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Question Paper Management Control & Information Systems (MB281) July 2005

Section A : Basic Concepts (30 Marks)


This section consists of questions with serial number 1 - 30. Answer all questions. Each question carries one mark. Maximum time for answering Section A is 30 Minutes.

1.

Which of the following statements is/are true with respect to transfer pricing? I. It motivates divisional managers to make good economic decisions. II. It is useful for evaluating performance of the divisional managers. III. It is a selling price established for goods or services sold by one division to other in the same organization. IV. It does not help in measuring divisional performances. (a) Only (I) above (c) Both (I) and (II) above (e) (I), (II) and (III) above. (b) Only (II) above (d) (I), (II), (III) and (IV) above

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2.

Bidhan Ltd. has furnished the following budgeted and actual sales for the month of June 2005: Particulars Units sold Sale price Budget 11,500 units Rs.80 per unit Actual 12,000 units Rs.71 per unit

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The company has made the same budget for the month of July 2005. If actual sales drop by 20% over the month, the company may witness a sales volume variance of (a) Rs.1,52,000 (A) (b) Rs.1,31,400 (A) (c) Rs.1,30,000 (A) (d) Rs.1,31,400 (F) 3. (e) Rs.1,52,000 (F).
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Which of the following statements is false in relation to budgets? Direct labor budget represents direct labor requirements necessary to produce the types and quantities of output planned in the production budget (b) An inventory budget can be prepared to find out the values of direct materials and finished inventory (c) A fixed budget is a budget that is prepared for a range, i.e. for more than one level of activity (d) A direct material budget indicates the expected amount of direct material required to produce the budgeted units of finished goods (e) Direct labor budget costs consist of wages paid to employees who are engaged directly in specific production output. (a)

4.

If an investment project has a profitability index of 1.20, the (a) (b) (c) (d) (e) Cost of capital of the project is greater than its internal rate of return Cost of capital used in the index calculation has to be less than 20% Projects internal rate of return is 20% Net present value of the project is positive Internal rate of return of the project exceeds its net present value.

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5.

Which of the following are techniques of cost reduction? I. II. III. IV. Using better quality materials. Pay incentives for better productivity. Cutting rates of pay. Using a cheaper material. (b) Both (I) and (II) above (d) Both (II) and (IV) above 1

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(a) Both (II) and (III) above (c) Both (I) and (III) above (e) Both (III) and (IV) above.

6.

Which of the following is not a cause for Material Usage Variance? (a) Sub-standard materials (c) Non-standard material mixture (e) Purchasing non-standard lots. (b) Pilferage of materials (d) Wastage due to inefficient mixture

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7.

In activity based costing (ABC), a cost driver is the (a) (b) (c) (d) (e) Factor which causes the costs of an activity Mechanism for accumulating the costs of an activity Cost relating to more than one product Cost relating to more than one service Overhead cost that is incurred as a direct consequence of an activity.

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8.

The process of deciding on new strategies of an organization is called (a) Strategy planning (c) Strategy formulation (b) Strategic process (d) Strategy implementation (e) Business plan.

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9.

Which of the following is/are useful with respect to value chain concept from the strategic planning perspective? I. Linkages with suppliers. II. Linkages with customers. III. Process linkages within the value chain of the firm. (a) Only (I) above (c) Both (I) and (II) above (e) All (I), (II) and (III) above. (b) Only (II) above (d) Both (II) and (III) above

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10. Which of the following is not termed as required rate of return in case of application of net present value method for capital budgeting analysis? (a) Cost of capital (c) Cut off rate (b) Discount rate (d) Hurdle rate (e) Risk-free rate.

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11. A segment of an organization is referred to as a profit center if it has the (a) Responsibility for developing markets for and selling the output of the organization (b) Authority to make decisions affecting the major determinants of profit, including the power to choose its markets and sources of supply (c) Responsibility for combining materials, labor and other factors of production into a final output (d) Authority to provide specialized support to other units within the organization (e) Authority to make decisions affecting the major determinants of profit, including the power to choose its markets and sources of supply and significant control over the amount of invested capital. 12. Goal congruence is (a) (b) (c) (d) (e) The desire and the commitment to achieve a specific goal The extent to which superiors have the authority to make decisions The extent to which subordinates have the authority to make decisions The attempt to accomplish a specific goal The integration of the organizational and the employees personal goals.

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13. Consider the following data pertaining to a company: Year 1 2 3 4 5 Book value of fixed investments (Rs.) 2,00,000 2,60,000 2,20,000 1,80,000 1,40,000 Profit before tax (Rs.) 80,000 90,000 75,000 65,000 90,000

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The tax rate applicable to the company for the 5 years is 40%. The accounting rate of return (ARR) of the company is (a) 32.50% (b) 30.50% (c) 28.30% 2 (d) 26.00% (e) 24.00%.

14. AB Ltd. produces product- KL. The company has provided the following standards for one unit of KL: Direct materials: 25 kg at Rs.5.00 per kg Direct labor: 10 hours of skilled labor at Rs.15 per hour Variable overhead: 10 hours at Rs.15 per hour Fixed overhead: Rs.60,000 at a normal operating level of 3,000 units The company produced 2,500 units at a total materials price of Rs.3,33,900 for 63,000 kg of direct material. The materials price variance is (a) Rs.18,900 (A) (d) Rs.22,500 (F) (b) Rs.18,900 (F) (e) Rs.18,750 (A). (c) Rs.22,500 (A)

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15. A difference between standard costs used for cost control and budgeted costs (a) Can exist because standard costs must be determined after the budget is completed (b) Can exist because standard costs represent what cost should be, whereas budgeted costs represent expected actual costs (c) Can exist because budgeted costs are historical costs, whereas standard costs are based on engineering studies (d) Cannot exist because they should be the same amounts (e) Can exist because standard costs must be determined before the budget is completed. 16. Strategic planning provides direction to an organizations mission, objectives, and strategy, facilitating the development of plans for each of the organizations functional areas. Which among the following cannot be said about strategic planning? (a) It helps managers to anticipate problems before they arise and deal with problems before they become severe (b) It shows awareness of changing environment, which is a foundation for organizational change (c) It helps managers to set realistic objectives that are demanding, yet attainable (d) It is easy to appraise the performance of strategic planning (e) Strategic planning is a creative and analytical process. 17. Which of the following is true about the Non-Financial Audit? (a) (b) (c) (d) (e) It relies primarily on standards set externally Procedures are formalized and consistent from company to company Standards are essentially the same from audit to audit Focus is on complying with standards set by external groups Audience is generally internal, with data being used primarily to improve performance.

