CA Final – Page 2 – GST Guntur

Value of Supply – CA Final IDT Study Material

Leave a Comment / CA Final / By Murali / April 11, 2023 May 10, 2023

Value of Supply – CA Final IDT Study Material is designed strictly as per the latest syllabus and exam pattern.

Value of Supply – CA Final IDT Study Material

Question 1.
Vayu Ltd. provides you the following particulars relating to goods supplied by it to Agni Ltd :

Particulars	Amount
List price of the goods (exclusive of Taxes and discounts).	76,000
Special packing at the request of customer to be charged to the customer.	5,000
Duty levied by local authority on the sale of such goods.	4,000
CGST and SGST charged in invoice.	14,400
Subsidy received from a NGO (The price of ₹ 76,000 given above is after considering the subsidy)	5,000

Vayu Ltd. offers 3% discount of the list price of the goods which is recorded in the invoice for the goods. Determine the value of taxable supplies made by Vayu Ltd. [May 2018, Old, 5 Marks]
Answer:
Computation of value of taxable supplies by Vayu Ltd.

Particulars	Amount
List price of the goods	76,000
Add: Special packing [Note 1]	5,000
Duty levied by local authority on sale of goods [Note 2]	4,000
CGST and SGST charged [Note 2]	–
Subsidy received from a NGO [Note 3]	5,000
Less: Discount offered = 3% of List price = ₹ 76,000 × 3% [Note-4]	2,280

Notes:

1. Being incidental expenses charged by the supplier to the recipient of supply, packing charges are includible in the value as per section 15(2)(c) of the CGST Act, 2017.

2. Taxes, duties, etc. levied under any law for the time being in force other than CGST, SGST/ UTGST, IGST are includible in the value as per section 15(2)(a) of CGST Act, 2017. Duty levied by local authority on sale of goods has been assumed to be recovered from Agni Ltd. and not included in the list price of the goods.

3. Subsidy directly linked to the price received from a non-Government body is includible in the value in terms of section 15(2)(e) of CGST Act, 2017.

4. Since discount is known at the time of supply, it is deductible from the value in terms of section 15(3)(a) of CGST Act, 2017

Question 2.
M/s. Jonty India Ltd. a manufacturer of heavy machines registered at Jaipur (Rajasthan) supplied one machine to M/s. Dhanuka Ltd. of Udaipur (Rajasthan) on 05-02-2020 under an invoice of the same date. Using the information given below, compute the value of the machine and the GST payable (CGST & SGST or IGST as the case may be) in cash for the month of February, 2020 by M/s. Jonty Ltd. with appropriate working notes.

(i) The basic price of the machine (exclusive of taxes and discount) : ₹ 28,50,000
(ii) Trade discount is allowed at 3% on the basic price and is shown in the invoice : ₹ 85,500
(iii) Secondary packing (in iron sheets) charges for safe transportation of the machine on the request of buyer. : ₹ 30,000
(iv) Design and engineering charges of the machine. : ₹ 90,000
(v) Tax levied by Municipal Authority on the sale of the machine. : ₹ 25,000
(vi) Subsidy received by the supplier form the State Government to encourage manufacture of the machine. : ₹ 80,000
(vii) Pre-delivery inspection charges paid to an independent agency in terms of the agreement for supply. The amount was paid by MIs. Dhanuka Ltd. : ₹ 22,000
(viii) Interest amount paid by MIs. Dhanuka Ltd. for delay in payment for the machine. : ₹ 12,000

Inward Supplies
(i) IGST paid on food items for consumption by employees working in the factory. : ₹ 8,000
(ii) SGST and CGST (₹ 15,000 each) paid on Electrical transformer used in the manufacturing process. : ₹ 30,000

Note:
(i) M/s. Jonty India Ltd. has no input tax credit balance at the beginning of February, 2020. All the other conditions necessary for availing the eligible input tax credit have been fulfilled.
(ii) There are no other transactions of supplies during the month of February, 2020.
(iii) M/s. Jonty India Ltd. and M/s Dhanuka Ltd. are not related persons. [Nov 2018, 10 Marks]
Answer:
Computation of value of machine sold by M/s. Jonty India Ltd.

Particulars	Amount
Basic price of machine	28,50,000
Add: Secondary packing [Note 1(iii)]	30,000
Design and engineering charges [Note 1(iii)]	90,000
Tax levied by Municipal Authority [Note 1(i)]	25,000
Pre-delivery inspection charges paid by M/s. Dhanuka Ltd. [Note 1(i)]	22,000
Interest for delay in payment [₹ 12,000 × 100/118] [Note 1 (iv)] – (rounded off)	10,169
Less: 3% Trade discount on basic price of machinery = ₹ 28,50,000 × 3% [Note 2]	(85,500)
Taxable value of supply	29,41,669

Computation of net GST payable (in cash) by M/s. Jonty India Ltd. for the month of February, 2020

Particulars	CGST @ 9%	SGST@ 9%
Tax on value of ₹ 29,41,669 (rounded off)	2,64,750	2,64,750
Less /Input Tax Credit [ITC] of tax paid on electrical transformer used in the manufacturing process [Note 3]	15,000	15,000
Net GST payable	2,49,750	2,49,750

Note 1 : As per Section 15(2) of the CGST Act, 2017, value includes following activities or transactions:

(i) Any taxes levied under any law for the time being in force other than CGST/SGST/ UTGST/IGST, if charged separately by the supplier are includible in the value of supply.

(ii) Any amount that the supplier is liable to pay in relation to such supply, but which has been incurred by the recipient of the supply and not included in the price actually paid or payable for the goods and/or services is includible in the value of supply.

(iii) All incidental expenses, including packing, charged by the supplier to the recipient of a supply are includible in the value of supply and any amount charged for anything done by the supplier in respect of the supply of goods at the time of, or before delivery of goods is includible in the value of supply.

(iv) Interest for the delayed payment of any consideration for any supply is includible in the value of supply. Further, it is assumed that such interest is inclusive of tax and that the same has been received by M/s. Jonty India Ltd. in the month of February itself. Therefore, the time of supply of such interest will be in February, 2018 and the same will be considered while paying the tax liability of that month.

(v) Subsidies directly linked to the price excluding subsidies provided by the Central Government and State Governments are includible in the value of supply. Since in the given case, subsidy is received from State Government, the same has not been included in the value of supply presuming it to be directly linked to the price.

