CA Final November 2023 Suggested Answers Paper 5 Strategic Cost Management and Performance Evaluation (Old Scheme)

FOR CA FINAL EXAM PREPARATION

CA Final 2023
Suggested Answers ·
Paper 5 Strategic Cost
Management and
Performance
Evaluation (Old
Scheme)
EXAM YEAR TYPE

CA Final 2023 Suggested Answers
SUBJECT

Paper 5 Strategic Cost Management and Performance Evaluation (Old Scheme)
DATE

November 2023

Notes · Sample Papers · Previous Year Papers · Mock Tests

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION
Question No.1 is compulsory.

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Candidates are also required to answer any

o m four questions from the remaining five questions.
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Question 1m
.c Working notes should form part of the respective answers.
s e
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a is one of the largest a sports and athleisure brand that is involved in the design, g
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Style Activewear
a
aequipment, and services.
development, manufacturing and marketing and sales of apparel, footwear, accessories,

Mission: “To bring inspiration and innovation to every athlete in the country”.
We champion continual progress for athletes and support by taking action to help athletes reach
their potential. This is achieved by our drive product innovation for athletes everywhere.
Countless ideas are tested in pursuit of aiding performance, injury risk reduction, enhancing
perception and feel, and delivery of innovative products to athletes.

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Vision: "To contribute to the sustainable development of society and that of the environment

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with which we interact."

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Style believes in the ideology that in order to expand its horizon in the global market, it needs

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to have a sustainable business strategy. The company is committed to focusing as much on

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social and environmental concerns as they do on profits. Style follows 'Triple Bottom Line' (TBL)

a
which is an accounting framework which aims to measure the social, environmental, and
economic performance of the company over a period of time. As a part of its sustainable
business strategy the company has undertaken the following initiatives:
• 100% waste was diverted from the landfill in the company's extended supply chain with at
least 80% being recycled back into Style products.
• Maintain 100% pay equity across all employee levels on an annual basis.
• 70% absolute reduction of greenhouse gas (GHG) emissions in owned or operated
facilities through 100% renewable electricity and fleet electrification.

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•
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Marketing strategy to communicate its commitment to the Triple Bottom to help win

c. o • 25% reduction in freshwater usage per litre for textile dyeing and finishing.
customers and continue to grow its loyal base of consumers.
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l success. However,
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• Cover 100% of employees' health insurance costs.
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Style is deeply committed to achieving sustainable growth and financial
since past three years the company has observed a decline in both top -line and bottom-line
figures which is a matter of utmost importance. This decline serves as a critical signal to evaluate
and address the challenges.
Decline in revenue (top-line) has resulted from various factors such as:

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2 FINAL EXAMINATION: NOVEMBER, 2023

• The major issue faced by Style is a high level of competition by various other players in
the market which are more or less of equal size. The market for products in apparel,
sportswear, and supplements is anticipated to go on, and there exist several other
companies which are involved in the same apparel industry as Style. This has posed a
competitive challenge for the Style Limited as the consumer can opt to go for the alternative
companies which offer the same products.
• Style predicts that emergence of new players is probable due to the potential attractiveness
of the apparel industry.
• Style's clients and consumers involve both wholesale clients and retail clients. Wholesale
clients, such as PQR Sporting Goods and the Sports Authority, have a height of negotiating
influence, as they have a capability of substituting Style's merchandise for other companies
with the same products to get the huge surplus.
The company does its retail business through retailers who stock other brands as well.
This means that the diligently cultivated exclusivity is sometimes sacrificed because it has
not yet spread its wings to include exclusive retailer outlets as part of its business strategy.
• Counterfeiting is a serious threat that causes Style to lose many potential sales. Style
knock offs are easily found in a lot of markets.
Decrease in profitability (bottom-line) may be attributed to the following:
• Due to intense competition in the market, Style is forced to undertake strategies that will
attract customers into the business. The on-going recession has also taken a heavy toll on
Style with consumers becoming more price conscious and retailers demanding higher
margins. The combination of retailing in third party outlets and competing brands cutting
prices has made the going tough for Style.
One of the basic strategies undertaken by Style in the face of intensive competition is a
price reduction. The price reduction affects the profitability margins resulting in low profit.
• Other major issues faced by Style are increased operating costs, inefficiencies in
processes and fluctuation in raw material prices.
The CEO of Style, Mr. Aariv has remarked, "Declines in top-line and bottom-line figures are not
uncommon in the business world, and our management team is diligently working to identify the
root causes of this decline and formulate a comprehensive plan to reverse the trend."
The Management team of Style has proposed a few initial suggestions to be implemented with
immediate effect:
➢ The ultimate objective of Style should be, to achieve superior performance in comparison
to their competitors and attain a definitive competitive advantage.
➢ A Brands and organizations are normally different, as well as customers, therefore there
is the requirement for brand strategy.
➢ The company needs to open exclusive retail outlets across the country.

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 3

➢ The company should outsource major aspects of its production to overseas facilities.
Style's merchandise will be produced by a lot of manufacturers who are situated across

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different nations.
Required
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(i) Evaluate the company's mission statement. (2 Marks)

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of Triple Bottom Line' (TBL) framework mentioned above into social bottom line, la
partse
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(ii) Categorize the six sustainable business strategy initiatives undertaken by Style forming

l a bottom line or economic bottom line. Discuss very briefly the reason fora
ag classifying the initiative under a specific category.
environmental
(6 Marks)
(iii) Advise on the relevance of "Brand Strategy" in the context of Style. (3 Marks)
(iv) Evaluate how industry structure analysis (Porter's five forces analysis) is helpful to assess
the threat of new entrants into the market. Do you believe that the industry in which Style
operates would be an easy welcome for the new entrants? (2 Marks)
(v) "Wholesale clients, such as PQR Sporting Goods and the Sports Authority, have a height
of negotiating influence, as they have a capability of substituting Style's merchandise for

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other companies with the same products." Discuss what does this statement convey.

. c o (2 Marks)

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(vi) Do you foresee any challenges with outsourcing

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(2 Marks)

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(vii) Advise how IS/IT strategy would
organisation have a more comfortable existence than its competitors. (3 Marks)
Answer
(i) Mission Statement is a statement of an organization’s purpose, answering the question
of why a company exists, its reason to be. The Mission statement of Style is “To bring
inspiration and innovation to every athlete in the country.” The mission statement is
consumer focussed rather than being a product focussed statement.

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The statement can be understood through the following points:

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(a) Product/ Services offered: Style Activewear is a well-established brand in

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(b) Primary Market for the product or service would be the sportingegoods industry
sportswear, footwear, accessories, equipment, and services.

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where the primary customers are athletes, pursuing various

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professionally or a serious hobby (athleisure).
a (c) Style wishes to support and partner with its customers in their sports journey by aiding
their performance, reducing the risk of injury, designing innovative products that
enhance the ability of the athlete to achieve excellence in their pursuit.

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4 FINAL EXAMINATION: NOVEMBER, 2023

(d) The company wishes to have a wide presence in the sports goods industry.
The Mission statement of Style Activewear thus has a holistic outlook of what its
business is about and how it wishes to participate in the athlete’s development
as a sportsperson.
(ii) Categorization of initiatives under Triple Bottom Line reporting are as below −
The environmental bottom line measures the impact on resources, such as air, water,
ground, and emissions to determine the environment impact and ecological footprints.
The social equity bottom line relates to corporate governance, motivation, incentives,
health and safety, human capital development, human rights, and ethical behaviour.
The economic bottom line refers to measures maintaining or improving the company’s
success in term of adding value to shareholders.

(a) 100% waste was diverted from the landfill in the company’s extended supply
chain with at least 80% being recycled back into Style products – Waste diverted
from landfill, majority of which is further recycled back into the company’s products
reflects a positive impact that this initiative is having on the environment. Therefore,
this will get reflected under environment bottom line.
(b) Maintain 100% pay equity across all employee levels on an annual basis – Pay
equity across all employee levels will boost employee morale and motivation.
Therefore, this will get reflected under social bottom line.
(c) 70% absolute reduction of greenhouse gas (GHG) emission in owned or
operated facilities through 100% renewable electricity and fleet electrification –
This has a positive impact on the environment as it results in cleaner surroundings,
reduction of carbon footprints. Therefore, this will get reflected under environmental
bottom line.
(d) Marketing strategy to communicate its commitment to the Triple Bottom to help
win customers and continue to grow its loyal base of customers – Growing and
maintaining customer base has an impact on the market share of the company, which
ultimately improves the company’s financial performance. Therefore, this will get
reflected under economic bottom line.
(e) 25% reduction in freshwater usage per litre for textile dyeing and finishing –
This has a positive impact on the environment as this results in conservation of scarce
resources of the planet. Therefore, this will get reflected under environmental
bottom line.
(f) Cover 100% of employees’ health insurance costs – This has a positive impact on
maintaining the health and safety of the employees, thereby contributing to human
capital development. Therefore, this will get reflected under social bottom line.

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 5

(iii) Relevance of Brand Strategy Analysis
A brand becomes a common, well recognized symbol using which an organization

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channels its efforts to provide value to its customers. Brand strategy requires sophisticated

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understanding of the marketplace, knowing exactly how the brand and its offerings fit into

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it, knowing the audience in the market, and utilizing resources wisely to market its products

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in a targeted and effective way. Therefore, a branding strategy helps in establish a product

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a management team of Style Activewear has an initiative that says, “Brands anda
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within a market and will help it grow and mature with time.
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ag organizations are normally different, as well as its customers, therefore the requirement
for brand strategy.”
Style Activewear is operating in an increasingly competitive market, that still has potential
to grow. It is facing serious issues in establishing itself in the market due to the presence
of substitutes. Substitutes provide wholesale buyers the negotiating power to lower the
prices, and this is hurting Style’s revenue growth. On the retail front, again a crowded
marketplace with many players, the lack of brand power is lowering the visibility of

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Style’s products. Due to recession the customers have become price conscious and are

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unwilling to pay high prices for its products, at the same time retailers are demand higher

emStyle’s products in the marketplace would
margins. Both of this is again hurting Style’s growth.