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18. Consider the following data pertaining to production department in Shivam Ltd. for the month of June 2005: Actual overhead costs Standard hours for actual work Actual hours during the month Standard overhead rate The overhead cost variance is (a) Rs.2,200 (Favorable) (c) Rs.2,500 (Favorable) (b) Rs.2,200 (Adverse) (d) Rs.1,200 (Adverse) (e) Rs.1,200 (Favorable). Rs.62,200 6,000 hours 6,400 hours Rs.10 per hour

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19. Which of the following is false about Just In Time? (a) The main purpose of this philosophy is to reduce inefficiency and unproductive time in the production process (b) The main aim of just-in-time is to ensure the delivery of raw materials at the right time and in the right quantity and reduce buffer inventory (c) The amount spent on set-up costs is increased with the introduction of numerically controlled machine tools (d) Just-in-time helps in decreasing the procurement costs (e) Just-in-time helps in providing fast and accurate information to managers and also build strong relationship between the customer and manufacturer. 20. Which of the following is false in respect of budgetary control? (a) It is used to measure and compare actual results with the anticipated results 3

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(b) Budgetary control offers an overall picture of performance of various functions of the organization (c) Budgetary control is handled by the budgetary controller (d) Budgetary control does not help in pinning down responsibility and accountability for performance of each member (e) Budgetary control brings about the integration of policy, plans, and actions of the different departments. 21. In responsibility accounting system, a feedback report that focuses on the difference between budgeted amounts and actual amounts is an example of (a) Management by objectives (c) Assessing blame (e) Zero based budgeting. (b) Management by exception (d) Creating rewards to successful managers
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22. Which of the following is not true in the context of management control systems in organizations? (a) Subunits comprise individuals who perform certain activities to fulfill purpose of the organisation (b) In the past subunits were not expected to be aware of the overall purpose of the organisation (c) The management establishes the purpose, goals and objectives of an organisation and delegate responsibility of various subunits to accomplish the goals (d) The control systems play a major role in coordinating the efforts of these subunits (e) Efficient coordination of errors in subunits results in excess transaction costs. 23. The key variable in an insurance industry is (a) (b) (c) (d) (e) Percentage of absenteeism among employees Time spent on management development programs Preventive and breakdown maintenance The number of policies processed in a given period of time Number of research projects undertaken and those completed.

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24. An analysis that helps in identifying a wide range of key variables which facilitate the analysis of a particular situation and initiate prompt action is called (a) Factor analysis (c) Multivariate analysis (e) Performance analysis. (b) Key variable analysis (d) Control analysis

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25. During the month of June 2005, Siraj Ltd. used 5,000 kg. of material at a total standard cost of Rs.24,000. The material usage variance was Rs.576 (adverse). The standard usage of material for the period is (a) 5,120 kg (b) 4,760 kg (c) 4,880 kg (d) 5,240 kg (e) 5,060 kg.

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26. Which of the following is false about Informal Control System? It promotes greater compatibility of personnel and encourage the willingness to serve organizational purpose (b) It decreases the organizations ability to make adaptive responses (c) Informal actions in an organisation include enabling the easy flow of information through all the hierarchical levels of the organisation (d) It shortens the communication channels (e) Management must rely upon certain formal systems to prevent instability within the units. 27. Which of the following is an advantage of external control style of managing employees? Employees will invest all of their potential in their area of work and ignore other aspects that are important for the well-being of an organization as a whole (b) Only the positive outcomes of a particular task would be informed to the higher authorities (c) Employees will concentrate only on one aspect of their job and ignore the rest (d) Because of high control executed by the top management, superior will be able to monitor subordinates work and there would be no manipulations (e) Employees will not have any commitment towards the organisation and will perform only to obtain rewards and benefits. 28. Which of the following is not true about TQM? (a) It ensures that organizations attain the efficiency targets as well as satisfy customers (b) It is the responsibility of the employees to implement TQM (c) It emphasizes customer satisfaction and commitment to continuous improvement of its services 4 (a) (a)

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and products (d) The subsystems and components of control system should be so designed as to help a TQM program achieve customer satisfaction (e) Middle management should ensure that the environment needed for the implementation of TQM is easily susceptible to changes. 29. A company is considering a capital budgeting decision involving a risky foreign investment. Risk can best be minimized by selecting the investment alternative with (a) (b) (c) (d) (e) Highest net present value (NPV) Highest Benefit/Cost ratio (B/C ratio) Highest internal rate of return (IRR) Highest accounting rate of return (ARR) Shortest payback period.
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30. The strategic action which indicates a decision to withdraw from the business either through a process of slow liquidation or outright sale is called (a) Harvest (b) Divest (c) Hold END OF SECTION A (d) Build (e) Budget.

