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No. of Pages - 08
No. of Questions - 06

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

CA PROFESSIONAL (STRATEGIC LEVEL I) EXAMINATION - JUNE 2013

13304 - STRATEGIC MANAGEMENT ACCOUNTING

Instructions to candidates:

(1) Time allowed:

Reading and planning : 15 minutes
Writing : 3 hours

(2) Marks : 100 marks

(3) (i) Section A - Question No. 01 is compulsory.
(ii) Section B - Answer any four (04) questions.
.
(4) Begin each answer on a separate page. Submit all workings.

(5) All answers should be in English Language, in the answer booklets provided.
____________________________________________________________________________

SECTION - A
Question No. 01

‘CC Division’ and ‘CM Division’ are two profit centers of Ceydeck Holdings (CH) (pvt) Ltd.
CC Division was formed to manufacture ‘Component A’ for CM Division and presently sells the
excess production to the external market. CM Division manufactures a special type of motor for
the external market and utilizes two units of Component A to produce one unit of such motor.
The following has been forecasted for the forthcoming year:

Division CC Division CM
(Component A) (Motor)
Selling price per unit to the external market (Rs.) 1,600 9,100
Variable production cost per unit (Rs.) (Note 1) 750 4,500
Divisional fixed production cost per unit (Rs.) 220 750
Variable selling and distribution cost per unit (Rs.) 130 650
(Note 2)
Fixed administration overheads (Rs.) 3 million 8 million
Budgeted production capacity (units) 75,000 30,000
Sales to external market (units) 35,000 20,000
Capital employed (Rs.) 160 million 280 million

Note 1 - Variable production cost of CM Division includes the purchase cost of Component A
and other variable costs relating to the production.
Note 2 - CC Division does not incur variable selling and distribution cost for internal transfers.
Fixed production cost is absorbed to the products on the basis of the budgeted production
capacities.
Among other determinants, Return on Capital Employed (ROCE) is a key factor which
determines the bonuses and other incentives of the divisions. It is CH’s policy to give an
additional incentive to its divisions for the achievement of ROCE above 15%.
Company at present prices all internal transfers at production cost plus 20%.
In the management meeting held recently, manager of the CC Division has expressed his
disagreement on the ROCE based incentive scheme and the present transfer pricing policy.
You are the management accountant of CH. Using the above information you are required to;

(a) Calculate the Return on Capital Employed (ROCE) for the two divisions and explain why
CC Division’s manager has disagreed with the present incentive scheme.
(7 marks)

(b) Find the additional number of units of Component A that CC Division should be allowed
to sell to the external market for the divisional manager to be benefited from the ROCE
based incentive scheme.
(3 marks)

(c) Find the impact to the CM Division from the sale of such additional quantities as
calculated in part (b) above.
(3 marks)

(2)
(d) Manager of the CM Division has forecasted the following possible sales of motors for the
forthcoming year at different price levels.

Selling price per unit (Rs.) Sellable Quantity (Units)

9,100 20,000
8,900 24,000
8,700 29,000
8,500 30,000

(i) Using the above information find the selling price and the respective quantity of
motors which will maximize the profit of the company as a whole and determine
the company profit at this optimal level.
(8 marks)

(ii) It is proposed that CH adopts a dual rate transfer pricing system for Component A
whereby the supplying division will receive a price equivalent to market price less
variable selling and distribution expenses and the receiving division will be
charged at the marginal cost of Component A.

Calculate the profit and ROCE of each division at the optimal level (per d (i)
above), and show that the proposed dual rates transfer pricing system could be
used to resolve the present transfer pricing issues.
(5 marks)

(iii) Briefly state two (02) practical issues with the dual rate transfer pricing policy.
(2 marks)
(Total 28 marks)

SECTION - B
(Answer any four (04) questions)

Question No. 02

Division B of Damsel Holdings PLC (DH) manufactures a specialized product Y. The following
information relates to the manufacture of product Y for the last month;

Per unit of
product Y (Rs.)
Direct material cost 250
Direct labour cost (Rs. 200 per hour) 100
Variable overhead cost 50

Direct material cost includes the cost of 2 kg of division’s main raw material at Rs. 95 per kg.
Total fixed overhead budgeted for a month was Rs. 3 million. Company absorbs budgeted fixed
overhead on the production volume basis, at Rs. 100 per unit of product Y.

