1 FINANCIAL MANAGEMENT

1 Financial Analysis and Planning – Ratio Analysis 001 - 033

2 Estimation of Working Capital 034 - 059

3 Management of Receivable and Management of Payables 060 - 073

4 Cash and Treasury Management 074 - 085

2 COSTING

1 Service Costing Or Operating Costing 086 - 098

2 Material Cost Control Stock Valuation 099 - 128

3 Employee Cost And Direct Expense 129 - 153

 FINANCIAL
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 INTER CA FINANCIAL MANAGEMENT

FINANCIAL ANALYSIS AND PLANNING

– RATIO ANALYSIS

THEORY SECTION

Meaning and Objective

Ratio is relationship between two variables to arrive at a meaningful result. Absolute
figures do not communicate any meaningful result and hence the need for ratios. Ratios
also help in comparing the performance of the company with that of its competitors as
well as with the company's own performance of last year.

Scope
In this chapter we will learn to:
(a) Calculate ratios from the given financial statements.
(b) Prepare Financial Statements from the given ratios.
(c) Calculate ratios and interpretation of the results.

Types of Ratios
All the ratios which we will learn under this chapter can broadly be classified into 3 types.
- Balance Sheet Ratios (numerator and denominator comes from Balance Sheet)
- Profit and Loss Ratios (numerator and denominator comes from P & L)
- Mixed Ratios (Numerator from P&L and denominator from Balance Sheet)

(A) BALANCE SHEET RATIOS

Balance Sheet Ratios are also known as Solvency ratios, as they test the solvency
(ability to pay) position of the company. These ratios are calculated in pure numbers
(2, 1.5, 3, etc.). The lenders and the creditors of the company generally use these
ratios.
We need to learn the following set of ratios under the head Balance Sheet Ratios
- Current Ratio
- Quick Ratio
- Super Quick Ratio

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- Stock to Working Capital Ratio

- Debt Equity Ratio
- Capital Gearing Ratio
- Proprietary Ratio

• Current Ratio

This Ratio indicates the ability of the company to pay its current liabilities with the help
of current assets. The standard Ratio is considered to be 2:1, which indicates that against
every 1 rupee of current liability the company is having 2 rupees of current assets to
pay its current liabilities as at the balance sheet date. It is a test of short term solvency
position. A very low ratio indicates unsatisfactory liquidity position & a very high ratio
shows inefficient utilization of funds.

• Quick Ratio

Quick Ratio indicates the ability of the company to pay the quick liabilities or immediate
liabilities with the help of Quick Assets. Quick Assets are those current assets which are
immediately convertible into cash without any loss of time or value. The standard ratio is
1:1, which indicates that against every 1 rupee of current liability the company is having
1 rupee of quick asset to repay its current liability. It is a measure of immediate solvency
position. Quick ratio is also known as Acid test ratio, Liquid Ratio or 1:1 Ratio.
Note: Many times Bank overdraft is deducted from current liabilities to arrive at quick
liabilities.

• Super Quick Ratio

This ratio is also known as Absolute Liquidity Ratio, Cash Ratio, Cash Reservoir Ratio.
This ratio indicates that against 1 rupee of current liability how cash and near cash is
available with the company to pay the current liability.

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• Stock to Working Capital Ratio

This ratio indicates the extent to which the working capital of the company is blocked in
the form of stock. Lower the ratio, higher is the liquidity with the company.

• Debt Equity Ratio

It indicates the proportion of funds belonging to the outsiders to that of the shareholders.
The standard ratio of 2 : 1 which indicates that against 1 rupee of shareholders fund
raised the company has raised 2 rupees from outsiders. Debt Equity ratio is a measure of
financial risk. Higher the Debt Equity ratio higher is the financial risk. Debt equity ratio is
also known as Financial Leverage or Banker’s Ratio.
Debt = Total Long Term Loans.
Equity = Equity Share capital + Preference Share Capital + Reserves and Surplus

• Capital Gearing Ratio

Equity Shareholders funds = Equity share Capital + Reserves and Surplus

This ratio is an extended version of Debt Equity Ratio. It indicates proportion of funds
entitled for fixed commitment (in the form of interest or dividend) to that of funds not
entitled for fixed commitment.
In absence of Preference Share capital, Capital Gearing Ratio = Debt Equity Ratio. The
word gearing indicates risk. High gearing indicate high risk and vice versa.

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• Proprietary Ratio

This ratio indicates the extent to which the total assets of the company are financed
by the shareholders. Higher the ratio better is the long term stability. Total Assets =
Fixed Assets + Long term Investment + Current Assets.

(B) MIXED RATIOS

In mixed ratio numerator comes from P&L and denominator from Balance Sheet.
Since the P&L figures are generally for the whole year and the Balance Sheet as at
a particular date, there exists a timing difference between the numerator and the
denominator and hence, to eliminate the timing difference we take average of the
Balance Sheet figure. Average = (opening balance + closing balance)/2. In absence
of information about the opening balances, closing balance sheet figures are to be
considered.

• Turnover Ratios
• Turnover Ratios are also known as Activity Ratios, Performance Ratios or
Velocity Ratios. These ratios are always computed in times and hence are also
known as Times Ratios (e.g. 4 times, 10 times, etc.)
• We have to learn the following ratios under this head
• Capital Employed Turnover.
• Fixed Asset Turnover.
• Working Capital Turnover.
• Stock Turnover.
• Accounts Receivable (or Debtors) Turnover.
• Accounts Payable (or Creditors) Turnover.

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Capital Employed
Turnover- Sales /
Capital Employed

Fixed Asset Working Capital

Turnover- Sales / Turnover- Sales /
Assets Working Capital

Current Assets Current Liabilities

A/c’s Receivable A/c’s Payable Turnover

Stock Turnover Ratio Turnover =Cr. Cash Bank =Cr. Purchase/Average
=COGS/Average Stock Sales/Average Creditors - Average
Debtor+Average B/R B/P

Capital Employed turnover ratio

This Ratio indicates how efficiently the money invested in the business is used during the
year to generate sales.

Fixed Assets Turnover Ratio

This ratio indicates how efficiently the fixed assets were used during the year for generating
sales.

Working Capital Turnover Ratio

This Ratio indicates how well the money invested in working capital was used during the
year for generating sales.

Stock Turnover Ratio

This ratio indicates how many times the stock was turned over i.e. how many times
the stock that was purchased was sold during the year. Higher the ratio efficient is the
inventory management. This ratio is useful for calculating the average holding period of
stock

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A/c’s Receivable Turnover (or Debtors Turnover)

This ratio indicates how many times the debtors were turned over i.e. how many times
cash was collected from customers for the goods sold during the year. Higher the ratio
efficient is the receivables management. This ratio is useful for calculating the average
collection period.

A/c’s Payable Turnover (or Creditors Turnover)

This ratio indicates how many times the creditors were turned over i.e. how many times
cash was paid to the suppliers for the goods that were purchased. This ratio is useful for
calculating the average payment period.

PROFITABILITY RATIOS IN RELATION TO INVESTMENT

Other set of ratios in mixed ratios is profitability ratios in relation to investment

Return on Capital Employed (ROCE) / Return on Investment (ROI)

This ratio is an indicator of the earning power of the business. It indicates how much
returns has the business earned during the year in % terms on the money employed in
the business.
Capital Employed = Shareholders Funds + Loan Funds

Return on Shareholders’ Funds

This ratio indicates how much returns the company has earned for shareholders during
the year have earned on their funds in % terms

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Return on Equity (Equity share-holders Funds)

This ratio indicates how much returns the company has earned for equity shareholders
during the year on their investments in % terms.

Return on Equity Share Capital

This ratio indicates how much returns the company has earned for equity shareholders
during the year on the share capital in % terms. Equity share capital is also known as
ordinary capital/common stock.

(C) PROFIT AND LOSS RATIOS

These ratios are also known as profitability ratios in relation to sales.
In this segment we have to learn the following ratios
• Gross Profit Ratio
• Operating Profit Ratio
• Operating Ratio
• Administrative Expenses Ratio
• Selling Expenses Ratio
• Net Profit Ratio

Gross Profit Ratio

This ratio indicates the trading profitability. Higher the gross margin the better it is.

Operating Profit Ratio

This ratio indicates the operating profitability. Higher the operating margins better it is.

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Operating Ratio
= 1 – operating profit ratio
OR

Administrative Expenses Ratio

This ratio indicates that to generate sales how much admin expenses have been incurred
in % terms.

Selling Expenses Ratio

This ratio indicates that to generate sales how much selling expenses have been incurred
in % terms.

Net Profit Ratio

SOME OTHER IMPORTANT RATIOS

Earnings per Share (EPS)

Dividend per Share (DPS)

Dividend Payout (DP) Ratio

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Retention Ratio

Book (Balance Sheet) Value per share (BVPS)

Price Earnings Ratio (PE Ratio)

PE Ratio is popularly known as PE multiple. This ratio indicates how many times an
investor is willing to pay to earn 1 rupee of EPS. PE ratio is one factor that determines
the MPS.
MPS = PE x EPS.

Earnings Price Ratio / Earnings Yield Ratio

Yield is defined as the rate of return on the amount invested. The above ratio is a
return on investment ratio. It indicates how much returns an investor has earned on
his investment in percentage terms.

Dividend Price Ratio / Dividend Yield Ratio

It indicates how much returns in the form of Dividend an investor has earned on his
investment in percentage terms.

Interest Coverage Ratio (IC Ratio)

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This ratio is also called the times interest earned ratio and it measures the ability
of the firm to pay the fixed interest liability. It may be noted that EBIT is operating
profits of the firm, therefore, the IC ratio measures as to how many times the interest
liability of the firm is covered with the operating profits of the firm.

Preference Dividend Coverage Ratio

This ratio attempts to measure the ability of the firm to pay fixed preference dividend
and tells us how secure the preference dividend is in relation to the earning power of
the company.

Debt Service Coverage Ratio

This ratio calculates the company’s ability to repay loan instalment + payment of
interest. Higher the ratio better it is.

DU PONT ANALYSIS FOR EVALUATING ROE

= NP Ratio x Asset Turnover Ratio x Equity Multiplier

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XYZ LTD
BALANCE SHEETAS AT 31ST MARCH...
PARTICULARS RS RS
SOURCES OF FUNDS
A) SHAREHOLDERS FUNDS
Share Capital xx
Reserves and Surplus xx
xx

B) BORROWED FUNDS
Secured Loans xx
Unsecured Loans xx xx
TOTAL SOURCES OF FUNDS/CAPITAL EMPLOYED xxxx

APPLICATIONS OF FUNDS
C) FIXED ASSETS
Gross Block xx
Less: Provision for Depreciation (xx)
Net Block/ WDV xx

D) LONG TERM INVESTMENTS xx

E) WORKING CAPITAL xx
Current Assets xx xx
Less: Current Liabilities (xx)
TOTAL APPLICATION OF FUNDS xxxx

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PROFIT AND LOSS STATEMENT FOR THE YEAR END 31ST MARCH...
PARTICULARS RS RS
Sales xx
Less: Cost of Goods Sold (COGS) (xx)
Gross Profit xx

Operating Expenses
Administrative Expenses xx
Selling Expenses xx
Depreciation xx xx
Operating Profits xx
Less: Non Operating Expenses (xx)
Add: Non Operating Incomes xx
Earnings before Interest and Tax (EBIT) xx
Less: Interest (xx)
Earnings before Tax (EBT) xx
Less: Tax (xx)
Earnings after Tax (EAT) xx
Less: Preference Dividend (xx)
Earnings for Equity Shareholders xx
Less: Equity Dividend (xx)
Retained Earnings xx

Important Points to remember

- Shareholder’s funds are also known as Owner’s Funds, Proprietors Funds, Net
Worth or Equity
- Borrowed Funds are also known as Debt or Loan Funds
- Capital Employed is Debt + Equity
- Shareholder’s Funds = Share Capital + Reserves and Surplus – Miscellaneous
Expenditures not w/off
- Fundamental Balance Sheet Equation
Shareholder’s Funds + Borrowed Funds = Fixed Assets + LT Investments +Working
Capital

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CLASSWORK SECTION

Question 1
The following is the Balance Sheet of Z Ltd. on 31st March, 2020 and other information
from which you are required to calculate the following ratios:
(a) Current Ratio.
(b) Liquid Ratio.
(c) Stock Working Capital Ratio.
(d) Capital Gearing Ratio.
(e) Stock Turnover Ratio.
(f) Debtors Turnover Ratio and Collection Period.
Stock on 1.4.2019 was ` 1,20,000. Sales (all credit) were ` 20,00,000. Gross Profit on
sales was 25%. Debtors on 1.4.2019 were ` 40,000.
Balance Sheet on 31.3.2020
Liabilities ` Assets `
12% Preference Capital 3,00,000 Fixed Assets 7,80,000
Equity Share Capital 6,40,000 Short Term Investments 2,00,000
Capital Reserve 60,000 Stock 3,80,000
General Reserve 2,00,000 Debtors 3,60,000
Profit & Loss A/c 20,000 Prepaid Expenses 60,000
14% Debentures 1,60,000
Creditors 3,20,000
Bank Overdraft 80,000
17,80,000 17,80,000

Question 2
The Following information relates to X. Ltd for the year end March 31st 2020.
Net Working Capital ` 12,00,000/-
Fixed Assets to Proprietors Funds 0.75
Working Capital Turnover 5 Times
Return on Equity (ROE) 15%
You are required to calculate:
(a) Proprietors Funds
(b) Fixed Assets
(c) Net Profit Ratio

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Question 3
Following is the abridged Balance Sheet of Alpha Ltd.:
Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Profit and Loss Account 17,000 Plant and Machineries 50,000
Current Liabilities 40,000 Less: Depreciation 15,000 35,000
1,15,000
Stock 21,000
Receivable 20,000
Bank 1,000 42,000
Total 1,57,000 Total 1,57,000
With the help of the additional information furnished below, you are required to prepare
Trading and Profit & Loss Account and a Balance Sheet as at 31st March, 2020:
(i) The company went in for reorganisation of capital structure, with share capital
remaining the same as follows:
Share Capital 50%
Other Shareholder’s funds 15%
5% Debentures 10%
Payables 25%
Debentures were issued on 1st April, interest being paid annually on 31st March.
(ii) Land and Buildings remained unchanged. Additional plant and machinery has been
bought and a further ` 5,000 depreciation written off.
(The total fixed assets then constituted 60% of total fixed and current assets.)
(iii) Working capital ratio was 8: 5.
(iv) Quick assets ratio was 1: 1.
(v) The receivables (four-fifth of the quick assets) to sales ratio revealed a credit period
of 2 months. There were no cash sales.
(vi) Return on net worth was 10%.
(vii) Gross profit was at the rate of 15% of selling price.
Ignore Taxation.

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Question 4
Ganpati Limited has furnished the following ratios and information relating to the year
ended 31st March, 2020.
Sales ` 60,00,000
Return on net worth 25%
Rate of income tax 50%
Share capital to reserves 7:3
Current ratio 2
Net profit to sales 6.25%
Inventory turnover (based on cost of goods sold) 12
Cost of goods sold ` 18,00,000
Interest on debentures ` 60,000
Receivables ` 2,00,000
Payable ` 2,00,000
You are required to:
(a) Calculate the operating expenses for the year ended 31st March, 2020.
(b) Prepare a balance sheet as on 31st March in the following format.

Balance Sheet as on 31st March, 2020

Liabilities ` Assets `
Share Capital Fixed Assets
Reserve and Surplus Current Assets
15% Debentures Stock
Payables Receivables
Cash

Question 5
The capital structure of Beta Limited is as follows:
Equity share capital of ` 10 each 8,00,000
9% preference share capital of ` 10 each 3,00,000
11,00,000
Additional information: Profit (after tax at 35 per cent), ` 2, 70,000; Depreciation,
` 60,000; Equity dividend paid, 20 per cent; Market price of equity shares, ` 40.
You are required to compute the following, showing the necessary workings:
(a) Dividend yield on the equity shares
(b) Cover for the preference and equity dividends
(c) Earnings per shares
(d) Price-earnings ratio.

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Question 6
MN Limited gives you the following information related for the year ending 31st March,
2020:
(1) Current Ratio 2.5: 1
(2) Debt-Equity Ratio 1: 1.5
(3) Return on Total Assets (After Tax) 15%
(4) Total Assets Turnover Ratio 2
(5) Gross Profit Ratio 20%
(6) Stock Turnover Ratio 7
(7) Current Market Price per Equity Share ` 16
(8) Net Working Capital ` 4, 50,000
(9) Fixed Assets ` 10, 00,000
(10) 60,000 Equity Shares of ` 10 each
(11) 20,000, 9% Preference Shares of `10 each
(12) Opening Stock ` 3, 80,000
You are required to calculate:
(i) Quick Ratio
(ii) Fixed Assets Turnover Ratio
(iii) Proprietary Ratio
(iv) Earnings per Share
(v) Price-Earning Ratio.

Question 7
The assets of SONA Ltd. consist of fixed assets and current assets, while its current
liabilities comprise bank credit in the ratio of 2: 1. You are required to prepare the Balance
Sheet of the company as on 31st March 2020 with the help of following information:
Share Capital ` 5, 75,000
Working Capital (CA-CL) ` 1, 50,000
Gross Margin 25%
Inventory Turnover 5 times
Average Collection Period 1.5 months
Current Ratio 1.5:1
Quick Ratio 0.8: 1
Reserves & Surplus to Bank & Cash 4 times
Assume 360 days in a year

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Question 8
The following is the Profit and loss account and Balance sheet of KLM LLP.
Trading and Profit & Loss Account
Particulars Amount (`) Particulars Amount (`)
To Opening stock 12,46,000 By Sales 1,96,56,000
To Purchases 1,56,20,000 By Closing stock 14,28,000
To Gross profit c/d 42,18,000
2,10,84,000 2,10,84,000
By Gross profit b/d 42,18,000
To Administrative By Interest on investment 24,600
expenses 18,40,000 By Dividend received 22,000
To Selling & distribution
expenses 7,56,000
To Interest on loan 2,60,000
To Net profit 14,08,600
42,64,600 42,64,600

Balance Sheet as on......

Capital & Liabilities Amount (`) Assets Amount (`)
Capital 20,00,000 Plant & machinery 24,00,000
Retained earnings 42,00,000 Building 42,00,000
General reserve 12,00,000 Furniture 12,00,000
Term loan from bank 26,00,000 Sundry receivables 13,50,000
Sundry Payables 7,20,000 Inventory 14,28,000
Other liabilities 2,80,000 Cash & Bank balance 4,22,000
1,10,00,000 1,10,00,000
You are required to COMPUTE:
(i) Gross profit ratio
(ii) Net profit ratio
(iii) Operating cost ratio
(iv) Operating profit ratio
(v) Inventory turnover ratio
(vi) Current ratio
(vii) Quick ratio
(viii) Interest coverage ratio
(ix) Return on capital employed

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Question 9
The following figures and ratios are related to a company:
(i) Sales for the year (all credit) ` 90,00,000
(ii) Gross Profit ratio 35 percent
(iii) Fixed assets turnover (based on cost of goods sold) 1.5
(iv) Stock turnover (based on cost of goods sold) 6
(v) Liquid ratio 1.5:1
(vi) Current ratio 2.5:1
(vii) Receivables (Debtors) collection period 1 month
(viii) Reserves and surplus to Share capital 1:1.5
(ix) Capital gearing ratio 0.7875
(x) Fixed assets to net worth 1.3 : 1
You are required to PREPARE:
(a) Balance Sheet of the company on the basis of above details.
(b) The statement showing working capital requirement, if the company wants to make
a provision for contingencies @ 15 percent of net working capital.

Question 10
The following information of ASD Ltd. relate to the year ended 31st March, 2022:
Net profit 8% of sales
Raw materials consumed 20% of Cost of Goods Sold
Direct wages 10% of Cost of Goods Sold
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of Cost of Goods Sold
Gross Profit 15% of Sales
Debt collection period 2 Months (All sales are on credit)
Current ratio 2:1
Fixed assets to Current assets 13 : 11
Fixed assets to sales 1:3
Long-term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4

You are required to PREPARE-

(a) Profit & Loss Statement of ASD Limited for the year ended 31st March, 2022 in the
following format.

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Particulars (`) Particulars (`)

Direct Materials consumed ? By Sales ?
Direct Wages ?
Works (Overhead) ?
Gross Profit c/d ?
? ?
Selling and Distribution Expenses ? By Gross Profit b/d ?
Net Profit ?
? ?

(b) Balance Sheet as on 31st March, 2022 in the following format.

Liabilities (`) Assets (`)
Share Capital ? Fixed Assets 1,30,00,000
Reserves and Surplus ? Current Assets:
Long term loans ? Stock of Raw Material ?
Current liabilities ? Stock of Finished Goods ?
Debtors ?
Cash ?
? ?

Question 11
The following figures are related to the trading activities of M Ltd.
Total assets ` 10,00,000
Debt to total assets 50%
Interest cost 10% per year
Direct Cost 10 times of the interest cost
Operating Exp. ` 1,00,000
The goods are sold to customers at a margin of 50% on the direct cost
Tax Rate is 30%
You are required to calculate:
(i) Net profit margin (after tax)
(ii) Net operating profit margin (before tax)
(iii) Return on assets (after tax)
(iv) Return on owner’s equity (after tax)
(v) Asset turnover Ratio

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Question 12
From the following figures and ratios draw out Balance Sheet and Trading and Profit and
Loss Account:
(a) Share Capital ` 1,80,000
(b) Working Capital ` 63,000
(c) Bank O/D ` 10,000
There is no fictitious asset. In Current Assets there are no assets other than stock, Debtors
and Cash. Closing Stock is 20% higher than the Opening Stock.
i. Current Ratio 2.5
ii. Quick Ratio 1.5
iii. Proprietary Ratio
(Fixed Assets : Proprietary Fund) 0.7
iv. Gross Profit Ratio 20% (to sales)
v. Stock Velocity 4
vi. Debtors' Velocity 36.5 days
vii. Net Profit Ratio 10%

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HOMEWORK SECTION

Question 1
X Co. has made plans for the next year. It is estimated that the company will employ
total assets of ` 8,00,000; 50 per cent of the assets being financed by borrowed capital
at an interest cost of 8 per cent per year. The direct costs for the year are estimated at
` 4,80,000 and all other operating expenses are estimated at ` 80,000. The goods will
be sold to customers at 150 per cent of the direct costs. Tax rate is assumed to be 50 per
cent.
You are required to calculate: (i) net profit margin (after tax); (ii) return on assets (after
tax); (iii) asset turnover and (iv) return on owners’ equity (after tax); (v) operating margin
(before tax).

Question 2
The following accounting information and financial ratios of PQR Ltd. relate to the year
ended 31st December, 2020
I Accounting Information:
Gross Profit 15% of Sales
Net Profit 8% of sales
Raw materials consumed 20% of works cost
Direct Wages 10% of works cost
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of works cost
Debt collection period 60 days
All sales are on credit
II Financial Ratios:
Fixed assets to sales 1:3
Fixed assets to Current assets 13:11
Current ratio 2:1
Long – term loans to Current liabilities 2:1
Capital to Reserves and Surplus 1:4

If value of fixed assets as on 31st December, 2020 amounted to ` 26 lakhs, prepare a

summarised Profit and Loss Account of the company for the year ended 31st December,
2020 and also the Balance Sheet as on 31st December, 2020.