Section B : Problems/Caselets (50 Marks)


This section consists of questions with serial number 1 7. Answer all questions. Marks are indicated against each question. Detailed workings/explanations should form part of your answer. Do not spend more than 110 - 120 minutes on Section B. 1. Sarma Ltd. is reviewing an investment proposal in a project involving capital outlay of Rs.76,00,000 in plant and machinery. The project would have a life of 5 years at the end of which the plant and machinery could fetch a resale value of Rs.34,00,000. Further, the project would also need a working capital of Rs.8,00,000 which would be built during the first year and to be released from the project at the end of year 5. The project is expected to yield the following pre-tax cash profits: Year 1 2 3 4 5 Cash profits (Rs.) 26,00,000 25,00,000 18,00,000 18,00,000 16,00,000

A 20% depreciation for plant and machinery is available on Written Down Value (WDV) basis. Assume that corporate tax is paid one year in arrear of the periods to which it relates and first year depreciation allowance would be claimed against the profits of year 1. The Assistant Management Accountant has calculated NPV of the project using the companys corporate target of 20% pre-tax return and has ignored the taxation effect in cash flows. The corporate tax is expected to be 35% during the life of the project and thus the companys post-tax rate of return is 13%. You are required to a. b. Calculate the NPV of the project as Assistant Management Accountant would have calculated. Re-calculate the NPV of the project taking tax into consideration and comment on the desirability of the project. (4 + 7 = 11 marks) < Answer > 2. Dutta Ltd. manufactures and sells Product X. The company uses standard costing system. The company has furnished the following information pertaining to the standard costs per unit of Product X for the month of June 2005: Particulars Direct material 2 meter at the rate of Rs.5 per metre Direct labor 1 hour at the rate of Rs.3.50 per hour Variable overhead 1 hour at the rate of Rs.2.50 per hour Total Rs. 10.00 3.50 2.50 16.00

During June 2005, 5,500 units of product X were produced by the company and the related data are as follows: Direct material acquired at the rate of Rs.6.00 per metre Material consumed Direct labor -? hours at the rate of Rs.? per hour Variable overheads incurred 18,000 metre 13,600 metre Rs.26,500 Rs.19,475

The variable overhead efficiency variance is Rs. 1,250 (adverse). Variable overheads are based on direct labor hours. There was no stock of raw material in the beginning. Being a finance controller evaluate the performance of the company by presenting all the relevant variances. (9 marks) < Answer > 6

Caselet 1
Read the following caselet carefully and answer the following questions: 3. What precautions should be taken by the business in using budgeting as a tool for cost control program? (5 marks) < Answer > 4. The caselet argues that a successful cost control program needs active involvement of the staff. Why do you think active involvement of employees is necessary? Discuss. (5 marks) < Answer > 5. Frame a broad strategy, explaining the various steps, for the implementation of the cost reduction campaign in an organization. (7 marks) < Answer > If the recent corporate actions are anything to go by, it appears, as if the importance of a cost cutting program is often ignored when the business is going on smoothly. It is only in economic recession that companies consider the implementation of cost control programs. Cost cutting program benefits an organization by reducing the pressure on the profit margins. A successful cost control program needs active involvement of the staff, effective utilization of the budgeting resources in the program. The main areas of concern in a cost cutting program include the personnel costs and the purchasing function. In a tight economy, there is general recognition that business as usual wont cut it, and managers need to find ways to get by with less of everything. Often overlooked, however, is the similarity that should exist between management in a cutback and managing a going business in the best of times. The best cost-cutting program is a program of cost control and work prioritizing which functions equally well in good times and bad. The most difficult of times can give managers the opportunity to install cost-cutting programs with credibility and with the support of those affected. Deciding which costs to cut is just as important as determining how much to cut. Cutting across the board is never the right approach its only a question of how much unnecessary damage this does. A better approach is to attack the problem by grouping functions, departments, and projects into one of the following four categories: Select areas where cost cutting will not stop recovery or affect critical current programs. Cut these sharply or eliminate them entirely. Select activities that must be retained but can be delayed or cut back into an inactive state for four to six moths. Determine where money can be spent more effectively in areas that cant be cut back. Finally, consider investing in new or existing projects that can benefit the cost-control program and be of continuing value in a recovery.

Cost control program is not an overnight program to save money. It takes time, hard work and persistence in good times and bad. The payoff is the potential for strong and immediate improvement in profits or reduced losses, a way of managing all resources more professionally and more productively and a permanent improvement in how an organization deals with hard times.

Caselet 2
Read the following caselet carefully and answer the following questions:

6.

As Window-making department has evolved into a core competency of Multree, is the demand to make it a profit center justified? (6 marks) < Answer >

7.

The caselet states that while the transfer price should not be considered relevant for deciding to transfer goods between departments, but it becomes relevant when inappropriate reward systems were used. Discuss why and how the reward system is linked to transfer pricing. (7 marks) < Answer >

Through numerous organizational changes, Multrees Window-making Department evolved from a traditional cost center to a pseudo profit center, hybrid cost-profit center, and finally to a real profit center. During this evolution, Multrees management learned three valuable lessons about transfer pricing: 7

Marked-up transfer prices and market price-based transfer prices added no value to the firm when Windowmaking was not allowed to sell to outside customers. While the transfer price should not be considered relevant for deciding to transfer, it became relevant when inappropriate reward systems were used. Only four accounting numbers are relevant in deciding to transfer, and the transfer price is not one of them! Multree Homes is a Northern Nevada firm that produces manufactured homes in one medium-sized plant. As is common in many companies, the Window-making Department began as a cost center, providing windows to the Assembly Department. Over the years, Window-making developed into a core competency, and Cherie, the department manager, pressured Multree management for the authority to sell windows to outside customers. At first, management balked, believing Window-makings sole responsibility should be to provide high-quality windows, on time, and within budget for Multrees manufactured homes. Historically, Window-makings performance was evaluated only with cost variances. As a partial response to Cheries request, Julie, the CFO, who holds the Certified Management Accountant (CMA) designation, decided to implement some activity-based management (ABM) vendor performance measures she developed for Multrees suppliers as part of a supply-side strategic cost management initiative. Julie argued that departments within a company are simply suppliers to other departments (internal customers), and, as such, departments supplying goods or services to other departments should be evaluated using three accounting measures for quality, service, and cost: Complete order-filling ratio, On-time delivery ratio and Cost variances. The complete order-filling ratio is a combined quality and service measure calculated as the number of complete deliveries divided by the number of deliveries received. As another service measure, the on-time delivery ratio is the number of deliveries received when due, divided by the total number of deliveries. To measure quality costs as well as efficiency, Window-makings cost variances are determined using a secondgeneration activity-based costing (ABC) system. Regardless of where cost variances occur, they are coded in terms of activity problems, their sources, and their causes. So, a cost variance is the total cost to fix a problem including any labor, materials, or direct technology costs incurred.