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prominently communicate the lvalue
A brand strategy that helps establish

who is the athlete. A brand a
products bring to the final customer,
strategy differentiate its products from its
competitors/ substitutes.
Style Activewear can own different brands for its products at the same time. Each
range of product be it accessory, equipment, apparel could have a different brand. Each
brand can target different types of customers, a brand developed for premium
customers who want quality versus a brand for the cost-conscious customers who
can compromise on quality. Each type of product and each type of customer segment

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can be targeted to communicate the value that Style Activewear is offering to its target

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audience. This will improve the visibility of the product and help it establish itself in different

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market spaces. Depending on a successful brand strategy, the company can use the brand

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to grow it market share. This can help counter the negotiating power of wholesale

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buyers to whom Style can justify the need for charging premium for some of its

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popular products. It also increases the product’s visibility in the retail space.

ag Style could leverage e-commerce and reach out directly to customers, thereby
establishing direct contact with the end user. This strategy will be more successful if it has
a clear brand strategy in place. Direct interaction with the customers can help it save costs
spend on intermediaries, while also helping it grow its market share.

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6 FINAL EXAMINATION: NOVEMBER, 2023

(iv) Industry Structure Analysis as per Porter’s Five Forces
Industry structure (or environment) analysis highlights the profitability potential of any
industry using Porter’ five force model. Higher the intensity of competition results in
lower potential profitability and vice-versa. The five forces include the threat of new
entrants into the market. New entrants to the market bring new capacity and resources
that may ultimately eat into the market share of the existing incumbent firms. Barriers
to entry in the form of capital requirement, technology, economies of scale, reaction of
existing firms to competition etc.
The market in which Style operates has a high threat of new entrants Style knock offs,
which are counterfeit products are easily found in a lot of markets. This has posed a serious
threat to the company. This means that the barriers to entry are low. The counterfeit
products affect the brand identity and pose as a substitute of the original product. This has
begun to reduce the market share of players like Style and hence pose a threat to the
company. Given the information in the scenario, it seems that the market in which Style
operates does have low entry barriers and has a high threat of new entrant s. Not just
counterfeit products, but good margins can also pose a threat of new entrants. For
example, the sportswear apparel has attractive margins which can attract new players in
the market.
(v) Wholesale clients such as PQR Sporting Goods and the Sports Authority have a high
negotiating power over Style. Therefore, these buyers have higher bargaining power.
The negotiating or bargaining power stems from the fact that Style’s products have
equivalent substitutes within the market. It seems that the cost of switching between
the products is low. Hence, despite Style manufacturing and designing products that may
have differentiating features, it may not be able to command a premium price that it
might want to sustain its margins due to the availability of equivalent substitutes.
(vi) In order to improve its profitability, Style’s management has decided to outsource major
aspects of its production to overseas facilities spread across different nations. Style should
outsource its production only when the incremental cost savings (including any benefit
from costs foregone due to outsourcing) is greater than the incremental costs from
outsourcing. This is the quantitative(financial) aspect of outsourcing decision. The
company also needs to consider qualitative factors such as quality of goods produced
by the outsourcing vendors, reliability of these vendors, impact on customers etc.
before deciding on whether to outsource major portion of its production to overseas
facilities.
(vii) IS/IT and Porter’s Five Forces
(a) Threat of new entrants: For existing players sophisticated IT applications can be
used to create a barrier for entry for new entrants. This is because sophisticated IT
applications are expensive and take time to develop and imitate. This would be
a barrier for a new entrant. Also, computer-controlled production can increase the
economies of scale for the existing firms, which can create another barrier of entry

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 7

for the new firms. On the other hand, new entrants can also use IS/IT to break down
existing barriers in an industry.

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For example, in banking industry, Internet Banking, Mobile Banking and Use of

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Automated teller machines (ATMs) reduced the banking at branch hence cost of

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establishing branches can be saved by new entrants.

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(b) Supplier’s bargaining power: IS/IT can be used to prevent cartelisation of suppliers

l a s with better price discovery for its raw material and service requirements. IT is g
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a Strategic or operational alliance are formed with the vendors and access of ERP
intensively used to realise the concept of integrated supply chain as a reality.

extended to include them as part of larger supply chain.
(c) Buyer’s bargaining power: IT maybe used to reach out directly to the end
customers of a product, thereby reducing the bargaining power of intermediaries.
Companies can cater to the final customers directly through online portals. This has
improved customer service as well as market reach. Customer data warehousing and
mining provides large volume of data about customer choice, preference, buying pattern

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which can be used by the company to provide personalized service to its customers.

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(d) Threat of substitutes: Companies can use computer aided design and

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manufacturing to develop new products ahead of their competitors and then patent

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them in order to prevent its rivals from imitating its innovation. Intellectual property

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rights and research and development can help companies restrict other firms from

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doing the same business and can create barriers to entry. This reduces the threat of
substitutes.
(e) Competitive Rivalry: Profitability or market share is determined by the intensity of
competition within the industry. A company can use IT resources to gain cost
leadership. IT resources can help in the execution of strategies like Just in Time
systems, Enterprise Resource Systems etc. IT can also be used for collaborative
venture that make organisation too big to fail or reduced the competitor’s motivation
and effect.

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For example, A reputed travel agency and a hotel chain come together as travelling

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and stay partner. IT can also be used for relationship building with client and

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customers so that they remain engaged with organisation this automatically reduce

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the threat from rivals, for these online notifications may be used.

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To conclude, Business Organisation can use IT/ IS to transform business and

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its aspects to reduce and counter five forces, while outperform its peers or

a rivals.
Conceptually correct brief explanations are sufficient for each step. Alternate Points
or Reasoning are also possible. However, issue must be addressed properly, and the
answer must respond to the requirement.

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8 FINAL EXAMINATION: NOVEMBER, 2023

Question 2
(a) The Management of a Company aims to streamline its cost structure related to quality
management while focusing on quality improvement. They have identified the following
cost elements associated with quality:
Cost Elements Amount (`)
Product Returns and Replacements 2,40,000
Incoming Raw material Inspections 2,10,000
Packaging Material Inspection 1,05,000
Quality Audits 1,80,000
Materials Rejection and Disposal 95,000
Product Acceptance 1,55,000
Education of Suppliers 1,45,000
Rework of Defective products 1,40,000
Outside Certification 1,10,000
Cost of Recalls 90,000
Post-purchase Customer support 1,10,000
Supplier Evaluation and Selection 90,000
Production line testing 75,000
Downtime due to quality issues 2,15,000
Required
(i) Categorise each cost element into prevention, appraisal, internal failure, and external
failure categories. (7 Marks)
(ii) Determine the percentage of total costs of quality incurred in each cost category by
utilizing the provided cost breakdown for the company. (1 Mark)
(iii) Interpret the distribution of costs across different quality-related categories and
suggest potential strategies the company could adopt to enhance its quality
management practices while optimizing costs, with a focus on prevention, appraisal,
and addressing failure costs. (2 Marks)
(b) PQ Company, a manufacturer of computer games, has developed a new game called the
'WIN'. This is an interactive 3D game and is the first of its kind to be introduced to the
market. PQ Company is going to launch the 'WIN' in time for the peak selling season.
The following cost details relate to 'WIN' are:

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 9

Development Launch Growth Maturity Decline

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Time period Finished 1 year 1 year 1 year 1 year

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R&D Costs (` in lakhs) 200

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Marketing Costs (` in lakhs) 50 40 30 9

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Production cost per unit ( ` ) 250 225 200 225

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Production volume (lakhs 1 5 10
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a The launch price is proving a contentious issue between managers. The Marketing
units)

Manager is keen to start with a low price of around 300 to gain new buyers and achieve
target market share. The Account's Manager is concerned that this does not cover cost
during launch phase and has produced the following schedule to support this:
Launch Phase ` in lakhs
Amortized R&D costs (200/4) 50

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Marketing Costs 50

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Production Costs (250*1) 250

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Total Costs 350

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Total production (units in lakhs)
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Cost per unit ( `) a 350

Traditionally PQ Company has priced its games based on standard manufacturing cost
plus selling and administration cost plus a profit margin. However, the management team
of PQ Company has recently attended a computer games conference where everyone was
talking about life cycle costing and market based pricing approaches. The Managing
Director of PQ Company would like more details on the topics they heard about and how
they could have been applied to 'WIN’.

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Required

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(i) Calculate cost per unit for the whole life cycle of the product 'WIN' and comment on

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the implications of this cost with regards to the pricing of the product during the launch

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phase. (6 Marks)

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(ii) Evaluate any one issue the management team will need to consider at each stage in
a the product life cycle of 'WIN. (4 Marks)

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10 FINAL EXAMINATION: NOVEMBER, 2023

Answer
(a) (i) Categorisation of Cost Elements
Costs Prevention Appraisal Internal External
Cost Cost Failure Failure
(`) (`) Cost (`) Cost (`)
Product Returns and --- --- --- 2,40,000
Replacements
Incoming Raw Material --- 2,10,000 --- ---
Inspections
Packaging Material Inspection --- 1,05,000 --- ---
Quality Audits 1,80,000 --- --- ---
Material Rejection and --- 95,000 --- ---
Disposal
Product Acceptance --- 1,55,000 --- ---
Education of Suppliers 1,45,000 --- --- ---
Rework of Defective Products --- --- 1,40,000 ---
Outside Certification --- 1,10,000 --- ---
Cost of Recalls --- --- --- 90,000
Post-purchase Customer --- --- --- 1,10,000
Support
Supplier Evaluation and 90,000 --- --- ---
Selection
Product line testing --- 75,000 --- ---
Downtime due to quality issues --- --- 2,15,000 ---
Total 4,15,000 7,50,000 3,55,000 4,40,000
(ii) Percentage of Total Costs of Quality
Costs Prevention Appraisal Internal External
Cost Cost Failure Cost Failure Cost
Total Cost ` 4,15,000 ` 7,50,000 ` 3,55,000 ` 4,40,000
% of Total Cost 21.17% 38.27% 18.11% 22.45%
(iii) Interpretation
The company's cost for prevention accounts for 21.17% of the total, while
appraisal cost accounts for 38.27%. The combined cost of both quality

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 11

conformance costs is close to 60%. Thus, 40% of the cost is attributed to non -
conformance. A substantial portion of the entire cost—nearly 17%—is attributed to

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product recalls and returns, which is not a positive indication.