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Question 3
From the following information, prepare a summarised Balance Sheet as at 31st March,
2020:
Net Working Capital ` 2, 40,000
Bank overdraft ` 40,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus ` 1, 60,000
Current ratio 2.5
Liquid ratio (Quick Ratio) 1.5

Question 4
With the help of the following information complete the Balance Sheet of MNOP Ltd.:
Equity share capital ` 1, 00,000
The relevant ratios of the company are as follows:
Current debt to total debt 0.40
Total debt to Equity share capital 0.60
Fixed assets to Equity share capital 0.60
Total assets turnover 2 Times
Inventory turnover 8 Times

Question 5
In a meeting held at Solan towards the end of 2019, the Directors of M/s HPCL Ltd. have
taken a decision to diversify. At present HPCL Ltd. sells all finished goods from its own
warehouse. The company issued debentures on 01.01.2020 and purchased fixed assets
on the same day. The purchase prices have remained stable during the concerned period.
Following information is provided to you:
Income Statements
Particulars 2019 (`) 2020 (`)
Cash Sales 30,000 32,000
Credit Sales 2,70,000 3,00,000 3,42,000 3,74,000
Less: Cost of goods sold 2,36,000 2,98,000
Gross profit 64,000 76,000
Less: Operating Expenses
Warehousing 13,000 14,000
Transport 6,000 10,000
Administrative 19,000 19,000
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Selling 11,000 49,000 14,000

Interest 2,000 59,000
Net Profit 15,000 17,000

Balance Sheet
Assets & Liabilities 31-12-2019 31-12-2020
Fixed Assets (Net Block) - 30,000 - 40,000
Receivables 50,000 82,000
Cash at Bank 10,000 7,000
Stock 60,000 94,000
Total Current Assets (CA) 1,20,000 1,83,000
Payables 50,000 76,000
Totals Current Liabilities (CL) 50,000 76,000
Working Capital (CA – CL) 70,000 1,07,000
Total Assets 1,00,000 1,47,000
Represented by:
Share Capital 75,000 75,000
Reserve and Surplus 25,000 42,000
Debentures - 30,000
1,00,000 1,47,000

You are required to calculate the following ratios for the years 2019 - 2020.
(i) Gross Profit Ratio
(ii) Operating Expenses to Sales Ratio.
(iii) Operating Profit Ratio
(iv) Capital Turnover Ratio
(v) Stock Turnover Ratio
(vi) Net Profit to Net Worth Ratio, and
(vii) Receivables Collection Period.

Ratio relating to capital employed should be based on the capital at the end of the year.
Give the reasons for change in the ratios for 2 years. Assume opening stock of ` 40,000
for the year 2019. Ignore Taxation.

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Question 6
JKL Limited has the following Balance Sheets as on March 31, 2019 and March 31, 2020:
Balance Sheet
Assets & Liabilities (`) In Lakhs
March 31, 2020 March 31, 2019
Sources of Funds:
Shareholders Funds 2,377 1,472
Loan funds 3,570 3,083
5,947 4,555
Applications of Funds:
Fixed Assets 3,466 2,900
Cash and bank 489 470
Debtors 1,495 1,168
Stock 2,867 2,407
Other 1,567 1,404
Current Assets (3,937) (3,794)
Less: Current Liabilities 5,947 4,555

The Income Statement of the JKL Ltd. for the year ended is as follows:
(`) In Lakhs
March 31, 2020 March 31, 2019
Sales 22,165 13,882
Less: Cost of Goods sold 20,860 12,544
Gross Profit 1,305 1,338
Less: Selling, General and Administrative 1,135 752
expenses
Earnings before Interest and Tax (EBIT) 170 586
Interest Expense 113 105
Profits before Tax 57 481
Tax 23 192
Profits after Tax (PAT) 34 289

Required:
(i) Calculate for the year 2019 – 2020:
(a) Inventory turnover ratio
(b) Financial Leverage

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(c) Return on Capital Employed (ROCE)

(d) Return on Equity (ROE)
(e) Average Collection period.
(ii) Give a brief comment on the Financial Position of JKL Limited.

Question 7
Using the following information, complete the Balance Sheet given below:
(i) Total debt to net worth 1: 2
(ii) Total assets turnover 2
(iii) Gross profit on sales 30%
(iv) Average collection period (Assume 360 days in a year) 40 days
(v) Inventory turnover ratio based on cost of goods sold and year- 3
end inventory
(vi) Acid test ratio 0.75

Balance Sheet as on March 31, 2020

Liabilities ` Assets `
Equity Shares Capital 4,00,000 Plant and Machinery and -
Reserves and Surplus 6,00,000 other Fixed Assets
Total Debt: Current Assets:
Current liabilities - Inventory -
Debtors -
- Cash -
- -

Question 8
Using the following data, complete the Balance Sheet given below:
Gross Profit  ` 54,000
Shareholders’ Funds  ` 6, 00,000
Gross Profit margin  20%
Credit sales to Total sales  80%
Total Assets turnover  0.3 times
Inventory turnover  4 times
Average collection period (a 360 days year)  20 days
Current ratio  1.8
Long-term Debt to Equity  40%

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Balance Sheet
Creditors ………….. Cash …………..
Long-term debt ………….. Debtors …………..
Shareholders’ funds ………….. Inventory …………..
Fixed assets …………..

Question 9
The following accounting information and financial ratios of M Limited relate to the year
ended 31st March, 2020:
Inventory Turnover Ratio 6 Times
Creditors Turnover Ratio 10 Times
Debtors Turnover Ratio 8 Times
Current Ratio 2.4
Gross Profit Ratio 25%
Total sales ` 30,00,000; cash sales 25% of credit sales; cash purchases ` 2,30,000;
Working capital ` 2,80,000; closing inventory is ` 80,000 more than opening inventory.

You are required to calculate:

(i) Average Inventory
(ii) Purchases
(iii) Average Debtors
(iv) Average Creditors
(v) Average Payment Period
(vi) Average Collection Period
(vii) Current Assets
(viii) Current Liabilities.

Question 10
The total sales (all credit) of a firm are ` 6, 40,000. It has a gross profit margin of 15
per cent and a current ratio of 2.5. The firm’s current liabilities are ` 96,000; inventories
` 48,000 and cash ` 16,000. (a) Determine the average inventory to be carried by the firm,
if an inventory turnover of 5 times is expected? (Assume a 360 day year). (b) Determine
the average collection period if the opening balance of debtors is intended to be of
` 80,000? (Assume a 360 day year).

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Question 11
Using the following information, complete this balance sheet:

Long-term debt to net worth 0.5 to 1

Total asset turnover 2.5 x

Average collection period* 18 days

Inventory turnover 9x

Gross profit margin 10%

Acid-test ratio 1 to 1

*Assume a 360-day year and all sales on credit.

` `
Cash - Notes and payables 1,00,000
Account - Long – term debt -
Inventory - Common stock 1,00,000
Plant and equipment - Retained earnings 1,00,000
Total assets - Total liabilities and equity -

Question 12
From the following information, you are required to PREPARE a summarised Balance
Sheet for Rudra Ltd. for the year ended 31st March, 2022
Debt Equity Ratio 1:1
Current Ratio 3:1
Acid Test Ratio 8:3
Fixed Asset Turnover (on the basis of sales) 4
Stock Turnover (on the basis of sales) 6
Cash in hand 5,00,000
Stock to Debtor 1:1
Sales to Net Worth 4
Capital to Reserve 1:2
Gross Profit 20% of cost
COGS to Creditor 10:1
Interest for entire year is yet to be paid on Long Term loan @ 10%

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Question 13
Using the following information, PREPARE and complete the Balance Sheet given below:
(i) Total debt to net worth : 1:2
(ii) Total assets turnover : 2
(iii) Gross profit on sales : 30%
(iv) Average collection period : 40 days
(Assume 360 days in a year)
(v) Inventory turnover ratio based on cost of goods : 3
sold and year - end inventory
(vi) Acid test ratio : 0.75
Balance Sheet
As on March 31, 20X8
Liabilities Rs. Assets Rs.
Equity Shares Capital 4,00,000 Plant & Machinery & Fixed Assets -
Reserves and Surplus 6,00,000
Total Debt: Current Assets:
Current Liabilities - Inventory -
Debtors -
Cash. -

Question 14
SN Ltd. has furnished the following ratios and information relating to the year ended 31st
March 2021:
Share Capital Rs. 6,25,000
Working Capital Rs. 2,00,000
Gross Margin 25%
Inventory Turnover 5 times
Average Collection Period 1.5 months
Current Ratio 1.5:1
Quick Ratio 0.7:1
Reserves & Surplus to Bank & Cash 3 times
Further, the assets of the company consist of fixed assets and current assets, while its
current liabilities comprise bank credit and others in the ratio of 3:--. Assume 360 days
in a year.
You are required to PREPARE the Balance Sheet as on 31st March 2021.

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Question 15
Using the information given below, PREPARE the Balance Sheet of SKY Private Limited:
(i) Current ratio 1.6:1
(ii) Cash and Bank balance 15% of total current assets
(iii) Debtors turnover ratio 12 times
(iv) Stock turnover (cost of goods sold) ratio 16 times
(v) Creditors turnover (cost of goods sold) ratio 10 times
(vi) Gross profit ratio 20%
(vii) Capital gearing ratio 0.6
(viii) Depreciation rate 15% on W.D.V.
(ix) Net fixed Assets 20% of total assets
(Assume all purchase and sales are on credit)
Balance Sheet of SKY Private Limited as at 31.03.2020
Liabilities Amount in ` Assets Amount in `
Share Capital 25,00,000 Fixed assets
Reserve & surplus ? Opening WDV ? ?
12% Long term debt ? Less: Depreciation ? ?
Current liabilities
Creditors ? Current Assets
Provisions & outstanding 68,50,000 Stock ?
expenses ?
Debtors ?
Cash and bank balance ? ?
Total ? Total ?
(Detailed working notes are not required to be shown)

Question 16
The following is the information of XML Ltd. relate to the year ended 31-03-2018:
Gross Profit 20% of Sales
Net Profit 10% of Sales
Inventory Holding period 3 months
Receivable collection period 3 months
Non-Current Assets to Sales 1:4
Non-Current Assets to Current Assets 1:2
Current Ratio 2:1
Non-Current Liabilities to Current Liabilities 1:1
Share Capital to Reserve and Surplus 4:1
Non-current Assets as on 31st March, 2017 ` 50,00,000

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Assume that:
(i) No change in Non-Current Assets during the year 2017-18
(ii) No depreciation charged on Non-Current Assets during the year 2017-18.
(iii) Ignoring Tax
You are required to Calculate cost of goods sold, Net profit, Inventory, Receivables and
Cash for the year ended on 31st March, 2018

Question 17
The accountant of Moon Ltd. has reported the following data:
Gross profit ` 60,000
Gross Profit Margin 20 per cent
Total Assets Turnover 0.30:1
Net Worth to Total Assets 0.90:1
Current Ratio 1.5:1
Liquid Assets to Current Liability 1:1
Credit Sales to Total Sales 0.80:1
Average Collection Period 60 days
Assume 360 days in a year

You are required to complete the following:

Balance Sheet of Moon Ltd.
Liabilities ` Assets `

Net Worth Fixed Assets

Current Liabilities Stock
Debtors
Cash
Total Liabilities Total Assets

Question 18
Masco Limited has furnished the following ratios and information relating to the year
ended 31st March 2021:
Sales ` 75,00,000
Return on net worth 25%
Rate of income tax 50%
Share capital to reserves 6:4
Current ratio 2.5

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Net profit to sales (After Income Tax) 6.50%

Inventory turnover (based on cost of goods sold) 12
Cost of goods sold ` 22,50,000
Interest on debentures ` 75,000
Receivables (includes debtors ` 1,25,000) ` 2,00,000
Payables ` 2,50,000
Bank Overdraft ` 1,50,000

You are required to:

(a) Calculate the operating expenses for the year ended 31st March, 2021.
(b) Prepare a balance sheet as on 31st March in the following format:
Liabilities ` Assets `
Share Capital Fixed Assets
Reserves and Surplus Current Assets
15% Debentures Stock
Payables Receivables
Bank Term Loan Cash

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Notes

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Notes

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ESTIMATION OF WORKING CAPITAL

THEORY SECTION

Meaning and Objective

Capital is nothing but money required to start or run the business. How much to raise money
depends on, how much we are planning to invest. Invest where? Invest in Fixed Assets and
Working Capital. Fixed Assets cannot work on its own until and unless adequate level of
working capital is maintained. This extra capital that we need for smooth working of our
fixed assets is known as working capital.

Objective
This chapter will give us the answer to the following question,
“How much money should we raise to meet our working capital requirement”?
The level of working capital depends on the level of Current Assets and the level of
Current Liabilities. The level of Current assets in turn depends upon the level of Stock
(Stock of Raw Material, WIP, Finished Goods), Debtors and Cash Bank, whereas the level
of Current liabilities is dependent on the level of Creditors and Outstanding expenses. So
if we can fairly estimate the level of these individual components of current assets and
the current liabilities we can very well estimate our Working Capital Requirement.

Scope
In this chapter we will learn
(a) How to estimate our working capital requirement
(b) Working Capital Operating Cycle
(c) How to finance the Working Capital requirement
* How to estimate our working Capital requirement

There are two approaches for estimating our working capital requirement
(1) Total Basis: Under this approach all the expenses and profit margins are considered
for estimating our working capital needs.

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(2) Cash Cost Basis: Under this approach only cash expenses are considered for estimating
our working capital needs

Rates of Valuation of various items –

Component Total Approach Cash Cost Approach
Raw Materials Purchase Price net of discounts Purchase Price net of discounts
W o r k - i n - Raw Materials+50% of [Direct Raw Materials + 50% of [Direct Labour
Progress Labour +Direct Expenses +All + Direct Expenses + Production OH
Production OH] excluding Depreciation]
Finished Goods Cost of Production Cost of Production Less Depreciation
Sundry Debtors Selling Price Selling Price Less Profit Margin Less
Depreciation
Sundry Creditors Purchase Price net of discounts Purchase Price net of discounts

Note: For WIP valuation, it is assumed that materials are fully issued and conversion (i.e.
Labour and Production OH) is half - complete.

* Working Capital Operating Cycle

The process of conversion of cash back into cash is known as Working Capital
Operating Cycle i.e. the process of cash which is used for purchasing Raw materials to
again get converted back into cash as realisation from Debtors is known as Working
Capital Operating Cycle and the time taken for this conversion of cash back into cash
is known as duration of Operating Cycle.
CASH CYCLE OF MANUFACTURING FIRM CASH CYCLE OF TRADING FIRM

Cash
Cash
Debtors

Raw Materials Debtors

Finished Goods

Work-in-Progress Finished Goods

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Duration of the Working Capital Operating Cycle is calculated in the following manner
Raw material holding period xx
WIP conversion period xx
Finished Goods Holding period xx
Debtors Collection Period xx
Gross Duration xx
Less: Creditors Payment period xx
Net Duration xx

* Financing of Working Capital

Working Capital can be classified based on (a) Concept or (b) Time Factor, as under -

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There are two views as to the amount of Permanent Working Capital –

PERMANENT WORKING CAPITAL

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Approaches to Finance the working Capital

Hedging Approach
Hedging approach is also known as matching approach. It is based upon concept of
bifurcation of total working capital needs into permanent and temporary working capital.
Under this approach, the permanent working capital needs are financed by long term
sources and the temporary working capital requirement from short term sources.

Conservative Approach
As the name suggests, under this approach finance manager doesn’t undertake risk. As
a result, all the working capital needs are financed by long term source and the use of
short term sources may be restricted to unexpected and emergency situations only.

Aggressive Approach
A working capital policy is also called as aggressive policy if the firm decides to finance a
part of the permanent working capital by short term sources. So, the short term financing
under aggressive policy is more than hedging approach.

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CLASSWORK SECTION
Question 1
Cost sheet of the company provides the following data:
Particulars Cost p.u.
Raw Material 50
Direct Labour 20
Overheads (including Depreciation ` 10) 40
Total Cost 110
Profit 20
Selling Price 130
Additional information:
- Raw materials remain in stores for one month
- Credit allowed by suppliers is one month
- Credit allowed to Debtors is 2 months
- Time lag in payment of wages is 10 days
- Time lag in payment of expenses is 30 days
- 25% of the sales are on cash basis
- Cash balance is expected to be ` 1,00,000.
- Finished goods remain in warehouse for 2 month.
You are required to estimate the working capital required to finance a level of activity of
50000 units p.a. Assume that all the business activities are carried out evenly throughout
the year. Assume 360 days for calculation purpose.

Question 2
The following annual figures relate to XYZ Co.
`
Sales (at two months' credit) 36,00,000
Materials consumed (Suppliers extend two months' credit) 9,00,000
Wages (paid monthly in arrears) 7,20,000
Manufacturing expenses outstanding at the end of the year
(Cash expenses are paid one month in arrears) 80,000
Total administrative expenses, paid as above 2,40,000
Total Sales promotion expenses, paid quarterly in advance 1,20,000
The company sells its products on gross profit of 25% counting depreciation as part of
the cost of production. It keeps one month's stock each of raw materials and finished
goods, and a cash balance of ` 1,00,000.
Assuming a 20% safety margin, work out the working capital requirements of the company
on cash cost basis. Ignore work-in-process.

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Question 3
MA LIMITED is commencing a new project for manufacture of a plastic component. The
following cost information has been ascertained for annual production of 12,000 units
which is the full capacity :
Cost per unit `
Materials 40
Direct Labour and variable expenses 20
Fixed Manufacturing expenses 6
Depreciation 10
Fixed Administration expenses 4
` 80
The selling price per unit is expected to be ` 96 and the selling expenses ` 5 per unit, 80%
of which is variable.
In the first two years of operations, production and sales are expected to be as follows:
Year Production no. of units Sales no. of units
1 6,000 5,000
2 9,000 8,500
To assess the working capital requirements, the following additional informations is
available:
a) Stock of materials 2.25 months' average consumption
b) Work in process Nil
c) Debtors 1 month's average sales
d) Cash balance ` 10,000
e) Creditors for supply of materials : 1 month's average purchases during the year
f) Creditors for expenses: 1 month's average of all expenses during the year
Prepare, for the two years,
(i) A projected statement of Profit / Loss (ignoring taxation); and
(ii) A projected statement of working capital requirements on total basis.

Question 4
Samreen Enterprises has been operating its manufacturing facilities till 31.3.2017 on a
single shift working with the following cost structure:
Per unit (`)
Cost of Materials 6.00
Wages (out of which 40% fixed) 5.00
Overheads (out of which 80% fixed) 5.00
Profit 2.00
Selling Price 18.00
Sales during 2016 – 2017 - ` 4, 32,000.

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As at 31.3.2017 the company held:

(`)
Stock of raw materials (at cost) 36,000
Work-in-progress (valued at prime cost) 22,000
Finished goods (valued at total cost) 72,000
Sundry debtors 1,08,000
In view of increased market demand, it is proposed to double production by working an
extra shift. It is expected that a 10% discount will be available from suppliers of raw
materials in view of increased volume of business. Selling price will remain the same. The
credit period allowed to customers will remain unaltered. Credit availed of from suppliers
will continue to remain at the present level i.e., 2 months. Lag in payment of wages and
expenses will continue to remain half a month.
You are required to assess the additional working capital requirements, if the policy to
increase output is implemented.

Question 5
Following information is forecasted by the CS Limited for the year ending 31st March, 2020:
Balance as at Balance as at
1st April, 2019 ` 31st March, 2020 `
Raw Material 45,000 65,000
Work-in-progress 35,000 51,000
Finished goods 60,000 70,000
Debtors 1 ,12,000 1,35,000
Creditors 50,000 70,000
Annual purchases of raw material (all credit) 4,00,000
Annual cost of production 7,50,000
Annual cost of goods sold 9,15,000
Annual operating cost 9,50,000
Annual sales (all credit) 11,00,000

You may take one year as equal to 365 days.

Calculate the Net operating cycle period.
(i) Calculate the Net operating cycle period.
(ii) Number of operating cycles in a year.

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Question 6
The following information is provided by the DPS Limited for the year ending 31st March, 2020.
Raw material storage period 55 days
Work-in-progress conversion period 18 days
Finished Goods storage period 22 days
Debt collection period 45 days
Creditors’ payment period 60 days
Annual Operating cost ` 21, 00,000
(Including depreciation of ` 2, 10,000)
[1 year = 360 days]
You are required to calculate:
(i) Operating Cycle period.
(ii) Number of Operating Cycle in a year.
(iii) Amount of working capital required for the company on a cash cost basis.
(iv) The company is a market leader in its product, there is virtually no competitor in the
market. Based on a market research it is planning to discontinue sales on credit and
deliver products based on pre-payments. Thereby, it can reduce its working capital
requirement substantially.
What would be the reduction in working capital requirement due to such decision?

Question 7
An engineering company is considering its working capital investment for the year 2019-20.
The estimated fixed assets and current liabilities for the next year are ` 6.63 crore and
` 5.967 crores respectively. The sales and earnings before interest and taxes (EBIT) depend
on investment in its current assets - particularly inventory and receivables. The company
is examining the following alternative working capital policies:
Working Capital Investment in Current Estimated Sales EBIT
Policy Assets (` Crores) (` Crores) (` Crores)
Conservative 11.475 31.365 3.1365

Moderate 9.945 29.325 2.9325

Aggressive 6.63 25.50 2.55

You are required to calculate the following for each policy:
(i) Rate of return on total assets.
(ii) Net working capital position.
(iii) Current assets to fixed assets ratio.
(iv) Discuss the risk-return trade off of each working capital policy.

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Question 8
The management of MNP Company Ltd. is planning to expand its business and consults
you to prepare an estimated working capital statement. The records of the company
reveal the following annual information:
`

Sales –Domestic at one month’s credit 24,00,000

Export at three month’s credit (sales price 10% below domestic price) 10,80,000
Materials used (suppliers extend two months credit) 9,00,000
Lag in payment of wages – ½ month 7,20,000
Lag in payment of manufacturing expenses (cash) – 1 month 10,80,000
Lag in payment of Adm. Expenses – 1 month 2,40,000
Sales promotion expenses payable quarterly in advance 1,50,000
Income tax payable in four instalments of which one falls in the next 2,25,000
financial year

Rate of gross profit is 20%.

Ignore work-in-progress and depreciation.
The company keeps one month’s stock of raw materials and finished goods (each) and
believes in keeping ` 2,50,000 available to it including the overdraft limit of ` 75,000 not
yet utilized by the company.
The management is also of the opinion to make 12% margin for contingencies on computed
figure.
You are required to prepare the estimated working capital statement for the next year.

Question 9
Aneja Limited, a newly formed company, has applied to the commercial bank for the first
time for financing its working capital requirements. The following information is available
about the projections for the current year :
Estimated level of activity : 1,04,000 completed units of production plus 4,000 units of
work-in-progress. Based on the above activity, estimated cost per unit is:
Raw Material ` 80 per unit
Direct Wages ` 30 per unit
Overheads ` 60 per unit
Total Cost ` 170 per unit
Selling Price ` 200 per unit

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Raw materials in stock : Average 4 weeks consumption, work-in-progress (assume 50%

completion stage in respect of conversion cost) (materials issued at the start of the
processing).
Finished goods in stock 8,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors / receivables Average 8 weeks
Lag in payment of wages Average 1.5 weeks
Cash at banks (for smooth operation) is expected to be ` 25,000.
Assume that production is carried on evenly throughout the year (52 weeks) and wages
and overheads accrue similarly. All sales are on credit basis only.
You are required to calculate the net working capital required.

Question 10
On 01st April, 2020, the Board of Directors of ABC Ltd. wish to know the amount of
working capital that will be required to meet the programme they have planned for the
year. From the following information, PREPARE a working capital requirement forecast
and a forecast profit and loss account and balance sheet:
Issued share capital `6,00,000
10% Debentures `1,00,000
Fixed Assets `4,50,000

Production during the previous year was 1,20,000 units; it is planned that this level of
activity should be maintained during the present year.
The expected ratios of cost to selling price are; raw materials 60%, direct wages 10%
overheads 20%.
Raw materials are expected to remain in store for an average of two months before issue
to production. Each unit of production is expected to be in process for one month. The
time lag in wage payment is one month.
Finished goods will stay in the warehouse awaiting dispatch to customers for approximately
three months.
Credit allowed by creditors is two months from the date of delivery of raw materials.
Credit given to debtors is three months from the date of dispatch.
Selling price is `5 per unit.
There is regular production and Sales cycle and Wages and overheads accure similarly.

