CA PE - II :: Cost Accounting and Financial Management : May 2004

RST Limited specializes in the distribution of pharmaceutical products. It buys from the pharmaceutical companies and resells to each of the three different markets :

In the past, RST Limited has used gross margin percentage to evaluate the relative profitability of its distribution channels.

The company plans to use activity-based costing for analysing the probability of its distribution channels.

The April, 2004 operating costs (other than cost of goods sold) of RST Limited are Rs. 8,27,970. These operating costs are assigned to five activity areas. The cost in each area and the quantity of the cost allocation basis used in that area for April, 2004 are as follows :

Required :

(i)	Compute for April, 2004 gross-margin percentage for each of its three distribution channels and compute RST Limited's operating income.
(ii)	Compute the April, 2004 rate per unit of the cost-allocation base for each of the five activity areas.
(iii)	Compute the operating income of each distribution channel in April, 2004 using the activity-based costing information. Comment on the results. What new insights are available with the activity-based cost information?
(iv)	Describe four challenges one would face in assigning the total April, 2004 operating costs of Rs. 8,27,970 to five activity areas.

MST Limited has collected the following data for its two activities. It calculates activity cost rates based on cost driver capacity.

Activity Power Quality Inspections

Cost Driver Kilowatt hours Number of Inspections

Capacity 50,000 Kilowatt hours 10,000 Inspections

Cost Rs. 2,00,000 Rs. 3,00,000

The company makes three products, M,S and T. For the year ended March 31, 2004, the following consumption of cost drivers was reported :

Product	Kilowatt Hours	Quality Inspections
M S	10,000 20,000	3,500 2,500
T	15,000	3,000

Required :

(i)	Compute the costs allocated to each product from each activity
(ii)	Calculate the cost of unused capacity for each activity.
(iii)	Discuss the factors the management considers in choosing a capacity level to compute the budgeted fixed overhead cost rate.

ZED Limited is working by employing 50 skilled workers. It is considered the introduction of incentive scheme-either Halsey scheme (with 50% bonus) or Rowan scheme-of wage payment for increasing the labour productivity to cope up the increasing demand for the product by 405. It is believed that proposed incentive scheme could bring about an average 20% increase over the present earnings of the workers; it could act as sufficient incentive for them to produce more.

Because of assurance, the increase in productivity has been observed as revealed by the figures for the month of April, 2004.
 

Hourly rate of wages (guaranteed) Average time for producing one unit by one worker at the previous performance (This may be taken as time allowed) Number of working days in the month Number of working hours per day of each worker Actual production during the month

Rs. 30 1.975 hours 24 8 6,120 units

Required :

(i)	Calculate the effective rate of earnings under the Halsey scheme and the Rowan scheme
(ii)	Calculate the savings to the ZED Limited in terms of direct labour cost per piece
(iii)	Advise ZED Limited about the selection of the scheme to fulfill his assurance.

JKL Limited produces two products-J and K-together with a by-product L from a single main process (process I). Product J is sold at the point of separation for Rs. 55 per kg, whereas product K is sold for Rs. 77 per kg after further processing into product K2. By-product L is sold without further processing for Rs. 19.25 per kg.

Process I is closely monitored by a team of chemists, who planned the output per 1,000 kg of input materials to be as follows :

Product J Product K Product L Toxic waste

500kg 350 kg 100 kg 50 kg

The toxic waste is disposed at a cost of Rs. 16.50 per kg, and arises at the end of processing.

Process II which is used for further processing of product K into product K2 has the following cost structure :

Fixed costs Variable cost

Rs. 2,64,000 per week Rs. 16.50 per kg processed

The following actual data relate to the first week of the month:

Product I Opening Work-in-progress Material input Direct Labour Variable Overheads Fixed Overheads Outputs : Product J Product K Product L Toxic waste Closing Work-in-progress

Nil 40,000 kg costing Rs. 6,60,000 Rs. 4,40,000 Rs. 1,76,000 Rs. 2,64,000 19,200 kg 14,400 kg   4,000 kg   2,400 kg     Nil

Required :

(i)	Prepare Process I account for the first week of the month using the final sales value method of attribute the pre-separation costs to join products.
(ii)	Prepare the toxic waste account and Process II account for the first week of the month
(iii)	Comment on the method used by the JKL Limited to attributed the pre-separation costs to joint products.
(iv)	Advise the management of JKL Limited whether or not, on purely financial grounds, it should continue to process product K into product K2 : (a) If product K could be sold at the point of separation for Rs. 47.30 per kg; and (b) If the 60% of the weekly fixed costs of Process II were avoided by but processing product K further.