(3)
You are in the process of preparing the budget for the next year and have been advised on the
following cost increases;
 Raw material prices of all direct materials by 25%
 Direct labour by 10%
 Variable overheads by 20%
 Budgeted fixed overheads by 10%
When you discussed these cost increases with the production manager he has suggested using a
cheaper grade of main raw material instead of presently used standard grade. The price of this
cheaper grade is always 80% of the standard grade. If cheaper grade is used following changes
will have to be considered:
 A loss of 5% from total input materials is required to be provided.
 The quality inspection process is required to be further strengthened which will increase
the fixed cost by Rs. 810,000 per month.
 Labour productivity will reduce by 12% from the present level.
At present the selling price is determined by adding 40% profit margin to the total cost and no
decisions have been made so far on the revision of this price. However the marketing manager
has informed you that he can sell the following monthly quantities next year;
Unit Selling price At existing At Rs. 680 At Rs. 650
price
Sellable quantity (units) 30,000 35,000 43,000
Based on the above information the CEO has asked you to;
(a) Calculate the unit variable cost with standard main raw material and the cheaper grade of
main raw material
(4 marks)
(b) Prepare an analysis which will enable the management to choose the best selling price
and the grade of the main raw material which will maximize DH’s profit. (You are
required to show your calculation of profits.)
(8 marks)
(c) Calculate the minimum quantity of product Y that should be sold per month in order for
you to recommend the cheaper grade of main raw material at the optimal price chosen in
part (b) above. (assume that any quantity of product Y is sellable in the market).
(2 marks)

(d) DMPL is another company of Damsel Holdings, marketing a single product. The
following information is relevant for DMPL and its main competitor. Using this
information you are required to prepare a brief comparison between the two companies in
terms of “operating leverage” (support your comparison with necessary calculations)
DMPL DMPL’s competitor
Annual turnover Rs. 100 million Rs. 100 million
Contribution to sales 80% 45%
Fixed cost per annum Rs. 20 million Rs. 10 million
(4 marks)
(Total 18 marks)
(4)
Question No. 03
A pharmaceutical manufacturing company is developing three medicinal compounds X, Y and Z
for diabetic patients. For this purpose four chemicals A, B, C and D are used in different
proportions. The following information has been given on the three products.
Chemical Usage Selling Price/kg Availability
% make-up per kg Price per month kg
Rs. Per kg Rs.
A B C D A 3000 1200
X 10 10 20 60 1660 B 1200 2000
Y 10 20 10 60 1620 C 2400 2200
Z 20 10 10 60 1620 D 200 Any Quantity

The manufacturing costs of each type of compound, excluding cost of materials, are Rs. 220 per
kg.
You are required to:
(a) Apply the above data into a linear programming model so that the company will
maximize its contribution. (3 marks)
(b) Construct the initial simplex tableau and explain the term ‘slack variables’ (consider a, b
and c as the slack variables for A, B and C) (2 marks)

(c) Interpret the final matrix of the simplex solution given below.
X Y Z a b c Solution
1 0 3 20 -10 0 4000
0 1 -1 -10 10 0 8000
0 0 -0.4 -3 1 1 600
0 0 440 3400 800 0 5680000
Your interpretation should include the following:

Optimal production quantities, resource utilization, shadow prices of fully utilized resources,
effect of production of item(s) not in the optimum mix, impact on the optimum mix, contribution
and utilization of other resources if an additional 1kg of fully utilized resource is made available.
(9 marks)
(d) Use the final matrix above to
(i) Estimate the effect of an increase in A of 100 kg per month.
(ii) Estimate the effect of a contract from an influential customer for a minimum 200
kg of Z to be supplied.
(iii) Recommend the appropriate cause of action if additional 500 kg per month of
chemical A are offered at Rs. 4,000 per kg.
(iv) Recommend the appropriate cause of action if additional 500 kg per month of
chemical B are offered at Rs. 3,200 per kg.
(4 marks)
(Total 18 marks)
(5)
Question No. 04
Research Department of Creamy Cheese Manufacturers (CCM) has developed a high quality
recipe for cheese. A wholesaler has proposed to buy CCM’s entire production of 100,000 packs
at Rs. 600 per pack provided CCM makes a commitment now.

(A) CCM is currently negotiating with an overseas party which has a well known brand
name for cheese to market its new variety of cheese under that brand name. However
it will take some time to reach a conclusion on such negotiation.
(B) CCM has also received information that a competitor is also planning to introduce a
similar high quality variety of cheese. If the competitor introduces his product in the
market, then it will have an impact on the price at which CCM could sell the product.
The intention of CCM at the moment is to focus on the market acquisition and therefore
concentrate on the revenue rather than profit.

