16-AF-601-SMA

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ICMAPakistan

STRATEGIC MANAGEMENT

ACCOUNTING (AF-601)

SEMESTER-6

SPRING (AUGUST) 2014 EXAMINATIONSMonday, the 18th August 2014

Extra Reading Time: 15 MinutesWriting Time: 03 Hours

Maximum Marks: 100 Roll No.:

(i) Attempt all questions.

(ii) Answers must be neat, relevant and brief.(iii) Use of non-programmable scientific calculators of any model is allowed.

(iv) Read the instructions printed inside the top cover of answer script CAREFULLY before attempting the paper.

(v) In marking the question paper, the examiners take into account clarity of exposition, logic of arguments,effective presentation, language and use of clear diagram/ chart, where appropriate.

(vi) DO NOT write your Name, Reg. No. or Roll No., or any irrelevant information inside the answer script.

(vii) Question Paper must be returned to invigilator before leaving the examination hall.

Answer Script will be provided after lapse of 15 minutes Extra Reading Time (9:15 a.m. or 2:15 p.m. [PST] as the case may be).

MarksQ. 1 Excellent Engineering Limited is a medium sized, well established company, producing high

quality products. The company is performing quite well in terms of market share andprofitability during the last many years in the competitive environment. The management of

the company has a team of professionals and all the decisions are taken on merit taking intoaccount the pros and cons of a scenario. You are the management accountant of thecompany and responsible to provide the various financial analyses to the management fordecision making.

Pricing of Product:

A board meeting is to be held in the next week where they will decide the pricing of a productfor the next period after considering the various options.

The following information is available from the records: Rupees

Previous Period Current Period

No. of units 100,000 106,000

Sales price per unit 26 26Sales revenue 2,600,000 2,756,000

Costs 2,000,000 2,154,800

Profit 600,000 601,200

You find that between the previous and current periods there was 4% general cost inflationand it is forecasted that costs will rise a further 6% in the next period. As a matter of policy,the company did not increase the selling price in the current period although competitorsraised their prices by 4% to allow for the increased costs. A survey by economic consultantswas conducted and it is revealed that the demand for the product is elastic with an estimatedprice elasticity of demand of 1.5 (i.e., the rate of change in demand is 1 times of the pricechange rate). However, there will be no change in demand if the Excellent Engineering Ltd.,

increases the price with its competitors.Special Machinery Order:

Excellent Engineering Ltd., has just completed an order for a piece of special machinery forFriends Engineering Ltd., and learnt that the company has defaulted on the order due tobankruptcy. The selling price of the said order is Rs.145,000 and Excellent Engineering Ltd.,has right to forfeit the deposit of Rs. 14,500 as per contract agreement. The product managerof the Excellent Engineering Ltd., has identified the costs already incurred in the production ofthe special machinery for Friends Engineering Ltd., as follows:

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Direct material 33,200

Direct labour 42,800

Manufacturing overhead applied:

Variable 21,400

Fixed 10,700 32,100

Fixed selling and administrative costs 10,810

Total 118,910

Another company, Novelty Engineering Ltd., is also interested to buy the special machinery ifit is reworked to Noveltys specifications. Excellent Engineering Ltd., offered to sell thereworked machinery to Novelty as a special order for Rs. 136,800. However, Novelty wouldpay the price when it takes delivery in two months. The additional identifiable costs to reworkthe machinery to Noveltys specifications are as follows: Rupees


Direct labour 8,400

Total 20,800

A second alternative available to Excellent Engineering Ltd., is to convert the specialmachinery to the standard model, which sells for Rs. 125,000. The additional identifiable costs

for this conversion are as follows: Rupees


Direct labour 6,600

Total 12,300

A third alternative for Excellent Engineering Ltd., is to sell the machine as it is for a price ofRs. 104,000. However, the potential buyer of the unmodified machine does not want it for 60days. This buyer has offered a Rs. 14,000 down payment, with the remainder due upondelivery.

The sales commission rate on sales of standard models is 2%, while the rate on special orderis 3%. Normal credit terms for sales of standard models are 2/10, net/30. In general,customers pay the bills for the standard model within discount period. However, credit termsfor a special order are negotiated with the customer(s). The time required for rework is onemonth.

The allocation rates for manufacturing overheads and fixed selling and administrative costsare as follows:

Manufacturing costs:

Variable 50% of direct labour cost

Fixed 25% of direct labour cost

Fixed selling and administrative costs 10% of the total of direct material, directlabour, and manufacturing overhead costs

Marketing a New Product:

Excellent Engineering Ltd., is also considering whether to develop and market a new productLiphon. Development costs are estimated to be Rs. 360,000, and there is a 0.75 probabilitythat the development effort will be successful and a 0.25 probability that the developmenteffort will be unsuccessful. If the development is successful, the product will be marketed, andits possible outcome would be as under:

Possible Outcome Profit/ (Loss) (Rs.) Probability

Very successful 1,080,000 0.4

Moderately successful 200,000 0.3

Failure (800,000) 0.3

Each of the above profit and loss calculations is after taking into account the developmentcosts of Rs. 360,000.

