PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

All questions are compulsory.

Working notes should form part of the answer wherever appropriate,
suitable assumptions should be made.
Questi on 1
Answer any five of the following:
(i) Using Taylors differential piece rate system, find the earning of A from the following
particulars:
Standard time per piece 12 minutes
Normal rate per hour (in a 8 hours day) Rs. 20
A produced 37 Units
(ii) Briefly discuss, how the synergetic effect help in reduction in costs.
(iii) Explain in brief the explicit cost with examples.
(iv) Explain briefly the conditions when supplementary rates are used.
(v) The average annual consumption of a material is 18,250 units at a price of Rs. 36.50 per
unit. The storage cost is 20% on an average inventory and the cost of placing an order is
Rs. 50. How much quantity is to be purchased at a time?
(vi) Enumerate the various methods of Time booking. (5 2 = 10 Marks)
Answer
(i ) Standard output per day
units 40
12
60 8
= |
.
|

\
|
Actual output = 37 units
Efficiency percentage
92.5% 100
40
37
=
Under this method lower rate is 83% of the normal piece rate and is applicable if
efficiency of worker is below 100%.
Earning rate per unit = 83% of
unit per 3.32 or
* 5
20
Earning = 37 3.32 = Rs. 122.84
* In one hour, production will be = units 5
minutes 12 i.e. peice, per time standard
minutes 60
=
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 4
(i i ) Two or more products are produced and managed together.
The result of combined efforts are higher than sum of the results of individual products.
Analysis of synergetic effect is helpful in cost control.
(i i i ) Out of pocket cost, involving immediate payment of Cash. Salaries, Wages, Postage and
Telegram, Printing and Stationery, Interest on Loan are some examples of Explicit Costs.
(i v) When the amount of under absorbed and over absorbed overhead is significant or large,
because of differences due to wrong estimation, then the cost of product needs to be
adjusted by using supplementary rates (under and over absorption/actual overhead) to
avoid misleading impression.
(v) Quantity to be purchased
units 500 2,50,000
36.50 of 20%
50 18,250 2
= =

(vi ) The various methods of time booking are:
(a) Job ticket.
(b) Combined time and job ticket.
(c) Daily time sheet.
(d) Piece work card.
(e) Clock card.
Questi on 2
A company has three production departments (M
1
, M
2
and A
1
) and three service department,
one of which Engineering service department, servicing the M
1
and M
2
only. The relevant
informations are as follows:
Product X Product Y
M
1
10 Machine hours 6 Machine hours
M
2
4 Machine hours 14 Machine hours
A
1
14 Direct Labour hours 18 Direct Labour hours
The annual budgeted overhead cost for the year are
Indirect Wages Consumable Supplies
(Rs.) (Rs.)
M
1
46,520 12,600
M
2
41,340 18,200
A
1
16,220 4,200
Stores 8,200 2,800
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
5
Engineering Service 5,340 4,200
General Service 7,520 3,200
Rs.
Depreciation on Machinery 39,600
Insurance of
Machinery
7,200
Insurance of Building 3,240 (Total building insurance cost for
M
1
is one third of annual premium
Power 6,480
Light 5,400
Rent 12,675 (The general service deptt. is
located in a building owned by
the company. It is valued at Rs.
6,000 and is charged into cost at
notional value of 8% per annum.
This cost is additional to the rent
shown above)
The value of issues of materials to the production departments are in the
same proportion as shown above for the Consumable supplies.
The following data are also available:
Department Book value
Machinery
(Rs.)
Area
(Sq. ft.)
Effective
H.P. hours %
Production
Direct
Labour
hour
Capacity
Machine
hour
M
1
1,20,000 5,000 50 2,00,000 40,000
M
2
90,000 6,000 35 1,50,000 50,000
A
1
30,000 8,000 05 3,00,000
Stores 12,000 2,000
Engg. Service 36,000 2,500 10
General Service 12,000 1,500
Required:
(i) Prepare a overhead analysis sheet, showing the bases of apportionment of overhead to
departments.
(ii) Allocate service department overheads to production department ignoring the
apportionment of service department costs among servi ce departments.
(iii) Calculate suitable overhead absorption rate for the production departments.
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 6
(iv) Calculate the overheads to be absorbed by two products, X and Y.
(6 + 4 + 3 + 2 = 15 Marks)
Answer
(i ) Summary of Apporti onment of Overheads
(Rs.)
Producti on Deptt. Servi ce Deptt.
Items
Basi s of
Apporti onment
Total
Amount
M1 M2 A1 Store
Servi ce
Engi neering
Servi ce
General
Servi ce
Indirect
wages
Allocation given 1,25,140 46,520 41,340 16,220 8,200 5,340 7,520
Consumable
stores
Allocation given 45,200 12,600 18,200 4,200 2,800 4,200 3,200
Depreciation Capital value of
machine
39,600 15,840 11,880 3,960 1,584 4,752 1,584
Insurance of
Machine
Capital value of
machine
7,200 2,880 2,160 720 288 864 288
Insurance
on Building
3
1
to MI
Balance area
basis
3,240 1,080 648 864 216 270 162
Power HP Hr% 6,480 3,240 2,268 324 648
Light Area 5,400 1,080 1,296 1,728 432 540 324
Rent Area 12,675 2,535 3,042 4,056 1,014 1,268 760
Rent of
general
service
Direct 8% of
6,000
480
_______

