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CA FINAL NEW COURSE (Nov 2021)

GROUP II – PAPER 5
Strategic Cost Management and Performance Evaluation (SCMPE)
(Series 1)
Time Allowed: - 3 Hours Maximum Marks: 100

This paper comprises 6 questions. Question No. 1 is compulsory. Attempt

any 4 questions out of the remaining 5 questions.

Marks
1 Air India is a major airline operating from India. It is the biggest airline operator 20
within the domestic airline segment and is a well-established player in the
international airline segment. Except for a period of few years as outlined below,
Air India has been operating for the last 3 decades in a segment that caters
primarily to the business and premium segment travellers. On its international
routes and certain long distance, yet busy domestic routes, the airline offers full
service on-board. The ticket price includes on board entertainment, transfer of
baggage between flights, more leg room, option to upgrade from economy to
business class seats, meals, and beverages etc. Baggage allowance is liberal with
each flyer being allowed 2 checked in baggage and a cabin baggage. A tag line in
its advertising goes “GRAB YOUR BAGS, THEY FLY FREE”. In the domestic
segment, the airline operates across major metro cities and certain other tier-2
cities. International flights operate only from these major metro cities.
Indian aviation industry has been growing exponentially in the recent years due
to a thriving economy. Consequently, there have been many new entrants in the
domestic segment, offering low-cost fares to customers. These airlines have
been offering tickets at huge discounts, thereby attracting a sizable chunk of
customers away from Air India. To counter this and maintain its market share,
Air India also followed suit. For a period of five years, tickets on various
domestic routes were offered at low competitive price. At the same time, low
fares can be offered only if it is profitable to do so. Therefore, certain cost
management measures were undertaken. Air India converted to a “no-frills”
airline on most of the domestic routes. Now a ticket covered only the cost of the
seat and 1 checked in baggage and 1 cabin baggage. Going further, baggage
allowance was reduced to economize on space and fuel requirements. To avail
any other facility, the flyer wanted had to purchase extra. Another measure
taken was to offer last-minute deals of tickets at a heavy discount if the flight is
not fully occupied. Vacant seats are “perishable”, therefore instead of letting
them go empty, the flight can be filled at cheaper rates. This yield management
measure based on capacity utilization was expected to increase market share
and subsequently the airline’s revenue. Tickets could be booked online using the
internet rather than through ticket kiosks maintained by the airline at various

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 locations in selected cities.
In order to quickly respond to a competitor’s move, the pricing and marketing
staff were given sufficient autonomy to make this price war work. Therefore, in
many situations, decisions could be taken even without the prior approval of the
top management. Meanwhile adding to the stiff competition, fuel prices have
been soaring in the last few years. Maintenance of aircrafts, staff compensation
and other overheads have also been increasing. Landing fees in major airports
have increased manifold due to congestion and limited slots on account of
multiple airline operators vying for limited slots.
Given this scenario, after 5 years of operations, the management at Air India found
that they were not able to generate sufficient profits on many of the domestic
routes. A price discount by a competitor had to be matched with a similar price
discount by Air India and vice versa. Offering last minute deals to fill up capacity
did not generate additional revenue. The volume of last-minute flyers was low. It
was found that most flyers booking at the last minute were anyway “price
indifferent”. Had the deals not been offered, the flyer would have been willing to
pay more money anyway to use the airline. Therefore, neither did these deals
generate extra customers nor extra revenue.
Air India has always been perceived to cater the premium segment traveller,
therefore participating in this price war had been contrary to its image of a
premium quality airline. This left a section of the customers confused about the
product offering. Therefore, the management of Air India decided to discontinue
its discount pricing strategy and exit the "low cost" airline business. The tickets
are now being offered at its usual “full service” rates. This strategy is proposed
to be followed for both current and prospective projects and operations.
The government has been formulating policies that are aimed at changing the
landscape of the aviation sector. Airports are being built in smaller cities and
towns that until date did not have one. This will improve connectivity within the
country. It will increase air traffic as the public now has an alternate means to
travel other than road and rail transport. Instead of flying between two small
airports directly, Air India proposes to develop a model where flyers from
smaller towns are connected to one of the major metro cities which will serve as
a main hub. For Air India, the cost of operations will be lower as compared to
flying point to point between the two small airports. For the passengers, better
connectivity and more route options will be available. For example, a flyer from
a smaller city, wanting to go to a destination abroad can now reach the nearest
hub by flying with Wings. From the hub, Air India can fly the passenger further
to the desired destination abroad in its international fleet. For the flyer, this is a
better alternative as compared to reaching the hub by say road transport. For
Air India, the proposition broadens its customer base. To this effect, Air India is
already scouting the market for smaller aircrafts that can be operated more
economically on the hub-spoke route. Also, it is in talks with for partnership
with other airlines, hotels, car rentals in order to offer attractive holiday
packages to customers. Since most of the other airlines do not have the scale of
operations to achieve the “hub-spoke” model or the ability to offer holiday
packages, Air India identifies this as a unique proposition that it can offer its
customers. This time the proposed tag line for its advertisement would be
“INDIA TO FLY ANYWHERE, ANYTIME”. Also, Air India proposed to increase the

