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Test Series: May,2020

MOCK TEST PAPER – 1
FINAL COURSE: GROUP – II
PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION
Question No. 1 is compulsory
Answer any four questions from the remaining five questions
Time Allowed – 3 Hours Maximum Marks – 100

1. ABC manufactures electronic components for washing machines in an assembly line.

Recent market survey reports indicate erosion of its clientele. Feedback taken from
customers suggest that the company’s products were not of good quality. ABC is
concerned because its competitors have been able to achieve zero defect performance in
terms of nil sale returns on account of quality and nil subsequent warranty cost.
Therefore, the competitors enjoy huge customer loyalty.
To satisfy its customers, the company ABC wants to improve its product quality.
Consequently, it has decided to undertake Six Sigma study of its operations.
Below is the additional information given about ABC’s operations:
Yearly sales of electronic components are 25,000 units at Rs.20,000 each. Of these, 1%
sales are returned due to quality issues. These are scrapped and a replacement is made
by the company. In addition, each product is under warranty for one year after sale. If a
claim is accepted under warranty, service and replacement of parts is done free of cost.
Current yearly warranty claims (these are separate from sales returns), which is also
representative of the average yearly warranty claims, amount to Rs.30,00,000 per
annum.
Quality control check and inspection is carried out directly at the assembly line. There is
no quality check done at any other point in the entire work flow. Total time spent on
inspection is 2,000 hours in a year which costs the company Rs.10,00,000 per annum.
Inspection leads to 10% rejection i.e. 2,525 units. These units require only one cycle of
rework, after which they are ready for sale. Rate of rework in the units rejected on
inspection at the assembly line is 5 units in 1 hour. Cost of rework is Rs.6,250 per hour.
The variable cost of electronic component is Rs.12,500.
The Six Sigma team as part of its study found that rework on products was mainly due to
the following reasons:
(1) Assembly line workers, including new hires, learnt on the job as to how to assemble
the input material to produce the final electronic component. This lead to many
errors due to lack of proper standardized training. Therefore, on account of these
errors, the entire electronic component has to assembled again.

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(2) Sub-standard quality of raw material is detected on inspection only at the assembly
line. By this time, the defective material is already fitted into the final electronic
component. Therefore, entire component has to be reworked upon to replace the
defective raw material input.
(3) Machines are outdated and are not entirely suitable for the current production
methodology.
Proposed solutions to tackle these issues are as follows:
(1) Provide training to assembly line workers to train them on the production
methodology. This training is expected to standardize work flow, thereby reducing
errors. Such training programs will be held regularly to update the workers on new
methodologies. These programs can also serve as employee feedback sessions
about the actual working conditions at the assembly line. This two-way
communication can improve and streamline the production process. Brainstorming
can help detect or give heads up about potential problems in the production
process. Total training hours in a year are expected to be 5,000 hours, costing
Rs.1,000 each hour.
(2) Currently poor quality of raw material input is detected only on inspection at the
assembly line. This results in wastage of resources in terms of material, time and
capacity. In addition to the existing inspection at the assembly line, a new functional
area for quality planning and improvement is proposed to be set up. At the time of
procurement, the department will determine the appropriate quality of raw material
input, ensure that suppliers supply material as per these requirements as well as
suggest alternatives that can help improve product quality. By ensuring quality of
raw materials at the beginning of the production process, wastage of resources is
reduced, if not can be eliminated. Cost of setting up such a facility will be
Rs.1,50,00,000. In addition to this facility, inspection will continue at the assembly
line. This ensures complete quality check during the entire production cycle. At the
same time, due to the introduction of this new functionality for quality control, the
pressure on resources for inspection at the assembly line would reduce.
(3) Current machines should be replaced entirely with new machines. Old machines
can be sold for negligible amount as scrap. New machines would cost
Rs.3,60,00,000 having a life of three years.
Implementation of the above three solutions can have the following impact:
• Rework of products can be entirely eliminated.
• Sale returns will reduce from 1% to 0% due to better quality of products.
• Yearly warranty claims will reduce from Rs.30,00,000 to nil per annum.

