 450
B 8400 8505 105F 70 588
C 9600 9720 120F 25 240
24000 24300 300 1278
Sales quantity contribution variance

Product Budget Sales Actual sales Difference Contribution Variance
at budget mix
A 6400 6075 325F 75 24375F
B 9200 8505 695 F 70 48650F
C 8700 9720 1020A 25 25500A
24300 24300 47525F
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Exercise 1
GH manufactures a product using skilled labour and high quality materials. The company
operates a standard costing system and a just-in-time (JIT) purchasing and production system.
The standard selling price and variable costs for one unit of the product are as follows:
Selling price 136

Materials (2 kg @ $10 per kg) 20
Labour (3 hours @ $24 per hour) 72
The budgeted sales for October were 38,000 units.

Actual results for October were as follows:
Production and sales 36,000 units selling price $134 per unit
Materials 76,000 kg costing $754,000
Labour 114,000 hours paid costing $2,656,000
Required
A. Prepare a statement that reconciles the budgeted contribution with the actual contribution
for October. Your statement should show the variances in as much detail as possible.
At a recent Board meeting the Management Accountant presented a statement showing the
variances for the previous quarter in total as follows:
Variance Adverse Favorable

Material Price Variance 15500
Material Usage variance 22500
Labor Rate Variance 130800
Labor Efficiency Variance 146400
Sales Volume Contribution Variance 182600
Sales Price variance 134000
The Production Director explained to the Board that, in an attempt to reduce costs, he made a
decision at the start of the three month period to adjust the labour mix by replacing some of the
skilled labour with semi-skilled labour and to reduce the quality of the materials used. The
standard costs were not adjusted to reflect these changes.
The Sales Director stated that the sales team were being forced to reduce the selling price due to
concerns expressed by customers about the quality of the product. There had also been a large
increase in customer complaints and returns of faulty products.
53 | P a g e
Required:
B. Discuss the performance of the Production Director using the information given in the
variance statement above.
The Management Accountant has provided more detailed information regarding the labour mix.
The labour cost shown in the original standard cost was made up as follows:
Skilled labour 1.8 hours @ $30 per hour $54

Semi-skilled labour 1.2 hours @ $15 per hour $18
TOTAL 3 HOURS USD 72
The actual mix of labour used in October was as follows:

Skilled labour 64,000 hours costing $1,750,000
Semi-skilled labour 50,000 hours costing $906,000
The Management Accountant has decided to undertake further variance analysis using the more
detailed information.
Required:
Calculate the following variances for October, taking account of the more detailed information
regarding the labour mix:
(i) The total labour efficiency variance
(ii) The total labour mix variance
(iii) The total labour yield variance
Solution: see Cima Nov 2013
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CHAPTER FIVE: DISCOUNTED CASH FLOW AND CAPITAL BUDGETING

(INVESTMENT APPRAISAL)
 Time Value of Money

 Compound Interest
 Discounting vs. compounding
 The cost of capital/discount rate/required rate of return
 Nature of Cash flows
Relevant Cash flows: which will be affected by decision making.

i. Opportunity Cost: Special type of relevant cost
ii. Avoidable Costs
iii. Differential or Incremental Cost
Non-relevant Costs:
i. Sunk costs or past costs
ii. Absorbed Fixed costs or overheads that will not increase or decrease as a result of the
decision being taken.
iii. Expenditure that will be incurred in the future, but as a result of decisions taken in the
past that cannot now be changed. Committed costs.
iv. Historical cost depreciation
v. Notional Costs
Cash flows to include= Cash flows if project accepted – cash flow if project rejected.
Stages in capital budgeting

1. Identify projects
2. Gather information from all parts of the value chain to evaluate alternative projects
3. Forecast all potential cash flows attributable to the alternative projects
4. Make decisions by choosing among alternatives (which investment yields the greatest
benefit and the least cost to the organization)
Appraisal methods
1. Net Present Value (NPV)
2. Internal Rate of Return (IRR)
3. The Profitability Index
4. The Payback Period
5. Accounting Rate of Return (Average Annual Profit / Average Value of Investment)
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Advantages and disadvantages of Appraisal methods
 Does it consider time value of money?

 What does it consider cash flows or accounting profit?
 Does it consider the whole life of the project?
 Is it easy to compute or difficult?
 Is it absolute amount or percentage?
 Is it easy to understand and compare?
Decision Criterion
 NPV is main selector

 Mutually Exclusive Project: the project with higher NPV is preferred
 Attitude toward risk is to be considered.
 A low risk project with a lower expected NPV may be preferred to a high risk project
with a higher NPV.
 IRR is normally reported as part of a project appraisal. However, since it is a relative
measure which lacks an element of scale it should not be used to select between
alternatives.
 A large project with a high NPV will normally be preferred to a small project with a
lower NPV but a higher IRR.
Categories of Cash flows
1. Net Initial Investment
a. Cash outflow to purchase the machine

b. Cash outflow for working capital
c. After tax cash inflow from current disposal of the old machine.
2. Cash flow from operations
a. Annual after tax cash flow from operations (excluding the depreciation effect)
b. Income tax cash savings from annual depreciation deductions
3. Terminal Cash Flow
c. After tax cash flows from terminal disposal of machines

d. After tax cash flows from terminal recovery of working capital
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Problem ONE
Unbreakable Manufacturing manufactures over 20,000 different products made from metal,
including building materials, tools, and furniture parts. The manager of the furniture parts division
has proposed that his division expand into bicycle parts as well. The furniture parts division currently
generates cash revenues of $5,000,000 and incurs cash costs of $3,550,000, with an investment in
assets of $12,050,000. One-fourth of the cash costs are direct labor.
The manager estimates that the expansion of the business will require an investment in working
capital of $25,000. Because the company already has a facility, there would be no additional rent or
purchase costs for a building, but the project would generate an additional $390,000 in annual cash
overhead. Moreover, the manager expects annual materials cash costs for bicycle parts to be
$1,300,000, and labor for the bicycle parts to be about the same as the labor cash costs for furniture
parts. The controller of Unbreakable, working with various managers, estimates that the expansion
would require the purchase of equipment with a $2,575,000 cost and an expected disposal value of
$370,000 at the end of its seven-year useful life. Depreciation would occur on a straight-line basis.
The CFO of Unbreakable determines the firm’s cost of capital as 14%. The CFO’s salary is $150,000
per year. Adding another division will not change that. The CEO asks for a report on expected
revenues for the project, and is told by the marketing department that it might be able to achieve cash
revenues of $3,372,500 annually from bicycle parts. Unbreakable Manufacturing has a tax rate of
35%.
Required:
1. Separate the cash flows into four groups:+(1) net initial investment cash flows,+(2) cash flows
from operations,+(3) cash flows from terminal disposal of investment, and+(4) cash flows not
relevant to the capital budgeting problem.
2. Calculate the NPV of the expansion project and comment on your analysis.
Solution
Try yourself. The problem is solved in the class.
Problem TWO
ABC Company is now considering investing in a machine to produce plastic furniture. The plastic
furniture will be produced in a building, owned by the company, which is vacant, and the land can be
sold for Tk.150 lacs after taxes, if building is not used for factory of plastic furniture. However, after
five years the land can be sold for Tk.200 lacs after adjustment for restoration costs and taxes.
Meanwhile the company spent Tk.25 lacs to investigate marketing potential of such plastic product.
The Chief Financial Officer of the company is preparing an analysis of the proposed new product. He
summarizes his assumptions as follows:
The cost of the machine is Tk. 100 lacs. The machine has estimated market value at the end of five
years of Tk. 3 lacs. The machine will be depreciated on a straight line basis over its useful lives.
Production by year during five year life of the machine is expected to be as follows:
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Year Year 1 Year 2 Year 3 Year 4 Year 5

