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[Paper - 4] Cost Accounting & Financial
Management
[Paper - 4A] Cost Accounting
Chapter - 1 : Basic Concepts
2008 - Nov [1] Answer the following :
(iv) State the method of costing that would be most suitable for :
(a) Oil refinery
(b) Bicycle manufacturing
(c) Interior decoration
(d) Airlines company (2 marks)
Answer :
(iv) The suitable method of costing for the following is :
(a) Oil Refinery : Process costing
(b) Bicycle manufacturing : Batch costing or Multiple costing
(c) Interior decoration : Job costing but if on a larger basis
then Contract costing
(d) Airlines company : Operating costing
Chapter - 2 : Material
2008 - Nov [1] Answer the following :
(i) The annual carrying cost of material 'X' is Rs. 3.6 per unit and its total
carrying cost is Rs. 9,000 per annum. What would be the Economic
order quantity for material 'X', if there is no safety stock of material X?
(2 marks)
Answer :
(i) As per the given information :
C = Rs. 3.6 per unit per annum
Total carrying cost = Rs. 9,000 per annum.
Let the annual consumption of material ‘X’ for the year = A
PCC Group - II Paper 4 II-2
Then, total carrying cost = 3.6 × A
9000 = 3.6 × A
or A = = 2500 units
Total carrying cost =
9000 =
squaring bo th the sides, we get
8,10,00,000 = 18,000 O
O = = Rs. 4,500
Therefore, ordering cost per order i.e. O = Rs. 4,500
EOQ =
=
EOQ = 2500 units (2 marks)
2008 - Nov [1] Answer the following :
(v) Differentiate between “scrap” and “defectives” and how they are
treated in cost accounting. (2 marks)
Answer :
(v) Distinction between ‘scrap’ and ‘defectives’ are as follows :
Basis Scrap Defectives
1. Meaning Scrap is the incidental residue
from cer ta in types o f
manufacture, usually of small
amount and low value,
recoverable without further
processing.
Defective work signifies
those units of production
which can be rectified and
turned out as good units by
t h e a p p l i c a t i o n o f
additional materials, labour
or other service.
2. Reason Scrap is inherent in nature. Defectives arise due to sub-
standard materials, bad-
superv i s ion , i m p roper
planning, poor workm-
a n s h i p i n ad e q u a t e
equipment and careless
inspection.
PCC Group - II Paper 4 II-3
3. Avoidability Scrap, since inherent in
nature, cannot be avoided.
To some extent, defectives
may be unavoidable, but
with proper care it is
possible to avoid defects in
the goods produced.
4. Control The measures to control scrap
losses and obtain maximum
gainful utilisation of raw
material are :
(a) Proper product designing
by the Production Plann-
ing Department.
(b)U se of standardise d
m a t e r i a l s - ,
e q u i p m e n t s ,
personnel and
efficiency by
the Prod-uction
Dep-artment.
(c)Preparation of periodical
scrap, re-ports,
c o r r e c t i v e -
actions etc. by
the Cost Co-
ntrol Dept.
Control of defective may
cover the following two
areas :
(a)Control over defectives
produced
(b)Control over re-working
costs.
For exercising effective
control over defectives
produced and the cost of
re- working, standards for
normal percentage of
defectives and re-workings
should be established.
Chapter - 3 : Labour
2008 - Nov [3] (b) Describe briefly, how wages may be calculated under the
following systems:
(i) Gantt task and bonus system
(ii) Emerson's efficiency system
(iii) Rowan system
(iv) Halsey system
(v) Barth system. (9 marks)
Answer :
The various systems of wage payment have been discussed below :
PCC Group - II Paper 4 II-4
(i) Gantt task and bonus system :
This system, like Emerson’s system, involves, measurement of
efficiency. It is a combination of time and piece work system.
According to this system a high standard or task is set on the basis of
careful time and motion study. The worker’s actual performance is
compared with the standard and efficiency determined.
Only time wages are paid to the worker for production below the
set standard. If the standards are achieved or exceeded, the payment to
the concerned worker is made at a higher piece rate. The piece rate fixed
under this system also includes an element of bonus to the extent of
20%. The figure of bonus to such workers is calculated over the time
rate of the workers.
Thus, the system consists of paying a worker on time basis if he
does not attain the standard and on piece basis if he does.
Wages payable to workers under this plan are calculated as under:
Output Payment
(i) Output below standard
(ii) Output at standard
(iii) Output above standard
Guaranteed time rate
Time rate plus bonus of 20%
(usually) of time rate
High piece rate on worker’s
whole output.
It is so fixed, so as to include a
bonus of 20% of the time rate.
(ii) Emerson’s Efficiency System :
Emerson was one of Taylor’s associates. He guaranteed time wages but
wanted to reward efficiency. Under this system, minimum time wages
are guaranteed. But beyond a certain level of efficiency, bonus in
addition to minimum day wages is given.
A worker who is able to attain efficiency, measured by his output
equal to 2/3rd of the standard efficiency, or above, is deemed to be an
efficient worker deserving encouragement. The scheme thus provides
for payment of bonus at a rising scale at various levels of efficiency,
ranging from 66.67% to 150%. For a performance below 66.67% only
time rate wages without any bonus are paid. Above 66.67% to 100%
efficiency, bonus varies between 0.01% and 20%. Above 100%
efficiency, bonus of 20% of basic wages plus 1% for each 1% increase
in efficiency is admissible.
PCC Group - II Paper 4 II-5
It can be summarised as below :
Less than 66b% -only time wages
66b% to 100% -Basic (100%) + Bonus (0.01% to
20%)
100% - above - B a s i c ( 1 0 0 % ) + B o n u s
(20%)+1% for each 1% increase in
efficiency.
