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(1) Copyright Reserved No. of Page = 09 No. of Questions = 07 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA CERTIFICATE IN ACCOUNTING AND BUSINESS - II EXAMINATION MARCH 2012 05204 - FUNDAMENTALS OF MANAGEMENT ACCOUNTING AND BUSINESS FINANCE Time Allowed : 3 Hours Marks : 100 Marks Instructions to candidates: (1) (i) Part "A" - Answer both questions. (ii) Part "B" - Answer any four (4) questions. (2) Submit all workings. (3) Begin each answer on a separate page. (4) All answers should be in one language, in the medium applied for, in the answer booklets provided. _____________________________________________________________________________________ PART "A" Answer both questions Question No. 01 Pet Feeders (Pvt) Ltd. (PFL), a pet food manufacturing company is evaluating a new project of manufacturing a special grade of pet food item for the export market. The market research conducted by an overseas research firm at a fee of Rs. 500,000 confirms the marketability of the product and has estimated a product life span of 5 years. The company will be entitled for a tax holiday period of 5 years for this new project. The following information is also relevant for the project; (a) The company has already negotiated for a lease arrangement for the adjoining land and building at an annual rent of Rs. 800,000. 50% of the total rentals for the entire lease term need to be paid at the time of signing the agreement (at the commencement of the project). The balance amount is payable in equal installments at the end of each of the five years. Legal fees and stamp duty to be incurred in this agreement is estimated to be Rs. 400,000.
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FUNDAMENTALS OF MANAGEMENT ACCOUNTING AND ......05204 - FUNDAMENTALS OF MANAGEMENT ACCOUNTING AND BUSINESS FINANCE Time Allowed : 3 Hours Marks : 100 Marks Instructions to candidates:

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Page 1: FUNDAMENTALS OF MANAGEMENT ACCOUNTING AND ......05204 - FUNDAMENTALS OF MANAGEMENT ACCOUNTING AND BUSINESS FINANCE Time Allowed : 3 Hours Marks : 100 Marks Instructions to candidates:

(1)

Copyright Reserved

No. of Page = 09

No. of Questions = 07

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

CERTIFICATE IN ACCOUNTING AND BUSINESS - II EXAMINATION MARCH 2012

05204 - FUNDAMENTALS OF MANAGEMENT ACCOUNTING AND BUSINESS FINANCE

Time Allowed : 3 Hours Marks : 100 Marks Instructions to candidates: (1) (i) Part "A" - Answer both questions. (ii) Part "B" - Answer any four (4) questions. (2) Submit all workings. (3) Begin each answer on a separate page. (4) All answers should be in one language, in the medium applied for, in the answer

booklets provided. _____________________________________________________________________________________

PART "A" Answer both questions

Question No. 01 Pet Feeders (Pvt) Ltd. (PFL), a pet food manufacturing company is evaluating a new project of manufacturing a special grade of pet food item for the export market. The market research conducted by an overseas research firm at a fee of Rs. 500,000 confirms the marketability of the product and has estimated a product life span of 5 years. The company will be entitled for a tax holiday period of 5 years for this new project. The following information is also relevant for the project; (a) The company has already negotiated for a lease arrangement for the adjoining land

and building at an annual rent of Rs. 800,000. 50% of the total rentals for the entire lease term need to be paid at the time of signing the agreement (at the commencement of the project). The balance amount is payable in equal installments at the end of each of the five years. Legal fees and stamp duty to be incurred in this agreement is estimated to be Rs. 400,000.

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(b) Plant and machinery required for the project will be acquired at start of the project at an agreed price of Rs. 125 million and it is estimated to have a net realizable value at the end of the project period, of Rs. 15 million.

(c) Sales and cost information for the project are as follows;

Year

01 Year

02 Year

03 Year

04 Year

05

Sellable Quantity - Packs '000

700

1,200

800

400

250

Selling price per Pack (Rs.)

125

150

150

140

120

Payments for materials (Rs. million)

43

75

52

25

16 Payments for contract labour (Rs. million) (Note 01)

3.0

3.5

3.6

2.7

2.3

Working Capital Requirement (Rs. million)

10 - - - -

Note 01 – Five existing employees have been sent abroad in last month for a training program relating to this kind of manufacturing process at a cost of Rs. 500,000/-. If the project is accepted, these 05 employees each currently earning Rs. 25,000/- a month will be transferred to this project at a monthly salary of Rs. 35,000/- each. These employees are entitled for a general annual salary increase of 10% starting from 2nd year of the project. The loss of contribution in the current operation due to the above transfer is estimated to be Rs. 2 million a year. Note 02 – General overheads of the company are estimated to increase by Rs. 5 million

for a year with the acceptance of the project. Note 03 – The factory manager will be assigned to overlook the operations of the new

project. It is estimated that an hour a day from his normal duty hours has to be allocated for this operation. His current monthly salary is Rs. 150,000/- and will not be entitled for any additional payment for this assignment.