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Question 11
Kalyan limited has provided you the following information for the year 2021-22:
By working at 60% of its capacity the company was able to generate sales of ` 72,00,000.
Direct labour cost per unit amounted to ` 20 per unit. Direct material cost per unit was
40% of the selling price per unit. Selling price was 3 times the direct labour cost per unit.
Profit margin was 25% on the total cost.

For the year 2022-23, the company makes the following estimates:
Production and sales will increase to 90% of its capacity. Raw material per unit price will
remain unchanged. Direct expense per unit will increase by 50%. Direct labour per unit
will increase by 10%. Despite the fluctuations in the cost structure, the company wants
to maintain the same profit margin on sales
.
Raw materials will be in stock for one month whereas finished goods will remain in stock
for two months. Production cycle is for 2 months. Credit period allowed by suppliers is
2 months. Sales are made to three zones:

Zone Percentage of sale Mode of Credit

A 50% Credit period of 2 months

B 30% Credit period of 3 months

C 20% Cash Sales

There are no cash purchases and cash balance will be ` 1,11,000

The company plans to apply for a working capital financing from bank for the year
2022 -23. ESTIMATE Net Working Capital of the Company receivables to be taken on
sales and also COMPUTE the maximum permissible bank finance for the company using
3 criteria of Tandon Committee Norms. (Assume stock of finished goods to be a core
current asset).

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Question 12
Balance sheet of X Ltd for the year ended 31st March,2022 is given below:
(` in lakhs)
Liabilities Amount Assets Amount
Equity Shares ` 10 each 200 Fixed Assets Raw 500

Retained earnings 200 Raw Materials a/s 150

11% Debentures 300 W/P 100

Public deposits (Short-Term) 100 Finished goods 50

Trade Creditors 80 Debtors 125

Bills Payable 100 Cash/Bank 55

980 980

Calculate the amount of maximum permissible bank finance under three methods as per
Tandon Committee lending norms.
The total core current assets are assumed to be ` 30 lakhs.

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HOMEWORK SECTION

Question 1
The following information has been extracted from the records of a Company:

Product Cost Sheet `/unit

Raw materials 45
Direct labour 20
Overheads 40
Total 105
Profit 15
Selling price 120
• The materials are in process on an average for 4 weeks. The degree of completion is 50%.
• Finished goods stock on an average is for one month.
• Time lag in payment of wages and overheads is 1½ weeks.
• Time lag in receipt of proceeds from debtors is 2 months.
• Credit allowed by suppliers is one month.
• 20% of the output is sold against cash.
• The company expects to keep a Cash balance of ` 1, 00,000.
• Take 52 weeks per annum.
• Raw material holding period on an average is one month
The Company is poised for a manufacture of 1, 44,000 units in the year.
You are required to prepare a statement showing the Working Capital requirements of the
Company.

Question 2
A newly formed company has applied to the Commercial Bank for the first time for
financing its working capital requirements. The following information is available about
the projections for the current year:
Per unit
Elements of cost: (`)
Raw material 40
Direct labour 15
Overhead 30
Total cost 85
Profit 15
Sales 100

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Other information:
Raw material in stock: average 4 weeks consumption, Work – in progress (completion
stage, 50 per cent), Finished goods in stock: on an average, one month.
Credit allowed by suppliers is one month.
Credit allowed to debtors is two months.
Average time lag in payment of wages is 1½ weeks and 4 weeks in overhead expenses.
Cash in hand and at bank is desired to be maintained at ` 50,000.
All Sales are on credit basis only.

Required:
Prepare statement showing estimate of working capital needed to finance an activity level
of 96,000 complete units of production and 8000 units of WIP. Assume that production is
carried on evenly throughout the year, and wages and overhead accrue similarly. For the
calculation purpose 4 weeks may be taken as equivalent to a month and 52 weeks in a
year.

Question 3
On 1st January, the Managing Director of Naureen Ltd. wishes to know the amount of
working capital that will be required during the year. From the following information
prepare the working capital requirements forecast.
Production during the previous year was 60,000 units. It is planned that this level of
activity would be maintained during the present year.
The expected ratios of the cost to selling prices are Raw materials 60%, Direct wages 10%
and Overheads 20%.
Raw materials are expected to remain in store for an average of 2 months before issue
to production.
Each unit is expected to be in process for one month, the raw materials being fed into the
pipeline immediately and the labour and overhead costs accruing evenly during the month.
Finished goods will stay in the warehouse awaiting dispatch to customers for approximately
3 months.
Credit allowed by creditors is 2 months from the date of delivery of raw material.
Credit allowed to debtors is 3 months from the date of dispatch.
Selling price is ` 5 per unit.
There is a regular production and sales cycle.
Wages and overheads are paid on the 1st of each month for the previous month.
The company normally keeps cash in hand to the extent of ` 20,000.

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Question 4
The following annual figures relate to XYZ Co.,
(`)
Sales (at two months’ credit) 36,00,000
Materials consumed (suppliers extend two months’ credit) 9,00,000
Wages paid (1 month lag in payment) 7,20,000
Cash manufacturing expenses (expenses are paid one month is arrear) 9,60,000
Administrative expenses (1 month lag in payment) 2,40,000
Sales promotion expenses (paid quarterly in advance) 1,20,000

The company sells its products on gross profit of 25%. Depreciation is considered as a
part of the cost of production. It keeps one month’s stock each of raw materials and
finished goods, and a cash balance of ` 1,00,000.
Assuming a 20% safety margin, work out the working capital requirements of the company
on Total basis. Ignore work-in-process.

Question 5
The Trading and Profit and Loss Account of Beta Ltd. for the year ended 31st March, 2011
is given below:
Particulars Amount (`) Particulars (`) Amount (`)

To Opening Stock: By Sales (Credit) 20,00,000

Raw Materials 1,80,000 By Closing
Stock:
Work –in –Progress 60,000 Raw Materials 2,00,000
Finished Goods 2,60,000 5,00,000 Work – in – progress 1,00,000
To Purchases (credit) 11,00,000 Finished Goods 3,00,000 6,00,000
To Wages 3,00,000
To Production 2,00,000
Expenses
To Gross Profit c/d 5,00,000 _______
26,00,000 By Gross Profit 26,00,000
To Administration 1,75,000 b/s 5,00,000
Expenses
To Selling Expenses 75,000
To Net Profit 2,50,000 ________
5,00,000 5,00,000
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The opening and closing balances of debtors were ` 1, 50,000 and ` 2, 00,000 respectively
whereas opening and closing creditors were ` 2, 00,000 and ` 2, 40,000 respectively.
You are required to ascertain the working capital requirement by operating cycle method.

Question 6
A proforma cost sheet of a Company provides the following data:
(`)
Raw material cost per unit 117
Direct Labour cost per unit 49
Factory overheads cost per unit 98
(includes depreciation of 18 per unit at budgeted level of activity)
Total cost per unit 264
Profit 36
Selling price per unit 300
Following additional information is available:
Average raw material in stock : 4 weeks
Average work-in-process stock : 2 weeks
(% completion with respect to Materials : 80%
Labour and Overheads : 60%)
Finished goods in stock : 3 weeks
Credit period allowed to debtors : 6 weeks
Credit period availed from suppliers : 8 weeks
Time lag in payment of wages : 1 week
Time lag in payment of overheads : 2 weeks
The company sells one-fifth of the output against cash and maintains cash balance of
` 2,50,000.
Required:
Prepare a statement showing estimate of working capital needed to finance a budgeted
activity level of 78,000 units of production. You may assume that production is carried on
evenly throughout the year and wages and overheads accrue similarly.

Question 7
STN Ltd. is a readymade garment manufacturing company. Its production cycle indicates
that materials are introduced in the beginning of the production phase; wages and
overhead accrue evenly throughout the period of cycle. The following figures for the
12 months ending 31st December 2022 are given.

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Production of shirts 54,000 units

Selling price per unit ` 200
Duration of the production cycle 1 month
Raw material inventory held 2 month’s consumption
Finished goods stock held for 1 month
Credit allowed to debtors is 1.5 months and credit allowed by creditors is 1 month.
Wages are paid in the next month following the month of accrual.
In the work-in-progress 50% of wages and overheads are supposed to be conversion
costs.
The ratios of cost to sales price are-raw materials 60% direct wages 10% and overheads
20%. Cash is to be held to the extent of 40% of current liabilities and safety margin of
15% will be maintained.
Calculate amount of working capital required for the company on a cash cost basis.

Question 8
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 `

Raw materials 20
Direct labour 15
Manufacturing overheads:
`
Variable 15
Fixed 10 25
Selling and Distribution overheads:

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................................1½ months.

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(iii) Credit allowable by creditors...............................4 months.

(iv) Lag in payment of wages.....................................1 month.
(v) Lag in payment of overheads...............................½ month.
(vi) Cash in hand and Bank is expected to be ` 60,000.
(vii) Provision for contingencies is required @ 10% of working 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.

Question 9
Q Ltd. sells goods at a uniform rate of gross profit of 20% on sales including depreciation
as part of cost of production. Its annual figures are as under:
(`)
Sales (At 2 months’ credit) 24,00,000
Materials consumed (Suppliers credit 2 months) 6,00,000
Wages paid (Monthly at the beginning of the subsequent month) 4,80,000
Manufacturing expenses (Cash expenses are paid – one month in arrear) 6,00,000
Administration expenses (Cash expenses are paid – one month in arrear) 1,50,000
Sales promotion expenses (Paid quarterly in advance) 75,000
The company keeps one month stock each of raw materials and finished goods. A
minimum cash balance of ` 80,000 is always kept. The company wants to adopt a 10%
safety margin in the maintenance of working capital.
The company has no work in progress
Find out the requirements of working capital of the company on cash cost basis.

Question 10
A Company is considering its working capital investment and financial policies for the next
year. Estimated fixed assets and current liabilities for the next year are ` 2.60 crores and
` 2.34 crores respectively. Estimated Sales and EBIT depend on current assets investment,
particularly inventories and book-debts.
The Financial Controller of the company is examining the following alternative Working
Capital Policies:
(` in crore)
Working Capital Policy Investment in Current Assets Estimated Sales EBIT
Conservative 4.50 12.30 1.23
Moderate 3.90 11.50 1.15
Aggressive 2.60 10.00 1.00

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After evaluating the working capital policy, the Financial Controller had advised the
adoption of the moderate working capital policy. The company is now examining the use
of long-term and short-term borrowings for financing its assets. The company will use
` 2.50 crores of the equity funds. The corporate tax rate is 35%. The company is considering
the following debt alternatives.
(` in crore)
Financing Policy Short-term Debt Long-term Debt
Conservative 0.54 1.12
Moderate 1.00 0.66
Aggressive 1.50 0.16
Interest rate – Average 12% 16%

You are required to CALCULATE the following:

(i) Working Capital Investment for each policy:
(a) Net Working Capital position
(b) Rate of Return
(c) Current ratio
(ii) Financing fo each policy:
(a) Net Working Capital position
(b) Rate or Return on Shareholders’ equity.
(c) Current Ratio

Question 11
Day Ltd., a newly formed company has applied to the Private Bank for the first time for
financing it’s Working Capital Requirements. The following information is available about
the projections for the current year:
Estimated Level of Activity Completed Units of Production 31,200 plus unit of work
in progress 12,000
Raw Material Cost ` 40 per unit

Direct Wages Cost ` 15 per unit

Overhead ` 40 per unit (inclusive of Depreciation `10 per unit)

Selling Price ` 130 per unit

Raw Material in Stock Average 30 days consumption

Work in Progress Stock Material 100% and Conversion Cost 50%

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Finished Goods Stock 24,00 Units

Credit Allowed by the supplier 30 days
Credit Allowed to Purchasers 60 days
Direct Wages [Lag in payment] 15 days
Expected Cash Balance ` 2,00,000

Assume that production is carried on evenly throughout the year (360 days) and wages
and overheads accrue similarly. All sales are on the credit basis. You are required to
CALCULATE the Net Working Capital Requirement on Cash Cost Basis.

Question 12
While applying for financing of working capital requirements to a commercial bank, TN
Industries Ltd. projected the following information for the next year:
Per unit Per unit
Cost Element
(`) (`)
Raw materials
X 30
Y 7
Z 6 43
Direct Labour 25
Manufacturing and administration overheads (excluding depreciation) 20
Depreciation 10
Selling overheads 15
113

Additional Information:
(a) Raw Materials are purchased from different suppliers leading to different credit
period allowed as follows:
X – 2 months; Y– 1 months; Z – ½ month
(b) Production cycle is of ½ month. Production process requires full unit of X and Y
in the beginning of the production. Z is required only to the extent of half unit in
the beginning and the remaining half unit is needed at a uniform rate during the
production process.
(c) X is required to be stored for 2 months and other materials for 1 month.
(d) Finished goods are held for 1 month.

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(e) 25% of the total sales is on cash basis and remaining on credit basis. The credit
allowed by debtors is 2 months.
(f) Average time lag in payment of all overheads is 1 months and ½ months for direct
labour.
(g) Minimum cash balance of ` 8,00,000 is to be maintained.
CALCULATE the estimated working capital required by the company on cash cost basis if
the budgeted level of activity is 1,50,000 units for the next year. The company also intends
to increase the estimated working capital requirement by 10% to meet the contingencies.
(You may assume that production is carried on evenly throughout the year and direct
labour and other overheads accrue similarly.)

Question 13
PQR Ltd., a company newly commencing business in the year 2021-22, provides the
following projected Profit and Loss Account:
(`) (`)

Sales 5,04,000
Cost of goods sold 3,67,200
Gross Profit 1,36,800
Administrative Expenses 33,600
Selling Expenses 31,200 64,800
Profit before tax 72,000
Provision for taxation 24,000
Profit after tax 48,000
The cost of goods sold has been arrived at as under:
Materials used 2,01,600
Wages and manufacturing Expenses 1,50,000
Depreciation 56,400
4,08,000
Less: Stock of Finished goods
(10% of goods produced not yet sold) 40,800
3,67,200
The figure given above relate only to finished goods and not to work-in-progress. Goods
equal to 15% of the year’s production (in terms of physical units) will be in process on
the average requiring full materials but only 40% of the other expenses. The company
believes in keeping materials equal to two months’ consumption in stock.

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All expenses will be paid one month in advance. Suppliers of materials will extend
1 -1/2 months credit. Sales will be 20% for cash and the rest at two months’ credit. 70%
of th e Income tax will be paid in advance in quarterly instalments. The company wishes
to keep ` 19,200 in cash. 10% must be added to the estimated figure for unforeseen
contingencies. PREPARE an estimate of working capital.

Question 14
Bita Limited manufactures used in the steel industry. The following information regarding
the company is given for your consideration:
(i) Expected level of production 9000 units per annum.
(ii) Raw materials are expected to remain in store for an average of two months
before issue to production.
(iii) Work-in-progress (50 percent complete as to conversion cost) will approximate to
1/2 month’s production.
(iv) Finished goods remain in warehouse on an average for one month.
(v) Credit allowed by suppliers is one month.
(vi) Two month’s credit is normally allowed to debtors.
(vii) A minimum cash balance of ` 67,500 is expected to be maintained.
(viii) Cash sales are 75 percent less than the credit sales.
(ix) Safety margin of 20 percent to cover unforeseen contingencies.
(x) The production pattern is assumed to be even during the year.
(xi) The cost structure for Bita Limited’s product is as follows:
`
Raw Materials 80 per unit
Direct Labour 20 per unit
Overheads (including depreciation ` 20) 80 per unit
Total Cost 180 per unit
Profit 20 per unit
Selling Price 200 per unit

You are required to estimate the working capital requirement of Bita limited.

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Question 15
From the following data, calculate the maximum permissible bank finance under the
three methods suggested by the Tandon Committee:
Liabilities ` in lakhs
Creditors 120
Other current liabilities 40
Bank borrowing 250
Total 410
Current Assets ` in lakhs
Raw material 180
Work-in - progress 60
Finished goods 100
Receivables 150
Other current assets 20
Total current assets 510
The total Core Current Assets (CCA) are Z 200 lakhs

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Notes

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Notes

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RECEIVABLES MANAGEMENT

THEORY SECTION

Meaning
Sales department would like to grant more & more credit in an effort to increase the
sales. It is the finance manager who has to decide whether the credit period should be
extended. A credit policy decision is a "trade - off" between profit on additional sales &
cost of carrying debtors. Cost of carrying debtors (COCD) means minimum return required
on investment in debtors. A credit policy decision may be general or customer specific.

Scope
The three basic aspects of management of Sundry Debtors will be studied in this Chapter.
1. Credit Policy : decisions on credit period to be allowed, early payment discount
rates, etc.
2. Credit Analysis : decisions on whether credit can be extended to a particular customer.
3. Factoring : decision on whether services of factor should be taken or not.

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CLASSWORK SECTION

Question 1
A company currently has an annual turnover of ` 10 lakhs and an average collection
period of 45 days. The company wants to experiment with a more liberal credit policy
on the ground that increase in collection period will generate additional sales. From the
following information, kindly indicate which of the policies you would like the company
to adopt:

Increase in collection Increase in Sales

Credit Policy Percentage of default
period (`)
1 15 days 50,000 2%

2 30 days 80,000 3%
The selling price of the product is ` 5, average costs per unit at current level is ` 4 and the
variable costs per unit is ` 3.
The current bad debt loss is 1% and the required rate of return on investment is 20%. A
year can be taken to comprise of 360 days.

Question 2
PTX Limited is considering a change in its present credit policy. Currently it is evaluating
two policies. The company is required to give a return of 20% on the investment in
new accounts receivables. The company's variable costs are 70% of the selling price.
Information regarding present and proposed policies is as follows:

Present Policy Policy Option 1 Policy Option 2

Annual Credit Sales (`) 30,00,000 42,00,000 45,00,000
Debtors turnover ratio 4 times 3 times 2.4 times
Loss due to bad debts 3% of sales 5% of sales 6% of sales
Note: Return on investment in new accounts receivable is based on cost of investment in
debtors.
Which option would you recommend?

Question 3
A Company has sales of ` 25, 00,000. Average collection period is 50 days, bad debt
losses are 5% of sales and collection expenses are ` 25,000. The cost of funds is 15%. The
Company has two alternative Collection Programmes:

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Programme I Programme II
Average Collection Period reduced to 40 days 30 days
Bad debt losses reduced to 4% of sales 3% of sales
Collection Expenses ` 50,000 ` 80,000
Evaluate which Programme is viable.

Question 4
A group of customers want to enter into a contract with you to buy goods worth ` 20
lakhs during 2022-2023 the deliveries to be made in four equal instalments quarterly.
The price of the commodity is ` 20 per unit on which you expect a profit of ` 10. The
acceptance of this proposal would mean an additional recurring expenditure of ` 10,000
p.a. on your part.

The ageing schedule of accounts receivables in respect of this group of customers in the
past was as follows:
Period Percentage of bills for which payment is received
At the end of 30 days 15%
At the end of 60 days 25%
At the end of 90 days 40%
At the end of 100 days 20%

Assuming an opportunity cost of 20% of the funds locked up in accounts receivables, will
be desirable to accept this proposal?

Question 5
A company is presently having credit sales of ` 12 lakh. The existing credit terms are 1/10,
net 45 days and average collection period is 30 days. The current bad debts loss is 1.5%. In
order to accelerate the collection process further as also to increase sales, the company is
contemplating liberalization of its existing credit terms to 2/10, net 45 days. It is expected
that sales are likely to increase by 1/3 of existing sales, bad debts increase to 2% of sales
and average collection period to decline to 20 days. The contribution to sales ratio of the
company is 22% and opportunity cost of investment in receivables is 15 percent (pre-tax).
50 per cent and 80 percent of customers in terms of sales revenue are expected to avail
cash discount under existing and liberalization scheme respectively. The tax rate is 30%.
Should the company change its credit terms?
(Assume 360 days in a year).

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Question 6
A company is considering using a factor; the following information is relevant
(a) The current average collection period for the company’s debt is 80 days and 0.5% of
the debtors default. The factor has agreed to pay within 60 days and will suffer the
loss of any bad debts.
(b) The annual charges for the factoring is 2% which is payable annually at the end of
the year. Administrative cost savings will amount to ` 1,00,000/- p.a.
(c) Annual Sales all are on credit are ` 1,00,00,000/-. Variable cost is 80% of sales. The
company’s cost of capital is 15% p.a.
Should the company enter into factoring agreement?

Question 7
A firm has credit sales of ` 360 lakhs and its average collection period is 30 days. The
financial controller estimates, bad debt losses are around 2% of credit sales. The firm
spends ` 1,40,000 annually on debtors administration. This cost comprises of telephonic
and fax bills along with salaries of staff members. These are the avoidable costs.
A Factoring firm has offered to buy the firm’s receivables. The factor will charge 1%
commission and will pay an advance against receivables on an interest @15% p.a. after
withholding 10% as reserve. What should the firm do? Assume 360 days in a year.

Question 8
A Ltd. has total sales of ` 3.2 crores and its average collection period is 90 days. The past
experience indicates that bad-debt losses are 1.5% on sales. The expenditure incurred
by the firm in administering its receivable collection efforts are ` 5,00,000. A factor is
prepared to buy the firm’s receivables by charging 2% commission. The factor will pay
advance on receivables to the firm at an interest rate of 18% p.a. after withholding 10%
as reserve. Calculate the effective cost of factoring to the Firm.

Question 9
As a part of the strategy to increase sales and profits, the sales manager of a company
proposes to sell goods to new customers with 10% risk of non-payment. This group would
require one and a half months credit and is likely to increase sales by ` 1,00,000 p.a. Production
and selling expenses amount to 80% of sales and the income-tax rate is 50%. The company's
minimum required rate of return (after tax) is 25%. Should the sales manager proposal be
accepted. Also find the degree of risk of non-payment that the company should be willing to
assume if the required rate of return (after tax) were (i) 30% (ii) 40% and (iii) 60%.

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Question 10
A bank is analysing the receivables of Jackson Company in order to identify acceptable
collateral for a short-term loan. The company’s credit policy is 2/10 net 30. The bank
lends 80 percent on accounts where customers are not currently overdue and where
the average payment period does not exceed 10 days past the net period. A schedule
of Jackson’s receivables has been prepared. How much will the bank lend on pledge of
receivables, if the bank uses a 10 per cent allowance for cash discount and returns?
Amount Days Outstanding in Average Payment
Accounts
` days Period historically
74 25,000 15 20
91 9,000 45 60
107 11,500 22 24
108 2,300 9 10
114 18,000 50 45
116 29,000 16 10
123 14,000 27 48
1,08,800

Question 11
Tony Limited, manufacturer of Colour TV sets is considering the liberalization of existing
credit terms to three of their large customers A, B and C. The credit period and likely
quantity of TV sets that will be sold to the customers in addition to other sales are a
follows:
Quantity sold (No. of TV Sets)
Credit Period (Days) A B C
0 1,000 1,000 -
30 1,000 1,500 -
60 1,000 2,000 1,000
90 1,000 2,500 1,500
The selling price per TV set is Rs. 9,000. The expected contribution is 20% of the selling
price. The cost of carrying receivable averages 20%per annum.
You are required:
(a) COMPUTE the credit period to be allowed to each customer.
(Assume360daysinayearforcalculationpurposes).
(b) DEMONSTRATE the other problems the company might face in allowing the credit
period as determined in (a)above?

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HOMEWORK SECTION

Question 1
A firm has a current sale of ` 50,00,000. The firm has unutilised capacity. In order to
boost its sales, it is considering the relaxation in its credit policy. The proposed terms of
credit will be 60 days credit against the present policy of 45 days. As a result, the bad
debts will increase from 1.5% to 2% of sales. The firm’s sales are expected to increase by
10%. The variable operating costs are 72% of the sales. The Firm’s corporate tax rate is
35%, and it requires an after-tax return of 15% on its investment. Should the firm change
its credit period?

Question 2
A new customer with 10% risk of non-payment desires to establish business connections
with you. He would require 1.5 month of credit and is likely to increase your sales by
` 1,20,000 p.a. Cost of sales amounted to 85% of sales. The tax rate is 30%. Should you
accept the offer if the required rate of return is 40% (after tax)?