This system does not pre-suppose a high degree of average
performance. Wages on time basis are guaranteed.
(iii) Rowan System :
In it essence, the plan is similar to the Halsey Plan wages at the ordinary
rate for actual time put in by a worker are guaranteed and a bonus given,
if the worker saves time out of the standard time, set for him. According
to this plan, the bonus is that proportion of wages of actual time taken
which time saved bears to the standard time.
Formula for calculating wages under Rowan system:
× Time taken × Rate per hour.
(iv) Halsey system :
Under this method, standard time for doing a job is determined and
workers are encouraged to do the job in less than the standard time. A
standard is fixed for each job or process. If there is no saving on this
standard time allowance, the worker is paid only his day rate. He gets
his time rate even if he exceeds the standard time limit, since his day
rate is guaranteed. If, however, he does the job in less than the standard
time, he gets a bonus equal to 50 percent of wages of time saved; the
employer benefits by the other 50 percent. The scheme also is
sometimes referred to as the Halsey fifty percent plan.
Formula for claculating wages under Halsey system :
= Time taken × T ime Rate + 50% of time saved × Time Rate
The Halsey Weir system is the same as the Halsey system except that
the bonus paid to workers is 30% of time saved. This system is useful
for capital intensive industry.
(v) Barth System :
Barth system is particularly suitable for trainees and beginners and also
for unskilled workers. The reason is that for low production efficiency,
the earnings are higher than in the piece work system but as the
efficiency increases, the rate of increase in the earnings falls.
Formula for calculating the remuneration under Barth Plan :
Earnings = Hourly Rate ×
PCC Group - II Paper 4 II-6
Chapter - 4 : Overheads
2008 - Nov [1] Answer the following :
(ii) A machinery was purchased from a manufacturer who claimed that his
machine could produce 36.5 tonnes in a year consisting of 365 days.
Holidays, break-down, etc., were normally allowed in the factory for 65
days. Sales were expected to be 25 tonnes during the year and the plant
actually produced 25.2 tonnes during the year. You are required to state
the following figures :
(a) rated capacity
(b) practical capacity
(c) normal capacity
(d) actual capacity (2 marks)
Answer :
(ii) Rated Capacity :
(a) Rated capacity or ideal capacity is the maximum number of
operating hours that could be available ignoring the stoppages due
to down time, repairs, etc.
Therefore, as per the information provided in the question,
Rated capacity = 36.5 tonnes.
(b) Practical Capacity :
This measure represents the maximum level at which a company
can realistically operate at full efficiency. This allows for
unavoidable operating interruptions which means that practical
capacity is less than ideal capacity.
Therefore,
Number of working days in a year = 365 ! 65 = 300 days
Practical capacity = = 30 tonnes.
Practical capacity ranges from 75% to 85% of rated capacity
(Like here it is = 82.19%)
(c) Normal Capacity :
It is the rate of activity needed to meet average sales demand over
a period that is sufficiently long to cover seasonal, cyclical and
trend variations in the pattern of demand for company’s products.
Normal capacity represents 75% to 90% of practical capacity.
Therefore, in the given question, normal capacity is Rs. 25 tonnes.
PCC Group - II Paper 4 II-7
Normal Capacity in % = ×100 = 68.49%
(d) Actual Capacity :
Actual capacity represents the actual activity which has been
performed like, in the given question.
Actual Capacity = 25.2 tonnes.
Actual Capacity in % = ×100 = 69.10%
Chapter - 5 : Non-Integrated Accounts & Integrated
Accounts
2008 - Nov [2]As of 31st March, 2008, the following balances existed in a
firm's cost ledger, which is maintained separately on a double entry basis :
Debit Credit
Rs. Rs.
Stores Ledger Control A/c 3,00,000 )
Work-in-progress Control A/c 1,50,000 )
Finished Goods Control A/c 2,50,000 )
Manufacturing Overhead Control A/c 15,000
Cost Ledger Control A/c 6,85,000
7,00,000 7,00,000
During the next quarter, the following items arose :
Rs.
Finished Product (at cost) 2,25,000
Manufacturing overhead incurred 85,000
Raw material purchased ,25,000
Factory wages 40,000
Indirect labour 20,000
Cost of sales 1,75,000
Materials issued to production 1,35,000
Sales returned (at cost) 9,000
Materials returned to suppliers 13,000
Manufacturing overhead charged to production 85,000
You are required to prepare the Cost Ledger Control A/c, Stores Ledger
Control A/c, Work-in-progress Control A/c, Finished Stock Ledger Control
A/c, Manufacturing Overhead Control A/c, Wages Control A/c, Cost of Sales
A/c and the Trial Balance at the end of the quarter. (15 marks)
PCC Group - II Paper 4 II-8
Answer :
Cost Ledger Control Account
Particulars Amount Particulars Amount
To Stores ledger
(Control A/c Mat.
returned to
suppliers)
To Balance c/d
(Bal. fig.)
13,000
9,42,000
By Balance b/d
By Stores ledger control
A/c (M at. pur.)
By Manufacturing
Overhead Control
A/c (overhead
incurred)
By Wages Control A/c
(40,000% 20,000)
6,85,000
1,26,000
85,000
60,000
9,55,000 9,55,000
Stores Ledger Control Account
Particulars Amount Particulars Amount
To Balance b/d
To Cost ledger control
A/c (M at. pur.)
3,00,000
1,25,000
By WIP control A/c
(Mat. issued)
By Cost Ledger Control
A/c (M at.
received. to
supplier)
By Balance c/d
(bal. fig.)
