INSTITUTE OF COST AND MANAGEMENT ACCOUNTANTS OF PAKISTAN
SPRING (SUMMER) 2007 EXAMINATION
Friday, the 25th May, 2007 .
MANAGEMENT ACCOUNTING-DECISION MAKING (S-502)
Stage—5
Time Allowed —2 Hours 45 Minutes Maximum Marks —90
(i) Attempt ALL questions.
(ii) Answers must be neat, relevant and brief.
(iii) In marking the question paper, the examiners take into account clarity of exposi-
tion, logic of arguments, effective presentation, language and use of clear diagram
or chart where appropriate.
(iv) Read the instructions printed on the top cover of answer script CAREFULLY before
attempting the paper.
(v) DO NOT write your Name, Reg. No. or Roll No. anywhere inside the answer script.
(vi) Question No. 1-."Multiple Choice Question” printed separately, is an integral part
of this question paper.
Q. 2. Brown Ltd. is a company that has in stock some materials of type XY Marks
that cost Rs. 75,000 but these materials are now obsolete and have a
scrap value of only Rs. 21,000. Other than selling the material for
scrap, there are only two alternative uses for them.
Alternative 1: Convert the obsolete materials into a specialized
product, which would require the following additional
work and materials :
Material A 600 units
Material B 1,000 units
Direct labour :
5,000 hours unskilled
§,000 hours semi-skilled
5,000 hours highly skilled Total 15,000 hours
Extra selling and delivery expenses Rs. 27,000
Extra advertising expenses Rs. 18,000
The conversion would produce 900 units of saleable products, and
these could be sold for Rs. 300 per unit.
ug PTOMaterial A is already in stock and is widely used within the firm. Marks
Although present stocks together with orders already planned will be
sufficient to facilitate normal activity, any extra material used by adopt-
ing this alternative will necessitate such materials being replaced imme-
diately. Material B is also in stock, but it is unlikely that any additional
supplies can be obtained for some considerable time because of an
industrial dispute. At the present time material B is normally used in the
production of product Z, which sells at Rs. 390 per unit and incurs total
variable cost (excluding material B) of Rs. 210 per unit. Each unit of
product Z uses four units of Material B.
The details of materials A and B are as follows :
Material A Material B
(Rupees) (Rupees)
Acquisition cost at time of purchase 100 per unit 410 per unit
Net realizable value 85 per unit 18 per unit
Replacement cost 90 per unit
Alternative 2: Adapting the obsolete materials for use as a substitute
for a sub-assembly that is regularly used in the firm.
Details of the extra work and materials required are as follows :
Material C 1,000 units
Direct labour :
4,000 hours unskilled
1,000 hours semi-skilled
4,000 hours highly skilled Total 9,000 hours
1,200 units of the sub-assembly are regularly used per quarter at a cost
of Rs. 900 per unit. The adaption of material XY would reduce the
quantity of the sub-assembly purchased from outside the firm to 900
units for the next quarter only. However, since the voiume of pur-
chases would be reduced, some discount would be lost, and the price
of those purchased from outside would increase to Rs. 1,050 per unit
for the quarter.
Material C is not available externally, but is manufactured by Brown Ltd.
The 1,000 units required would be available from stocks, but would be
219produced as extra production. The standard cost per unit of material C Marks
would be as follows :
(Rupees)
Direct labour, 6 hours unskilled labour 18
Raw materials 13,
Variable overhead, 6 hours at Re. 1 6
Fixed overhead, 6 hours at Rs. 3 18
55
The wage rates and overhead recovery rates for Brown Ltd. are :
Variable overhead Re. 1 per direct labour hour
Fixed overhead Rs. 3 per direct labour hour
Unskilled-labour Rs. 3 per direct labour hour
Semi-skilled labour Rs. 4 per direct labour hour
Highly skilled labour Rs. 5 per direct labour hour
The unskilled labour is employed on a casual basis, and sufficient
labour can be acquired to exactly meet the production requirements.
Semi-skilled labour is part of the permanent labour force, but the com-
pany has temporary excess supply of this type of labour at the present
time. Highly skilled labour is in short supply and cannot be increased
significantly in the short term; this labour is presently engaged in meet-
ing the demand for product L, which requires 4 hours of highly skilled
labour. The contribution from the sale of one unit of product L is Rs. 24.