Production units 5000 8000 12000 10000 6000
The price of plastic furniture in the first year will be Tk.2000 per unit. The plastic market is very
competitive, so the CFO believes that the price will increase by only 2 percent per year, as compared
to general inflation rate of 5 percent. First year production cost will be Tk.1000 per unit, production
costs are expected to grow at 10 percent per year. The company is subject to 35 percent corporate tax
rate. Management determines that an immediate (year 0) investment in different items of working
capital of Tk.10 lacs is required. Thereafter net working capital would be 10 percent of sales of the
year up to the 4th year and all working capital would be recovered in the 5th year.
The project would be financed by bank loans and equity at a debt-equity ratio of 70:30. Incremental
borrowing rate would be 13.50 percent and required rate of return on share capital is 19.50 percent.
Weighted average cost of capital to be rounded to nearest whole number.
Required:
Calculate Net Present Value (NPV) of the project and advise the company whether to accept the
investment project.
Solution
Question one
Figure in lacs Taka

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Investments
Plastic Furniture machines -100.00 3.00
Opportunity of land and building -150.00 200.00
Net Working Capital 10.00 10.00 16.32 24.97 21.22 0.00
Change in Working Capital -10.00 0.00 -6.32 -8.65 3.75 21.22
Total Cash flow of investment -260.00 0.00 -6.32 -8.65 3.75 224.22
Income
Sales Revenues 100.00 163.20 249.72 212.20 129.90
Operating costs 50.00 88.00 145.20 133.10 87.84
Depreciation 19.40 19.40 19.40 19.40 19.40
Income before taxes 30.60 55.80 85.12 59.70 22.66
Tax @35% 10.71 19.53 29.792 20.895 7.931
Income after taxes 19.89 36.27 55.33 38.81 14.73
Add: Depreciation 19.40 19.40 19.40 19.40 19.40
Cash flows from Operations 39.29 55.67 74.73 58.21 34.13
Total Cash flow from the project -260.00 39.29 49.35 66.08 61.96 258.35
PV factor @12%
( 13.5%*.65*.70+.19.5%*.3) 1.00 0.89 0.80 0.71 0.64 0.57
Discounted cash flows -260.00 35.08 39.34 47.03 39.37 146.59
NPV 47.42
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We see that project has positive Net present of value of Taka 47.42 lacs. Yes, I recommend for
accepting the project.
Topics: Inflation and Capital Budgeting
Tax payment
Problem THREE
LM is a supermarket chain that operates 500 stores. The company’s sales have fallen behind its
competitors as it currently does not offer its customers an online shopping service.
It is considering a proposal to establish an online shopping service using the technology of PQ,
an existing online retailer.
Sales revenue and gross profit

The number of customers using the online delivery service in the first five years is estimated to
be as follows:
Year 1 100,000 customers per week
Customers are expected to spend an average of $200 per week. Delivery to customers will be
free of charge. The expected gross profit margin is 20% of selling price.
Loss of existing in-store sales

It is estimated that 30% of customers purchasing online would have purchased in store if the
online facility was not available. The sales revenue per customer and gross profit margin on on-
line sales will be same as that for in-store sales.
Capital expenditure
LM will purchase a fleet of delivery vehicles costing $15 million. The vehicles will have a useful
life of five years and will be depreciated on a straight line basis. They will have no residual value
at the end of the five year period. The vehicles will be eligible for tax depreciation.
Contract with the online retailer

The contract with PQ will be for an initial period of 5 years. LM will pay $340 million to buy
one of PQ’s existing warehouses. LM will also invest $90 million to expand the facility. The
expanded warehouse will then be leased back to PQ for five years for a fee of $20 million per
annum. The cost of purchasing the warehouse and the expansion costs will not be eligible for tax
depreciation. The warehouse will have a realisable value of $350 million at the end of the five
year period.
LM will pay 1% of gross profit from the online business to PQ. LM will also pay a fee of $30
million per annum to license the technology and as a contribution towards PQ's research and
development costs.
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Other operating costs

The online operation will result in additional costs in the first year of $60 million, including
delivery costs but excluding depreciation. This amount will rise by $5 million each year as the
customer numbers increase.
Taxation
LM’s Financial Director has provided the following taxation information:
• Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in the
year of disposal.
• Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises,
the balance is paid in the following year.
• LM has sufficient taxable profits from other parts of its business to enable the offset of any pre-
tax losses on this project.
Other information
• A cost of capital of 12% per annum is used to evaluate projects of this type.
• Ignore inflation.
Required:
(a) Evaluate whether LM should go ahead with the proposal to establish an on-line shopping
service. You should use net present value as the basis of your evaluation. Your workings should
be rounded to the nearest $million.
(b) Explain TWO other factors that LM should consider before deciding whether to go ahead
with the contract.
Solution
W1 Gross profit
year 1 2 3 4 5
100000 120000 150000 160000 170000
10400 10400 10400 10400 10400
0.2 0.2 0.2 0.2 0.2
Profit 208.00 249.60 312.00 332.80 353.60
w2 Initial cash outlay
vehicle 15
Warehouse 340
expansion 90
445
Calculation of Tax deprecation
1st year 3.8 3.75
2nd year 2.8 6.56
3rd year 2.1 8.67
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4th year 1.58 10.25

5th year 4.75 15.00
Calculation of Operating Cash Flows

Gross profit 0 208.00 249.60 312.00 332.80 353.60
Cash operating expense 0 -60 -65 -70 -75 -80
Lost profit due to online
shopping 0 -62.4 -74.88 -93.6 -99.84 -106.08
cash inflow from leasse rental 0 20 20 20 20 20
Pay to PQ @1% of gross profit 0 -2.08 -2.496 -3.12 -3.328 -3.536
License fee 0 -30 -30 -30 -30 -30
depreciation Expenses -3.8 -2.8 -2.1 -1.58 -4.75
Taxable profit (A) 69.72 94.42 133.18 143.05 149.23
Tax at 30% 20.916 28.3272 39.954 42.9156 44.7702
Tax paid (B) -10.458 -14.1636 -19.977 -21.4578 -22.3851
Tax paid (second instalment) © 0 -10.458 -14.1636 -19.977 -21.4578 -22.3851
Add: depreciation 3.8 2.8 2.1 1.58 4.75
After Tax Operating Cash flows 63.06 72.60 101.14 103.20 110.14 -22.39
Year 0 1 2 3 4
5 6
Initial cash outlay -445 0 0 0 0
0
Terminal Cash flow 350
annual after tax cash flow -445 63.06 72.60 101.14 103.20 460.14 -22.39
Discount factor 1 0.892857 0.797194 0.71178 0.635518 0.567427 0.506631
-445 56.30536 57.87819 71.98903 65.58369 261.0964 -11.341
NPV 57
IRR
Calculation of Annual Tax