1,35,000
13,000
2,77,000
4,25,000 4,25,000
Work in Progress Control Account
Particulars Amount Particulars Amount
To Balance b/d
To Wages Control A/c
(direct wages)
To Stores Ledger
1,50,000
40,000
By Finished stock
(ledger control A/c
(finished product at
cost)
2,25,000
PCC Group - II Paper 4 II-9
Control A/c
(Mat. issued)
To Manufacturing over-
head control
A/c
(O.H. charged to
production)
1,35,000
85,000
By Balance c/d
(bal. fig.)
1,85,000
4,10,000 4,10,000
Finished Stock Ledger Control Account
Particulars Amount Particulars Amount
To Balance b/d
To WIP Control A/c
(finished prod. at cost)
To Cost of Sales A/c
(Sales return-at cost)
2,50,000
2,25,000
9,000
By Cost of Sales A/c
By Balance c/d
(Bal. fig.)
1,75,000
3,09,000
4,84,000 4,84,000
Manufacturing Overhead Control Account
Particulars Amount Particulars Amount
To Wages Control A/c
(Indirect Labour)
To Cost ledger control
A/c (Overhead
incurred)
20,000
85,000
By Balance b/d
By WIP Control A/c
(Overhead charges to
production)
By Balance c/d
15,000
85,000
5,000
1,05,000 1,05,000
Wages Control Account
Particulars Amount Particulars Amount
To Cost Ledger control 60,000 By WIP Contract A/c 40,000
PCC Group - II Paper 4 II-10
A/c (40,000%20,000) (Direct wages)
By Manufacturing over-
head contro l A/c
(indirect labour)
20,000
60,000 60,000
Cost of Sales Account
Particulars Amount Particulars Amount
To Finished Stock
ledger control A/c
1,75,000 By Finished Stock
Ledger Control A/c
(Sales- return at cost)
By Balance c/d
9,000
1,66,000
1,75,000 1,75,000
TRIAL BALANCE
For the year ending 31st March, 2008
ParticularsAmount
Debit
Amount
Credit
Cost Ledger Control Account
Stores Ledger Control Account
Work-in-Progress Control Account
Finished Stock Ledgers Control Account
Manufacturing Overhead Control Account
Cost of Sales Account
2,77,000
1,85,000
3,09,000
5,000
1,66,000
9,42,000
Total 9,42,000 9,42,000
Chapter - 8 : Contract Costing
2008 - Nov [4] Answer the following
(iii) A contract expected to be completed in year 4, exhibits the following
information :
PCC Group - II Paper 4 II-11
End of Value of Cost of Cost of Cash Cash
Year work work work received
certified to date not yet
certified
(Rs.) (Rs.) (Rs.) (Rs.)
1. 0 50,000 50,000 0
2. 3,00,000 2,30,000 10,000 2,75,000
3. 8,00,000 6,60,000 20,000 7,50,000
The contract price is Rs. 10,00,000 and the estimated profit is 20%.
You are required to calculate, how much profit should have been
credited to the Profit and Loss A/c by the end of years 1, 2, and 3.
(3 marks)
Answer :
(iii) At the end of year - 1
Since percentage completion of contract is 0, therefore, no profit will
be recognised in the Profit & Loss Account.
At the end of year - 2
Notional Profit
= Value of work certified - (cost of work to date - cost of work not yet
certified)
= Rs.3,00,000 ! (Rs. 2,30,000 ! Rs. 10,000)
= Rs. 80,000
Percentage completion = ×100
= ×100 = 30%
Since percentage completion ranges between 25% to 50%.
Therefore, estimated profit to be transferred to Profit & Loss A/c (at
the end of year 2)
= × Notional Profit ×
= × 80,000 ×
= Rs. 24,444.44
At the end of year - 3
Notional Profit :
= Value of work certified ! (cost of work to date ! cost of work not
yet certified )
PCC Group - II Paper 4 II-12
= Rs. 8,00,000 ! (Rs. 6,60,000 ! Rs. 20,000)
= Rs. 1,60,000
Percentage completion = ×100
×100 = 80%
Since, percentage completion is in the range between 50% to 90%.
Therefore, estimated profit to be transferred to Profit & Loss A/c (at
the end of year - 3)
× Notional Profit ×
= × 1,60,000 ×
= Rs. 1,00,000
Chapter - 9 : Operating Costing and Multiple Costing
2008 - Nov [1] Answer the following :
(iii) State the unit of cost for the following industries :
(a) Transport
(b) Power
(c) Hotel
(d) Hospital (2 marks)
Answer :
(iii) The unit of cost for various industries are as follows :
Industry Unit of Cost
(a) Transport (i) Goods - Per ton km. or per quintal km.
(ii) Passengers - Per passenger km.
(b) Power Per kilo-watt hour (Kwh) or Horse Power (HP)
(c) Hotel Per Room-day or Per Service-day
(d) Hospital Per Patient-day or Per Bed-day or per
Operation
PCC Group - II Paper 4 II-13
Chapter - 10 : Process Costing
2008 - Nov [4] Answer the following :
(i) A product passes from Process I and Process II. M aterials issued to
Process I amounted to Rs. 40,000, Labour Rs. 30,000 and
manufacturing overheads were Rs. 27,000. Normal loss was 3% of
input as estimated. But 500 more units of output of Process I were
lost due to the carelessness of workers. Only 4,350 units of output
were transferred to Process II. There were no opening stocks. Input
raw material issued to Process I were 5,000 units. You are required to
show Process I account. (3 marks)
Answer :
(i)
Particulars Units Amount Particulars Units Amount
To MaterialTo LabourTo Manufacturing
overheads
5,000 40,00030,00027,000
By Normal loss(5000×8%)
By Abnormal loss(@ Rs. 20 p.u.)