Required :
Prepare and present cost information, advising whether the stocks of
material XY should be sold, converted into a specialized product
(alternative 1) or adapted for use as a substitute for a sub-assembly
(alternative 2).
Following is the budgeted room occupancy of Hotel Shaheen for the
next financial year.
Average %
July—September 90
October—December 55
January—March 45
April—dune 60
3/9
20
PTORevenue for the year is estimated at Rs. 150 million, which is generat- Marks
ed from the following three profit centres:
Profit Centre %
+ Accomodation 45
+ Restaurant/catering 35
+ Snacks bar 20
Total 100
Note: The accomodation revenue is earned from several different
categories of guests each of which pay a different rate per
room. ~
The three profit centres have the following gross margin percentage
Restauran/
Accomodation Catering Snacks Bar
% % %
Revenue 100 100 100
Wages 20 30 15
Cost of sales _ 40 50
Direct costs 10 30 10 80 35 70
Gross margin ~~ 70 “20 30
Fixed costs for the year are estimated at Rs. 28,250,000. Capital
employed is Rs. 350 million. In order to improve the return on capital
employed, the management have following two propositions under
consideration :
(1) To offer special two nights package at a reduced price of Rs.
1,250 per night. {t is expected that those availing the offer would
spend an amount equal to 40% of the accomodation charge in the
restaurant (catering), and 20% in the snacks bar,
To increase prices. Management feels that there will be no drop
in volume of sales if restaurant (catering) prices are increased by
10% and snacks bar prices by 5%. Accomodation prices will also
have to be increased.
(2
Required :
(a
Calculate the budgeted return on capital employed (ROCE) 5
before tax
4/9(b) Calculate
(i) How many two-nights packages would need to be sold each
week in the three off-peak quarters to improve the return on
capital employed (ROCE) by a further 4% above the percent-
age. calculated in (a) above.
(ii) By what percentage the price of accomodation would need to
be increased to achieve the desired increase in ROCE calcu-
lated in [b (i)] above.
Meezan Company Ltd. are the manufacturers of grass cutting
machines, which they have been selling for Rs. 800 per unit for a
number of years. The selling price is now under review, and the follow-
ing information is available on costs and likely demand :
The standard variable cost of manufacture is Rs. 500 per unit and a
cost variance analysis for the last 20 months shows the following trend
and that the same is likely to continue in the future :
10 months—10% adverse variance of standard variable cost
occurred during the period.
6 months—-No variance of satandard variable cost.
4 months—5% favourable variance occured in standard vari-
able cost.
Monthly data :
Fixed cost have been Rs. 250 per unit on an average sales level of
20,000 units, but these costs are expected to rise in the future and the
following estimates have been made for the total fixed cost :
Rs.
Optimistic estimate (Probability 0.3) 4,100,000
Most likely estimate (Probability 0.5) 4,250,000
Pessimistic estimate (Probability 0.2) 4,500,000
The demand at the two new prices under consideration is as
follows :
Estimated demand at hin ice: it
selling price/unit Rs. 850 Rs. 900
Optimistic (Probability 0.2) 21,000 Units 19,000 Units
Most likely (Probability 0.5) 19,000 Units 17,500 Units
Pessimistic (Probability 0.3) 16,500 Units 15,500 Units
Sig
Marks.
PTOItis assumed that alt estimates and probabilities are independent.
Required :
(a) Advise the management, whether they should change the selling
price, and if so, the price you would recommend based on the
information given above.
(b)
Calculate the expected profit at your recommended price and
resulting margin of safety, expressed as a percentage of
expected sales.
IC)
Critically comment on the method of analysis you have used to
deal with the probabilities given in the question.
(d) Describe briefly, how computer assistance might improve the
analysis.
Consolidated Petroleum Products Ltd., is a medium size petroleum
refinery with a distributors network. The company is facing shortage of
funds for investment in the forthcoming financial year.
You, being the finance manager of the company have the responsi-
bility of resource allocation and are evaluating the following investment
proposals which are not mutually exclusive.
The company is in a capital rationing situation and can only invest
Rs. 45 million in capital projects in the next financial year.
Project 1: To replace the existing instrumentation control station.