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If company wants to continue to improve its reputation for quality, it needs to

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reduce the number of units rejected by customers, which means it will need to

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eStatement Showing Life Cycle Cost
increase conformance costs. Higher spending on conformance led to lower

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costs of non- conformance.

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(b) (i)
Particulars Amount
R& D Costs (` in lakhs) 200
Marketing Costs (` in lakhs) 129
Production Cost (` in lakhs) 4,275
Total (` in lakhs) 4,604
Production Volume (lakhs units) 20

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Cost per unit 230.2

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Comment on implications

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the accountant was right to beaconcerned about the launch price being set at ` 300
l at that whole life cycle the marketing manager’s
The cost was calculated at ` 350 per

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per unit. However, looking
proposal seems more reasonable. The average cost per unit over the entire life of
the product is only ` 230.20 per unit. Therefore, a starting price of ` 300 per unit
would seem reasonable and would result in a profit of ` 69.80 per unit.
If PQ were to implement life cycle costing, it would provide an overview of the “WIN”
's performance. This would provide vital information when assessing potential cost
reduction opportunities as well as revenue extension opportunities for the
game.

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As the “WIN” is the first of its type to the market, PQ could pursue one of the Market-

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based pricing strategies -

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Price Skimming

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This method of pricing sets high initial prices in an attempt to exploit

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of the market which are relatively insensitive to price changes.

ag computer games is generally highly inelastic, PQ would be
market skimming strategy and set a high price to take advantage of the new
game and the timing of its launch.

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12 FINAL EXAMINATION: NOVEMBER, 2023

Penetration pricing
This method sets in very low prices the initial stages of a product's life cycle to
gain rapid acceptance of the product and therefore a significant market share.
This method of pricing is followed if a company wishes to discourage new entrants to
the market. There may also be significant economies of scale to be gained if the low
pricing leads to high volume and therefore cost reduction.
Target pricing
This method would mean that PQ would first undertake some market research to
determine the target selling price for the “WIN.” It would then use this target
selling price to arrive at a target cost.
(ii) Issue the management team will need to consider
Introduction
The product is introduced to the market. The product has been designed. Developed
and packaged. Large amounts of money have already been spent on WIN up to this
point.
Advertising and Marketing: When the product is first launched on the market
demand is likely to be small. A lack of familiarity with the new product and its sources
of availability will work against large initial sales, and it will usually be necessary to
spend heavily on advertising to bring the product to the attention of potential
customers.
A combination of relatively high costs, relatively low sales volume, and the potential
problem of rejection by the market conspire to make this the riskiest stage in the life
cycle.
Growth
Assuming the product successfully negotiates the perils of the introduction stage, it
will enter the growth phase, where demand for the product increases steadily and
average costs fall, with the economies of scale that a company the greater production
volume.
This stage should offer the greatest potential for profit to the producer, even though
competitors will be prompted to enter the growing market.
Cost reduction and control: As volume increases and unit cost begins to fall,
managers should avoid assuming that the product is cost efficient. The target cost (if
used) should continually be reduced during this stage and staff should continue to
develop new cost-efficient production methods.

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 13

Maturity
By this stage the WIN will have reached the mass market and the increase in demand

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will begin to slow down. The sales curve will flatten out and eventually start to decline.

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Profitability will generally to at a lower level than in the growth phase.

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Product development: In order to generate higher profits, PQ Company may try to

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extend the phase in the product’s life cycle. The product may be modified or improved,
la
l a s as a means of sustaining its demand. Managers may try to reach new market
a g
ag
segments.
Decline
The fall in sales accelerates when the market reaches saturation point. It is likely that
new technology will mean that superior interactive games are being launched.
Although it is still possible to make profits for a short period during this stage, it is
only a matter of time before the rapidly dwindling sales volumes herald the onset of
losses for all producers who remain in the market. The product has effectively
reached the end of this life cycle and more profitable opportunities must be sought
elsewhere.

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c. o
The final decision that must be reached is when to withdraw the product from the

m
market.

e
s issue must be addressed properly, and the
a
Conceptually correct brief explanations are sufficient for each step. Alternate Points

l
ag
or Reasoning are also possible. However,
answer must respond to the requirement.

Question 3
(a) Violet Limited comprises of two divisions, Division P and Division M, both of which are
resident in a country where company profits are subject to taxation at 30%.
Division P is the Production division which assembles desktop computers and sells to
several industry sectors. Many of the components used in these desktop computers are
purchased from Division M.

o m
Division M manufactures components from raw materials, many of which are imported. The

m
components are sold globally. Some of the components are sold to Division P.
.c
c. o Both Division P and Division M are profit centers.
s
m
e are as follows:
s em a
l Division M
Operating results of both the divisions for the year ended 31 March 2023
Division P g
st

gla Particulars
a Amount (`)
a External Sales
Amount (`)
63,00,00,000 20,00,00,000
Sales to Division P - 17,50,00,000

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14 FINAL EXAMINATION: NOVEMBER, 2023

Total Sales 63,00,00,000 37,50,00,000
Less: Cost of Sales 45,00,00,000* 12,50,00,000
Administration costs 11,00,00,000 6,50,00,000
Operating Profit 7,00,00,000 18,50,00,000
[*Cost of Sales in Division P includes the cost of components purchased from Division M.]
The current policy of the company is to allow the managers of each division to negotiate
with each other concerning the transfer prices.
The manager of Division M charges the same price internally for its components that it
charges to its external customers. The manager of Division M argues that this is fair
because if the internal sales were not made, he could increase his external sales. An
analysis of the market demand shows that currently Division M satisfies only 80% of the
external demand for its components.
The manager of the production division, Division P believes that the price being charged
by Division M for the components is too high and is restricting Division P's ability to win
orders.
Recently Division P failed to win a potentially profitable order which it priced using its
normal gross profit mark-up. The competitor who won the order set a price that was 10%
lower than Division P's price.
An analysis of the cost structure of Division M indicates that 40% of the cost of sales is
fixed costs and the remaining costs vary with the value of sales.
Required
(i) Evaluate how the present transfer pricing policy is affecting the overall performance
of the group. (2 Marks)
(ii) Recommend, with appropriate calculations, the transfer price, or prices at which the
components should be supplied by Division M to Division P. (Assume that if division
M sells components internally, there is a chance of saving on distribution costs, bad
debts risk and currency risk up to 10% of the sales amount. Another assumption is
that if internal transfer is done at variable cost, then a small saving incentive of 10%
may be added to the variable cost). (6 Marks)
(iii) The company's CEO is considering relocating Division M to a country that has a much
lower rate of company taxation than that in its current location. Explain the potential
tax consequences of the internal transfer pricing policy if Division M were to relocate.
(2 Marks)
(b) V-Air is one of the growing number of low-cost airlines in the country of YZ. V-Air's strategy
is to operate a low-cost, high efficiency airline, and it does this by:
• Operating mostly in secondary cities to reduce landing costs.

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 15

• Using only one type of aircraft in order to reduce maintenance and operational costs.
These planes are leased rather than bought outright.

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• Having only one category of seat class.

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• Having no pre-allocated seats or in-flight entertainment.

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• Focusing on e-commerce with customers both booking tickets and checking in for

s e flights online.
g
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The airline was given an A+ grading by the country's aviation authority, which rank all of
the country's airlines based on the number of flights which arrive on time at their
destinations. Fifty eight V- Air flights were cancelled in 2022 compared to forty four in 2021.
This increase was due to an increase in the staff absentee rate at V-Air from 4 days per
staff member per year to 5.3 days.
The average 'ground turnaround time' for airlines in the country of YZ is 50 minutes,
meaning that, on average, planes are on the ground for cleaning, refuelling etc. for 50
minutes before departing again. Customer satisfaction surveys show that 85% of
customers are happy with the standard of cleanliness on V-Air's planes.

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The number of passengers carried by airline has grown from 4,00,000 passengers on a

.
total of 3,850 Flights in 2021 to 9,75,000 passengers on 7,560 flight in 2022. The overall

em
growth of V-Air has been helped by the limited route licensing policy followed by the

a s
government of country YZ. This has given V-Air almost monopoly status on some of its

g l
routes. However, the government is now set to change this policy with almost immediate

a
effect and it has become more important than ever to monitor performance eff ectively.
Required
(i) Discuss advantages of using financial measure as a performance measure.
(2 Marks)
(ii) Construct a Balanced Score Card table such that, for each perspective, TWO goals
together with corresponding performance measures are identified for V- Air. Also
evaluate why those goals and performance measures are relevant to V - Air.

o m
(8 Marks)

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c. o (a) (i) Currently
Answer
Division P, the desktop manufacturing unit, purchasesmsome of its
m s e Both have an
s e
components from Division M, the component manufacturing unit.
g a
l policy
l a a
external market for its products. The current transfer pricing allows each

ag division to negotiate with each other concerning transfer prices on internal
Internal sales amount to ` 17,50,00,000 for the year ended March 31 2023. Both
sales.
st

Divisions are profit centers, therefore there is accountability on the manager of each
division for the profit the division generates. Consequently, the manager of Division
M wants to reflect maximum sales revenue in his books, which will in turn boost the