By Transfer to Process-II A/c(@ Rs. 20 per units)
150
500
4,350
G
10,000
87,000
5,000 97,000 5,000 97,000
Working Notes :
Calculation of rate :
= =
= Rs. 20 per unit
Note: In the absence of any information, it is assumed that normal loss is not
sold as scrap.
Chapter - 12 : Standard Costing
2008 - Nov [4] Answer the following :
(iv) UV Ltd. presents the following information for November, 2008 :
Budgeted production of product P = 200 units.
Standard consumption of Raw materials = 2 kg per unit of P.
Standard price of material A = Rs. 6 per kg.
Actually, 250 units of P were produced and material A was purchased
at Rs. 8 per kg and consumed at 1.8 kg. per unit of P. Calculate the
material cost variances. (3 marks)
PCC Group - II Paper 4 II-14
Answer :
250 units of P were produced from material A.
For one units of P = 1.8 kg of material A is required, so for 250 units of P =
250 × 1.8 = 450 kg of material A is required.
Total Actual cost of output P produced 250 units
Actual cost = 250 × 1.8 × 8 = Rs. 3,600
Standard cost = For Actual output produced i.e.; 250 units of P, raw material
A will be required as in standard consumption ratio of 2 kg. per unit of P.
So for 250 units, standard raw material A required = 250 × 2 = 500 kg.
Standard cost per unit of X = Rs. 6 per kg.
So that standard cost = 500 × 6 = Rs. 3,000
Material cost variance = Standard cost ! Actual cost
= 3000 ! 3600 = 600 (A)
Material price variance = 2700 ! 3600 = 900 (A)
Material mix variance = Nil
Material yield variance = 3000 ! 2700 = 300 (F)
Material Usages variance = 3000 ! 2700 = 300 (F)
Chapter - 13 : Marginal Costing
2008 - Nov [4] Answer the following :
(ii) PQ Ltd. reports the following cost structure at two capacity levels :
(100% capacity)
2,000 units 1,500 units
Production overhead I Rs. 3 per unit Rs. 4 per unit
Production overhead II Rs. 2 per unit Rs. 2 per unit.
If the selling price, reduced by direct material and labour is Rs. 8 per
unit, what would be its break-even po int ? (3 marks)
PCC Group - II Paper 4 II-15
Answer :(ii) Production overhead I is fixed overhead.
In case of 2000 units & 2000 × 3 = 6,000In case of 1500 units & 1500 × 4 = 6,000Hence, Fixed Production Overhead = Rs. 6,000Variable Production Overhead = Rs. 2 per unitContribution : Rs. per unitSelling price reduced by material & labour 8Less : Variable production overhead 2
Contribution 6� Contribution = Rs. 6 per unit
BEP (in units) :
=
= = 1000 units
Chapter - 14 : Budgets & Budgetary Control
2008 - Nov [1] Answer the following :
(vi) Explain briefly the concept of 'flexible budget'. (2 marks)
Answer :
(vi) Flexible Budgets show the expected results of a responsibility centre
for several activity levels. It is a budget which by recognising the
difference between fixed, semi-variable and variable costs is designed
to change in relation to level of activity attained. It is not rigid as it can
be recasted on the basis of activity level to be achieved. It consists of
services of static budgets for different levels of activity. Variance
analysis through flexible budget provides useful information as each
cost is analysed according to its behaviour.
It facilitates the ascertainment of cost, fixation of selling price
and submission of quotations. Flexible budgets provide a meaningful
basis of comparison of the actual performance with the budgeted
targets.
Such budgets are especially useful in estimating and controlling
factory costs and operating expenses.
Flexible Budgeting may be resorted to in the follow ing situations:
(a) New Business :
In case of new business venture, due to its typical nature, it may
be difficult to forecast the demand of a product accurately.
(b) Uncertain Environment :
Where the business is dependent upon the mercy of nature.
PCC Group - II Paper 4 II-16
(c) Factor M arket Conditions :
In the case of Labour intensive industry where the production of
the concern is dependent upon the availability of labour.
Chapter - 15 : Product Cost Sheet
2008 - Nov [3] (a) ABC Ltd. can produce 4,00,000 units of a product per
annum at 100% capacity. The variable production costs are Rs. 40 per unit and
the variable selling expenses are Rs. 12 per sold unit. The budgeted fixed
production expenses were Rs. 24,00,000 per annum and the fixed selling
expenses were Rs. 16,00,000. During the year ended 31st March, 2008, the
company worked at 80% of its capacity. The operating data for the year are as
follows :
Production 3,20 ,000 units
Sales @ Rs. 80 per unit 3,10 ,000 units
Opening stock of finished goods 40,000 units
Fixed production expenses are absorbed on the basis of capacity and fixed
selling expenses are recovered on the basis of period.
You are required to prepare Statements of Cost and Profit for the year
ending 31st March, 2008 :
(i) On the basis of marginal costing
(ii) On the basis of absorption costing. (7 marks)
Answer 4 :
Production Overhead absorption rate =
=
= Rs. 6 per unit.
Closing Stock (in units)
= Op. Stock % Production ! Units so ld
= 40,000 % 3,20,000 ! 3,10,000
= 50,000 units.