END OF SECTION B

Section C : Applied Theory (20 Marks)


This section consists of questions with serial number 8 - 9. Answer all questions. Marks are indicated against each question. Do not spend more than 25 -30 minutes on section C.

8.

Control in service organizations is different from control in manufacturing organizations. In this context, explain the differentiating factors that influence the control of service organization in comparison with that of manufacturing organization. (12 marks) < Answer >

9.

Incentive compensation plays an important role in encouraging and motivating the managers of an organization in achieving its objectives and goals. If proper and attractive compensation is given to the managers, it encourages them to work hard and put in all efforts and strive for the development of the organization. In this perspective, discuss the different incentive plans available for motivating the employees. (8 marks) < Answer >

END OF SECTION C END OF QUESTION PAPER

Suggested Answers Management Control & Information Systems (MB281) July 2005
Section A : Basic Concepts
1. Answer: (e) Reason: Transfer pricing motivates divisional managers to perform well. It is useful for evaluating performance of the divisional managers. It also helps in measuring divisional performance. It is the selling price established for goods or services sold by one division to other under the same organization. Therefore, (d) is not correct, (e) is correct. Answer : (a) Reason: The projected sales in July 2005 (according to analysts ) = 12,000 units 20% of 12,000 units = 9,600 units. Sales volume variance = Standard sale price (Actual sales quantity - Standard sales quantity ) = Rs.80 (9,600 units - 11,500 units) =Rs.1,52,000 (A) Answer: (c) Reason: A fixed budget is not prepared for a range, rather it is used unaltered during the budget period. It is prepared for a particular activity level and it does not change with actual activity level being higher or lower than the budgeted activity level. Answer : (d) Reason : The profitability index is the ratio of the present value of future cash inflows to the initial net cash investment. It is a variation of the NPV method that facilitates comparison of different-sized investments. A profitability index greater than 1 indicates a profitable investment, or one that has a positive net present value. (a) is not correct because, if the index is 1.20 and the discount rate is the cost of capital, the NPV is positive, and the IRR must be higher than the cost of capital. (b) & (c) are not correct because the IRR is the discount rate at which the NPV is Rs.0, which is also the rate at which the profitability index is 1. The IRR cannot be determined solely from the index. (e) is not correct because the IRR is a discount rate, whereas the NPV is an amount. Answer : (b) Reason : Technique I: Though they are more expensive, better quality materials might save costs because they are less likely to be faulty and/or might last longer. Technique II: Costs can be reduced by improving productivity levels. Technique III: This is a method of cost control rather than cost reduction. Technique IV: Cheaper materials may impair the suitability of goods or services for the use intended. Hence, option (b) is correct. Option (a), (c), (d) and (e) are not correct. 6. Answer: (e) Reason: Sub-standard materials, Pilferage of materials, Non-standard material mixture, Wastage due to inefficient mixture are causes of material usage variance. However purchasing non-standard lots leads to reduction in quantity discount which is a cause for material price variance. Answer : (a) Reason : A cost driver is the factor which causes the costs of an activity to increase or decrease. (b) is not correct because it is a description of cost pool. (c) & (d) are not correct because it is a description of a common cost. 9
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(e) 8.

is not correct because it is a description of an attributable overhead cost.


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Answer : (c) Reason : The strategy formulation is the process of deciding on new strategies of an organization. Therefore, (c) is correct. (a) & (e) are not correct because these are the process of deciding on the programs that the organization will undertake and the approximate amount of resources that will be allocated. (b) is not correct because it is a process of preparing a strategy. Statement (d) is not correct because, strategy implementation comes after strategy formulation.

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Answer : (e) Reason : From the strategic planning perspective, the value chain concept highlights three potentially useful areas. i. ii. iii. Linkages with suppliers Linkages with customers Process linkages within the value chain of the firm.

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10. Answer : (e) Reason : The rate used to discount factor cash flows is sometimes called the cost of capital, the discount rate, the cutoff rate or hurdle rate. A risk free rate is the rate available on risk-free investments such as government bonds. The risk-free rate is not equivalent to the cost of capital because the latter must incorporate a risk premium. Therefore answers (a), (b), (c) and (d) are not correct. 11. Answer: (b) Reason: A profit center is a segment of a company responsible for both revenues and expenses. A profit center has the authority to make decisions concerning markets (revenues) and sources of supply (costs). Option (a) is not correct because a revenue center is responsible for developing markets and selling the firms products. Option (c) is not correct because a cost center combines labor, materials, and other factors of production into a final output. Option (d) is not correct because a service center provides specialized support to other units of the organization. Option (e) is incorrect because an investment center is responsible for revenues, expenses, and the amount of invested capital. 12. Answer : (e) Reason : Goal congruence is an integration of the goals of the organization and the individuals working in the organization. is not correct because motivation is the desire and the commitment to achieve a specific goal. (b) & (c) are not correct because autonomy is the extent to which individuals (Both supervisors and subordinates) have the authority to make decisions. (d) is not correct because managerial effort is the extent of the attempt to accomplish a specific goal. 13. Answer : (e) Reason : Accounting rate of return
(Rs.80, 000 + Rs.90, 000 + Rs.75, 000 + Rs.65, 000 + Rs.90, 000)(1 0.4) Rs.2, 00, 000 + Rs.2, 60, 000 + Rs.2, 20, 000 + Rs.1,80, 000 + Rs.1, 40, 000 Rs.4, 00, 000 (0.60) Rs.2, 40, 000 Rs.10, 00, 000 = Rs.10, 00, 000 = 24%.

