M.Com Previous Year Solved Papers: Cost and Management Accounting' 2015 (September - Incomplete)


2015 (August)
COMMERCE
Paper: 103
(Cost and Management Accounting)
Full Marks – 80
Time – Three Hours
The figures in the margin indicate full marks for the questions.
1. (a) Define ‘Costing’ and ‘Cost accounting’. Describe the importance of cost accounting as a managerial tool. 2+4+10=16
Ans: Introduction to Cost Accounting

Cost: The term ‘cost’ has to be studied in relation to its purpose and conditions. As per the definition by the Chartered Institute of Management Accountants (C.I.M.A.), London ‘cost’ is the amount of actual expenditure incurred on a given thing.
Costing: The C.I.M.A., London has defined costing as the ascertainment of costs. “It refers to the techniques and processes of ascertaining costs and studies the principles and rules concerning the determination of cost of products and services”.
Cost Accounting: It is the method of accounting for cost. The process of recording and accounting for all the elements of cost is called cost accounting. I.C.M.A. has defined cost accounting as follows: “The process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. In its widest usage it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried out or planned”.
Cost Accountancy: The term ‘Cost Accountancy’ includes Costing and Cost accounting. Its purposes are Cost-control and Profitability – ascertainment. It serves as an essential tool of the management for decision-making.
I.C.M.A., has defined cost accountancy as follows: “The application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there from for the purpose of managerial decision making”.
Advantages of Cost Accounting (Aid to Management)
a)      Helps in Decision Making: Cost accounting helps in decision making. It provides vital information necessary for decision making. For instance, cost accounting helps in deciding:
1.       Whether to make a product buy a product?
2.       Whether to accept or reject an export order?
3.       How to utilize the scarce materials profitably?
b)      Helps in fixing prices: Cost accounting helps in fixing prices. It provides detailed cost data of each product (both on the aggregate and unit basis) which enables fixation of selling price. Cost accounting provides basis information for the preparation of tenders, estimates and quotations.
c)       Formulation of future plans: Cost accounting is not a post-mortem examination. It is a system of foresight. On the basis of past experience, it helps in the formulation of definite future plans in quantitative terms. Budgets are prepared and they give direction to the enterprise.
d)      Avoidance of wastage: Cost accounting reveals the sources of losses or inefficiencies such as spoilage, leakage, pilferage, inadequate utilization of plant etc. By appropriate control measures, these wastages can be avoided or minimized.
e)      Highlights causes: The exact cause of an increase or decrease in profit or loss can be found with the aid of cost accounting. For instance, it is possible for the management to know whether the profits have decreased due to an increase in labour cost or material cost or both.
f)       Reward to efficiency: Cost accounting introduces bonus plans and incentive wage systems to suit the needs of the organization. These plans and systems reward efficient workers and improve productivity as well improve the morale of the work -force.
g)      Prevention of frauds: Cost accounting envisages sound systems of inventory control, budgetary control and standard costing. Scope for manipulation and fraud is minimized.
h)      Improvement in profitability: Cost accounting reveals unprofitable products and activities. Management can drop those products and eliminate unprofitable activities. The resources released from unprofitable products can be used to improve the profitability of the business.
i)        Preparation of final accounts: Cost accounting provides for perpetual inventory system. It helps in the preparation of interim profit and loss account and balance sheet without physical stock verification.
j)        Facilitates control: Cost accounting includes effective tools such as inventory control, budgetary control and variance analysis. By adopting them, the management can notice the deviation from the plans. Remedial action can be taken quickly.
Or
(b) Describe the benefits and limitations of Activity-based costing.                           8+8=16