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16 FINAL EXAMINATION: NOVEMBER, 2023

profits shown by Division M. The revenue generated by Division M on internal sales
will be reflected as cost of sales in the books of Division P. Since Division M is
charging a higher external sale price, the costs that Division P needs to recoup from
its sales to the external market increases. Pricing for Division P is based on gross
profit mark up, which is based on its cost price. Since the cost of procurement from
Division M is high, the pricing for Division P’s desktop computers is also higher.
This is affecting Division P’s ability to compete in the external market. The
internal transfer pricing policy resulted in the loss of a potential order due to
inability of Division P to lower its price in order to compete with its competitor.
The manager of Division P may be unwilling to lower the price of its desktop because
he has an accountability for the profit reflected in the division’s books. Overall, the
transfer pricing policy is not promoting goal congruence for Violet Limited as
each manager wants to reflect the maximum divisional profit. This has resulted
in loss of market share, revenue and profits for the company as a whole.
(ii) Recommended Transfer Price for internal sales of components from Division M
to Division P.
The cost structure of Division M is composed on fixed component 40% of cost of sales
and the balance being variable cost. Total cost of Division M is ` 19,00,00,000 for the
year comprising of cost of sales ` 12,50,00,000 and administration costs
` 6,50,00,000. The cost structure in terms of fixed and variable cost is summarized
below in Table 1.
Table-1: Cost Structure Analysis of Division M
Amount in `
Total cost of Division M (Cost of Sales + Administration Cost) 19,00,00,000
Less: Administration Costs (assumed fixed hence irrelevant) 6,50,00,000
Less: Fixed Cost (40% of cost of sales) 5,00,00,000
Variable Cost 7,50,00,000
Therefore, the variable cost component for Division M is ` 7,50,00,000 for the
year.
The calculation of contribution margin earned by Division M from its sales is
summarized in Table 2. It is given in the problem that internal sales of Division M are
also priced at external sale price for each unit. Therefore, the contribution earned on
both internal and external sales is the same.
Table-2: Calculation of Contribution Margin for Division M
Amount in `
Total Sales of Division M 37,50,00,000

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 17

Less: Variable Cost (refer to table 1) 7,50,00,000
Contribution 30,00,00,000
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Contribution Margin = Contribution / Total Sales × 100 80%

.co
Note 1: Variable cost related to internal sales = Total variable cost × internal sales /
s e m
m
e= ` 7,50,00,000 × (` 17,50,00,000/ ` 37,50,00,000)
total sales
la
l a s a g
ag
= ` 3,50,00,000
Division M is currently catering to only 80% of its external sales. Its current external
sales for the year are ` 20,00,00,000. The calculation for lost external sales on
account of internal transfer to Division P is shown is Table 3.
Table-3: Lost External Sales of Division M
Amount in `
Current External Sales (80% of external demand) …(A) 20,00,00,000
Total External Demand for
o m
DivisionM's Components
(` 20,00,00,000/ 80%)
. c …(B) 25,00,00,000

e m
s 80%
Lost Sales due to internal transfer to Division P …(B)- (A) 5,00,00,000

l a
g on lost sales amounting to ` 4,00,00,000 is currently
Contribution on Lost Sales @ 4,00,00,000
Note 2: The contributionamargin
being recouped from Division P as full external price is charged by Division M even
on internal transfers. Therefore, Division M is not suffering loss of profitability on
account of internal sales.
It is important to analyse the capacity utilization of Division M. The level of capacity
utilization will determine whether Division M is justified in charging any opportunity
cost, in the form of contribution lost from external sales. The analysis of Division M’s
capacity utilization is shown in Table 4.

o m
m c
. in `
Table-4: Capacity utilization Assessment of Division M

c. o m
se17,50,00,000
Amount

s em la 5,00,00,000
Internal Sales to Division P

la g
a 12,50,00,000
Lost External Sales of Division M due to Internal Transfer

ag Excess of Internal Demand over and above Lost Sales
Contribution on Sales charged on “Internal Sales” using
unutilized excess capacity at Division M @ 80% 10,00,00,000

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18 FINAL EXAMINATION: NOVEMBER, 2023

Division M is currently catering to internal sales of ` 17,50,00,000 while the external
sales lost due to this internal order is only ` 5,00,00,000. Division M is justified in
charging the contribution margin on ` 5,00,00,000 lost external sales, amounting to
` 4,00,00,000 for the year, as this represents an opportunity cost for the Division.
The rest of the internal sales to Division P that is the balance ` 12,50,00,000 sales is
being generated from unutilized capacity lying idle at Division M.
Note 3: If Division M catered to only external demand and had not catered to internal
demand for Division P. it would still have excess unused capacity. Instead of
remaining idle this excess unused capacity is used to cater to Division P's
requirements to generate sales worth ` 12,50,00,000 for Division M.
Note 4: In order to promote goal congruence, Division M should not charge
contribution on the internal sales generated using its excess unutilized production
capacity. Therefore, Division M should not charge contribution on such sales. This
will result in a reduction in internal transfer price amounting to ` 10,00,00,000.
Therefore, it can be concluded that there is scope for Division M to reduce the internal
transfer price that it charges to Division P. There is scope for reduction in the following
areas:
(1) Savings in variable cost on internal transfers on account of lower risk of bad
debts, distribution cost, currency risk etc. that amounts to 10% of sale value.
This amounts to ` 1,75,00,000 for this year.
(2) As discussed in the capacity utilization analysis, lower the sale price on internal
transfers by ` 10,00,00,000 on production made from unused idle capacity at
Division M.
Transfer Price from Division M to Division P
Variable Cost on Internal Sales 3,50,00,000
Less: Savings in Variable Cost (due to internal transfer
distribution cost, bad debt risk, currency risk = 10% of internal
sales)
(assumed ‘complete amount’ is included in the variable cost
of sales) 1,75,00,000
Revised Variable Cost on Internal Sales 1,75,00,000
Add: Markup (for unutilised capacity - transfer)
[1,75,00,000 (revised VC) × 12,50,00,000 (internal transfer)/
17,50,00,000 (total transfer)] @10% 12,50,000
Add: Contribution Margin on Lost Sales (for lost external sale) 4,00,00,000
Transfer Price 5,87,50,000

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 19

As shown above, the transfer price that can be agreed upon between Division
M and Division P will be ` 5,87,50,000.

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This part can also be solved by considering that Division M (profit center) will

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transfer the unsatisfied external demand at market price less savings on

.
distribution costs, bad debts risk and currency risk up to 10% of the lost sales
e m
m
eTransfer at Market price due to unsatisfied external sales
amount then the transfer price will be –
l a s
s
la Less: Saving in distribution cost, bad debt risk, currency risk @10% 50,00,000 a
5,00,00,000
g
ag Value of transfer at market price less small savings (A) 4,50,00,000
The balance portion can be transferred at variable cost plus a small saving incentive
of 10% being added to the variable cost.
Variable Cost on Internal Sales (17,50,00,000-5,00,00,000) X 20% 2,50,00,000
Add: Markup (for unutilised capacity - transfer) @10% 25,00,000
Value of transfer price for unutilised capacity (B) 2,75,00,000
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c. o
In such a situation the maximum range of transfer price may be computed as

m transfer policy if Division M were to
(iii) Potential tax consequences ofeinternal
7,25,00,000 [4,50,00,000 +2,75,00,000]

l s
a company tax rate.
g
a is 30% for Division M. Therefore, 30% of taxable profit
relocate to a country with lower
The tax rate at current location
of Division M. By relocating Division M to a country with lower company tax rate,
the tax impact on earnings can be reduced. This will increase the overall after -
tax profits of the company. Also, where the tax rate is lower, Division M can
charge a higher rate on its internal transfers. The result of this would be that
revenue at Division M would be charged at a lower rate. Meanwhile Division P
can claim a higher cost of procurement which can be used to reduce its taxable
profit, which is charged at a higher rate of 30%. Again, this will increase the

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overall after-tax profits of the company.

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c. o m
The goal of such tax planning decisions should be to reduce the tax impact on

se
earnings for the company within the legal prescribed framework and not tax

s em l a This question can
avoidance.
Conceptually correct brief explanations are sufficient for eachgstep.
gla a
a
also be solved by assuming ‘Administration Costs’ as variable.

(b) (i) Financial measures can be quantified and provide definite information to key
stakeholders like management, shareholders, and lenders about the impact of the
company’s strategic decisions on the revenue and earnings of the company.

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20 FINAL EXAMINATION: NOVEMBER, 2023

▪ Focus on financial objectives is linked to the overall objective of wealth creation
of shareholders. External users of accounts recognise financial measures as a
tool to identify the success or failure of the policies of the directors who, as
stewards of the assets, are entrusted with the task of increasing the wealth of
shareholders.
▪ Such measures are objective. Terms like earnings per share are easily
understandable and shareholder clearly understands what his / her gain is.
▪ Quantification of results is possible.
▪ The measures are comparable across companies of a particular industry.
▪ The framework to measure financial performance is established in most of the
cases.
(ii) Balanced Scorecard Table for V Air, a low-cost high efficiency airline −
Perspective Strategic Measure Relevance to V Air
Objective
Financial Goal-1: To use Lease costs of Operating efficiency
Perspective fewer planes to plane per - will be driven by
transport customers customer getting more
customers on fewer
planes. This goal and
measure cover the
cost side of this.
V Air strategy is to win
market through cost
leadership. Hence
lower cost is of
paramount
importance to the
airline.
Goal-2: To increase Revenue per This covers the first
seat revenue per available part of achieving
plane passenger mile operating efficiency –
Revenue per by having fewer empty
average seat seats on planes
kilometre
Customer Goal-1: To ensure ‘On time arrival’ V Air is currently
Perspective that flights are on ranking from the number A+ in the
time. aviation authority rankings. If it
becomes known as a
particularly reliable

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 21

airline, customers are
more likely to use it,

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which will ultimately

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increase revenue.

