ICAP. Question Bank. Cost and management accounting

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1 ICAP Question Bank P Cost and management accounting

2 Second edition published by Emile Woolf Limited Bracknell Enterprise & Innovation Hub Ocean House, 12th Floor, The Ring Bracknell, Berkshire, RG12 1AX United Kingdom Emile Woolf International, January 2015 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, without the prior permission in writing of Emile Woolf Publishing Limited, or as expressly permitted by law, or under the terms agreed with the appropriate reprographics rights organisation. You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer. Notice Emile Woolf International has made every effort to ensure that at the time of writing the contents of this study text are accurate, but neither Emile Woolf International nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain. Emile Woolf International ii The Institute of Chartered Accountants of Pakistan

3 Certificate in Accounting and Finance Cost and management accounting C Contents Page Question and Answers Index v Questions Section A Objective test and long-form questions 1 Answers Section B Objective test and long-form answers 83 Emile Woolf International iii The Institute of Chartered Accountants of Pakistan

4 Cost and management accounting Emile Woolf International iv The Institute of Chartered Accountants of Pakistan

5 Certificate in Accounting and Finance Cost and management accounting I Index to Objective test and long-form questions and answers Question page Answer page Chapter 1 - Inventory valuation 1.1 Steel Rods XYZ Limited Mehanti Limited 2 85 Chapter 2 - Inventory management 2.1 Stock items 6786 and Inventory control Alpha Motors (Pvt) Ltd ABC Karachi Limited Moder Distributors Limited Robin Limited Ore Limited Explain 8 92 Chapter 3 - Accounting for overheads 3.1 Overhead cost per unit 9 93 Emile Woolf International v The Institute of Chartered Accountants of Pakistan

6 Cost and management accounting Question page Answer page 3.2 Apportionment Service departments Zia Textile Mills Ternary Engineering Limited Production and service RT Limited Ahsan Enterprises Amber Limited Sparrow (Pvt) Limited Chapter 4 - Marginal costing and absorption costing 4.1 Differences Marginal and absorption Zulfiqar Limited ATF Limited Mazahir (Pakistan) Limited Silver Limited Chapter 5 - Cost flow in production 5.1 Cost ledger Kaat Limited Mirza Limited Quality Limited Sapphire Limited Chapter 6 - Job, batch and service costing 6.1 Job Ahmer and company Chapter 7 - Process costing 7.1 Process costing: The basic rules Process 1 and process Emile Woolf International vi The Institute of Chartered Accountants of Pakistan

7 Index to questions and answers Question page Answer page 7.3 Equivalent units Yahya Limited Two processes Smart Processing Limited Hornbill Limited Fowl Limited Joint process Binary Ltd Platinum limited Chapter 8 - Budgeting 8.1 Budgeted profit and loss account Budgeted profit and loss account Budgeted profit and loss account Cash requirements Budgeted profit Profit forecast statement Cash budget Regression method Production cost budget Cash budget Chapter 9 - Standard costing 9.1 Standard cost ICA Standard cost - Idle time Chapter 10 - Variance analysis 10.1 Reconcile Simple variances Overhead variances Manufacturing cost variance Emile Woolf International vii The Institute of Chartered Accountants of Pakistan

8 Cost and management accounting Question page Answer page 10.5 Variances and operating statements Volume and expenditure variances Lettuce Moongazer BRK Carat Hexa Limited Excellent Limited Watool Limited ABC Limited Standard cost sheet Chapter 11 - Target costing 11.1 Scriba company Target Chapter 12 - Relevant costs 12.1 Jimco Materials and relevant costs Printing leaflets JD Product B Fazal Industries Limited Describe terms Topaz Limited Tychy Limited Chapter 13 - Cost-Volume-Profit (CVP) analysis 13.1 Octa Electronics Soft drink company Solvent Limited Emile Woolf International viii The Institute of Chartered Accountants of Pakistan

9 Index to questions and answers Question page Answer page Chapter 14 - Decision making techniques 14.1 Limiting factors Shortages Make or buy Condaco Decimal world Limited Three products Areesh Limited Jaseem Limited Bauxite Limited Artery Limited Chapter 15 - Introduction to financial instruments 15.1 Sources of finance Direct and indirect investment FI definitions FI definitions Chapter 16 - Time value of money 16.1 DCF and relevant costs Annuities and perpetuities Investment appraisal and inflation DCF exercises Conto Company Baypack Company Larkana Fabrication Limited Badger Chapter 17 Sustainability reporting 17.1 Benefits of sustainability reporting IFAC sustainability framework Key considerations for professional accountants Emile Woolf International ix The Institute of Chartered Accountants of Pakistan

10 Cost and management accounting Emile Woolf International x The Institute of Chartered Accountants of Pakistan

11 S E C T I O N Certificate in Accounting and Finance Cost and management accounting A Objective test and long-form questions CHAPTER 1 INVENTORY VALUATION 1.1 STEEL RODS During the month of February the following transactions in steel rods took place: 1 February Purchased per ton 2 February Purchased per ton 3 February Sold 2 tons 5 February Purchased per ton 6 February Sold 3 tons 10 February Purchased per ton 12 February Sold 8 tons 15 February Purchased per ton 16 February Sold 2 tons 20 February Purchased per ton 25 February Sold 7 tons Required Calculate the prices to be applied to the issues and the closing balance figures using: (a) FIFO (b) Weighted average. (8) (6) (14) Emile Woolf International 1 The Institute of Chartered Accountants of Pakistan