2. (a) (i) Distinguish between Job costing and Process costing                    8
Ans: Difference between Job costing and Process Costing
Basis of distinction
Job Costing
Process Costing
Basic
Job costing is used when the cost object is an individual (or a lot/batch) unit or a distinct product or service.
Process Costing is generally used for a mass of identical product or service.
Accumulation of Cost
Costs can be accumulated by each individual product or service.
The Costs are accumulated in a period. The total costs in a period are divided over the number of units to get an average unit cost.
Cost Determination
Job costing is done against a specific order being produced.
Costs are compiled for each process over a period of time.
Cost Calculation
Costs are calculated when a job is over.
Costs are calculated at the end of a cost period like an accounting year.
Transfer
There are usually no transfers of costs from one job to another.
Transfer of costs from one process to another is made as the product moves from one process to the other.
Forms and Details
There is more paper work.
It has lesser paper work.
Inventory
There is little or no inventory.
There is regular and significant inventory.
Mechanization
It is less amenable to mechanization & automation.
It is more amenable to mechanization & automation.
(ii) The following data relate to a manufacturing concern:
Production
Cost of production
Normal loss
Actual loss
Scrap value
= 1,000 units
= Rs. 1,850
= 10% of production
= 150 units
= Re. 0.50 per unit
Prepare Process Account and Abnormal Loss Account                          8
(b) Why it is necessary for reconciliation of cost and financial accounts? State the reasons for differences between profits shown by both the sets of accounts.                                       6+10=16
Ans: Meaning of Reconciliation of Cost and Financial Accounts
When cost accounts and financial accounts are maintained in two different sets of books, there will be prepared two profit and loss accounts - one for costing books and the other for financial books. The profit or loss shown by costing books may not agree with that shown by financial books. Such a system is termed as, ‘Non-Integral System’ whereas under the integral system of accounting, there are no separate cost and financial accounts. Consequently, the problem of reconciliation does not arise under the integral system.
However, where two sets of accounting systems, namely, financial accounting and cost accounting are being maintained, the profit shown by the two sets of accounts may not agree with each other. Although both deal with the same basic transactions like purchases consumption of materials, wages and other expenses, the difference of purpose leads to a difference in approach in a collection, analysis and presentation of data to meet the objective of the individual system.
Financial accounts are concerned with the ascertainment of profit or loss for the whole operation of the organisation for a relatively long period, usually a year, without being too much concerned with cost computation, whereas cost accounts are concerned with the ascertainment of profit or loss made by manufacturing divisions or products for cost comparison and preparation and use of a variety of cost statements. The difference in purpose and approach generally results in a different profit figure from what is disclosed by the financial accounts and thus arises the need for the reconciliation of profit figures given by the cost accounts and financial accounts.
The reconciliation of the profit figures of the two sets of books is necessary due to the following reasons
a)      It helps to identity the reasons for the difference in the profit or loss shown by cost and financial accounts.
b)      It ensures the arithmetical accuracy and reliability of cost accounts.
c)       It contributes to the standardization of policies regarding stock valuation, depreciation and overheads.
d)      Reconciliation helps the management in exercising a more effective internal control.
Reasons for disagreement between Profits as per financial accounting and Profits as per cost accounting:
The difference in the profitability of cost and financial records may be due to the following reasons.
1)      Items included in the financial accounts but not in cost accounts.
Ø  Purely financial income- such as interest received on bank deposits, interest and dividend on investments, rent receivables, transfer fee received, profit on the sale of assets etc.
Ø  Purely financial charges – such as losses due to scraping of machinery, losses on the sale of investments and assets, interest paid on the bank loans, mortgages, debentures etc., expenses of company’s transfer office, damages payable at law etc.
Ø  Appropriation of profit – the appropriation of profit is again a matter which concerns only financial accounts. Items like payment of income tax and dividends transfer to reserve, heavy donations, writing off of preliminary expenses, goodwill and patents appear only in profit and loss appropriation account and the costing profit and loss a/c is not affected.
2)      Items included in cost accounts only: There are certain items which are included in cost accounts but not in financial accounts. They are: Charges in lieu of rent where premises are owned, interest on capital employed in production but upon which no interest is actually paid.
3)      Under/Over absorption of overhead expenses: In cost accounts, overheads are absorbed at predetermined rates which are based on past data. In the financial accounts the actual amount incurred is taken into account. There arise a difference between the actual expenses and the predetermined overheads charged to product or job.
If overheads are not fully recovered, which means that the amount of overheads absorbed in cost accounts is less than the actual amount, the shortfall is called as under recovery or under absorption. If overhead expenses recovered in cost accounts are more than that of the actually incurred, it is called over absorption. Thus, both the over and under recovery may cause the difference in the profits of both the records.
4)      Different basis of stock valuation: In cost accounts, the stock of finished goods is valued at cost by FIFO, LIFO, average rate, etc. But, in financial accounts stocks are valued either at cost or market price, whichever is less.
The valuation of work-in-progress may also lead to variation. In financial books only prime cost may be taken into account for this purpose whereas in cost accounts, it may be valued at prime cost plus factory overhead.
5)      Different basis of depreciation adopted: The rates and methods of charging depreciation may be different in two sets of accounts. 
3. (a) Prepare a comparative Balance Sheet of X Co. Ltd. from the following data and show the trend percentages:   16