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Goal-2: To reduce The number of Again, if flights are

m la s
the number of flights cancelled seen to be cancelled

s e flights cancelled frequently by V Air,
g
l a customers will not
a
ag
want to use it.
Number of flight
cancellations
increased from 44 in
2021 to 58 in 2022.
This can affect
customer perception
of the airline and
affect customer

m
ranking.

c. o
Internal Goal-1: Cycle time ‘On the ground’ Cycle time

em
perspective optimization time optimization to

s
increase flying hours

g l a for each aircraft.

a
Currently the average
"ground turnaround
time" is 50 minutes.
Less time spent on the
ground means fewer
planes are needed,
which will reduce
plane leasing costs.
However, it is

m
important not to

co
compromise the

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quality of cleaning or
m
se
make errors in

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refuelling as a

las a g
consequence of

g
reducing on the

a
ground time.
Goal-2: To improve The percentage Currently 85% of
the cleanliness of of customers customers are
V-Air’s planes happy with the satisfied with the

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22 FINAL EXAMINATION: NOVEMBER, 2023

standard of the standard of
planes, as cleanliness on V Air's
reported in the planes. This could be
customer causing loss of
satisfaction revenue.
surveys.
Goal-3: To develop Percentage Since the company
the online booking downtime relies entirely on the
system booking system for
customer booking of
flights and check-in, it
is critical that it can
deal with the growing
number of customers.
Goal 4: Flight No. of instances Number of flights
Safety of serious lapses operated by V Air has
in flight safety nearly doubled from
3,850 flights in 2021
to 7,560 flights in
2022. The passengers
serviced have also
doubled. Ensure flight
safety should be a
priority for V Air.
Learning Goal-1: Route Number of V Air's monopoly on
and Growth Network Routes expected certain routes can
Development to be with drawn change due to change
Number of New in government policy.
Routes This could increase
% of Load for competition.
New Route Therefore, it would
explore new revenue
Time period to
streams.
break-even
Goal-2: Staff The number of V Air should allow for
Motivation and days absent per personal growth of
Loyalty employee employees to combat
staff attrition and staff
absenteeism. Staff
absenteeism
increased from 4 days
per staff per year to

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 23

5.3 days this year.
Employee feedback

m
should be taken to

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understand the

co m
reason.

m . Motivated staff
s e
e la
promotes customer

l a s Goal-3: Functional Number of days’ V Air should improve a g
focused culture.

ag excellence
Leadership skills
and training
ground
per
crew
and maintain its
strategic skill ratio
member through training and
Number of development
training programs programs
Improve job readiness
through training by
making employees

m
multi skilled. For

co
example,

. If ground crew are

em
better trained, they

l a s can reduce the

g
number of minutes
a that the plane stays on
the ground, which will
result in fewer planes
being required and
therefore lower costs.

Conceptually correct brief explanations are sufficient for each step. Alternate
classifications, measures or reasoning are also possible. However, the issue

m
must be addressed properly, and the answer must respond to the requirement. Only

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two goals together, along with corresponding performance measures and relevance,

c. o Question 4 m
are sufficient.

em l a which offers a se
las (a) DP Capital Advisors Private Limited is an investment advisory g
wide variety of services on succession, real estate, insurance,aand wealth management
g
company

a advisory services which is customizable to fit the client's individual needs. Over th e past
three years, DP has seen increased competition, evolving customer preferences, and
rising costs. As a result, its profit margins have been steadily declining.

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24 FINAL EXAMINATION: NOVEMBER, 2023

The Board of Directors of DP recognizes the urgent need to improve profitability. They
believe that there is a need for Business Process Reengineering (BPR) effort which can
help identify and address inefficiencies, streamline operations and ultimately boost profits.
Required:
(i) Explain very briefly what is meant by business process Reengineering (BPR). What
is the purpose of business process reengineering? (2 Marks)
(ii) Recommend the main stages of Business Process a Reengineering (BPR) exercise.
(2 Marks)
(iii) Advise how Business Process Reengineering (BPR) could help to improve the profits
of DP Capital. (1 Mark)
(b) PQC owns and operates a chain of popular cocoa shops that serve over 50 different
varieties of cocoa based beverages. The constraint at the cocoa shops is the amount of
time required to fill an order, which can be considerable for the more complex beverages.
Sales are often lost because customers leave after seeing a long waiting line to place an
order. Intensive analysis of the company's existing products has revealed that the
opportunity cost of order filling time is ` 180 per minute. The company is considering
introducing a new product 'Dark Choco bar', to be made with dark cocoa, milk, cream and
sugar. The variable cost of the standard size 'Dark Choco bar' would be ` 20 and the time
required to fill an order for the beverage would be 40 seconds.
Required:
(i) Recommend the minimum acceptable selling price for the 'Dark Choco bar' product.
(3 Marks)
(ii) List the situations where 'minimum pricing approach would be useful. (2 Marks)
OR
'Sweda' is a small proprietary firm that engages in trading activities. In the last few months,
'Sweda' has witnessed significant growth in its business and is now considering whether
to administer its own internal service department for maintaining books or use an external
accounting service.
It has obtained the following cost estimates for each option:
Internal Service Department
Amount (`)
Purchase Hardware / Software 5,000 per annum
Hardware / Software Maintenance 2,500 per annum
Accounting Stationery 1,500 per annum
Part- time Accounting clerk 60,000 per annum

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 25

External Service Department
Amount (`) Volume
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Processing of invoices /credit notes 2.5 per document 5,000 per annum

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Processing of cheque payments 2.5 per cheque 4,000 per annum

e m
Reconciling supplier accounts 50 per supplier per 150 suppliers
la s
l a s(Uniform through -out the year) month
a g
ag (i) Calculate the net benefit/loss of outsourcing the accounting activities and advise on
Required:

the course of action to be taken. (3 Marks)
(ii) Evaluate the qualitative factors involved in this outsourcing decision. (2 Marks)
(c) CAL Limited is a steel manufacturing company. The company has major expansion plans
to make a global presence. The company recently automated its plant at the beginning of
the current year and installed a flexible manufacturing system. CAL hired XYZ Consultants,
a leading business consultancy firm to review its business processes and recommend

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suitable action plan.

.
em
XYZ Consultants have informed the management that several adjustment problems have

s
been encountered, including problems relating to performance measurement. They have

l a
recommended the company to use performance measures for its operations such as

ag
throughput time, delivery cycle time and manufacturing cycle efficiency. In this connection,
they have gathered data relating to these measures for the first four months of operations.
Particulars Month 1 Month 2 Month 3 Month 4
Percentage of on-time deliveries 93% 88% 85% 81%
Total Sales (units) 3,310 3,172 3,015 2,906
Further, the following average times have been logged over the last four months:
Particulars Average per month (days)

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1 2 3 4

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c. o em2.0 1.9
Move time per unit 0.5 0.4 0.5

em
Process time per unit 2.2
s
a 19.5 21.0
16.5 l18.0
2.1

las Wait time per order before start of production
g
a 5.1 5.9 6.8
ag Queue time per unit
Inspection time per unit
4.4
0.7 0.8 0.8 0.7

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26 FINAL EXAMINATION: NOVEMBER, 2023

Required
(i) Calculate the throughput time, Manufacturing Cycle Efficiency (MCE) and the delivery
cycle time for each month. (5 Marks)
(ii) Evaluate the company's performance over the last four months with respect to the
three parameters as calculated in (i) above. (3 Marks)
(iii) XYZ Consultants have suggested in their report to management that "application of
MCE (Manufacturing Cycle Efficiency) can be done in reducing the Non-Value-Added
Activities." Advise how? (2 Marks)
Answer
(a) (i) BPR is the fundamental rethinking and radical redesign of business processes
to achieve dramatic improvement in critical contemporary measures of
performance, such as cost, quality, service, and speed. In other words, BPR is
concerned with the result of the process (i.e., with those activities that add value to
the process).
(ii) To implement BPR, firstly, each business process of DP Capital needs to be
divided into a series of processes. Then, each business process requires to be
documented and analysed to find out whether it is essential, whether it provides
support to other valuable processes and whether it is adding value.
Any process which does not add value or does not provide essential support
to the value adding activities must be removed. Those processes that remain
require to be re-engineered/ re-structured so that can be as efficient as
possible.
(iii) For DP Capital, new technology should be introduced to improve these processes.
However, DP Capital must ensure that the statutory compliances regarding these
processes are not undermined. DP is facing a hyper-competitive marketplace where
customers expect a superior experience. BPR activities would help DP Capital in
understanding those processes which DP’s customers value the most and remove
those that are not valued. Now a days various firms are offering diverse range of
services such as direct access to executive management, a single point of contact to
coordinate all their needs, appointment consultancy to save time, free online services
24/7 etc. Clearly these are valuable business processes valued by the customer. DP
Capital should incorporate all these facilities in their processes to enhance customer
satisfaction and service level. It is likely that BPR may increase costs in short-
term as investment in technology. However, this would also reduce substantial
levels of manual activities and processes thereby providing speedy services to
customers. In the long term, this would result in high levels of efficiency,
profitability and better levels of customer satisfaction and retention.
Conceptually correct brief explanations are sufficient.

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 27

(b) (i) The selling price of the new ‘Dark Choco bar’ product should at least cover its variable
cost and its opportunity cost. The variable cost of the new product is `20, and its

m
opportunity cost can be computed by multiplying the opportunity cost of `180 per

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minute of order filling time by the amount of time required to fill an order for the new

co m
product.

m . s e
e Cost Component la
Minimum Selling Price for ‘Dark Choco bar’

a s
l Variable Cost
`
a g
ag
20
Add: Opportunity Cost (180/ 60 × 40) 120
Relevant costs of manufacturing 140
Hence, the selling price of the new product should at least cover both its variable cost
of ` 20 and its opportunity cost of ` 120, for a total of ` 140.
(ii) The minimum pricing approach is a useful method in situations where there i s
a–

m
c. o
▪ lot of intense competition,

clearance of old inventories, m
▪ surplus production capacity,

s e
la
▪

g
a share of the product.
▪ getting special orders and/ or
▪ improving the market
OR
(i) Calculation of the net benefit/ loss of outsourcing
Internal Service External Service
Department Cost Department Cost
` Per annum ` Per annum

m
Purchase Hardware/ Software 5,000 ---

m
Hardware/ Software Maintenance 2,500
c. o ------
c. o Accounting Stationery 1,500
se
m ---
s em la
Part-time Accounting Clerk 60,000

la
Processing of Invoices/ Credit Notes
g
a---
--- 12,500

ag Processing of Cheque Payments 10,000
Reconciling Supplier Accounts --- 90,000
(Uniform through-out the year)
69,000 1,12,500

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28 FINAL EXAMINATION: NOVEMBER, 2023

It would not be cost effective to outsource the accounting activities as the cost
of outsourcing exceeds internal processing costs.
(ii) The following qualitative factors must be taken into account when outsourcing
the accounting task:
▪ Reliability and the trust for outsourcing the accounting function to the third
party as the payment cycles, processing of invoices, and supplier accounts have
to be maintained with secrecy and has to be managed well.
▪ The time required for the accounting activity and the potential impact on the
overall productivity of the business if this activity is outsourced.
▪ Compliance with the various laws is achievable when outsourced.
▪ The outside company must be able to communicate clearly and in a timely
manner along with providing a proactive approach to resolving issues.
Alternate Points or Reasoning are also possible. However, the issue must be
addressed properly, and the answer must respond to the requirement.