Taxable profit 73.52 97.224 135.28 144.632 153.984
Tax at 30% 22.056 29.1672 40.584 43.3896 46.1952
PROBLEM FOUR
PT is a major international computer manufacturing company. It is considering investing in the
production of micro-computers. These computers will be targeted at the education market with
the specific aim of encouraging children to learn computer science at an early age.
Sales of the micro-computers are expected to be 100,000 units in Year 1 and then to increase at
the rate of 20% per annum for the remainder of the project life. The project has a life of five
years.
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The company’s research and development division has already spent $250,000 in developing the
product. A further investment of $10 million in a new manufacturing facility will be required at
the beginning of Year 1. It is expected that the new manufacturing facility could be sold for cash
of $1.5 million, at Year 5 prices, at the end of the life of the project. The manufacturing facility
will be depreciated over 5 years using the straight line method.
The project will also require an investment of $3 million in working capital at the beginning of
the project. The amount of the investment in working capital is expected to increase by the rate
of inflation each year.
The selling price of the new product in Year 1 will be $45 and the variable cost per unit will be
$25. The selling price and the variable cost per unit are expected to increase by the rate of
inflation each year.
The micro-computers will be exclusively produced in the new manufacturing facility. The total
fixed costs in Year 1 will be $2.5 million including depreciation. The fixed costs are expected to
increase thereafter by the rate of inflation each year.
Taxation
PT’s Financial Director has provided the following taxation information:
year of disposal.
• PT has sufficient taxable profits from other parts of its business to enable the offset of any pre-
tax losses.
Other information
• Inflation is expected to be 4% per annum throughout the life of the project.
Required:
(a) Evaluate whether PT should go ahead with the investment project. You should use net present
value as the basis of your evaluation. Your workings should be rounded to the nearest $000.
(b) Explain TWO other factors that the company should consider before making a final decision
about the investment project.
Solution
(a)
Contribution Years 1 – 5
Year 1: 100,000 x $20 = $2,000k
Year 2: 100,000 x 1.2 = 120,000 x $20 = $2,400k x 1.04 = $2,496k
Year 3: 120,000 x 1.2 = 144,000 x $20 = $2,880k x 1.042 = $3,115k
Year 4: 144,000 x 1.2 = 172,800 x $20 = $3,456k x 1.043 = $3,888k
Year 5: 172,800 x 1.2 = 207,360 x $20 = $4,147k x 1.044 = $4,852k
Fixed Costs
Depreciation per annum = ($10m - $1.5m) / 5 = $1.7m
Fixed costs (excluding depreciation) per annum
= $2.5m - $1.7m = $0.8m
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Taxation Year 1 Year 2 Year 3 Year 4 Year 5

$000 $000 $000 $000 $000
Contribution 2,000 2,496 3,115 3,888 4,852
Fixed costs (800) (832) (865) (900) (936)
Net cash flows 1,200 1,664 2,250 2,988 3,916
Tax (2,500) (1,875) (1,406) (1,055) (1,664)
depreciation
Taxable profit (1,300) (211) 844 1,933 2,252
Taxation @ 390 63 (253) (580) (676)
30%
Net present Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

value
$000 $000 $000 $000 $000 $000
Investment / (10,000 1,500
residual value )
Working (3,000) (120) (125) (130) (135) 3,510
capital
Net cash flows 1,200 1,664 2,250 2,988 3,916
Tax cash flow 195 32 (127) (290) (338)
Tax cash flow 195 31 (126) (290) (338)
Net cash flow (13,000 1,275 1,766 2,024 2,437 8,298 (338)
after tax )
Discount 1.000 0.893 0.797 0.712 0.636 0.567 0.507
factors @ 12%
Present value (13,000 1,139 1,408 1,441 1,550 4,705 (171)
)
Net present value = - $2,928k

The net present value is negative therefore the project should not go ahead.
(b)
The project is concerned with the education of children in computer science and with
encouraging them to be involved in computer science at an early age. This is a new market for
the company and may have long term benefits if children start to use full scale computers at an
earlier age than normally would be expected.
Whilst the project makes a negative net present value the company may be able to improve its
brand image if it is seen to be supplying relatively low cost computers to the education market.
The company could benefit from being involved in this project as they are being seen to be
concerned with the education needs of children.
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PROBLEM NO: FIVE

MRT is considering whether to tender for a franchise to operate a government owned rail
network. Under the terms of the franchise agreement MRT would have to make a fixed annual
payment to government and would also be required to make significant investments to maintain
and develop the rail networks infrastructure. MRT would be entitled to the profits from operating
the rail network for the period of franchise.
The franchise is for a period of six years after which it will be put out to tender again.
Passenger numbers and fares:
Passenger numbers in year 1 are estimated to be 170M and will increase at a rate of 3% per
annum. Rail fares in year 1 will be Tk.10 per passenger and future price increase will be
restricted under the franchise agreement to the rate of inflation. MRT plans to implement the full
fare increase each year of franchise agreement. Inflation over the six year period of the franchise
is expected to be 4% per annum.
Capital Investment
MRT plans to make a total capital investment of Tk.700M in two installments. This will involve
introducing high speed trains, updating the existing train carriages and improving facilities at
railway stations. An investment of Tk.400M will be made at the start of the franchise. The
remaining Tk.300M investments will be made at beginning of year 4. At the end of the franchise,
the equipment is expected to have a residual value of Tk.100M at year six prices. Both
installments of capital investment will become eligible for tax depreciation when they are
incurred.
There will be requirement for working capital of TK.80M at the start of the franchise period. The
requirement of working capital will not be affected by inflation.
Costs
The estimated annual costs, at year 1 prices, over the franchise period are as follows:
Salary Costs BDT 400M

Fixed Maintenance costs BDT 80M
Payment to the Government BDT 1000M
Other fixed operating costs (excluding BDT 240M
depreciation)
The annual payment to the government will remain at year 1 prices throughout the period of the
franchise. All the other costs listed above will increase at the same rate of inflation as the
passenger fares.
Taxation
MTR’s Financial Director has provided the following taxation information:
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year of disposal.
• MRT has sufficient taxable profits from other parts of its business to enable the offset of any
pre-tax losses on this project.
Other information
Instructions
a. Evaluate whether MRT should tender for the nail franchise. You should use net present
value as the basis of your evaluation. Total revenue, total costs and tax benefits/charges
per annum should each be rounded to the nearest Taka. Ignore any costs to be incurred in
the tendering process.
b. Calculate sensitivity of the decision to tender to a change in passenger numbers.
c. Explain the benefits of carrying out a sensitivity analysis before making investment
decisions. You should use the figures calculated in (b) above to illustrate your answer.
Solution
Annual after tax cash flow
Year 0 1 2 3 4 5 6 7
Revenue 1700 1821 1950.7 2090 2238 2397.7
Costs:
payment to Government 1000 1000 1000 1000 1000 1000
other operating costs 720 748.8 778.752 809.9 842.3 875.99
Depreciation expenses 100 75 56 117 88 164
Taxable profit -120 -2.76 115.946 162.7 308.1 357.75
Tax@ 30% -36 -1 35 49 92 107
0 1 2 3 4 5 6 7
NPV calculation
capital investment -400 -300 100
Working Capital -80 80
65 | P a g e
115.94 162. 308. 357.7