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• With the introduction of the new facility, time required for inspection at the assembly
line would reduce from 2,000 hours to 1,200 hours. Cost of inspection to do quality
check at the assembly line would reduce from Rs.10,00,000 per annum to
Rs.600,000 per annum.
• Due to better quality, ABC can build better reputation with the customers which can
further yield additional sales of 5,000 units per year.
Required
You are the management accountant at ABC. As part of the Six Sigma project
implementation team, you are requested to EVALUATE proposals suggested by the Six
Sigma team. The team has used the DMAIC technique to assess quality improvements.
(20 Marks)
2. Star Industries Ltd. manufactures standard heavy duty steel storage racks for industrial
use. Each storage rack is sold for Rs.750 each. The company produces 10,000 racks per
annum. Relevant cost data per annum are as follows:
Cost Component Budget Actual Actual Cost p.a.
(Rs.)
Direct Material 5,00,000 sq. ft. 5,20,000 sq. ft. 20,00,000
Direct Labour 90,000 hrs. 1,00,000 hrs. 10,00,000
Machine Setup 15,000 hrs. 15,000 hrs. 1,50,000
Mechanical Assembly 200,000 hrs. 200,000 hrs. 30,00,000

The actual and budgeted operating levels are the same. Actual and standard rates of
material procurement and hourly labor rate are also the same. Any variance in cost is
solely on account of difference in the material usage and hours required to complete
production. Aggressive pricing from competitors has driven down sales. A comparable
rack is available in the market for Rs.675 each. Vishal, the marketing manager has
determined that in order to maintain the company’s existing market share of 10,000
racks, Star Industries must reduce the price of each rack to Rs.675.
Required
(i) CALCULATE the current cost and profit per unit. IDENTIFY the non-value added
activities in the production process. (6 Marks)
(ii) CALCULATE the new target cost per unit for a sales price of Rs.675 if the profit per
unit is maintained. (2 Marks)

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(iii) RECOMMEND what strategy Star Industries should adopt to attain target cost
calculated in (ii) above. (12 Marks)
3. X Ltd. first opened its door in 1991 for business and now it is a major supplier of metals
supporting over a dozen different industries and employs experts to support each
industry. These include Wood & Panel Products Manufacturing, Hearth Products, Site
Furnishings, Commercial and Residential Construction etc. It has grown through devotion
to its customers, dedication to customer service and commitment to quality products. The
company has two divisions: Division ‘Z’ and Division ‘E’. Each division work as an
investment centre separately. Salary of each divisional manager is Rs. 720,000 per
annum with the addition of an annual performance related bonus based on divisional
return on investment (ROI). A minimum ROI of 12% p.a. is expected to be achieved by
each divisional manager. If a manager only achieves the 12% target, he will not be
rewarded a bonus. However, for every whole 1% point above 12% which the division
achieves for the year, a bonus equal to 3% of annual salary will be paid subject to a
maximum bonus of 20% of annual salary. The figures belonging to the year ended 31
March 2019 are given below:
Division ‘Z’ (‘000) Division ‘E’ (‘000)
Revenue 29,000 17,400
Profit 5,290 3,940
Less: Head Office Cost (2,530) (1,368)
Net Profit 2,760 2,572
Non- Current Assets 19,520 29,960
Cash, Inventory, and Trade 4,960 6,520
Receivable
Trade Payable 5,920 2,800
Manager Responsible HAI FAI
During the financial year 2018-19, FAI manager of Division ‘E’ invested Rs. 13.6 million
in new equipment including an advanced cutting machine, which will increase productivity
by 10% per annum. HAI, manager of Division ‘Z’, has made no investment during the
year, even its computer system needs updation. Division ‘Z’’s manager has already
delayed payments of its suppliers due to limited cash & bank balance although the cash
balance at Division ‘Z’ is still better than that of Division ‘E’.
Required
(i) For each division, COMPUTE, ROI for the year ending 31 March 2019. EXPLAIN
the figures used in your calculation. (6 Marks)
(ii) COMPUTE bonus of each manager for the year ended 31 March 2019. (4 Marks)