(c) (i) Calculations
Particulars Month 1 Month 2 Month 3 Month 4
Throughput time = 0.5 + 2.2 = 0.4 + 2.1 = 0.5 + 2 = 0.5 + 1.9
+ 4.4 + 0.7 + 5.1 + 0.8 + 5.9 + 0.8 + 6.8 + 0.7
= 7.8 days = 8.4 days = 9.2 days = 9.9 days
Manufacturing = 2.2/ 7.8 = 2.1/ 8.4 = 2/ 9.2 = 1.9/ 9.9
Cycle Efficiency = 28.21% = 25% = 21.74% = 19.19%
Delivery Cycle Time = 7.8 +16.5 = 8.4 + 18 = 9.2 + 19.5 = 9.9 + 21
= 24.3 days = 26.4 days = 28.7 days = 30.9 days
(ii) All the performance measures display unfavourable trends.
• Throughput time per unit is increasing largely because of increase in
queue time.
• Manufacturing cycle efficiency (MCE) is declining which implies that
majority of the time a unit is in process is spent on activities that do not
add value to the product.
Particulars Month 1 Month 2 Month 3 Month 4
Manufacturing Cycle = 28.21% = 25% = 21.74% = 19.19%
Efficiency

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 29

Non-Value-Added = 71.79% = 75% = 78.26% = 80.81%
Activities

m
c. o
• Delivery cycle time is increasing. In addition, the percentage of on-time

o m m
c
deliveries has dropped month on month basis from 93% in Month 1 to 81%

. e
eofmcourse is to have an efficiency of 100%. This will be achieved when all non-value- glas
in Month 4.

s
(iii) As a company reduces nonvalue added activities, the MCE increase rapidly. The goal,

g la added activities have been eliminated and process time is equal to throughput time. a
a Or
A manufacturing cycle efficiency of less than 1 means that there is non- value- added
time in the production system. For example, 0.40 would mean that 60% of a product’s
time would be spent in non- value- added activities. In many manufacturing
companies MCE is less than 0.10. Reducing non-value-added activities means that
the seller can get the product into the hand of the customer faster (and get paid
sooner) and do so at a lower cost.

m
c. o
To reduce or eliminate non -value-added activities,
Inspection time can be reduced by developing the concept of total quality control

em the concept of cellular manufacturing.
and zero-defect manufacturing.
Moving time can be reduced bysdeveloping

g a can be reduced by developing the concept of JIT
ltime
Inventory System. Justain time method eliminate a significant amount of idle time
Waiting time and storage

(especially storage) and increase MCE. JIT also has a positive impact on engineering,
purchasing, receiving, warehousing, accounting, human resource and marketing.
MCE can also be computed with the formula:
Processing Time
Inspection Time + Process Time + Queue Time + Move Time + Wait Time

m
Or say, throughput time also includes Wait Time.

m .co
All components of MCE and Delivery Cycle Time have been given based on ‘per unit’

c. o m
except Wait time, which is given on ‘per order’ basis. This question has been solved

se
by considering the same on ‘per unit’ basis. Alternate Solution is also possible.

s em g l a
la
Question 5
(a) CMP Chemicals have the following environmental activities andaproduct information:
ag Environmental activity costs:
Activity Costs
Design processes (to reduce pollution) ` 21,60,000

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30 FINAL EXAMINATION: NOVEMBER, 2023

Test for contamination ` 38,40,000
Treat toxic waste ` 96,00,000
Maintain environmental equipment ` 60,00,000
Driver data:
Solvent ‘Acetone’ Solvent ‘Benzene’
Design hours 4,000 2,000
Testing hours 3,500 4,500
Pounds of waste 2,000 38,000
Maintenance hours 400 9,600
Other production data:
Solvent ‘Acetone’ Solvent ‘Benzene’
Non-environmental production costs ` 4,41,60,000 ` 7,82,40,000
Units produced 4,00,000 4,00,000
Required
(i) Calculate the environmental cost per unit and the total cost per unit of each product
using Activity Based Costing (ABC). (6 Marks)
(ii) Assume that the design costs increased to ` 38,40,000 and the cost of toxic waste
decreased to ` 48,00,000 and the Solvent Benzene uses 4,000 hours out of 8,000
(total new design hours) design hours. Also assume that waste is cut by 50 per cent
and that Solvent Benzene is responsible for 18,000 of 20,000 pounds of toxic waste.
Evaluate the new environmental cost per unit for Solvent Benzene. (2 Marks)
(iii) "The full and correct costing of products is a pre-condition for making sustainable
business decisions such as the volume and choices of products to be produced. EMA
converts many environmental overhead costs into direct costs and allocates them to
the products that are responsible for their incurrence." In the light of this statement
briefly, discuss the results of improved costing by EMA. (2 Marks)
(b) SKY Limited is a well-established manufacturing company that operates in a competitive
and rapidly changing industry. The company is currently using a traditional budgeting
approach, preparing annual budgets based on historical data and top -down targets set by
senior management. The priorities are discussed mostly or only at the senior management
level as they are making decisions on the budget allocation. The finance team monitors
actual vs. plan variance analysis.
However, the company is facing challenges in adapting to market fluctuations and lacks
the agility to respond quickly to emerging trends. The management is considering

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 31

transitioning to a different budgeting approach i.e. Beyond Budgeting. Going forward, SKY
wants to move away from the existing planning processes. This new approach will lead to

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a drastic mind-set change across the business. Instead of asking "Do I have the budget

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for this?", the organization would focus on "Is this the right thing to do for our customers?".

co m
The Finance team will now play a key role in enabling communication, based on trust

m .
across cross functional teams, sending a clear message that there is no secret budget or
s e
s e l a
hidden agenda, In the spirit of transparency, reporting outcomes will be shared across the

g
a transformation will help team members acquire broader skills by moving away froma
lThis
business at all levels.

ag being purely financial analysts to becoming holistic analysts or business analyst.
Instead of reassessing all assumptions, all the time (what would hap pen in traditional
budgeting), SKY will focus on those which have a real impact and only involve those people
from the business they really needed, allowing the rest of the business to make an impact
where it mattered the most - with the customers.
Required
(i) Discuss briefly the 'Traditional Budgeting Management Model' that SKY is following.

m
co Budgeting Model' in the context of SKY
(1 Mark)

m .
(ii) Explain very briefly the key feature of 'Beyond
Limited.
e
s management are built upon foundation principles
(2 Marks)

l a
which relate to 'leadershipgprinciples' and 'management processes. Few principles/
(iii) Principles for adaptive performance

processes have been citeda below:
Particulars Whether ‘Leadership Principle’ Brief Explanation
or ‘Management Processes’
Plans and Forecasts
Resource Allocation
Autonomy

m
c. o
Transparency

m
c. o orm
Customers
From the above information, identify the 'leadership principle' e
em l a s 'management

las ag
processes and discuss very briefly the principles/processes mentioned in the table.

ag (iv) Discuss the key prerequisites for SKY's transitioning to Beyond Budgeting
(5 Marks)

implementation. (2 Marks)

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32 FINAL EXAMINATION: NOVEMBER, 2023

Answer
(a) (i) Calculation of environment production cost per unit and the total cost per unit
for each product
Activity Base Acetone Benzene Total Cost
Design Process Design hours 14,40,000 7,20,000 21,60,000
Acetene = 4,000 / 6,000 ×
` 21,60,000
Benzene = 2,000/ 6,000 ×
` 21,60,000
Test for Contamination Testing hours 16,80,000 21,60,000 38,40,000
Acetene = 3,500 / 8,000 ×
` 38,40,000
Benzene = 4,500/ 8,000 ×
` 38,40,000
Treat Toxic Waste Pounds of 4,80,000 91,20,000 96,00,000
Acetene = 2,000/ 40,000 × waste
` 96,00,000
Benzene = 38,000/ 40,000 ×
` 96,00,000
Maintain Environmental Maintenance 2,40,000 57,60,000 60,00,000
Equipment Hours
Acetene = 400/10,000 ×
` 60,00,000
Benzene = 9600/10,000 ×
` 60,00,000
Total Environment Production Cost 38,40,000 1,77,60,000 2,16,00,000
Add: Total Non-environment Production Cost 4,41,60,000 7,82,40,000 12,24,00,000
Total Cost of Production 4,80,00,000 9,60,00,000 14,40,00,000
Units Produced 4,00,000 4,00,000 8,00,000
Environment Production Cost per unit 9.60 44.40
Total Cost of Production per unit 120.00 240.00

(ii) Evaluation- Revised environment production cost per unit for Benzene is ` 35.40
per unit. This has reduced from ` 44.40 per unit. The company invested more in
improving the design of Benzene, due to which its share of design costs went up to
50% (4,000 hours out of 8,000 hours) while previously it was 33.33 % (2,000 hours
out of 6,000 hours). Hence, the share of design costs for Benzene has increased.
However, this investment has resulted in reduction of toxic waste, it has halved to

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 33

20,000 pounds from 40,000 pounds. Due to the investment in better design, the share
of Benzene in generation of toxic waste reduced to 90% of total waste (18,000 pounds

m
out of 20,000 pounds) from previously being 95% of total waste (38,000 pounds out

m c. o
of total 40,000 pounds). The cost of treating toxic water reduced dramatically to

c. o m
` 48,00,000 from ` 96,00,000. Since Benzene’s share in total toxic water production

e
mcan thushasbereduced as
reduced, lower cost has been allocated to it.