Taxable profit -120 -2.76 6 7 1 5
Tax paid (1st installment) 18 1 -18 -25 -46 -54
Tax paid (1st
installment) 18 0 -17 -24 -46 -53
Add: Depreciation
expense 100 75 56 117 88 164
- 237. 326. 601.7
After tax cash flows -480 -2 91.24 146.05 7 1 5 -53
0.63 0.56 0.45
PV factor@12% 1 0.893 0.797 0.712 6 7 0.507 2
- 72.71 - 151. 184. 305.0
Discounted cash flows -480 1.786 8 103.99 2 9 9 -24
104.120
NPV 9
0 2 3 4 5 6 7 8
Revenue before tax 1700 1821.04 1951 2090 2238.4 2398
Revenue after tax [R(1-tax)] 1190 1274.73 1365 1463 1566.9 1678
PV factor 0.893 0.797 0.712 0.636 0.567 0.507
Discounted after tax revenue 1062.7 1015.96 972.2 930.3 888.41 851
5720.5
Sensitivity to no of revenue 1.818%
0 1 2 3 4 54 6 7
operating cost before tax 720 748.8 778.752 809.9 842.3 875.99
after tax operating costs 504 524.16 545.126 566.9 589.6 613.19
pv factor 0.893 0.797 0.712 0.636 0.567 0.507
discounted costs 450.07 417.76 388.13 360.6 334.3 310.89
2261.7
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PROBLEM SIX
Bethesda Mining is a midsized coal mining company with 20 mines located in Ohio,
Pennsylvania, West Virginia, and Kentucky. The company operates deep mines as well
as strip mines. Most of the coal mined is sold under contract, with excess production sold
on the spot market.
The coal mining industry, especially high-sulfur coal operations such a Bethesda bas been hard
hit by environmental regulations. Recently, however, a combination of increased demand for
coal and new pollution reduction technologies has led to an improved market demand for high
demand for sulfur coal. Bethesda has just been approached by Mid-Ohio Electric Company with
a request to supply coal for its electronic generations for next four years. Bethesda Mining does
not have enough excess capacity at its existing mines to guarantee the contract. The company is
considering opening a strip mine in Ohio on 5,000 acres of land purchased 10 years ago for Taka
6 million. Based on recent appraisal, the company feels it could receive Taka 7 million on an
after tax basis if it sold the land today.
Strip mining is a process where the layers of topsoil above a coal vein are removed and the
exposes coal is removed. Some time ago, the company would simply remove the coal and leave
the land unusable condition. Changes in mining regulations now force a company to reclaim the
land; that is, when the mining is completed, the land must be restored to near its original
condition. The land can then be used for other purpose. Because it is currently operating at all
full capacity, Bethesda will need to purchase additional necessary equipment, which will cost 85
million taka .The equipment will be depreciated on a seven –year straight schedule. The contract
runs for only four year. At that time the coal from the site will be entirely mined .The company
feels that the equipment can be sold for 60 percent of its initial purchase price in four years.
However, Bethesda plans to open another strip mine at that time and will use the equipment at
the new mine.
The contract calls for the delivery of 500,000 tons of coal per year at a price of 95tk per ton.
Bethesda mining feels that coal production will be 620,000 tons, 680,000 tons, 730,000 tons, and
590,000 tons, respectively over the next four years. The excess production will be sold in the
spot market at an average of 90tk per ton. Variable costs amount to 31tk per ton, and fixed costs
are 4,300,000tk per year. The mine will require a net working capital investment of 5 percent of
sales. The NWC will be built up in the year prior to the sales.
Bethesda will be responsible for reclaiming the land at termination of the mining. This will be
occur in year 5. The company uses an outside company for reclamation of all the company’s
strip mines. It is estimated the cost of reclamation will be 2.8 million taka. After the land is
reclaimed, the company plans to donate the land to the state for use as a public park and
recreation area. This will occur in year 6 and result in a charitable expense deduction of 7.5
million taka. Bethesda faces a 38 percent tax rate and has a 12 percent required return on new
strip mine projects. Assume that a loss in any year will result in a tax credit.
67 | P a g e
You have been approached by the president of the company with a request to analyze the project.
Calculate the payback period, profitability index, average accounting return, net present value,
internal rate of return, and modified internal rate of return for the new strip mine. Should
Bethesda mining taka the contract and open the mine?
Solution
W1
Calculation of Initial Investment

Opportunity cost of land 7
cost of equipment 85
Working Capital 2.92
94.9
w2 Calculation of depreciation
cost of equipment 85
Less: Residual Value 0
Depreciable value 85
Annual depreciation 12.1
w3 Calculation of Annual operating cash flow

0 1 2 3 4 5
Revenue
contract sales 47.5 47.5 47.5 47.5
spot market sales 10.8 16.2 20.7 8.1
less: variable costs -19.22 -21.08 -22.63 -18.29
Less: Fixed costs -4.3 -4.3 -4.3 -4.3
Depreciation -12 -12 -12 -12
Taxable profit 22.78 26.32 29.27 21.01
Tax 8.6564 10.0016 11.1226 7.9838
After tax profit 14.1236 16.3184 18.1474 13.0262
Add: Depreciation 12 12 12 12
Annual after tax
operating cash flow 26 28 30 25
W4 Cash from sale of equipment after four years

Sale value 51
Less: tax on capital
Loss/Gain -5.32
45.7
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w5 Calculation of capital loss/gain

cost 85
less: depreciation 48
Book value 37
Sales value 51
Capital Gain 14
Working capital Assessment
47.5 47.5 47.5 47.5

10.8 16.2 20.7 8.1
58.3 63.7 68.2 55.6
2.92 3.185 3.41 2.78 0
increase in working capital 2.920 0.270 0.225 -0.630 -2.780
Topics
Replacement Decision
Sensitivity Analysis
Scenario Analysis
Capital Rationing
Project Selections
PROBLEM SEVEN
Mr. Ishtiaque, a partly qualified student of ICMAB has recently joined in Fresh Food Processing
Limited, a private limited company. The CFO of the company is skeptical with regard to
competence of CMA student. In first day of Mr. Ishtique, the CFO asked him to recommend
appropriate course of action regarding the replacement of old machinery with new machinery
that has more capacity and is less costly to operate. The characteristic of the old and new
equipment are given below:
Existing Machinery Proposed Machinery

Current Book Value Tk. 400,000
Current Market Value Tk. 600,000 Acquisition cost Tk. 1000,000
Remaining Life 10 years Expected Life 10 Years
Annual Sales Tk. 300,000 Annual Sales Tk. 450,000
Cash Operating Tk. 120,000 Cash Operating Tk. 150,000
Expenses Expense
Annual Depreciation Tk. 40,000 Annual Depreciation Tk. 100,000
Accounting Salvage 0 Accounting Salvage 0
Value Value
Expected Salvage Value Tk. 100,000 Expected Salvage Tk. 200,000
Value
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Additional Information:
i. If the new equipment replaces the old equipment, an additional investment of
Tk.80,000 in net working capital will be required.
ii. The project will be financed by Debt: Equity Ratio of 70: 30. Required rate of return
on equity is 20% and effective interest rate on bank loan is 16.30%. The corporate tax
rate is 30%
Required:
Calculate the net present value of replacement of existing machine and advise the company on the
acceptability of the proposed purchase.
Solution
Workings
Initial Outlay= Cost of new machine + Net Working Capital – Net cash from sale of old machine
= 1000,000 + 80000 – 540,000
= 540,000
New machine Old machine Difference
Revenue from Sales 450000 300000 150000
Cash Operating Expense 150000 120000 30000
Depreciation 100000 40000 60000
EBIT 200000 140000 60000
Tax @30% 60000 42000 18000
PAT 140000 98000 42000
Plus: Deprecation 100000 40000 60000
Cash flows from Operation 240000 138000 102000
Terminal Cash flows

New Old Difference
Resale value 200000 100000 100000
Less: Tax on Capital 60000 30000 30000
Gain
Working Capital 80000
Total 150000
Discount rate
= 20%X30%+16.30%X(1-0.30)X70%
=14%
Calculation of NPV
Year Cash flows PV Factor @14% Discounted cash flows