Question 3
JKL Ltd. is considering the revision of its credit policy with a view to increasing its sales
and profit. Currently all its sales are on credit and the customers are given one month’s
time to settle the dues. It has a contribution of 40% on sales and it can raise additional
funds at a cost of 20% per annum. The marketing manager of the company has given the
following options along with estimates for considerations:
Particulars Current Position I Option II Option III Option
Sales (` in lakhs) 200 210 220 250
Credit period (in months) 1 1½ 2 3
Bad debts (% of sales) 2 2½ 3 5
Cost of Credit administration (` in lakhs) 1.20 1.30 1.50 3.00
You are required to advise the company for the best option

Question 4
Mosaic Limited has current sales of ` 15 lakhs per year. Cost of sales is 75 per cent
of sales and bad debts are one per cent of sales. Cost of sales comprises 80 per cent
variable costs and 20 per cent fixed costs, while the company’s required rate of return is
12 per cent. Mosaic Limited currently allows customers 30 days’ credit, but is considering
increasing this to 60 days’ credit in order to increase sales.

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It has been estimated that this change in policy will increase sales by 15 per cent, while
bad debts will increase from one per cent to four per cent. It is not expected that the policy
change will result in an increase in fixed costs and creditors and stock will be unchanged.
Should Mosaic Limited introduce the proposed policy? (Assume a 360 days year)

Question 5
A company has prepared the following projections for a year:
Sales 21,000 units
Selling Price per unit ` 40
Variable Costs per unit ` 25
Total Costs per unit ` 35
Credit period allowed One month
The Company proposes to increase the credit period allowed to its customers from one
month to two months. It is envisaged that the change in the policy as above will increase
the sales by 8%. The company desires a return of 25% on its investment.
You are required to examine and advise whether the proposed Credit Policy should be
Simplemented or not.

Question 6
A firm has a total sales of ` 12,00,000 and its average collection period is 90 days.
The past experience indicates that bad debt losses are 1.5% on sales. The expenditure
incurred by the firm in administering receivable collection efforts are ` 50,000. A factor
is prepared to buy the firm’s receivables by charging 2% commission. The factor will pay
advance on receivables to the firm at an interest rate of 16% p.a. after withholding 10%
as reserve. Calculate effective cost of factoring to the firm. Assume 360 days in a year.

Question 7
A company currently has an annual turnover of ` 50 lakhs and an average collection
period of 30 days. The company wants to experiment with a more liberal credit policy on
the ground that increase in collection period will generate additional sales.
From the following information, kindly indicate which policy the company should adopt:
Credit policy Average collection period Annual sales (` lakhs)
A 45 days 56
B 60 days 60
C 75 days 62
D 90 days 63

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Costs: Variable cost: 80% of sales

Fixed cost: ` 6 lakhs per annum
Required (pre-tax) return on investment: 20%
A year may be taken to comprise of 360 days.

Question 8
A trader whose current sales are in the region of ` 6 lakhs per annum and an average
collection period of 30 days wants to pursue a more liberal policy to improve sales. A
study made by a management consultant reveals the following information:
Increase in collection
Credit Policy Increase in sales Present default anticipated
period
A 10 days ` 30,000 1.5%
B 20 days ` 48,000 2%
C 30 days ` 75,000 3%
D 45 days ` 90,000 4%

The selling price per unit is ` 3. Average cost per unit is ` 2.25 and variable costs per unit
are ` 2. The current bad debt loss is 1%. Required return on additional investment is 20%.
Assume a 360 days year.
Which of the above policies would you recommend for adoption?

Question 9
Metalica Toys manufacturers dye cast metallic cars for kids. Its present sale is ` 60 lakhs
per annum with 20 days credit period. The company is contemplating an increase in the
credit period with a view to increasing sales. Present variable costs are 70% of sales
and the total fixed costs ` 8 lakhs per annum. The company expects pre-tax return on
investment @ 25%.

Some other details are given as under:

Average Collection Period Expected Annual Sales
Proposed Credit Policy
(days) (` Lakhs)
I 30 65
II 40 70
III 50 74
IV 60 75
You are required to advise the company on the policy to be adopted. Assume 360-days a
year. Calculations should be made upto two digits after decimal.

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Question10
ABC Ltd. is considering relaxing its credit policy, for which the management has
evaluated two policies. From the following information kindly indicate which of the
credit policy you would like the company to adopt.
(i) Annual credit sales at present ` 87.5 lakhs
(ii) Proposed Credit Sales
Policy I – ` 105 lakhs and Policy II – ` 118 lakhs
(iii) Accounts receivable turnover and Bad debts
Existing I II
7 times 5.25 times 4.2 times
` 2.63 lakhs 5.25 lakhs ` 7.88 lakhs

(iv) ABC is required to give a return over 30% on the investment in the accounts
receivables.
(v) Variable cost ratio is 70%.

Question 11
Navya Ltd has annual credit sales of Rs. 45 lakhs. Credit terms are 30 days, but its
management of receivables has been poor and the average collection period is 50
days, Bad debt is 0.4 per cent of sales. A factor has offered to take over the task of
debt administration and credit checking, at an annual fee of 1 per cent of credit sales.
Navya Ltd. estimates that it would save Rs. 35,000 per year in administration costs
as a result. Due to the efficiency of the factor, the average collection period would
reduce to 30 days and bad debts would be zero. The factor would advance 80 per
cent of invoiced debts at an annual interest rate of 11 per cent. Nawa Ltd. is currently
financing receivables from an overdraft costing 10 per cent per year.
If occurrence of credit sales is throughout the year, COMPUTE whether the factor’s
services should be accepted or rejected. Assume 365 days in a year.

Question 12
MN Ltd. has a current turnover of ` 30,00,000 p.a. Cost of Sale is 80% of turnover
and Bad Debts are 2% of turnover, Cost of Sales includes 70% variable cost and 30%
Fixed Cost, while company’s required rate of return is 15%. MN Ltd. currently allows
15 days credit to its customer, but it is considering increase this to 45 days credit in
order to increase turnover.

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It has been estimated that this change in policy will increase turnover by 20%, while
Bad Debts will increase by 1%. It is not expected that the policy change will result in
an increase in fixed cost and creditors and stock will be unchanged.
Should MN Ltd. introduce the proposed policy? (Assume 360 days year)

Question 13
A firm has a total sales of Rs. 200 lakhs of which 80% is on credit. It is offering credit
terms of 2/40, net 120. Of the total, 50% of customers avail of discount and the balance
pay in 120 days. Past experience indicates that bad debt losses are around 1 % of credit
sales. The firm spends about Rs. 2,40,000 per annum to administer its credit sales. These
are avoidable as a factor is prepared to buy the firm’s receivables. He will charge 2%
commission. He will pay advance against receivables to the firm at an interest rate of
18% after withhoLding 10% as reserve.
(i) What is the effective cost of factoring? Consider year as 360 days.
(ii) If bank finance for working capital is available at 14% interest, should the firm avail
of factoring service

Question 14
Sug Ltd. is a regular eash customer of Quest Ltd. The former has offered to buy goods of
Rs.20,00,000 in one year and is expected to make payments as per following schedule :
By the end of 20 days 15% of the Bill
By the end of 45 days 30% of the Bill
By the end of 90 days 25% of the Bill
By the end of 100 days 28% of the Bill
Non Recovery (Discount) 2% of the Bill

Purchases of Rs. 20,00,000 would be scattered over the year and to be made in equal
quantities on the first day of each quarter. The selling price and the profit per unit are
Rs. 200 and Rs. 30 per unit. Quest Ltd. expects that if the offer is accepted, additional
cost of Rs. 35,000 p.a. would be required. The opportunity cost of funds for Quest Ltd.
may be taken as 25%; Should the offer be accepted or not ?

Question 15
Hari Ltd has just acquired a large order. As a result, it needs an additional Rs. 75,000 in
Working Capital immediately. It has been determined that there are three feasible sources
of funds. Determine the best course of action for the Company.

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• Trade Credit: The Company buys about Rs. 50,000 of Materials per month on term
of 3/30, net 90. Discounts are taken.
• Bank Loan: The Firm’s Bank will Lend Rs. 1,00,000 at 13%. A 10% Compensating
Balance will be required, which otherwise would not be maintained by the company.
• Factoring: A Factor will buy the Company’s Receivables ( Rs. 1,00,000 per month,
which have a collection period of 60 days. The Factor will advance up to 75% of
the Face Value of the Receviables at 12% on an annual basis. The Factor will also
charge a 2% Fee on all Receiables purchased. It has been estimated that the Factor’s
Services will save the Company, Credit Department Expenses and Bad-Debt Expenses
of Rs. 1,500 per month.

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PAYABLES MANAGEMENT

CLASSWORK SECTION

Question 1
A Ltd. is in the manufacturing business and it acquires raw material from X Ltd. on a
regular basis. As per the terms of agreement the payment must be made within 40 days
of purchase. However, A Ltd. has a choice of paying Rs. 98.50 per Rs. 100 it owes to X
Ltd. on or before 10th day of purchase.
Required:
EXAMINE whether A Ltd. should accept the offer of discount assuming average billing of
A Ltd. with X Ltd. is Rs. 10,00,000 and an alternative investment yield a return of 15%
and company pays the invoice.

Question 2
Lalita Ltd purchases Raw Materials on terms of 2/10, net 30. A review of the Company’s
records by the Owner, Mr. Easwar, revealed that payments are usually made 15 days
after purchases are received. When asked why the Firm did not take advantage of its
discounts, the Accountant, Mr. Ram, replied that it cost only 2% for these funds, whereas
a Bank Loan would cost the Company 12%.
(a) What mistake is Ram making?
(b) What is the Real Cost of not taking advantage of the Discount?
(c) If the Firm could not borrow from the Bank and was forced to resort to the use of
Trade Credit funds, what suggestion might be made to Ram that would reduce the
Annual Interest Cost?

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Notes

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Notes

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CASH AND TREASURY MANAGEMENT

THEORY SECTION

Meaning
Cash Budgets are a tool for forecasting short - term cash requirements of an enterprise.
They provide a blueprint of the cash inflows and outflows that are expected to occur in
the immediate future period. They assist the management in determining the surplus or
shortage of funds and to take suitable action. The Cash Budget can be prepared for short
period or for long period.
Monthly Cash Budget
Particulars April May June
Opening Balance
Add : Receipts
Cash sales
Collection from debtors
Raising of loans
Issue of share capital or debentures
Sale of FA / Investments
Income from Investments, etc.
(A)
Less : Payments
Payment to suppliers
Payment of operating expenses
Purchase of FA / Investments
Redemption of shares / debentures
Repayment of loans
Interest Payment, etc.
(B)
Balance (A - B)
Borrowings
Repayment of borrowings
Investment of surplus cash
Balance c/f to Next month

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CLASSWORK SECTION

Question 1
From the following information relating to a departmental store for the three months
period ending 31st March, 2022, you are required to prepare the following :
Monthly cash budget on receipts and payments basis.
It is anticipated that the working capital items on 31st December, 2022 will be as follows:
` 000's
Cash in hand and at bank 545
Short-term investments 300
Debtors 2,570
Stock 1,300
Trade Creditors 2,110
Other Creditors 200
Dividends Due 485
Tax Due 320

BUDGETED PROFIT STATEMENT

Particulars ` 000's
Jan. Feb. March
Sales 2,100 1,800 1,700
Cost of Sales 1,635 1,405 1,330

Gross Profit 465 395 370

Administrative, selling and distribution expenses 315 270 255
and interest
Net Profit prior to tax 150 125 115

BUDGETED BALANCES AT THE END OF EACH MONTH

` 000's
31st Jan. 28th Feb. 31st March
Short-term investments 700 ---- 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade Creditors 2,000 1,950 1,900
Other Creditors 200 200 200
Dividends Due 485 ---- ----
Tax Due 320 320 320
Depreciation amounting to ` 60,000 is included in the budgeted expenditure for each month.
Capital expenditure amounting to ` 8,00,000 is expected to be incurred during February 2023
and proceeds from the sale of plant and equipment of ` 50,000 is expected in March, 2022.

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Question 2
A manufacturing company has prepared a budget for the year ended 31.12.2022. Using
the relevant data given below, prepare a cash budget for each of the months of February,
March and April 2022.
Estimated Variable Cost Per Unit `
Direct Materials 3
Direct Wages 4
Production Overheads 2
Total 9

Fixed Overheads are estimated at ` 48,000 per annum. These are expected to be incurred
in equal amounts each month during the budget period. Estimated sales at `11 per unit
for the first 5 months are given below:
Month Unit
January 6,200
February 6,800
March 5,400
April 6,000
May 6,000
10% of the sales will be made on cash. Balance will be made on one month's credit. The
following further information are available:
1. Finished goods stock : 75% of each month's invoiced sales units to be produced in the
month of sale and 25% of each month's invoiced sales units to be produced in the
previous month.
2. Stock of direct materials : 50% of direct materials required for each month's production
to be purchased in the previous month.
3. Terms of Payments : (a) Direct materials : To be paid for in the month following the
month of purchase ; (b) Direct Wages : 50% in the month used and the balance in
the following month ; and (c) Expenses : 1 month's lag.
4. Estimated cash balance as on 1.2.2022 ` 5,000.

Question 3
A firm maintains a separate account for cash disbursement. Total disbursements are
` 1,05,000 per month or ` 12,60,000 per year. Administrative and transaction cost of
transferring cash to disbursement account is ` 20 per transfer. Marketable securities yield
is 8% per annum.
Determine the optimum cash balance according to William J. Baumol model.

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Question 4
Prepare monthly cash budget for six months beginning from April 2023 on the basis of
the following information:-
(i) Estimated monthly sales are as follows:-
(`) (`)
January 1,00,000 June 80,000
February 1,20,000 July 1,00,000
March 1,40,000 August 80,000
April 80,000 September 60,000
May 60,000 October 1,00,000

(ii) Wages and salaries are estimated to be payable as follows:-

(`) (`)
April 9,000 July 10,000
May 8,000 August 9,000
June 10,000 September 9,000

(iii) Of the sales, 80% is on credit and 20% for cash. 75% of the credit sales are collected
within one month and the balance in two months. There are no bad debt losses.
(iv) Purchases amount to 80% of sales and are made on credit and paid for in the month
preceding the sales.
(v) The firm has 10% debentures of ` 1,20,000. Interest on these has to be paid quarterly
in January, April and so on.
(vi) The firm is to make an advance payment of tax of ` 5,000 in July, 2023.
(vii) The firm had a cash balance of ` 20,000 on April 1, 2023, which is the minimum
desired level of cash balance. Any cash surplus/deficit above/below this level is made
up by temporary investments/liquidation of temporary investments or temporary
borrowings at the end of each month (interest on these to be ignored).

Question 5
K Ltd. has a Quarterly cash outflow of `9,00,000 arising uniformly during the Quarter.
The company has an investment portfolio of Marketable Securities. It plans to meet the
demands for cash by periodically selling marketable securities. The marketable securities
are generating a return of 12% p.a. Transaction cost of converting investments to cash
is `60. The company uses Baumol model to find out the optimal transaction size for
converting marketable securities into cash.
Consider 360 days in a year.

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You are required to calculate

(i) Company’s average cash balance
(ii) Number of conversions each year and
(iii) Time interval between two conversions

Question 6
Slide Ltd. is preparing a cash flow forecast for the three months period from January to
the end of March. The following sales volumes have been forecasted:
Months December January February March April
Sales (units) 1,800 1,875 1,950 2,100 2,250
Selling price per unit is ` 600. Sales are all on one month credit. Production of goods
for sale takes place one month before sales. Each unit produced requires two units of
raw materials costing ` 150 per unit. No raw material inventory is held. Raw materials
purchases are on one month credit. Variable overheads and wages equal to ` 100 per
unit are incurred during production and paid in the month of production. The opening
cash balance on 1st January is expected to be ` 35,000. A long term loan of ` 2,00,000
is expected to be received in the month of March. A machine costing ` 3,00,000 will be
purchased in March.
(a) Prepare a cash budget for the months of January, February and March and calculate
the cash balance at the end of each month in the three months period.
(b) Calculate the forecast current ratio at the end of the three months period.

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HOMEWORK SECTION

Question 1
Ram, Arun & Kalish, Chartered Accountants are partners of the Firm Ranka Associates
specialising in the areas of internal and corporate audit, taxation and project consultancy.
The revenue of the firm is steadily increasing over the years. For the year they decided to
operate a budgetary control system to monitor the profitability as well as cash movements.
To start with the following forecast of profits was prepared for the first six months:
RANKA ASSOCIATES (` IN '000)
PROJECTED PROFIT FORECASTS FOR THE SIX MONTHS ENDING 30.9.2023
Particulars April May June July Aug. Sept.
Incomes Internal / Corporate Audit 60 60 60 60 60 60
Taxation 30 45 40 50 40 60
Project Consultancy 30 50 30 40 60 40
Total A 120 155 130 150 160 160
Expenses
Depreciation 10 10 10 10 10 10
Rent 5 5 5 5 5 5
Stipend 15 15 15 15 15 15
Telephone 5 7 8 9 13 15
Office Expenses & Salaries 35 45 50 35 40 42
Training 5 6 4 10 12 13
Travel & Conveyance 10 12 13 14 15 15
Partners & Assistants' Salaries 20 30 35 35 40 40
Total B 105 130 140 133 150 155
Profit (A – B) 15 25 (10) 17 10 5

The following additional information is significant:

(a) Rent is payable in advance on the last day of the previous quarter.
(b) Stipend will be paid in the same month.
(c) Telephone will be paid every two months in arrears. (i.e. April and May will be paid in June)
(d) Office expenses and Salaries will be paid in the following month.
(e) Travel & Training will be paid in the same month.
(f) Partners and assistants salaries will be paid in the following month.
(g) The firm is planning to invest a sum of ` 50,000 in July for acquiring a computer.
(h) The firm expects to pay a self-assessment tax of ` 5,000 and advance tax of `15,000
in August.

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(i) The firm is planning to open a branch and spend a sum of ` 20,000 in September in
this regard.
(j) Collection of Fees : Internal / Corporate Audit fees will be collected in the following
month. Taxation : 50% in the same month and 50% in the following month.
Consultancy charge is normally received after 2 months.
(k) The firm's Cash Balance as on July 1st was ` 25,000.
You are required to:
(i) Prepare a Cash Budget for each of the three months - July, August and
September.
(ii) Suggest two improvements that could smoothen the cash position as on 30th
September.

Question 2
From the following information relating to a departmental store, you are required to
prepare for the three months ending 31st March, 2023:-
(a) Month-wise cash budget on receipts and payments basis; and
(b) Statement of Sources and uses of funds for the three months period.

It is anticipated that the working capital at 1st January, 2023 will be as follows:-
` in ‘000’s
Cash in hand and at bank 545
Short term investments 300
Debtors 2,570
Stock 1,300
Trade creditors 2,110
Other creditors 200
Dividends payable 485
Tax due 320
Plant 800

Budgeted Profit Statement ` in ‘000’s

January February March
Sales 2,100 1,800 1,700
Cost of sales 1,635 1,405 1,330
Gross Profit 465 395 370
Administrative, Selling and Distribution 315 270 255
Expenses
Net Profit before tax 150 125 115

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Budgeted balances at the end of each months ` in ‘000’s

31st Jan. 28th Feb. 31st March.
Short term investments 700 --- 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade creditors 2,000 1,950 1,900
Other creditors 200 200 200
Dividends payable 485 --- ---
Tax due 320 320 320
Plant (depreciation ignored) 800 1,600 1,550
Depreciation amount to ` 60,000 is included in the budgeted expenditure for each month.

Question 3
You are given below the Profit & Loss Accounts for two years for a company:
Profit and Loss Account
Year 1 Year 2 Year 1 Year 2
` ` ` `
To Opening stock 80,00,000 1,00,00,000 By Sales 8,00,00,000 10,00,00,000

To Raw materials 3,00,00,000 4,00,00,000 By Closing stock 1,00,00,000 1,50,00,000

To Stores 1,00,00,000 1,20,00,000 By Misc. Income 10,00,000 10,00,000

To Manufacturing 1,00,00,000 1,60,00,000

Expenses

To Other Expenses 1,00,00,000 1,00,00,000

To Depreciation 1,00,00,000 1,00,00,000

To Net Profit 1,30,00,000 1,80,00,000

9,10,00,000 11,60,00,000 9,10,00,000 11,60,00,000

Sales are expected to be ` 12,00,00,000 in year 3.

As a result, other expenses will increase by ` 50, 00,000 besides other charges. Only raw
materials are in stock. Assume sales and purchases are in cash terms and the closing
stock is expected to go up by the same amount as between year 1 and 2. You may assume
that no dividend is being paid. The Company can use 75% of the cash generated to service
a loan. How much cash from operations will be available in year 3 for the purpose?
Ignore income tax.

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Question 4
The following information relates to Zeta Limited, a publishing company:
The selling price of a book is Rs. 15, and sales are made on credit through a book club
and invoiced on the last day of the month.
Variable costs of production per book are materials (Rs. 5), labour (Rs. 4), and overhead
(Rs. 2)
The sales manager has forecasted the following volumes:
Month No. of Books
Nov 1,000
Dec 1,000
Jan 1,000
Feb 1,250
Mar 1,500
Apr 2,000
May 1,900
Jun 2,200
July 2,200
Aug 2,300
Customers are expected to pay as follows:
One month after the sale 40%
Two months after the sale 60%
The company produces the books two months before they are sold and the creditors for
materials are paid two months after production. Variable overheads are paid in month
following production and are expected to increase by 25% in April; 75% of wages are
paid in the month of production and 25% in the following month. A wage increase of
12.5% will take place on 1st March.
The company is going through a restructuring and will sell one of its free hold properties
in May for Rs. 25,000, but it is also planning to buy a new printing press in May for
Rs. 10,000.Depreciation is currently Rs. 1,000 per month, and will rise toRs.1,500 after
the purchase of the new machine.
The company’s corporation tax (of Rs. 10,000) is due for payment in March.
The company presently has a cash balance at bank on 31 December 2013, of Rs.1,500.
You are required to prepare a cash budget for the six months from January to June.

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Question 5
Consider the balance sheet of Maya Limited at December 31 (in thousands).The company
has received a large order and anticipates the need to go to its bank to increase its
borrowings. As a result, it has to forecast its cash requirements for January, February
and March. Typically, the company collects 20 percent of its sales in the month of sale,
70 per cent in the subsequent month, and 10 per centin the second month after the sale.
All sales are credit sales.
Rs. Rs.
Cash 50 Accounts payable 360
Accounts receivable 530 Bank loan 400
Inventories 545 Accruals 212
Current assets 1,125 Current liabilities 972
Net fixed assets 1,836 Long-term debt 450
Common stock 100
Retained earnings 1,439
Total assets 2,961 Total liabilities and equity 2,961

Purchases of raw materials are made in the month prior to the sale and amount to
60 percent of sales in the subsequent month. Payments for these purchases occur in
the month after the purchase. Labour costs, including overtime, are expected to be
Rs.1,50,000 in January, Rs. 2,00,000 in February, and Rs. 1,60,000 in March. Selling, ad-
ministrative, taxes, and other cash expenses are expected to be Rs. 1,00,000 per month
for January through March. Actual sales in November and December and projected sales
for January through April are as follows (in thousands):
Rs. Rs. Rs.
November 500 January 600 March 650
December 600 February 1,000 April. 750

On the basis of this information:

(a) Prepare a cash budget for the months of January, February and March.
(b) Determine the amount of additional bank borrowings necessary to maintain a cash
balance of Rs. 50,000 at all times.
(c) Prepare a pro forma balance sheet for March 31.