Expected life of the new equipment is 6 years, the initial cost of which
is Rs. 18,750,000 and the annual after tax cash inflow is estimated to
be Rs. 5,437,500.
Project 2: Construction of storage warehouse. Cost Rs. 5,250,000,
expected life 5 years and expected annual after tax cash inflow of
Rs. 2,250,000 to commence from year—2.
Project 3; Purchase of a new distribution heavy duty vehicle. Cost
Rs. 8,250,000, expected life 3 years and expected annual after tax
inflow of Rs. 3,375,000.
Project 4: Construction of new loading bay with appropriate equip-
ments. Cost Rs. 15,750,000, expected life 8 years and estimated
annual after tax cash inflow of Rs. 4,275,000.
6/9
Marks
6
5
3
3Marks,
Project 5: Construction of a weigh-bridge. Cost 10,125,000, expected life
7 years and estimated annual after tax cash inflow of Rs. 2,700,000.
Project 6: Addition of a locomotive for internal rail system. Cost
Rs. 12,750,000, estimated life 4 years and estimated annual after tax
cash inflow of Rs. 5,250,000.
It is envisaged that all cash inflows would commence on the last day of
the same year with the exception of project 2 whose cash flow will start
‘on the last day of second year. All cash inflows would continue to be
received on the last day of the year.
Tax is assumed to be paid in the year in which profits are earned. The
company’s marginal cost of capital for the coming year is estimated at
16%.
Required :
(a) Recomend which projects should be undertaken and why ? 15
(Prepare and present all working notes).
(b) In addition to the factors already given in the question, what other 3
factors, in your opinion, you would consider before making a final
recommendation.
Q.6. AlKaram Company's budget for the year 2007-08 includes the follow-
ing items for its five divisions :
Operating Divisional
Income Assets
1. Data entry network solutions 1,650 8,160
2. Computers (Hardwares) 125 4,250
3. Office appliances 205 940
4. Cell phones 100 625
5. Software programmes 60 1,250
2,140" 9,225
The manager of each division is paid a salary plus commission related
to retum on investment (i.e., operating income divided by divisional
assets). The company uses 12% required rate of return for new invest-
ments in all the divisions.
79 PTO~ Marks,
The company’s management is concerned about the commission
element of the divisional managers’ emoluments.
The divisions have recently submitted their investment proposals for the
forthcoming year's budget. These investment proposals are based on
discounted cash flow with positive NPV using 12% requied rate of
return.
Following is the expected increase in operating income and divisional
assets during the year 2007-08 as submitted by the divisions :
Year 2007-08
Increase in Increase in
operating income assets
‘Rs. million) (Rs. million)
1. Data entry network solutions 375 1,565
2. Computers (Hardwares) 80 625
3. Office appliances 120 625
4. Cell phones 30 155
5. Software programmes 45 315
Total : 650 3,285,
Required
(a) How do the divisionai investment proposals effect their ROI? 10
Calculate the divisional ROI! on the following assumptions :
(i) Before the proposed investment,
(ii) Of the proposed investment, and
(ii) The combined investment (original investment and proposed
investment).
(iv) Comment on the results thereof.
(b) How will the adoption of proposed investment affect the residual 10
income of respective divisions? Calculate the residual income by
divisions under three assumptions as mentioned/given in (a-i, ii &
ili) above. Also comment on the results.
8/9DISCOUNT TABLE
Present value of
ENT Vé Ordinary Annuity of
Rupee 4
Period(s) | 10% 12% 14% 16% 18% |[Period(s}| 16%
1 0.9091 | 08929 | 0.8772 | 0.8621 | 0.8475 1 0.8621
2 o.e264 | 07972 | 07695 | 0.7432 | 0.7182 2 1.6052
3 0.7513 | 0.7118 | 0.6750 | 0.6407 | 0.6086 3 2.2459
4 0.6830 | 0.6355 | 0.5921 | 0.5523 | 0.5158 4 2.7982
5 0.6209 | 0.5674 | 0.5194 | 0.4761 | 0.4371 5 3.2743
6 0.5645 | 0.5066 | 0.4556 | 0.4104 | 0.3704 3.6847
7 0.5132 | 0.4523 4.0386
8 0.4665 | 0.4039
THE END
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