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Question Paper

Management Control & Information Systems (MB281) July 2005

Section A : Basic Concepts (30 Marks)

This section consists of questions with serial number 1 - 30.

Answer all questions. Each question carries one mark.

Maximum time for answering Section A is 30 Minutes.

1. Which of the following statements is/are true with respect to transfer pricing?

I. It motivates divisional managers to make good economic decisions.II. It is useful for evaluating performance of the divisional managers.III. It is a selling price established for goods or services sold by one division to other in the same

organization.IV. It does not help in measuring divisional performances.

(a) Only (I) above (b) Only (II) above(c) Both (I) and (II) above (d) (I), (II), (III) and (IV) above(e) (I), (II) and (III) above.

< Answer >

2. Bidhan Ltd. has furnished the following budgeted and actual sales for the month of June 2005:

Particulars Budget Actual

Units sold 11,500 units 12,000 unitsSale price Rs.80 per unit Rs.71 per unit

The company has made the same budget for the month of July 2005. If actual sales drop by 20% overthe month, the company may witness a sales volume variance of

(a) Rs.1,52,000 (A) (b) Rs.1,31,400 (A)

(c) Rs.1,30,000 (A) (d) Rs.1,31,400 (F) (e) Rs.1,52,000 (F).

< Answer >

3. Which of the following statements is false in relation to budgets?

(a) Direct labor budget represents direct labor requirements necessary to produce the types andquantities of output planned in the production budget

(b) An inventory budget can be prepared to find out the values of direct materials and finishedinventory

(c) A fixed budget is a budget that is prepared for a range, i.e. for more than one level of activity(d) A direct material budget indicates the expected amount of direct material required to produce the

budgeted units of finished goods(e) Direct labor budget costs consist of wages paid to employees who are engaged directly in specific

production output.

< Answer >

4. If an investment project has a profitability index of 1.20, the

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

< Answer >

5. Which of the following are techniques of cost reduction?

I. Using better quality materials.II. Pay incentives for better productivity.III. Cutting rates of pay.IV. Using a cheaper material.

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

< Answer >

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6. Which of the following is not a cause for Material Usage Variance?

(a) Sub-standard materials (b) Pilferage of materials(c) Non-standard material mixture (d) Wastage due to inefficient mixture(e) Purchasing non-standard lots.

< Answer >

7. In activity based costing (ABC), a cost driver is the

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

< Answer >

8. The process of deciding on new strategies of an organization is called

(a) Strategy planning (b) Strategic process(c) Strategy formulation (d) Strategy implementation (e) Business plan.

< Answer >

9. Which of the following is/are useful with respect to value chain concept from the strategic planningperspective?

I. Linkages with suppliers.

II. Linkages with customers.III. Process linkages within the value chain of the firm.

(a) Only (I) above (b) Only (II) above(c) Both (I) and (II) above (d) Both (II) and (III) above(e) All (I), (II) and (III) above.

< Answer >

10. Which of the following is not termed as required rate of return in case of application of net presentvalue method for capital budgeting analysis?

(a) Cost of capital (b) Discount rate(c) Cut off rate (d) Hurdle rate (e) Risk-free rate.

< Answer >

11. A segment of an organization is referred to as a profit center if it has the

(a) Responsibility for developing markets for and selling the output of the organization(b) Authority to make decisions affecting the major determinants of profit, including the power to

choose its markets and sources of supply(c) Responsibility for combining materials, labor and other factors of production into a final output(d) Authority to provide specialized support to other units within the organization(e) Authority to make decisions affecting the major determinants of profit, including the power to

choose its markets and sources of supply and significant control over the amount of investedcapital.

< Answer >

12. Goal congruence is

(a) The desire and the commitment to achieve a specific goal(b) The extent to which superiors have the authority to make decisions(c) The extent to which subordinates have the authority to make decisions

(d) The attempt to accomplish a specific goal(e) The integration of the organizational and the employees personal goals.

< Answer >

13. Consider the following data pertaining to a company:

YearBook value of fixed

investments(Rs.)

Profit before tax(Rs.)

1 2,00,000 80,0002 2,60,000 90,0003 2,20,000 75,0004 1,80,000 65,0005 1,40,000 90,000

The tax rate applicable to the company for the 5 years is 40%. The accounting rate of return (ARR) ofthe company is

(a) 32.50% (b) 30.50% (c) 28.30% (d) 26.00% (e) 24.00%.

< Answer >

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14. AB Ltd. produces product- KL. The company has provided the following standards for one unit of KL:

Direct materials: 25 kg at Rs.5.00 per kg

Direct labor: 10 hours of skilled labor at Rs.15 per hour

Variable overhead: 10 hours at Rs.15 per hour

Fixed overhead: Rs.60,000 at a normal operating level of 3,000 units

The company produced 2,500 units at a total materials price of Rs.3,33,900 for 63,000 kg of directmaterial. The materials price variance is

(a) Rs.18,900 (A) (b) Rs.18,900 (F) (c) Rs.22,500 (A)(d) Rs.22,500 (F) (e) Rs.18,750 (A).

< Answer >

15. A difference between standard costs used for cost control and budgeted costs

(a) Can exist because standard costs must be determined after the budget is completed(b) Can exist because standard costs represent what cost should be, whereas budgeted costs represent

expected actual costs(c) Can exist because budgeted costs are historical costs, whereas standard costs are based on

engineering studies(d) Cannot exist because they should be the same amounts(e) Can exist because standard costs must be determined before the budget is completed.

< Answer >

16. Strategic planning provides direction to an organizations mission, objectives, and strategy, facilitatingthe development of plans for each of the organizations functional areas. Which among the followingcannot be said about strategic planning?

(a) It helps managers to anticipate problems before they arise and deal with problems before theybecome severe

(b) It shows awareness of changing environment, which is a foundation for organizational change(c) It helps managers to set realistic objectives that are demanding, yet attainable(d) It is easy to appraise the performance of strategic planning(e) Strategic planning is a creative and analytical process.