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Notes

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Notes

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SERVICE COSTING OR
OPERATING COSTING

THEORY SECTION
It is followed by those companies which are providing services for e.g., Transport
companies, School & Colleges, Hospitals, Theaters, Hotels etc.
We have to calculate Total cost of providing service.
Type of Industry Unit of Cost
1. Goods Transport Company → Tonne Kms. (per tonne per km.)
2. Passenger Transport Co → Passenger kms. (per passenger per km.)
3. Hotels → Room Days (per room per day)
4. Hospitals → Per Bed per day or
Per Patient per day

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CLASSWORK SECTION

Question 1
Mr. X owns a bus which runs according to the following schedule:
(i) Delhi to Chandigarh and back, the same day.
Distance covered: 250 km. one way.
Number of days run each month : 8
Seating capacity occupied 90%.
(ii) Delhi to Agra and back, the same day.
Distance covered: 210 km. one way
Number of days run each month : 10
Seating capacity occupied 85%
(iii) Delhi to Jaipur and back, the same day.
Distance covered: 270 km. one way
Number of days run each month : 6
Seating capacity occupied 100%
(iv) Following are the other details:
Cost of the bus ` 12,00,000
Salary of the Driver ` 24,000 p.m.
Salary of the Conductor ` 21,000 p.m.
Salary of the part-time Accountant ` 5,000 p.m.
Insurance of the bus ` 4,800 p.a.
Diesel consumption 4 km. per litre at ` 56 per litre
Road tax ` 15,915 p.a.
Lubricant oil ` 10 per 100 km.
Permit fee ` 315 p.m.
Repairs and maintenance ` 1,000 p.m.
Depreciation of the bus @ 20% p.a.
Seating capacity of the bus 50 persons.
Passenger tax is 20% of the total takings. Calculate the bus fare to be charged from
each passenger to earn a profit of 30% on total takings. The fares are to be indicated per
passenger for the journeys:
(i) Delhi to Chandigarh (ii) Delhi to Agra and (iii) Delhi to Jaipur.

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Question 2
SMC is a public school having five buses each plying in different directions for the transport
of its school students. In view of a 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 work-load 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 the 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 8 km. The school works 25 days in a month
and remains closed for vacation in May, June and December. Bus fee, however, is payable
by the students for all 12 months in a year.
The details of expenses for a year are as under:
Driver’s salary ` 4,500 per month per driver
Cleaner’s salary ` 3,500 per month
(Salary payable for all 12 months)
(one cleaner employed for all the five buses)
Licence fee, taxes, etc. ` 8,600 per bus per annum
Insurance ` 10,000 per bus per annum
Repairs & maintenance ` 35,000 per bus per annum
Purchase price of the bus ` 15,00,000 each
Life of each bus 12 years
Scrap value of bus at the end of life ` 3,00,000
Diesel cost ` 45.00 per litre
Each bus gives an average mileage of 4 km. per litre of diesel.
Seating capacity of each bus is 50 students.
The seating capacity is fully occupied during the whole year.
Students picked up and dropped within a range up to 4 km. of distance from the school
are charged half fare and fifty per cent of the students travelling in each trip are in this
category. Ignore interest. Since the charges are 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
five buses for a year.
(ii) Work out the average cost per student per month in respect of –
(A) students coming from a distance of upto 4 km. from the school and
(B) students coming from a distance beyond 4 km. from the school.

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Question 3
A transport company has a fleet of three trucks of 10 tonnes capacity each plying in
different directions for transport of customer's goods. The trucks run loaded with goods
and return empty. The distance travelled, number of trips made and the load carried per
day by each truck are as under:
Truck No. One way Distance No. of trips per Load carried per trip /
Km day day tonnes
1 16 4 6
2 40 2 9
3 30 3 8

The analysis of maintenance cost and the total distance travelled during the last two
years is as under
Year Total distance travelled Maintenance Cost
1 1,60,200 46,050
2 1,56,700 45,175
The vehicles operate 24 days per month on an average.
Required
(i) Calculate number of km.
(ii) Calculate number of Ton km.
(iii) Calculate maintenance of cost

Question 4
A Mineral is transported from two mines – 'A' and 'B' and unloaded at plots in a Railway
Station. Mine A is at a distance of 10 km., and B is at a distance of 15 km. from railhead
plots. A fleet of lorries of 5 tonne carrying capacity is used for the transport of mineral
from the mines. Records reveal that the lorries average a speed of 30 km. per hour, when
running and regularly take 10 minutes to unload at the railhead. At mine 'A' loading time
averages 30 minutes per load while at mine 'B' loading time averages 20 minutes per
load.
Drivers' wages, depreciation, insurance and taxes are found to cost ` 9 per hour operated.
Fuel, oil, tyres, repairs and maintenance cost ` 1.20 per km.
Draw up a statement, showing the cost per tonne-kilometer of carrying mineral from
each mine.

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Question 5
Global Transport Ltd. charges ` 90 per ton for its 6-ton truck lorry load from city ‘A’ to
city ‘B’. The charges for the return journey are ` 84 per ton. No concession or reduction in
these rates is made for any delivery of goods at intermediate station ‘C’.
In January 20X8, the truck made 12 outward journeys for city ‘B’ with full load out of
which 2 tons were unloaded twice in the way at city ‘C’. The truck carried a load of 8 tons
in its return journey for 5 times but was once caught by police and ` 1,200 was paid as
fine. For the remaining trips the truck carried full load out of which all the goods on load
were unloaded once at city ‘C’. The distance from city ‘A’ to city ‘C’ and city ‘B’ are 140 km.
and 300 km. respectively.
Annual fixed costs and maintenance charges are ` 60,000 and `12,000 respectively.
Running charges spent during January 20X8 are ` 2,944.
You are required to find out the cost per absolute ton-kilometre and the profit for January, 20X8.

Question 6
A company is considering three alternative proposals for conveyance facilities for its
sales personnel who has to do considerable traveling, approximately 20,000 kilometres
every year. The proposals are as follows:
(i) Purchase and maintain its own fleet of cars. The average cost of a car is ` 6,00,000.
(ii) Allow the Executive use his own car and reimburse expenses at the rate of ` 10 per
kilometer and also bear insurance costs.
(iii) Hire cars from an agency at ` 1,80,000 per year per car. The company will have to
bear costs of petrol, taxes and tyres.
The following further details are available:
Petrol ` 6 per km. Repairs and maintenance ` 0.20 per km.
Tyre ` 0.12 per km. Insurance `1,200 per car per annum
Taxes ` 800 per car per annum Life of the car: 5 years with annual mileage of
20,000 km.
Resale value: ` 80,000 at the end of the fifth year.
Work out the relative costs of three proposals and rank them.

Question 7
BHG Toll Plaza Ltd built a 60 km. long highway and now operates a toll plaza to collect
tolls from passing vehicles using the highway. The company has estimated that a total
of 12 crore vehicles (only single type of vehicle) will be using the highway during the 10
years toll collection tenure.

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Toll Operating and Maintenance cost for the month of April 2020 are as follows:
(i) Salary to –
 Collection Personnel (3 Shifts and 4 persons per shift) - ` 550 per day per
person
 Supervisor (2 Shifts and 1 person per shift) - ` 750 per day per person
 Security Personnel (3 Shifts and 6 persons per shift) - `450 per day per person
 Toll Booth Manager (2 Shifts and 1 person per shift) - `900 per day per person
(ii) Electricity – ` 8,00,000
(iii) Telephone – ` 1,40,000
(iv) Maintenance cost – ` 30 Lakh
Monthly depreciation and amortisation expenses will be ` 1.50 crore. Further, the company
needs 25% profit over total cost to cover interest and other costs.

Required:
(i) CALCULATE cost per kilometer per month.
(ii) CALCULATE the toll rate per vehicle.

Question 8
AD Higher Secondary School (AHSS) offers courses for 11th & 12th standard in three
streams i.e. Arts, Commerce and Science. AHSS runs higher secondary classes along with
primary and secondary classes, but for accounting purpose it treats higher secondary as
a separate responsibility centre. The Managing committee of the school wants to revise
its fee structure for higher secondary students. The accountant of the school has provided
the following details for a year:
Amount (`)
Teachers’ salary (25 teachers × ` 35,000 × 12 months) 1,05,00,000
Principal’s salary 14,40,000
Lab attendants’ salary (2 attendants × ` 15,000 × 12 months) 3,60,000
Salary to library staff 1,44,000
Salary to peons (4 peons × ` 10,000 × 12 months) 4,80,000
Salary to other staffs 4,80,000
Examinations expenditure 10,80,000
Office & Administration cost 15,20,000
Annual day expenses 4,50,000
Sports expenses 1,20,000

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Other information:
(i)
Standard 11 & 12 Primary &
Arts Commerce Science Secondary
No. of students 120 360 180 840
Lab classes in a year 0 0 144 156
No. of examinations in a year 2 2 2 2
Time spent at library per year 180 hours 120 hours 240 hours 60 hours
Time spent by principal for 208 hours 312 hours 480 hours 1,400 hours
administration
Teachers for 11 & 12 standard 4 5 6 10
(ii) One teacher who teaches economics for Arts stream students also teaches commerce
stream students. The teacher takes 1,040 classes in a year, it includes 208 classes
for commerce students.
(iii) There is another teacher who teaches mathematics for Science stream students
also teaches business mathematics to commerce stream students. She takes 1,100
classes a year, it includes 160 classes for commerce students.
(iv) One peon is fully dedicated for higher secondary section. Other peons dedicate their
15% time for higher secondary section.
(v) All school students irrespective of section and age participates in annual functions
and sports activities.
Required:
(i) CALCULATE cost per student per annum for all three streams.

Question 9
A lodging home is being run in a small hill station with 100 single rooms. The home offers
concessional rates during six off- season months in a year. During this period, half of
the full room rent is charged. The management’s profit margin is targeted at 20% of the
room rent. The following are the cost estimates and other details for the year ending on
31st March 20X7. [Assume a month to be of 30 days].
(i) Occupancy during the season is 80% while in the off- season it is 40% only.
(ii) Total investment in the home is ` 200 lakhs of which 80% relate to buildings and
balance for furniture and equipment.
(iii) Expenses:
- Staff salary [Excluding room attendants] : ` 5,50, 000
- Repairs to building : ` 2,61,000

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- Laundry charges : `80, 000

- Interior : ` 1,75,000
- Miscellaneous expenses : ` 1,90,800
(iv) Annual depreciation is to be provided for buildings @ 5% and on furniture and
equipment @ 15% on straight-line basis.
(v) Room attendants are paid ` 10 per room day on the basis of occupancy of the rooms
in a month.
(vi) Monthly lighting charges are ` 120 per room, except in four months in winter when
it is ` 30 per room.
You are required to work out the room rent chargeable per day both during the season
and the off-season months on the basis of the foregoing information.

Question 10
ABC Hospital runs a Critical Care Unit (CCU) in a hired building. CCU consists of 35 beds
and 5 more beds can be added, if required.
Rent per month - ` 75,000
Supervisors – 2 persons – ` 25,000 Per month – each
Nurses – 4 persons – ` 20,000 per month – each
Ward Boys – 4 persons – ` 5,000 per month – each
Doctors paid ` 2, 50,000 per month – paid on the basis of number of patients
attended and the time spent by them
Other expenses for the year are as follows:
Repairs – ` 81,000
Food to Patients – ` 8,80,000
Other services to patients – ` 3, 00,000
Laundry charges – ` 6,00,000
Medicines – ` 7,50,000
Other expenses – ` 10, 80,000
Administration expenses allocated – ` 10,00,000
It was estimated that for 150 days in a year 35 beds are occupied and for 80 days only
25 beds are occupied.
The hospital hired 750 beds at a charge of ` 100 per bed per day, to accommodate the
flow of patients. However, this does not exceed more than 5 extra beds over and above
the normal capacity of 35 beds on any day.
You are required to calculate profit per Patient day, if the hospital recovers on an average
` 2,000 per day from each patient.

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HOMEWORK SECTION

Question 1
From the following data pertaining to the year 20X7-X8 prepare a cost statement
showing the cost of electricity generated per kwh by Chambal Thermal Power Station.
Total units generated 10,00,000 kwh
(`)
Operating labour 15,00,000
Repairs & maintenance 5,00,000
Lubricants, spares and stores 4,00,000
Plant supervision 3,00,000
Administration overheads 20,00,000
5 kWh. of electricity generated per kg. of coal consumed @ ` 4.25 per kg. Depreciation
charges @ 5% on capital cost of ` 2,00,00,000.

Question 2
Sanziet Lifecare Ltd. operates in life insurance business. Last year it launched a new term
insurance policy for practicing professionals ‘Professionals Protection Plus’. The company
has incurred the following expenditures during the last year for the policy:
`
Policy development cost 11,25,000
Cost of marketing of the policy 45,20,000
Sales support expenses 11,45,000
Policy issuance cost 10,05,900
Policy servicing cost 35,20,700
Claims management cost 1,25,600
IT cost 74,32,000
Postage and logistics 10,25,000
Facilities cost 15,24,000
Employees cost 5,60,000
Office administration cost 16,20,400
Number of policy sold- 528
Total insured value of policies- `1,320 crore

Required:
(i) CALCULATE total cost for Professionals Protection Plus’ policy segregating the costs

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into four main activities namely (a) Marketing and Sales support, (b) Operations, (c)
IT and (d) Support functions.
(ii) CALCULATE cost per policy.
(iii) CALCULATE cost per rupee of insured value.

Question 3
GTC has a lorry of 6-ton carrying capacity. It operates lorry service from city A to city
B. It charges ` 2,400 per ton from city ‘A’ to city ‘B’ and ` 2,200 per ton for the return
journey from city ‘B’ to city ‘A’. Goods are also delivered to an intermediate city ‘C’ but no
concession or reduction in rates is given. Distance between the city ‘A’ to ‘B’ is 300 km and
distance from city ‘A’ to ‘C’ is 140 km.
In January 2020, the truck made 12 outward journeys for city ‘B’. The details of journeys
are as follows:
Outward journey No. of journeys Load (in ton)
‘A’ to ‘B’ 10 6
‘A’ to ‘C’ 2 6
‘C’ to ‘B’ 2 4
Return journey No. of journeys Load (in ton)
‘B’ to ‘A’ 5 8
‘B’ to ‘A’ 6 6
‘B’ to ‘C’ 1 6
‘C’ to ‘A’ 1 0
Annual fixed costs and maintenance charges are ` 6,00,000 and ` 1,20,000 respectively.
Running charges spent during January 2020 are ` 2,94,400 (includes ` 12,400 paid as
penalty for overloading).
You are required to:
CALCULATE the cost as per (a) Commercial ton-kilometre. (b) Absolute ton- kilometre

Question 4
Refer Question 8 of Classwork Section. Now Solve following additional required parts.
(i) If the management decides to take uniform fee of ` 1,000 per month from all higher
secondary students, CALCULATE stream wise profitability.
(ii) If management decides to take 10% profit on cost, COMPUTE fee to be charged from
the students of all three streams respectively.

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Question 5
The data given relates to "Vasanth Talkies" mini theatre, for the year ending 31st March,
2018.

Salaries
` `
1 Manager 800 p.m. Carbon 7,235
10 Gate-keepers 200 p.m. each Miscellaneous Expenditure 5,425
2 Operators 400 p.m. each Advertisement 34,710
4 Clerks 250 p.m. each Administrative Expenditure 18,000
Electricity & Oil 11,655 Hire of print 1,40,700

The premises are valued at ` 6,00,000 and the estimated life is 15 years. Projector and
other equipments cost ` 3,20,000 on which 10% depreciation is to be charged.
Daily three shows are run throughout the year. The total capacity is 625 seats which is
divided into three classes as follows
Janata circle 250 seats
Sanman circle 250 seats
Lord's circle 125 seats
Ascertain rate per man-show assuming that:
(a) 20% of the seats remain vacant, and
(b) Weightage to be given to the three classes in the ratio of 1:2:3.
Determine the rates for each class if the management expects 30% return on gross
proceeds. Ignore entertainment taxes

Question 6
In order to develop tourism, ABCL airline has been given permit to operate three flights
in a week between X and Y cities (both side). The airline operates a single aircraft of 160
seats capacity. The normal occupancy is estimated at 60% throughout the year of 52
weeks. The one-way fare is ` 7,200. The cost of operation of flights are:
Fuel cost (variable) ` 96,000 per flight
Food served on board on non-chargeable basis ` 125 per passenger
Commission 5% of fare applicable for all booking
Fixed cost:
Aircraft lease ` 3,50,000 per flight
Landing Charges ` 72,000 per flight

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Required:
(i) Calculate the net operating income per flight.
(ii) The airline expects that its occupancy will increase to 108 passengers per flight if the
fare is reduced to ` 6,720. Advise whether this proposal should be implemented or not.

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IMPORTANT THEORY QUESTIONS FOR EXAMINATION

Question 1
Explain briefly, what do you understand by Operating Costing. How are composite units
computed?  (3 Marks, November 2009)

Answer
Operating Costing: It is method of ascertaining costs of providing or operating a service.
This method of costing is applied by those undertakings which provide services rather
than production of commodities. This method of costing is used by transport companies,
gas and water works departments, electricity supply companies, canteens, hospitals,
theatres, schools etc.
Composite units may be computed in two ways:
(a) Absolute (weighted average) tones kms, quintal kms etc.
(b) Commercial (simple average) tonnes kms, quintal kms etc.
Absolute tonnes-kms are the sum total of tonnes kms arrived at by multiplying various
distances by respective load quantities carried.
Commercial tonnes-kms, are arrived at by multiplying total distance kms, by average
load quantity.

Question 2
What do you understand by operating costing? How are composite units computed?
 (4 Marks, November 2012)
Answer
Meaning of Operating Costing: Operating Costing is a method of ascertaining costs of
providing or operating a service. This method of costing is applied by those undertakings
which provide services rather than production of commodities. This costing method is
usually made use of by transport companies, gas and water works departments, electricity
supply companies, canteens, hospitals, theatres, schools etc.
Computation of composite units: When two units are merged into one it is called Composite
units. It is explained with example as follows.
Composite units i.e. tonnes kms., quintal kms. etc. may be computed in two ways.
(i) Absolute (weighted average) tonnes-kms.
Absolute tonnes-kms, are the sum total of tonnes-kms., arrived at by multiplying
various distances by respective load quantities carried.
(ii) Commercial (simple average) tonnes-kms. Commercial tonnes-kms., are arrived at
by multiplying total distance kms., by average load quantity.

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MATERIAL COST CONTROL,

STOCK VALUATION AND STOCK
CONTROL

THEORY SECTION

A. How To Purchase [Raw Materials]

Step Document Copies From To Copies With
1. Purchase Requisition 3 Stores Purchase Stores
Form Purchase
Account
2. Letters Purchase Suppliers
3. Quotations Suppliers Purchase
4. Purchase Order 5 Purchase Suppliers Purchase
Suppliers
Stores
Receiving
Accounts
5 Delivery Challan 2 Suppliers Receiving Suppliers
Dept. Receiving
6. Goods Received Note 5 Receiving Suppliers Receiving
OR Receiving Report Dept. Suppliers
OR Material Inward Purchase
Note Stores
Accounts
7. Material Outward 5 Stores Suppliers Stores
Note [For Purchase Suppliers [2]
Return] Accounts
Outward
register
8. Raw Materials 2 Production Stores Production
Requisition Form Stores

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9 Raw Materials Issue 3 Stores Production Stores

Form Production
Accounts
10 R.M. Returns Forms 3 Production Stores Production
[Memo] Stores
Accounts
11 Raw Materials 2 Production Another Prod. Production
Transfer Form Dept Another
Prod.depts.

B. HOW MUCH TO BUY / MANUFACTURE AT A TIME:

(i) Total Ca or Acquisition cost or ordering cost :
The Acquisition cost is that cost which we specifically incur, every time the order
for buying the raw material is placed. The examples are paper & other stationery
cost that we incur for preparing the purchase requisition, purchase order etc., the
postage cost incurred for inviting the quotations, telephone expenses to be incurred,
fuel or carriage inward and so on.
The acquisition cost, as such, depends on the number of times that we buy but the
number of times that we buy itself would depend on how much we buy every time.
The more we buy at a time, the less the number of times we buy & therefore the less
would be our Ca. Thus, to minimise Ca, we should buy less no. of times.
It should be noted that expenses which are unaffected by the number of times
we buy are not acquisition costs at all (e.g. Salary of purchase department staff,
depreciation of vehicles etc.)

(ii) Total Ci or carrying cost:

This cost depends on the average stock that we carry in our inventory. The average
stock is half of how much we buy every time.
Interest cost, real or notional, that we incur on investments in our inventory or the
insurance premium that we pay to insure the stock against certain risk are examples
of carrying cost items.
The more we buy at a time, the more would be our investment and accordingly, the
more would be our carrying cost. To minimise Ci, we must buy less at a time so that
the investment & consequently, the carrying cost would get reduced.
It should be noted that expenses which are unaffected by quantity of stock that we
keep are not Ci items (e.g. salary of store keeper, depreciation or rent warehouse

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etc.). Also unless instructed otherwise any change in purchase price or rate of interest
would change Ci.

(iii) Ca v/s Ci :
These two cost items are equally strong but conflicting cost items. If one tries to
minimise one of them the other would automatically increase. For example, to
minimise Ca, we should buy less number of times which means we should buy more
at a time. But if we buy more at a time, the Ci would increase.
The EOQ does one very important job of striking a good balance between the two by
making the two equal.

B. WHEN TO BUY:
(1) Re-order level (ROL):
This is the stock level which, when reached, signifies that the action should be
taken to procure fresh quantity of raw material. The ROL has to be such that
the stock out is eliminated completely.
If the stock-out is not to occur, then, we must find out the maximum-possible
requirements of raw material during the maximum possible lead time that
lapses before we get fresh quantity of Raw Material.
Therefore ROL= Maximum consumption in maximum lead time + safety stock /
buffer stock / base stock (if given).

(2) Maximum (possible) stock:

After ROL is reached & before we get the fresh quantity, at least some consumption
would take place out of ROL quantity. If we want maximum possible stock, the
consumption should be minimum possible. Just after that consumption is over,
we would get fresh quantity of Raw Material which would be Re-order quantity
(which could be EOQ or other than EOQ).
Therefore Maximum possible stock = ROL ¬– Minimum consumption in minimum
lead time + Re-order quantity.

(3) Minimum (desirable) stock:

The minimum desirable level is the usual stock. Once our stock level reaches
below minimum level, it signifies that the conditions are unusual & unless
some urgent steps are taken, the stock-out may occur. However as long as the
conditions are normal we have nothing to worry about.

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The maximum lead time & the maximum consumption occur only rarely & so is
the case with minimum consumption & minimum lead time. These are extremes
& do not occur regularly. What happens usually is the average lead time &
average consumption. In other words as long as reduction from ROL is equal to
average consumption in average lead time, we have nothing to worry about as
that is something very normal and it happens in every inventory cycle. It is only
when, the stock goes below that level, that must make us worry.
Therefore, the minimum stock = ROL – Average consumption in average lead
time.

(4) Average stock =

(5) Danger Level:
1. Level at which emergency purchase action is made to replenish stock.
2. Level at which stocks are issued only on "most needed" basis.
Average consumption x Emergency lead time

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CLASSWORK SECTION

Question 1
Calculate the Economic Order Quantity from the following information. Also state the
number of orders to be placed in a year.
Consumption of materials per annum :  10,000 kg.
Order placing cost per order :  ` 50
Cost per kg. of raw materials :  `2
Storage costs :  8% on average inventory

Question 2
(i) Compute E.O.Q. and the total material cost for the following:
Annual Demand = 5,000 units
Unit price = ` 20.00
Order cost = ` 16.00
Storage rate = 2% per annum
Interest rate = 12% per annum
Obsolescence rate = 6% per annum

(ii) Determine the total cost that would result for the items if an incorrect price of
` 12.80 is used.

Question 3
G. Ltd. produces a product which has a monthly demand of 4,000 units. The product
requires a component X which is purchased at ` 20. For every finished product, one unit
of component is required. The ordering cost is ` 120 per order and the holding cost is
10% p.a.

You are required to calculate:

(i) Economic order quantity.