s eItcompany the toxic waste produced. Therefore, the total environment gl
concluded that by investing in better design of Benzene, the

g la cost by ` 31,20,000 for the year, primarily benefitting reduction in the cost ofa
a production of Benzene.
Workings
Calculation for revised cost of production
Activity Base Acetone Benzene Total Cost
Design Process Design 19,20,000 19,20,000 38,40,000
Acetene = 4,000 / 8,000 × hours
` 38,40,000

m
c. o 16,80,000
Benzene = 4,000/ 8,000 ×
` 38,40,000

em
Test for Contamination Testing 21,60,000 38,40,000

a s
Acetene = 3,500 / 8,000 × hours

g l
` 38,40,000

a
Benzene = 4,500/ 8,000 ×
` 38,40,000
Treat Toxic Waste Pounds of 4,80,000 43,20,000 48,00,000
Acetene = 2,000/ 20,000 × waste
` 48,00,000
Benzene = 18,000/ 20,000 ×
` 48,00,000
Maintain Environmental Maintenance 2,40,000 57,60,000 60,00,000
Equipment Hours

m
Acetene = 400/10,000 ×

c. o
` 60,00,000

m
c. o
Benzene = 9600/10,000 ×
` 60,00,000
e m 1,84,80,000
em
Total Environment Production Cost

l a s
43,20,000 1,41,60,000

las Add: Total Non-environment Production Cost

ag4,00,000 14,08,80,000
4,41,60,000 7,82,40,000 12,24,00,000

g
Total Cost of Production 4,84,80,000 9,24,00,000

a Units Produced
Environment Production Cost per unit
4,00,000
10.80 35.40
8,00,000

Total Cost of Production per unit 121.20 231.00

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34 FINAL EXAMINATION: NOVEMBER, 2023

(iii) Environment Management Accounting (EMA) is the process of collection and analysis of
information related to environmental cost for internal decision making. Most of the
environmental cost get accounted as overheads (indirect expenses) in the accounting
records. EMA culls out these costs by identifying and estimating environmental related
activities and seeks to control these costs. The focus of EMA is not on financial costs, but
it also considers the environmental cost or benefit of any decisions made. Due to better
transparency of cost structure, EMA enables better strategic decision making. It provides
information on environmental impact that if actioned upon in the correct way can improve
the environmental efficiency of the business thereby improving its sustainability. The major
areas of application of EMA are product pricing, budgeting, investment appraisal,
calculating costs and setting quantified performance targets.
OR
The results of improved costing by EMA may include:
• Different pricing of products as a result of re-calculated costs;
• Re-evaluation of the profit margins of products;
• Phasing-out certain products when the change is dramatic;
• Re-designing processes or products in order to reduce environmental costs and
• Improving housekeeping and monitoring of environmental performance.
(b) (i) Traditional Budgeting Model followed at SKY Limited is an annual exercise
controlled centrally by the senior management alone. It has a top-down approach,
targets are set by the senior management which is communicated further down to the
middle and lower-level management of the company. The primary focus is on
managing the financials, to set targets for revenue, profits, and growth. Targets
are primarily based on historical data and not on the current cost information and
business requirements. Therefore, targets are incremental in nature and actual
performance is compared with them using variance analysis. Allocation of finances
(budgets) is centrally co-ordinated.
(ii) Beyond Budgeting is an adaptive, decentralized process that with focus on
improving future results especially those create value for the customer. The
organization culture is more externally focussed fostering competitive success. It
encourages an organization to adapt to the changing business scenario and
constantly innovate in order to provide value to the customers. Rather the
achieving just financial targets and limiting spends based on historic budgets, the
lower-level management is encouraged to take up projects if they create the right
value for the customer. Therefore, there is more decentralized functioning that
makes the organization more agile to changes.
Resource allocation is based on demand for the project / activity and may
include allocation to multiple teams across the organization rather than being

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 35

restricted to one specific department as it was in the case of traditional
budgeting model. This requires dynamic co-ordination across multiple teams

m
in the organization.

m c. o
co
While goals may be set at a lower level based on current existing scenario, the

. e m
process involves continuous planning through rolling budgets and KPIs. This allows

e m
for more timely allocation of resources and encourages a culture of innovation.

la s
a s
l Particulars
(iii) Process classification as Leadership Principle or Management Principle.
a g
ag
Leadership Principle / Brief explanation
Management Process
Plans and Management Process Shift in focus is on creation of value
Forecasts for the customer. Focus in on
beating competitors. Reduces
internal rivalry and biases.
Rolling budgets, incorporating
current business needs and KPIs
make plans and forecasts more

o m
lean and flexible. Predictions are

c
. Resources are made available as
more realistic and unbiased.
Resource
e m
Management Process
Allocation
la s needed. This makes teams more

g
cost conscious. Spending

Autonomy
a
Leadership Principle
becomes more value added.
Participative, bottom-up approach
by giving proper authority to
operational managers. Due to their
involvement in the daily operations,
they can react more quickly to
changing situations making the
organization more agile. Clear
authority and responsibilities also
m
co
help in motivating employees in

m .
c. o
overcoming challenging situations

m
se
as it builds more trust within the

em la
organization.

las Transparency Leadership Principle
a g
Creates information systems which

g
provide fast and open information
a throughout the organization.
This increases the agility of the
organization, making it more
adaptive to change. It also helps to

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36 FINAL EXAMINATION: NOVEMBER, 2023

build cross-functional teams whose
focus is not on internal
performance measures but on
beating competitors of the
organization.
Customers Leadership Principle Focus of Beyond Budgeting is on
customer value creation and
competitive success. Organization
has more customer-oriented
teams making them more reactive
and adaptive to changing
customer requirements.
(iv) Pre-requisites to transition to Beyond Budgeting implementation −
(a) Define the case for change and provide an outline vision. Beyond Budgeting is
particularly useful in industries undergoing rapid change which require the
company to be agile or those that use techniques like Total Quality Management
that require continuous improvement to be successful. In the case of SKY
Limited, the industry is subject to rapid changes making a case for Beyond
Budgeting.
(b) Be Prepared to convince the Board. SKY is moving from a centralized top-down
traditional budgeting model to a more participative bottom-up approach. This
requires a drastic change in mind set across the business. For this to be
successfully implemented, the senior management and the Board need to be
convinced and receptive to decentralized approach of operations.
(c) A clear Vision is needed to know what exactly is required from Beyond
Budgeting. Accordingly design and implement new processes in a
participative manner involving appropriate levels of management and
oversight. Train and educate employees across the organization to help them
understand the new system. Beyond Budgeting requires empowerment,
collaboration, trust and transparency.
(d) Finance moves from a traditional role of finance provider. It now plays a more
participative role where their role will move from being financial analysts to
more holistic business analysts. This requires them to acquire broader skills
and knowledge about the business.
(e) Processes should be in place to evaluate results and consolidate gains.
Authority and responsibility of roles require continuous oversight to ensure
that the system works effectively. This is another reason why the senior
management should be agreeable to the change; have a clear vision of the
outcomes they need from transitioning to Beyond Budgeting and being able to

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 37

guide the organization in its transition from traditional budget-based model to a
more dynamic budgeting model.

m
c. o
Conceptually correct brief explanations are sufficient for each step. Alternate

o m
Points/ Reasoning are also possible. However, the issue must be addressed

.c
properly, and the answer must respond to the requirement.
e m
Question 6m
e l a s
l a s Comfort (KC)’ is a Company which manufactures innovative appliances to help g
a
g
(a) 'Kitchen

a reviews its product range and enhances its existing products by developing new models to
the modern nuclear family in managing their cooking and cleaning needs. KC continually

satisfy the demands of its customers. The company intends to always have products at
each stage of the product lifecycle to ensure the company's continued presence in the
market.
KC is currently reviewing its two flagship products, Product X and Product Y.
I. Product X was introduced to the market some time ago and is now about to enter the
maturity stage of its life cycle. The maturity stage is expected to last for 10 weeks.

m
c. o
Each unit has a variable cost of ` 570 and takes 3 standard hours to produce. Market
Research has identified four possible prices at which Product X could be sold and the

em 1,500
expected demand at those prices.

a s
Weekly Demand (Unit) l
Selling Price Per Unit ( `) 1,275 1,200 1,125

a g 1,200 1,600 2,400 2,600
The Sales Director is confused which of four possible prices the company should
charge in the next ten weeks.
II. Product Y was introduced to the market two months ago using a penetration pricing
policy and is now about to enter its growth stage. This stage is expected to last for 20
weeks. Each unit has a variable cost of ` 600 and takes 5 standard hours to produce.
Market research has indicated that there is a linear relationship between its selling
price and the number of units demanded, of the form P = a-bx. At a selling price of

m
c. o
` 1,250 per unit, demand is expected to be 1,500 units per week. For every ` 50

m
increase in selling price the weekly demand will reduce by 100 units and for every

c. o em of 12,000
` 50 decrease in selling price, the weekly demand will increase by 100 units.

em s
la extra capacity will
The Company currently has a production facility which has a capacity

las a g
standard hours per week. This facility is being expanded but the

g
not be available for 10 weeks.

a Required
(i) Recommend which of the four selling prices should be charged for Product X, in order
to maximize its contribution during its maturity stage. (3 Marks)

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38 FINAL EXAMINATION: NOVEMBER, 2023