(It has been assumed that the basic price of the machine has been arrived at after adjusting the subsidy and that the basic price is the price charged from the customer. Consequently, subsidy received from State Government has not been reduced from the basic price of the machine while arriving at the taxable value of supply.

However, it is also possible to assume that the subsidy has yet not been adjusted in the basic price and that the price which will be charged from the customer is ₹ 27,70,000 (₹ 28,50,000 – ₹ 80,000) i.e., after excluding subsidy. In that case, the value of supply will be ₹ 28,61,669.)

Note 2: Trade discount has been shown in the invoice and hence, the same is excluded from the value of supply in terms of section 15(3) of the CGST Act, 2017.

Note 3: ITC on food or beverages is specifically disallowed unless the same is used for making outward taxable supply of the same category or as an element of the taxable composite or mixed supply [Section 17(5)]. (It has been assumed that the food items are provided free of cost to the employees in the course of employment) Further, since transformers are used in the course or furtherance of business, ITC thereon is available in terms of section 16(1).

Examiner’S Comment
Majority of the examinees computed the amount of GST payable correctly. However, they did not provide adequate reasoning in respect of interest and pre-delivery inspection charges.

Question 3.
Surya Agencies has agreed to supply goods to customer’s premises. Goods valued, ₹ 80,000 are taxable at 5% IGST as it is an inter-State supply. It also pays freight arid transit insurance of ₹ 12,000. GTA is a registered entity and has charged GST (6% CGST and 6% SGST) under forward charge.
(i) Compute the Invoice value of supply including IGST.
(ii) What will be the Invoice value of supply including IGST, if the supply was under ex-factory basis instead of door delivery basis? [Nov 2019, 4 Marks]
Answer:
(i) Computation of Invoice value of supply including IGST in case of door delivery.

Particulars	Amount
Value of Goods	80,000
Add: Charges for freight & Insurance	12,000
Value of supply	92,000
IGST @ 5% (WN1) → 5% of 92,000	4,600
Invoice value of supply	96,600

Working Notes:

It is a complete supply & principal element in Goods. Therefore the rate of Tax of principal element will be charged on the value.
Surya agencies can claim ITC of GST paid on GTA services (₹ 1,440 = 12% of 12,000)

(ii) Supply at the Ex-factory price instead of door delivery basis

Particulars	Amount
Supply of Goods	80,000
IGST @ 5% of value	4,000
Invoice value of supply	84,000

Note: The above answer is based on the view that part (ii) of the question is an independent case and thus, the information provided in the first paragraph of the question regarding payment of freight and transit insurance by Surya Agencies does not apply to it. Moreover, when the contract is ex-factory, it implies that the freight and insurance will be the buyer’s responsibility and seller will have no role, whatsoever, in delivering the goods to the customer’s premises.

Question 4.
Dushyant rents out a commercial building owned by him to Bharat for the month of December, for which he charges a rent of ₹ 19,50,000. Dushyant pays the maintenance charges of ₹ 1,00,000 (for the December month) as charged by the local society. These charges have been reimbursed to him by Bharat. Further, Bharat had given ₹ 2,50,000 to Dushyant as interest free refundable security deposit.

Further, Dushyant has paid the municipal taxes of ₹ 2,85,000 which he has not charged from Bharat. You are required to determine the value of supply and the GST liability of Dushyant for the month of December assuming CGST and SGST rates to be 9% each.
Note: All the amounts given above are exclusive of GST. [RTP May 2020]
Answer:
Computation of the value of supply and the GST liability of Dushyant for the month of December

Particulars	Amount (₹)
Rent of the commercial building	19,50,000
Maintenance charges paid to the local society, reimbursed by Bharat [Note 1]	1,00,000
Interest free refundable security deposit [Note 2]	Nil
Municipal taxes paid by Dushyant [Note 3]	Nil
Value of supply	20,50,000
CGST@ 9%	1,84,500
SGST@ 9%	1,84,500

Notes:

Maintenance charges paid to the local society, reimbursed by Bharat, such charges ultimately form part of the rent paid by Bharat to Dushyant and thus, will form part of the value.
Interest free refundable security deposit, Such security deposit does not constitute consideration in terms of section 2(31) of the CGST Act, 2017 and thus, is not includible in the value.
Municipal taxes paid by Dushyant, the same is not includible in the value since such taxes are not charged to the recipient.

Question 5.
Honeycure Laboratories Ltd. is a registered supplier of bulk drugs in Delhi. It manufactures bulk drugs and supplies the same in the domestic and overseas market. The bulk drugs are supplied within Delhi and in the overseas market directly from the company’s warehouse located in South Delhi.

For supplies in other States of India, the company has appointed consignment agents in each such State. However, supplies in Gurgaon (Haryana) and Noida (U.P.) are effected directly from South Delhi warehouse. The drugs are supplied to the consignment agents from the South Delhi warehouse.

Honeycure Laboratories Ltd. also provides drug development services to drug manufacturers located in India, including testing of their new drugs in its laboratory located in Delhi.
The company has furnished the following information for the month of January, 20XX:

Particulars	Rs.
Advance received towards drug development services to be provided to Orochem Ltd., a drug manufacturer, located in Delhi [Drug development services have been provided in February, 20XX and invoice is issued on 28.02.20XX]	5,00,000
Advance received for bulk drugs to be supplied to Novick Pharmaceuticals, a wholesale dealer of drugs in Gurgaon, Haryana [Invoice for the goods is issued at the time of delivery of the drugs in March, 20XX]	6,00,000
Supply of bulk drugs to wholesale dealers of drugs in Delhi	60,00,000
Bulk drugs supplied to Anchor Pharmaceuticals Inc., USA under bond [Consideration received in convertible foreign exchange]	90,00,000
Drug development services provided to Unipharma Ltd., a drug manufacturer, located in Delhi	6,00,000

You are required to determine the GST liability [CGST & SGST or IGST, as the case may be] of Honeycure Laboratories Ltd. for the month of January, 20XX with the help of the following additional information furnished by it for the said period:

1. Consignments of bulk drugs were sent to Cardinal Pharma Pvt. Ltd. and Rochester Medicos – agents of Honeycure Laboratories Ltd. in Punjab and Haryana respectively. Cardinal Pharma Pvt. Ltd and Rochester Medicos supplied these drugs to the Medical Stores located in their respective States for ₹ 60,00,000 and ₹ 50,00,000 respectively.

