Indian Institute of Management Kashipur

Programme : PGP (2017 - 19) Date : 26/12/2017

Exam : End - Term Duration : 3 hours
Course : Management Accounting Marks : 50
Note:
1. Close book/notes examination. Laptops are not allowed. Only calculator is allowed.
2. Paper is divided in two sections – Section A and Section B. In section A, there are three
questions; you have to attempt any two questions out of them. Each question in this
section carries 15 marks. In Section B, there is only one question – Question No 4. This
question is compulsory and carries 20 marks.
3. Please show your calculations clearly.

Section A

1. J.T. Brooks and Company, a manufacturer of quality handmade walnut bowls, has had a
steady growth in sales for the past 5 years. However, increased competition has led Mr.
Brooks, the president, to believe that an aggressive marketing campaign will be necessary
next year to maintain the company’s present growth. To prepare for next year’s marketing
campaign, the company’s controller has prepared and presented Mr. Brooks with the
following data for the current year, 2017:

Variable cost (per bowl):

Direct materials $ 3.00
Direct manufacturing labour 8.00
Variable overhead (manufacturing, marketing,
distribution, and customer service) 7.50
Total variable cost per bowl $18.50
Fixed costs:
Manufacturing $ 20,000
Marketing, distribution, and customer service 194,500
Total fixed costs $214,500
Selling price $ 35.00
Expected sales, 22,000 units $770,000
Income tax rate 40%

Required:
a) What is the projected after tax net income for 2017?
b) What is the breakeven point in units for 2017?
c) Mr. Brooks has set the revenue target for 2018 at a level of $875,000 (or 25,000 bowls).
He believes an additional marketing cost of $16,500 for advertising in 2018, with all
other costs remaining constant, will be necessary to attain the revenue target. What is
the after tax net income for 2018 if the additional $16,500 is spent and the revenue target
is met?
d) What is the breakeven point in revenues for 2018 if the additional $16,500 is spent for
advertising?
e) If the additional $16,500 is spent, what are the required 2018 revenues for 2018 net
income to equal 2017 net income?
f) At a sales level of 25,000 units, what maximum amount can be spent on advertising if a
2018 after tax net income of $108,450 is desired?
2. Excel Corporation manufactures three products at its plant. The plant capacity is limited to
120,000 machine hours per year on a single-shift basis. Direct material and direct labour
costs are variable. The following data are available for planning purposes:

Total Direct Direct

Demand Sales Material Labour Variable Machine
(units) for price per Cost per Cost per Overheads hours per
Product next year unit unit unit per unit unit
XL1 2,00,000 $10.00 $4.00 $2.00 $2.00 0.20
XL2 2,00,000 14.00 4.50 3.00 3.00 0.35
XL3 2,00,000 12.00 5.00 2.50 2.50 0.25

Required:
a) Given the capacity constraint, determine the production levels for the three products
that will maximize profits.
b) The company can add more machine hours working overtime; however, the direct
labour cost per unit will be higher by 50% for the units produced during overtime
because of the overtime premium. Materials cost and variable overhead cost per unit
will be the same for overtime production as regular production. Is it worthwhile
operating overtime? If yes, how many hours of overtime should be engaged? Show
your calculations clearly.
c) If fixed costs are Rs 3,50,000, what will be company’s operating profit if i) no
overtime hours are engaged, ii) overtime hours are engaged.
3. Your company is to carry out a major modernization of its factory commencing in two
weeks’ time. During the modernization, which is expected to take four weeks to complete,
no production of the company’s single product will be possible. Company wants to have
sufficient finished goods inventory to meet out the demand during this period. The company
is also interested to effectively manage its liquidity during this period; therefore, you are
assigned to prepare a cash budget for next six weeks, on weekly basis.
You have the following relevant information:
Sales/Debtors: Company produces and sells a single product. Demand for the product at
Rs100 per unit is expected to continue at 800 units per week (the level of sales
achieved for the last four weeks) for one further week. It is then expected to reduce
to 700 units per week for three weeks, before rising to a level of 900 units per week
where it is expected to remain for several weeks. All sales are on credit, 50 per cent
being received in cash in the week following the week of sale and 50 per cent in the
week after that.
Production/Finished goods stock: Production will be at a level of 1200 units per week for
the next two weeks. Then production will be stopped for major modernization for
next four weeks. Finished goods stock is 2800 units at the beginning of week 1.
Raw material stock: Raw material stock is Rs 36 000 at the beginning of week 1. This will
be increased by the end of week 1 to Rs 40 000 and reduced to Rs10 000 by the end
of week2.
Costs:
Per unit cost of production is as follows:
Variable: Rs
Raw material 35
Direct labour 20
Overhead 10
Fixed:
Overhead 25

Fixed overheads have been apportioned to units on the basis of the normal output
level of 800 units per week and include depreciation of Rs 4000 per week.
In addition to the above unit costs, overtime premiums of Rs 5000 per week will be
incurred in weeks 1 and 2 due to increased production.