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 turnaround time of flights for better capacity utilization.
Ticket booking is still offered over the internet. In the past, customers like this
option due to the convenience it offered. Dedicated customer service lines
available 24 ×7 to resolve issues is proposed.
The management of Air India wants to have a seamless implementation of this
project. This could be a game changer for the company that will help it consolidate
its position in the aviation industry. Therefore, a meeting has been called to
discuss critical reporting that needs to be in place that ensures a successful
launch.
Required
(i) EVALUATE the strategy adopted by Air India in becoming a “no frills”
airline.
(ii) IDENTIFY the strategy adopted by Air India for the proposed project.
(iii) The entire strategy of Air India for the proposed project depends on
information available about the future outlook in the industry.
RECOMMEND guidelines to the management to put in place a control
reporting mechanism that can enable Air India to take preventive measures
to avoid errors in its strategy.
(iv) In its previous venture, it took 5 years for Air India to decide to exit the “no
frills” airline operations. To avoid a delay in taking such decisions,
RECOMMEND guidelines to the management to put in place a control
reporting mechanism that can enable Air India to correct its errors and
make changes in its operations in a more timely manner.

2 Sports Co is a large manufacturing company specialising in the manufacture of a 20

wide range of sports clothing and equipment. The company has two divisions:
Clothing (Division C) and Equipment (Division E). Each division operates with
little intervention from Head Office and divisional managers have autonomy to
make decisions about long-term investments.
Sports Co measures the performance of its divisions using return on investment
(ROI), calculated using controllable profit and average divisional net assets. The
target ROI for each of the divisions is 18%. If the divisions meet or exceed this
target the divisional managers receive a bonus.
Last year, an investment which was expected to meet the target ROI was rejected
by one of the divisional managers because it would have reduced the division’s
overall ROI. Consequently, Sports Co is considering the introduction of a new
performance measure, residual income (RI), in order to discourage this
dysfunctional behaviour in the future. Like ROI, this would be calculated using
controllable profit and average divisional net assets.
The draft operating statement for the year, prepared by the company’s trainee
accountant, is shown below:

Particulars Division C Division E

₹ ’000 ₹ ’000
Sales revenue 3,800 8,400

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 Less variable costs (1,400) (3,030)
Contribution 2,400 5,370
Less fixed costs (945) (1,420)
Net profit 1,455 3,950
Opening divisional controllable net assets 13,000 24,000
Closing divisional controllable net assets 9,000 30,000

Notes:
(1) Included in the fixed costs are depreciation costs of ₹ 165,000 and ₹
460,000 for Divisions C and E respectively. 30% of the depreciation costs in
each division relates to assets controlled but not owned by Head Office.
Division E invested ₹2m in plant and machinery at the beginning of the year,
which is included in the net assets figures above, and uses the reducing
balance method to depreciate assets. Division C, which uses the straight-line
method, made no significant additions to non-current assets. It is the policy
of both divisions to charge a full year’s depreciation in the year of
acquisition.
(2) Head Office recharges all of its costs to the two divisions. These have been
included in the fixed costs and amount to ₹ 620,000 for Division C and ₹
700,000 for Division E.
(3) Sports Co has a cost of capital of 12%.
Required:
(i) Calculate the return on investment (ROI) for each of the two divisions of
Sports Co.
(ii) Discuss the performance of the two divisions for the year, including the
main reasons why their ROI results differ from each other. Explain the
impact the difference in ROI could have on the behaviour of the manager of
the worst performing division.
(iii) Calculate the residual income (RI) for each of the two divisions of Sports
Co and briefly comment on the results of this performance measure.
(iv) Explain the advantages and disadvantages of using residual income (RI) to
measure divisional performance.