(i) On the basis of marginal costing :
Statement of Cost and Profit
For the year ended 31st March, 2008
ParticularsAmount
Rs. ‘000
Amount
Rs. ‘000
Sales (3,10,000 × 80) 24,800
PCC Group - II Paper 4 II-17
Less : Total variable cost
Opening stock (40,000 × 40)
Add : Variable Production O.H. (3,20,000 × 40)
Less : Closing stock (50,000 × 40)
Add : Variable selling OH (3,10,000 × 12)
1,600
12,800
14,400
2,000
12,400
3,720 16,120
Contribution :
Less : Total Fixed Overheads
Fixed production overhead (4,00,000 × 6)
Add : Fixed selling overhead
NET PROFIT
2,400
1,600
8,680
4,000
4,680
(ii) On the basis of Absorption Costing
Statement of Cost and Profit
For the year ended 31st March, 2008
ParticularsAmount
Rs. ‘000
Amount
Rs. ‘000
Sales (3,10,000 × 80)
Less : Cost of goods sold
Opening stock (40,000 × 46)
Add : Variable Production O.H. (320,000 × 40)
Add : Fixed Production O.H (320,000 × 6)
Less : Closing stock (50,000 × 46)
Less : Selling Overheads
Fixed selling O.H.
Variable Selling O.H. (310,000 × 12)
1,840
12,800
1,920
16,560
2,300
1,600
3,720
24,800
14,260
10,540
5,320
NET PROFIT 5,220
PCC Group - II Paper 4 II-18
Working Notes :
Reconciliation of Net Profit under Absorption & M arginal Costing
ParticularsAmount
Rs. ‘000
Amount
Rs. ‘000
N.P. Under Absorption Costing
Less : Under absorption of O.H. (80,000×6)
(+) Over valuation of closing stock
(50,000 × 6)
(!) Over valuation of Op. stock
(40,000 × 6)
480
300
(240)
5,220
540
N.P. under Marginal Costing 4,680
[Paper - 4B] Financial Management
Chapter - 2:Time Value of Money
2008 - Nov [8] Answer the following :
(i) A company offers a Fixed deposit scheme whereby Rs. 10,000 matures
to Rs. 12,625 after 2 years, on a half-yearly compounding basis. If the
company wishes to amend the scheme by compounding interest every
quarter, what will be the revised maturity value ? (3 marks)
Answer :
The future value of single Cashflow is defined as :
FV = PV (1 +r)n
FV = Future value n years hence
PV = Present value of Cashflow today.
r = Rate of interest per annum
n = No. of periods for which compounding is done.
Substituting values in the equation.
12,625 = 10,000 (1 + r)4
By solving through interpolation, we get the annual rate at 12% p.a.
Now if the Co. goes for quarterly compounding the maturity value will be
Quarterly Rate = 12% ÷ 4 = 3%
FV = 10,000 (1 + 0 .3) 8
FV = Rs. 12,668/-
PCC Group - II Paper 4 II-19
Chapter - 3 : Financial Analysis and Planning
2008 - Nov [5] Answer the following :
(v) How is return on capital employed calculated ? What is its
significance?
(vi) What is quick ratio ? What does it signify? (2 marks each)
Answer :
(v) Return on capital employed =
Return = Profit after tax
+ Tax
+ Interest
+ Non trading Expenses
! Non operating incomes
Capital employed = Equity share capital
+ preference share capital
+ Reserves & surplus + P & L (Cr. Bal.) + Long term loans
+ Debentures
! Non trading investment - Fictitious Assests
! P & L (Dr. Bal)
Significance of ratio “ Return on capital employed” :
1. Overall profitability of the business is highlighted
2. Comparison of “Return on capital employed with rate of interest
debt leads to financial leverage.
(vi) Quick ratio also termed as “acid test ratio” is one of the best measures
of liquidity
It is worked out as follows :
Quick Ratio =
In the above formula !Quick Assets = Current Assets ! Inventories
Quick liabilities = Current liabilities ! Bank!Overdraft ! Cash credit
Quick ratio of 1: 1 is an ideal ratio significance :
It indicates whether the firm is in a position to pay its current
liabilities within a month or immediately.
2008 - Nov [6]Balance Sheets of a company as on 31st March, 2007 and 2008
were as follows :Liabilities 31.3.07 31.3.08 Assets 31.3.07 31.3.08
Rs. Rs. Rs. Rs.Equity Share Capita l10,00,000 10,00,000 Goodwill 1,00,000 80,000
PCC Group - II Paper 4 II-20
8% P.S. Capital 2,00,000 3,00,000 Land andGeneral Reserve 1,20,000 1,45,000 Building 7,00,000 6,50,000Securities Premium ) 25,000 Plant andProfit & Loss A/c 2,10,000 3,00,000 Machinery 6,00,000 6,60,00011% Debentures 5,00,000 3,00,000 InvestmentsCreditors 1,85,000 2,15,000 (non-trading) 2,40,000 2,20,000Provision for tax 80,000 1,05,000 Stock 4,00,000 3,85,000Proposed Dividend 1,36,000 1,44,000 Debtors 2,88,000 4,15,000
Cash and Bank 88,000 93,000Prepaid Expenses 15,000 11,000Premium onRedemptionof Debenture ) 20,000
24,31,000 25,34,000 24,31,000 25,34,000
Additional Information :
1. Investments were sold during the year at a profit of Rs. 15,000.
2. During the year an old machine cos ting Rs. 80,000 was sold for
Rs.36,000. Its written down value was Rs. 45,000.
3. Depreciation charged on Plants and Machinery @ 20 percent on the
opening balance.
4. There was no purchase or sale of Land and Building.
5. Provision for tax made during the year was Rs. 96,000.
6. Preference shares were issued for consideration of cash during the year.
You are required to prepare :
(i) Cash flow statement as per AS-3.
(ii) Schedule of changes in working capital. (15 marks)
Answer :
(a) Cash flow Statement for the year ending 31-3-07
Particulars Rs. Rs.