______

______

______

______

______
480
______
Total 2,45,415 85,775 80,834 32,072 14,534 17,882 14,318
(i i ) Al l ocati on of servi ce departments overheads
Production Deptt. Service Deptt.
Service Deptt.
Basis of
Apportionment
M1 M2 A1 Store
Service
Engineering
Service
General
Service
Store Ratio of
consumable value
(126 :182 : 42)
5,232 7,558 1,744 (14,534)
Engineering
service
In Machine hours
Ratio of M1 and
M2 (4 : 5)
7,948 9,934 (17,882)
General
service
LHR Basis
20 : 15 : 30 4,406 3,304 6,608 (14,318)
Production
Department
allocated in (i)
_______ 85,775 80,834 32,072
Total 2,45,415 1,03,361 1,01,630 40,424
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
7
(i i i ) Overhead Absorpti on rate
M
1
M
2
A
1
Total overhead allocated 1,03,361 1,01,630 40,424
Machine hours 40,000 50,000
Labour hours 3,00,000
Rate per MHR 2.584 2.033
Rate per Direct labour .135
(i v) Statement showi ng overhead absorpti on for Product X and Y
Machine
Deptt.
Absorption
Rate
Product X
Hours Rs.
Product Y
Hours Rs.
M
1
2.584 10 25.84 6 15.50
M
2
2.033 4 8.13 14 28.46
A
1
.135 14 .54 18 2.43
34.51 46.39
Questi on 3
(a) AKP Builders Ltd. Commenced a contract on April 1, 2005. The total contract was for Rs.
5,00,000. Actual expenditure for the period April 1, 2005 to March 31, 2006 and
estimated expenditure for April 1, 2006 to December 31, 2006 are given below:
2005-06
(Actuals)
Rs.
2006-07 (9 months)
(Estimated)
Rs.
Material Issued 90,000 85,750
Labour : Paid 75,000 87,325
Outstanding at the end 6,250 8,300
Plant 25,000
Sundry Expenses : Paid 7,250 6,875
Prepaid at the end 625
Establishment charges 14,625
A part of the material was unsuitable and was sold for Rs. 18,125 (Cost bei ng Rs.
15,000) and a part of plant was scrapped and disposed of for Rs. 2,875. The value of
plant at site on 31 March, 2006 was Rs. 7,750 and the value of material at site was Rs.
4,250. Cash received on account to date was Rs. 1,75,000, representing 80% of the
work certified. The cost of work uncertified was valued at Rs. 27,375.
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 8
The contractor estimated further expenditure that would be incurred in completion of the
contract:
+ The contract would be completed by 31st December, 2006.
+ A further sum of Rs. 31,250 would have to be spent on the plant and the residual
value of the pant on the completion of the contract would be Rs. 3,750.
+ Establishment charges would cost the same amount per month as in the previous
year.
+ Rs. 10,800 would be sufficient to provide for contingencies.
Required:
Prepare Contract account and calculate estimated total profit on this contract. Profit
transferrable to Profit and Loss account is to be calculated by reducing estimated Profit
in proportion of work certified and contract price. (8 Marks)
(b) A Company produces two joint products P and Q in 70 : 30 ratio from basic raw materials
in department A. The input output ratio of department A is 100 : 85. Product P can be
sold at the split of stage or can be processed further at department B and sold as product
AR. The input output ratio is 100 : 90 of department B. The department B is created to
process product A only and to make it product AR.
The selling prices per kg. are as under:
Product P Rs. 85
Product Q Rs. 290
Product AR Rs. 115
The production will be taken up in the next month.
Raw materials 8,00,000 Kgs.
Purchase price Rs. 80 per Kg.
Deptt. A Deptt. B
Rs. Lacs Rs. Lacs
Direct materials 35.00 5.00
Direct labour 30.00 9.00
Variable overheads 45.00 18.00
Fixed overheads 40.00 32.00
Total 150.00 64.00
Selling Expenses:
Rs. in Lacs
Product P 24.60
Product Q 21.60
Product AR 16.80
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
9
Required:
(i) Prepare a statement showing the apportionment of joint costs.
(ii) State whether it is advisable to produce product AR or not. (8 Marks)
Answer
(a) AKP Bui l ders Ltd.
Contract Account (20052006)
Particulars Rs. Particulars Rs.
To Material issued 90,000 By Material (sold) 18,125