2010
2011
2012
2013
2014
Liabilities and owners’ Equity:
Reserves
Long term liabilities
Current liabilities
100
73
304
213
100
78
316
183
135
125
332
235
135
125
425
264
170
96
478
307
Total Liabilities
690
677
827
949
1,051
Assets
2010
2011
2012
2013
2014
Fixed Assets
Current Assets
Investments
154
524
12
182
482
13
221
591
15
270
631
48
309
689
53
Total Assets
690
677
827
949
1,051
Or
(b) What is Common-size Statement? What are its objectives? Describe the utility of such a statement.          4+6+6=16
Ans: Common Size Statements: These are the statements which indicate the relationship of different items of a financial statement with a common item by expressing each item as a percentage of that common item. The percentage thus calculated can be easily compared with the results of corresponding percentages of the previous year or of some other firms, as the numbers are brought to common base. Such statements also allow an analyst to compare the operating and financing characteristics of two companies of different sizes in the same industry. Thus, common size statements are useful, both, in intra-firm comparisons over different years and also in making inter-firm comparisons for the same year or for several years. This analysis is also known as ‘Vertical analysis’.
Characteristics/Essentials of Common Size Statements
Common Size statements are regarded as indices of an enterprise‘s performance and position. As such, extreme care and caution should be exercised while preparing these statements. Common Size statements generally reflect the following observable characteristics:
a)      Internal Audience: Common Size statements are intended for those who have an interest in a given business enterprise. They have to be prepared on the assumption that the user is generally familiar with business practices as well as the meaning and implication of the terms used in that business.
b)      Articulation: The basic Common Size statements are interrelated and therefore are said to be articulated‘. Example: Profit and Loss account shows the Common Size results of operations and represents an increase or decrease in resources that is reflected in the various balances in the balance sheet.
c)       Historical Nature: Common Size statements generally report what has happened in the past. Though they are used increasingly as the basis for the future by prospective investors and creditors, they are not intended to provide estimates of future economic activities and their effect on income and equity.
d)      Legal and economic consequences: Common Size statements reflect elements of both economics and law. They are conceptually oriented towards economics, but many of the concepts and conventions have their origin in law. Example: Conventions of disclosure and materiality
e)      Technical Terminology: Since Common Size statements are products of a technical process called accounting‖, they involve the use of technical terms. It is, therefore, important that the users of these statements should be familiar with the different terms used therein and conversant with their interpretations and meanings.
f)       Summarization and Classification: The volume of business transaction affecting the business operations are so vast that summarization and classification of business events and items alone will enable the reader to draw out useful conclusions.
g)      Money Terms: All business transactions are quantified, measured and related in monetary terms. In the absence of this monetary unit of measurement, Common Size statements will be meaningless.
h)      Various Valuation Methods: The valuation methods are not uniform for all items found in a Balance Sheet. Example: Cash is stated at current exchange value; Accounts receivable at net realizable value; inventories at cost or market price whichever is lower; fixed assets at cost less depreciation.
i)        Accrual Basis: Most Common Size statements are prepared on accrual basis rather than on cash basis i.e., taking into account all incomes due but not received and all expenses due but not paid.
j)        Need for Estimates and judgement: Under more than one circumstance, the facts and figures to be presented through Common Size statements are to be based on estimates, personal opinions and judgements. Example: Rate of depreciation, the useful economic life of a fixed asset, provision for doubtful debts are all instances where estimates and personal judgements are involved.
k)      Verifiability: it is essential that the facts presented through Common Size statements are susceptible to objective verification, so that the reliability of these statements can be improved.
l)        Conservatism: Wherever and whenever estimates and personal judgements become essential during the course of preparation of Common Size statements, such estimates, should be based moderately on a conservative basis to avoid any possibility of overstating the assets and incomes.
m)    Understandability: Common Size statements should be prepared following the accepted accounting principles for better understanding of the users.
n)      Comparable: Common Size statements should disclose the information in such a manner that they are conformable for inter-firm and intra-firm comparison.
Merits of Common Size Statements:
a)      A common size statement facilitates both types of analysis, horizontal as well as vertical. It allows both comparisons across the years and also each individual item as shown in financial statements.
b)      Comparison of the performance and financial condition in respect of different units of the same industry can also be done.
c)       These statements help the management in making forecasts for the future.
Demerits of Common Size Statements:
a)      If there is no identical head of accounts, then inter-firm comparison will be difficult.
b)      Inter-firm comparison may be misleading if the firms are not of the same age and size, follow different accounting policies.
c)       Inter-period comparison will also be misleading if there is frequent changes in accounting policies.