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MarksRequired:

(a) What would be the financial outcome if the company maintains the Rs. 26 selling pricefor the next period whereas competitors will increase their prices by 6%. Would yourfinancial outcome be different if the company also raises its price by 6%? 14

(b) Write a short report to the board, with appropriate figures, recommending whether thecompany should maintain the selling price of Rs.26 or raise it by 6%. 03

(c) State what assumptions you have used in fixing the selling price for the next period. 03

(d) Determine the net contribution each of the three alternatives of piece of specialmachinery will add to Excellent Engineering Ltd.s profit before tax. 07

(e) If Novelty makes a counteroffer, what is the lowest price Excellent Engineering Ltd.,should accept for the reworked machinery? Explain your answer. 04

(f) Discuss the influence of fixed manufacturing overhead cost should have on the salesprice quoted by Excellent Engineering Ltd., for special orders. 02

(g) Demonstrate the viability of launching the new product Liphon by a decision tree. 07

Q. 2 (a) Syed Ltd., sells books and software over the Internet. The CEO of the company was onbusiness tour in Dubai where he learned that his company is not efficient in inventoryhandling costs. Companies in the same business have an average on purchasing,

warehousing, and distribution costs 13% of sales and these companies were quiteefficient as compared to Syed Ltd.sresults for the past year. The following informationis available for the year just ended:

Cost Driver Cost Driver AllocationActivities Cost Driver

Quantity Cost (Rs.) Books Software

Receiving No. of purchase orders 2,000 600,000 70% 30%

Warehousing No. of inventory moves 9,000 720,000 80% 20%

Outgoing shipments No. of shipments 15,000 450,000 25% 75%

The company sold books of Rs. 7,800,000 and software turnover was Rs. 5,200,000during the year. An analysis of the companys activities revealed various inefficiencieswith respect to the warehousing of books and outgoing shipments of software. These

inefficiencies resulted in an extra 550 inventory moves and 250 shipments, respectively.Required:

(i) Describe the activity based management. Explain a non-value-added activity. 02

(ii) How much did non-value-added activities cost Syed Ltd., in last year? 02

(iii) Will the elimination of non-value-added activities allow Syed Ltd., to achieve a 13%cost percentage for each of the product lines? Show calculations. 08

(iv) How much additional cost cutting is required to achieve the target percentage?What methods might the company use to reduce the cost? 01

(b) Alliance Industries manufactures components for the heavy goods vehicle industry. Thecompany has set its annual goals for next year to increase its turnover by 25 to 30% andenhance its profit at least by 15%. A substantial amount has been allocated for

promotional activities. The CFO of the company has suggested in the board meetingthat we should identify the most profitable customer or group of customers to allowmarketing efforts. The following annual information regarding three of its key customersis available:

Customers X Y Z

Gross margin (Rs.) 947,000 1,120,000 1,106,000

General administration costs (Rs.) 70,000 134,000 112,000

Units sold (Nos.) 2,300 2,900 1,900

Orders placed (Nos.) 150 160 240

Sales visits (Nos.) 40 25 50

Invoices raised (Nos.) 155 195 525

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The company uses an activity based costing system and the analysis of customerrelated costs is as follows: Rupees

Sales visits (per visit) 840

Order processing (per order placed) 380

Despatch costs (per order placed) 700

Billing and collections (per invoice raised) 194

Required:How would you rank the customers using customer profitability analysis (CPA)? 05

Q. 3 The management of XYZ Ltd., recently decided to adopt a just-in-time (JIT) inventory policy toovercome steadily rising costs and free up cash tied up in inventory for the purpose ofinvestment. The production manager is quite confident that inventory will decrease fromRs. 7,200,000 to 1,200,000. It is expected that released funds could be invested @ 12% perannum. The additional information on yearly basis is as under:

! The company would have savings in insurance and property taxes of Rs. 54,000 due toreduction in inventories.

! XYZ Ltd., will lease 75% of an existing warehouse space to another firm for Rs. 8 persquare foot. The warehouse has 15,000 square feet.

! XYZ Ltd., is to remodel production and receiving dock facilities at a cost of Rs.1,200,000to accommodate the increased number of small shipment from the suppliers. Theconstruction costs will be depreciated over a 10-year life.

! A shift in suppliers will cause the purchase and use of more expensive raw materialscausing extra burden to the company of Rs.200,000. However, these materials shouldgive rise to fewer warranty and repair problems after XYZ Ltd.s finished product is sold,resulting in net savings for the firm of Rs. 50,000.