To Labour 75,000 By Plant (sold) 2,875
Add: Outstanding 6,250 81,250 By Plant at site 7,750
To Plant 25,000 By Material at site 4,250
To Sundry Expenditure 7,250
Less: Pre-paid 625 6,625
To Establishment charges 14,625 By Balance c/d 1,87,625
To Profit and Loss A/c
(Profit on sale of
material)
3,125 _______
2,20,625 2,20,625
To Balance b/d 1,87,625 By Work in progress
To Balance c/d 58,500 Certified 2,18,750
_______ Uncertified 27,375
2,46,125 2,46,125
To Profit and Loss A/c* 29,960.55 By Balance 58,500
To Work in progress 28,539.45 _______
58,500 58,500
* Profit to Profit and Loss A/c =
price Contract
certified Work
Profit Estimated
29,960.55 Rs.
5,00,000
2,18,750
68,481.25 =
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 10
Memorandum Contract Account (9 months)
Particulars Rs. Rs. Particulars Rs.
To Material
(90,000 + 3,125
18,125)
75,000
By Contractees A/c 5,00,000
Add: New Addition 85,750 1,60,750
To Plant (25,000 2,875) 22,125
Add: New (+) 31,250
Less: Closing () 3,750 49,625
To Establishment charges 14,625
Add: For nine months
= 9
12
14,625
10,968.75 25,593.75
To Sundry Expenditure 6,625
Add: New (+) 6,875
Previous prepaid (+) 625 14,125.00
To Labour 81,250
Add: (87,325 6,250) (+) 81,075
Outstanding (+) 8,300 1,70,625
To Reserve for
contingencies
10,800
To Estimated Profit 68,481.25 _______
5,00,000 5,00,000
(b) Input in Deptt. A 80,000 kgs.
Yield 85%
Therefore Output = 85% of 8,00,000 = 6,80,000 kgs.
Ratio of output for P and Q = 70 : 30.
Product of P = 70% of 6,80,000 = 4,76,000 kgs.
Product of Q = 30% of 6,80,000 = 2,04,000 kgs.
Statement showi ng apporti onment of j oi nt cost
P Q Total
Product kgs. 4,76,000 2,04,000
Selling price per kg. Rs. 85.00 290.00
Rs. lakhs Rs. lakhs Rs. lakhs
Sales 404.60 591.60 996.20
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
11
Less: Selling expenses 24.60 21.60 46.20
Net sales 380 570 950
Ratio 40% 60% 100%
Rs. lakhs
Raw materials (8,00,000 kgs. Rs. 80) 640
Process cost of department A 150
790
Apporti onment of Joi nt Cost
(In the ratio of Net Sales i.e. P : Q., 40% : 60%.
Joint Cost of P = Rs. 316 lakhs
Joint Cost of Q = Rs. 474 lakhs
Statement showi ng the profi tabi l i ty of further processi ng of
product P and converted i nto product AR
Product AR
Output = 90% of 4,76,000 kgs. = 4,28,400 kgs.
Rs. lakhs
Joint costs 316.00
Cost of Department B 64.00
Selling expenses 16.80
396.80
Sales value (Rs. 115 4,28,400) 492.66
Profit (492.66 396.80) 95.86
If P is not processed profitability is as under.
Rs. lakhs
Sales 380.00
Less: Joint expense 316.00
Profit 64.00
Further processing of product P and converting into product AR is beneficial to the
company because the profit increaser by Rs. 31.86 lakhs (95.86 64.00).
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 12
Questi on 4
Answer any three of the following:
(i) Discuss the treatment of spoilage and defectives.
(ii) What items are generally included in good uniform costing manual?
(iii) Operation costing is defined as refinement of Process costing. Explain it.
(iv) Enumerate the factors which cause difference in profits as shown in Financial Accounts
and Cost Accounts. (3 3 = 9 Marks)
Answer
(i ) Treatment of spoilage and defectives:
Spoi l age:
Normal spoilage are included in cost either by charging the loss to the production order
or charging it to production overhead. The cost of abnormal spoilage is charged to
costing profit and loss account.
Defecti ves:
Normal defectives can be recovered : charged to good production
: charged to general overhead
: charged to department.
If defectives are abnormal and are due to causes beyond the control of organization then
they should be charged to profit and loss account.
(i i ) Uniform costing manual includes essential informations and instructions to implement
accounting procedures.
(a) Introduction: It includes objects and scope of the planning.
(b) Accounting procedure and planning includes rules, and general principle to be
followed.
