The Hindu Business Line : Costing process for the moulded chairs

RST Ltd manufactures plastic moulded chairs. Three models of moulded chairs, all variation of the same design, are standard, deluxe and executive. The company uses an operation-costing system.

RST Ltd has extrusion, form, trim and finish operations. Plastic sheets are produced by the extrusion operation.

During the forming operation, the plastic sheets are moulded into chair seats and the legs are added.

The standard model is sold after this operation.

During the trim operation, the arms are added to the deluxe and executive models and the chair edges are smoothed. Only the executive model enters the finish operation in which padding is added.

All of the units produced receive the same steps within each operation. In April 2003 units of production and direct material cost incurred are as shown in Table 11.

The total conversion costs for April 2003 are as presented in Table 12.

Required: i) For each product produced by RST Ltd during April 2003, determine the unit cost and the total cost.

ii) Now consider the following information for May. All unit costs in May are identical to the April unit costs calculated as in (i).

At the end of May, 1,500 units of the deluxe model remain in work-in-progress. These units are 100 per cent complete as to materials and 65 per cent complete in the trim operation.

Determine the cost of the deluxe model work-in-process inventory at the end of May.

The product-wise unit cost and total cost are worked out in Table 13.

Total materials cost = Rs 3,55,250

Total conversion cost = Rs 11,53,125

Total cost = Rs 15,08,375

Note: Students can verify their answers in the examination hall itself.

ii) The cost of WIP at the end of May is shown in Table 14.

Reconciliation

A MANUFACTURING company disclosed a net loss of Rs 3,47,000 as per their cost accounts for the year ended March 31, 2003. The financial accounts, however, disclosed a net loss of Rs 5,10,000 for the same period.

The information given in Table 15 was revealed as a result of scrutiny of the figures of both the sets of accounts.

Prepare a memorandum reconciliation account.

The memorandum reconciliation account is presented in Table 16.

NPV, IRR

THE cash flows of Projects C and D are presented in Table 17.

i) Why is there a conflict of rankings?

ii) Why should you recommend project C in spite of lower internal rate of return? Table 18 shows the PV factors for the different periods.

While Project C is ranked first under the NPV method, Project D takes the top spot under the IRR method. There is a conflict of rankings.

This is because the IRR method assumes that funds are invested at the internal rate of return, whereas the NPV method assumes that the investment rate is equal to cost of capital, which is the minimum required rate for the company. Because of these different assumptions, the results of both the methods are contradictory.

Project C is recommended because it has a higher NPV than Project D, despite its IRR being lower.

The NPV method is an absolute measure of surplus which is Rs 4,139 in the case of Project C. Investments, at Rs 10,000, are the same for both the projects. The NPV of Project D is Rs 3,823 only. IRR is relative measure.

Hence, Project C is recommended.

Note: The PV factors are not relevant for decision-making.

Indifference point

CALCULATE the level of earnings before interest and tax (EBIT) at which the EPS indifference point between the following financing alternatives will occur.

Equity share capital of Rs 6,00,000 and 12 per cent debentures of Rs 4,00,000; or equity share capital of Rs 4,00,000, 14 per cent preference share capital of Rs 2,00,000 and 12 per cent debentures of Rs 4,00,000.

Assume the corporate tax rate is 35 per cent and the par value of equity share is Rs 10 in each case.

(EBIT - i (1 - T ) / No. of equity shares = (EBIT - i ) ( 1 - T ) - preference dividend / No. of equity shares

(EBIT - 48,000) (1 - 0.35) / 60,000 = (EBIT - 48,000) (1 - 0.35 ) - 28,000 / 40,000

0.65 EBIT - 31,200 / 60,000 = 0.65 EBIT - 31,200 - 28000 / 40,000

By cross multiplication:

26,000 EBIT - 12,480 lakh = 39,000 EBIT - 18720 lakh - 16,800 lakh

26,000 EBIT - 12480 lakh = 39,000 EBIT - 35,520 lakh

(39,000 EBIT - 26,000 EBIT) : 13,000 EBIT = 23,040 lakh

EBIT = 23,040 lakh / 13,000 = 1.77230 lakh

The reconciliation is shown in Table 19.

(To be concluded)

(Suggested answers to the May 2003 CA (PE II) paper on cost accounting and financial management.)

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