2. Bulk drugs have been supplied to Ronn Medicos Pvt. Ltd. – a wholesale dealer of bulk drugs in Gurgaon, Haryana for consideration of ₹ 15,00,000. Honeycure Laboratories Ltd. owns 60% shares of Ronn Medicos Pvt. Ltd. Open market value of the bulk drugs supplied to Ronn Medicos Pvt. Ltd. is ₹ 30,00,000. Further, Ronn Medicos Pvt. Ltd. is not eligible for full input tax credit.

Note:
(i) All the given amounts are exclusive of GST, wherever applicable.
(ii) Assume the rates of GST to be as under:

Goods/services supplied	CGST	SGST	IGST’
Bulk drugs	2.5%	2.5%	5%
Drug development services	9%	9%	18%

You are required to make suitable assumptions, wherever necessary. [MTP, May 2019, 9 Marks]
Answer:
(a) Computation of GST Liability of Honeycure Laboratories Ltd. for the month of January, 20XX

Particulars	Rs.
Advance received towards drug development services to be provided to Orochem Ltd., a drug manufacturer, located in Delhi [Drug development services have been provided in February, 20XX and invoice is issued on 28.02.20XX]	5,00,000
Advance received for bulk drugs to be supplied to Novick Pharmaceuticals, a wholesale dealer of drugs in Gurgaon, Haryana [Invoice for the goods is issued at the time of delivery of the drugs in March, 20XX]	6,00,000
Supply of bulk drugs to wholesale dealers of drugs in Delhi	60,00,000
Bulk drugs supplied to Anchor Pharmaceuticals Inc., USA under bond [Consideration received in convertible foreign exchange]	90,00,000
Drug development services provided to Unipharma Ltd., a drug manufacturer, located in Delhi	6,00,000

Notes:

1. Intra-State supply of services, supply of drug development services to Orochem Ltd. of Delhi is subject to CGST and SGST @ 9% each.
As per Section 13(2) of the CGST Act : The time of supply of services is the earlier of the date of invoice or date of receipt of payment, if the invoice is issued within 30 days of the supply of service. In the given case, invoice is issued within 30 days of the supply of service.
Therefore, time of supply of services will be date of receipt of advance and hence, GST is payable on the advance received in January, 2OXX.

2. Inter-State supply of goods, supply of bulk drugs to Novick Pharmaceuticals of Gurgaon, Haryana is subject to IGST @ 5%.
As per Section 12(2) of the CGST ActThe time of supply of goods is the earlier of the date of issue of invoice due date of issue of invoice as per Section 31 of CGST Act. Accordingly, the time of supply of the advance received for bulk drugs to be supplied to Novick Pharmaceuticals is the time of issue of invoice, which is in March, 20XX. Thus, said advance will be taxed in March, 20XX and not in January, 20XX.

3. Being an intra-State supply of goods, supply of bulk drugs to wholesale dealers of drugs in Delhi is subject to CGST and SGST @ 2.5 % each.

4. As per Section 16(1) of the IGST Act, 2017 Export of goods is a zero-rated supply. A zero-rated supply under bond is made without payment of integrated tax [Section 16(3) (a) of IGST Act],

5. Being an intra-State supply of services, supply of drug development services to Unipharma Ltd. of Delhi is subject to CGST and SGST @ 996 each.

6. Value of supply of goods made through an agent is determined as per rule 29 of the CGST Rules. In the given case, since open market value is not available, value of bulk drugs supplied to consignment agents – Cardinal Pharma Ltd. and Rochester Medicos – will be ₹ 99,00,000 [90% of (₹ 60,00,000 + ₹ 50,00,000)]. Further, being an inter-State supply of goods, supply of bulk drugs to the consignment agents is subject to IGST @ 5%.

7. If any person directly or indirectly controls another person, such persons are deemed as related persons. [Clause (a)(v) of Explanation to section 15 of the CGST Act]. In the given case, since Honeycure Laboratories Ltd. owns 6096 shares of Ronn Medicos, both are related persons.

Value of supply of goods between related persons (other than through an agent) is determined as per rule 28 of the CGST Rules. Accordingly, the value of supply of goods between related persons is the open market value of such goods and not the invoice value.

Furthermore, since Ronn Medicos is not eligible for full input tax credit, value declared in the invoice cannot be deemed to be the open market value of the goods. Thus, open market value of the bulk drugs supplied to Ronn Medicos i.e., ₹ 30,00,000 is the value of supply of such goods. Further, being an inter-State supply of goods, supply of bulk drugs to Ronn Medicos is subject to IGST @ 5%.

Question 6.
Kaya Trade Links Pvt. Ltd. is a registered manufacturer of premium ceiling fans. It sells its fans exclusively through distributors appointed across the country. The maximum retail price (MRP) printed on the package of a fan is ₹ 10,000. The company sells the ceiling fans to distributors at ₹ 7,000 per fan (exclusive of applicable taxes). The applicable rate of GST on ceiling fans is 18%.

The stock is dispatched to the distributors on quarterly basis stock for a quarter being dispatched in the second week of the month preceding the relevant quarter. However, additional stock is dispatched at any point of the year if the company receives a requisition to that effect from any of its distributors. The company charges ₹ 1,000 per fan from distributors towards packing expenses.

The company has a policy to offer a discount of 10% (per fan) on fans supplied to the distributors for a quarter, if the distributors sell 500 fans in the preceding quarter. The discount is offered on the price at which the fans are sold to the distributors (excluding all charges and taxes).

The company appoints Prakash Sales as a distributor on 1st April and dispatches 750 fans on 8th April as stock for the quarter April-June. Prakash Sales places a purchase order of 1,000 fans with the company for the quarter July-September. The order is dispatched by the company on 10th June and the same is received by the distributor on 18th June. The distributor makes the payment for the fans on 26th June and avails applicable input tax credit. The distributor reports sales of 700 fans for the quarter April-June and 850 fans for the quarter July-September.