! Three store men will be directly affected by the adoption of JIT decision. Two store menwill be transferred to other position with XYZ Ltd., and one will be terminated. Eachemployee is earning Rs. 60,000 per annum.

! It is forecasted that reduced raw material inventory levels and resulted stockouts will costXYZ Rs. 140,000.

Required:

(a) Compute the annual financial impact of XYZs decision to adopt a JIT inventory system. 05

(b) If the JIT system is implemented in its true sense, what is the likelihood of excessive rawmaterial stockouts? 01

(c) Adoption of a JIT purchasing system will often result in less need for the inspection ofincoming materials and parts. Why? 01

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Q. 4 You are the newly appointed Management Accountant of Gama Ltd., a company providesconsultancy services to NGOs and various small industries. The operating statement for its ITdivision which operates as profit centre for the year ended June 30, 2014 is as under:

Rupees

Budget Actual Variance

Chargeable consultancy hours 2,400 2,500 100

Central administration costs fixed 30,000 31,500 1,500 (A)

Consultantssalaries fixed 160,000 168,000 8,000 (A)

Casual wages variable 1,920 1,200 720 (F)

Motor and travel costs fixed 8,800 8,800 -

Telephone fixed 1,200 1,600 400 (A)

Telephone variable 4,000 4,300 300 (A)

Printing, postage & stationery variable 5,280 5,180 100 (F)

Depreciation of equipment fixed 6,400 7,160 760 (A)

Total costs 217,600 227,740 10,140 (A)

Fees charged 360,000 400,000 40,000 (F)

Profit 142,400 172,260 29,860 (F)

The IT divisions manager Mr. Kamal Alvi, having the IT background, does not know howflexible budget differs from the static budget. In the beginning of July 2013, he was assignedthe budget and he is extremely happy that the actual profit has exceeded the budgetexpectations by Rs. 29,860. He is keen to know how this has been achieved.

You have determined that central administration costs are not directly attributable to the profitcentre but depreciation of equipment is an attributable cost. However, depreciation is not acontrollable cost since the profit centre manager has no control over investment decisions.

Required:

(a) Explain the present approach to budgeting adopted in Gama Ltd., and discuss theadvantages and disadvantages of involving consultants in the preparation of futurebudgets. 07

(b) Prepare an alternative statement for the profit centre which distinguishes clearlybetween controllable profit and attributable profit and which provides a realistic measureof the variances for the period. 08

Q. 5 (a) Spices Food Ltd., is a local fast food chain. The company have many outlets across thecity, being managed as divisions. The performance of each division manager isevaluated on the basis of Return on Investment (ROI) for award of bonus. The companyas a whole produced a 13% return on its investment.

Recently, the companys Alpha Division was approached by Ehsan Ltd., a company inthe same business, and offered to sell its running business. The following data isavailable to recent performance of Alpha Division and the Ehsan Ltd.:

Rs.000

Alpha Division Ehsan Ltd.

Sales 16,800 10,400

Variable costs (% of sales) 70% 65%

Fixed costs 4,300 3,340

Invested capital 3,700 1,250

The management of Alpha Division has determined that in order to upgrade the EhsanLtd., to the standards of Spices Food Ltd., an additional capital of Rs. 750,000 would beneeded.

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Required:

(i) Compute the current ROI of the Alpha Division and ROI after the acquisition ofEhsan Ltd. What is the likely reaction of Alpha Divisional management towards theacquisition? Why? 06

(ii) What is the likely reaction of Spices Food Ltd.s management towards theacquisition? Why? 04

(iii) Would the division be better off if it does not upgrade the Ehsan Ltd., to SpicesFood Ltd.s standards? Show computations to support your answer. 02

(iv) Assume that Spices Food Ltd., uses residual income to evaluate performance anddesires a 12% minimum return on invested capital. Compute the current residualincome of the Alpha Division and its residual income if the Ehsan Ltd., is acquired.Will divisional management be likely to change its attitude towards the acquisition?Why? 03

(b) Delta Division operates as an investment centre. The managing director of the divisionattended a seminar last week on Economic Value Added (EVA), a tool of performancemeasure and was quite impressed by the idea. He has asked you to calculate the EVAof Delta Division. The requisite information are as under:

! The book value of the non-current assets is Rs. 166,000 but their replacement valueis estimated to be Rs. 196,000. Working capital in the division has a value ofRs.38,000.

! The operating profits of the division for the year just ended were Rs. 37,000, aftercharging historical cost depreciation of Rs. 16,200 and the costs of a majoradvertising campaign is Rs.12,000. The advertising campaign is expected to boostrevenues for two years. An economic depreciation charge for the period would havebeen Rs. 24,600. The risk adjusted weighted average cost of capital (WACC) for thecompany is 11% per annum. Ignore taxation.

Required:

Calculate the Economic Value Added (EVA) for Delta Division. 05

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16-AF-601-SMA