A. Cash flow from operating activities. Net
profit before tax and extraordinary items
(3,00,000!2,10,000)
Adjustments :
Add :
General reserve
Provision for tax [W.N.-1]
Loss on sale of Machinery [W.N.-2]
Depreciation on Machinery [W.N.-2]
Depreciation on land and building
Provision for proposed dividend[W.N.4]
Goodwill written off
25,000
96,000
9,000
1,20,000
50,000
1,44,000
20,000
90,000
PCC Group - II Paper 4 II-21
Loss :
Profit on sale of investment [W.N.-3]
Operating profit before working Capital
changes
Adjustment for working capital changes
Add :
Decrease in stock
Decrease in prepaid expenses
Increase in creditors
Less :
Increase is debtors
(15,000)
15,000
4,000
30,000
(1,27,000)
5,39,000
Operating Profit afters adjustment of
working capital changes
(-) income tax paid
4,61,000
71,000
Net cash flow from operating activities 3,90,000 3,90,000
B. Cash flow from investing activities
Sale of investment [WN-3]
Sale of plant and machinery [WN.-2]
Purchase of plant [W.N-2]
35,000
36,000
(2,25,000)
Net Cash flow from investing activities 1,54,000
C. Cash flow from financing activities
Issue of 8% preference shares
Premium on issue of preference shares
Redemption of debentures
Dividend paid
1,00,000
25,000
(2,20,000)
(1,36,000)
Net cash flow from financing activity (2,31,000)
Net increase in Cash and Cash
equivalents during the year
Add : Cash and cash equivalents at the
beginning of the year
Cash and cash equivalents at the end of
the year.
5,000
88,000
93,000
PCC Group - II Paper 4 II-22
working notes :
Tax A/c
To bank (bal fig)
(paid during year)
To bal c/d
71,000
1,05,000
By bal b/d
By P & L
(prov. made)
80,000
96,000
1,76,000 1,76,000
2. Plant and M achinery A/c
To bal b/d.
To B ank (bal. fig)
(machinery purchased)
6,00,000
2,25,000
By Depreciation
By Bank (sale of machinery)
By P & L (loss on sale of
mach.)
By bal c/d
1,20,000
36,000
9,000
6,60,000
8,25,000 8,25,000
3. Investments A/c
To bal b/d
To P & L (Profit on sale of
investment)
2,40,000
15,000
By bank (sale of
investments)
By bal c/d.
35,000
2,20,000
2,55,000 2,55,000
4. It has been assumed that last year's proposed dividend has been paid and
a provision of current years dividend has been made out of the profits.
(b) Schedule of Changes in Working Capital
Particulars As on31-3-07
As on31-3-08
Increasein WorkingCapital
Decrease inWorkingCapital
A. Current Assets :StockDebtorsCash and BankPrepaid expenses
4,00,0002,88,000
88,00015,000
3,85,0004,15,000
93,00011,000
1,27,0005,000
15,000
4,000
PCC Group - II Paper 4 II-23
7,91,000 9,04,000
B. Current liabilities :Creditors 1,85,000 2,15,000 30,000
1,85,000 2,15,000
Working Capital (A-B)Increase in workingCapital
6,06,000 6,89,000
1,32,000(83,000)1,32,000
Ans : Increase in working Capital Rs. 82,000
Note :Proposed dividend is not treated as current liability.
2008 - Nov [8]Answer the following :
(iii) What do you mean by Stock Turnover ratio and Gearing ratio ?
(3 marks)
Answer :
Inventory/ Stock turn over ratio
It establishes the relationship between the cost of goods sold during the
year and average inventory held during the year.
It is calculated as follows :
Inventory/Stock turnover Ratio =
In above formula :
Average inventory =
This ratio indicates that how fast inventory is sold.
A high ratio is good from the view point of liquidity and a low ratio would
indicate that inventory is not sold and remains in godown for a long time.
Note : Turnover is generally taken as cost of goods sold.
Gearing Ratio :
It is also called as “Capital Gearing Ratio”. It shows the proportion of
fixed interest (d ividend) bearing capital to funds belonging to equity share-
holders funds.
It is calculated as follows :
Capital Gearing Ratio = Preference Capital +
This ratio helps to judge the long term solvency position of a firm.
PCC Group - II Paper 4 II-24
Chapter - 4 : Cost of Capital & Capital Structure
2008 - Nov [5] Answer the following :
(iii) Discuss the concept of ''Optimal Capital Structure.'' (2 marks)
Answer 5 : Refer Para No. 5 & 6 of the Notes Zone on page no. 560.
Chapter - 5 : Business Risk, Financial Risk & Leverage
2008 - Nov [8] Answer the following :
(ii) A company operates at a production level of 1,000 units . The
contribution is Rs. 60 per unit, operating leverage is 6, combined
leverage is 24. If tax rate is 30%, what would be its earnings after tax?
(3 marks)
Answer :
Contribution = 1000 units @ Rs. 60 per unit
= Rs. 60,000
Operating leverage = 6
Operating leverage =
6 =
EBIT =
Combined leverage = 24
Combined leverage = Operating leverage ×Financial leverage
24 = 6 × FL
Financial leverage = 4
Financial Leverage =
4 =
� EBT = Rs. 2,500
Earnings before tax = Rs. 2,500
(!) tax @ 30% = Rs. 750
Earnings after tax (EAT) = Rs 1750
PCC Group - II Paper 4 II-25
Chapter - 6 : Typing of Financing
2008 - Nov [5] Answer the following :
(i) Write a short note on “Deep Discount Bonds”. (2 marks)
Answer :
Deep Discount Bonds :
Deep discount bonds are a form of zero interest bonds. These bonds are
sold at a discounted value and an maturity face value is paid to the investors.
In such bonds, there is no interest payout during lock in period. When such
bonds are sold in the stock market, the difference realised between face value
and market price is the capital gain DBI was the first to issue deep discount
bonds.
2008 - Nov [5] Answer the following :
(ii) Explain the methods of venture capital financing. (2 marks)
Answer : Refer Para No. 12 of the Notes Zone on page no. 631.