(ii) If the minimum lot size to be supplied is 4,000 units, what is the extra cost, the
company has to incur?

(iii) What is the minimum carrying cost, the company has to incur?

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Question 4
ZED Company supplies plastic crockery to fast food restaurants in metropolitan city. One
of its products is a special bowl, disposable after initial use, for serving soups to its
customers.
Bowls are sold in pack 10 pieces at a price of ` 50 per pack.
The demand for plastic bowl has been forecasted at a fairly steady rate of 40,000 packs
every year. The company purchases the bowl directly from manufacturer at ` 40 per pack
within a three days lead time. The ordering and related cost is ` 8 per order. The storage
cost is 10% per annum of average inventory investment.
Required:
(i) Calculate Economic Order Quantity.
(ii) Calculate number of orders needed every year.
(iii) Calculate the total cost of ordering and storage bowls for the year.
(iv) Determine when should the next order to be placed. Assuming that the company
does maintain a safety stock and that the present inventory level is 333 packs with
a year of 360 working days.

Question 5
X. Ltd. for some time had been buying the inventory at random till recently when it
switched over to EOQ system of buying.
The firm’s annual requirement is 12,000 units. The cost of carrying inventory is ` 15 per
unit per annum. The ordering cost is ` 400 per order.
One supplier has approached the purchase manager with a proposal that if the company
buys all 12,000 units at a time, then he would give 10% discount in the purchase price
which is ` 100 per unit.
Decide whether the proposal should be accepted or not.

Question 6
JP Limited, manufacturer of a special product, follows the policy of EOQ (economic order
quantity) for one of its components. The components details are as follows:
`
Purchase price per components 200
Cost of an order 100
Annual cost of carrying one unit in inventory 10% of purchase price
Total cost of inventory carrying and ordering per annum 4,000
The company has been offered a discount of 2% on the price of the component, provided

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the lot size is 2,000 components at a time.

You are required to :
(i) Compute the EOQ
(ii) Advise whether the quantity discount offer can be accepted. (Assume that the
inventory carrying cost does not vary according to discount policy)
(iii) Would your advise differ if the company is offered 5% discount on a single order.

Question 7
A company manufactures a product from a raw material, which is purchased at ` 60
per kg. The company incurs a handling cost of ` 360 plus freight of ` 390 per order.
The incremental carrying cost of inventory of raw material is ` 0.50 per kg. per month.
In addition, the cost of working capital finance on the investment in inventory of raw
material is ` 9 per kg. per annum. The annual production of the product is 1,00,000 units
and 2.5 units are obtained from one kg of raw material.
Required
(i) Calculate the economic order quantity of raw materials.
(ii) Advise, how frequently should orders for procurement be placed.
(iii) If the company proposes to rationalize placement of orders on quarterly basis, what
percentage of discount in the price of raw materials should be negotiated?

Question 8
(a) EXE Limited has received an offer of quantity discounts on its order of materials as
under:

Category Price per ton (`) Ton (Nos.)

1 1,200 Less than 500
2 1,180 500 and less than 1,000
3 1,160 1,000 and less than 2,000
4 1,140 2,000 and less than 3,000
5 1,120 3,000 and above.
The annual requirement for the material is 5,000 tons. The ordering cost per order is
` 1,200 and the stock holding cost is estimated at 20% of material cost per annum.
You are required to compute the most economical purchase level.
(b) What will be your answer to the above question if there are no discounts offered
and the price per ton is ` 1,500?

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Question 9
Two components, A and B are used as follows:
Normal usage 50 per week each
Maximum usage 75 per week each
Minimum usage 25 per week each
Re-order quantity A: 300; B: 500
Re-order period A: 4 to 6 weeks
B: 2 to 4 weeks
Calculate for each component (a) Re-ordering level, (b) Minimum level, (c) Maximum
level, (d) Average stock level.

Question 10
From the details given below, calculate:
(i) Re-ordering level (ii) Maximum level
(iii) Minimum level (iv) Danger level.
Re-ordering quantity is to be calculated on the basis of following information:
Cost of placing a purchase order is ` 20
Number of units to be purchased during the year is 5,000
Purchase price per unit inclusive of transportation cost is ` 50
Annual cost of storage per units is ` 5.
Details of lead time: Average- 10 days, Maximum- 15 days, Minimum-5 days.
For emergency purchases - 4 days.
Rate of consumption: Average: 15 units per day, Maximum: 20 units per day

Question 11
A Company uses three raw materials A, B and C for a particular product for which the
following data apply:
Raw Usage Re-order Price Delivery period (In weeks) Re-order Minimum
Material per quantity per Kg Minimum Average Maximum level level (Kgs.)
unit of (Kgs.) (`) (Kgs)
Product
(Kgs.)
A 10 10,000 10 1 2 3 8,000 ?
B 4 5,000 30 3 4 5 4,750 ?
C 6 10,000 15 2 3 4 ? 2,000
Weekly production varies from 175 to 225 units, averaging 200 units of the said product.

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What would be the following quantities:

(i) Minimum stock of A,
(ii) Maximum stock of B,
(iii) Re-order level of C,
(iv) Average stock level of A.

Question 12
Aditya Ltd. produces a product ‘Exe’ using a raw material Dee. To produce one unit of Exe,
2 kg of Dee is required. As per the sales forecast conducted by the company, it will able
to sale 10,000 units of Exe in the coming year. The following is the information regarding
the raw material Dee:
(i) The Re-order quantity is 200 kg. less than the Economic Order Quantity (EOQ).
(ii) Maximum consumption per day is 20 kg. more than the average consumption per
day.
(iii) There is an opening stock of 1,000 kg.
(iv) Time required to get the raw materials from the suppliers is 4 to 8 days.
(v) The purchase price is ` 125 per kg.
There is an opening stock of 900 units of the finished product Exe.
The rate of interest charged by bank on Cash Credit facility is 13.76%.
To place an order company has to incur ` 720 on paper and documentation work.
From the above information find out the followings in relation to raw material Dee:
(a) Re-order Quantity
(b) Maximum Stock level
(c) Minimum Stock level
(d) Calculate the impact on the profitability of the company by not ordering the EOQ.
 [Take 364 days for a year].

Question 13
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 ` 800 per
casting.
The castings are used evenly throughout the year in the production process on a 360-days-
per-year basis. The company estimates that it costs ` 9,000 to place a single purchase
order and about ` 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.

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Delivery from the foundry generally takes 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:
Delivery time (days) 6 7 8 9 10
Percentage of occurrence 75 10 5 5 5
Required:
(i) Compute the economic order quantity (EOQ).
(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 the 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 ` 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 ` 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?

Question 14
M/s Tyrotubes trades in four wheeler tyres and tubes. It stocks sufficient quantity of tyres
of almost every vehicle. In year-end 20X1-X2, the report of sales manager revealed that
M/s Tyrotubes experienced stock-out of tyres.
The stock-out data is as follows:
Stock – out of Tyres No. of times
100 2
80 5
50 10
20 20
10 30
0 33
M/s Tyrotubes loses ` 150 per unit due to stock-out and spends ` 50 per unit on carrying
of inventory.
Determine optimum safest stock level.

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Question 15
An invoice in respect of a consignment of chemicals A and B provides the following
Information:
(`)
Chemical A: 10,000 Kgs. at ` 10 per Kg. 1,00,000
Chemical B: 8,000 Kgs. at ` 13 per Kg. 1,04,000
Basic custom duty @ 10% (Credit is not allowed) 20,400
Railway freight 3,840
Total cost 2,28,240

A shortage of 500 kgs. in chemical A and 320 kgs. in chemical B is noticed due to normal
breakages. You are required to determine the rate per kg. of each chemical, assuming a
provision of 2% for further deterioration.

STOCK VALUATION AND STOCK CONTROL

Question 16
The following transactions in respect of material Y occurred during the six months ended
30th June, 20X1:
Month Purchase (units) Price per unit (`) Issued units
January 200 25 Nil
February 300 24 250
March 425 26 300
April 475 23 550
May 500 25 800
June 600 20 400

Required:
(i) The Chief Accountant argues that the value of closing stock remains the same no
matter which method of pricing of material issues is used. Do you agree? Why or
why not? Detailed stores ledgers are not required.
(ii) When and why would you recommend the LIFO method of pricing material issues?

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Question 17
The following information is extracted from the Stores Ledger:
Material X
Opening Stock Nil
Purchases:
Jan. 1 100 @ ` 1 per unit
Jan. 20 100 @ ` 2 per unit
Issues:
Jan.22 60 for Job W 16
Jan. 23 60 for Job W 17
Complete the receipts and issues valuation by adopting the First-In-First-Out, Last- In-
First-Out and the Weighted Average Method. Tabulate the values allocated to Job W 16,
Job W 17 and the closing stock under the methods aforesaid and discuss from different
points of view which method you would prefer.

Question 18
From the following details, draw a plan of ABC selective control:
Items Units Unit cost (`)
1 7,000 5.00
2 24,000 3.00
3 1,500 10.00
4 600 22.00
5 38,000 1.50
6 40,000 0.50
7 60,000 0.20
8 3,000 3.50
9 300 8.00
10 29,000 0.40
11 11,500 7.10
12 4,100 6.20

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To solve the above question, We must calculate value, value percentage & quantity
parentage. It is calculated as follows
Items Units Unit Cost Value Value % Quantity %
1 7,000 5.00 35,000 9.84 3.20
2 24,000 3.00 72,000 20.24 10.96
3 1,500 10.00 15,000 4.22 0.68
4 600 22.00 13,200 3.71 0.27
5 38,000 1.50 57,000 16.02 17.35
6 40,000 0.50 20,000 5.62 18.26
7 60,000 0.20 12,000 3.37 27.40
8 3,000 3.50 10,500 2.95 1.37
9 300 8.00 2,400 0.68 0.14
10 29,000 0.40 11,600 3.26 13.24
11 11,500 7.10 81,650 22.95 5.25
12 4,100 6.20 25,420 7.14 1.88
Total 2,19,000 3,55,770 100.00 100.00

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HOMEWORK SECTION

Question 1
Aditya Agro Ltd. produces edible oils of different varieties. The monthly demand pattern
for the finished products are as follows:
Mustard oil 45,000 Litre
Soybean oil 15,000 Litre
Olive oil 3,000 Litre

To produce one litre of Mustard oil, Soybean oil and Olive oil, 5 kg. of mustards, 6 kg. of
soybeans and 4.5 kg. of olives are required respectively. There is no opening and closing
stock of materials.
Aditya Agro Ltd. can purchase the materials either from the farmers directly or from
the wholesale market. The company can purchase any quantity of materials from the
wholesale market but in case of purchase from the farmers, it has to purchase the minimum
specified quantity of materials at a time. Following is the material-wise summary related
with the purchase of materials:

Wholesale Farmers
Market
Mustard:
Minimum Quantity to be purchased Any quantity 13,50,000 kg.
Purchase price per kg. (`) 15.00 12.50
Government Tax* 2% ---
Transportation cost per purchase 6,000 15,000
Sorting and piling cost per purchase --- 1,200
Loading cost per 50 kg. 10.00 5.00
Unloading cost per 50 kg. 2.00 2.00
Soybean:
Minimum Quantity to be purchased Any Quantity 2,70,000 kg.
Purchase price per kg. (`) 11.00 9.00
Government Tax** --- ---
Transportation cost per purchase 9,000 12,000
Sorting and piling cost per purchase --- 800
Loading cost per 50 kg. 10.00 3.00
Unloading cost per 50 kg. 2.00 2.00

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Olive:
Minimum Quantity to be purchased Any Quantity 1,62,000 kg.
Purchase price per kg. (`) 36.00 28.00
Import duty*** --- 10%
Transportation Cost per purchase (`) 3,000 11,000
Sorting and piling cost per purchase 1,800 ---
Loading cost per 50 kg. 10.00 25.00
Unloading cost per 50 kg 2.00 2.00
The company is paying 12.5% p.a. as interest to its bank for cash credit facility and
` 100 per 100 kg. as rent to the warehouse.
* Government tax for Mustard will be added to the purchased price of mustards.
** There was no Government tax for Soybean.
*** Import duty will be added to purchase price.

You are required to

(i) Calculate the purchase cost of each material
(a) from Wholesale market
(b) from the Farmers
(ii) Calculate Economic Order Quantity of each material under the both options.
(iii) Recommend the best purchase option for the material ‘olive’.

Question 2
From the following data for the year ended 31st December, 20X1, calculate the inventory
Turnover ratio of the two items and put forward your comments on them.
Material A (`) Material B (`)
Opening stock 1.1.20X1 10,000 9,000
Purchase during the year 52,000 27,000
Closing stock 31.12.20X1 6,000 11,000

Question 3
A Company manufactures a special product which requires a component ‘Alpha’. The
following particulars are collected for the year 20X1:
(i) Annual demand of Alpha 8,000 units
(ii) Cost of placing an order ` 200 per order
(iii) Cost per unit of Alpha ` 400
(iv) Carrying cost p.a. 20%

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The company has been offered a quantity discount of 4 % on the purchase of ‘Alpha’
provided the order size is 4,000 components at a time.
Required:
(i) Compute the economic order quantity
(ii) Advise whether the quantity discount offer can be accepted.

Question 4
‘AT’ Ltd. furnishes the following store transactions for September, 20X1:
1-9-X1 Opening balance 25 units value ` 162.50
4-9-X1 Issues Req. No. 85 8 units
6-9-X1 Receipts from B & Co. GRN No. 26 50 units @ ` 5.75 per unit
7-9-X1 Issues Req. No. 97 12 units
10-9-X1 Return to B & Co. 10 units
12-9-X1 Issues Req. No. 108 15 units
13-9-X1 Issues Req. No. 110 20 units
15-9-X1 Receipts from M & Co. GRN. No. 33 25 units @ ` 6.10 per unit
17-9-X1 Issues Req. No. 121 10 units
19-9-X1 Received replacement from B & Co. GRN No. 38 10 units
20-9-X1 Returned from department, material of
M & Co. MRR No. 4 5 units
22-9-X1 Transfer from Job 182 to Job 187 in the dept. 5 units
MTR 6
26-9-X1 Issues Req. No. 146 10 units
29-9-X1 Transfer from Dept. “A” to Dept. “B” MTR 10 5 units
30-9-X1 Shortage in stock taking 2 units

Write up the priced stores ledger on FIFO method and discuss how would you treat the
shortage in stock taking.

Question 5
Raw materials ‘AXE’ costing ` 150 per kg. and ‘BXE’ costing ` 90 per kg. are mixed in equal
proportions for making product ‘A’. The loss of material in processing works out to 25% of
the product. The production expenses are allocated at 40% of direct material cost. The
end product is priced with a margin of 20% over the total cost.

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Material ‘BXE’ is not easily available and substitute raw material ‘CXE’ has been found for
‘BXE’ costing ` 75 per kg. It is required to keep the proportion of this substitute material
in the mixture as low as possible and at the same time maintain the selling price of the
end product at existing level and ensure the same quantum of profit as at present.
You are required to compute the ratio of the mix of the raw materials ‘AXE’ and ‘CXE’.

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IMPORTANT THEORY QUESTIONS FOR EXAMINATION

Question 1
List five types of inefficiency in the use of materials that may be discovered as the result
of investigating material quantity variances. What measures may be taken in each such
situation to prevent their recurrence?

Answer
The five types of inefficiency in the use of materials that may be discovered as a result of
investigating materials quantity variances are as follows :
1. Purchase of inferior quality of materials.
2. Inefficient labour force leading to excessive utilisation of materials.
3. Defective machines, tools and equipments and bad or improper maintenance leading
to breakdowns resulting in excessive usage of materials.
4. Inaccurate technical specifications and slackness in inspection may cause more
rejections, resulting in greater requirement of materials for rectification of defects.
5. Faulty material processing.
The measures which may be taken in each of the above situations to prevent their
recurrence in future are as below :
1. To ensure the purchase of proper quality of material, each lot of material
purchased should be inspected in accordance with the terms and conditions
of purchase before they are accepted and issued for production. The extent
of inspection may depend on the circumstances. For instance, when materials
are of small value or where the quality of raw materials does not appreciably
affect the final product, the inspection may not be very rigid. In such a case,
inspection may be carried out by taking random samples. However, for
materials of vital importance like raw materials for explosive factories or for
pharmaceutical concerns where material cost is high, a rigid or strict inspection
will be necessary.
2. Labour inefficiency can be reduced by adopting following measures :
(a) Imparting on-the-job training to workers.
(b) Supervising the workers while performing the jobs.
(c) Evaluating workers performance.
(d) Incorporating incentive schemes for workers.
(e) Reducing labour turnover ratio.
3. The wastage of material can also be reduced by properly maintaining machines,

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tools and other equipment. The concern should adopt a policy of preventive
maintenance. The use of such a policy will reduce machine down time and
over-consumption of materials. Besides this, workers must be educated to
realise fully the importance of tools and equipment in their day-to-day work.
4. A reduction in the number of defective units, in this case may automatically
bring down the excessive consumption of material required for rectification
of defects. Reduction in the number of defectives can be achieved by laying
down accurate technical specifications, standards for materials and tactfully
handling the problem of slackness.
5. Faulty material processing also results in excess consumption of material.
The supervisors at the shop floor level should educate and guide the workers
properly so that they make use of the correct procedure laid down for processing
raw materials.

Question 2
Discuss briefly how the following items are to be treated in costs :
(i) Carriage inwards raw materials
(ii) Storage losses
(iii) Cash discount received
(iv) Insurance costs on stocks of raw materials.

Answer
(i) Carriage inwards on raw materials: It represents the expenditure incurred in bringing
raw materials to factory from outside. This expense is directly allocated to materials
and thus forms a part of the .cost of such materials. When this is not practicable
and allocation to specific items of materials is difficult, the expense is treated as
manufacturing overhead and is charged to cost of production at a re-determined
rate. In some of the undertakings the practice is to charge these expenses as a
percentage of cost, weight or some other physical unit of material.
(ii) Storage losses: The losses arising out of storage of material can be classified into
two categories. The treatment of losses under each category in Cost Accounts is as
under:
(a) Losses due to reasons like evaporation, shrinkage, absorption and moisture, etc.
are considered as normal losses. Such losses are absorbed by good production
units by inflating the cost of material issued for production.
(b) Losses due to fire, flood, storm, theft etc. are treated as abnormal losses. If

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these losses are heavy and are not recoverable from the insurance authorities,
it is preferred to charge them to Costing Profit and Loss Account.
(iii) Cash discount received: It is an allowance given by the vendor for prompt payment
of material price. The opinion among accountants about its treatment differs. Two
prevalent approaches for treating the cash discount received are as follows:
(a) The cash discount received in the course of materials buying should be deducted
from the invoice price of the materials. This way the discount received will
reduce the purchase price of the materials.
(b) It may be treated as an item of financial nature and therefore be kept outside
the purview of cost accounting. However, it can be dealt in the following manner.
The full invoice price should be charged to the material account crediting the
suppliers with the net invoice price, and the discount earned account with
the amount of cash discount received. If the prompt payment could not be
made, the discount lost is debited to the discount lost account. Any difference
between the discount earned and discount lost may be treated as an item of
administrative overhead.
(iv) Insurance costs on stocks of raw materials : The amount paid as insurance costs
(insurance premium) on stocks of raw materials is meant for covering the risk which
may arise due to fire, theft, riot etc. The insurance cost is apportioned over different
materials on the basis of their value. This cost may be charged directly to the cost
of material.

Question 3
Distinguish between spoilage and defectives in a manufacturing company. Discuss their
treatment in cost accounts and suggest a procedure for their control.

Answer
Spoilage can be defined as the materials which are badly damaged in the course of
manufacturing operations to the extent that they cannot be rectified economically and
hence taken out of process, to be disposed of in some manner without further processing.
Spoilage may be either normal or abnormal.
Defective products are such semi-finished or finished products produced by a
manufacturing unit, which are not in conformity with laid-down standard or dimensional
specifications. Defectives produced can be re-worked or reconditioned by the application
of additional materials, labour and / or processing and brought to the point of either
standard or sub-standard product. The costs incurred for reconditioning are known as

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the "Costs of re-operations of the defectives". Defective production may be the result
of various causes such as sub-standard materials, bad-workmanship, carelessness in
planning, laxity in inspection etc.
The difference between spoilage and defectives is that while spoilage cannot be repaired
or reconditioned, defectives can be rectified and transformed, either back to standard
production or to seconds.
Treatment of spoilage and defectives in Cost Accounting : Under Cost Accounts normal spoilage
costs (i.e., which is inherent in the operation) are included in cost either by charging the
loss due to spoilage to the production order or charging it to production overhead so that
it is spread over all products. Any value realised from the sale of spoilage is credited
to production order or production overhead account, as the case may be. The cost of
abnormal spoilage (i.e. arising out of causes not inherent in manufacturing process) are
charged to the Costing Profit and Loss Account. When spoiled work is the result of rigid
specifications the cost of spoiled work is absorbed by good production while the cost of
disposal is charged to production overheads.
The problem of accounting for defective work is the problem of accounting of the costs of
rectification or rework.
The possible ways of treatment are as below :
(i) Defectives that are considered inherent in the process and are identified as normal
can be recovered by using the following methods:
(a) Charged to good products: The loss is absorbed by good units. This method is
used when 'seconds' have a normal value and defectives rectified into 'seconds'
or 'first' are normal.
(b) Charged to general overheads: When the defectives caused in one department are
reflected only on further processing, the rework costs are charged to general
overheads.
(c) Charged to the departments overheads: If the department responsible for
defectives can be identified then the rectification costs should be charged to
that department.
(d) Charged to Costing Profit and Loss Account: If defectives are abnormal and are
due to causes beyond the control of organisation; the rework cost should be
charged to Costing Profit and Loss Accounts.
(ii) Where defectives are easily identifiable with specific jobs the re-work costs are
debited to the job.
Procedure for the control of Spoilage and Defectives : To control spoilage, allowance for
a normal spoilage should be fixed up and actual spoilage should be compared with

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standard set. A systematic procedure of reporting would help control over spoilage.
A spoilage report (as below) would highlight the normal and abnormal spoilage,
the department responsible, the causes of spoilage and the corrective action taken
if any.
Control of defectives may cover the following two areas :
(a) Control over defectives produced
(b) Control over reworking costs.
For exercising effective control over defectives produced and the cost of reworking,
standards for normal percentage of defectives and reworking costs should be
established.

Question 4
Define (i) Replacement Price and (ii) Standard Price. Discuss the objectives of these methods
of pricing of materials and state the circumstances in which they are used.

Answer
(i) Replacement Price is defined as the price at which it is possible to purchase an item,
identical to that which is being replaced or revalued.
(ii) A Standard Price may be defined as a predetermined price fixed for a specified period
on the basis of all factors which may affect future price.
Under Replacement Price method, materials issued are valued at the replacement
costs of the items. This method pre-supposes the determination of the replacement
cost of the materials at the time of each issue, viz., the cost at which identical
materials could be currently purchased. The product cost under this method is at
current market price which is the main objective of the replacement price method.
Replacement Price method is used to value material issues in periods of rising prices
because the cost of material considered in cost of production would be able to
replace the materials at the increased price. This method is used to find the true cost
of production.
The fixation of Standard Price takes into account the quantity of materials to be
purchased, possibility of price fluctuations, etc. The Standard Price is used for
comparison with actual prices from period to period and to measure the efficiency of
the purchase of materials. This is used in conjunction with Standard Costing System
for control purposes and is a tool to the management if fluctuations in prices are not
violent.

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Question 5
Explain the distinction between waste and scrap in the manufacturing process. Discuss
their treatment in cost accounts and suggest a procedure for control.