Examine the scenario with reference to section 15 of the CGST Act, 2017 and compute the taxable value of fans supplied by Kaya Trade Links Pvt. Ltd. to Prakash Sales during the quarter July-September.
Note: Make suitable assumptions, wherever necessary. [MTP, May 2018, 8 Marks]
Answer:
Prakash Sales is entitled for 1096 discount on fans supplied by Kaya Trade Links Pvt. Ltd. for the quarter July-September as it has sold more than 500 fans in the preceding quarter April-June. However, since the entire stock for the quarter July-September has already been despatched by Kaya Trade Links pvt. Ltd. in the month of June, the discounts on the fans supplied to Prakash Sales for the quarter July-September will be a post-supply discount.

As per Section 15(3)(a) of the CGST Act, 2017 Such post-supply discount will be allowed as a deduction from the value of supply since the discount policy was known before the time of such supply and the discount can be specifically linked to relevant invoices (invoices pertaining to fans supplied to Prakash Sales for the quarter July-September) provided Prakash Sales reverses the input tax credit attributable to the discount on the basis of document issued by Kaya Trade Links Pvt. Ltd.
The value of supply will thus, be computed as under:

Particulars	Amount (₹)
Price at which the fans are supplied to Prakash Sales [Note 1]	7,000
Add: Packing expenses [Note 2]	1,000
Less: Discount [Note 3]	(700)
Value of taxable supply of one unit of fan	7,300
Value of taxable supply of fans for the quarter July-September [₹ 7,300 × 1,000]	73,00,000

Notes:
(1) The value of a supply is the transaction value, which is the price actually paid or payable for the said supply, in terms of section 15(1) of the CGST Act presuming that the supplier and the recipient of supply are not related and price is the sole consideration for the supply.

(2) The value of supply includes incidental expenses like packing charges in terms of section 15(2)(c) of the CGST Act.

(3) Since all the conditions specified in section 15(3)(b) of the CGST Act have been fulfilled, the post-supply discount will be allowed as deduction from the value of supply presuming that Prakash Sales has reversed the input tax credit attributable to such discount on the basis of document issued by Kaya Trade Links Pvt. Ltd. The input tax credit to be reversed will work out to be ₹ 1.26 lakh [1,000 × (7,000 × 10%) × 18%].

Question 7.
Determine the value of supply and the GST liability, to be collected and paid by the owner, with the following

	₹
Rent of the commercial building	18,00,000
Maintenance charges collected by local society from the owner and reimbursed by the tenant	2,50,000
Owner intends to charge GST on refundable advance, as GST is applicable on advance	6,00,000
Municipal taxes paid by the owner	3,00,000

[MTP, May/Nov 2018, Old]
Answer:
Computation of Value of Supply

Particulars	Amount (₹)
Rent of the commercial building	18,00,000
Maintenance charges collected by the local society from the owner and reimbursed by the tenant [ Note-1]	2,50,000
Refundable advance [Note-2]	Nil
Municipal taxes paid by the owner [Note-3]	Nil
Value of supply	20,50,000
CGST @ 9%	1,84,500
SGST @ 9%	1,84,500

Notes:-

1. Being reimbursed by the tenant, such charges ultimately form part of the rent paid by the tenant to the owner and thus, will form part of the value.
2. As per Section 2(31) of the CGST Act, 2017:- Being refundable, the advance is in the nature of security deposit which does not constitute consideration and thus, is not includible in the value.
3. Being an expenditure incurred by the supplier, the same is not includible in the value, assuming that such taxes are not charged to the recipient.

Question 8.
Maahi Ltd. of Bhopal (Madhya Pradesh) is a supplier of machinery. Maahi Ltd. has supplied machinery to ABC Enterprises in Indore (Madhya Pradesh) on 1st October, 2017. The invoice for supply has been issued on 1st October, 2017. Maahi Ltd. and ABC Enterprises are not related and price is the sole consideration for the supply.
Following information is provided:

Basic price of machinery excluding all taxes is ₹ 20,00,000. In addition to the basic price, Maahi Ltd. has collected the design and engineering charges of ₹ 10,000 and loading charges of ₹ 20,000 for the machinery. The commission of ₹ 10,000 has also been charged by Maahi Ltd. from ABC Enterprises.

Maahi Ltd. provides 1 year mandatory warranty for the machinery on payment of additional charges of ₹ 1,00,000.
Maahi Ltd. has collected consultancy charges in relation to pre-installation planning of ₹ 10,000 and freight and insurance charges from place of removal to buyer’s premises of ₹ 20,000.

Maahi Ltd. received subsidy of ₹ 50,000 from Central Government for supplying the machinery to backward region since receiver was located in a backward region. Maahi Ltd. also received ₹ 50,000 from the joint venture partner of ABC Enterprises for making timely supply of machinery to the recipient.

A cash discount of 1% on the basic price of the machinery is offered at the time of supply, if ABC Enterprises agrees to make the payment within 30 days of the receipt of the machinery at his premises. Discount @1% was given to ABC Enterprises as it agreed to make the payment within 30 days.
The machinery attracts CGST and SGST @ 18% (9% + 9%) and IGST @18%.
Compute the CGST and SGST or IGST payable, as the case may be, on the machinery. [MTP Nov 2018, 12 Marks]
Answer:
Computation of GST payable

Particulars	Amount ₹
Basic Price of the machinery	20,00,000
Add: Design and engineering charges [Note 1]	20,000
Loading charges [Note 1]	10,000
Warranty cost [Note 2]	1,00,000
Commission [Note 1]	10,000
Consultancy charges in relation to pre-installation planning [Note 1]	10,000
Freight and insurance charges [Note 2]	20,000
Subsidy received from Central Government [Note 3]	Nil
Receipts from Joint Venture of ABC Enterprises [Note 3]	50,000
Less: 196 discount on basic price = ₹ 20,00,000 X 196 [Note 4]	(20,000)
Value of supply	22,00,000
CGST @ 9% [Note 5]	1,98,000
SGST @ 9% [Note 5]	1,98,000

Notes:

1. As per Section 15(2)(c) of CGST Act, 2017: – Design and engineering charges, loading charges, commission or any amount (any amount charged for anything done by the supplier in respect of the supply of goods at the time of, or before delivery of goods) are includible in the value of supply.

2. Supply of machinery (goods) with supply of ancillary services like warranty and freight and insurance is a composite supply, the principle supply of which is the supply of machinery. [Section 2(30) of the CGST Act, 2017 read with section 2(90) of that Act], Thus, value of such ancillary supply is includible in the value of composite supply.