Chapter - 7: International Financing
2008 - Nov [5] Answer the following :
(iv) Name the various financial instruments dealt with in the international
market. (2 marks)
Answer :
Some of the various financial instruments dealt with in the international market
are discussed below :
1. Euro Issue : An Euro issue is a issue listed on a foreign stock exchange.
It is an instrument which raises foreign currency in the international
market. through the issue of :
(i) Depository Receipts-ADR & GDR
(ii) Foreign Currency convertible bonds
2. Euro Bonds : Euro bonds are long term loans raised by entities enjoying
an excellent credit rating.
These bonds are issued for a period ranging between 3 to 20 years.
3. Foreign Bonds : Foreign Bonds are debt instrument denominated in a
currency which is foreign to the borrower and is sold in the country of
that currency.
4. Fully Hedged Bonds : Fully hedged bonds are the foreign bonds devoid
of the risk of currency fluctuation.
It eliminates the risk by selling the entire streams of principal and
interest payment in forward market.
PCC Group - II Paper 4 II-26
5. Floating Rate Note : The floating Rate Notes provide foreign currency
at a rate lower than foreign loans. They are issued for a period upto 7
years.
The interest rates are adjusted to reflect the prevailing exchange
rate.
6. Euro Commercial Paper : Euro commercial papers are promissory notes
with a maturity period of less than one year. These are unsecured
instruments issued by a corporate body. The main investors are banks
insurance companies, fund managers etc.
7. Foreign Currency option : Foreign currency option is a right to buy or
sell a sum of foreign currency at a predetermined rate on a future date.
8. Foreign Currency Futures : A foreign currency future is a right to by
or sell a sum of foreign currency at a fixed exchange rate on a specific
future date.
It is an alternative to forward contract for hedging of exchange risk
.
Chapter - 8: Capital Budgeting
2008 - Nov [7] (b) A company wants to invest in a machinery that would cost
Rs. 50,000 at the beginning of year 1 . It is estimated that the net cash inflows
from operations will be Rs. 18,000 per annum for 3 years, if the company opts
to service a part of the machine at the end of year 1 at Rs. 10,000 and the scrap
value at the end of year 3 will be Rs. 12,500. However, of the company decides
not to services the part, it will have to be replaced at the end of year 2 at
Rs.15,400. But in this case, the machine will work for the 4th year also and get
operational cash inflow of Rs. 18,000 for the 4 th year. It will have to be
scrapped at the end of year 4 at Rs. 9,000. Assuming cost of capital at 10% and
ignoring taxes, will you recommend the purchase of this machine based on the
net present value of its cash flows?
If the supplier gives a discount of Rs. 5,000 for purchase, what would be
your decision? (The present value factors at the end of years 0, 1, 2, 3, 4, 5 and
6 are respectively 1, 0.9091, 0.8264, 0.7513, 0.6830, 0.6209 and 0.5644).
(7 marks)
PCC Group - II Paper 4 II-27
Answer :
Option - I (Part of the Machine is serviced)
Year Cash inflows PV Factor PV of Cash flow
0
1
2
3
3
(50,000)
1 8 , 0 0 0 ! 1 0 , 0 0 0
18,000
18,000
12,500
1.00
.9091
.8264
.7513
.7513
(50,000)
7272.8
14,875
13,523
9,391
P.V of inflows = Rs. 45,062
P.V of outflows = Rs. 50,000
Net present value = P.V of inflows - P.V. of outflows
= 45,062 ! 50,000
= Rs. (4,938)
Since the options have unequal lives, Equivalent Annuity value (EAV) is
calculated as follows :
EAV. =
= = Rs. (1986)
Option -II (Part of the machine is replaced)
Year Cash inflows PV Factor PV of Cash flows
0
1
2
3
4
4.
(50,000)
18,000
18,000!15,400
18,000
18,000
9,000
1.00
.9091
.8264
.7513
.6830
.6830
(50,000)
16,364
2,149
13,523
12,294
6,147
P.V of inflows = Rs. 50,477
P.V of outflow = Rs. 50,000
Net present value (NP V) = P.V. of inflows ! P.V of outflows
NPV = Rs. 50,477- Rs. 50,000
= Rs. 477
EAV =
= Rs. 150
Option I has a negative EAV (i.e. of Rs. 1986) whereas option II has a positiveEAV of Rs. 150. Therefore, option II shall be opted.
PCC Group - II Paper 4 II-28
If the Co. decides to service the part, then it is not viable to purchase themachine but if it decides to replace it then machine may be recommended forpurchase although the Cash flows are very minimal.
If the supplier gives a discount of Rs. 5,000 for purchases : Outflow = 50,000!5,000
= Rs. 45,000
Option I
Year Cash inflows PV Factor PV of Cash flows
0
1
2
3
3
(45,000)
18,000!10,000
18,000
18,000
12,500
1.00
.9091
.8264
.7513
.7513
(45,000)
7,273
14,875
13,523
9,391
P.V of inflows = Rs. 45,062
P.V. of outflows = Rs. 45,000
N.P .V = P.V. of inflows !P.V. of outflows
= Rs. 45,062 !Rs. 45,000
= Rs. 62
EAV =
= = Rs. 24.93
Option-II
Year Cash inflows PV Factor PV of Cash flow
0
1
2
3
4
4
(45,000)
18,000
18,000!15,400
18,000
18,000
9,000
1.00
.9091
.8264
.7513
.6830
.6830
(45,000)
16,364
2,149
13,523
12,294
6,147
P.V of inflows = Rs. 50,477
P.V of outflows = Rs. 45,000
NPV = Rs. 50,177!Rs. 45,000 = Rs. 5,477
EAV =
= = Rs. 1,728
NPV of both the options are positive but since Option-II has a higher NPV than
option I hence, option II shall be adopted. In this case, the NPV as well as
PCC Group - II Paper 4 II-29
equivalent Annuity is better in replacing the part of the machine, hence
machine may be recommended for purchase.