< Answer >

17. Which of the following is true about the Non-Financial Audit?

(a) It relies primarily on standards set externally

(b) Procedures are formalized and consistent from company to company(c) Standards are essentially the same from audit to audit(d) Focus is on complying with standards set by external groups(e) Audience is generally internal, with data being used primarily to improve performance.

< Answer >

18. Consider the following data pertaining to production department in Shivam Ltd. for the month of June2005:

Actual overhead costs Rs.62,200Standard hours for actual work 6,000 hoursActual hours during the month 6,400 hoursStandard overhead rate Rs.10 per hour

The overhead cost variance is

(a) Rs.2,200 (Favorable) (b) Rs.2,200 (Adverse)(c) Rs.2,500 (Favorable) (d) Rs.1,200 (Adverse) (e) Rs.1,200 (Favorable).

< Answer >

19. Which of the following is false about Just In Time?

(a) The main purpose of this philosophy is to reduce inefficiency and unproductive time in theproduction process

(b) The main aim of just-in-time is to ensure the delivery of raw materials at the right time and in theright quantity and reduce buffer inventory

(c) The amount spent on set-up costs is increased with the introduction of numerically controlledmachine tools

(d) Just-in-time helps in decreasing the procurement costs(e) Just-in-time helps in providing fast and accurate information to managers and also build strong

relationship between the customer and manufacturer.

< Answer >

20. Which of the following is false in respect ofbudgetary control?

(a) It is used to measure and compare actual results with the anticipated results

< Answer >

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(b) Budgetary control offers an overall picture of performance of various functions of the organization(c) Budgetary control is handled by the budgetary controller(d) Budgetary control does not help in pinning down responsibility and accountability for

performance of each member(e) Budgetary control brings about the integration of policy, plans, and actions of the different

departments.

21. In responsibility accounting system, a feedback report that focuses on the difference between budgeted

amounts and actual amounts is an example of

(a) Management by objectives (b) Management by exception(c) Assessing blame (d) Creating rewards to successful managers(e) Zero based budgeting.

< Answer >

22. Which of the following is not true in the context of management control systems in organizations?

(a) Subunits comprise individuals who perform certain activities to fulfill purpose of the organisation(b) In the past subunits were not expected to be aware of the overall purpose of the organisation(c) The management establishes the purpose, goals and objectives of an organisation and delegate

responsibility of various subunits to accomplish the goals(d) The control systems play a major role in coordinating the efforts of these subunits(e) Efficient coordination of errors in subunits results in excess transaction costs.

< Answer >

23. The key variable in an insurance industry is

(a) Percentage of absenteeism among employees(b) Time spent on management development programs(c) Preventive and breakdown maintenance(d) The number of policies processed in a given period of time(e) Number of research projects undertaken and those completed.

< Answer >

24. An analysis that helps in identifying a wide range of key variables which facilitate the analysis of aparticular situation and initiate prompt action is called

(a) Factor analysis (b) Key variable analysis(c) Multivariate analysis (d) Control analysis(e) Performance analysis.

< Answer >

25. During the month of June 2005, Siraj Ltd. used 5,000 kg. of material at a total standard cost ofRs.24,000. The material usage variance was Rs.576 (adverse). The standard usage of material for theperiod is

(a) 5,120 kg (b) 4,760 kg (c) 4,880 kg (d) 5,240 kg (e) 5,060 kg.

< Answer >

26. Which of the following is false about Informal Control System?

(a) It promotes greater compatibility of personnel and encourage the willingness to serveorganizational purpose

(b) It decreases the organizations ability to make adaptive responses(c) Informal actions in an organisation include enabling the easy flow of information through all the

hierarchical levels of the organisation(d) It shortens the communication channels

(e) Management must rely upon certain formal systems to prevent instability within the units.

< Answer >

27. Which of the following is an advantage of external control style of managing employees?

(a) Employees will invest all of their potential in their area of work and ignore other aspects that areimportant for the well-being of an organization as a whole

(b) Only the positive outcomes of a particular task would be informed to the higher authorities(c) Employees will concentrate only on one aspect of their job and ignore the rest(d) Because of high control executed by the top management, superior will be able to monitor

subordinates work and there would be no manipulations(e) Employees will not have any commitment towards the organisation and will perform only to

obtain rewards and benefits.

< Answer >

28. Which of the following is not true about TQM?

(a) It ensures that organizations attain the efficiency targets as well as satisfy customers(b) It is the responsibility of the employees to implement TQM(c) It emphasizes customer satisfaction and commitment to continuous improvement of its services

< Answer >

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and products(d) The subsystems and components of control system should be so designed as to help a TQM

program achieve customer satisfaction(e) Middle management should ensure that the environment needed for the implementation of TQM is

easily susceptible to changes.

29. A company is considering a capital budgeting decision involving a risky foreign investment. Risk canbest be minimized by selecting the investment alternative with

(a) Highest net present value (NPV)(b) Highest Benefit/Cost ratio (B/C ratio)(c) Highest internal rate of return (IRR)(d) Highest accounting rate of return (ARR)(e) Shortest payback period.

< Answer >

30. The strategic action which indicates a decision to withdraw from the business either through a processof slow liquidation or outright sale is called

(a) Harvest (b) Divest (c) Hold (d) Build (e) Budget.

< Answer >

END OF SECTION A

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Section B : Problems/Caselets (50 Marks)

This section consists of questions with serial number 1 7.

Answer all questions.

Marks are indicated against each question.

Detailed workings/explanations should form part of your answer.Do not spend more than 110 - 120 minutes on Section B.

1. Sarma Ltd. is reviewing an investment proposal in a project involving capital outlay of Rs.76,00,000 in plant andmachinery. The project would have a life of 5 years at the end of which the plant and machinery could fetch aresale value of Rs.34,00,000. Further, the project would also need a working capital of Rs.8,00,000 which wouldbe built during the first year and to be released from the project at the end of year 5. The project is expected toyield the following pre-tax cash profits:

YearCash profits

(Rs.)