3 (a) Company XYZ produces two components (M and N) and is planning the 10
allocation of its available resources for the next period.
75 units of component M and 60 units of component N are required to be
produced but machine hour capacity is restricted to a total of 300 hours. Any
deficit of components produced in-house can be made up by the purchase of
any quantity of either component from an outside supplier.
The objective of company XYZ is to satisfy the requirement for components at
minim um total cost. The following information is available concerning each
component.
Cost (₹ per unit) M N
Direct materials 6.20 8.70
Direct Labour 5.10 7.50

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 Variable production overheads 1.20 1.30
Fixed production overheads 4.80 6.40
Total 17.30 23.90
Machine hours (per unit) 2.00 3.00
Price from outside supplier (₹ per unit) 18.50 25.90
Company XYZ also supports the concept of life cycle costing for new investment
decisions covering its engineering activities. The financial side of this philosophy
is now well established and its principles extended to all other areas of decision
making. The company is to replace a number of its machines and the Production
Manager is torn between the Exe Machine, a more expensive machine with a life of
12 years, and the Wye machine with an estimated life of 6 years. If the Wye
machine is chosen, it is likely that it would be replaced at the end of 6 years by
another Wye machine. The pattern of maintenance and running costs differs
between the two types of machine and relevant data are shown below:
Exe Wye
Purchase price ₹ 19,000 ₹13,000
Trade-in value/breakup/scrap ₹ 3,000 ₹ 3,000
Annual repair costs ₹ 2,000 ₹ 2,600
Overhaul costs (at year 8) ₹ 4,000 (at year 4) ₹ 2,000
Estimated financing costs 10% p.a. 10% p.a.
Required:
For the next period:
(i) Calculate the variable costs of producing each component in – house and
also calculate the extra costs of buying-in each component
(ii) Determine which component should have production priority and
calculate the number of units of each component that should be
manufactured by company XYZ.
(iii) Recommend with supporting figures, which machine to purchase, stating
any assumptions made?

3 (b) The Hi Life Co (HL Co) makes sofas. It has recently received a request from a 10
customer to provide a one-off order of sofas, in excess of normal budgeted
production. The order would need to be completed within two weeks. The
following cost estimate has already been prepared:

Direct materials: Note ₹

Fabric 200 m2 at ₹17 per m2 1 3,400
Wood 50 m2 at ₹8·20 per m2 2 410
Direct labour:
Skilled 200 hours at ₹16 per hour 3 3,200
Semi-skilled 300 hours at ₹12 per hour 4 3,600
Factory overheads 500 hours at ₹3 per hour 5 1,500
Total production cost 12,110
Administration overheads 10% of total production cost 6 1,211

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 Total cost 13,321

Notes
1 The fabric is regularly used by HL Co. There are currently 300 m2 in
inventory, which cost ₹17 per m2. The current purchase price of the
fabric is ₹17·50 per m2.
2 This type of wood is regularly used by HL Co and usually costs ₹8·20 per m2.
However, the company’s current supplier’s earliest delivery time for the wood
is in three weeks’ time. An alternative supplier could deliver immediately but
they would charge ₹8·50 per m2. HL Co already has 500 m2 in inventory but
480 m2 of this is needed to complete other existing orders in the next two
weeks. The remaining 20 m2 is not going to be needed until four weeks’ time.
3 The skilled labour force is employed under permanent contracts of
employment under which they must be paid for 40 hours per week’s labour,
even if their time is idle due to absence of orders. Their rate of pay is ₹16 per
hour, although any overtime is paid at time and a half. In the next two weeks,
there is spare capacity of 150 labour hours.
4 There is no spare capacity for semi-skilled workers. They are currently
paid ₹12 per hour or time and a half for overtime. However, a local agency
can provide additional semi-skilled workers for ₹14 per hour.
5 The ₹3 absorption rate is HL Co’s standard factory overhead absorption rate;
₹1·50 per hour reflects the cost of the factory supervisor’s salary and the
other ₹1·50 per hour reflects general factory costs. The supervisor is paid an
annual salary and is also paid ₹15 per hour for any overtime he works. He
will need to work 20 hours’ overtime if this order is accepted.
6 This is an apportionment of the general administration overheads
incurred by HL Co.
Required:
Prepare, on a relevant cost basis, the lowest cost estimate which could be used as
the basis for the quotation. Explain briefly your reasons for including or
excluding each of the costs in your estimate.