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14. Answer : (a) Reason: Materials price variance: Actual quantity used x (Standard price - Actual price). The actual price is Rs.3,33,900/63,000 = Rs.5.30. The standard quantity of material is 2,500 x 25 = 62,500 kg. The materials price variance is 63,000 x (Rs.5.00 - Rs.5.30) = Rs.18,900 unfavorable variance. 10

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15. Answer: (b) Reason : Standard cost are predetermined, attainable unit costs. Standard cost systems isolate deviations of actual from expected costs. One advantage of standard costs is that they facilitate flexible budgeting. Accordingly, standard and budgeted costs should not differ when standards are currently attainable. However, in practice, budgeted (estimated actual) costs may differ from standard costs when operating conditions are not expected to reflect those anticipated when the standards were developed. Answer (a) is incorrect because standard costs are determined independently of the budget. Answer (c) is incorrect because budgeted costs are expected future costs, not historical cost. Answer (d) is incorrect because budgeted and standard costs should in principle be the same, but in practice they will differ when standard costs are not expected to be currently attainable. Answer (e) is not correct. Therefore (b) is the answer. 16. Answer : (d) Reason : It is extremely difficult to appraise the performance of strategic planning as there are no prescribed standards against which the performance can be measured. All other statements for strategic planning are true except (d). Therefore the correct answer is (d). 17. Answer: (e) Reason: In Non-Financial Audit, audience is generally internal, with data being used primarily to improve performace. The other statements (a), (b), (c) and (d) pertain to Financial Audit. 18. Answer: (b) Actual overheads cost Less: Applied overhead cost = (Standard hours for actual work standard overhead rate) 6,000 hours Rs.10 Overhead cost variance Rs.62,200 Rs. 60,000

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Rs. 2,200 (Adverse)


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19. Answer: (c) Reason: The amount spent on set-up costs is decreased with the introduction of numerically controlled machine tools but not increased. The other options are true and hence not the correct answers. 20. Answer : (d) Reason : Budgetary control is a device for finding out how the activities of an organization are progressing. it helps in pinning down responsibility and accountability for performance to each member (a) It is used to measure and compare actual results with the anticipated results, as provided in the budget.

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(b) Budgetary control offers an overall picture of performance of various functions of the organization. (c) Budgetary control is handled by the budgetary controller.

(e) Budgetary control brings about the integration of policy, plans, and actions of the different department. 21. Answer : (b) Reason : Accounting system should have certain controls that provide for feedback reports indicating deviations from expectations. Management may then focus on those deviations for either reinforcement or correction. Option (a) is incorrect because MBO is not considered with responsibility accounting. Option (c) is incorrect because the responsibility accounting system should not be used exclusively to assess blame. Option (d) is incorrect because responsibility accounting should not be used exclusively to give rewards. Option (e) is incorrect because feedback reports concentrate on deviations, but not to the total exclusion of other budgeted variables. 22. Answer : (e) Reason : Efficient coordination of errors in subunits results in lower transaction costs and 11
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does not result in excess costs. Subunits comprise individuals who perform certain activities to fulfill the purpose of the organisation. The control systems play a major role in coordinating the efforts of these subunits. In the past subunits were not expected to be aware of the overall purpose of the organisation. The management establishes the purpose, goals and objectives of an organisation and delegate resposibility of various subunits to accomplish the goals. 23. Answer : (d) Reason : In an insurance industry, the key variables are number of claims settled in a given period, number of policies processed in a given period of time etc. The other options are incorrect because, percentage of absenteeism among employees is one of the key variables of Hotel Industry, time spent on management development programs and number of research projects undertaken and those completed are the key variables of Management training institute, preventive and breakdown maintenance is the key variable of Power industry. 24. Answer : (c) Reason : Multivariate analysis helps in identifying the critical control variables and latent factors. Multivariate analysis helps in identifying a wide range of key variables, which help in analyzing a particular situation and initiates prompt action. The other options are incorrect. 25. Answer : (c) Reason : The correct answer is (b).
Rs.24, 000 5, 000 kgs
Rs.576 Rs.4.80
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Standard price per kg Usage variance (Kg)

= =

= =

Rs.4.8 120 kg.

Standard usage = 5,000 kg 120 kg. = 4,880 kg or Material Usage Variance = Standard Price ( Actual Quantity Standard quantity ) Rs.576 = Rs.4.80 (5,000- Standard quantity ) . Standard quantity= 4,880 Kg. 26. Answer : (b) Reason : Informal Control System increases the organizations ability to make adaptive responses. Hence alternative (b) is false. The other alternatives are true. 27. Answer: (d) Reason: The advantages of external control style of managing employees are: Because of high control executed by the top management, superior will be able to monitor subordinates work and there would be no manipulations And subordinates may be motivated to perform as rewards are directly linked to performance. The other options are disadvantages hence not the correct answers. Answer: (b) 28. Reason: It is the responsibility of the top management to implement TQM and not employees. The other options are true hence not the correct answers. 29. Answer : (e) Reason : The payback period measures how quickly the initial investment will be recorded. Management can best manage risk by recouping its money quickly. Options (a), (b), (c) and (d) are incorrect because they consider risk only indirectly through the selection of the discount rate. 30. Answer: (b) Reason: Divest indicates a decision to withdraw from the business either through a process of slow liquidation or outright sale. The other options are incorrect because: Harvest: this action has the goal of maximising short term earnings and cash flow, 12
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Depreciation allowances Tax rebate: (Rs. lakh)

even at the expense of market share (a). Hold: this action aims to protect the business units market share and competitive position (c). Build: this indicates that the business units goal is to increase its market share, even at the expense of short-term earnings and cash flow (d). Budget: this involves deciding on the allocation of resources and targets of each business unit (e).