1 26,00,000

2 25,00,000

3 18,00,0004 18,00,000

5 16,00,000

A 20% depreciation for plant and machinery is available on Written Down Value (WDV) basis. Assume thatcorporate tax is paid one year in arrear of the periods to which it relates and first year depreciation allowancewould be claimed against the profits of year 1.

The Assistant Management Accountant has calculated NPV of the project using the companys corporate target of20% pre-tax return and has ignored the taxation effect in cash flows.

The corporate tax is expected to be 35% during the life of the project and thus the companys post-tax rate ofreturn is 13%.

You are required toa. Calculate the NPV of the project as Assistant Management Accountant would have calculated.

b. Re-calculate the NPV of the project taking tax into consideration and comment on the desirability of theproject.

(4 + 7 = 11 marks) < Answer >

2. Dutta Ltd. manufactures and sells Product X. The company uses standard costing system. The company hasfurnished the following information pertaining to the standard costs per unit of Product X for the month of June2005:

Particulars Rs.

Direct material 2 meter at the rate of Rs.5 per metre 10.00

Direct labor 1 hour at the rate of Rs.3.50 per hour 3.50

Variable overhead 1 hour at the rate of Rs.2.50 per hour 2.50

Total 16.00

During June 2005, 5,500 units of product X were produced by the company and the related data are as follows:

Direct material acquired at the rate of Rs.6.00 per metre 18,000 metre

Material consumed 13,600 metre

Direct labor -? hours at the rate of Rs.? per hour Rs.26,500

Variable overheads incurred Rs.19,475

The variable overhead efficiency variance is Rs. 1,250 (adverse). Variable overheads are based on direct laborhours. There was no stock of raw material in the beginning.

Being a finance controller evaluate the performance of the company by presenting all the relevant variances.

(9 marks) < Answer >

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Caselet 1

Read the following caselet carefully and answer the following questions:

3. What precautions should be taken by the business in using budgeting as a tool for cost control program?


4. The caselet argues that a successful cost control program needs active involvement of the staff. Why do you think

active involvement of employees is necessary? Discuss.


5. Frame a broad strategy, explaining the various steps, for the implementation of the cost reduction campaign in anorganization.


If the recent corporate actions are anything to go by, it appears, as if the importance of a cost cutting program is oftenignored when the business is going on smoothly. It is only in economic recession that companies consider theimplementation of cost control programs. Cost cutting program benefits an organization by reducing the pressure on theprofit margins. A successful cost control program needs active involvement of the staff, effective utilization of thebudgeting resources in the program. The main areas of concern in a cost cutting program include the personnel costsand the purchasing function.

In a tight economy, there is general recognition that business as usual wont cut it, and managers need to find ways toget by with less of everything. Often overlooked, however, is the similarity that should exist between management in acutback and managing a going business in the best of times.

The best cost-cutting program is a program of cost control and work prioritizing which functions equally well in goodtimes and bad. The most difficult of times can give managers the opportunity to install cost-cutting programs withcredibility and with the support of those affected.

Deciding which costs to cut is just as important as determining how much to cut. Cutting across the board is never theright approach its only a question of how much unnecessary damage this does. A better approach is to attack theproblem by grouping functions, departments, and projects into one of the following four categories:

Select areas where cost cutting will not stop recovery or affect critical current programs. Cut these sharply or

eliminate them entirely. Select activities that must be retained but can be delayed or cut back into an inactive state for four to six

moths.

Determine where money can be spent more effectively in areas that cant be cut back.

Finally, consider investing in new or existing projects that can benefit the cost-control program and be ofcontinuing value in a recovery.

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

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

6. As Window-making department has evolved into a core competency of Multree, is the demand to make it a profitcenter justified?


7. The caselet states that while the transfer price should not be considered relevant for deciding to transfer goodsbetween departments, but it becomes relevant when inappropriate reward systems were used. Discuss why andhow the reward system is linked to transfer pricing.


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

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Marked-up transfer prices and market price-based transfer prices added no value to the firm when Window-making was not allowed to sell to outside customers.

While the transfer price should not be considered relevant for deciding to transfer, it became relevant wheninappropriate reward systems were used.

Only four accounting numbers are relevant in deciding to transfer, and the transfer price is not one of them!

Multree Homes is a Northern Nevada firm that produces manufactured homes in one medium-sized plant. As is

common in many companies, the Window-making Department began as a cost center, providing windows to theAssembly Department. Over the years, Window-making developed into a core competency, and Cherie, the departmentmanager, pressured Multree management for the authority to sell windows to outside customers. At first, managementbalked, believing Window-makings sole responsibility should be to provide high-quality windows, on time, and withinbudget for Multrees manufactured homes.

Historically, Window-makings performance was evaluated only with cost variances. As a partial response to Cheriesrequest, Julie, the CFO, who holds the Certified Management Accountant (CMA) designation, decided to implementsome activity-based management (ABM) vendor performance measures she developed for Multrees suppliers as partof a supply-side strategic cost management initiative. Julie argued that departments within a company are simplysuppliers to other departments (internal customers), and, as such, departments supplying goods or services to otherdepartments should be evaluated using three accounting measures for quality, service, and cost:

Complete order-filling ratio,

On-time delivery ratio and

Cost variances.

The complete order-filling ratio is a combined quality and service measure calculated as the number of completedeliveries divided by the number of deliveries received. As another service measure, the on-time delivery ratio is thenumber of deliveries received when due, divided by the total number of deliveries.

To measure quality costs as well as efficiency, Window-makings cost variances are determined using a second-generation activity-based costing (ABC) system. Regardless of where cost variances occur, they are coded in terms ofactivity problems, their sources, and their causes. So, a cost variance is the total cost to fix a problem including anylabor, materials, or direct technology costs incurred.