The management of CCM has formulated the possible outcomes and the price at which they
could market the product as follows:
O1 - No competitive product and CCM gets the new brand name – Rs. 680 per pack
O2 - No competitive product but CCM doesn’t get the new brand name – Rs. 640 per pack
O3 - Competitive product introduced and CCM gets the new brand name – Rs. 600 per pack
O4 - Competitive product introduced and CCM doesn’t get the new brand name – Rs. 320 per
pack

Management of CCM has identified three possible strategies they could adopt which are given
below.
S1 - Commit to the wholesaler for the 100,000 packs to be sold at Rs. 600 per pack.
S2 - Sell the entire production of 100,000 packs after the outcomes of A and B are known.
S3 - Commit to the wholesaler for 50,000 packs (assume the wholesaler is agreeable to
purchase this quantity at Rs. 600 per pack) and sell the balance 50,000 packs once the
outcomes of A and B are known.
You are required to:
(a) Draw up a pay off table for CCM and determine the solution based on
(i) Maxi – Min Rule
(ii) Maxi – Max Rule
(iii) Min – Max Regret Rule (8 marks)
(b) Briefly explain the underlying principle(s) of the three rules given in (a) above.
(2 marks)
(c) It has been estimated that the probability of competitor introducing his product is 55%
and that there is a 65% chance that CCM will get the new brand name. Determine the
optimum policy for the company using the criterion of maximizing expected pay off.
(5 marks)
(d) Determine the expected value of perfect information for CCM.
(3 marks)
(Total 18 marks)
(6)
Question No. 05

Dumax (Pvt) Ltd (DPL) operates a standard costing system and prepares variance reports on a
monthly basis for management decisions. DPL has recorded adverse labour efficiency variances
for some months. Though the company has a proper operation in place it has investigated all
these adverse variances in the past. Based on these reports for the last 36 months, following
estimates have been made;

 80% of the variances stemmed from a random cause and as such no corrective action was
taken.
 Corrective action was taken for all the variances caused by a nonrandom occurrence and
such corrective action has eliminated 95% of the variances.
 The average cost of conducting an investigation was Rs. 225,000.
 An average cost of Rs. 800,000 has been incurred by DPL to correct a nonrandom cause.
Further, it has been observed that the correction process has taken a period of time during
which some production activities had to be stopped. The present value of lost
contribution due to production stoppages is estimated to be Rs. 200,000 and is not
included in the formerly indicated cost of correction.
 DPL suffers losses with a present value of Rs. 6 million if the variances stemmed from a
nonrandom cause are not eliminated.

By analysing the information a research firm has advised the management to continue
investigating all the future variances and take corrective action if the cause is a nonrandom
occurrence.
You are the management accountant of the company and the management has asked you to;
(a) Justify the advice of the research firm by drawing a clearly labeled decision tree
incorporating all the above-given information and evaluating with relevant calculations,
the two options of investigating and not investigating.
(12 marks)

(b) Calculate the minimum probability level of random occurrences for the variance, in order
for you to advise the management not to investigate future variances.
(3 marks)

(c) State three causes of the variances that would require an investigation to be carried out.
(3 marks)
(Total 18 marks)

(7)
Question No. 06

(a) Explain with examples, four (04) categories under which environmental costs are
typically classified.
(8 marks)
(b) Briefly explain ‘Life Cycle Costing’.
(2 marks)

(c) The following information relating to overhead costs has been extracted from the budget
of XYZ Limited for the six months from 1 July 2013 to 31 December 2013.

Activity Cost driver Units of cost Cost (Rs. 000)

driver
Product design Design hours 4,000 6,000
Purchasing Purchase orders 2,000 600
Production Machine hours 6,000 4,500
Packing Volume (cubic metres) 10,000 1,200
Distribution Weight (kg) 60,000 1,800

XYZ is planning to design a new product NP during the second half of 2013. The
production related cost of Rs. 4.5 million includes depreciation amounting to
Rs. 900,000 of which Rs. 25,000 relates to machines that will be used for production of
NP and charged on a straight line basis.
The following additional information is applicable to the new product NP :
1. Estimated total output over the product life cycle of four years is 5,000 units.
2. For designing purposes 200 design hours are required.
3. Output in the second half of 2013 is 250 units.
4. Equivalent batch size per purchase order is 50 units.
5. Production time is 0.375 machine hours per unit; volume is 0.4 m3 per unit and
weight is 3 kg per unit.

(i) Calculate the overhead cost per unit of NP which should include an appropriate
share of life cycle costs.
(6 marks)

(ii) If the market price of NP is expected to be Rs. 550 per unit, and XYZ Limited
expects a profit margin of 25% on cost, determine the target cost per unit of NP.
(2 marks)
(Total 18 marks)

(8)