Section B : Problems
1. a. Assistant Management Accountants calculation (i.e. ignoring taxation) (Rs. in lakhs) Investment Plant and Working machinery i l (76) (8) 26 25 18 18 34 8 16

0 1 2 3 4 5

(76) 18 25 18 18 58

1.0 0.8333 0.6944 0.5787 0.4823 0.4019

(76) 15.00 17.36 10.42 8.68 23.31 (1.23)

It is assumed that working capital would reduce cash flows in year 1 and would be recovered soon after the end of year 5. The working capital cash flows are therefore assigned to years 1 and 5. Here it is observed that NPV is negative and hence the Assistant Management Accountant would have concluded that the project should be rejected. b. Allowing for taxation Tax on Cash profit: (Rs. Lakh)

13

2 3 4 5 6

48.640 38.912 31.130 24.904

12.160 9.728 7.782 6.226 *(9.096)

4.256 3.405 2.724 2.179 (3.184)

3 4 5 6 6

* Profit on sale of plant & machinery (34 24.904)=9.096 Calculation of NPV of the project: (Rs. lakh) Investment Year 0 1 2 3 4 5 6 34 8 Plant and machinery (76) (8) Working capital Tax saved by Depreciation 5.320 4.256 3.405 2.724 (1.005)* 26 25 18 18 16 (9.10) (8.75) (6.30) (6.30) (5.60) Cash profits Tax on profits Net cash flow (76) 18.00 21.22 13.51 15.11 54.42 (6.61) Discount factor @13% 1 0.885 0.783 0.693 0.613 0.543 0.480 Present value (76) 15.93 16.62 9.36 9.26 29.55 (3.17) 1.55 (Rs.2.179 Rs.3.184 = Rs.1.005) The NPV is positive, although it is very small in relation to the capital outlay of Rs.76 lakhs. It is also apparent that the positive NPV depends heavily on the assumption that the plant and machinery would have a resale value of Rs.34 lakhs at the end of year 5. Such projects which rely on their residual values for their positive NPV should normally be regarded as high-risk ventures.
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2.

Computation of Standard Costs and Actual costs Particulars Standard costs Direct materials (5,500Rs.10) Direct Labor (5,500Rs.3.50) Variable overheads (5,500Rs.2.50) Total standard costs (A) Rs. 55,000 19,250 13,750 88,000 Particulars Actual costs Direct materials (13,600 metersRs.6.00) Direct Labor Variable overheads Total actual costs (B) Rs. 81,600 26,500 19,475 1,27,575

Total cost variance = Rs.1,27,575 Rs. 88,000 =Rs. 39,575 (A) 1. Actual labor hours Variable overhead efficiency variance = Standard variable overhead rate per hour (Standard hours-Actual hours) Rs. 1,250 (A) = Rs2.50(5,5001 hour-Actual hours) Rs. 1,250 (A) = Rs.13,750-(Rs.2.5Actual hours) (Rs.2.5Actual hours) = Rs. 13,750+Rs.1,250 = Rs.15,000 Actual hours = Rs.15,000/2.5 = 6,000 hours 2. Actual wage rate per hour
Actual wages paid Rs.26, 500 = = Rs.4.42 Total actual hours 6, 000 hours

Computation material, labor and variable overhead variances 14

I.

Material Variances: 1. Material cost variance = Standard cost-Actual cost = (Rs.55,000 Rs.81,600)=Rs.26,600(A) 2.

Material price variance = Actual quantity of material consumed(Standard price Actual price) = 13,600 metres (Rs.5- Rs.6) = Rs13,600 (A) 3. Material usage variance = Standard price (Standard quantity-Actual quantity) = Rs. 5 (11,000 metres 13,600 metres) =Rs.13,000 (A) II. Labor variances: 1. Labor cost Variance Standard cost Actual cost Rs.(19,250 Rs. 26,500) =Rs.7,250 (A) 2. Labor rate variance = Actual hours(St.rate-Actual rate) = 6,000(Rs.3.50-Rs.4.42) = Rs.5,520(A) or Rs. 5,500 (A) 3. Labor efficiency variance = Standard rate per hour (Std. Hours actual hours) = Rs. 3.50 (5,500 hours 6,000 hours)=Rs.1,750 (A) III. Variable overhead variances: 1. Variable overhead cost variance = Standard variable overhead Actual variable overhead = (Rs.13,750 Rs. 19,475) = Rs.5,725 (A) 2. Variable overhead efficiency variance = Standard variable overhead rate per hour (Std. Hours for actual output Actual hours) = Rs. 2.50(5,500-6,000)= Rs. 1,250 (A) 3. Variable overhead budget (expenditure) variance Budgeted variable overhead Actual variable overhead (Actual hours worked Std.variable overhead per hour)-Actual variable overhead = (6,000Rs.2.50)-Rs.19,475 Rs.15,000-Rs.19,475 = Rs.4,475 (A)
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3.

The best single tool for cost control, in good times or bad, is still the budget performance report. Its important the budget is credible and the line items are understood to know which budget items are affected when the company is committed to spending money. It is necessary to get the details from the accounting department to help understand why the budget or cost objective was exceeded. Manage the budget line by line, not in total. Dont be satisfied with the months performance simply by staying within the overall department budget, because it could lead to the following common trap: When an account is under budget due to timing differences, that is, it will actually be spent later than budgeted, the favorable variance may offset and hide another account that has an unfavorable variance due to overspending. Later on, the timing difference catches up and you have an overall overspent condition. But attention is drawn to the wrong account in the wrong month, long after corrective action should have been taken. Subordinates should be held accountable for the specific elements of the budget that they control. If they dont have responsibility for separately reported cost centers, find some other ways to get them to relate to budget performance as a cost-control tool.
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4.