END OF SECTION B

Section C : Applied Theory (20 Marks)

This section consists of questions with serial number 8 - 9.

Answer all questions.

Marks are indicated against each question.

Do not spend more than 25 -30 minutes on section C.

8. Control in service organizations is different from control in manufacturing organizations. In this context, explainthe differentiating factors that influence the control of service organization in comparison with that of

manufacturing organization.


9. Incentive compensation plays an important role in encouraging and motivating the managers of an organization inachieving its objectives and goals. If proper and attractive compensation is given to the managers, it encouragesthem to work hard and put in all efforts and strive for the development of the organization. In this perspective,discuss the different incentive plans available for motivating the employees.


END OF SECTION C

END OF QUESTION PAPER

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Suggested Answers

Management Control & Information Systems (MB281) July2005

Section A : Basic Concepts

1. Answer: (e)

Reason: Transfer pricing motivates divisional managers to perform well. It is useful forevaluating performance of the divisional managers. It also helps in measuringdivisional performance. It is the selling price established for goods or services soldby one division to other under the same organization. Therefore, (d) is not correct,(e) is correct.

2. Answer : (a)

Reason: The projected sales in July 2005 (according to analysts )

= 12,000 units 20% of 12,000 units

= 9,600 units.

Sales volume variance

= Standard sale price (Actual sales quantity - Standard sales quantity )

= Rs.80 (9,600 units - 11,500 units)

=Rs.1,52,000 (A)

3. Answer: (c)

Reason: A fixed budget is not prepared for a range, rather it is used unaltered during thebudget period. It is prepared for a particular activity level and it does not changewith actual activity level being higher or lower than the budgeted activity level.

4. Answer : (d)

Reason : The profitability index is the ratio of the present value of future cash inflows to theinitial net cash investment. It is a variation of the NPV method that facilitatescomparison of different-sized investments. A profitability index greater than 1indicates a profitable investment, or one that has a positive net present value.

(a) is not correct because, if the index is 1.20 and the discount rate is the cost of

capital, the NPV is positive, and the IRR must be higher than the cost ofcapital.

(b) & (c) are not correct because the IRR is the discount rate at which the NPV isRs.0, which is also the rate at which the profitability index is 1. The IRRcannot be determined solely from the index.

(e) is not correct because the IRR is a discount rate, whereas the NPV is anamount.

5. Answer : (b)

Reason : Technique I: Though they are more expensive, better quality materials might savecosts because they are less likely to be faulty and/or might last longer.

Technique II: Costs can be reduced by improving productivity levels.

Technique III: This is a method of cost control rather than cost reduction.Technique IV: Cheaper materials may impair the suitability of goods or services forthe use intended.

Hence, option (b) is correct. Option (a), (c), (d) and (e) are not correct.

6. Answer: (e)

Reason: Sub-standard materials, Pilferage of materials, Non-standard material mixture,Wastage due to inefficient mixture are causes of material usage variance. Howeverpurchasing non-standard lots leads to reduction in quantity discount which is a causefor material price variance.

7. Answer : (a)

Reason : A cost driver is the factor which causes the costs of an activity to increase or

decrease.(b) is not correct because it is a description of cost pool.

(c) & (d) are not correct because it is a description of a common cost.

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

8. Answer : (c)

Reason : The strategy formulation is the process of deciding on new strategies of anorganization. Therefore, (c) is correct.

(a) & (e) are not correct because these are the process of deciding on the programsthat the organization will undertake and the approximate amount of resources that

will be allocated.(b) is not correct because it is a process of preparing a strategy.

Statement (d) is not correct because, strategy implementation comes after strategyformulation.

9. Answer : (e)

Reason : From the strategic planning perspective, the value chain concept highlights threepotentially useful areas.

i. Linkages with suppliers

ii. Linkages with customers

iii. Process linkages within the value chain of the firm.

10. Answer : (e)Reason : The rate used to discount factor cash flows is sometimes called the cost of capital,

the discount rate, the cutoff rate or hurdle rate. A risk free rate is the rate availableon risk-free investments such as government bonds. The risk-free rate is notequivalent to the cost of capital because the latter must incorporate a risk premium.

Therefore answers (a), (b), (c) and (d) are not correct.

11. Answer: (b)

Reason: A profit center is a segment of a company responsible for both revenues andexpenses. A profit center has the authority to make decisions concerning markets(revenues) and sources of supply (costs). Option (a) is not correct because a revenuecenter is responsible for developing markets and selling the firms products. Option(c) is not correct because a cost center combines labor, materials, and other factors

of production into a final output. Option (d) is not correct because a service centerprovides specialized support to other units of the organization. Option (e) isincorrect because an investment center is responsible for revenues, expenses, and theamount of invested capital.

12. Answer : (e)

Reason : Goal congruence is an integration of the goals of the organization and theindividuals working in the organization.

(a) is not correct because motivation is the desire and the commitment to achieve aspecific goal.

(b) & (c) are not correct because autonomy is the extent to which individuals (Bothsupervisors and subordinates) have the authority to make decisions.

(d) is not correct because managerial effort is the extent of the attempt to accomplish aspecific goal.

13. Answer : (e)

Reason : Accounting rate of return

=

(Rs.80,000 Rs.90,000 Rs.75,000 Rs.65,000 Rs.90,000)(1 0.4)

Rs.2,00,000 Rs.2,60,000 Rs.2,20,000 Rs.1,80,000 Rs.1,40,000

+ + + +

+ + + +

=

Rs.4,00,000 (0.60)

Rs.10,00,000

=

Rs.2,40,000

Rs.10,00,000 = 24%.

14. Answer : (a)

Reason: Materials price variance: Actual quantity used x (Standard price - Actual price). Theactual price is Rs.3,33,900/63,000 = Rs.5.30. The standard quantity of material is2,500 x 25 = 62,500 kg. The materials price variance is 63,000 x (Rs.5.00 - Rs.5.30)= Rs.18,900 unfavorable variance.