12 Cost and management accounting 1.2 XYZ LIMITED Q.1 XYZ Limited manufactures four products. The related data for the year ended December 31, 20X3 is given below: A B C D Opening inventory - Units 10,000 15,000 20,000 25,000 - Cost () 70, , , ,000 - NRV () 75, , , ,000 - Production in units 50,000 60,000 75, ,000 Costs of goods produced () 400, , ,000 1,200,000 Variable selling costs () 60,000 80,000 90, ,000 Closing inventory (units) 5,000 10,000 15,000 24,000 Damaged units included in closing inventory ,500 Inventory valuation method in use Weighted Average Weighted Average FIFO FIFO Unit cost of purchase from market () Selling price per unit () Unit cost to repair damaged units () The company estimates that selling expenses will increase by 10% in January 20X4. Required Compute the amount of closing inventory that should be reported in the statement of financial position as on December 31, 20X3. (15) 1.3 MEHANTI LIMITED Mehanti Limited (ML) produces and markets a single product Wee. Two chemicals Bee and Gee are used in the ratio of 60:40 for producing 1 litre of Wee. ML follows perpetual inventory system and uses weighted average method for inventory valuation. The purchase and issue of Bee and Gee for May 20X3, are as follows: Date Bee Gee Receipt Issue Receipt Issue Litre Rate Litre Litre Rate Litre X X X X X X X Emile Woolf International 2 The Institute of Chartered Accountants of Pakistan

13 Question bank: Objective test and long-form questions Following further information is also available: (i) Opening inventory of Bee and Gee was 1,000 litres at the rate of 50 per litre and 500 litres at the rate of 115 per litre respectively. (ii) (iii) (iv) (v) (vi) The physical inventories of Bee and Gee were 535 litres and 140 litres respectively. The stock check was conducted on 01 June and 31 May 20X3 for Bee and Gee respectively. Due to contamination, 95 litres of Bee and 105 litres of Gee were excluded from the stock check. Their net realisable values were Rs 20 and 50 per litre respectively. 250 litres of Bee which was received on 01 June 20X3 and 95 litres of Gee which was issued on 31 May 20X3 after the physical count were included in the physical inventory. 150 litres of chemical Bee was held by ML on behalf of a customer, whereas 100 litres of chemical Gee was held by one of the suppliers on ML s behalf. 100 litres of Bee and 200 litres of Gee were returned from the production process on 31 May and 01 June 20X3 respectively. (vii) 240 litres of chemical Bee purchased on 12 th May and 150 litres of chemical Gee purchased on 24 th May 20X3 were inadvertently recorded as 420 litres and 250 litres respectively. Required (a) (b) Reconcile the physical inventory balances with the balances as per book. Determine the cost of closing inventory of chemical Bee and Gee. Also compute the cost of contaminated materials as on 31 May 20X3. (15) Emile Woolf International 3 The Institute of Chartered Accountants of Pakistan

14 Cost and management accounting CHAPTER 2 - INVENTORY MANAGEMENT 2.1 STOCK ITEMS 6786 AND 6787 (a) A company uses 15,000 units of stock item 6786 each year. The item has a purchase cost of 4 per unit. The cost of placing an order for re-supply is 220. The annual holding cost of one unit of the item is 10% of its purchase cost. (b) Required (i) (ii) What is the economic order quantity for item 6786, to the nearest unit? What would be the effect of an increase in the annual holding cost per unit on (1) the EOQ and (2) total annual ordering costs? Data relating to stores item 6787 are as follows. Daily use: Lead time for re-supply: Reorder quantity: Required 300 units 5 20 days 10,000 units What should be the reorder level for this stock item, to avoid the possibility of inventory-outs? 2.2 INVENTORY CONTROL Entity G uses 105 units of an item of inventory every week. These cost 150 per unit. They are stored in special storage units and the variable costs of holding the item is 4 per unit each year plus 2% of the inventory s cost. Required (a) (b) If placing an order for this item of material costs 390 for each order, what is the optimum order quantity to minimise annual costs? Assume that there are 52 weeks in each year. Suppose that the supplier offers a discount of 1% on the purchase price for order sizes of 2,000 units or more. What will be the order size to minimise total annual costs? Emile Woolf International 4 The Institute of Chartered Accountants of Pakistan

15 Question bank: Objective test and long-form questions 2.3 ALPHA MOTORS (PVT.) LTD Alpha Motors (Pvt.) Ltd. uses a special gasket for its automobiles which is purchased from a local manufacturer. The following information has been made available by the procurement department: Annual requirement (no. of gaskets) 162,000 Cost per gasket () 1,000 Ordering cost per order () 27,000 Carrying cost per gasket () 300 The gaskets are used evenly throughout the year. The lead time for an order is normally 11 days but it can take as much as 15 days. The delivery time and the probability of their occurrence are given below: Required 2.4 ABC Delivery time (in days) Probability of occurrence 11 68% 12 12% 13 10% 14 6% 15 4% (a) Compute the Economic Order Quantity (EOQ) and the total Ordering Costs based on EOQ. (04) (b) What would be the safety stock and re-order level if the company is willing to take: a 20% risk of being out of stock? a 10% risk of being out of stock? (08) Note: Assume a 360 day year. ABC has recently established a new unit in Multan. Its planning for the first year of operation depicts the following: (i) Cash sales 600,000 units (ii) Credit sales 1,200,000 units (iii) Ending inventory Equivalent to 15 days sales (iv) Number of working days in the year 300 (v) Expected purchase price 450 per unit (vi) Manufacturer offers 2% discount on purchase of 500 units or more as bulk quantity discount. The company intends to avail this discount. (vii) Carrying costs include: Financial cost of investment in 16% per annum. Godown rent of 10,000 per month. (viii) Ordering costs are 300 per order. Required Compute the Economic Order Quantity (EOQ) and the estimated carrying costs and ordering costs for the first year of operation. (10) Emile Woolf International 5 The Institute of Chartered Accountants of Pakistan