One person, no matter how dedicated, will never accomplish cost control because any one person does not incur costs. For this reason, its important that the entire staff is aware of the need and rationale for the program. Accordingly, the entire staff should keep the cost-control guidelines in mind in their daily jobs, because thats when the real cost-control decisions are made. 15

Establish with key subordinates a cost-control goal they can shoot for as a team. Management must provide the parameters, but employees should feel like they helped decide on the specific objectives. The goals, guidelines and progress should be publicized. Staff memos, the company newsletter, bulletin boards and staff meetings can all be used. The staff must be conditioned by positive reinforcement to think in new ways. Recognition will reduce normal resistance to cost control.
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5.

Managers wish to achieve cost reduction in their own business can do so by following five steps: Generate buy-in with key stakeholders on the need: To avoid the negative connotations that employees may have with cost cutting, it is necessary to communicate clearly what cost reduction is and is not. At its core, cost reduction eliminates waste and conserves resources in order to reinvest the savings in critical business assets like employees, technology, and R&D. Reducing costs does not mean unnecessarily reducing quality, skimping on service, or anything else that could undermine a companys longevity within a competitive marketplace. Instead, cost reduction takes advantage of every opportunity to better leverage existing and new assets to bring value to customers and shareholders. Setting objectives: The exercise of setting objective is in the form of a vision statement. Struggling companies, for example, might want to cease their cash hemorrhaging in order to survive until their next round of funding. More established companies use cost reduction in an effort to stay competitive, while healthy businesses can use cost reduction campaign to strengthen their competitive position. Align Cost Reduction with Business Strategy: It is vital that cost reduction initiatives be conceived and deployed in concert with the overall business strategy to ensure that cost cutting does not detract from the strategic vision or negatively affect company performance. This can be achieved by calibrating the companys vision/objectives with its cash flow and budget, and then determining the financial gap between current capabilities and the future needs of the company. Armed with this information, managers can identify and prioritize areas that need to be strengthened and those to be rationalized. In practice, this exercise is more difficult than it sounds and may require additional activities to ensure that the prioritization is based on a comprehensive view of the organization. Choose appropriate approach: With these objectives in mind, the strategic manager will choose the cost reduction approach that best meets their objectives both from rupees saved and organizational impact. Set Goals and Prioritize: Now that the process has been communicated, the objectives have been outlined, the priorities have been set, and the approach is chosen, then business develop detailed and measurable goals that will help to achieve the broader vision. The above five-step strategy primes your organization to enact value creating and sustainable cost savings by ensuring that the cost reduction initiative has buy-in from company managers and employees, is aligned with the company vision, that it is applied in the right business area, and that the results are attainable and measurable. Ultimately, these are the success factors of any initiative.
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6.

The emphasis on traditional cost variance reporting did not satisfy some cost center managers, including Cherie, because the managers knew they were contributing to Multrees value, yet upper management only considered them cost creators. To overcome Cheries continuing requests to be seen as a profit creator, Window-making was changed into a pseudo profit center. Pseudo profit centers provide goods or services to other segments of a company but are not allowed to market those goods or services to outside customers. A profit is reported for these centers by charging internal customers a marked-up price, mimicking a real cash sales price from an outside supplier. For example, the standard absorptive manufacturing cost is $100, while the actual cost is $110 per window. Budgeted and actual volume is 1,000 windows. Thus, the cost of goods sold (COGS) is $100,000 and $110,000, respectively. Using a 20 percent markup on the $110 actual cost results in a $132 transfer price. This creates a favorable pseudo sales price variance in Window-making that swamps the real $10 per window cost variance. Window-making looks like it is contributing an extra $2,000 profit above budget, when, in fact, Multree profits are $10,000 less than budget due to the $10 per window cost variance. Cherie obviously was very happy with the new transfer pricing policy! 16

The Assembly Department manager, complained bitterly, though. He is charged a $12 per window unfavorable cost variance (a direct materials purchasing or price variance). In other words, Window-making can pass its cost variances to the next department and look good while doing it. Although returning Window-making to a cost center eliminated some nonvalue-added accounting and management activities, Cherie knew that her windows were high quality and that she could compete effectively in the market if allowed to sell them. To prove this, she proposed her first priority should be to supply Assembly, but she also should be allowed to use any surplus capacity to make and sell windows to other home builders. Transfer price should remain at the standard absorptive cost in this situation. Window-making is primarily a cost center but also is partly a profit center. As long as its first priority is to supply windows for Multrees homes, the home sales prices should recover all costs of the business, including Window-makings fixed costs. Thus, it should transfer at standard absorptive manufacturing cost.
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7.

Rewards are based on each profit centers segment margin, which includes outside sales and transfers (internal sales). This is a very common reward system. Because the selling manager is responsible for agreeing on sales prices and the buying manager is responsible for agreeing on purchase prices, they have to jointly agree on a transfer price. Because the transfer price determines how much of the differential profit from transferring appears in each profit centers net income (segment margin), the managers are in conflict with each other over the transfer price. Segmenting Multrees income statement into profit centers, including internal sales (transfers) within each segment margin, and then rewarding managers based on that segment margin has led to bad transfer decisions. The suggestion is to segment Window-makings income statement into internal and external sales. The management can see the transfers net cash flows (savings less cost variances) separately from external sales. With this information, they can reward transfers separately from external sales and profits. Segmenting Window-makings income statement and reporting two window purchase price variances for Assembly (from transfers and from outside purchases) allows for a dual reward system for transfers and external purchase/sales activities. Yet the managers still have to negotiate a transfer price. So, while a direct reward for transferring can be made, the managers still will have to jointly determine how much of that reward each receives. Establishing a separate reward system for transfers and segmenting their income statements is congruent with the dual reward system, but this policy still will not solve the negotiation problem. Multree management should decide in advance what percentage of the reward each manager receives for transferring. This reward system and transfer pricing policy functioned quite well for some time. Ultimately, though, competitive pressures began to impact sales prices and profits negatively, which caused to reconsider Multrees reward system. As a cost-cutting measure, Managers should not be rewarded for transferring. Management justifies this move by relating the transfer decision to coming to work on time. Employees are expected to come to work on time. They do not get rewarded for doing this. Similarly, profit center managers are expected to transfer when it increases overall firm cash flows and profits. This is common sense and does not require a reward.
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Section C: Applied Theory