During the modernization variable costs will be avoided, except for the direct labour
cost which will continue to incur at the level equivalent to 800 units production per
week. Outlays on fixed overheads will be reduced by Rs 5000 per week.

Payments: Creditors for raw materials are paid in the week following purchase. The
outstanding amount for purchase was Rs 27 000 at the beginning of week 1. All other
payments are made in the week in which the liability is incurred.

Cost of Modernisation: The company will need Rs 50,000 per week for four weeks for
modernization.

Liquidity: The company has a bank balance of Rs 60,000 at the beginning of Week1.
Company also have marketable securities of Rs 12,00,000; which can be sold as per
requirements. Company want keep a minimum cash balance of Rs 50,000. For
additional liquidity requirements, the company want to negotiate with bank for cash
credit.

Required:
Prepare a weekly cash budget covering the six-week period up to the planned completion of
the modernization and suggest the management of the company how much funds it needs to
mobilize for its liquidity needs during the modernization.
 Section B

4. The GlassArt Co. Ltd produces and sells lead crystal glassware. The firm consists of two
divisions, Commercial and Specialty. The Commercial division manufactures 300,000
glasses per year. It incurs variable manufacturing costs of Rs 90 per unit and annual fixed
manufacturing costs of Rs 60,00,000. The Commercial division sells 100,000 units
externally at a price of Rs 120 each, mostly to department stores. It transfers the remaining
200,000 units internally to the Specialty division, which modifies the units, adds an etched
design, and sells them directly to consumers online. GlassArt Co. has adopted a market-
based transfer-pricing policy. For each glass it receives from the Commercial division, the
Specialty division pays the weighted-average external price the Commercial division
charges its customers outside the company. The current transfer price is accordingly set at
Rs 120.

The Speciality division insures variable cost depending on the specification of the glass; this
cost generally vary from Rs 20 to Rs 50; with an average of Rs 40 per glass. The division
charges the customers Rs 200 to Rs 250 per glass; average selling price comes out to be Rs
230. The speciality division has annual fixed manufacturing costs of Rs 30,00,000. In
addition to this, corporate administrative, selling and distribution overheads (all fixed) are
Rs 50,00,000. These overheads are allocated to two divisions equally.

Naveen Kumar, the manager of the Speciality division, receives an offer from Home Décor,
a chain of upscale home furnishings stores. Home Décor offers to buy 100,000 glasses at a
price of Rs 140 each, knowing that the entire lead crystal industry (including GlassArt Co.)
has excess capacity at this time. The variable manufacturing cost to the Speciality division
for the units Home Décor is requesting is Rs 20, and there are no additional costs associated
with this offer. Accepting Home Décor’s offer would not affect existing external customers.

Required:
a) Prepare a statement showing present revenue, costs and profit of the GlassArt Co. as
a whole and its divisions without accepting Home Décor’s offer.
b) Prepare another statement showing revenue, costs and profit of the GlassArt Co. as
a whole and its divisions if Home Décor’s offer is accepted. To accept the offer, the
Commercial division will produce 100,000 additional units and this will not affect
company’s existing sales.
c) From the point of view of the company as a whole do you think it is profitable to
accept the offer?
d) If divisional managers are evaluated on the basis of their divisional profit, do you
think that Naveen Kumar will accept Home Décor’s offer? Why or why not.
e) Is there a problem of goal non-congruence in GlassArt Co? if yes, how this problem
can be resolved?
f) If Commercial division is working at full capacity and additional 100,000 units to
be supplied to Home Décor will reduce external sales of Speciality division, how
your answer to above questions [from b) to e) above)] will change.
g) You are invited by GlassArt Co. as consultant to advise them on their transfer
pricing policy. Write a letter to CEO of the company Mr Subhas Kumar stating your
recommendations.