16 Cost and management accounting 2.5 KARACHI LIMITED (a) Karachi Limited is a large retailer of sports goods. The company buys footballs from a supplier in Sialkot. Karachi Limited uses its own truck to pick the footballs from Sialkot. The truck capacity is 2,000 footballs per trip and the company has been getting a full load of footballs at each trip, making 12 trips each year. Recently the supplier revised its prices and offered quantity discount as under: Quantity Unit price () 2, , , , , Other related data is given below: All the purchases are required to be made in lots of 1,000 footballs. The cost of making one trip is 15,000. The company has the option to hire a third party for transportation which would charge 9 per football. The cost of placing an order is 2,000. The carrying cost of one football for one year is 80. (b) Required (i) (ii) Work out the most economical option. Compute the annual savings in case the company revises its policy in accordance with the computation in (i) above. (10) Briefly describe: (i) (ii) (iii) Stock out costs Lead time Reorder point (iv) Safety stock (04) Emile Woolf International 6 The Institute of Chartered Accountants of Pakistan

17 Question bank: Objective test and long-form questions 2.6 MODERN DISTRIBUTORS LIMITED Modern Distributors Limited (MDL) is a distributor of CALTIN which is used in various industries and its demand is evenly distributed throughout the year. The related information is as follows: (i) Annual demand in the country is 240,000 tons whereas MDL s share is 32.5% thereof. (ii) The average sale price is 22,125 per ton whereas the profit margin is 25% of cost. (iii) (iv) (v) (vi) Required The annual variable costs associated with purchasing department are expected to be 4,224,000 during the current year. It has been estimated that 10% of the variable costs relate to purchasing of CALTIN. Presently, MDL follows the policy of purchasing 6,500 tons at a time. Carrying cost is estimated at 1% of cost of material. MDL maintains a buffer stock of 2,000 tons. Compute the amount of savings that can be achieved if MDL adopts the policy of placing orders based on Economic Order Quantity. (15) 2.7 ROBIN LIMITED Robin Limited (RL) imports a high value component for its manufacturing process. Following data, relating to the component, has been extracted from RL s records for the last twelve months: Maximum usage in a month Minimum usage in a month Average usage in a month Maximum lead time Minimum lead time Re-order quantity Required 300 units 200 units 225 units 6 months 2 months 750 units Calculate the average stock level for the component. (05) Emile Woolf International 7 The Institute of Chartered Accountants of Pakistan

18 Cost and management accounting 2.8 ORE LIMITED Ore Limited (OL) is a manufacturer of sports bicycles. The company buys tyres from a local vendor. Following data, relating to a pair of tyres, has been extracted from OL s records: Cost (per unit) Storage cost based on average inventory 80 Insurance cost based on average inventory 60 Store keeper s salary (included in absorbed overheads) 8 Cost incurred on final quality check at the time of delivery 10 Other relevant details are as follows: (i) (ii) The purchase price is 900 per pair. The annual demand for tyres is 200,000 pairs. (iii) The ordering cost per order is 8,000. (iv) The delivery cost per order is 3,000. (v) OL s rate of return on investment in inventory is 15%. (vi) Required Recently the vendor has offered a quantity discount of 3% on orders of a minimum of 5,000 pairs. Evaluate whether OL should avail the quantity discount from the vendor. (10) 2.9 EXPLAIN Explain briefly what is meant by the term inventory control. Describe, giving reasons, the method of stock valuation which should be used in times of fluctuating prices. (05) Emile Woolf International 8 The Institute of Chartered Accountants of Pakistan

19 Question bank: Objective test and long-form questions CHAPTER 3 - ACCOUNTING FOR OVERHEADS 3.1 OVERHEAD COST PER UNIT A company makes two products, Product X and Product Y. Each product is processed through two cost centres, CC1 and CC2. The following budgeted data is available. CC1 CC2 Allocated and apportioned overheads 126, ,000 (All overheads are fixed costs.) Direct labour hours per unit Product X Product Y The budgeted production is 12,000 units of Product X and 10,000 units of Product Y. Fixed overheads are absorbed into costs on a direct labour hour basis. Required Calculate the budgeted total fixed overhead cost per unit for Product X and for Product Y. 3.2 APPORTIONMENT A production centre has three production departments, A, B and C. Budgeted production overhead costs for the next period are as follows: Factory rent 60,000 Equipment depreciation 80,000 Insurance 20,000 Heating and lighting 18,000 Indirect materials: Department A 7,000 Department B 6,600 Department C 9,400 Indirect labour: Department A 40,000 Department B 27,000 Department C 20,000 Insurance costs relate mainly to health and safety insurance, and will be apportioned on the basis of the number of employees in each department. Heating and lighting costs will be apportioned on the basis of volume. Other relevant information is as follows: Total Department A Department B Department C Direct labour hours 18,000 8,000 6,000 4,000 Number of employees Floor area (square metres) 1, Cost of equipment 1, (000s) Volume (cubic metres) 18,000 8,000 6,000 4,000 Emile Woolf International 9 The Institute of Chartered Accountants of Pakistan