(ii) Assuming that product X is produced as recommended in (i), calculate the selling
price of Product Y during its growth stage (for first 10 weeks and following 10 weeks).
(5 Marks)
(b) SED Electronics is an Indian company specializing in the design, development and global
distribution of electronic gadgets. Established in 1999 by Mr. ACE, the company has a
global footprint, offering a diverse range of communication devices such as Blueto oth
accessories, Infrared gadgets, Modems, Network cards, Smartphones, and Wi -Fi
innovations.
In pursuit of incentivizing the sales team's performance within the smartphone division, the
company's managing director has initiated a reward program for the month of December
2022. Among the accomplished sales managers, Mr. Zen has been singled out for his
remarkable achievements during this period.
Mr. Zen encountered an unfavourable Sale Price Variance for the SM 20 smartphone
model (featuring a 12 MP camera) amounting to ` 22,33,000. However, he skillfully
countered this setback by strategically adjusting the pricing of the SM 50 smartphone
variant (featuring a 50 MP camera). While the unit sales for SM 20 aligned with
expectations, the exceptional performance in SM 50 led to a favourable Sale Margin
Volume Variance of ` 22,50,000.
Given these insights, the company's managing director seeks your expert analysis to
evaluate Mr. Zen's performance comprehensively, aiding in the fair allocation of incentives
among the sales managers. For the month December 2022, the following budgeted and
actual data for the company's smart phone segment were taken from its records:
Budgeted data Actual data
Smartphone Sales Selling Standard Sales Selling
(units) price (per cost (per (units) price (per
system) ` system) ` system) `
SM 20 (Camera 12MP) 1,750 21,500 14,500 1,750 20,224
SM 50 (Camera 50MP) 625 52,000 29,500 725 55,080
The total market demand for SM 20 smartphone (Camera 12 MP) was as budgeted but as
a result of suppliers reducing the price of supporting headphone devices, the total market
demand for SM 50 smartphone (Camera 50 MP) rose by 40% in December 2022.
The company had sufficient capacity to meet the revised market demand for 875 units of
its SM 50 smartphone (Camera 50 MP) and therefore maintained its market share.
Required
(i) Calculate the following variances for both products:
(a) Sales Margin Mix Variance (2 Marks)

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 39

(b) Sale Margin Quantity Variance (2 Marks)
(c) Market Size Variance (2 Marks)

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(d) Market Share Variance (2 Marks)

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(ii) Evaluate the performance of Mr. Zen considering the Planning Variance and

Answer m
Operational Variance. (4 Marks)
s e
a s e g la
g l Statement Showing Contribution at Different Prices for Product X a
a
(a) (i)
Selling Weekly Variable Cost Contribution Total
Price per Demand ` ` Contribution `
Unit ` (units)
1,500 1,200 570 930 11,16,000
1,275 1,600 570 705 11,28,000
1,200 2,400 570 630 15,12,000
1,125 2,600 570 555 14,43,000

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Sales Director should charge ` 1,200 in the next ten weeks for Product X for a

em
demand of 2,400 units.
(ii) Demand Equation:
l a s
P = a – bx
a g
At a Selling Price of ` 1,250 per unit, Demand is expected to be 1,500 units.
Therefore, Demand Equation:
1,250 = a – 1,500 b
For every ` 50 increase in selling price the weekly demand will reduce by 100 units.
Therefore, Demand Equation:
1,300 = a – 1,400 b

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Now, Solving Both Equations:

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1,250 = a – 1,500 b
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1,300 = a – 1,400 b

s g la
la
– – +

g a
a
– 50 = – 100 b
Or, b = 0.50
On putting value of ‘b’ in the equation, the value of ‘a’:
1,250 = a – 1,500 b

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40 FINAL EXAMINATION: NOVEMBER, 2023

1,250 = a – 1,500 × 0.50
a = 2,000
Now the Demand Equation of Product Y will be:
P = 2,000 – 0.50x
First 10 Weeks
Standard Hours Available per week = 12,000
Utilised for Product ‘X’ per week = Weekly Demand × 3 Std. Hours
= 2,400 × 3 = 7,200 Hrs.
Balance Hours Available per week = 12,000 – 7,200 = 4,800 Hours
Possible Production of ‘Y’ per week = 4,800 Hours / 5 = 960 units
Demand Equation for Product ‘Y’
P = 2,000 – 0.50x
Now putting the weekly production figure in demand equation:
P = 2,000 – 0.50 × 960
P = ` 1,520/-
Following 10 Weeks
Standard Hours Available per week = 12,000
Possible Production of ‘Y’ per week = 12,000 Hours / 5 = 2,400 units
Demand Equation for Product ‘Y’
P = 2,000 – 0.50x
Now putting the weekly production figure in demand equation:
P= 2,000 – 0.50 × 2,400
P = ` 800/-
MR = 2,000 – x
MC = 600
Profit is Maximum at MC = MR
2,000 – x = 600
x = 1,400
Demand Equation for Product ‘Y’
P = 2,000 – 0.50x

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 41

Now putting the weekly production figure in demand equation:
P = 2,000 – 0.50 × 1,400

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P = ` 1,300/-

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Summary

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Particulars Price Volume First10 Next 10

la Selling
Weeks
NA a
Weeks
g
ag Stage
Price of ‘Y’ at Growth
First 10 Weeks
` 1,520 960 units Feasible

Profit Maximisation level of ‘Y’ ` 1,300 1,400 Units Not Feasible*
at Growth Stage Feasible
Selling Price of ‘Y’ at Growth ` 800 2,400 units NA Feasible
Stage Following 10 Weeks
*Best Option
(b) (i) Margin Volume Variance (For reference Only)

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Product Standard Margin Actual BudgetedDifference Variance

7,000 em
per unit (`) Qty. Quantity (` ’000)
SM 20
s
la 725
1,750 1,750 --- ---
SM 50
Total a g
22,500
2,475
625
2,375
+100 2,250 (F)
+100 2,250 (F)
Margin Mix Variance
Product Standard Margin Actual Revised Difference Variance
per unit (`) Qty. Actual (`’000)
Quantity
SM 20 7,000 1,750 1,650 +100 700 (F)
SM 50 22,500 725 825 -100 2,250 (A)
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Total 2,475 2,475 1,550 (A)

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Margin Quantity Variance

em la s
s
Product Standard Revised Budgeted Difference

la
Margin per Actual Quantity
g
a - 100 700 (A)
(`’000)

g
unit (`) Quantity
a SM 20 7,000 1,650 1,750
SM 50 22,500 825 625 + 200 4,500 (F)
Total 2,475 2,625 3,800 (F)

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42 FINAL EXAMINATION: NOVEMBER, 2023

Market Size Variance
SM 20 = (1,750 units – 1,750 units) × ` 7,000 = NIL
SM 50 = (875 units – 625 units) × ` 22,500 = ` 56,25,000 (F)
Market Share Variance
SM 20 = (1,650 units – 1,750 units) × ` 7,000 = ` 7,00,000 (A)
SM 50 = (825 units – 875 units) × ` 22,500 = ` 11,25,000 (A)
(ii) Evaluation of performance of Mr. Zen considering the Planning and Operational
Variances
A Planning Variance simply compares a revised standard (that should or would have
been used if planners had known in advance what was going to happen) to the original
standard. A planning variance is considered as not to be controllable by management.
The market size is not within the control of the sales manager and therefore
variances caused by changes in the market size would be regarded as planning
variances.
However, variances caused by changes in the selling prices and consequently
the selling price variances and market shares would be within the control of the
sales manager and treated as operating variances.
The market size variance compares the original and revised market sizes. This
is unchanged for SM 20 Phone so the only variance that occurs relates to the
SM 50 Phone and is ` 56,25,500 (F). It is vital to make this distinction because
as can be seen from the scenario the measurement of the ‘Zen’s performance
is incomplete if the revised market size is ignored.
The favourable volume variance of ` 22,50,000 referred to in the scenario is
made up of following elements,
(1) Market Size Variance ` 56,25,000 (F) which is a planning variance and is
outside the control of sale manager.
(2) Market Share Variance ` 18,25,000 (A) which is an Operational variance
that is within his control.
(3) Mix Variance ` 15,50,000 (A). In some situation management may be able
to control the mix via allocation of advertising and promotion budget etc.
It is this that has caused the overall volume variance to be favourable, and thus
‘Zen’ is not responsible for the overall favourable performance and does not
deserve performance incentive.

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PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION 43

Alternative
(i) Margin Volume Variance (For reference Only)

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Product Standard Margin Actual Budgeted Difference Variance

co m
per unit (`) Quantity

.
Qty. (`’000)

m s e
e SM 50 a
SM 20 7,000 1,750 1,750 --- ---

s g l
la Total -150 3,375 (A) a
22,500 725 875* -150 3,375 (A)

ag
2,475 2,625
* Based on Revised Market Demand
Margin Mix Variance
Product Standard Margin Actual Revised Difference Variance
per unit (`) Qty. Actual (`’000)
Quantity
SM 20 7,000 1,750 1,650 +100 700 (F)
SM 50 22,500 725 825 -100 2,250 (A)

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Total 2,475 1,550 (A)
Margin Quantity Variance
m Budgeted Difference Variance
eRevised
l a s Actual Quantity
g Quantity
Product Standard

a
Margin (`’000)
per unit (`)
SM 20 7,000 1,650 1,750 - 100 700 (A)
SM 50 22,500 825 875* - 50 1,125 (A)
Total 2,475 2,625 1,825 (A)
*Based on Revised Market Demand
Market Size Variance

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The market size variance compares the original and revised market sizes. This is

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unchanged for SM 20 Smartphone so the only variance that occurs relates to the

c. o se
m
SM 50 Smart Phone and is ` 56,25,500 (F) [250 phones × ` 22,500].

em la
Market Share Variance (‘000)

las = Margin Quantity Variance - Market Size Variance
a g
ag =
=
1,825 (A) – 5,625.5 (F)
` 3,800.50 (A)

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44 FINAL EXAMINATION: NOVEMBER, 2023

(ii) Evaluation
A Planning Variance simply compares a revised standard (that should or would have
been used if planners had known in advance what was going to happen) to the original
standard. A planning variance is considered as not to be controllable by management.
The market size is not within the control of the sales manager and therefore
variances caused by changes in the market size would be regarded as planning
variances.
However, variances caused by changes in the selling prices and consequently
the selling price variances and market shares would be within the control of the
sales manager and treated as operating variances.
The market size variance compares the original and revised market sizes. This
is unchanged for SM 20 Phone so the only variance that occurs relates to the
SM 50 Phone and is ` 56,25,500 (F).
It is vital to make this distinction because as can be seen from the scenario the
measurement of the ‘Zen’s performance is incomplete if the revised market size
is ignored.
The favourable volume variance of ` 22,50,000 referred to in the scenario is
made up of two elements, one of which, the market size, is a planning variance
which is outside his control. It is this that has caused the overall volume
variance to be favourable, and thus ‘Zen’ is not responsible for the overall
favourable performance.
Other Alternative Solution is also possible.

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