0 (540000) 1 (540000)
1-10 102000 5.216 (PVAF14%,10 yrs) 532040
10 150000 0.27 (PVF14%,10 yrs) 40500
NPV 32540
Decision: As NPV is Positive, I recommend for purchasing new machines.
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PROBLEM EIGHT
LM is concerned that replacing the delivery vehicles every five years will result in breakdowns
and customer complaints. It is therefore considering whether to replace the vehicles on a one,
two or three year cycle. The proposed contract with the online retailer expires after five years
however at the end of this period LM will continue to operate the online business. The delivery
vehicles will therefore require to be continually replaced.
Each vehicle costs $25,000. The operating costs Year 1 Year 2 Year 3
per vehicle for each year and the resale value at the $ $ $
end of each year are estimated as follows:
Operating costs 6,000 8,000 12,000
Resale value 16,000 10,000 4,000
Required:
Calculate, using the annualised equivalent method, whether the vehicles should be replaced on a
one, two or three year cycle. You should assume that the initial investment is incurred at the
beginning of year 1 and that all other cash flows arise at the end of the year. Ignore taxation and
inflation and use a cost of capital of 12%.
Solution
(c) Replace after Year 1 Replace after Year 2 Replace after Year 3
Year Discount Cash Present Cash Present Cash Present value
Factor flows value flows value flows $
@12% $ $ $ $ $
0 1.000 (25,000) (25,000) (25,000) (25,000) (25,000) (25,000)
1 0.893 10,000 8,930 (6,000) (5,358) (6,000) (5,358)
2 0.797 2,000 1,594 (8,000) (6,376)
3 0.712 (8,000) (5,696)
Net present value (16,070) (28,764) (42,430)
Cumulative 0.893 1.690 2.402
discount factor
Annualised (17,996) (17,020) (17,664)
equivalent
The lowest annualised equivalent cost occurs if the vehicles are kept for two years. Therefore the
optimum replacement cycle is to replace the vehicles every two years.
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Extra Problems
PROBLEM NINE
Xyz builders limited need to acquire the use of a crane for their construction business, and are
considering buying or leasing a crane. The crane costs TK.1M and its subject to the straight line
method of depreciation to a zero salvage value at the end of five years. In contrast, the lease rent
is Tk.2,20,000 per year to be paid in advance each year for five years. ZYZ Builders Limited can
raise debt at 14 percent payable in equal installments, each year installments due at the end of the
year. The company is in the 50 percent tax bracket. Should it lease or buy the equipment.
PROBLEM TEN
The equipment could be acquired on lease for a 4 year year contract period. The lease payment
of 5 lakh per is to be paid at the beginning of each year. The lease would also include
maintenance of the equipment.
The equipment could also be purchased for TK.2M financing the purchase by a bank loan for the
net purchase price. Under the borrow to purchase arrangement, Padma Security Systems Ltd.,
would have to maintain the equipment at cost of Tk.40000 per year, payable at year end. The
company charges depreciation at 30% p.a. on diminishing balance method for such type of
equipment. The depreciation is fully allowed for tax purposes. The expected residual value after
four years is 4 lakh. The company will replace the equipment after four years irrespective of
whether it buy or lease the equipment. The company has a tax rate of 35% and it’s after tax cost
of debt is 13%.
Required:
Calculate the PV of the equipment cost under lease or purchase option
PROBLEM ELEVEN
A bus operator has been experiencing a fall in passenger numbers over the past few years as a
result of intense competition from other transport providers. The company directors are
concerned to improve profit and are considering two possible alternatives.
Passenger volume last year was 20,000 passengers per day. The average fare was $2 per
passenger per day and variable costs per passenger per day were $0.50. If no investment is made
the current passenger volume, average fares and variable costs will remain the same on current
routes for the next five years. The company operates a full service for 365 days of the year.
Project 1 The company hired a management consultant, at a cost of $50,000, to review the
company’s fare structure. The consultant recommended that the company reduce fares by 10%
which will result in a 20% increase in passenger volume in the first year. In order to maintain
this level of passenger numbers, fares will remain at the reduced rate for years 2 to 5.
The increase in passenger numbers will result in the need for four new buses costing $250,000
each. The new buses will be depreciated on a straight line basis over their useful life of 5 years.
They will have no residual value at the end of their useful life. Other annual fixed costs,
including advertising costs, will increase by $100,000 in the first year and will remain at that
level for the life of the project. Variable costs will remain at $0.50 per passenger per day for the
life of the project.
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Project 2 Increase the number of buses to enable new routes to be opened. The new buses are expected to
cost $5,000,000 in total and have a useful life of five years with no residual value. Fixed costs, including
straight line depreciation, are expected to increase by $3,500,000 in the first year, as a result of opening
the new routes. Fixed costs will remain at the higher level for the life of the project. Additional working
capital of $1,000,000 will also be required.
The passenger numbers for year 1 on the new routes are predicted as follows:
Passenger numbers per day Probability

6,000 50%
9000 30%
12000 20%
It is expected that passenger numbers will increase by 3% per annum for the following four years. The
average fare per passenger for year 1 will be $2 and will remain at that level for the life of the project.
Variable costs will remain at $0.50 per passenger per day for the life of the project.
Additional Information Taxation and inflation should be ignored.
The company uses a cost of capital of 8% per annum.
Required
Advise the management of the company which project should be undertaken based on a financial
appraisal of the projects.
You should use net present value (NPV) to appraise the projects.
(ii) Explain TWO other major factors that should be considered before a final decision is made.
(b) Calculate the sensitivity of the choice between Project 1 and Project 2 to a change in passenger
numbers for Project 2.
Company D is planning its capital investment programme for next year. It is considering four potential
projects all of which have a positive net present value. The initial investment, internal rate of return (IRR)
and net present value (NPV), based on a cost of capital of 12%, are given below for each project.
Project Investment $000 NPV at 12% $000 IRR
A 50 13.6 12.6%
B 40 15.2 10.3%
C 20 10.2 13.1%
D 30 12.3 11.2%
Funding for the company is restricted to $110,000. The projects are independent and divisible i.e. part of
a project can be undertaken.
Required:
Prioritise the projects and determine how much funding should be allocated to each project
Solution
CIMA EXAM KIT March 2011
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CHAPTER SIX: Working Capital Management
Topics to be discussed
1. Inventory Management
2. Receivable Management
3. Cash Management
4. Short term sources of financing
5. Short term mode of investment/ investment
6. Working capital management policy
Inventories Management
Economic Order Quantity

1. Safety Stock
2. Re-order point
3. Normal Maximum Inventory
4. Absolute Maximum Inventory
5. Average Inventory
6. ABC methods for maintenance of materials
7. FIFO and Weighted Average method of Inventory valuation
Problem#1
PR is a retailer of bicycles. The most popular children’s bicycle has an annual demand of 30,000
units. Demand is predictable and spread evenly throughout the year.
The bicycles are purchased by PR for $200 each. Ordering costs are $150 per order and the
annual cost of holding one bicycle in inventory is $25
Calculate the economic order quantity (EOQ) for the children’s bicycle.
Calculate the total annual ordering and holding costs for the bicycle assuming the company
purchases the EOQ, does not hold any buffer inventory and the lead time is zero.
Problem 1(A)
D company uses component V22 in its construction process. The company has a demand of
45000 component pa. They cost $4.50 each. There is no lead time between order and delivery
and ordering costs amount to $100 per order. The annual cost of holding is 14.44%.
A 0.5% discount is available on orders of at least 3000 components and a 0.75% discount is
available if the order quantity is 6000 components or above.
Required: Calculate optimal order quantity.
Solution
EOQ = (2x45000x100/0.65)0.50
= 3721
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Order size 3000 units EOQ 6000

(3721)
Ordering costs =45000/3000=15 =45000/3721= =45000/6000
(no of orders*ordering orders*100 =1209 =750
cost) (A) =1500
Carrying costs (B) =3000/2*4.5*14.44% 1209 1949
=Average inventory =1500*4.5*14.44%
value*CC% =975
Savings from discount =(1013) =(1013) (1519)

(C) =45000*4.5*0.5% 45000*4.5*0.5% 45000*4.5*0.75%\
Net costs (A+B-C) 1462 1405 1180
Ans: optimal quantity of order is 6000 units. Because it offers the lowest costs.
Problem#2
Working days per year 250 days

Normal use per day 500 units
Maximum use per day 600 units
Minimum use per day 100 units
Lead Time 8 days
Variable cost of placing one order 16200
Variable carrying cost per unit per year 20.00
Required: Compute the following
i. Economic order of quantity

ii. Safety stock
iii. Re-order point
iv. Normal maximum inventory
v. Absolute maximum inventory
vi. Average normal inventory
vii. Total carrying costs
viii. Total ordering costs
Solutions
EOQ= 14230
Safety stock= Max use – Normal use X lead time = (600-500)X8 days= 800 kg
Re-order point = (normal usage X lead time)+ safety stock