20 Cost and management accounting Required (a) (b) (c) Calculate the overhead costs for each production department. Calculate an overhead absorption rate for the period for each department, assuming that a separate direct labour hour absorption rate is used for each department. Calculate an overhead absorption rate for the period, assuming that a single factory-wide direct labour hour absorption rate is used. 3.3 SERVICE DEPARTMENTS In a factory with four production departments and two service departments, the operating costs for the month of October were as shown below. Production Department 1 700,000 Production Department 2 300,000 Production Department 3 400,000 Service departments Canteen 78,000 Boiler house 100,000 1,578,000 The costs of running the canteen are apportioned to each department on the basis of the estimated use of the canteen by employees in each department. The costs of the boiler house are apportioned on the basis of the estimated consumption of power by each department. The service departments costs are therefore apportioned as follows: Canteen Boiler house % % Production Department Production Department Production Department Service departments Canteen - 20 Boiler house 10 - Required Prepare a statement showing the allocation of costs to the production departments using: (a) (b) the repeated distribution method the simultaneous equations method. Emile Woolf International 10 The Institute of Chartered Accountants of Pakistan

21 Question bank: Objective test and long-form questions 3.4 ZIA TEXTILE MILLS (a) (b) Explain the treatment of under-absorbed and over-absorbed factory overheads. Give three reasons for under-absorbed / over absorbed factory overheads. (06) On December 1, 20X3 Zia Textile Mills Limited purchased a new cutting machine for 1,300,000 to augment the capacity of five existing machines in the Cutting Department. The new machine has an estimated life of 10 years after which its scrap value is estimated at 100,000. It is the policy of the company to charge depreciation on straight line basis. The new machine will be available to Cutting Department with effect from February 1, 20X4. It is budgeted that the machine will work for 2,600 hours in 20X4. The budgeted hours include: 80 hours for setting up the machine; and 120 hours for maintenance. The related expenses, for the year 20X4 have been estimated as under: (i) (ii) (iii) (iv) (v) Electricity used by the machine during the production will be 10 units per 8.50 per unit. Cost of maintenance will be 25,000 per month. The machine requires replacement of a part at the end of every month which will cost 10,000 on each replacement. A machine operator will be employed at 9,000 per month. It is estimated that on installation of the machine, other departmental overheads will increase by 5,000 per month. Cutting Department uses a single rate for the recovery of running costs of the machines. It has been budgeted that other five machines will work for 12,500 hours during the year 20X4, including 900 hours for maintenance. Presently, the Cutting Department is charging 390 per productive hour for recovery of running cost of the existing machines. Required Compute the revised machine hour rate which the Cutting Department should use during the year 20X4. (08) Emile Woolf International 11 The Institute of Chartered Accountants of Pakistan

22 Cost and management accounting 3.5 TERNARY ENGINEERING LIMITED Ternary Engineering Limited produces front and rear fenders for a motorcycle manufacturer. It has three production departments and two service departments. Overheads are allocated on the basis of direct labour hours. The management is considering changing the basis of overhead allocation from a single overhead absorption rate to departmental overhead rate. The estimated annual overheads for the five departments are as under: Production Departments Service Fabrication Phosphate Painting Inspection Maintenance Direct materials 6, Direct labour 1, Indirect material Other variable overheads Fixed overheads Total departmental expenses 8, , Maximum production capacity 20,000 25,000 30,000 Direct labour hours 24,000 9,600 12,000 Machine hours 9,000 1,000 1,200 Use of service departments: Maintenance - Labour hours Inspection - Inspection hours 1, ,500 Required (a) Compute the single overhead absorption rate for the next year. (06) (b) Compute the departmental overhead absorption rates in accordance with the following: The Maintenance Department costs are allocated to the production department on the basis of labour hours. The Inspection Department costs are allocated on the basis of inspection hours. The Fabrication Department overhead absorption rate is based on machine hours whereas the overhead rates for Phosphate and Painting Departments is based on direct labour hours. (10) Emile Woolf International 12 The Institute of Chartered Accountants of Pakistan

23 Question bank: Objective test and long-form questions 3.6 PRODUCTION AND SERVICE The expenses of the production and service departments of a company for a year are as follows: Department Expenses before Service provided (%age) distribution of service department costs Dept. X Dept. Y 000 Production department - A B Service department X Y Required Allocate the service departments expenses to production departments by: Repeated distribution method Simultaneous equation method (13) 3.7 RT LIMITED Following information has been extracted from the records of RT Limited for August 20X3: Departments Production Service P-1 P-2 P-3 S-1 S-2 Budgeted machine hours 60, , ,000 Actual machine hours 60, , ,000 Budgeted labour hours 50, ,000 75,000 Actual labour hours 55, ,000 75,000 Budgeted material cost ( 50,000 40,000 3, ) Actual material cost ( 000) 50,000 42,000 3,200 Budgeted overheads ( 000) 1,200 2,000 2, Actual overheads ( 000) 1,250 2,000 1, Services provided by S-1 20% 30% 40% - 10% Services provided by S-2 30% 40% 20% 10% - Basis of overhead application Machine hours Labour hours 75% of Material cost Required (a) Allocate costs of service departments using repeated distribution method. (b) Compute department wise over / under applied overheads. (12) Emile Woolf International 13 The Institute of Chartered Accountants of Pakistan