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15. Answer: (b)

Reason : Standard cost are predetermined, attainable unit costs. Standard cost systems isolatedeviations of actual from expected costs. One advantage of standard costs is thatthey facilitate flexible budgeting. Accordingly, standard and budgeted costs shouldnot differ when standards are currently attainable. However, in practice, budgeted(estimated actual) costs may differ from standard costs when operating conditionsare not expected to reflect those anticipated when the standards were developed.

Answer (a) is incorrect because standard costs are determined independently of thebudget. Answer (c) is incorrect because budgeted costs are expected future costs, nothistorical cost. Answer (d) is incorrect because budgeted and standard costs shouldin principle be the same, but in practice they will differ when standard costs are notexpected to be currently attainable. Answer (e) is not correct. Therefore (b) is theanswer.

16. Answer : (d)

Reason : It is extremely difficult to appraise the performance of strategic planning as there areno prescribed standards against which the performance can be measured.

All other statements for strategic planning are true except (d). Therefore the correctanswer is (d).

17. Answer: (e)Reason: In Non-Financial Audit, audience is generally internal, with data being used

primarily to improve performace. The other statements (a), (b), (c) and (d) pertain toFinancial Audit.

18. Answer: (b)

Actual overheads cost Rs.62,200Less: Applied overhead cost =

(Standard hours for actual work standard overhead rate)

6,000 hours Rs.10

Rs. 60,000

Overhead cost variance Rs. 2,200 (Adverse)

19. Answer: (c)

Reason: The amount spent on set-up costs is decreased with the introduction of numericallycontrolled machine tools but not increased. The other options are true and hence notthe correct answers.

20. Answer : (d)

Reason : Budgetary control is a device for finding out how the activities of an organizationare progressing. it helps in pinning down responsibility and accountability forperformance to each member

(a) It is used to measure and compare actual results with the anticipated results, asprovided in the budget.

(b) Budgetary control offers an overall picture of performance of various functionsof the organization.

(c) Budgetary control is handled by the budgetary controller.

(e) Budgetary control brings about the integration of policy, plans, and actions ofthe different department.

21. Answer : (b)

Reason : Accounting system should have certain controls that provide for feedback reportsindicating deviations from expectations. Management may then focus on thosedeviations for either reinforcement or correction. Option (a) is incorrect becauseMBO is not considered with responsibility accounting. Option (c) is incorrectbecause the responsibility accounting system should not be used exclusively toassess blame. Option (d) is incorrect because responsibility accounting should not beused exclusively to give rewards. Option (e) is incorrect because feedback reports

concentrate on deviations, but not to the total exclusion of other budgeted variables.

22. Answer : (e)

Reason : Efficient coordination of errors in subunits results in lower transaction costs and

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does not result in excess costs.

Subunits comprise individuals who perform certain activities to fulfill the purpose ofthe organisation. The control systems play a major role in coordinating the efforts ofthese subunits. In the past subunits were not expected to be aware of the overallpurpose of the organisation. The management establishes the purpose, goals andobjectives of an organisation and delegate resposibility of various subunits toaccomplish the goals.

23. Answer : (d)

Reason : In an insurance industry, the key variables are number of claims settled in a givenperiod, number of policies processed in a given period of time etc.

The other options are incorrect because, percentage of absenteeism amongemployees is one of the key variables of Hotel Industry, time spent on managementdevelopment programs and number of research projects undertaken and thosecompleted are the key variables of Management training institute, preventive andbreakdown maintenance is the key variable of Power industry.

24. Answer : (c)

Reason : Multivariate analysis helps in identifying the critical control variables and latentfactors. Multivariate analysis helps in identifying a wide range of key variables,

which help in analyzing a particular situation and initiates prompt action. The otheroptions are incorrect.

25. Answer : (c)

Reason : The correct answer is (b).

Standard price per kg =

Rs.24,000

5,000kgs = Rs.4.8

Usage variance (Kg) =

Rs.576

Rs.4.80 = 120 kg.

Standard usage = 5,000 kg 120 kg. = 4,880 kg

or

Material Usage Variance = Standard Price ( Actual Quantity Standard quantity )

Rs.576 = Rs.4.80 (5,000- Standard quantity ) . Standard quantity= 4,880 Kg.

26. Answer : (b)

Reason : Informal Control System increases the organizations ability to make adaptiveresponses. Hence alternative (b) is false. The other alternatives are true.

27. Answer: (d)

Reason: The advantages of external control style of managing employees are:

Because of high control executed by the top management, superior will be able tomonitor subordinates work and there would be no manipulations

And subordinates may be motivated to perform as rewards are directly linked to

performance.The other options are disadvantages hence not the correct answers.

28. Answer: (b)

Reason: It is the responsibility of the top management to implement TQM and notemployees. The other options are true hence not the correct answers.

29. Answer : (e)

Reason : The payback period measures how quickly the initial investment will be recorded.Management can best manage risk by recouping its money quickly. Options (a), (b),(c) and (d) are incorrect because they consider risk only indirectly through theselection of the discount rate.

30. Answer: (b)

Reason: Divest indicates a decision to withdraw from the business either through a process ofslow liquidation or outright sale. The other options are incorrect because:

Harvest: this action has the goal of maximising short term earnings and cash flow,

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even at the expense of market share (a).

Hold: this action aims to protect the business units market share and competitiveposition (c).

Build: this indicates that the business units goal is to increase its market share, evenat the expense of short-term earnings and cash flow (d).

Budget: this involves deciding on the allocation of resources and targets of eachbusiness unit (e).

Section B : Problems

1. a. Assistant Management Accountants calculation (i.e. ignoring taxation)

(Rs. in lakhs)

Investment

Plant and Working

0 (76) (76) 1.0 (76)

1 (8) 26 18 0.8333 15.00

2 25 25 0.6944 17.36

3 18 18 0.5787 10.42

4 18 18 0.4823 8.68

5 34 8 16 58 0.4019 23.31

(1.23)

It is assumed that working capital would reduce cash flows in year 1 and would be recovered soon after theend of year 5. The working capital cash flows are therefore assigned to years 1 and 5.