= (500 kg x 8 days) + 800 kg
= 4800 kg
Normal Max Inventory = (EOQ+Safety stock) = 14230+800 = 15030
Absolute Max Inventory = (Normal Use per – Min use per day)X lead time + EOQ+Safety stock
= (500 -100)x8 days +14230+800
= 18230 kg
Average stock = [EOQ/2+safety stock]

= 14230/2+800
= 7915
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Problem#3:
Montreal Company has developed the following costs and other data pertaining to one its raw
materials.
Working days per year 250 days
Normal use per day 400 units
Maximum use per day 600 units
Minimum use per day 100 units
Lead Time 8 days
Cost of placing one order 16200
Carrying cost percentage 10%
Cost of per unit of raw material 2.50
Required: Compute the following
ix. Economic order of quantity

x. Safety stock
xi. Re-order point
xii. Normal maximum inventory
xiii. Absolute maximum inventory
xiv. Average normal inventory
xv. Total carrying costs
xvi. Total ordering costs
Solution
EOQ= 4000 units
Safety stocks = (max use per day- normal use per day)X lead time= 1600 units
Reorder point = Normal lead time usage + safety stock = (400 units x 8 days)+1600 units= 4800
units
Normal maximum inventory = safety stock + EOQ = 1600 + 4000 =5600 unit
Absolute maximum inventory = 5600 units + (normal use – minimum use) x lead time = 5600
units + 2400 units = 8000 units
Average normal inventory = safety stock + Average of EOQ= 1600 + 2000 = 3600 units
Total carrying costs = (EOQ/2+safety stock)x 2.5x 10%
Total order costs = no. of orders x ordering cost per order

(Total annual demand/EOQ)x
Problem#4:
Madina water tank company wants to produce new water pump besides its plastic water tank
having estimate production capacity of 6250 units per month. Madina requires to purchase
similar quantity of valves in order to manufacture the water pump costing Tk.150 per unit. The
carrying cost is estimated at 20% average inventory investment on the annual basis. The cost to
place and process the delivery is Tk.1800.
It takes 45 days to receive delivery from the date of an order and a safety stock is Tk.3250 value
is desired.
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Required:
i. The most economic order quantity and frequency of order in a year
ii. The order point
iii. The most economic order quantity, if the valves cost Tk.450 each instead of Tk.150 each.
Solution
√2XARxOC
𝐸𝑂𝑄 = CC
√2X6250x12x1800
𝐸𝑂𝑄 =
150x20%
EOQ = 3000 units
No. of orders = Total Annual Requirement /EOQ

= 75000/3000
= 25 order
Re-order point = (normal use per day x lead time)+ safety stock
= (6250/30 x 45) + (3250/150)
= 9397 units
When per unit cost is Tk.450, EOQ is as calculated below:
√2X6250x12x1800
𝐸𝑂𝑄 =
450x20%
= 1732 units
Receivables Management
Problem 5:
A company is concerned about its cash flow position. It has reviewed its trade receivable days
and is considering offering an early settlement discount. The company currently receives
payments from customers on average 65 days after the invoice date. The company’s current
credit terms are 30 days after the invoice date. The company is considering offering a 2% early
settlement discount for payment within 20 days of the invoice date.
Calculate the effective annual interest rate of the early settlement discount. You should use
compound interest methodology and assume a 365 day year
State TWO other methods that could be used to reduce the trade receivable days
77 | P a g e
Solution
= (2/45)/98X365X100= 17%
= (Discount Rate X 365X100)/ [(100-discount rate) X time saved due to offering discount]
Compound annual effective rate

=(1+2/98X100)365/45 -1
= 17.81%
= (discount amount/100-discount amount)365 days/time saved for allowing discount
Problem 6
A company is considering a change in its credit policy. It has estimated that if credit terms are
extended from 30 days to 60 days, total annual sales will increase by 10% from the current level
of Tk.12 Million. It has been estimated that as a consequence of the change in credit terms and
higher sales volume, bad debts would increase from 2% to 3% of sales. The company’s cost of
capital is 8%.
The increase in sales would not affect annual fixed costs. The contribution to sales ratio is 40%.
Required
Calculate the effect of the change in credit policy on the annual profit before taxation. Assume a
360 day year of 30 days each month.
Solution
Existing Policy New Policy
Investment in A/R =12000000/360*30 =13200000/360*60
=10,00,000 =22,00,000
Costs and benefits of new policy

Existing policy New Policy Difference
Contribution margin 48,00,000 52,80,000 4,80,000
Cost of working (80000) (176000) (96000)
capital (1000000*8%) (22,00,000*8%)
Bad debt expense (240000) (396000) (156000)
(12000000*2%) (13200000*3%)
Net Benefits/(costs) 2,28,000
Ans: As the new policy increases profit of the company by Tk.2,28,000, new policy should be
implemented.
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Problem 7
Calculate the effective annual interest rate of the early settlement discount. You should use
compound interest methodology and assume a 365 day year.
1. A company is offering a cash discount of 2.5% to receivables if they agree to pay debts
within one month. The usual credit period taken is 3 months.
2. 1.75% discount for payment within 3 weeks; alternatively, full payment must be made
within eight weeks of the invoice date. Assume there are 50 weeks in a year.
3. The company currently receives payments from customers on average 65 days after the
invoice date. The company’s current credit terms are 30 days after the invoice date. The
company is considering offering a 2% early settlement discount for payment within 20
days of the invoice date.
Solutions:
Requirement 1:
= [1+ (discount amount/100-discount amount)365 days/time saved for allowing discount -1
Effective Annual Interest Rate =[1+2.5/97.50)12/2 -1]= 16.40%
Effective Annual Interest Rate =[1+1.75/98.25)50/5 -1]= 19.31%
Effective Annual Interest Rate =[1+2/98)365/45 -1]= 17.81%
Problem#8:
Marton co produces a range of specialized components, supplinga wide range of customers, all
on credit terms. 20% of revenue is sold to one firm. Having used generous credit policies to
encourage past growth, marton co now has to finance a substantial overdraft and is concerned
about its liquidity.
Marton co borrows from its bank at 13% pa interest. No further sales growth in volume or value
terms is planned for the next year.
In order to speed up collection from customers, marton co is considering two alternative policies.
Option one:
Factoring on a non-recourse basis, the factor administering and collecting payment from marton
Co’s customers, this is expected to generate administrative savings of $200,000 pa and to lower
the average receivable collection period by 15 days. The factor will make a service charge of 1%
of marton Co’s revenue and also provide credit insurance facilities for an annual premium of
$80,000
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Option two:
Offering discounts to customers who settle their accounts early. The amount of the discount will
depend on speed of payment as follows.
Payment within 10 days of dispatch of invoices 3%
Payment within 20 days of dispatch of invoices 1.5%
It is estimated that customers representing 20% and 30% of martonCo’s sales respectively will
take up these offers, the remainder continuing to take their present credit period.
Extracts from marton co’s most recent accounts are given below:
000
Sales (all on credit) 20000
Cost of sales 17000
Operating profit 3000
Current Assets
inventory 2500
receivables 4500
cash nil
Required:
Calculate the relative costs and benefits in terms of annual profit before tax of each of the two
proposed methods of reducing receivables, and identify the most financially advantageous
policy.
Solution
Total Working Capital Management
Problem:9
An extract from WCC’s trial balance at the end of its financial year is given below: $000
Sales revenue (80% on credit) 1,400
Cost of sales 1,215
Purchases of materials (95% on credit) 915
Inventories at end of year
Raw materials 85
Finished goods 90
Trade receivables 185
Trade payables 125
Calculate working capital cycle of the company
Materials holding period = (365 X Average Raw Material Inventory)/Total Purchase