(c) Cost accounting planning includes methods of costing, relation between cost and
financial accounts and methods of integration.
(i i i ) Operation costing is concerned with the determination of the cost of each operation
rather than the process:
+ In the industries where process consist of distinct operations, the operation costing
method is applied.
+ It offers better control and facilitates, the computation of unit operation cost at the
end of each operation.
(i v) Causes of difference:
(a) Items included in financial accounts but not in cost accounts such as:
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
13
Interest received on bank deposits, loss/profit on sale of fixed assets and
investments, dividend, rent received.
(b) Items included in cost accounts on notional basis such as rent of owned building,
interest on own capital etc.
(c) Items whose treatment is different in the two sets of accounts such as inventory
valuation.
Questi on 5
Answer any five of the following:
(i) Define Modified Internal Rate of Return method.
(ii) Explain the need of debt-service coverage ratio.
(iii) Explain the term Ploughing back of Profits.
(iv) ABC Limited has an average cost of debt at 10 per cent and tax rate is 40 per cent. The
Financial leverage ratio for the company is 0.60. Calculate Return on Equity (ROE) if its
Return on Investment (ROI) is 20 per cent.
(v) Explain in brief the assumptions of Modigliani-Miller theory.
(vi) A person is required to pay four equal annual payments of Rs. 4,000 each in his Deposit
account that pays 10 per cent interest per year. Find out the future value of annuity at
the end of 4 years. (5 2 = 10 Marks)
Answer
(i ) Modi fi ed Internal Rate of Return (MIRR): There are several limitations attached with
the concept of the conventional Internal Rate of Return. The MIRR addresses some of
these deficiencies. For example, it eliminates multiple IRR rates; it addresses the
reinvestment rate issue and produces results, which are consistent with the Net Present
Value method.
Under this method, all cash flows, apart from the initial investment, are brought to the
terminal value using an appropriate discount rate(usually the cost of capital). This
results in a single stream of cash inflow in the terminal year. The MIRR is obtained by
assuming a single outflow in the zeroth year and the terminal cash in flow as mentioned
above. The discount rate which equates the present value of the terminal cash in flow to
the zeroth year outflow is called the MIRR.
(i i ) Debt Servi ce Coverage Rati o: Lenders are interested in this ratio to judge the firms
ability to pay off current interest and installments.
Instalment Interest
service debt for available Earnings
ratio coverage service Debt
+
=
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 14
Where,
Earning for debt service = Net profit
+ Non-cash operating expenses like depreciation and other
amortizations
+ Non-operating adjustments like loss on sale of
+ Fixed assets + Interest on Debt Fund.
(i i i ) Pl oughi ng back of Profi ts: Retained earnings means retention of profit and reinvesting
it in the company as long term funds. Such funds belong to the ordinary shareholders
and increase the net worth of the company. A public limited company must plough back a
reasonable amount of profit every year keeping in view the legal requirements in this
regard and its own expansion plans. Such funds also entail almost no risk. Further,
control of present owners is also not diluted by retaining profits.
(i v) ROE = [ROI + {(ROI r) D/E}] (1 t)
= [0.20 + {(0.20 0.10) 0.60}] (1 0.40)
=[ 0.20 + 0.06] 0.60 = 0.1560
ROE = 15.60%
(v) Assumpti ons of Modi gl i ani Mi l l er Theory
(a) Capital markets are perfect. All information is freely available and there is no
transaction cost.
(b) All investors are rational.
(c) No existence of corporate taxes.
(d) Firms can be grouped into Equivalent risk classes on the basis of their business
risk.
(vi )
|
|
.
|