3. Subsidies provided by the Central Government and State Governments are not includible in the value of supply in terms of section 15(2)(e) of the CGST Act, 2017. However, subsidy directly linked to the price received from a non-Government body is includible in the value in terms of section 15.

4. Cash discount has been given to ABC Enterprises upfront at the time of supply and thus would have been recorded in the invoice and hence, the same is excluded from the value of supply in terms of section 15(3)(a) of the CGST Act, 2017.

5. In the given case-

the location of the supplier is in Bhopal (Madhya Pradesh); and
the place of supply of machinery is the location of the machinery at the time at which the movement of the same terminates for delivery to the recipient i.e., Indore (Madhya Pradesh) vide section 10(1)(a) of IGST Act, 2017.

Therefore, as per section 8(1) of IGST Act, 2017, the given supply is an intra-State supply as the location of the supplier and the place of supply are in the same State. Thus, the supply will be leviable to CGST and SGST.

Question 9.
Cool Trade Links Pvt. Ltd. is a registered manufacturer of premium ceiling fans. It sells its fans exclusively through distributors appointed across the country. The maximum retail price (MRP) printed on the package of a fan is ₹ 10,000. The company sells the ceiling fans to distributors at ₹ 7,000 per fan (exclusive of applicable taxes). The applicable rate of GST on ceiling fans is 18%.

The stock is dispatched to the distributors on quarterly basis – stock for a quarter being dispatched in the second week of the month preceding the relevant quarter. However, additional stock is dispatched at any point of the year if the company receives a requisition to that effect from any of its distributors. The company charges ₹ 1,000 per fan from distributors towards packing expenses.

The company appoints Gupta Sales as a distributor on 1st April and dispatches 750 fans on 8th April as stock for the quarter April-June. Gupta Sales places a purchase order of 1,000 fans with the company for the quarter July-September. The order is dispatched by the company on 10th June and the same is received by the distributor on 18th June. The distributor makes the payment for the fans on 26th June and avails applicable input tax credit. The distributor reports sales of 700 fans for the quarter April-June and 850 fans for the quarter July-September.

Examine the scenario with reference to section 15 of the CGST Act, 2017 and compute the taxable value of fans supplied by Cool Trade Links Pvt. Ltd. to Gupta Sales for the quarter July-September.

Note: The supplier and the recipient of supply are not related and price is the sole consideration for the supply. Make suitable assumptions, wherever necessary. [MTP, Nov 2018, 8 Marks]
Answer:
As per Section 15(3)(a) of the CGST Act Pre-supply discounts recorded in invoices are allowed as deduction.
Further, post supply discounts are also allowed as deduction from the value of supply under section 15(3)(&) of the CGST Act if-

(i) such discount is established in terms of an agreement entered into at or before the time of such supply and specifically linked to relevant invoices; and
(ii) input tax credit is attributable to the discount on the basis of document issued by the supplier has been reversed by the recipient of the supply.

In given case post-supply discount will be allowed as a deduction from the value of supply since the discount policy was known before the time of such supply and the discount can be specifically linked to relevant invoices (invoices pertaining to fans supplied to Gupta Sales for the quarter July- September) provided Gupta Sales reverses the input tax credit attributable to the discount on the basis of document issued by Cool Trade Links Pvt. Ltd.

The value of supply will thus, be computed as under:

Particulars	Amount (₹)
Price at which the fans are supplied to Prakash Sales [Note 1]	7,000
Add: Packing expenses [Note 2]	1,000
Less: Discount [Note 3]	(700)
Value of taxable supply of one unit of fan	(7,300)
Value of taxable supply of fans for the quarter July-September [₹ 7,300 × 1,000] ”	73,00,000

Notes:

(1) The value of a supply is the transaction value, which is the price actually paid or payable for the said supply, in terms of section 15(1) of the CGST Act.

(2) The value of supply includes incidental expenses like packing charges in terms of section 15(2)(c) of the CGST Act.

(3) Since all the conditions specified in section 15(3)(&) of the CGST Act have been fulfilled, the post-supply discount will be allowed as deduction from the value of supply presuming that Gupta Sales has reversed the input tax credit attributable to such discount on the basis of document issued by Cool Trade Links Pvt. Ltd. The input tax credit to be reversed will work out to be ₹ 1.26 lakh [1,000 × (7,000 × 10%) × 18%].

Question 10.
Mr. Nagarjun, a registered supplied of Chennai, has received during the following Amount in respected of the activities undertaken by him during the month ended on 30th September, 2020:

Particulars	Amount
i. Amount charged for services provide to recognized sports body as selector of national team.	50,000
ii. Commission received as an insurance agent from insurance company.	65,000
iii. Amount charged as business correspondent for the service provide to the urban branched of nationalized bank with respect to saving bank accounts.	15,000
iv. Service to foreign diplomatic mission located in India	28,000
v. Funeral services.	30,000

He received the services from the unregistered goods transport agency for his business activities relating to serial numbers (i) to (iii) above the paid freight of ₹ 45,000 (his aggregated turnover of previous year was ₹ 9,90,000).
Note: All the transaction started above are intra-State transaction and also are exclusive of GST.
You are required to calculate gross value of taxable supply on which GST is to be paid by Mr. Nagarjun for the month of September, 2020. Working note should form part of your answer. [May 2018, 7 Marks]
Answer:
Computation of Value of Supply

Particulars	Amount (₹)
I. Supplies on which Mr. Nagarjun is liable to pay GST under forward charge
Amount charged for service provided to recognized sports body as selector of national team [Note 1]	50,000
Commission received as an insurance agent from insurance company [Note 2]	Nil
Amount charged as business correspondent for the services provided to the urban branch of a nationalised bank with respect to savings bank accounts [Note 3]	15,000
Services provided to foreign diplomatic mission located in India [Note 4]	28,000
Funeral services [Note 5]	Nil
II. Supplies on which Mr. Nagarjun is liable to pay GST under reverse charge
Services received from GTA [Note 6]	45,000
Value of taxable supply on which GST is to be paid	1,38,000

Working Notes:

1. As per Entry 68 of Exemption Notification No. 12/2017-CT(R):- Exemption has been granted to services provided to may recognized sport body by an individual as player, referee, umpire, coach or team manager for participation in a sporting event organized by a recognized sports body. Hence, services provided as a selector are not exempt.