Here it is observed that NPV is negative and hence the Assistant Management Accountant would haveconcluded that the project should be rejected.

b. Allowing for taxation

Tax on Cash profit:

(Rs. Lakh)

eprec a on a owances ax re a e:

(Rs. lakh)

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2 48.640 12.160 4.256 3

3 38.912 9.728 3.405 4

4 31.130 7.782 2.724 5

5 24.904 6.226 2.179 6

6 *(9.096) (3.184) 6

* Profit on sale of plant & machinery (34 24.904)=9.096

Calculation of NPV of the project:

(Rs. lakh)

Investment

Year Plant andmachinery

Workingcapital

Tax saved byDepreciation

Cashprofits

Tax onprofits

Net

cash

flow

Discount

factor

@13%

Presentvalue

0 (76) - (76) 1 (76)

1 (8) - 26 18.00 0.885 15.932 5.320 25 (9.10) 21.22 0.783 16.62

3 4.256 18 (8.75) 13.51 0.693 9.36

4 3.405 18 (6.30) 15.11 0.613 9.26

5 34 8 2.724 16 (6.30) 54.42 0.543 29.55

6 (1.005)* - (5.60) (6.61) 0.480 (3.17)

1.55

(Rs.2.179 Rs.3.184 = Rs.1.005)

The NPV is positive, although it is very small in relation to the capital outlay of Rs.76 lakhs. It is also apparent that

the positive NPV depends heavily on the assumption that the plant and machinery would have a resale value ofRs.34 lakhs at the end of year 5. Such projects which rely on their residual values for their positive NPV shouldnormally be regarded as high-risk ventures.

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2. Computation of Standard Costs and Actual costs

Particulars Rs. Particulars Rs.

Standard costs

Direct materials (5,500Rs.10)

Direct Labor (5,500Rs.3.50)

Variable overheads (5,500Rs.2.50)

55,000

19,250

13,750

Actual costs

Direct materials (13,600 metersRs.6.00)

Direct Labor

Variable overheads

81,600

26,500

19,475

Total standard costs (A) 88,000 Total actual costs (B) 1,27,575

Total cost variance = Rs.1,27,575 Rs. 88,000 =Rs. 39,575 (A)

1. Actual labor hours

Variable overhead efficiency variance = Standard variable overhead rate per hour (Standard hours-Actualhours)

Rs. 1,250 (A) = Rs2.50(5,5001 hour-Actual hours)

Rs. 1,250 (A) = Rs.13,750-(Rs.2.5Actual hours)

(Rs.2.5Actual hours) = Rs. 13,750+Rs.1,250 = Rs.15,000

Actual hours = Rs.15,000/2.5 = 6,000 hours

2. Actual wage rate per hour

.26,500 .4.426,000

Actual wages paid Rs RsTotal actual hours hours

= =

Computation material, labor and variable overhead variances

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I. Material Variances:

1. Material cost variance

= Standard cost-Actual cost

= (Rs.55,000 Rs.81,600)=Rs.26,600(A)

2. Material price variance

= Actual quantity of material consumed(Standard price Actual price)

= 13,600 metres (Rs.5- Rs.6) = Rs13,600 (A)

3. Material usage variance

= Standard price (Standard quantity-Actual quantity)

= Rs. 5 (11,000 metres 13,600 metres) =Rs.13,000 (A)

II. Labor variances:

1. Labor cost Variance

Standard cost Actual cost

Rs.(19,250 Rs. 26,500) =Rs.7,250 (A)

2. Labor rate variance = Actual hours(St.rate-Actual rate)

= 6,000(Rs.3.50-Rs.4.42) = Rs.5,520(A) or Rs. 5,500 (A)3. Labor efficiency variance

= Standard rate per hour (Std. Hours actual hours)

= Rs. 3.50 (5,500 hours 6,000 hours)=Rs.1,750 (A)

III. Variable overhead variances:

1. Variable overhead cost variance

= Standard variable overhead Actual variable overhead

= (Rs.13,750 Rs. 19,475) = Rs.5,725 (A)

2. Variable overhead efficiency variance

= Standard variable overhead rate per hour (Std. Hours for actual output Actual hours)

= Rs. 2.50(5,500-6,000)= Rs. 1,250 (A)3. Variable overhead budget (expenditure) variance

Budgeted variable overhead Actual variable overhead

(Actual hours worked Std.variable overhead per hour)-Actual variable overhead

= (6,000Rs.2.50)-Rs.19,475

Rs.15,000-Rs.19,475 = Rs.4,475 (A)

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3. The best single tool for cost control, in good times or bad, is still the budget performance report. Its important thebudget is credible and the line items are understood to know which budget items are affected when the company iscommitted to spending money.

It is necessary to get the details from the accounting department to help understand why the budget or costobjective was exceeded. Manage the budget line by line, not in total. Dont be satisfied with the monthsperformance simply by staying within the overall department budget, because it could lead to the followingcommon trap:

When an account is under budget due to timing differences, that is, it will actually be spent later than budgeted, thefavorable variance may offset and hide another account that has an unfavorable variance due to overspending.Later on, the timing difference catches up and you have an overall overspent condition. But attention is drawn tothe wrong account in the wrong month, long after corrective action should have been taken.

Subordinates should be held accountable for the specific elements of the budget that they control. If they donthave responsibility for separately reported cost centers, find some other ways to get them to relate to budgetperformance as a cost-control tool.

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

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Establish with key subordinates a cost-control goal they can shoot for as a team. Management must provide theparameters, but employees should feel like they helped decide on the specific objectives.