4. (a) “Ratios are mechanical and incomplete.” Comment on this statement giving justifications in support of your answer.                                                16
Ans: Meaning of Ratio Analysis
A ratio is one figure expressed in terms of another figure. It is mathematical yardstick of measuring relationship of two figures or items or group of items, which are related, is each other and mutually inter-dependent. It is simply the quotient of two numbers. It can be expressed in fraction or in decimal point or in pure number. Accounting ratio is an expression relating to two figures or two accounts or two set accounting heads or group of items stated in financial statement.
Ratio analysis is the method or process of expressing relationship between items or group of items in the financial statement are computed, determined and presented. It is an attempt to draw quantitative measures or guides concerning the financial health and profitability of an enterprise. It can be used in trend and static analysis. It is the process of comparison of one figure or item or group of items with another, which make a ratio, and the appraisal of the ratios to make proper analysis of the strengths and weakness of the operations of an enterprise.
According to Myers, “Ratio analysis of financial statements is a study of relationship among various financial factors in a business as disclosed by a single set of statements and a study of trend of these factors as shown in a series of statements."
Objectives of Ratio analysis
a)      To know the area of the business which need more attention.
b)      To know about the potential areas which can be improved with the effort in the desired direction.
c)       To provide a deeper analysis of the profitability, liquidity, solvency and efficiency levels in the business.
d)      To provide information for decision making.
e)      To Judge Operational efficiency
f)       Structural analysis of the company
g)      Proper Utilization of resources and
h)      Leverage or external financing
Advantages and Uses of Ratio Analysis
There are various groups of people who are interested in analysis of financial position of a company used the ratio analysis to workout a particular financial characteristic of the company in which they are interested. Ratio analysis helps the various groups in the following manner:
a)      To workout the profitability: Accounting ratio help to measure the profitability of the business by calculating the various profitability ratios. It helps the management to know about the earning capacity of the business concern.
b)      Helpful in analysis of financial statement: Ratio analysis help the outsiders just like creditors, shareholders, debenture-holders, bankers to know about the profitability and ability of the company to pay them interest and dividend etc.
c)       Helpful in comparative analysis of the performance: With the help of ratio analysis a company may have comparative study of its performance to the previous years. In this way company comes to know about its weak point and be able to improve them.
d)      To simplify the accounting information: Accounting ratios are very useful as they briefly summaries the result of detailed and complicated computations.
e)      To workout the operating efficiency: Ratio analysis helps to workout the operating efficiency of the company with the help of various turnover ratios. All turnover ratios are worked out to evaluate the performance of the business in utilising the resources.