4 (a) Glam Co is a hairdressing salon which provides both ‘cuts’ and ‘treatments’ to 10
clients. All cuts and treatments at the salon are carried out by one of the salon’s
three senior stylists. The salon also has two salon assistants and two junior
stylists.
Every customer attending the salon is first seen by a salon assistant, who washes
their hair; next, by a senior stylist, who cuts or treats the hair depending on which
service the customer wants; then finally, a junior stylist who dries their hair. The
average length of time spent with each member of staff is as follows:
Cut Hours Treatment Hours
Assistant 0·1 0·3
Senior stylist 1 1·5
Junior stylist 0·5 0·5
The salon is open for eight hours each day for six days per week. It is only

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 closed for two weeks each year. Staff salaries are ₹40,000 each year for senior
stylists, ₹28,000 each year for junior stylists and ₹12,000 each year for the
assistants. The cost of cleaning products applied when washing the hair is
₹0·60 per client. The cost of all additional products applied during a
‘treatment’ is ₹7·40 per client. Other salon costs (excluding labour and raw
materials) amount to ₹106,400 each year.
Glam Co charges ₹60 for each cut and ₹110 for each treatment.
The senior stylists’ time has been correctly identified as the bottleneck activity.
Required:
(i) Briefly explain why the senior stylists’ time has been described as the
‘bottleneck activity’, supporting your answer with calculations.
(ii) Calculate the throughput accounting ratio (TPAR) for ‘cuts’ and the TPAR
for ‘treatments’ assuming the bottleneck activity is fully utilised.

4 (b) Jamair was founded in September 2007 and is one of a growing number of low- 10
cost airlines in the country of Shania. Jamair’s strategy is to operate as a low-
cost, high efficiency airline, and it does this by:
– Operating mostly in secondary cities to reduce landing costs.
– Using only one type of aircraft in order to reduce maintenance and
operational costs. These planes are leased rather than bought outright.
– Having only one category of seat class.
– Having no pre-allocated seats or in-flight entertainment.
– Focusing on e-commerce with customers both booking tickets and checking
in for flights online.
The airline was given an ‘on time arrival’ ranking of seventh best by the country’s
aviation authority, who rank all 50 of the country’s airlines based on the number
of flights which arrive on time at their destinations. 48 Jamair flights were
cancelled in 2013 compared to 35 in 2012. This increase was due to an increase in
the staff absentee rate at Jamair from 3 days per staff member per year to 4·5
days.
The average ‘ground turnaround time’ for airlines in Shania is 50 minutes,
meaning that, on average, planes are on the ground for cleaning, refuelling, etc for
50 minutes before departing again. Customer satisfaction surveys have shown
that 85% of customers are happy with the standard of cleanliness on Jamair’s
planes.
The number of passengers carried by the airline has grown from 300,000
passengers on a total of 3,428 flights in 2007 to 920,000 passengers on 7,650
flights in 2013. The overall growth of the airline has been helped by the limited
route licensing policy of the Shanian government, which has given Jamair almost
monopoly status on some of its routes. However, the government is now set to
change this policy with almost immediate effect, and it has become more
important than ever to monitor performance effectively.
Required:
(i) Describe each of the four perspectives of the balanced scorecard.

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 (ii) For each perspective of the balanced scorecard, identify one goal together
with a corresponding performance measure which could be used by Jamair to
measure the company’s performance. The goals and measures should be
specifically relevant to Jamair.

5 (a) Bus Co is a large bus operator, operating long-distance bus services across the 10
country. There are two other national operators in the country. Bus Co’s mission
is to ‘be the market leader in long-distance transport providing a greener, cleaner
service for passengers nationwide’. Last month, an independent survey of 40,000
passengers was carried out, the results of which are shown in the table below:
Table: Bus passenger satisfaction % by national operator

Operator Overall Value for Punctuality Journey

satisfaction money time
Bus * 67 80 82
Prime * 58 76 83
Express * 67 76 89

* denotes that the percentage has not yet been calculated.

The ‘overall satisfaction’ percentages, which have not yet been inserted into the
table, are calculated using a weighted average which reflects the importance
customers place on each of the other three criteria above. The weightings used are
as follows:

Value for money 40%

Punctuality 32%
Journey time 28%

The managing director (MD) of Bus Co has said: ‘Independent research has shown
that our customers are the most satisfied of any national bus operator. We are
now leading the way on what matters most to customers – value for money and
punctuality.’
Required:
(i) Calculate the ‘overall satisfaction’ percentage for each operator.
(ii) Taking into account all the data in the table and your calculations from part
(a), discuss whether the managing director’s statement is true.
(iii) When measuring performance using a ‘value for money’ approach, the
criteria of economy, efficiency and effectiveness can be used. Briefly define
‘efficiency’ and ‘effectiveness’ and suggest one performance measure for
EACH, which would help Bus Co assess the efficiency and effectiveness of
the service it provides.