= (365X85)/915
= 34 days
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Finished Goods Holding Period = (365 X Average Finished Inventory)/Total Cost of sales
= (365 x 90)/1215
= 27 days
Receivables Holding Period = (365x Average A/R)/Total credit sales

= (365 x 185)/1120
= 60 days
Payables Holding Period = (365x average payables)/ total credit purchase

= (365 x 125)/869
= 53 days
Working capital cycle of the company/ Cash Conversion Cycle of the company=
Materials holding period + Finished Goods Holding Period + Receivables Holding Period –
Payables Holding Period
= 34 days+27 days+60 days – 53 days
= 68 days
Problem: 10
A newly formed company has applied for a loan to a commercial bank for financing its working
capital requirements. You are requested by the bank to prepare an estimate of the requirements of
the working capital of the company. Add 10% to your estimated figure to cover unforeseen
contingencies. The information about the projected profit and loss account of this company is as
under:
Sales 21,00,000.00
Cost of Goods Sold 15,30,000.00
Gross Profit 570,000.00
Administrative expenses 140,000

Selling expenses 130,000
270,000.00
Profit before tax 3,00,000
Provision for tax 1,00,000
Cost of goods sold

Materials used 8,40,000.00
Wages and manufacturing expenses 6,25,000.00
Depreciation 2,35,000.00
17,00,000.00
Less: stock of finished goods 170,000.00
COGS 15,30,000.00
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The figures given above relate to the goods that have been finished and not to work in
progress; goods equal to 15 percent of the year’s production (in terms of physical units)
are in process on an average requiring all materials but only 40% of other expenses. The
company believes in keeping two months consumption of material in stock; desired cash
balance is tk. 40,000.00
Average time lag in payment of all expenses is 1 month; suppliers of materials extend 1.5
months credit; sales are 20% cash, rest are at two months credit; 70 percent of the income
tax has to be paid in advance in quarterly installments.
You can make such assumptions as you deem necessary for estimating working capital
requirements.
Solutions
Inventories Taka Taka
Raw Materials (840000*2/12) 140000
Work in Process (840000+625000*40%)*15% 163500
Finished Goods (840000+625000)*10% 146500
450000
Account Receivables (1530000-235000*90%)*80%/12*2 175800
Cash 40000
Total Current Assets 665800
Accounts Payable (840000*1.5/12) 105000

Wages & Manufacturing exp. 625000/12 52083
Admin and Selling expense (270000/12) 22500
Total Current Liabilities 179583
Net Working Capital Required 486217
Add: 10% contingency 486217*10% 48622
534839
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Problem:11
You have been given the following information for a company
Summarized balance sheets (statement of financial position) as at 30 June
2007 (000) 2006 (000)
Non-current Assets 130 139
Current Assets:
Inventory 42 37
Receivables 29 23
Bank 3 5
74 65
Total Assets 204 204
Equities & Liabilities
Ordinary Share Capital (50% shares) 35 35
Share Premium Account 17 17
Revaluation Reserve 10 --
Profit & Loss Account 31 22
93 74
Non-current liabilities
5% secured loan notes 40 40
8% preference share 25 25
Current Liabilities
Trade Payables 36 55
Taxation 10 10
46 65
Summarized income statement for the year ended 30 June
2007 (000) 2006(000)

Sales 209 196
Opening Inventory 37 29
Purchase 162 159
Closing Inventory (42) (37)
Cost of Goods Sold 157 151
Gross Profit 52 45
Finance Costs 2 2
Depreciation 9 9
Sundry Expense 14 11
Operating profit 27 23
Taxation 10 10
Profit After Taxation 17 13
Dividends:
Ordinary Shares 6 5
Preference Shares 2 2
Retained Profit 9 6
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Required:
I. Calculate Liquidity Ratios in 2006 and 2007
II. Calculate length of working capital in 2006 and 2007
III. Evaluate whether the working capital is being managed effectively?
Solution: Solution is provided in CIMA text book. This is a very important problem. Try to
solve it.
Problem 12
The following data relate to Mugwump Co., a manufacturing company
Sales revenue for year 15,00,000

Cost as percentage of sales
Direct Materials 30%
Direct Labor 25%
Variable overheads 10%
Fixed Overheads 15%
Selling & distribution 5%
Average statistics relating to working capital are as follows:
Receivables take 2 ½ months to pay

Raw materials are in inventory for three months
WIP represents two months’ half produced goods
Finished goods represent one month’s production
Credit is taken
- Materials - 2 months
- Direct Labor – 1 week
- Variable Overheads 1 month
- Fixed overheads 1 month
- Selling & distribution ½ month
WIP and finished goods are valued at the cost of material, labour and variable expenses.
Required
Calculate the working capital requirement of Mugwump Co assuming that the labor force
is paid for 50 working weeks each year.
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Inventories Taka Taka
Raw Materials (1500000*0.3*3/12) 112500
Work in Process (1500000*65%*50%*2)/12 81250
Finished Goods (1500000*65%*1)/12 81250
275000
Account Receivables (1500000/12*2.5) 312500
Total Current Assets 587500
Accounts Payable (1500000*30%*2/12) 75000
Wages Payable (375000*1/50) 7500
Variable oveheads (1500000*10%*1/12) 12500
Fixed Overheads (1500000*15%*1/12) 18750
Selling & Distribution

Expense (1500000*5%*1/24) 3125
Total Current Liabilities 116875
Net Working Capital Required 470625
Short term finance and investments
Sources of finance:
Trade payables
Short term borrowing (bank overdrafts, bank loans
Financing exports (Letter of credit, export factoring))
Short term investments
Interest bearing bank accounts
Negotiable instruments (banknotes, bearer bonds, certificate of deposits, bill of exchange,
treasury bills)
Short dated government bonds
Other investments (corporate bonds, commercial paper)
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Problem # 13
A company has a highly seasonal business with the result that its borrowing requirement
fluctuates significantly throughout the year. There are two alternative ways of funding its short-
term borrowing requirement as follows:
1) The company’s bank has offered a $400,000 overdraft facility at an annual interest rate
of 12% per annum.
2) The company can take a $400,000 one year loan at an interest rate of 10% per annum.
The loan would be taken out on 1stJanuary. Any surplus funds can be deposited to earn
4% per annum.
The monthly borrowing requirements for the forthcoming year are as follows:
Month 1 2 3 4 5 6 7 8 9 10 11 12
$000 280 370 0 370 400 0 280 280 0 370 400 400
Required
Calculate the net cost of each alternative for forthcoming year. Each month is equal length and
there are fees payable.
State two advantages of Overdraft over short term finance.
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Chapter Seven
Expected Values, Risk and Uncertainty
Forecasting Techniques
i. Time Series Analysis

ii. Regression
iii. The High Low Method
High low method is commonly used in Cost Accounting:
Step 1: Find the variable cost
Increase in cost
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 =
Increase in Activity
Step 2: Find the Fixed Cost

A semi-variable cost consists of two components. Variable cost has been calculated in step 1 and
after variable cost, fixed cost is left behind.
Fixed cost = Total Cost – Variable cost
The Treatment of uncertainty and risk in decision making
1. Decision criteria
2. Pay-off tables
3. Measuring risk
4. Value of Information
5. Decision Trees
Risk: quantifiable: possible outcomes have associated probabilities. Variability in future
returns.
Uncertainty: unquantifiable: there are no. of possible outcomes but the probability of each
outcome is not known.
Expected values: ∑px
Risk neutral
Risk seekers
Risk averse
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Units sold Revenue Probability Pay-Off

