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 PTOMaterial 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 219produced 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 PTORevenue 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. PTOItis 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 3Marks, 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. 8/9DISCOUNT 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 919