24 Cost and management accounting 3.8 AHSAN ENTERPRISES Ahsan Enterprises (AE) produces three products Alpha, Beta and Gamma. The management has some reservations on the method of costing. Consequently, the cost accountant has reviewed the records and gathered the following information: (i) (ii) The costs incurred during the latest quarter were as follows: Rupees Direct material 240,000 Direct labour 1,680,000 Indirect wages machine maintenance 600,000 stores 360,000 quality control 468,000 cleaning and related services 400,000 Fuel and power 2,800,000 Depreciation on plant, machinery and building 1,560,000 Insurance on plant and machinery 240,000 Insurance on building 60,000 Stores, spares and supplies consumed 1,800,000 Rent, rates and taxes 1,200,000 The production report for the previous quarter depicted the following information: Production (units) Direct labour hours per unit Machine hours per unit Inspection hours per unit Alpha 12, Beta 20, Gamma 45, (iii) Other relevant details are as follows: Alpha Beta Gamma Factory space utilization 40% 35% 25% Cost of machinery ( in thousands) 6,000 4,000 3,000 Stores consumption ( in thousands) No. of units inspected ,350 The rate of depreciation for plant and machinery is 10% per annum. Required (a) (b) Determine the factory overhead cost per unit for products Alpha, Beta and Gamma by using single factory overhead rate based on direct labour hours. Recalculate the factory overhead cost per unit, for each product, by allocating individual expenses on the basis of specific utilisation of related facilities. (13) Emile Woolf International 14 The Institute of Chartered Accountants of Pakistan

25 Question bank: Objective test and long-form questions 3.9 AMBER LIMITED Amber Limited (AL) manufactures a single product. Following information pertaining to the year 20X4 has been extracted from the records of the company s three production departments. Budgeted Actual Department Material Labour Machine in million Hours A , ,000 B , ,000 C , ,000 A , ,000 B , ,000 C , ,000 AL produced 3.57 million units during the period. The budgeted labour rate per hour is 120. The overheads for department-a is budgeted at 5.0 million, for department-b at 15% of labour cost and for department-c at 5% of prime cost of the respective departments. Actual overheads for department A, B and C are 5.35 million, 8.90 million and 7.45 million respectively. Overheads are allocated on the following basis: Department-A Department-B Department-C Machine hours Labour hours Percentage of Prime cost There was no beginning or ending inventory in any of the production departments. Required (a) Budgeted overhead application rate for each department. (05) (b) The total and departmental actual cost for each unit of product. (08) (c) The over or under applied overhead for each department. (03) Emile Woolf International 15 The Institute of Chartered Accountants of Pakistan

26 Cost and management accounting 3.10 SPARROW (PVT) LIMITED Sparrow (Pvt) Limited (SPL) is engaged in the manufacture of two products A and B. These products are manufactured on two machines M1 and M2 and are passed through two service departments, Inspection and Packing, before being delivered to the warehouse for final distribution. SPL s overhead expenses for the month of August 2011 were as follows: Rupees Electricity 2,238,000 Rent 1,492,000 Operational expenses of machine M1 5,500,000 Operational expenses of machine M2 3,200,000 Following information relates to production of the two products during the month: A B Units produced 5,600 7,500 Labour time per unit Inspection department 15 minutes 12 minutes Labour time per unit Packing department 12 minutes 10 minutes The area occupied by the two machines M1 and M2 and the two service departments is as follows: Square feet Machine M1 5,500 Machine M2 4,800 Inspection department 12,000 Packing department 15,000 Machine M1 has produced 50% units of product A and 65% units of product B whereas machine M2 has produced 50% units of product A and 35% units of product B. Required Allocate overhead expenses to both the products A and B. (18) Emile Woolf International 16 The Institute of Chartered Accountants of Pakistan

27 Question bank: Objective test and long-form questions CHAPTER 4 MARGINAL COSTING AND ABSORPTION COSTING 4.1 DIFFERENCES Entity T manufactures a single product, and uses absorption costing. The following data relates to the performance of the entity during October. Profit Over-absorbed overhead Sales (48,000 units) Non-production overheads (all fixed costs) Opening inventory Closing inventory 37,000 24, , , , ,000 Units of inventory are valued at 9 each, consisting of a variable cost (all direct costs) of 3 and a fixed overhead cost of 6. All overhead costs are fixed costs. Required Calculate: (a) (b) the actual production overhead cost for October the profit that would have been reported in October if Entity T had used marginal costing. 4.2 MARGINAL AND ABSORPTION Entity RH makes and sells one product. Currently, it uses absorption costing to measure profits and inventory values. The budgeted production cost per unit is as follows: Direct labour 3 hours at 6 per hour 18 Direct materials 4 kilograms at 7 per kilo 28 Production overhead (Fixed cost) Normal output volume is 16,000 units per year and this volume is used to establish the fixed overhead absorption rate for each year. Costs relating to sales, distribution and administration are: Variable Fixed 20% of sales value 180,000 per year. There were no units of finished goods inventory at 1 October Year 5. The fixed overhead expenditure is spread evenly throughout the year. The selling price per unit is 140. For the two six-monthly periods detailed below, the number of units to be produced and sold are budgeted as follows: Six months ending 31 March Year 6 Six months ending 30 September Year 6 Production 8,500 units 7,000 units Sales 7,000 units 8,000 units Emile Woolf International 17 The Institute of Chartered Accountants of Pakistan