The goals, guidelines and progress should be publicized. Staff memos, the company newsletter, bulletin boards andstaff meetings can all be used. The staff must be conditioned by positive reinforcement to think in new ways.Recognition will reduce normal resistance to cost control.

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5. Managers wish to achieve cost reduction in their own business can do so by following five steps: Generate buy-in with key stakeholders on the need:

To avoid the negative connotations that employees may have with cost cutting, it is necessary tocommunicate clearly what cost reduction is and is not. At its core, cost reduction eliminates waste andconserves resources in order to reinvest the savings in critical business assets like employees, technology, andR&D. Reducing costs does not mean unnecessarily reducing quality, skimping on service, or anything elsethat could undermine a companys longevity within a competitive marketplace. Instead, cost reduction takesadvantage of every opportunity to better leverage existing and new assets to bring value to customers andshareholders.

Setting objectives:

The exercise of setting objective is in the form of a vision statement. Struggling companies, for example,might want to cease their cash hemorrhaging in order to survive until their next round of funding. More

established companies use cost reduction in an effort to stay competitive, while healthy businesses can usecost reduction campaign to strengthen their competitive position.

Align Cost Reduction with Business Strategy:

It is vital that cost reduction initiatives be conceived and deployed in concert with the overall businessstrategy to ensure that cost cutting does not detract from the strategic vision or negatively affect companyperformance. This can be achieved by calibrating the companys vision/objectives with its cash flow andbudget, and then determining the financial gap between current capabilities and the future needs of thecompany. Armed with this information, managers can identify and prioritize areas that need to bestrengthened and those to be rationalized. In practice, this exercise is more difficult than it sounds and mayrequire additional activities to ensure that the prioritization is based on a comprehensive view of theorganization.

Choose appropriate approach:

With these objectives in mind, the strategic manager will choose the cost reduction approach that best meetstheir objectives both from rupees saved and organizational impact.

Set Goals and Prioritize:

Now that the process has been communicated, the objectives have been outlined, the priorities have been set,and the approach is chosen, then business develop detailed and measurable goals that will help to achieve thebroader vision.

The above five-step strategy primes your organization to enact value creating and sustainable cost savings byensuring that the cost reduction initiative has buy-in from company managers and employees, is aligned with thecompany vision, that it is applied in the right business area, and that the results are attainable and measurable.Ultimately, these are the success factors of any initiative.

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6. The emphasis on traditional cost variance reporting did not satisfy some cost center managers, including Cherie,because the managers knew they were contributing to Multrees value, yet upper management only consideredthem cost creators. To overcome Cheries continuing requests to be seen as a profit creator, Window-makingwas changed into a pseudo profit center.

Pseudo profit centers provide goods or services to other segments of a company but are not allowed to marketthose goods or services to outside customers. A profit is reported for these centers by charging internal customers amarked-up price, mimicking a real cash sales price from an outside supplier.

For example, the standard absorptive manufacturing cost is $100, while the actual cost is $110 per window.Budgeted and actual volume is 1,000 windows. Thus, the cost of goods sold (COGS) is $100,000 and $110,000,respectively.

Using a 20 percent markup on the $110 actual cost results in a $132 transfer price. This creates a favorable pseudo

sales price variance in Window-making that swamps the real $10 per window cost variance. Window-makinglooks like it is contributing an extra $2,000 profit above budget, when, in fact, Multree profits are $10,000 lessthan budget due to the $10 per window cost variance. Cherie obviously was very happy with the new transferpricing policy!

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The Assembly Department manager, complained bitterly, though. He is charged a $12 per window unfavorablecost variance (a direct materials purchasing or price variance). In other words, Window-making can pass its costvariances to the next department and look good while doing it.

Although returning Window-making to a cost center eliminated some nonvalue-added accounting and managementactivities, Cherie knew that her windows were high quality and that she could compete effectively in the market ifallowed to sell them. To prove this, she proposed her first priority should be to supply Assembly, but she alsoshould be allowed to use any surplus capacity to make and sell windows to other home builders.

Transfer price should remain at the standard absorptive cost in this situation. Window-making is primarily a costcenter but also is partly a profit center. As long as its first priority is to supply windows for Multrees homes, thehome sales prices should recover all costs of the business, including Window-makings fixed costs. Thus, it shouldtransfer at standard absorptive manufacturing cost.

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7. Rewards are based on each profit centers segment margin, which includes outside sales and transfers (internalsales). This is a very common reward system. Because the selling manager is responsible for agreeing on salesprices and the buying manager is responsible for agreeing on purchase prices, they have to jointly agree on atransfer price. Because the transfer price determines how much of the differential profit from transferring appearsin each profit centers net income (segment margin), the managers are in conflict with each other over the transferprice. Segmenting Multrees income statement into profit centers, including internal sales (transfers) within eachsegment margin, and then rewarding managers based on that segment margin has led to bad transfer decisions.

The suggestion is to segment Window-makings income statement into internal and external sales. Themanagement can see the transfers net cash flows (savings less cost variances) separately from external sales. Withthis information, they can reward transfers separately from external sales and profits.

Segmenting Window-makings income statement and reporting two window purchase price variances for Assembly(from transfers and from outside purchases) allows for a dual reward system for transfers and external purchase/salesactivities. Yet the managers still have to negotiate a transfer price. So, while a direct reward for transferring can be made,the managers still will have to jointly determine how much of that reward each receives. Establishing a separate rewardsystem for transfers and segmenting their income statements is congruent with the dual reward system, but this policystill will not solve the negotiation problem.

Multree management should decide in advance what percentage of the reward each manager receives fortransferring. This reward system and transfer pricing policy functioned quite well for some time. Ultimately,though, competitive pressures began to impact sales prices and profits negatively, which caused to reconsiderMultrees reward system. As a cost-cutting measure, Managers should not be rewarded for transferring.

Management justifies this move by relating the transfer decision to coming to work on time. Employees areexpected to come to work on time. They do not get rewarded for doing this. Similarly, profit center managers areexpected to transfer when it increases overall firm cash flows and profits. This is common sense and does notrequire a reward.