Answer
Waste: It represents that portion of basic raw materials, which is either lost or which
evaporates or shrinks during a manufacturing process. It may be visible or invisible. But
it has no recovery value.
Scrap: The incidental residue arising from the manufacturing operations, small in quantity
and low in value, recoverable without further processing.
From the definitions of waste and scrap stated above it is quite apparent that waste
cannot be realised whereas scrap can be. Scrap is always visible whereas waste may or
may not be.
Waste can be differentiated as normal and abnormal. Normal waste is absorbed in the
cost of net output, whereas abnormal waste is transferred to the Costing Profit and Loss
Account.
For effective control of waste, normal allowances for yield and waste should be made
from past experience, technical factors and special features of the material process
and product. Actual yield and waste should be compared with anticipated figures and
appropriate actions should be taken where necessary. Responsibility should be fixed on
purchasing, storage, maintenance, production and inspection staff to maintain quality of
the materials and other standards. A systematic procedure for feedback of Achievements
against standards laid should be established.
Scrap may be treated in Cost Accounts in the following ways:
(i) Where the value of scrap is negotiable, it may be excluded from costs. In other
words, the cost of scrap is borne by good units and income from scrap is treated as
other income.
(ii) If the scrap value is considerable, the net sale proceeds of scrap (Gross sales proceeds
of scrap—the cost of selling scrap) is deducted from the material cost or factory
overhead. Under this method the material cost or factory overhead recovery rate
are reduced on account of sale proceeds of scrap. However, no distinction is made
between various processes or jobs.
(iii) Where the various jobs or processes give rise in varying amount of scrap, the scrap
from each job or process is recorded separately and the sale proceeds from the
same credited to the particular job or process. This method is useful where scrap is
of considerable value and does not arise uniformly. However, this would necessitate

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the scrap being identified with various jobs or processes. For this purpose detailed
records for scrap will be required.
Control of scrap really arises at the maximum effective utilization of the raw
material. Scrap control does not, therefore, start in the production department; it
starts from the stage of product designing. Thus the most suitable type of materials,
the appropriate size, the right type of equipment and personnel would help getting
maximum quantity of finished product from a given raw material.
The procedure for control of scrap should start with establishing a standard of
scrap with each department, job or process, taking into consideration the nature of
material, the nature of the manufacturing operation, the use of proper equipment,
the size of the material, the employment of proper personnel and defining areas
of responsibility. It is also necessary to establish a scheme of scrap reporting. The
actual scrap should be compared with the predetermined standard, and the reasons
for the difference, if any, should be investigated, corrective action taken, whenever
the actual scrap is found to be more than what is normally allowed. Also, it is to be
ensured that proper supervision is exercised at the scrap generation stage.

Question 6
What is ABC analysis? Discuss its role in a sound system of material control.

Answer
ABC analysis is a technique through which selective control can be exercised over the
various items of inventory. These days the manufacturing units have such a large number
of items in their stores that it is often not possible for the management to pay minute
attention to each and every item. A system is therefore divided by which these items are
classified according to their importance and then selective control exercised. ABC analysis
or Selective Inventory Control is a technique whereby the measure of control over an item
of inventory varies directly with its usage value. In other words, the high value items are
controlled more closely than the items of low value.
To classify the various items according to their usage value, the following procedure is
adopted:
(a) The quantity or the number of parts expected to be used for production in the given
period is estimated.
(b) The quantity as estimated above is multiplied by the unit value of the item.
(c) All the items are then re-arranged according to their usage value in a descending
order.

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(d) It would normally be found that a small number of items add upto a very high value.
Thus 5 to 10 percent of total items may constitute 70 to 85 percent of material cost.
Such items are classified as A items. Another 10 to 20 percent of total items may
represent 10 to 20 percent of the total material cost. These items may be categorised
as B items. The rest, i.e. 70 to 85-percent of items, though numerous, will thus form
only 5 to 10 percent of total material cost. These may be called C items.
This classification thus highlights the more significant items. Management can then
exercise a very close control over A items. It may apply occasional control over B
items. As regards C items, it may exercise control only in a general manner. For
example, it may order the quantities of C items annually or once in six months or so.
It is obvious that since C items do not have a high value, the total investment in such
items will not be large.
Regarding A items, the management will have to define the stock levels, i.e.,
maximum, minimum, reordering and danger very carefully. Also a close check on
the consumption of these items will have to be kept. The economic order quantity for
each of the items in this category should be worked out. Similarly other technique
of inventory control should also be applied to A items. It would be appreciated that
since A items constitute the bulk of the investment in the total inventory, it would
be worthwhile to bring them under close control and to apply modern management
inventory control techniques.
ABC analysis helps the management in the following ways:
(1) The investment in inventories is optimised through a close and direct control
over A items. This would naturally release funds which can then be channelised
into more profitable areas. This would raise the overall return on investment
earned by the unit.
(2) The ordering and carrying costs are reduced since the management would
attempt to optimise such costs so far as they relate to the bulk of the items.
(3) If the management seeks to exercise direct control over all the items of
inventory, the inventory control system would become very expensive. ABC
analysis therefore cuts down the cost of the system and relates its cost to the
attendant benefits.
(4) The main objectives of inventory control are fulfilled under this system at the
minimum cost. With scientific control of inventories, the stock turnover rate can
be maintained at comparatively high levels.
The concept of ABC analysis can be used in areas other than inventory also.
This technique basically emphasises that where the items to be controlled are

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numerous, one should categorise them according to their importance. Close control
should then be exercised on the most significant category. On the less important
categories, the degree of control maybe related to the benefit from control.
Thus finally it may be concluded that ABC analysis plays an important role for
a sound system of material control.

Question 7
Distinguish between: Perpetual Inventory System and continuous stock taking.

Answer
Distinction between Perpetual Inventory System and Continuous Stock taking:
Perpetual Inventory System: It is a system of stock control followed by the stores department.
Under this system, a continuous record of receipt and issue of material is maintained by
the stores department. In other words, in this system, stock control cards or bin cards and
the stores ledger show clearly the receipts, issues and balance of all items in stock at all
times. This system facilitates planning of production and ensures that production is not
interrupted for want of materials and stores.
Continuous Stock taking: It means physical verification of stores items on a continuous
basis to reveal the position of actual balances. Such a verification is conducted round the
year, thus covering each item of store twice or thrice. Any discrepancies, irregularities or
shortages brought to the notice, as a result of continuous stock verification are reported
to the appropriate authorities for initiating necessary rectification measures. This system
works as a moral check as stores staff and acts as a deterrent to dishonesty.
A perpetual inventory system is usually supported by a programme of continuous stock
taking. That is continuous stock taking is complementary to the perpetual inventory
system. Sometimes the two terms are considered synonymous but it is not so. The success
of the perpetual inventory system depends upon the maintenance and upto date writing
up of (i) the stores ledger and (ii) bincards/stock control cards, Continuous stock taking,
ensures the veracity of figures shown by the above records.

Question 8
Distinguish amongst:
1. Spoilage
2. Salvage
3. Rectification
How are they treated in Cost Accounts.

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Answer
1. Spoilage: It is the term used for materials which are badly damaged in manufacturing
operations, and they cannot be rectified economically and hence taken out of process
to be disposed of in some manner without further processing. Spoilage maybe either
normal or abnormal.
Normal spoilage (i.e., which is inherent in the operation) costs are included in costs
either by charging the loss due to spoilage to the production order or charging it to
production overhead so that it is spread over all products. Any value realised from
spoilage is credited to production order or production overhead account, as the case
may be.
The cost of abnormal spoilage (i.e., arising out of causes not inherent in manufacturing
process) are charged to the Costing Profit and Loss Account. When spoiled work is the
result of rigid specification, the cost of spoiled work is absorbed by good production
while the cost of disposal is charged to production overhead.
To control spoilage, allowance for normal spoilage should be fixed and actual
spoilage should be compared with standard set. A systematic procedure of reporting
would help control over spoilage. A spoilage report should highlight the normal and
abnormal spoilage, the department responsible, the causes of spoilage and the
corrective action taken, if any.
Salvage: Salvaged material refers to the material retrieved from the spoiled work.
Salvage is the process by which salvaged material is retrieved. The salvaged units of
material are usable in the production.
The value of salvaged material may be credited to the account to which spoilage is
charged.
Rectification: It means bringing back the defective units either to standard units of
production or as seconds, by reworking. The work of rectification in small concern's
is usually entrusted to the production shop, whereas in big concerns, a separate
department carries out the task. Before the start of rectification work an estimate
of the cost of rectification is prepared and compared with the excess value to be
obtained after rectification. The concern only goes ahead with the task of rectification
if the aforesaid comparison is found favourable.
The task of rectification is usually carried out under a 'Rectification Work Order', and
all costs of re-work are collected against this work order for material, labour and
overhead.
If the defective production is inherent in the process of manufacture, and arises as a
normal consequence of productive activities and if it can be identified with specific

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jobs, the rectification cost is charged to the jobs as the cost of manufacturing good
units of the product. This will have the effect of adding to the cost of the jobs. If
the expenditure on rectification is considered abnormal, it is excluded from product
costs and charged to Costing Profit and Loss Account.

Question 9
How are normal and abnormal loss of material arising during storage treated in Cost
Accounts? (May 2001, 5 Marks)

Answer
Cost Accounts treatment of normal and abnormal loss of material arising during storage.
The difference between the book balance and actual physical stock, which may either be
gain or loss, should be transferred to Inventory Adjustment Account pending scrutiny to
ascertain the reason for the difference.
If on scrutiny, the difference arrived at is considered as normal, then such a difference
should be transferred to overhead control account and if abnormal, it should be debited
to costing profit and loss account.
In the case of normal losses, an alternative method may be used. Under this method the
price of the material issued to production may be inflated so as to cover the normal loss.

Question 10
Distinguish clearly Bincards and Stores Ledger.  (May 1999, 4 Marks)

Answer
Both bin cards and stores ledger are perpetual inventory records. None of them is a
substitute for the other. These two records may be distinguished from the following points
of view:
(i) Bin card is maintained by the store keeper, while the stores ledger is maintained by
the cost accounting department.
(ii) Bin card is the stores recording document whereas the stores ledger is an accounting
record.
(iii) Bin card contains information with regard to quantities i.e. their receipt, issue and
balance while the stores ledger contains both quantitative and value information in
respect of their receipts, issue and balance.
(iv) In the bin card entries are made at the time when transaction takes place. But in the
stores ledger entries are made only after the transaction has taken place.

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(v) Inter departmental transfer of materials appear only in stores ledger.

(vi) Bin cards record each transaction but stores ledger records the same information in
a summarized form.

Question 11
What is Just in Time (JIT) purchases? What are the advantages of such purchases?
 (May 1999, 3 Marks)
Answer
Just in time (JIT) purchases means the purchase of goods or materials such that delivery
immediately precedes their use.
Advantages of JIT purchases:
Main advantages of JIT purchases are as follows :
1. The suppliers of goods or materials cooperates with the company and supply
requisite quantity of goods or materials for which order is placed before the start of
production.
2. JIT purchases results in cost savings for example, the costs of stock out, inventory
carrying, materials handling and breakage are reduced.
3. Due to frequent purchases of raw materials, its issue price is likely to be very close
to the replacement price. Consequently the method of pricing to be followed for
valuing material issues becomes less important for companies using JIT purchasing.
4. JIT purchasing are now attempting to extend daily deliveries to as many areas as
possible so that the goods spend less time in warehouses or on store shelves before
they are exhausted.

Question 12
"To be able to calculate a basic EOQ certain assumptions are necessary. "List down these
assumptions.  (November 1995, 2 Marks)

Answer
The computation of economic order quantity is subject to the following assumptions:
(i) Ordering cost (per order) and carrying cost (per unit/annum) are known and constant.
(ii) Anticipated usage (in units) of material for a period is uniform and known.
(iii) Cost per unit of the material (to be purchased) is known and it is constant.
Purchase Officer

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Question 13
How is slow moving and non-moving item of stores detected and what steps are necessary
to reduce such stocks?  (November 2001, 4 Marks)

Answer
Detection of slow moving and non-moving item of stores:
The existence of slow moving and non-moving item of stores can be detected in the
following ways.
(i) By preparing and scanning periodic reports showing the status of different items or
stores.
(ii) By calculating the stock holding of various items in terms of number of days/ months
of consumption.
(iii) By computing ratios periodically, relating to the issues as a percentage of average
stock held.
(iv) By implementing the use of a well - designed information system.
Necessary steps to reduce stock of slow moving and non-moving item of stores:
(i) Proper procedure and guidelines should be laid down for the disposal of non-moving
items, before they further deteriorates in value.
(ii) Diversify production to use up such materials.
(iii) Use these materials as substitute, in place of other materials.

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EMPLOYEE COST AND DIRECT

EXPENSE

THEORY SECTION

1. Calculation of Labour Cost

(I) Time Rate System
Wages depends on Actual hours worked by worker.
→ Basic wages = Time taken (Actual hours worked) x Rate per hour
→ Bonus is to be paid only if workers are efficient.
Efficiency means either time remaining constant, worker are producing more
units or output remaining constant, workers takes less time.

Bonus

Halsey System Rowan System

Bonus = 50% of time saves x Rate per hour Bonus = Time saved x Basic wages
Time Allowed

Time Allowed: It represents standard time allowed by the company to produced

one unit and it includes Normal Idle Time.
Time Saved:
Time Allowed for Actual Production xx
Time taken for Actual Production xx
xx
Total Wages = Basic Wages + Bonus
Effective Rate per Hour =
or Hourly Earning

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(II) Piece Rate System

Single / Straight Piece Rate System
Wages = Units Produced x Rate per Unit

2. Labour Turnover
It represent change in labour force of a company over a period of time.

Effect of Labour Turnover

Due to Labour Turnover, total Cost will increase because we have to incurr many
expenses like settlement cost, recruitment cost, training cost etc.
Efficiency of new workers will be less than old workers in the beginning and due to
that production will decrease.
Labour Turnover Rate
1. Separation Method
L. T. R. =

2. Replacement Method
L. T. R. =

3. Flux Method
L. T. R. =

Labour Turnover due to new recruitment

L. T. R. =

The total no. of workers joining, including replacements are called accessions.

L. T. R. =

When no. of accessions are considered, the Labour turnover rate by flux method can
be calculated as under.

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L. T. R. =

3. Cost to Company (C to C)
It includes all expenses incurred by employer on employee for e.g. Basic Wages
Dearness allowance, Bonus, employer's contribution to Provident fund etc.

Labour hour rate =

All workers are issued job cards by the company. In this job card they have to record
details about actual hours worked on different jobs.
Labour Cost of Job = Labour hours as per job cards x Labour hour rate
Any difference between expected labour hours and total hours as per job card is due
to abnormal idle time. Labour cost of abnormal idle time is to be debited to costing
P & L A/c.

4. Over Time and its Treatment

Overtime premium: Overtime is the amount of wages paid for working beyond normal
working hours as specified by Factories Act or by a mutual agreement between the
workers union and the management. According to Factories Act of 1948, a worker is
entitled for overtime at double the rate of his wages (including allowances) if he works
beyond 9 hours in a day or 48 hours in a week even where the Act is not applicable,
the practice is to pay for overtime work at higher rates usually in accordance with
a standing agreement between the employer and the workers. Hence, payment of
overtime consists of two elements, the normal wages i.e., the usual amount, and
the extra payment i.e., the premium. This amount of extra payment paid to a worker
under overtime is known as overtime premium.
The overtime payment affects the productivity and cost in many ways as follows:
(i) During overtime period the efficiency of a worker is low. This causes reduced
productivity, thus during this period the productivity is lesser than the normal
one.
(ii) In their anxiety to earn more, the workers may not concentrate on work during
normal time and thus the output during normal hours may also fall.
(iii) The practice of resorting to overtime adversely affects workers’ health which may
lead to increase in accident rate and consequently a decrease in productivity.

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(iv) Due to overtime, it is not possible to carry out necessary maintenance of plants
and machinery. Such a situation results occasionally in a major breakdown and
hence accounts for the stoppage of production cycle.
(v) Reduced output and increased premium are responsible for bringing an increase
in cost of production.

Overtime premium is a part of total wages of overtime period. In cost accounting

the treatment of overtime premium will be as follows:
(i) If the overtime is resorted to at the desire of the customer, then the entire
amount of overtime including overtime premium should be charged to the job
directly.
(ii) If it is due to a general pressure of work to increase the output, the premium as
well as overtime wages may be charged to general overheads.
(iii) If it is due to the negligence or delay of workers of a particular department, it
may be charged to the concerned department.
(iv) If it is due to circumstances beyond control, it may be charged to Costing Profit
& Loss Account.

As regards the control of overtimes is concerned, it is difficult to eliminate it

completely. But it is not difficult to control it and to keep it to the barest minimum.
The procedure for control of overtime work involves the following steps :
1. Entire overtime work should be duly authorized after investigating the reasons
for it.
2. Overtime cost should be shown against the concerned department. Such a
practice should enable proper investigation and planning of production in
future.
3. If overtime is a regular feature, the necessity for recruiting more men and
adding a shift should be considered.
4. If overtime is due to lack of plant and machinery or other resources, steps may
be taken to install more machines, or to resort to sub-contracting

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CLASSWORK SECTION
Question 1
Two workmen, ‘A’ and ‘B’, produce the same product using the same material. Their
normal wage rate is also the same. ‘A’ is paid bonus according to the Rowan system,
while ‘B’ is paid bonus according to the Halsey system. The time allowed to make the
product is 50 hours. ‘A’ takes 30 hours while ‘B’ takes 40 hours to complete the product.
The factory overhead rate is ` 5 per man-hour actually worked. The factory cost for the
product for ‘A’ is ` 3,490 and for ‘B’ it is ` 3,600.
Required:
(i) Compute the normal rate of wages;
(ii) Compute the cost of materials cost;
(iii) Prepare a statement comparing the factory cost of the products as made by the
two workmen.

Question 2
Jigyasa Boutiques LLP. (JBL) takes contract on job works basis. It works for various fashion
houses and retail stores. It has employed 26 workers and pays them on time rate basis.
On an average an employee is allowed 2 hours for boutique work on a piece of garment.
In the month of March two workers Margaret and Jennifer were given 30 pieces and 42
pieces of garments respectively for boutique work. The following are the details of their
work:
Margaret Jennifer
Work assigned 30 pcs 42 pcs.
Time taken 28 hours 40 hours
Workers are paid bonus as per Halsey System. The existing rate of wages is ` 50 per hour.
As per the new wages agreement the workers will be paid ` 55 per hour w.e.f. 1st April.
At the end of the month March, the accountant of the company has calculated wages to
these two workers taking ` 55 per hour.
(i) From the above information calculate the amount of loss that the company has
incurred due to incorrect rate selection.
(ii) What would be the loss incurred by the JBL due to incorrect rate selection if it had
followed Rowan scheme of bonus payment.
(iii) Amount that could have been saved if Rowan scheme of bonus payment was
followed.
(iv) Do you think Rowan scheme of bonus payment is suitable for JBL?

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Question 3
(a) Bonus paid under the Halsey Plan with bonus at 50% for the time saved equals the
bonus paid under the Rowan System. When will this statement hold good? (Your
answer should contain the proof).
(b) The time allowed for a job is 8 hours. The hourly rate is ` 8. Prepare a statement
showing:
i. The bonus earned
ii. The total earnings of employee and
iii. Hourly earnings.
Under the Halsey System with 50% bonus for time saved and Rowan System for each
hour saved progressively.

Question 4
The finishing shop of a company employs 60 direct workers. Each worker is paid ` 400 as
wages per week of 40 hours. When necessary, overtime is worked up to a maximum of
15 hours per week per worker at time rate plus one-half as premium. The current output
on an average is 6 units per man hour which may be regarded as standard output. If
bonus scheme is introduced, it is expected that the output will increase to 8 units per man
hour. The workers will, if necessary, continue to work overtime up to the specified limit
although no premium on incentives will be paid.
The company is considering introduction of either Halsey Scheme or Rowan Scheme of
wages incentive system. The budgeted weekly output is 19,200 units. The selling price is
`11 per unit and the direct material cost is ` 8 per unit. The variable overheads amount
to ` 0.50 per direct labour hour and the fixed overhead is ` 9,000 per week.
Prepare a statement to show the effect on the company’s weekly profit of the proposal to
introduce (a) Halsey Scheme, and (b) Rowan Scheme.

Question 5
Mr. A. is working by employing 10 skilled workers. He is considering the introduction
of some incentive scheme - either Halsey Scheme (with 50% bonus) or Rowan Scheme
of wage payment for increasing the Employee productivity to cope with the increased
demand for the product by 25%. He feels that if the 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 and he has accordingly given this
assurance to the workers. As a result of the assurance, the increase in productivity has
been observed as revealed by the following figures for the current month:

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Hourly rate of wages (guaranteed) ` 40

Average time for producing 1 piece by one worker at the previous 2 hours
performance (This may be taken as time allowed)
No. of working days in the month 25
No. of working hours per day for each worker 8
Actual production during the month 1,250 units
Required:
(i) Calculate effective rate of earnings per hour under Halsey Scheme and Rowan Scheme.
(ii) Calculate the savings to Mr. A in terms of direct labour cost per piece under the schemes.
(iii) Advise Mr. A as regards to which scheme is to be selected.

Question 6
Wage negotiations are going on with the recognised employees’ union, and the
management wants you as the as an executive of the company to formulate an incentive
scheme with a view to increase productivity.
The case of three typical workers A, B and C who produce respectively 180, 120 and 100
units of the company’s product in a normal day of 8 hours is taken up for study.
Assuming that day wages would be guaranteed at ` 75 per hour and the piece rate would
be based on a standard hourly output of 10 units, calculate the earnings of each of the
three workers and the employee cost per 100 pieces under (i) Day wages, (ii) Piece rate,
(iii) Halsey scheme, and (iv) The Rowan scheme.

Question 7
The existing Incentive system of Alpha Limited is as under:
Normal working week 5 days of 8 hours each plus 3 late shifts of 3 hours each
Rate of Payment Day work: ` 160 per hour
Late shift: ` 225 per hour

Average output per operator for 49-hours week

i.e. including 3 late shifts : 120 articles
In order to increase output and eliminate overtime, it was decided to switch on to a
system of payment by results. The following information is obtained:
Time-rate (as usual) : ` 160 per hour
Basic time allowed for 15 articles : 5 hours
Piece-work rate : Add 20% to basic piece-rate
Premium Bonus : Add 50% to time.

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Required:
(i) Prepare a Statement showing hours worked, weekly earnings, number of articles
produced and labour cost per article for one operator under the following systems:
(a) Existing time-rate
(b) Straight piece-work
(c) Rowan system
(d) Halsey premium system
Assume that 135 articles are produced in a 40-hour week under straight piece work,
Rowan Premium system, and Halsey premium system above and worker earns half the
time saved under Halsey premium system.

Question 8
The standard hours of job X is 100 hours. The job has been completed by Amar in 60
hours, Akbar in 70 hours and Anthony in 95 hours.
The bonus system applicable to the job is as follows:-
Percentage of time saved to time allowed Bonus
(Slab rate)
Saving upto 10% 10% of time saved
From 11% to 20% 15% of time saved
From 21% to 40% 20% of time saved
From 41% to 100% 25% of time saved
The rate of pay is ` 1 per hour, Calculate the total earnings of each worker and also the
rate of earnings per hour.

Question 9
Both direct and indirect employees of a department in a factory are entitled to production
bonus in accordance with a group incentive scheme, the outline of which is as follows:
(a) For any production in excess of the standard rate fixed at 16,800 tons per month
(of 28 days) a general incentive of ` 1,500 per ton is paid in aggregate. The total
amount payable to each separate group is determined on the basis of an assumed
percentage of such excess production being contributed by it, namely @ 65% by
direct employee, @ 15% by inspection staff, @ 12% by maintenance staff and @ 8%
by supervisory staff.
(b) Moreover, if the excess production is more than 20% above the standard, direct
employees also get a special bonus @ ` 500 per ton for all production in excess of
120% of standard.

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(c) Inspection staff are penalized @ ` 2,000 per ton for rejection by customer in excess
of 2% of production.
(d) Maintenance staff are also penalized @ ` 2,000 per hour for breakdown.
From the following particulars for a month, compute production bonus earned by each
group:
(a) Actual working days : 25
(b) Production : 21,000 tons
(c) Rejection by customer : 500 tons
(d) Machine breakdown : 40 hours

Question 10
A, B and C were engaged on a group task for which a payment of ` 72,500 was to be
made. A’s time basis wages are ` 800 per day, B’s ` 600 per day and C’s ` 500 per day.
A worked for 25 days; B worked for 30 days; and C for 40 days. Calculate the share of
bonus to be distributed among the workers and total earnings thereof.