28 Cost and management accounting The entity is considering whether to abandon absorption costing and use marginal costing instead for profit reporting and inventory valuation. Required (a) (b) (c) Calculate the budgeted fixed production overhead costs each year. Prepare statements for management showing sales, costs and profits for each of the six-monthly periods, using: (i) (ii) marginal costing absorption costing Prepare an explanatory statement reconciling for each six-monthly period the profit using marginal costing with the profit using absorption costing. 4.3 ZULFIQAR LIMITED Zulfiqar Limited makes and sells a single product and has the total production capacity of 30,000 units per month. The company budgeted the following information for the month of January 20X4: Normal capacity (units) 27,000 Variable costs per unit: Production () 110 Selling and administration () 25 Fixed overheads: Production () 756,000 Selling and administration () 504,000 The actual operating data for January 20X4 is as follows: Production 250 per unit Opening stock of finished goods 24,000 units 22,000 units 2,000 units During the month of January 20X4, the variable factory overheads exceeded the budget by 120,000. Required (a) Prepare profit statement for the month of January using: marginal costing; and absorption costing. (b) Reconcile the difference in profits under the two methods. (15) Emile Woolf International 18 The Institute of Chartered Accountants of Pakistan

29 Question bank: Objective test and long-form questions 4.4 ATF LIMITED Following information has been extracted from the financial records of ATF Limited: Production during the year units 35,000 Finished goods at the beginning of the year units 3,000 Finished goods at the end of the year units 1,500 Sale price per unit 200 Fixed overhead cost for the year 1,000,000 Administration and selling expenses 200,000 Annual budgeted capacity of the plant units 40,000 The actual cost per unit, incurred during the year, was as follows: Rupees Material 70 Labour 40 Variable overheads 30 Company uses FIFO method for valuation of inventory. The cost of opening finished goods inventory determined under the absorption costing method system was 450,000. Fixed overhead constituted 16% of the total cost last year. Required (a) (b) Prepare profit statements for the year, under absorption and marginal costing systems. Prepare reconciliation between the net profits determined under each system. (12) 4.5 MAZAHIR (PAKISTAN) LIMITED Mazahir (Pakistan) Limited manufactures and sells a consumer product Zee. Relevant information relating to the year ended June 30, 20X3 is as under: Raw material per unit Actual labour time per unit (same as budgeted) Actual machine hours per unit (same as budgeted) Variable production overheads Fixed production overheads Annual sales Annual production Selling and administration overheads (70% fixed) 5 kg at 60 per kg 4 hours at 75 per hour 3 hours 15 per machine hour 6 million 19,000 units 18,000 units 10 million Salient features of the business plan for the year ending June 30, 20X4 are as under: (i) Sale is budgeted at 21,000 units at the rate of 1,100 per unit. (ii) Cost of raw material is budgeted to increase by 4%. (iii) A quality control consultant will be hired to check the quality of raw material. It will help improve the quality of material procured and reduce raw material usage by 5%. Payment will be made to the consultant at 2 per kg. Emile Woolf International 19 The Institute of Chartered Accountants of Pakistan

30 Cost and management accounting (iv) The management has negotiated a new agreement with labour union whereby wages would be increased by 10%. The following measures have been planned to improve the efficiency: 30% of the savings in labour cost would be paid as bonus. A training consultant will be hired at a cost of 300,000 per annum to improve the working capabilities of the workers. On account of the above measures, it is estimated that labour time will be reduced by 15%. (v) Variable production overheads will increase by 5%. (vi) Fixed production overheads are expected to increase at the rate of 8% on account of inflation. Fixed overheads are allocated on the basis of machine hours. (vii) The company has a policy of maintaining closing stock at 5% of sales. In order to avoid stock-outs, closing stock would now be maintained at 10% of sales. The closing stocks are valued on FIFO basis. Required (a) Prepare a budgeted profit and loss statement for the year ending June 30, 20X4 under marginal and absorption costing. (b) Reconcile the profit worked out under the two methods. (20) 4.6 SILVER LIMITED Silver Limited (SL) produces and markets a single product. Following budgeted information is available from SL s records for the month of March 20X4: Volumes: Sales 100,000 units Production 120,000 units Standard costs: Direct materials per unit 0.8 kg at 60 per kg Labour per unit 27 minutes at 80 per hour Variable production overheads 40 per labour hour Variable selling expenses 15 per unit Fixed selling expenses 800,000 Fixed production overheads, at a normal output level of 105,000 units per month, are estimated at 2,100,000. The estimated selling price is 180 per unit. Required Assuming there are no opening stocks, prepare SL s budgeted profit and loss statement for the month of March 20X4 using absorption costing. (05) Emile Woolf International 20 The Institute of Chartered Accountants of Pakistan