40 400 0.15 60.00
100 1000 0.50 500.00
137 1370 0.35 497.50
EV= 1039
Risk Measures
Standard deviation
Coefficient of variation
Pay-off table and decision criteria
Maximax
Maximin
Minimax Regret
The maximax rule involves selecting the alternative that maximizes the maximum pay-off
achievable
This approach is suitable for an optimist who seeks to achieve the best results if the best happens.
Maximin
The maximin rule involves selecting the alternative that maximizes the minimum pay off
achievable
This approach is suitable for an pessimist who seeks to achieve the best results if the worst
happens.
The minimax regret

The minimax regret strategy is the one that minimizes the maximum regret. It is useful when
probabilities for outcomes are not available or where the investor is risk averse and wants to
avoid making a bad decision.
Perfect and imperfect information
Decision trees and multi stage decision problems
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Problem 1
EF sells personal computers on which it gives a one year warranty. EF is estimating the cost of warranty
claims for next year.
If all products under warranty need minor repairs the total cost is estimated to be $2 million. If all
products under warranty need major repairs it would cost $6 million. If all products under warranty need
to be replaced it would cost $10 million.
Based on past experience EF has estimated that 80% of products under warranty will require no repairs,
15% will require minor repairs, 3% will require major repairs and 2% will need to be replaced.
Required:
Calculate the expected value of the cost of warranty claims for next year.
Problem 2
A marketing manager is deciding which of four potential selling prices to charge for a new product. The
market for the product is uncertain and reaction from competitors may be strong, medium or weak. The
manager has prepared a payoff table showing the forecast profit for each of the possible outcomes.
Competitor Reaction Selling price
$80 $90 $100 $110
Strong 70000 80000 70000 75000
Medium 50000 60000 70000 80000
Weak 90000 100000 90000 80000
Required:
(i) Identify the selling price that would be chosen if the manager applies the maximin criterion to
make the decision.
(ii) Identify, using a regret matrix, the selling price that would be chosen if the manager applies the
minimax regret criterion to make the decision. (CIMA March 2014)
Problem 3
A. A company has to decide which of three mutually exclusive projects to invest in next year. The
directors believe that the success of the projects will vary depending on economic conditions. There is
a 30% chance that conditions will be good, a 20% chance that conditions will be fair and a 50%
chance that conditions will be poor. The company uses expected value to make this type of decision.
The net present value for each of the possible outcomes is as follows:
Economic condition Projects
A(000) B(000) C(000)
Good 700 800 700
Fair 400 500 600
Poor 300 400 500
A firm of economic analysts believes it can provide perfect information on economic conditions.
(CIMA March 2014)
Required:
Calculate the maximum amount that should be paid for the information from the firm of economic
analysts.
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B. A purchasing manager is deciding how many units of a product to purchase for the winter
season. The demand for the product is uncertain. The purchasing manager has prepared a
regret matrix showing the regret based on the contribution that each of the possible outcomes
would earn.
Quantity Purchased
Demand 10000 15000 20000 25000
10000 0 35000 70000 105000
15000 21000 0 32000 62000
20000 120000 26000 0 33000
25000 180000 120000 22000 0
If the manager applies the minimax regret criterion to make decisions, which quantity would be
purchased?
Problem 4
A company has to decide which of three machines to purchase to manufacture a product. Each
machine has the same purchase price but the operating costs of the machines differ. Machine A has
low fixed costs and high variable costs; Machine B has average fixed costs and average variable
costs whilst Machine C has high fixed costs and low variable costs. Machine A would consequently
be preferable if demand was low and Machine C would be preferable if demand was high. There is a
35% chance that demand will be high, a 40% chance that demand will be medium and a 25% chance
that demand will be low. The company uses expected value to make this type of decision.
The estimated net present values for each of the possible outcomes are as follows:
Economic condition Machines
A(000) B(000) C(000)
High 100 140 180
Medium 150 160 140
Low 200 100 80
A market research company believes it can provide perfect information on product demand.
Required:
Calculate the maximum amount that should be paid for the information from the market research
company.
Problem 5
XY has developed two new products, Product X and Product Y, but has insufficient resources to
launch both products. The success of the products will depend on the extent of competitor reaction.
There is a 20% chance that competitors will take no action, a 50% chance that they will launch a
similar product and a 30% chance that they will launch a better product.
The profit/loss that will be earned by each of the products depending on the extent of competitor
reaction is as follows:
90 | P a g e
Competitor Reaction Product X Product Y

No action 5,40,000 6,20,000
Launch a similar product 3,20,000 3,80,000
Launch a better product (150,000) (200,000)
Another option for XY would be to launch neither product. If it chooses this course of action
there is a 60% chance that competitors will take no action and there will be no effect on the
company’s profit. There is a 40% chance that competitors will launch a new product and
company profits will reduce by $100,000. (CIMA May 2014)
Required:
Demonstrate, using a decision tree and based on expected value, the best course of action
for the company.
Chapter Eight
Previous year Question and Solution
QUESTIONS ARE INTEGRAL PART OF THIS CLASS NOTE
=====THE END=====
91 | P a g e

P1 Class Notes by Sir Rafiqul Islam FCMA

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Class notes on Performance Operations (P1) by Rafiqul Islam, FCMA

Your broad syllabus is as follows:

Materials for study:

Hey don’t get upset!!

Try to think Try to link Try to implement

Variable costs Direct Materials Direct Costs/ Products Costs/ Inventorial

Purpose of Cost Classification Cost Classifications

Predicting cost behavior in response to  Variable cost (proportional to activity)

Simple Statement of Cost of Goods Sold

Particulars Taka Taka

Direct Labor (B)

Simple Statement of Cost of Goods Sold

Sales Revenue/Service Revenue

Absorption costing/full costing (Format)

Sales Taka Taka

Marginal Costing/ Direct Costing

Sales Taka Taka

Reconciliation of Profits under absorption costing and Marginal costing

It has been estimated that,

Break Even = (69000/ 0.63)

Requirement: (b): Alternative one

Requirement: (b): alternative two

Total Fixed Costs = (42000 +27000) = 69000

Break Even = (69000+45500/ 0.63)

Sales Tk. 270000

Total Per unit percentage

Break-even point in sales units = Fixed costs/unit contribution margin

Break-even point in sales Dollars = Fixed costs/CM Ratio

2. Incremental contribution margin

Increased CM (70000 increased sales x 30% CM ratio) 21000

Sales (27000x18 per unit) 4,86,000

4. Units sales to attain target profit

(Fixed Costs+ Target profit)/ CM per unit

= (90000 + 4500)/ 5.40 per unit

5. The new CM ratio would be = 13/20 = 65%

New break even sales = Fixed costs/Unit Contribution

Breakeven point in sales dollars = Fixed costs/CM ratio

Comparative income statement follow

Not automated Automated

Sinks Mirrors Vanities Total

Break-even point in dollar sales = Fixed Expense / CM ratio = 223600/0.52 = 430,000

2. Break-even point in total dollar sales = Fixed expenses/CM ratio

3. Memo to the president

i. Prepare a schedule of cost of goods manufactured.

Particulars Year 1 Taka Year 2Taka

a) Compute the unit product cost for each year under:

Calculation of Unit Product cost

Variable Costing Income statement

Reconciliation of net operating income

Basic production data at standard cost

Absorption Costing Income statement

Reconciliation of net operating income

Labor Hours Machine Hours

So Machine hours are bottleneck resources.

Product X (higher return per factory hour)

Total Factory costs (other than materials) = Labor: 400000

Labor (17500hrs @20tk) 3,50,000.00

Or this can be calculated in the following manner= 27,50,000.00

Products X : 20000 units @ tk. 75(10+25+40) = 1500,000