2. Note 2 : As per Notification No. 13/2017 For the tax payable on the commission of insurance agent is to be paid by the recipient of service under reverse charge ie. insurance company.

3. Note 3 : As per Entry No. 39 of Exemption Notification No. 12/2017 Services provided by Business Correspondent to a Banking Company in Rural area are exempt. Thus, such services provided in respect of urban area branch will be taxable.

4. Note 4 : As per Entry No. 59 of Exemption Notification No. 12/2017 Services provided by foreign diplomatic mission located in India are exempt. Thus Service provided to such mission are taxable.

5. Note 5: As per Entry No. 4 of Schedule III of CGST Act, 2017:- Funeral Services are not a supply and thus, are outside the ambit of GST.

6. Note 6: As per Notification No. 13/2017:- GST on services provided by GTA (not paying tax @ 12%) to inter alia a registered person is payable by the recipient of service i.e., the registered person, under reverse charge. The turnover of previous year is irrelevant.

Examiner’s Comment
The working notes for inclusion/exclusion of various activities for computation of gross value of taxable supply was missing in most of the cases. Largely, examinees answered merely on the basis of guess work instead of legal backing.

Question 11.
Determine taxable value of supply under the GST law with respect to each of the following independent services provided by the registered persons:
1. Fees charged from office staff for in-house personality development course conducted by M.V. College – ₹ 10,000.
2. Bus fees collected from students by M.V. College – ₹ 2,500 per month.
3. Housekeeping service provided by M/s. Clean well to Himavarsha Montessori school, a play school – ₹ 25,000 per month.
4. Info link supplied “Tracing Alphabets”, an online educational journal, to students of UKG class of Sydney Montessori School – ₹ 2,000. [May 2019, 4 Marks]
Answer:
1. As per Entry 66(a) of Notification No. 12/2017:

Services provided by an educational institution to its students, faculty and staff are exempt from GST.
Assuming that M.V. College provides education as a part of a curriculum for obtaining a qualification recognised by a law.

2. As per Entry 66(a) of Notification No. 12/2017 :

As assumed above that M.V. College provides education as a part of a curriculum for obtaining a qualification recognised by a law, the transport services provided by it to its students would be exempt from GST.

3. As per Entry 66(b) of Notification No. 12/2017:

Services provided to an educational institution, by way of, inter alia, house-keeping services performed in such educational institution are exempt from GST.
However such an exemption is available only when the said services are provided to a pre-school education and a higher secondary school or equivalent.
Therefore, house-keeping services provided to Himavarsha Montessori Play School would be exempt from GST.

4. As per Entry 66(b) of Notification No. 12/2017:
Services provided to an educational institution, [except
(1) Pre-school education and education upto higher secondary school or equivalent.
(2) Education is a part of an approved vocational education course;]

By way of supply of online educational journals or periodicals is exempt from GST.
Therefore, supply of online journal to students to UKG class of Sydney Montessori School will not be exempt from GST. Hence, the taxable value in this case will be ₹ 2,000.

Question 12.
Laxmi Ltd. of Bhopal (Madhya Pradesh) is a supplier of machinery. Laxmi Ltd. Has supplied machinery to PQR Enterprises in Indore(Madhya Pradesh) on 1st October, 2020. The invoice for supply has been issued on 1st October, 2020.Thus the time of supply of machinery is 1st October, 2020. Laxmi Ltd. And PQR Enterprises are not related. Following information is provided.

Basic price of machineries excluding all taxes but including design and engineering charges ₹ 10,000 and loading charges ₹ 20,000 – ₹ 20,00,000.

Laxmi Ltd. provide 2 years free warranty of machineries. Laxmi Ltd. also provide an extended one year warranty on payment of additional charged of ₹ 1,00,000. PQR enterprises opted for one year warranty.

Laxmi Ltd. has collected consultancy charges in relation to pre-installation planning of ₹ 10,000 and Freight and insurance charges from place of removal to buyer’s premises of ₹ 20,000.

Laxmi Ltd. received subsidy of ₹ 50,000 from Central Government for supplying the machinery to backward region since receiver was located in a backward region. Laxmi Ltd. also received ₹ 50,000 from the joint venture partner PQR enterprises for making timely supply of machinery of the reception.

A cash discount of 1% on the basic price of the machinery is offered at the time of supply. If PQR enterprises agree to make the payment within 30 days of the receipt of the machinery at his premises. Discount @ 1% was given to PQR enterprises as it agree to make the payment within 30 days. The machineries attract COST and SGST @ 18% (9%+9%) and IGST @18%.
Compute the CGST & SGST or IGST Payable as the case may be on the machinery. [May 2018, 10 Marks]
Answer:
Computation of Value of Supply

Particulars	Amount ₹₹
Price of the machinery (Transaction value u/s 15 i.e. price actually paid or payable.)	20,00,000
Add: Extended warranty cost [WN 1]	1,00,000
Consultancy charges in relation to pre-installation planning [WN 2]	10,000
Freight and insurance charges [WN 3]	20,000
Subsidy received from Central Government [WN 4]	Nil
Receipts from Joint Venture of PQR Enterprises [WN 5]	50,000
Less: 1% discount on basic price = ₹ 20,00,000 × 1%	(20,000)
Value of supply	21,60,000
CGST @ 9%	1,94,400
SGST @ 9%	1,94,400

Working Notes:

Includible in value since transaction value includes all elements of the price except those specially excluded u/s 15 of CGST Act, 2017
Includible in value of supply of machinery as per Section 15(2)(c) and Section 15(2)(d)
Includible in value of goods, because it is something done before delivery of goods
Not includible in value of supply as per Section 15(2)(e)
Includible in value of supply of machinery as per Section 15(2)(e)

Examiner’s Comment
Majority of the examinees computed the GST liability correctly but did not support their answer with adequate reasoning and thus lost marks.

Question 13.
Mrs. Kajal, a registered supplier of Jaipur (Rajasthan), has made the following supplies in the
month of January, 2020:
(i) Supply of a laptop bag along with the laptop to a customer of Mumbai for ₹ 55,000 (exclusive of GST).

(ii) Supply of 10,000 kits (at ₹ 50 each) amounting to ₹ 5,00,000 (exclusive of GST) to Ram Fancy Store in Kota (Rajasthan). Each kit consists of 1 hair oil, 1 beauty soap and 1 hair comb.