\
|
+
=
i
1 i) (1
A FVA
n
|
|
.
|

\
|
+
.10
1 .10) (1
4,000
n
4,000 4.641 = Rs. 18,564
Future Value of Annuity at the end of 4 years = Rs. 18,564
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
15
Questi on 6
The Balance Sheet of JK Limited as on 31st March, 2005 and 31st March, 2006 are given
below:
Balance Sheet as on (Rs. 000)
Liabilities 31.03.05 31.03.06 Assets 31.03.05 31.03.06
Share Capital 1,440 1,920 Fixed Assets 3,840 4,560
Capital Reserve 48 Less: Depreciation 1,104 1,392
General Reserve 816 960 2,736 3,168
Profit and Loss
Account
288 360 Investment 480 384
9% Debenture 960 672 Cash 210 312
Current Liabilities 576 624 Other Current
Assets
Proposed Dividend 144 174 (including Stock) 1,134 1,272
Provision for Tax 432 408 Preliminary
Expenses
96 48
Unpaid Dividend 18 _____ _____
4,656 5,184 4,656 5,184
Additional Informations:
(i) During the year 2005-2006, Fixed Assets with a book value of Rs. 2,40,000 (accumulated
depreciation Rs. 84,000) was sold for Rs. 1,20,000.
(ii) Provided Rs. 4,20,000 as depreciation.
(iii) Some investments are sold at a profit of Rs. 48,000 and Profit was credited to Capital
Reserve.
(iv) It decided that stocks be valued at cost, whereas previously the practice was to value
stock at cost less 10 per cent. The stock was Rs. 2,59,200 as on 31.03.05. The stock as
on 31.03.06 was correctly valued at Rs. 3,60,000.
(v) It decided to write off Fixed Assets costing Rs. 60,000 on which depreciation amounting
to Rs. 48,000 has been provided.
(vi) Debentures are redeemed at Rs. 105.
Required:
Prepare a Cash Flow Statement. (15 Marks)
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 16
Answer
Cash fl ow Statement (31
st
March, 2006)
(A) Cashfl ows from Operati ng Acti vi ti es
Profit and Loss A/c
(3,60,000 (2,88,000 + 28,800) 43,200
Adjustments:
Increase in General Reserve 1,44,000
Depreciation 4,20,000
Provision for Tax 4,08,000
Loss on Sale of Machine 36,000
Premium on Redemption of
Debenture
14,400
Proposed Dividend 1,74,000
Preliminary Exp. w/o 48,000
Fixed Assets w/o 12,000 12,56,400
Funds from Operation 12,99,600
Increase in Sundry Current Liabilities 48,000
Increase in Current Assets
12,72,000 (11,34,000 + 28,800) (1,09,200)
Cash before Tax 12,38,400
Tax paid 4,32,000
Cash from Operating Activities 8,06,400
(B) Cash from Investi ng Acti vi ti es
Purchases of fixed assets (10,20,000)
Sale of Investment 1,44,000
Sale of Fixed Assets 1,20,000 (7,56,000)
(C) Cash from Fi nanci ng Acti vi ti es
Issue of Share Capital 4,80,000
Redemption of Debenture (3,02,400)
Dividend paid (1,26,000) 51,600
Net increase in Cash and Cash
equivalents
1,02,000
Opening Cash and Cash equivalents 2,10,000
Closing Cash 3,12,000
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
17
Fi xed Assets Account
Particulars Rs. Particulars Rs.
To Balance b/d 27,36,000 By Cash 1,20,000
To Purchases (Balance) 10,20,000 By Loss on sales 36,000
By Depreciation 4,20,000
By Assets w/o 12,000
________ By Balance 31,68,000
37,56,000 37,56,000
Depreci ati on Account
Particulars Rs. Particulars Rs.
To Fixed Assets (on sales) 84,000 By Balance b/d 11,04,000
To Fixed Assets w/o 48,000 By Profit and Loss a/c 4,20,000
To Balance 13,92,000 ________
15,24,000 15,24,000
Questi on 7
(a) The following details of RST Limited for the year ended 31March, 2006 are given below:
Operating leverage 1.4
Combined leverage 2.8
Fixed Cost (Excluding interest) Rs. 2.04 lakhs
Sales Rs. 30.00 lakhs
12% Debentures of Rs. 100 each Rs. 21.25 lakhs
Equity Share Capital of Rs. 10 each Rs. 17.00 lakhs
Income tax rate 30 per cent
Required:
(i) Calculate Financial leverage
(ii) Calculate P/V ratio and Earning per Share (EPS)
(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a
high or low assets leverage?
(iv) At what level of sales the Earning before Tax (EBT) of the company will be equal to
zero?
(b) The turnover of PQR Ltd. is Rs. 120 lakhs of which 75 per cent is on credit. The variable
cost ratio is 80 per cent. The credit terms are 2/10, net 30. On the current level of sales,
the bad debts are 1 per cent. The company spends Rs. 1,20,000 per annum on
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 18
administering its credit sales. The cost includes salaries of staff who handle credit
checking, collection etc. These are avoidable costs. The past experience indicates that
60 per cent of the customers avail of the cash discount, the remaining customers pay on
an average 60 days after the date of sale.
The Book debts (receivable) of the company are presently being financed in the ratio of
1 : 1 by a mix of bank borrowings and owned funds which cost per annum 15 per cent
and 14 per cent respectively.
A factoring firm has offered to buy the firms receivables. The main elements of such
deal structured by the factor are:
(i) Factor reserve, 12 per cent
(ii) Guaranteed payment, 25 days
(iii) Interest charges, 15 per cent, and
(iv) Commission 4 per cent of the value of receivables.
Assume 360 days in a year.
What advise would you give to PQR Ltd. - whether to continue with the in house
management of receivables or accept the factoring firms offer? (8 + 8 = 16 Marks)
Answer
(a) (i ) Fi nanci al l everage
Combined Leverage= Operating Leverage (OL) Financial Leverage (FL)
2.8 = 1.4 FL
FL = 2
Financial Leverage = 2
(i i ) P/V Rati o and EPS
P/V ratio =
100
S
C

Operating leverage =
100
F C
C

2,04,000 C
C
1.4

=
1.4 (C 2,04,000) = C
1.4 C 2,85,600 = C
0.4
2,85,600
C =
C = 7,14,000
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
19
P/V =
23.8% 100
30,00,000
7,14,000
=
Therefore, P/V Ratio = 23.8%
EPS =
shares equity of No.
tax after Profit
EBT = Sales V FC Interest
= 30,00,000 22,86,000 2,04,000 2,55,000
= 2,55,000
PAT = EBT Tax
= 2,55,000 76,500 = 1,78,500
EPS 1.05
1,70,000
1,78,500
= =
(i i i ) Assets turnover
Assets turnover =
.784 0
38,25,000
30,00,000
Assets Total
Sales
= =
0.784 < 1.5 means lower than industry turnover.
(i v) EBT zero means 100% reduction in EBT. Since combined leverage is 2.8, sales
have to be dropped by 100/2.8 = 35.71%. Hence new sales will be
30,00,000 (100 35.71) = 19,28,700.
Therefore, at 19,28,700 level of sales, the Earnings before Tax of the company will
be equal to zero.
(b) In-house Deci si on
Rs.
Cash discount (Rs. 90 lakhs .60 .02) 1,08,000
Bad debts losses (90,00,000 .01) 90,000
Administration cost 1,20,000
Cost of funds in receivables* 1,08,750
4,26,750
*Average collection period (10 .6) + (60 days .40) = 30 days
Average investments in debtors =
lakhs 7.5
12
90
=
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 20
Cost of Bank funds
|
.
|