31 Question bank: Objective test and long-form questions CHAPTER 5 COST FLOW IN PRODUCTION 5.1 COST LEDGER At 1 July a manufacturing company had the following balances in the general ledger adjustment account in its cost ledger: Balance brought forward (credit) 5,625 Stores ledger control account 2,125 Finished goods stock control account 1,500 Work in progress control account 2,000 Required Open ledger accounts for the above items in the cost ledger, post the following items which occurred in the four-month period up to 31 October and open up other accounts as considered necessary, including a costing profit and loss account. Stock material purchased 12,000 Stock materials issued to production 12,500 Stock materials issued to maintenance department 1,000 Wages direct 10,830 Included in direct wages is indirect work 600 Factory overheads incurred 4,200 Factory overheads absorbed into production 5,800 Work transferred to finished stock, at cost 24,000 Factory cost of sales 22,500 Sales at selling price 28,750 Administrative and selling costs (to be written off against profits) 4,250 (16) 5.2 KAAT LTD Kaat Ltd operates separate cost accounting and financial accounting systems. The following manufacturing and trading statement has been prepared from the financial accounts for the quarter ended 31 March. Raw materials Opening stock 48,000 Purchases 108, ,800 Closing stock (52,000) Raw materials consumed 104,800 Direct wages 40,200 Production overhead 60,900 Production cost incurred 205,900 Emile Woolf International 21 The Institute of Chartered Accountants of Pakistan

32 Cost and management accounting Work in progress Opening stock 64,000 Closing stock (58,000) 6,000 Cost of goods produced carried down 211,900 Sales 440,000 Cost of goods sold Finished goods opening stock 120,000 Cost of goods produced brought down 211, ,900 Finished goods closing stock (121,900) (210,000) Gross profit 230,000 The following information has been extracted from the cost accounts: Control account balances at 1 January Raw material stores 49,500 Work in progress 60,100 Finished goods 115,400 Transactions for the quarter Raw materials issued 104,800 Cost of goods produced 222,500 Cost of goods sold 212,100 Loss of materials damaged by flood (insurance claim pending) 2,400 A notional rent of 4,000 per month has been charged in the cost accounts. Production overhead was absorbed at the rate of 185% of direct wages. Profit at the end of the period is shown as 238,970. Required (a) (b) Prepare the following control accounts in the cost ledger: (i) (ii) (iii) Raw materials stores Work in progress Finished goods (iv) Production overhead. (9) Prepare a statement reconciling the gross profit as per the cost accounts and the financial accounts. (3) (12) Emile Woolf International 22 The Institute of Chartered Accountants of Pakistan

33 Question bank: Objective test and long-form questions 5.3 MIRZA LIMITED Mirza Limited is engaged in the manufacturing of spare parts for automobile industry. The company records the purchase and issue of materials in a store ledger which is not integrated with the financial ledger. It is the policy of the company to value inventories on weighted average basis. The valuation is carried out by the Finance Department using stores memorandum record. A physical stock count is carried out after every six months. Any shortage/excess is then adjusted in the financial as well as stores ledger. On December 31, 20X3, physical stock count was conducted by the Internal Auditor of the company. He submitted the following statement to the Finance Department: Balance (in units) Cost per unit () Item Code Store Ledger Financial Records Physical Average Current ,500 20,500 20, ,000 10,000 10, ,500 5,500 5, ,000 4,500 5, ,200 1,200 1, On scrutinizing the details, Finance Department was able to ascertain the following reasons: Item Code Reasons 500 units were defective and therefore the Internal Auditor excluded them while taking the physical count. This item is not in use and is considered obsolete. The net realizable value is 0.60 per unit Shortage is due to theft A receipt of 1,000 units was not recorded. The remaining difference is due to errors in recording the quantity issued. 200 units returned to a supplier were not recorded. The invoiced cost was 3 per unit Discrepancy is due to incorrect recording of a Goods Receipt Note. Required (a) (b) Prepare necessary Journal entries to record the adjustments in the financial ledger. State how would you make the necessary adjustments in the stores ledger? (14) Emile Woolf International 23 The Institute of Chartered Accountants of Pakistan

34 Cost and management accounting 5.4 QUALITY LIMITED Quality Limited (QL) is a manufacturer of washing machines. The company uses perpetual method for recording and weighted average method for valuation of inventory. The following information pertains to a raw material (SRM), for the month of June 20X3. (i) (ii) Opening inventory of SRM was 100,000 units having a value of 80 per unit. 150,000 units were purchased on June 5, at 85 per unit (iii) 150,000 units were issued from stores on June 6. (iv) (v) (vi) 5,000 defective units were returned from the production to the store on June ,000 units were purchased on June 15 at per unit. On June 17, 50% of the defective units were disposed of as scrap, for 20 per unit, because these had been damaged on account of improper handling at QL. (vii) On June 18, the remaining defective units were returned to the supplier for replacement under warranty. (viii) On June 19, 5,000 units were issued to production in replacement of the defective units which were returned to store. (ix) On June 20, the supplier delivered 2,500 units in replacement of the defective units which had been returned by QL. (x) 150,000 units were issued from stores on June 21. (xi) During physical stock count carried out on June 30, 2010 it was noted that closing inventory of SRM included 500 obsolete units having net realizable value of 30 per unit. 4,000 units were found short. Required Prepare necessary journal entries to record the above transactions. (15) Emile Woolf International 24 The Institute of Chartered Accountants of Pakistan