(iii) 100 kits are given as free gift to Jaipur customers on the occasion of Mrs. Kajal’s birthday. Each kit consists of 1 hair oil and 1 beauty soap. Cost of each kit is ₹ 35, but the open market value of such kit of goods and of like kind and quality is not available. Input tax credit has not been taken on the goods contained in the kit.

(iv) Event management services provided free of cost for brother’s son marriage function in Indore (Madhya Pradesh). Cost of providing said services is ₹ 80,000, but the open market value of such services and of services of like kind and quality is not available.

(v) 1,400 chairs and 100 coolers hired out to Function Garden, Ajmer (Rajasthan) for ₹ 3,30,000 (exclusive of GST) including cost of transporting the chairs and coolers [₹ 20 (exclusive of GST) for each chair and each cooler] from Mrs. Kajal’s godown at Jaipur to the Function Garden, Ajmer. The cost of transportation of chairs and coolers is paid by Mrs. Kajal to an unregistered Goods Transport Agency (GTA).

Interest of ₹ 6,400 (inclusive of GST) was collected by Mrs. Kajal from Ram Fancy Store, Kota for the payment received with a delay of 30 days.
Assume rates of GST to be as under:-

Particulars	Rate of CGST (%)	Rate of SGST (%)	Rate of IGST (%)
1. Laptop	9	9	18
2. Laptop bag	14	14	28
3. Hair oil	9	9	18
4. Beauty soap	14	14	28
5. Hair comb	6	6	12
6. Event management service	2.5	2.5	5
7. Service of renting of chairs and coolers	6	6	12
Transportation service	2.5	2.5	5

From the above information, compute the GST liability (CGST and SGST and/or IGST, as the case may be) of Mrs, Kajal for the month of January, 2020. [May 2019, Old, 9 Marks]
Answer:
Computation of GST liability of Mrs. Kajal for the month of January, 2019

Particulars	Amount (₹)	CGST (₹)	SGST (₹)	IGST (₹)
(i) Supply of laptop bag along with laptop to Mumbai customer [WN 1]	55,000			9,900
(ii) Supply of kits to Ram Fancy Store [WN 2]	5,05,000	70,700	70,700
(iii) Free gifts to customers [WN 3]		Nil	Nil	Nil
(iv) Event management services provided free of cost for brother’s son marriage [WN 4]		Nil	Nil	Nil
(v) Chairs and coolers hired out to Function Garden [WN 5]	3,30,000	19,800	19,800
(vi) Transportation of chairs and coolers by GTA [WN 6]	30,000 (₹ 20 × 1,500)	750	750
Total GST liability		91,250	91,250	9,900

Working Notes:

1. Being naturally bundled, supply of laptop bag along with the laptop is a composite supply which is treated as the supply of the principal supply [viz. laptop] in terms of section 8(a) of the CGST Act, 2017 and is an inter-State supply. Accordingly, IGST @ 18% will be charged.

2. It is a mixed supply and is treated as supply of that particular supply which attracts highest tax rate [viz. beauty soap] in terms of section 8(b) of the CGST Act, 2017. Also, it’s an intra-State supply. Accordingly, CGST and SGST @ 14% each will be charged.

Interest of ₹ 6,400 [It has been assumed that interest on delayed payment received has been collected in the month of January, 2020 itself and is inclusive of GST.] charged for delayed payment as collected from Ram Fancy Store will be included in the value of supply in terms of section 15(2) of the CGST Act, 2017.
Therefore, total value of supply = ₹ 5,05,000 [₹ 5,00,000 + (₹ 6,400 × 100/128)]

3. It cannot be considered as supply under section 7 read with Schedule I of the CGST Act as the gifts are given to unrelated customers without consideration

4. It Cannot be considered as supply under section 7 read with Schedule I of the CGST Act as the service is provided to unrelated person without consideration.

5. Since Mrs. Kajal is not a GTA, transportation services provided by her are exempt [Notification No. 12/2017-CT (R) dated 28.06.2017.

However, since chairs and coolers are hired out along with their transportation, it is a case of composite supply wherein the principal supply is hiring out of chairs and coolers.
Also, it’s an intra-State supply. Accordingly, transportation service will also be taxed at the rate applicable for renting of chairs and coolers, viz. CGST and SGST @ 6% each.

6. GST on GTA services availed is payable under reverse charge mechanism since GST is payable @ 5% [It has been most logically assumed that Mrs. Kajal has not charged, from Function Garden, any mark-up on the cost of transportation paid by her to the unregistered GTA], Being an intra-State supply, CGST and SGST will be chargeable @ 2.5% each [It has been assumed that the unregistered GTA from whom the GTA services have been availed is located in the State of Rajasthan].

7. The above answer is based on the assumption that either the event management services are provided to brother for his son’s marriage and brother is not wholly dependent on Mrs. Kajal or such services are provided directly to brother’s son for his marriage. However, it is also possible to assume that the services are provided to brother for. his son’s marriage and brother is wholly dependent on Mrs. Kajal.

Question 14.
XYZ Ltd., New Delhi, manufactures biscuits under the brand name ‘Tastypicks’. Biscuits are supplied to wholesalers and distributors located across India on FOR basis from the warehouse of the company located at New Delhi. The company uses multiple modes of transport for supplying the biscuits to its customers spread across the country. The transportation cost is shown as a line item in the invoice and is billed to the customers with a mark-up of 2% on total amount of freight paid (inclusive of taxes).

Flour used for the production process is procured from vendors located in Madhya Pradesh on ex-factory basis. The company engages goods transport Agencies (GTA) to transport the flour from the factories of the vendors to its factory located in New Delhi.
The company has provided the following data relating to transportation of biscuits and flour in the month of April 20XX:

For sales within the NCR region (₹ 20,00,000), the company arranged a local mini-van belonging to an individual and paid him ₹ 54,000.
For sales to locations in distant States (₹ 1,78,00,000), the company booked the goods by Indian Railways and paid rail freight of ₹ 3,17,000.
For sales to locations in neighbouring States (₹ 55,00,000), the company booked the goods by road carriers (GTAs) and paid road freight of ₹ 3,73,000. Out of the total sales to neighbouring States, goods worth ₹ 10,00,000 were booked through a GTA which paid tax @ 12%. Freight of ₹ 73,000 was paid to such GTA.
For purchase of flour from Madhya Pradesh (₹ 25,00,000), the company booked the goods by a GTA and paid road freight of ₹ 55,000.
For purchase of butter from Punjab (₹ 15,00,000), the company booked the goods by a GTA and paid road freight of ₹ 35,000.
For local purchase of baking powder, the company booked the goods by a GTA in a single carriage and paid road freight of ₹ 1,500.
For transferring the biscuits (open market value – ₹ 4,00,000) to one of its sister concern in Rajasthan, the company booked the goods by a GTA and paid road freight of ₹ 40,000.