5 (b) BCG Manufacturers sell their product at ₹ 1,000 per unit. Their competitors are 10
likely to reduce the price by 15%. BCG Manufacturers want to respond
aggressively by cutting price by 20% and expect that the present volume of
150000 units per annum will increase to 200000 units. BCGM want to earn a 10%

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 target profit on sales. Based on a detailed value engineering, the comparative
position is given below:
Particu Existing (₹) Target (₹)
lars
Direct Material Cost per unit 400 385
Direct Labour Cost per unit 55 50
Direct machinery costs per unit 70 60
Direct Manufacturing expenses per unit 525 425
Manufacturing Overheads
No. of orders (₹ 80 per order) 22,500 21,250
Testing hours (₹ 2 per hour) 45,00,000 30,00,000
Units reworked (₹ 100 per unit) 12,000 13,000
Manufacturing overheads are allocated using relevant cost drivers. Other
operating costs per unit for the expected volume are estimated as follows:
Research and Design ₹ 50
Marketing and Customer Service ₹ 130
Total ₹ 180
Required:
(i) Calculate target costs per unit and target costs for the proposed volume
showing break up of different elements.
(ii) Prepare target product profitability statement.

6 (a) The Organic Bread Company (OBC) makes a range of breads for sale direct to the 10
public. The production process begins with workers weighing out ingredients on
electronic scales and then placing them in a machine for mixing. A worker then
manually removes the mix from the machine and shapes it into loaves by hand,
after which the bread is then placed into the oven for baking.
All baked loaves are then inspected by OBC’s quality inspector before they are
packaged up and made ready for sale. Any loaves which fail the inspection are
donated to a local food bank.
The standard cost card for OBC’s ‘Mixed Bloomer’, one of its most popular loaves,
is as follows:

White flour 450 grams at ₹1·80 per kg ₹ 0·81

Wholegrain flour 150 grams at ₹2·20 per kg ₹ 0·33
Yeast 10 grams at ₹20 per kg ₹ 0·20
Total 610 grams ₹ 1·34

Budgeted production of Mixed Bloomers was 1,000 units for the quarter, although
actual production was only 950 units. The total actual quantities used and their
actual costs were:

Kg ₹ per kg
White flour 408·5 1·90
Wholegrain flour 152·0 2·10
Yeast 10·0 20·00

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 Total 570·5 24

Required:
(i) Calculate the total material mix variance and the total material yield
variance for OBC for the last quarter.
(ii) Using the information in the question, suggest FOUR possible reasons
why an ADVERSE MATERIAL YIELD variance could arise at OBC.

6 (b) A company has two divisions A and B, making products A and B respectively. 10
One unit of A is an input for each unit of B. B has a production capacity of
45,000 units and ready market. Other information available regarding Division
A are:

Capacity (production units) 50,000

Maximum External Sales 30,000
Fixed Cost upto 30,000 units. Beyond 30,000 units- It increases 430,000
by 50,000 for every additional 10,000 units
Variable Manufacturing Cost p.u. 55
Variable Selling Cost p.u. (external sales) 10
Variable Selling Cost p.u. (special order/ transfer to B) 5
Selling Price p.u. (external market) 80
Selling Price (special sales) 70
B can buy the input A from outside at a slightly incomplete stage at ₹ 45 p.u. and
will incur subcontracting charges of ₹ 30 p.u. to match it to the stage at which it
receives goods from Division A. Division B is willing to pay a maximum of ₹ 75
p.u. if Division A supplies its entire demand of 45,000 units. If Division A
supplies lesser quantity, Division B is willing to pay only ₹ 70 p.u.
Division A has also received a special order for 15,000 units which it needs to
either accept in full or reject. Division A may choose to avoid variable selling
cost of ₹ 5 p.u. on transfer to B or special order, by incurring a fixed overhead of
₹ 50,000 p.a. instead.
(i) What is the best strategy for Division A? Show the profitability of that
option.
(ii) What will the range of transfer price be under if the best strategy is
chosen?

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10