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Section C: Applied Theory

8. Control in service organizations is different from control in manufacturing organizations. There are somecharacteristics, which are also applicable to the management control of legal, research and development, and otherservice departments in companies in generally, which are stated under:

Absence of inventory buffer

Manufacturing organizations maintain an inventory of goods in order to tackle sales fluctuations in future. Thisdoes not hold true for service organizations. They cannot store their services. For example, the airplane seat, hotelroom, or the services of professionals like lawyers, physicians cannot be stored. Further, in the short run, the costsof many service organizations are essentially fixed. Simply by closing some of the rooms, a hotel cannot reduce itscosts substantially. Moreover, the impact on the morale of its staff and the costs of rehiring make accounting firms,law firms, and other professional organizations reluctant to layoff professional personnel in times of low salesvolume.

In most service organizations, therefore, the extent to which current capacity is matched by demand serves as a keyvariable. Organizations try to match these in essentially two ways. Through marketing efforts and priceconcessions they try to stimulate demand in off-season periods. Low rates in off-seasons are offered by cruise linesand resort hotels; hotels offer low rates on weekends; low rates are offered by public utilities during slack periods.

The importance of the loss from unsold services can be grasped from the fact that occupancy rates, "sold hours",load factors, student enrollment, hospital admissions, and similar indications of success in selling availableservices are usually key variables in all types of service organizations.

Difficulty in controlling quality

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The products of a manufacturing company should be inspected for quality before they arc released in the market,but this cannot be done in case of a service organization's products. The quality of the products offered by serviceorganizations cannot be judged until it is rendered to the customer. Also, the judgments regarding the quality of theproduct are often subjective. The management of a restaurant may judge the quality of the food and approve of it,but customer satisfaction also depends on how the food is served. Since it is difficult to measure the quality ofeducation, few educational organizations have a formal quality control system. In the case of a public accountingfirm, it is possible to measure the number of hours spent on an audit, but not the thoroughness of the work doneduring those hours. There is no objective way of appraising the soundness of the recommendations made by aconsulting firm. Likewise, it may take several years for the loopholes or ambiguities in documents drafted by a lawfirm to come to light. It describes the difficulty in measuring intangible attributes and the costs related to them.

Labor intensive

Manufacturing companies can reduce costs by replacing labor with additional equipment and by automatingproduction lines. This measure, however, cannot be adopted by most service companies. Addition of expensiveequipment does take place in hospitals too; but, at the same time, most of these provide better treatment facilities.

Multi unit organizations

Service organizations operate through many small units set-up in different locations. These units act as individualprofit centers for the service organizations. Fast-food companies, gasoline stations and auto rental companies aresome of the examples of such service organizations. The units of a service organization are either wholly owned orfranchised. Most of these units are similar in size and operations and hence provide a basis for analyzing budgets

and evaluating performance. The information generated from such an analysis can be used to distinguish the highperforming units from the low performing units. Care must be taken in making such comparisons because unitsdiffer in the mix of services they provide, in the resources that they use, and in various other ways. "DataEnvelopment Analysis" is a technique adopted for making adjustments for these differences. It identifies the mostefficient units by using statistical methods of allowing for differences.

Quantity measurement

Though it is easy to keep track of the quantity of tangible goods, both during the production process and when thegoods are sold, this is not the case with many services. For example, while it is possible to measure the number ofpatients treated in a day by a physician, and to even classify these visits by the type of complaint, it is not possibleto measure the amount of service that the physician provides to each of these patients.

Historical development

The necessity for valuing work-in-process and finished goods inventories for financial statement purposes initiated

the growth of cost accounting in manufacturing companies. Raw data, that can be easily adapted for use in settingselling prices and for other management purposes, is provided by these systems. It was on the foundation of costaccounting systems that standard cost systems, separation of fixed and variable costs, and analysis of varianceswere established.

Most texts on cost accounting, until a few decades ago, dealt only with the practices in manufacturing companies.There was no similar impetus to develop cost data for most service organizations (with the notable exception ofrailroads and other regulated public.industries). The use of product cost and other management accounting data byservice organizations is fairly recent-mostly since World War II. Management control systems in serviceorganizations are now rapidly becoming as well developed as those in manufacturing companies.

Implications for Management Control

Management control systems in service organizations differ from those in manufacturing organizations, in degree,rather than in kind. In both types of organizations, the essential features are the same. Planning, in both, is done in

terms of programs and responsibility centers, including profit centers and investment centers for organization unitsmeeting the criteria. In both type of organizations, the management control process involves programming,budgeting, measurement of performance, and appraisal of performance.

The control systems currently found in service organizations, being relatively recent in their development, tend tobe less advanced than those in manufacturing organizations. Due to the difficulty in measuring both the quantityand the quality of output, judgments pertaining to both the efficiency and the effectiveness of performance aremore subjective than in situations where output consists of physical goods. This implies that there is more room forlegitimate differences of opinion about performance. The recognition by managers of the fact that performance isnot easy to measure make it eminently worthwhile to launch a search for better tools for improving itsmeasurement.

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9. The incentive compensation is an important mechanism that encourages and motivates managers to achieve

organizations objectives. It is commonly observed and experienced fact that managers put forth a great deal ofeffort on activities that are rewarded and less on activities that are not rewarded. A managers total compensationpackage consists of three components :(a) Salary, (b) Benefits and (c) Incentive compensation. In the question weare concerned with Incentive compensation only.

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Incentive compensation plans can be classified as:

a. Short-term incentive plans

b. Long-term incentive plans

Short-term incentive plans are usually based on performance in the current year. Long-term incentive plans relatecompensation to long-term accomplishments. A manager can earn a bonus under both plans.

Short-term incentive plans:

The total bonus pool Carryovers

Deferred payments

Long-term incentive plans:

Stock options

Stock appreciation rights

Phantom shares

Performance shares

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