35 Question bank: Objective test and long-form questions 5.5 SAPPHIRE LIMITED (a) (b) Briefly describe the following terms: (i) (ii) (iii) Marginal cost Stock out cost Sunk cost (iv) Cost unit (06) Sapphire limited (SL) fabricates parts for auto manufacturers and follows job order costing. The company s head office is situated in Lahore but the factory is in Karachi. A separate set of records is kept at the head office and at the factory. Following details were extracted from SL s records for the month of February 20X4. Jobs A B C Materials issued to production (units) Material X 40,000-10,000 Material Y - 75,000 25,000 Direct labour hours worked (hours) 6,000 9,000 15,000 Labour rate per hour () The other related information is as follows: (i) (ii) (iii) (iv) (v) Materials purchased on account: 100,000 units of material X at 25 per unit 150,000 units of material Y at 35 per unit The head office prepared the payroll and deducted 8% for payroll taxes. The payroll amounted to 3.0 million out of which 1.0 million pertained to selling and administrative staff salaries. After charging direct labour cost to each job the balance amount of payroll cost was attributed to general factory overhead. Factory overhead was applied to the jobs at 25 per direct labour hour. Actual factory overheads amounted to 700,000 including depreciation on machinery amounting to 400,000. All payments were made by head office. Over or under-applied factory overheads are closed to cost of goods sold account. (vi) Jobs A and B were completed during the month. Job A was sold for 2.0 million to one of the auto manufacturer on credit. The customer however, agreed to settle the transaction at 2% cash discount. (vii) Selling and administrative expenses, other than salaries paid during the month were 500,000. Required Prepare journal entries to record all the above transactions in SL s factory ledger and general ledger for the month of February 20X4. (16) Emile Woolf International 25 The Institute of Chartered Accountants of Pakistan

36 Cost and management accounting CHAPTER 6 JOB, BATCH AND SERVICE COSTING 6.1 JOB 6789 A company operates a job costing system. Job number 6789 will require 345 of direct materials and 210 of direct labour, which is paid 14 per hour. Production overheads are absorbed at the rate of 30 per direct labour hour and non-production overheads are absorbed at the rate of 40% of prime cost. Required What is the total expected cost of the job? 6.2 AHMER AND COMPANY Ahmer and Company is engaged in production of engineering parts. It receives bulk orders from bicycle manufacturers and follows job order costing. On July 1, 20X3 two jobs were in progress whereas two jobs were opened during the year. The details are as follows: JOBS A B C D Work in process opening () 1,400,000 2,500, Raw material issued from stores () 800,000 1,200,000 1,500, ,000 Direct labour hours worked (Hours) 20,000 30,000 15,000 18,000 Rate of direct labour per hour () Other related information is as follows: (i) Factory overhead is applied to the jobs at 10 per labour hour. (ii) Actual factory overheads for the year amounted to 900,000. (iii) (iv) (v) Required Under/over applied factory overheads are charged to profit and loss account. Job A was completed during the year. All the goods were shipped to the customers. Job B was also completed during the year. However, about 10% of the goods were rejected during inspection. These were transferred to Job C where they will be used after necessary adjustments. Prepare journal entries to record all the above transactions. (14) Emile Woolf International 26 The Institute of Chartered Accountants of Pakistan

37 Question bank: Objective test and long-form questions CHAPTER 7 PROCESS COSTING 7.1 PROCESS COSTING: THE BASIC RULES The following examples take you through the basic rules for process costing. Required For each of the following examples, calculate: (a) (b) the cost of completed output from the process, and if there is any, the cost of any abnormal loss or the value of any abnormal gain Example 1 1,500 litres of a liquid were input to a process at a cost of 7,200. Normal loss is 20% of the input quantity. Actual loss was equal to the normal loss. Example 2 1,500 litres of liquid were input to a process at a cost of 7,200. A normal loss of 20% of the input is expected. The actual output for the period was only 1,100 litres. Example 3 1,500 litres of liquid were input to a process at a cost of 7,200. A normal loss of 20% of the input is expected. Loss is sold as scrap, for a net sales price of 0.40 per litre. The actual output from the process was 1,200 litres. Example 4 1,500 litres of liquid were input to a process at a cost of 7,200. The output from the process was 1,100 litres. Normal loss is 20% of the input quantity. Any lost units have a scrap value of 0.40 per litre. Example 5 1,500 litres of liquid were input to a process at a cost of 7,200. Normal loss is 20% of the input quantity but the actual output for the period was 1,250 litres. Loss has no scrap value. Example 6 1,500 litres of liquid were input to a process at a cost of 7,200. The output from the process was 1,250 units. Normal loss is 20% of the input quantity. Any lost units have a scrap value of 0.40 per litre. 7.2 PROCESS 1 AND PROCESS 2 A manufacturing company operates two processes. Output from Process 1 is transferred as input to Process 2. Output from Process 2 is the finished product. Data for the two processes in January are as follows: Process 1 Opening work in process Nil Units introduced into the process 14,000 Units completed and transferred to the next process 10,000 (Process 2) Closing work-in-progress 4,000 Material cost added during the period 70,000 Conversion cost added during the period 48,000 Emile Woolf International 27 The Institute of Chartered Accountants of Pakistan