EPS is a Public School having 25 buses each plying in different directions for the transport of its school students. In view of large number of students availing of the bus service, the buses work two shifts daily both in the morning and in the afternoon. The buses are garaged in the school. The workload of the students has been so arranged that in the morning, the first trip picks up senior students and the second trip plying an hour later picks up junior students. Similarly, in the afternoon, the first trip takes the junior students and an hour later the second trip takes the senior students home.

The distance travelled by each bus, one way is 16 kms. The school works 24 days in a month and remains closed for vacation in May and June. the bus fee, hwoever, is payable by the students for all the 12 months in a year.

Each bus gives an average of 10 kms per litre of diesel. The seating capacity of each bus is 60 students. The seating capacity is fully occupied during the whole year.

Ignore interest. Since the bus fees has to be based on average cost, you are required to :

(i)	Prepare a statement showing the expenses of operating a single bus and the fleet of 25 buses for a year.
(ii)	Work out average cost per student per month in respect of : (a) Students coming from a distance of upto 4 kms from the School; (b) Students coming from a distance of upto 8 kms from the School; and (c) Students coming from a distance of upto 16 kms from the School;

IPL Limited uses a small casting in one of its finished products. The castings are purchased from a foundry. IPL Limited purchases 54,000 castings per year at a cost of Rs. 800 per casting.

The castings are used evenly throughout the year in the production process on a 360-day-per-year basis. The company estimates that it costs Rs. 9,000 to place a single purchase order and about Rs. 300 to carry one casting in inventory for a year. The high carrying costs result from the need to keep the castings in carefully controlled temperature and humidity conditions, and from the high cost of insurance.

Delivery from the foundry generally taken 6 days, but it can take as much as 10 days. The days of delivery time and percentage of their occurrence are shown in the following tabulation :

Required :

(i)	Compute the economic order quantity (EQO).
(ii)	Assume the company is willing to assume a 15% risk of being out of stock. What would be the safety stock? The re-order point?
(iii)	Assume the company is willing to assume a 5% risk of being out of stock. What would be safety stock? The re-order point?
(iv)	Assume 5% stock-out risk. What would be the total cost of ordering and carrying inventory for one year?
(v)	Refer to the original data. Assume that using process re-engineering the company reduces its cost of placing a purchase order to only Rs. 600. In addition, company estimates that when the waste and inefficiency caused by inventories are considered, the true cost of carrying a unit in stock is Rs. 720 per year. (a) Compute the new EOQ. (b) How frequently would the company be placing an order, as compared to the old purchasing policy?

The company sells its products on gross-profit of 25% assuming depreciation as a part of cost of production. It keeps two month's stock of finished goods and one month's stock of raw materials as inventory. It keeps cash balance of Rs. 2,50,000.

Assume a 5% safety margin, work out the working capital requirements of the company on cash basis. Ignore work-in-progress.

Required :

The present value interest factor values at different rates of discount are as under :

Rate of discount	t0	t1	t2	t3	t4	t5	t6
0.15 0.18 0.20 0.24	1.00 1.00 1.00 1.00	0.8696 0.8475 0.8333 0.8065	0.7561 0.7182 0.6944 0.6504	0.6575 0.6086 0.5787 0.5245	0.5718 0.5158 0.4823 0.4230	0.4972 0.4371 0.4019 0.3411	0.4323 0.3704 0.3349 0.2751
0.26	1.00	0.7937	0.6299	0.4999	0.3968	0.3149	0.2499

Discuss the relationship between the cost of equity and financial leverage in accordance with MM Proposition II.

The debentures of ABC Limited are redeemable after three years and are quoting at Rs. 981.05 per debenture. The applicable income tax rate for the company is 35%.

The current market price per equity share is Rs. 60. The prevailing default-risk free interest rate on 10-year GOI Treasury Bonds is 5.5%. The average market risk premium is 8%. The beta of the company is 1.1875.

The preferred stock of the company is redeemable after 5 years is currently selling at Rs. 98.15 per preference share.

PQR Limited has decided to go in for a new model of Mercedes Car. The cost of the vehicle is Rs. 40 lakhs. The company has two alternatives :

LMN Limited is willing to provide the car on finance lease of PQR Limited for five years at an annual rental of Rs. 8.75 lakhs, payable at the end of the year.

The vehicle is expected to have useful life of 5 years, and it will fetch a net salvage value of Rs. 10 lakhs at the end of year five. The depreciation rate for tax purpose is 40% on written-down value basis. The applicable tax rate for the company is 35%. The applicable before-tax borrowing rate for the company is 13.8462%.

The values of present value interest factor at different rates of discount are as under :

Rate of discount	t1	t2	t3	t4	t5
0.138462	0.8784	0.7715	0.6777	0.5953	0.5229
0.09	0.9174	0.8417	0.7722	0.7084	0.6499

Discuss the Return on assets (ROA) and Return on Equity (ROE) by bringing out clearly the impact of financial leverage.