Question 11
It is seen from the job card for repair of the customer’s equipment that a total of 154
labour hours have been put in as detailed below:
Worker ‘A’ Worker ‘B’ Worker ‘C’
paid at ` 200 per paid at ` 100 per paid at ` 300 per
day of 8 Hours day of 8 hours day of 8 hours
Monday (hours) 10.5 8.0 10.5
Tuesday (hours) 8.0 8.0 8.0
Wednesday (hours) 10.5 8.0 10.5
Thursday (hours) 9.5 8.0 9.5
Friday (hours) 10.5 8.0 10.5
Saturday (hours) -- 8.0 8.0
Total (hours) 49.0 48.0 57.0
In terms of an award in an employee conciliation, the workers are to be paid dearness
allowance on the basis of cost of living index figures relating to each month which works
out @ ` 968 for the relevant month. The dearness allowance is payable to all workers
irrespective of wages rate if they are present or are on leave with wages on all working days.
Sunday is a weekly holiday and each worker has to work for 8 hours on all week days
and 4 hours on Saturdays; the workers are however paid full wages for Saturday (8 hours
for 4 hours worked).

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Overtime is paid twice of ordinary wage rate if a worker works for more than nine hours
in a day or fourty eight hours in a week. Excluding holidays, the total number of hours
works out to 176 in the relevant month. The company’s contribution to Provident Fund
and Employees State Insurance Premium are absorbed into overheads.
Work out the wages payable to each worker.

Question 12
In a factory, the basic wage rate is ` 100 per hour and overtime rates are as follows:
Before and after normal working hours 175% of basic wage rate
Sundays and holidays 225% of basic wage rate
During the previous year, the following hours were worked
- Normal time 1,00,000 hours
- Overtime before and after working hours 20,000 hours
Overtime on Sundays and holidays 5,000 hours
Total 1,25,000 hours

The following hours have been worked on job ‘Z’

Normal 1,000 hours
Overtime before and after working hrs 100 hours.
Sundays and holidays 25 hours
Total 1,125 hours
You are required to calculate the labour cost chargeable to job ‘Z’ and overhead in each
of the following instances:
(a) Where overtime is worked regularly throughout the year as a policy due to the
workers’ shortage.
(b) Where overtime is worked irregularly to meet the requirements of production.
(c) Where overtime is worked at the request of the customer to expedite the job.

Question 13
During audit of account of the G Ltd., your assistant found errors in the calculation of the
wages of factory workers and he wants you to verify his work.
He has extracted the following information:
(i) The contract provides that the minimum wage for a worker is his base rate.
It is also paid for downtimes i.e.; the machine is under repair or the worker is without
work. The standard work week is 40 hours. For overtime production, workers are
paid 150 percent of base rates.

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(ii) Straight Piece Work – The worker is paid at the rate of ` 20 per piece.
(iii) Percentage Bonus Plan – Standard quantities of production per hour are established
by the engineering department. The workers’ average hourly production, determined
from his total hours worked and his production, is divided by the standard quantity
of production to determine his efficiency ratio. The efficiency ratio is then applied to
his base rate to determine his hourly earnings for the period.
Your assistant has produced the following schedule pertaining to certain workers of a
weekly pay roll:
Worker Wages Total Downtime Units Standard Base Gross
incentive plan hours hours produced units rate wages as
per book
Mohan* Straight piece 46 ---- 455 ---- 180 9,500
work
John Straight piece 44 ---- 425 ---- 180 8,500
work
Harish Percentage 40 4 250 200 220 12,000
bonus plan
* Total hours of Mohan include 6 overtime hours.
Prepare a schedule showing whether the above computation of workers’ wages is correct
or not. Give details.

Question 14
From the following information, calculate Labour turnover rate and Labour flux rate:
No. of workers as on 01.01.2013 = 7,600
No. of workers as on 31.12.2013 = 8,400
During the year, 80 workers left while 320 workers were discharged 1,500 workers were
recruited during the year of these, 300 workers were recruited because of exits and the
rest were recruited in accordance with expansion plans.

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Question 15
Corrs Consultancy Ltd. is engaged in BPO industry. One of its trainee executives in the
Personnel department has calculated labour turnover rate 24.92% for the last year using
Flux method.
Following is the some data provided by the Personnel department for the last year:
Employees At the beginning Joined Left At the
end

Data Processors 540 1,080 60 1,560

Payroll Processors ? 20 60 40
Supervisors ? 60 -- ?
Voice Agents ? 20 20 ?
Assistant Managers ? 20 -- 30
Senior Voice Agents 4 -- -- 12
Senior Data Processors 8 -- -- 34
Team Leaders ? -- -- ?
Employees transferred from the Subsidiary Company
Senior Voice Agents -- 8 -- --
Senior Data Processors -- 26 -- --
Employees transferred to the Subsidiary Company
Team Leaders -- -- 60 --
Assistant Managers -- -- 10 --
At the beginning of the year there were total 772 employees on the payroll of the company.
The opening strength of the Supervisors, Voice Agents and Assistant Managers were in the
ratio of 3 : 3 : 2.
The company has decided to abandon the post of Team Leaders and consequently all the
Team Leaders were transferred to the subsidiary company.
The company and its subsidiary are maintaining separate set of books of account and
separate Personnel Department.
You are required to calculate:
(i) Labour Turnover rate using Replacement method and Separation method.
(ii) Verify the Labour turnover rate calculated under Flux method by the trainee executive
of the Corrs Consultancy Ltd.

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Question 16
The management of B.R Ltd. is worried about their increasing employee turnover in the
factory and before analyzing the causes and taking remedial steps, it wants to have an
idea of the profit foregone as a result of employee turnover in the last year.
Last year sales amounted to ` 83,03,300 and P/V ratio was 20 per cent. The total number
of actual hours worked by the direct employee force was 4.45 lakhs. As a result of the
delays by the Personnel Department in filling vacancies due to employee turnover,
1,00,000 potentially productive hours were lost. The actual direct employee hours
included 30,000 hours attributable to training new recruits, out of which half of the hours
were unproductive.

The costs incurred consequent on employee turnover revealed, on analysis, the following:
Settlement cost due to leaving ` 43,820

Recruitment costs ` 26,740

Selection costs ` 12,750

Training costs ` 30,490

Assuming that the potential production lost as a consequence of employee turnover

could have been sold at prevailing prices, find the profit foregone last year on account of
employee turnover.

Question 17
In a factory working six days in a week and eight hours each day, a worker is paid at the
rate of ` 100 per day basic plus D.A. @ 120% of basic. He is allowed to take 30 minutes
off during his hours shift for meals-break and a 10 minutes recess for rest. During a week,
his card showed that his time was chargeable to:
Job X 15 hrs.
Job Y 12 hrs.
Job Z 13 hrs.
The time not booked was wasted while waiting for a job. In Cost Accounting, how would
you allocate the wages of the workers for the week?

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Question 18
CALCULATE the earnings of A and B from the following particulars for a month and
allocate the employee cost to each job X, Y and Z:
A B
(i) Basic Wages (`) 10,000 16,000
(ii) Dearness Allowance 50% 50%
(iii) Contribution to provident Fund (on basic wages) 8% 8%
(iv) Contribution to Employee’s State Insurance (on basic 2% 2%
wages)
(v) Overtime (Hours) 10 --

The normal working hours for the month are 200. Overtime is paid at double the total of
normal wages and dearness allowance. Employer’s contribution to state Insurance and
Provident Fund are at equal rates with employees’ contributions. The two workers were
employed on jobs X, Y and Z in the following proportions:
Jobs X Y Z
Worker A 40% 30% 30%
Worker B 50% 20% 30%
Overtime was done on job Y.

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HOMEWORK SECTION

Question 1
You are given the following information of a worker:
(i) Name of worker : Mr. Roger
(ii) Ticket No. : 002
(iii) Work started : 1-4-19 at 8 a.m.
(iv) Work finished : 5-4-19 at 12 noon
(v) Work allotted : Production of 2,160 units
(vi) Work done and approved : 2,000 units
(vii) Time and units allowed : 40 units per hour
(viii) Wage rate : ` 25 per hour
(ix) Mr. Roger worked 9 hours a day.
You are required to calculate the remuneration of Mr. Roger on the following basis:
(i) Halsey plan and
(ii) Rowan plan

Question 2
A factory having the latest sophisticated machines wants to introduce an incentive scheme
for its workers, keeping in view the following:
(i) The entire gains of improved production should not go to the workers.
(ii) In the name of speed, quality should not suffer.
(iii) The rate setting department being newly established are liable to commit
mistakes.
You are required to devise a suitable incentive scheme and demonstrate by an illustrative
numerical example how your scheme answers to all the requirements of the management.

Question 3
The Accountant of Y Ltd. has computed employee turnover rates for the quarter ended
31st March, 20X1 as 10%, 5% and 3% respectively under ‘Flux method’, ‘Replacement
method’ and ‘Separation method’ respectively. If the number of workers replaced during
that quarter is 30, find out the number of workers for the quarter
(i) recruited and joined and
(ii) left and discharged and
(iii) Equivalent employee turnover rates for the year.

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Question 4
An article passes through five hand operations as follows:
Operation No. Time per article Grade of worker Wage rate per hour
(`)
1 15 minutes A 0.65
2 25 minutes B 0.50
3 10 minutes C 0.40
4 30 minutes D 0.35
5 20 minutes E 0.30

The factory works 40 hours a week and the production target is 600 dozens per week.
Prepare a statement showing for each operation and in total, (1) the number of operators
required, (2) the labour cost per dozen and (3) the total labour cost per week to produce
the total targeted output.

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IMPORTANT THEORY QUESTIONS FOR EXAMINATION

Question 1
Distinguish between Idle Time and Idle Facilities. How are they treated in Cost Accounts?
Develop a system of control for Idle Time in a factory.

Answer
Idle time: It refers to the labour time paid for but not utilised on production. Idle time
thus represents the time for which wages are paid but no output is obtained. This is the
period during which the workers remain idle. It arises due to various reasons. According to
reasons, idle time can be classified into normal idle time and abnormal idle time. Normal
idle time is the time which cannot be avoided or reduced in the normal course of business.
For example, some labour time is bound to be lost due to the time taken by workers to
cover the distance between the factory gate and the department or the actual work place
where they are working. Sometime also elapses between the finishing of one job and
the starting of another job. Since a worker cannot work continuously for the whole day,
sometime is required during which he attends to this personal needs, such as taking lunch
or rest to avoid normal fatigue. It is thus obvious that normal idle time is unavoidable.
Abnormal idle time may arise because of inefficiency, mischief and misfortune such as
breakdown of machines for a long period, power failure, non-availability of materials,
etc. generally, it is avoidable and controllable. However, abnormal idle time arising on
account of strike, lockouts, floods, etc. may be uncontrollable. By proper care and caution
abnormal idle time can be reduced or eliminated to a very great extent.
Idle facilities: The terms facilities has a wider connotation. It may include production
capacity as well. Facilities may be provided by the fixed assets such as building space,
plant/equipment capacity etc., or by various service functions such as material services,
production services, personnel services etc., if a firm is not able to make full use of all
these facilities then the firm may be said to have idle facilities. Thus, idle facilities refer
to that part of total production facilities available which remain unutilized due to any
reason such as non-availability of raw-material, etc. Idle facilities differ from idle time.
A firm may have idle facilities even when it works full time; e.g., when facilities have been
provided on too large a scale.
Treatment of idle time in Cost Accounting: Treatment of idle time in coast accounting depends
upon its nature. The cost of normal idle time is charged to the cost of production. This
may be done by inflating the labour rate or the normal idle time may be transferred to
factory overhead for absorption through factory overhead absorption rate. In relative

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terms, the cost of normal idle time is generally nominal. As against normal idle time
cost, the cost of abnormal idle time sometime may be quite substantial. Since these costs
are beyond the control of the management and being abnormal in nature, they do not
form part of cost of production. Therefore, payment for them is not included in cost of
production and is transferred to costing profit and loss account.
Treatment of idle facilities in Cost Accounting: Normal idle facilities cost which arises due
to unavoidable reasons, should be included in the works overhead. On the other hand,
abnormal idle facilities cost which arises due to plants or machines/facilities remaining
idle on account of trade depression or for want of work etc., should be written off to
costing profit and loss account.
System of controlling idle time: The system of idle time control aims at controlling the time
for which a worker has been paid but has not been utilised for productive purposes. Such
a loss of time is know as idle time. The control of idle time requires the use of a proper
system of recording the idle time, ascertaining its reasons for occurrence and initiating
suitable administrative action to stop its reoccurrence.
To record the duration of idle time and to ascertain the reasons of its occurrence, the
format given as below may be used. This format not only records the time paid for but
also the standard time which a worker should take to produce a unit of output. The
time actually paid on comparison with standard time may reveal the element of idle
time, if any. After this the reasons for the occurrence of idle time should be ascertained
and stated in the suitable column of the format. In this way a statement of labour time
utilization is usually prepared. Such a statement is quite useful to the officers who are
concerned with the control of idle time. In fact it serve as a sound basis for their actions
to control idle time. Such a statement clearly points out to persons responsible for the
control of idle time the reasons for the occurrence of idle time.
Finally, the concerned officer may suggest the remedial measures to minimize the
occurrence of idle time in future.

Question 2
What do you understand by Overtime Premium?
What is the affect of overtime payment on productivity and cost?
Discuss the treatment of overtime premium in cost accounts and suggest a procedure for
control of overtime work.

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Answer
Overtime premium: Overtime is the amount of wages paid for working beyond normal
working hours as specified by Factories Act or by a mutual agreement between the
workers union and the management. According to Factories Act of 1948, a worker is
entitled for overtime at double the rate of his wages (including allowances) if he works
beyond 9 hours in a day or 48 hours in a week even where the Act is not applicable, the
practice is to pay for overtime work at higher rates usually in accordance with a standing
agreement between the employer and the workers. Hence, payment of overtime consists
of two elements, the normal wages i.e., the usual amount, and the extra payment i.e.,
the premium. This amount of extra payment paid to a worker under overtime is known
as overtime premium.
The overtime payment affects the productivity and cost in many ways as follows :
(i) During overtime period the efficiency of a worker is low. This causes reduced
productivity, thus during this period the productivity is lesser than the normal one.
(ii) In their anxiety to earn more, the workers may not concentrate on work during
normal time and thus the output during normal hours may also fall.
(iii) The practice of resorting to overtime adversely affects workers’ health which may
lead to increase in accident rate and consequently a decrease in productivity.
(iv) Due to overtime, it is not possible to carry out necessary maintenance of plants and
machinery. Such a situation results occasionally in a major breakdown and hence
accounts for the stoppage of production cycle.
(v) Reduced output and increased premium are responsible for bringing an increase in
cost of production.
Overtime premium is a part of total wages of overtime period. In cost accounting the
treatment of overtime premium will be as follows:
(i) If the overtime is resorted to at the desire of the customer, then the entire amount
of overtime including overtime premium should be charged to the job directly.
(ii) If it is due to a general pressure of work to increase the output, the premium as well
as overtime wages may be charged to general overheads.
(iii) If it is due to the negligence or delay of workers of a particular department, it may
be charged to the concerned department.
(iv) If it is due to circumstances beyond control, it may be charged to Costing Profit &
Loss Account.
As regards the control of overtimes is concerned, it is difficult to eliminate it completely.
But it is not difficult to control it and to keep it to the barest minimum.
The procedure for control of overtime work involves the following steps :

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1. Entire overtime work should be duly authorized after investigating the reasons for it.
2. Overtime cost should be shown against the concerned department. Such a practice
should enable proper investigation and planning of production in future.
3. If overtime is a regular feature, the necessity for recruiting more men and adding a
shift should be considered.
4. If overtime is due to lack of plant and machinery or other resources, steps may be
taken to install more machines, or to resort to sub contracting.

Question 3
What are piece-rate? What advantage and disadvantages are attributed to their use?
What principles should govern the determination and revision of piece-rates?

Answer
Piece Rate: It is that rate, which is paid to a worker for producing a single unit of output.
The wages of a worker under piece rate method are calculated by multiplying the number
of units of output produced by a pre-determined piece rate. For example, if the pre-
determined piece rate is ` 5 per unit and a worker has produced 200 units, then the total
wages to be paid will be ` 1,000.
To be more exact, the above type of piece rate method is known as straight piece rate. It
has another variation also, which is known as differential piece rate. Under differential
piece rate system, different piece rates are given to workers for different levels of efficiency.
Important advantage and disadvantages which are attributed to the use of piece rates
are as follows:
Advantages of piece rates:
1. The application of piece rate acts as an incentive to workers to produce more to
maximize their earnings.
2. Due to increase in output, the per unit total cost of production reduces.
3. Losses due to mishandling of machines and breakage of tools etc., are minimized, as
the workers understand fully their importance.
4. Workers are constantly on the lookout to develop improved methods of performing
jobs which may result in increased productivity.
5. The piece rate method is easily understood by workers and thus it is highly appreciated.
6. The use of piece rates reduces supervision costs.
Disadvantages of piece rates:
1. To maximize earnings, sometime sub - standard quality of goods are produced by
workers.

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2. Workers hardly have any consideration for the resources of the concern. They may
waste material and mishandle tools and machinery. Such an act on the part of
workers reduces the concern’s profitability.
3. The use of piece rate has no place for less efficient workers.
4. Due to continuous working for several hours, the health of workers is adversely
affected.
5. The determination of a piece rate acceptable to workers is a difficult task. In fact, it
is a disputable point between employees and employer.
Important principles of piece rate determination and revision :
Important principles which should govern the determination and revision of piece rates
are as follows:
1. Different piece rates should be determined for different types of jobs.
2. The piece rates determination should give due consideration to factors such as
requirement of jobs, conditions under which jobs would be performed, risk involved,
efforts involved while working on the job, etc.
3. The wage rate should be such that it guarantees a minimum living wage to ensure
a satisfactory standard of living.
4. It should reduce/stabilize labour turnover on its application.
5. It should act as an incentive to motivate workers in giving a higher output.
6. The wage rate should be able to reduce absenteeism and late coming.
7. It should be acceptable to trade unions.
8. It should be flexible and capable of being adapted to changed circumstances.
9. Piece rates should be revised as and when they are revised by other firms in the
industry or there is an increase in the cost of living index.
10. It may be revised at the end of the contract period as settled between management
and workers union.

Question 4
List down the factors to be considered before introducing a scheme of incentive to workers.

Answer
An incentive can be defined as the stimulation of effort and effectiveness on the part of
workers by offering monetary inducement or enhanced facilities. It means that incentive
can be given in monetary or non - monetary form to workers. It is usually linked with
the efforts made by individual workers or by their work group for increasing production.
By the implementation of such a scheme not only the workers but also the employer is

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benefited. Due to increased production the overhead cost is spread over a larger output
and thus per unit cost of production of the product is reduced.
Factors to be considered before introducing a scheme of incentives to workers.
1. The impact of the Scheme in motivating workers.
2. The impact of the scheme on workers performing:
(i) Quality job and thus giving a lower output
(ii) Routine job with a potential to give a higher output.
(iii) Job by using an automatic machine, where the possibility of increasing the
output beyond the fixed number does not exist.
3. The reaction of workers and union leaders towards the incentive scheme.
4. How for it is practicable to measure the performance of each worker, as it is necessary
for the calculation of incentive?
5. The extent of saving in cost of production per unit due to increased production.
6. The incentive schemes prevailing in other areas and industries or similar business.
7. The effect of incentive scheme on different sets of workers e.g., unskilled and skilled
workers.
8. The exactitude with which standards of performance can be laid down. As it is
necessary for the introduction of a scheme of incentives.
9. The cost of operating the scheme.
10. The capacity of the market to absorb the increased production because of the scheme
without reducing the selling price.

Question 5
Discuss the three methods of calculating labour turnover.  (Nov. 2004, 3 Marks)

Answer
Methods of Calculating labour turnover

(i) Replacement method =

(ii) Separation method =

(iii) Flux method =

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Question 6
Discuss two types of Costs, which are associated with labour turnover.
 (Nov. 2003, 3 Marks)
Answer
Two types of costs associated with labour turnover are:
(i) Preventive costs : These costs are incurred to keep the labour turnover rate at a low
level. They include costs of accommodation, transport facilities, medical services,
welfare schemes, pension schemes, environment improvement, lighting, heating,
air-conditioning etc. The rate of labour turnover is usually low, if a company incurs
higher preventive costs.
(ii) Replacement costs : These costs arise due to high labour turnover, e.g. cost of advertising,
recruitment, selection, training & induction, abnormal breakage and scrap, extra
wages & overheads etc., caused as a result of inefficient and inexperienced newly
recruited workers.

Question 7
Discuss the accounting treatment of Idle time and overtime wages.
 (May 2003, 3 Marks)
Answer
Accounting treatment of idle time wages & overtime wages in cost accounts:
Normal idle time is treated as a part of the cost of production. Thus, in the case of direct
workers, an allowance for normal idle time is built into the labour cost rates. In the case
of indirect workers, normal idle time is spread over all the products or jobs through the
process of absorption of factory overheads.
Under Cost Accounting, the overtime premium is treated as follows :
• If overtime is resorted to at the desire of the customer, then the overtime premium
may be charged to the job directly.
• If overtime is required to cope with general production programme or for meeting
urgent orders, the overtime premium should be treated as overhead cost of particular
department or cost center which works overtime.
• Overtime worked on account of abnormal conditions should be charged to costing
Profit & Loss Account.
• If overtime is worked in a department due to the fault of another department the
overtime premium should be charged to the latter department.

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Question 8
Discuss the effect of overtime payment on productivity  (Nov. 2004, 3 Marks)

Answer
Effect of overtime payment on productivity: Overtime work should be resorted to only when
it is extremely essential because it involves extra cost. The overtime payment increases
the cost of production in the following ways:
1. The overtime premium paid is an extra payment in addition to the normal rate.
2. The efficiency of operators during overtime work may fall and thus output may be
less than normal output.
3. In order to earn more the workers may not concentrate on work during normal time
and thus the output during normal hours may also fall.
4. Reduced output and increased premium of overtime will bring about an increase
cost of production.

Question 9
State the circumstances in which time rate system of wage payment can be preferred in a
factory.  (Nov. 2004, 3 Marks)

Answer
Circumstances in which time rate system of wage payment can be preferred :
In the following circumstances the time rate system of wage payment is preferred in a
factory.
1. Persons whose services cannot be directly or tangibly measured, e.g., general helpers,
supervisory and clerical staff etc.
2. Workers engaged on highly skilled jobs or rendering skilled services, e.g., tool making,
inspection and testing.
3. Where the pace of output is independent of the operator, e.g., automatic chemical
plants.

Question 10
Discuss briefly, how will you deal with casual workers and workers employed on outdoor
work in Cost Accounts.  (May 2002, 4 Marks)

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Answer
Causal and outdoor workers
Casual workers (badli workers) are employed temporarily, for a short duration to cope
with sporadic increase in volume of work. If the permanent labour force is not sufficient to
cope effectively with a rush of work, additional labour (casual workers) are employed to
work for a short duration. Outdoor workers are those workers who do not carry out their
work in the factory premises. Such workers either carry out the assigned work in their
homes (e.g., knitwear, lamp shades) or at a site outside the factory.
Casual workers are engaged on a daily basis. Wages are paid to them either at the
end of the day’s work or after a periodic interval. Wages paid are charged as direct or
indirect labour cost depending on their identifiability with specific jobs, work orders, or
department.
Rigid control should be exercised over the out-workers especially with regard to following:
1. Reconciliation of materials drawn/issued from the store with the output.
2. Ensuring the completion of output during the stipulated time so as to meet
comfortably the orders and contracts.

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