f)       To workout short-term financial position: Ratio analysis helps to workout the short-term financial position of the company with the help of liquidity ratios. In case short-term financial position is not healthy efforts are made to improve it.
g)      Helpful for forecasting purposes: Accounting ratios indicate the trend of the business. The trend is useful for estimating future. With the help of previous years’ ratios, estimates for future can be made.
Limitations of Ratio Analysis
In spite of many advantages, there are certain limitations of the ratio analysis techniques. The following are the main limitations of accounting ratios:
a)      Limited Comparability: Different firms apply different accounting policies. Therefore the ratio of one firm can not always be compared with the ratio of other firm.
b)      False Results: Accounting ratios are based on data drawn from accounting records. In case that data is correct, then only the ratios will be correct. For example, valuation of stock is based on very high price, the profits of the concern will be inflated and it will indicate a wrong financial position. The data therefore must be absolutely correct.
c)       Effect of Price Level Changes: Price level changes often make the comparison of figures difficult over a period of time. Changes in price affect the cost of production, sales and also the value of assets. Therefore, it is necessary to make proper adjustment for price-level changes before any comparison.
d)      Qualitative factors are ignored: Ratio analysis is a technique of quantitative analysis and thus, ignores qualitative factors, which may be important in decision making. For example, average collection period may be equal to standard credit period, but some debtors may be in the list of doubtful debts, which is not disclosed by ratio analysis.
e)      Effect of window-dressing: In order to cover up their bad financial position some companies resort to window dressing. They may record the accounting data according to the convenience to show the financial position of the company in a better way.
f)       Costly Technique: Ratio analysis is a costly technique and can be used by big business houses. Small business units are not able to afford it.
g)      Misleading Results: In the absence of absolute data, the result may be misleading. For example, the gross profit of two firms is 25%. Whereas the profit earned by one is just Rs. 5,000 and sales are Rs. 20,000 and profit earned by the other one is Rs. 10, 00,000 and sales are Rs. 40, 00,000. Even the profitability of the two firms is same but the magnitude of their business is quite different.
Or
(b) From the following Balance Sheet of a company, you are required to calculate the ratios as given below –
1)      Debt-Equity Ratio.
2)      Equity Ratio.
3)      External Equities to Total Assets Ratio.
4)      Fixed Assets or Net Worth Ratio.
5)      Current Assets to Net Worth Ratio.                                                                 4+(3x4)=16
Balance Sheet
As at ………………
Liabilities
Rs.
Assets
Rs.
3,000 Equity shares @ Rs. 100 each
7% Debentures
Reserve & Surplus
Sundry Creditors
Bills Payable
3,00,000
1,50,000
80,000
30,000
50,000
Buildings
Furniture
Machinery
Stock
Debtors
Cash balances
2,50,000
40,000
2,10,000
60,000
30,000
20,000