Note 04 –

The cost of capital of PFL is 20% per annum. The present criteria used by the management to approve an investment are as follows: a. Net Present Value is to be positive (NPV) b. Internal Rate of Return (IRR) is greater than 1.2 times Cost of Capital c. Payback period is less than 3 years d. Accounting Rate of Return (ARR) in the first two years is acceptable

to the management

You are a Management Trainee who has joined PFL recently and working under the direct supervision of the Finance Manager. The Finance Manager is in the process of preparing a Board Paper on the above project and has asked you to assist him.

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Accordingly you are required to:

1. (a) State three aspects that are looked at when a good investment appraisal criterion is selected : and discuss; (b) why NPV is relatively a superior criteria than pay back and ARR (c ) the possible reasons as to why PFL management is concerned about ARR

(6 marks) 2. Compute the Net Present Value (NPV), Internal Rate of Return (IRR) and payback

period for the project clearly showing the cash flows and their timing considered in the calculation

(10 marks) 3. Prepare a list to the management, of any cash flows that were not considered for the

above computation with reasons (2 marks)

4. Draft a note with the recommendation to the management on the project (2 marks)

(Total 20 marks) Question No. 02 BE FAIR (BF), is a medium scale producer of an ayurwedic cosmetic cream, ‘fair’. BF operates 48 weeks for a year. BF is in the process of preparing the budget for the year 2012/2013. It has been agreed that the annual budget should be segregated into four quarters. You are the Assistant Management Accountant who has been tasked to coordinate information gathering and prepare a draft budget. Accordingly you have compiled the following information. 1. Trends Production and sales of the product is spread evenly over the year. However during Quarters 2 and 4 BF expects an increase of 30% in demand compared to other two quarters due to weather patterns. 2. Pricing Strategy BF believes that comparatively high prices are perceived to reflect high value for customers. Therefore BF determines its price by adding 20% premium on competitor’s price. Current price of competing product for fair is Rs. 200. Competitor’s price is expected to increase by 10% at the beginning of Quarter 2 and Quarter 4. 3. Production and Sales You have gathered the following information from Sales and Production Directors. (a) Sales

Fair Target sales (units) for the year 2012/2013 460,000 Target sales (units) for first Quarter 2013/ 2014 120,000 Target sales (units) for second quarter 2013/ 2014 100,000 (b) Resource utilisation

Fair Material content per unit (kg) 0.1 Labour per unit (hours) 0.25

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BF adopts absorption costing method for calculate unit cost of finished products. (c) Resource availability and utilization

(i) Production Labour

There are 50 production employees who work 40 hours per week (8 hours x 5 days) and are paid Rs. 64 per hour. Any hours in excess of this involves payment of an overtime premium of 25%.

(ii) Purchasing, Opening stock and Closing Stock The purchasing manager believes that raw material will cost Rs. 1,100 per kg throughout next year. Opening stocks were bought at Rs. 1000 per kg. Estimated stocks at the beginning of the budgeted period:

Raw material (kg) 6,700 ‘Fair’ (28,000 units) Rs. 4,368, 000

Closing stocks Raw material should be sufficient for 6 weeks production requirement of the following quarter. BF maintains closing stock of finished goods that is equivalent to three weeks sales of the following quarter. BF adopts FIFO method for issue raw material and finished goods

(d) Overheads

(i) Production overheads According to the past cost behaviour, production overhead cost of BF follows a simple regression model as follows. Yfair = 1, 155,000 + 30 Xfair In the above equations Y refers to total production overhead cost in rupees and X refers to number of units produced. Fixed production overheads are absorbed into units based on labour hours.

(ii) Other Overheads

Q 1 Q2 Q3 Q4 Total Administration cost (Rs.) 500,000 800,000 600,000 800,000 2,700,000 Sales and distribution (Rs.) 330,000 600,000 200,000 700,000 1,830,000 You are required to: 1. State the stages of the budgeting process and discuss the benefits of participatory

budgeting (4 marks)

2. Prepare the following budgets for Quarter 1, 2, 3 and 4 for the year 2012/ 2013 a. sales Budget b. production budget c. purchases budget d. labour budget

(12 marks) 3. Prepare budgeted Annual Income Statement for the year 2012/2013.