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(iii) DISCUSS whether ROI provides justifiable basis for computing the bonuses of
managers and the problems arising from its use at X Ltd. for the year ended 31
March 2019. (10 Marks)
4. (a) ‘F’ manages the school canteen (approximately 1,600 students) at Delhi. The
current cash payment system requires three clerks (paid Rs.90 per hour), employed
for about 4 hours a day. The canteen operates approximately 240 days a year.
‘F’ is considering a Wireless Cash Management System (WCMS), where a student
could just swipe an ID Card for payment. This system would cost Rs.1,25,000 to
setup and Rs.36,000 per year to operate. ‘F’ believes that he could manage with
one clerk if he were to implement the system.
Required
ADVISE ‘F’ on the choice of a plan, assuming working life of WCMS as 5 years.
(Ignore the time vale of money) (5 Marks)
(b) The MD of P Limited, a 150 persons engineering company, decided it was time to
fire the company's biggest client. Although the client provided close to 60% of the
company's annual revenue, P Limited decided that dropping this client was
necessary. The client was profitable.
The MD of P Limited stated "We cannot be a great place to work without employees,
and this client was bullying my employees. Its demands for turnaround were
impossible to meet even with people working seven days a week. No client is worth
losing my valued employees".
The initial impact on revenues was significant. However, P Limited was able to cut
costs and obtain new customers to fill the void. Moreover, the dropped client later
gave P Limited two projects on more equitable terms.
Required
(i) Discuss the reasons behind dropping of a profitable client by P Limited.
(5 Marks)
OR
(ii) State five qualitative factors that management should consider in outsourcing
and make or buy decisions. (5 Marks)
(c) ‘Ax’ and ‘Bx’ are two customers of N Electronics Ltd., a manufacturer of audio
players. Selling price per unit is Rs.5,400. Its cost of production per unit is Rs.4,420.
Additional costs are:
Order Processing Cost……………………………..Rs.2,000 per order
Delivery Costs……………………………………….Rs.3,500 per delivery

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Details of customers ‘Ax’ and ‘Bx’ for the period are given below:
Customer ‘Ax’ Customer ‘Bx’
Audio Players purchased (nos.) 350 500
No. of orders 5 (each of 70 units) 10 (each of 50 units)
No. of deliveries 5 0
The company’s policy is to give a discount of 5% on the selling price on orders for
50 units or more, and to further give 8% discount on the undiscounted selling price if
a customer uses his own transport of collect the order. Assume that production
levels are not altered by these orders.
Required
(i) ANALYSE the profitability by comparing profit per unit for each customer.
(6 Marks)
(ii) COMMENT on the discount policy on delivery. (4 Marks)
5. (a) Golden paints is a manufacturer of industrial dyes. It has received an order for 200
kgs of powder dye that needs to be customized to certain specifications. The job
would require the following materials:
Material Total Units Book value of Realizable Replacement
units already in the units in value cost
required inventory inventory (Rs.per (Rs.per unit)
(Rs.per unit) unit)
M 2,000 0 NA NA 8
N 3,000 1,200 7 8 10
O 2,000 1,400 12 9 14
P 500 500 9 12 15
I) Material N is used regularly in production of all types of dyes that Golden
plaints produces. Therefore, any stock used towards this job order would need
to be replaced to meet other production demands.
II) Inventory of material O and P are from stock that was purchased in excess
previously. Material O has no other use other than for this special order.
Material P can be used as a substitute for 700 units of material Z which
currently costs Rs.11 per unit. The company does not have any inventory of
material Z currently.