6,10,000

6,10,000

5. (a) Explain the meaning of working capital. Describe the factors that affect the amount of working capital requirement.                                                 6+10=16
Ans: Meaning and definition of Working Capital
The capital required for a business is of two types. These are fixed capital and working capital. Fixed capital is required for the purchase of fixed assets like building, land, machinery, furniture etc. Fixed capital is invested for long period, therefore it is known as long-term capital. Similarly, the capital, which is needed for investing in current assets, is called working capital. The capital which is needed for the regular operation of business is called working capital. Working capital is also called circulating capital or revolving capital or short-term capital.
In the words of John. J Harpton “Working capital may be defined as all the short term assets used in daily operation”.
According to “Hoagland”, “Working Capital is descriptive of that capital which is not fixed. But, the more common use of Working Capital is to consider it as the difference between the book value of the current assets and the current liabilities.
From the above definitions, Working Capital means the excess of Current Assets over Current Liabilities. Working Capital is the amount of net Current Assets. It is the investments made by a business organisation in short term Current Assets like Cash, Debtors, Bills receivable etc.
Factors Affecting Working Capital Requirement
The level of working capital is influenced by several factors which are given below:
a)      Nature of Business: Nature of business is one of the factors. Usually in trading businesses the working capital needs are higher as most of their investment is found concentrated in stock. On the other hand, manufacturing/processing business needs a relatively lower level of working capital.
b)      Size of Business: Size of business is also an influencing factor. As size increases, an absolute increase in working capital is imminent and vice versa.
c)       Production Policies: Production policies of a business organisation exert considerable influence on the requirement of Working Capital. But production policies depend on the nature of product. The level of production, decides the investment in current assets which in turn decides the quantum of working capital required.
d)      Terms of Purchase and Sale: A business organisation making purchases of goods on credit and selling the goods on cash terms would require less Working Capital whereas an organisation selling the goods on credit basis would require more Working Capital. If the payment is to be made in advance to suppliers, then large amount of Working Capital would be required. 286
e)      Production Process: If the production process requires a long period of time, greater amount of Working Capital will be required. But, simple and short production process requires less amount of Working Capital. If production process in an industry entails high cost because of its complex nature, more Working Capital will be required to finance that process and also for other expenses which vary with the cost of production whereas if production process is simple requiring less cost, less Working Capital will be required.
f)       Turnover of Circulating Capital: Turnover of circulating capital plays an important and decisive role in judging the adequacy of Working Capital. The speed with which circulating capital completes its cycle i.e. conversion of cash into inventory of raw materials, raw materials into finished goods, finished goods into debts and debts into cash decides the Working Capital requirements of an organization. Slow movement of Working Capital cycle requires large provision of Working Capital.
g)      Dividend Policies: Dividend policies of a business organisation also influence the requirement of Working Capital. If a business is following a liberal dividend policy, it requires high Working Capital to pay cash dividends where as a firm following a conservative dividend policy will require less amount of Working Capital.
h)      Seasonal Variations: In case of seasonal industries like Sugar, Oil mills etc. More Working Capital is required during peak seasons as compared to slack seasons.
i)        Business Cycle: Business expands during the period of prosperity and declines during the period of depression. More Working Capital is required during the period of prosperity and less Working Capital is required during the period of depression.
j)        Change in Technology: Changes in Technology as regards production have impact on the need of Working Capital. A firm using labour oriented technology will require more Working Capital to pay labour wages regularly.
k)      Inflation: During inflation a business concern requires more Working Capital to pay for raw materials, labour and other expenses. This may be compensated to some extent later due to possible rise in the selling price. 287
l)        Turnover of Inventories: A business organisation having low inventory turnover would require more Working Capital where as a business having high inventory turnover would require limited or less Working Capital.
m)    Taxation Policies: Government taxation policy affects the quantum of Working Capital requirements. High tax rate demands more amount of Working Capital.
n)      Degree of Co-ordination: Co-ordination between production and distribution policies is important in determining Working Capital requirements. In the absence of co-ordination between production and distribution policies more Working Capital may be required.
Or
(b) Prepare a statement showing the working capital needed to finance a level of activity of 3,00,000 units of output for the year. The cost structure for the company’s product for the above mentioned activity level is detailed below –
Elements of Cost
Cost per unit

Raw materials
Direct labour
Overheads
Rs.
20
5
15
Total cost
Profit 
40
10
Selling price
50

Raw materials are held in stock, on an average for two months. Work-in-progress will approximate to half-a-month’s production. Finished goods remain in warehouse, on an average, for a month. Suppliers of materials extend one month’s credit. Two months credit is normally allowed to debtors. A minimum cash balance of Rs. 25,000 is expected to be maintained. The production pattern is assumed to be uniform during the year.                                  16

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