(4 marks) (Total 20 marks)

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PART "B" (Answer any four (4) questions)

Question No. 03 KVC is manufacturing product X using 3 sequential processes. In process II additional materials are added to the base units which have been transferred from Process I. The output units are then be transferred to Process III for finishing. The following details relate to Process II for the month of February 2012. Both base units and additional material are introduced to this process at its commencement. Work-in-progress at the beginning of the month was in the process II 6,500 units valued at Rs. 984,500 which is 40% completed as to conversion costs. 728,000 base units valued at Rs. 51,549,680 were transferred to the process II during the period. The cost of additional material added to the process II was Rs. 24,016,720. During the month, total labour and production overheads costs incurred were Rs. 14,141,200 and Rs. 3,535,300 respectively. Normal loss in process II is assessed at 3% from the input base units (excluding opening work-in-progress). All losses are identified at the end of the process and can be sold at a price of Rs. 65 per unit. The total loss made during the period was recorded as 24,340 units. 700,160 units of completed output were transferred to the finishing process (Process III). The closing work-in-progress in process II at the end of February was 10,000 units, which is 70% completed as to conversion costs. The company is using the FIFO method in its costing system. You as the Assistant Management Accountant are required to: 1. Calculate number of units of normal loss and abnormal loss made during the month of

February 2012 (1 1/2 marks)

2. Prepare a statement of equivalent units and thereby calculate the cost per equivalent unit for the month of February

(6 marks) 3. Write up the following ledger accounts

Process II Account Normal Loss Account Abnormal Loss Account

(5 ½ marks) 4. Calculate the cost per equivalent base unit for the month of February if the company

operates Average Cost method instead of FIFO method. Assume the value of base units included in the opening WIP is Rs. 455,000

(2 marks) (Total 15 marks)

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Question No. 04 Chaya Limited (CL) manufactures plastic products for household market. The Product Development division has planned three new products to be introduced to the market next year. The following information has been compiled on the three products with a view to make a presentation to the Board of Directors.

Product A B C Unit Price (Rs) 500 700 1000 Cost of Production per unit (Rs.) Material (Rs 200 per kg) (Rs.)- Note 1 200 300 600 Unskilled Labour (Rs. 50 per hour) (Rs.) - Note 3 50 100 100 Skilled Labour hours per unit - Notes 2 & 4 1 2 2 Estimated demand per month (units) 3000 2000 5000

Note 1 – According to the Procurement Manager only 12,000kg of material can be sourced

per month Note 2 – Skilled labour required for the planned production is scarce and therefore will be

kept in the permanent cadre of CL and will be paid a monthly salary of Rs. 20, 000 per employee. It has been planned to have 50 skilled workers on the cadre.

Note 3 – Unskilled workers are abundantly available and therefore they will not be kept on

the permanent cadre and will be paid on hourly basis Note 4 – Employees on the permanent cadre work 8 hours per day and 25 days a month.

You are the Assistant Management Accountant reporting to the Finance Manager who has requested you to assist him in preparation of the board presentations by performing certain calculations. Accordingly you are required to:

1. Compute: a. unit contribution for the three products b. contribution per unit of scarce resource(s) and respective rankings c. the recommended product mix

(5 marks) 2. The Marketing Manager has informed that Product B requires a special packaging

which costs Rs 60 per unit even to sell the product at the current price. You are required to: a. determine the revised contribution and contributions per unit of scarce

resource(s) with respective rankings.

b. determine the optimum product mix using graphical linear programming where relevant and necessary (When linear programming is used, the linear programing model with object function must be clearly stated and a clearly labelled graph must be produced)

(10 marks) (Total 15 marks)

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Question No. 05 Safety Hands (Pvt) Ltd., (SHL)is a large-scale industrial glove liner manufacturing company. Though the company operates within a family controlled group SHL carries out its operations independently. SHL operates a full standard costing system. The following material and labour standards were prepared for the month of February 2012 in respect of a dozen of pairs of gloves.