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Required
ANALYSE the relevant costs of material while deciding whether to accept the order
or not? (10 Marks)
(b) ZM Inc. is a family run business based in Country Z. It is a manufacturer of two types of
flooring rolls, one for industrial usage and the other for domestic residential use,
throughout mainland of Country Z. The company started with the production of
residential domestic flooring. It is now an established player in this market. In the recent
years, the company pioneered into making flooring rolls for industrial usage. The
management has the following information about the budgeted and actual data for 2019-
Particulars Static Budget Actual Result
Industrial Domestic Total Industrial Domestic Total
Unit Sales 200 600 800 270 570 840
in Rolls
( ‘000)
Contribution 10.00 24.00 34.00 12.825 15.390 28.215
Margin
(Z$ in
millions)
In late 2018, a marketing research estimated market volume for industrial and
domestic flooring at 8m Rolls. Actual market volume for 2019 was 7m Rolls. Actual
sales trend of ZM Inc. is indicative of the sales trends for individual products in the
future years, it is likely that they might continue to sell a similar sales trajectory. A
newly appointed accountant has computed following variances:

Sales Variance Sales Quantity

Z$2.30 m (F) Variance
Z$1.70m (F)
Sales Mix Sales Quantity
Variance Variance Market Share
Market Size Variance
Z$0.60 m (F) Z$1.70 m (F) Variance
Z$4.25m (A)
Z$5.95m (F)
Domestic Domestic
Z$2.40m (A) Z$1.20m (F)

Industrial Industrial
Z$3.00m (F) Z$0.50m (F)

‘m’ refers to million

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Required
Assuming yourself as a performance management expert of ZM, the CEO has asked
you to ADVISE strategic inputs on ‘two types of flooring rolls’ to help out her in
strategic decision making. (10 Marks)
6. (a) The CEO of P Limited is concerned with the amounts of resources currently spent
on customers warranty claims. Each box of its product is printed with the logo:
“satisfaction guaranteed or your money back”. P is having difficulty competing with
X Limited because it does not have the reputation for high quality that X Limited
enjoys. Since the warranty claims are so high, the CEO of P Limited would like to
assess what costs are being incurred to ensure the quality of the product. Following
information is collected from various departments within the company relating to
2018-19:
Rs.
Warranty claims 4,25,000
Employee training costs 1,20,000
Rework 3,00,000
Lost profits from lost customers due to impaired reputation 8,10,000
Cost of rejected units 50,000
Sales return processing 1,75,000
Testing 1,70,000
For the year 2019-20, the CEO is considering spending the following amounts on a
new quality programme:
Rs.
Inspect raw material 1,20,000
Reengineer the production process to improve product quality 7,50,000
Supplier screening and certification 30,000
Preventive maintenance on plant equipment 70,000
P expects the new quality programme to save costs by the following amounts:
Rs.
Reduction in lost profits from lost sales due to impaired 8,00,000
reputation
Reduction in rework costs 2,50,000
Reduction in warranty costs 3,25,000
Reduction in sales return processing 1,50,000

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Required
(i) PREPARE a Cost of Quality Statement for the year 2018-19 showing the
percentage of the total costs of quality incurred in each cost category.
(3 Marks)
(ii) PREPARE a cost benefit analysis of the new quality programme showing how
the quality initiative will affect each cost category. (3 Marks)
(iii) STATE how the manager trade-offs among the four categories of quality
costs. (4 Marks)
(b) BYZ, a leading school of management in the heart of India’s financial centre of
Mumbai, preparing its budget for 2019. In previous years, the director of the school
has prepared the budget without the participation of senior staff and presented it to
the school board for approval.
Last year the Board blasted the director over the lack of participation of his senior
staff in the budget process for 2018 and requested that for the 2019 budget the
senior staff were to be involved.
Required
LIST the potential advantages and disadvantages to the BYZ of involving the senior
staff in the budget preparation process. (10 Marks)

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