\
|
.15
2
1
7.5 Rs.
56,250
Cost of Owned funds
|
.
|

\
|
.14
2
1
7.5 Rs.
52,500
1,08,750
Offer Al ternati ve
Factoring commission (Rs. 90 lakhs .04) 3,60,000
Interest charges .88(90 lakhs 3,60,000) = 76,03,200 .15
360
25
79,200
Cost of owned funds invested in receivables
(90,00,000 76,03,200) .14
360
25
13,580
4,52,780
Deci si on: PQR should not go for the factoring alternative as the cost of factoring is
more.
Cost of In-house Decision 4,26,750
Cost of Factoring Firm 4,52,780
Net loss (26,030)
Questi on 8
Answer any three of the following:
(i) Differentiate between Business risk and Financial risk.
(ii) Diagrammatically present the DU PONT CHART to calculate return on equity.
(iii) What are the main responsibilities of a Chief Financial Officer of an organisation?
(iv) Explain in brief the features of Commercial Paper. (3 3 = 9 Marks)
Answer
(i ) Busi ness Ri sk and Fi nanci al Ri sk
Business risk refers to the risk associated with the firms operations. It is uncertainty
about the future operating income, i.e. how well can the operating income be predicted?
It can be measured by standard deviation of basic earning power ratio.
Whereas, Financial risk refers to the additional risk placed on firms shareholders as a
result of debt use in financing. Companies that issue more debt instruments would have
higher financial risk than companies financed mostly by equity. Financial risk can be
PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT
21
measured by ratios such as firms financial leverage multiplier, total debt to assets ratio
etc.
(i i ) Du Pont Chart
There are three components in the calculation of return on equity using the traditional
DuPont model- the net profit margin, asset turnover, and the equity multiplier. By
examining each input individually, the sources of a company's return on equity can be
discovered and compared to its competitors.
Return on Equity = (Net Profit Margin) (Asset Turnover) (Equity Multiplier)
Du Pont Chart
(i i i ) Responsi bi l i ti es of Chi ef Fi nanci al Offi cer (CFO)
The chief financial officer of an organisation plays an important role in the companys
goals, policies, and financial success. His main responsibilities include:
(a) Financial analysis and planning: Determining the proper amount of funds to be
employed in the firm.
(b) Investment decisions: Efficient allocation of funds to specific assets.
(c) Financial and capital structure decisions: Raising funds on favourable terms as
possible, i.e., determining the composition of liabilities.
(d) Management of financial resources (such as working capital).
(e) Risk Management: Protecting assets.
(i v) Features of Commerci al Paper (CP)
A commercial paper is an unsecured money market instrument issued in the form of a
promissory note. Since the CP represents an unsecured borrowing in the money market,
Assets Turnover =
Sales NA
Financial Leverage (Balance
Sheet) = NA NW
Return on Net Assets
(RONA) = EBIT NA
Profit Margin =
EBIT Sales
Return on Equity
(ROE) = PAT NW
Financial Leverage (Income)
= PAT E BIT
PROFESSIONAL COMPETENCE EXAMINATION : MAY, 2007 22
the regulation of CP comes under the purview of the Reserve Bank of India which issued
guidelines in 1990 on the basis of the recommendations of the Vaghul Working Group.
These guidelines were aimed at:
(i) Enabling the highly rated corporate borrowers to diversify their sources of short term
borrowings, and
(ii) To provide an additional instrument to the short term investors.
It can be issued for maturities between 7 days and a maximum upto one year from the
date of issue. These can be issued in denominations of Rs. 5 lakh or multiples therefore.
All eligible issuers are required to get the credit rating from credit rating agencies.