2008 - Nov [8] Answer the following :
(iv) Explain the concept of multiple Internal rate of Return. (3 marks)
Answer :
Multiple Internal Rate of Return :
In cases where project cash flows change signs or reverse during the life
of a project, there may be more that one IRR. These are called Multiple
Internal Rate of Return
The most common drawback in using the internal rate of return to
evaluate deterministic cash flow streams is the possibility of multiple
conflicting internal rates, or no internal rate at all. We claim, however, that
contrary to current consensus, multiple or nonexistent internal rates are not
contradictory, meaningless or invalid as rates of return. There is, moreover, no
need to carefully examine a cash flow stream to rule out the possibility of
multiple internal rates, or to throw out or ignore “unreasonable” rates. What we
show is that when there are multiple (or even complex-valued) internal rates,
each has a meaningful interpretation as a rate of return on its own underlying
investment stream.
Some of the advantages of MIRR are :
1. This method makes use of concept of time value of money.
2. All the Cash flows in the project are considered.
Some of the limitations of MIRR are :
1. Calculation process is tedious
2. The IRR approach creates a peculiar situation if we compare two projects
with different inflow/outflow patterns.
3. In case of mutually exclusive projects decision based only on IRR may
not be correct.
Chapter - 9: Meaning, Concept & Policies of Working
Capital
2008 - Nov [7] (a) MN Ltd. is commencing a new project for manufacture of
electric toys. The following cost information has been ascertained for annual
production of 60,000 units at full capacity :
Amount per unit
Rs.
Raw materials 20
Direct labour 15
Manufacturing overheads :
Rs.
PCC Group - II Paper 4 II-30
Variable 15
Fixed 10 25
Selling and Distribution overheads :
Rs.
Variable 3
Fixed 1 4
Total cost 64
Profit 16
Selling price 80
In the first year of operations expected production and sales are 40,000
units and 35,000 units respectively. To assess the need of Working capital, the
following additional information is available :
(i) Stock of Raw materials ............. 3 months consumption.
(ii) Credit allowable for debtors .............. 1 months.
(iii) Credit allowable by creditors ............. 4 months.
(iv) Lag in payment of wages ............. 1 month.
(v) Lag in payment of overheads ............... month.
(vi) Cash in hand and Bank is expected to Rs. 60,000.
(vii) Provision for contingencies is required @ 10% of W orking capital
requirement including that provision.
You are required to prepare a projected statement of Working capital
requirement for the first year of operations. Debtors are taken at cost.
(9 marks)
Answer :
MN Ltd.
Projected Statement of Working Capital Requirement
for the first year of operations
CURRENT ASSETS Rs.
Stock of Materials (W.N.1) 2,00,000
Debtors (W.N.3) 3,05,000
Finished goods (W.N.4) 3,25,000
Cash (Given) 60,000
Total Current Assets (A) 8,90,000
CURRENT LIABILITIES
Creditors for supply of materials 3,33,333
Creditors for wages [W.N.2(a)] 50,000
Creditors for Overheads [W.N.2(b)] 56,875
PCC Group - II Paper 4 II-31
Total Current Liabilities (B) 4,40,208
Estimated W orking Capital Requirement 4,49,792
Add: Provision for Contingencies 49,976
(10% of total working capital requirement)
Total Working Capital Requirement
4,99,768
Working Notes:
1. Calculation of Creditors for supply of materials:
Materials consumed during the year 8,00,000
Add: Closing Stock of Raw M aterials
(8,00,000 x 3/12) 2,00,000
Total Purchases made during the year 10,00,000
Average Creditors (based on 4 months credit period)
[10,00,000 x 4/12] 3,33,333
2. Calculation of Creditors for Expenses:
(a) Creditors for Wages
Total wages paid 6,00,000
Average Creditors [6,00,000 x 1/12] 50,000
(b) Creditors for Overheads
Total Manufacturing Overhead 12,00,000
Total Selling and Distribution Overhead 1,65,000
13,65,000
Average Creditors [13,65,000 x 0.5/12] 56,875
3. Calculation of Average Debtors at Cost of Sales
Average Debtors (At Cost) [24,40,000 x 1.5/12] 3,05,000
4.
MN Ltd.
Projected Statement of Profit / Loss
(Ignoring Taxation)
Production (units) 40,000
Sales (units) 35,000
Sales Revenue @ Rs.80 per unit (A) 28,00,000
Cost of Production:
Materials @ Rs.20 per unit 8,00,000
Direct Labour @ Rs.15 per unit 6,00,000
Manufacturing Overheads:
Variable [40,000 x 15] 6,00,000
Fixed [60,000 x 10] 6,00,000 12,00,000
Cost of goods available for sale 26,00,000
PCC Group - II Paper 4 II-32
[For 40 ,000 units]
Less: Closing Stock at average cost 3,25,000
[26,00,000 x 5,000/40,000]
Cost of goods sold [of 35000 units] 22,75,000
Add: Selling & Distribution Overheads:
Variable [35,000 x 3] 1,05,000
Fixed [60,000 x 1] 60,000 1,65,000
Cost of Sales (B) 24,40,000
Profit [A - B] 3,60,000
Shuchita Prakashan (P) Ltd.25/19, L.I.C. Colony, Tagore Town,
ALLAHABAD- 211002
Visit us : www.shuchita.com
�
PCC Group - II Paper 4 II-33
PCC Group - II Paper 4 II-34
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