Fabric A – 1.2 Kg. @ Rs. 241/- per Kg. Fabric B – 0.5 Kg. @ Rs. 342/- Per Kg. Direct Labour – 15 minutes @ Rs. 100/hour

The material utilization for the month of February was as follows;

Opening Stock

for February 2012 (kg)

Closing Stock for February

2012 (kg)

Utilisation (kg)

Fabric A 25,000 45,000 441,000 Fabric B 12,000 40,000 183,800

The actual purchase cost of Fabric A was Rs. 110.64Mn and that of Fabric B was 72.012Mn. 94,000 direct labour hours were utilised at a cost of Rs. 9.212Mn to complete 364,000 dozens of pairs during the month under review. No work in progress stocks were recorded both at the beginning and at the end of the period. You as the Assistant Management Accountant of SHL are requested to; 1. Prepare a note for Finance Manager’s review explaining the usefulness of standard

costing and variance analysis, for an organization (3 marks)

2. Compute and interpret the following variances: Material price variance Material usage variance Labour Rate Variance Labour Efficiency Variance

(6 marks) 3. Explain the possible causes for adverse labour efficiency variances

(3 marks)

4. The management is evaluating an incentive scheme to reward relevant staff based on the favourable variances in their respective function. Based on the calculations and interpretations in 2 above, briefly describe three matters to be further investigated in respect of favourable material price variance before rewarding purchasing division.

(3 marks) (Total 15 marks)

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Question No. 06 Investor PLC is a company listed in the Colombo Stock Exchange. Its policy is to maintain a capital structure having Debt : Equity at 1:2 ratio. On 1st January 2012 the company had Rs 800Mn in equity (with 10 million issued shares) and Rs 400 Mn in Debt carrying interest at 10% per annum. The company expects an annual return (before interest and tax) of 20% on total capital at the beginning of the year which will remain consistent in the foreseeable future. Depreciation and capital allowances are equal and will be Rs 60 Mn per annum. The company’s dividend policy is to maintain a pay-out ratio of 60%. The industry average cost of equity is 12% and the company is liable to pay tax at 40% on its profits. You are working as a management trainee in an investment advisory firm. A client of yours has shown interest in acquiring a significant stake in Investor PLC and has appointed your firm as his advisor. Your manager has asked you to assist him in preparing a preliminary report for the client. Accordingly you are required to: 1. Calculate the following:

a. Projected profit after interest and tax for 2012 b. Estimated Return on Equity (ROE) on Equity at the beginning of 2012 c. Annual estimated growth rate d. Weighted Average Cost of Capital (WACC) e. Estimated value of Investor PLC shares using dividend growth model

(7 marks)

2. Your manager is aware that the client is looking to acquire a stake in the company with which he would be able to obtain control of the company. Hence your manager is of the view that free cash flow basis is more appropriate in estimating the value of its shares. You have been informed that Rs. 120 million need to be invested annually as capital expenditure to maintain the anticipated growth as estimated in 1(c) above. You are required to: a. Calculate the annual free cash flow b. Calculate the estimated value of Investor PLC shares using discounted cash

flow model c. Give two possible reasons why free cash flow value is greater than dividend

based value d. Explain why discounted cash flow method is more appropriate in the given

situation (8 marks)

(Total 15 marks)

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Question No. 07 This question has FOUR parts independent to each other. You are required to answer only THREE of them of your choice Your Managing Director, though a non-finance professional, has much respect to the finance function of the business. He loves to read articles and books relating to finance. He has picked up the following ideas from his recent readings and needed further clarification. You are the Assistant Management Accountant in the Finance Department. In the absence of the Finance Manager, Managing Director has discussed the ideas and requested you to prepare a document providing further information as specified below. 1. “Activity Based Costing (ABC) approach for allocation of overhead costs is much

relevant and objective than the traditional overhead cost allocation method(s)”. Discuss the above statement giving pitfalls of traditional overhead allocation method(s) and merits of ABC approach.

(5 marks)

2. “The role of the Finance Manager of an organisation is to maximize profit for shareholders by taking correct investment, financing and asset management decisions”. Critically evaluate the above statement.

(5 marks)

3. “When evaluating investment projects, it is appropriate to use different ‘required rates of return’ depending on the risk profile of each project instead of using the overall required rate of return of the firm. In other words, different investment projects are appraised by discounting at different required rates of return. Otherwise projects which should really have accepted could be rejected while those which should have rejected could be accepted.” Do you agree with the above opinion? Justify your answer with reasons.

(5 marks)

4. “Since interest on debt capital is tax deductible the effective cost of debt is much lower than the cost of equity. Therefore by increasing the proportion of debt in capital structure WACC can be reduced”

Do you agree with the above opinion? Justify your answer with reasons.

(5 marks) (Total any 3 parts × 5 = 15 marks)