8. Control in service organizations is different from control in manufacturing organizations. There are some characteristics, which are also applicable to the management control of legal, research and development, and other service departments in companies in generally, which are stated under: Absence of inventory buffer Manufacturing organizations maintain an inventory of goods in order to tackle sales fluctuations in future. This does not hold true for service organizations. They cannot store their services. For example, the airplane seat, hotel room, or the services of professionals like lawyers, physicians cannot be stored. Further, in the short run, the costs of many service organizations are essentially fixed. Simply by closing some of the rooms, a hotel cannot reduce its costs substantially. Moreover, the impact on the morale of its staff and the costs of rehiring make accounting firms, law firms, and other professional organizations reluctant to layoff professional personnel in times of low sales volume. In most service organizations, therefore, the extent to which current capacity is matched by demand serves as a key variable. Organizations try to match these in essentially two ways. Through marketing efforts and price concessions they try to stimulate demand in off-season periods. Low rates in off-seasons are offered by cruise lines and resort hotels; hotels offer low rates on weekends; low rates are offered by public utilities during slack periods. The importance of the loss from unsold services can be grasped from the fact that occupancy rates, "sold hours", load factors, student enrollment, hospital admissions, and similar indications of success in selling available services are usually key variables in all types of service organizations. Difficulty in controlling quality 17

The products of a manufacturing company should be inspected for quality before they arc released in the market, but this cannot be done in case of a service organization's products. The quality of the products offered by service organizations cannot be judged until it is rendered to the customer. Also, the judgments regarding the quality of the product are often subjective. The management of a restaurant may judge the quality of the food and approve of it, but customer satisfaction also depends on how the food is served. Since it is difficult to measure the quality of education, few educational organizations have a formal quality control system. In the case of a public accounting firm, it is possible to measure the number of hours spent on an audit, but not the thoroughness of the work done during those hours. There is no objective way of appraising the soundness of the recommendations made by a consulting firm. Likewise, it may take several years for the loopholes or ambiguities in documents drafted by a law firm to come to light. It describes the difficulty in measuring intangible attributes and the costs related to them. Labor intensive Manufacturing companies can reduce costs by replacing labor with additional equipment and by automating production lines. This measure, however, cannot be adopted by most service companies. Addition of expensive equipment does take place in hospitals too; but, at the same time, most of these provide better treatment facilities. Multi unit organizations Service organizations operate through many small units set-up in different locations. These units act as individual profit centers for the service organizations. Fast-food companies, gasoline stations and auto rental companies are some of the examples of such service organizations. The units of a service organization are either wholly owned or franchised. Most of these units are similar in size and operations and hence provide a basis for analyzing budgets and evaluating performance. The information generated from such an analysis can be used to distinguish the high performing units from the low performing units. Care must be taken in making such comparisons because units differ in the mix of services they provide, in the resources that they use, and in various other ways. "Data Envelopment Analysis" is a technique adopted for making adjustments for these differences. It identifies the most efficient units by using statistical methods of allowing for differences. Quantity measurement Though it is easy to keep track of the quantity of tangible goods, both during the production process and when the goods are sold, this is not the case with many services. For example, while it is possible to measure the number of patients treated in a day by a physician, and to even classify these visits by the type of complaint, it is not possible to measure the amount of service that the physician provides to each of these patients. Historical development The necessity for valuing work-in-process and finished goods inventories for financial statement purposes initiated the growth of cost accounting in manufacturing companies. Raw data, that can be easily adapted for use in setting selling prices and for other management purposes, is provided by these systems. It was on the foundation of cost accounting systems that standard cost systems, separation of fixed and variable costs, and analysis of variances were established. Most texts on cost accounting, until a few decades ago, dealt only with the practices in manufacturing companies. There was no similar impetus to develop cost data for most service organizations (with the notable exception of railroads and other regulated public.industries). The use of product cost and other management accounting data by service organizations is fairly recent-mostly since World War II. Management control systems in service organizations are now rapidly becoming as well developed as those in manufacturing companies. Implications for Management Control Management control systems in service organizations differ from those in manufacturing organizations, in degree, rather than in kind. In both types of organizations, the essential features are the same. Planning, in both, is done in terms of programs and responsibility centers, including profit centers and investment centers for organization units meeting the criteria. In both type of organizations, the management control process involves programming, budgeting, measurement of performance, and appraisal of performance. The control systems currently found in service organizations, being relatively recent in their development, tend to be less advanced than those in manufacturing organizations. Due to the difficulty in measuring both the quantity and the quality of output, judgments pertaining to both the efficiency and the effectiveness of performance are more subjective than in situations where output consists of physical goods. This implies that there is more room for legitimate differences of opinion about performance. The recognition by managers of the fact that performance is not easy to measure make it eminently worthwhile to launch a search for better tools for improving its measurement.
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9.

The incentive compensation is an important mechanism that encourages and motivates managers to achieve organizations objectives. It is commonly observed and experienced fact that managers put forth a great deal of effort on activities that are rewarded and less on activities that are not rewarded. A managers total compensation package consists of three components :(a) Salary, (b) Benefits and (c) Incentive compensation. In the question we are concerned with Incentive compensation only. 18

Incentive compensation plans can be classified as: a. Short-term incentive plans b. Long-term incentive plans Short-term incentive plans are usually based on performance in the current year. Long-term incentive plans relate compensation to long-term accomplishments. A manager can earn a bonus under both plans. Short-term incentive plans: The total bonus pool Carryovers

Deferred payments Long-term incentive plans: Stock options Stock appreciation rights Phantom shares
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Performance shares

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19