(i) Based on the particulars given above, compute the GST payable on the amount paid for transportation by XYZ Ltd. when it avails the services of different transporters.
(ii) Compute the GST charged on transportation cost billed by the company to its customers.
Note: – Assume the rate of GST on transportation of goods and biscuits to be 5% and 12% respectively [except where any other rate is specified in the question], [RTP, Nov. 2018]
Answer:
(i) Computation of GST payable on amount paid for transportation by XYZ Ltd. when it avails the services of different transporters

Particulars	Freight [₹]	GST payable [₹]
Transportation of biscuits in a local mini van belonging to an individual [WN 1]	54,000	Nil
Transportation of biscuits by Indian Railways	3,17,000	15,850
Transportation of biscuits by GTA [WN 2]	3,00,000	15,000
Transportation of biscuits by GTA @12% [WN 3]	73,000	8,760
Transportation of flour by GTA [WN 4]	55,000	Nil
Transportation of butter by GTA [WN 5]	35,000	1,750
Transportation of baking powder by GTA [WN 6]	1,500	Nil
Transportation of biscuits by GTA to sister concern [WN 7]	40,000	2,000
Total tax payable by XYZ Ltd. on availing services of different transporters		43,360

Working Notes:

Transportation of goods by road otherwise than by a GTA is exempt from GST – Notification No. 12/2017
GST is payable by XYZ Ltd. under reverse charge in terms of section 5(3) of the IGST Act, 2017.
When the GTA pays tax @ 12%, tax is payable by the GTA under forward charge and not by the recipient under reverse charge – Notification No. 10/2017.
Services provided by GTA by way of transport (in a goods carriage) of, inter alia, flour are exempt from GST vide Notification No. 9/2017.
Though services provided by GTA by way of transport (in a goods carriage) of, inter alia, milk is exempt from GST vide Notification No. 9/2017, road transport of butter will not be exempted as butter is milk product and not milk. GST is payable by XYZ Ltd. under reverse charge.
Services provided by a GTA by way of transport in a goods carriage of goods, where consideration charged for the transportation of goods on a consignment transported in a single carriage does not exceed ₹ 1,500, are exempt from GST vide Notification No. 9/2017.
GST is payable by XYZ Ltd. under reverse charge in terms of section 5(3) of the IGST Act, 2017.

(ii) Computation of GST charged on transportation cost billed by XYZ Ltd. to its customers
The supply of biscuits and transportation service is a composite supply, chargeable to tax at the rate applicable to the principal supply (biscuits) i.e. 12% [Section 8(a) of the CGST Act, 2017.

Particulars	Freight paid [₹][A]	GST paid on freight [₹][B]	Freight billed (with markup @ 2% on [A]+[B]) [₹]	GST charged @ 12% [₹]
Transportation of biscuits in a local mini van belonging to an individual	54,000		55,080	6,610
Transportation of biscuits by Indian Railways	3,17,000	15,850	3,39,507	40,741
Transportation of biscuits by GTA	3,00,000	15,000	3,21,300	38,556
Transportation of biscuits by GTA @ 12%	73,000	8,760	83,395	10,007
Total tax charged by XYZ Ltd. on transportation cost billed to the customers*				95,914

*Note: It has been assumed that there is no mark-up on transportation cost billed to sister concern (non-customer).

Question 15.
ABC Ltd., registered in Noida (Uttar Pradesh) is a supplier of machinery used for making bottle caps. The supply of machinery is effected as under:

The wholesale price of the machinery (excluding all taxes and other expenses) at which it is supplied in the ordinary course of the business to various customers is ₹ 42,00,000. However, the actual price at which the machinery is supplied to an individual customer varies within a range of ± 10% depending upon the terms of contract of supply with the particular customer.

Apart from the price of the machinery, ABC Ltd. charges from the customer the following incidental expenses:

Associated handling and loading charges of ₹ 10,000
Installation and commissioning charges of ₹ 1,00,000. The machinery can be dismantled and erected at another site, if required. The above charges are compulsorily levied in every case of supply of machinery.

Transportation of machinery to the customer’s premises is arranged by ABC Ltd. through a third-party service provider [Goods Transport Agency (GTA)]. The customer enters into a separate service contract with the GTA and pays the freight directly to it.

The company provides one-year free warranty for the machinery. Further, the company also provides an extended two-year warranty on payment of additional charge of ₹ 3,00,000, to all its customers.

A cash discount of 2% on the price of the machinery is offered at the time of supply, if the customer agrees to make the payment within 15 days of the receipt of the machinery at his premises. In the event of failure to make the payment within the stipulated time, the company-

Recovers the discount given; and
Charges interest @1% per month or part of the month on the total amount due from the customer (towards the machinery supplied) from the date of making the supply till the date of payment. However, no interest is charged on the tax dues.

For every machinery supplied, ABC Ltd. receives a grant of ₹ 2,00,000 from its holding company DEF Ltd:
ABC Ltd. has supplied a machinery to D Pvt. Ltd. on August 1,20XX at a price of ₹ 40,00,000 (excluding all taxes). D Pvt. Ltd. has its corporate office in New Delhi. However, the machinery has been installed at its manufacturing unit located in Gurugram (Haryana). D Pvt. Ltd. has paid the freight directly to the GTA and the charges for two-year extended warranty. Discount @ 2% was given to D Pvt. Ltd. as it agreed to make the payment within 15 days. However, D Pvt. Ltd. paid the consideration on 31st October, 20XX.
Assume the rates of taxes to be as under:
Bottle cap making machine

CGST – 6%

SGST- 6%

IGST – 12%

Service of transportation of goods

CGST – 2.5%

SGST – 2.5%

IGST – 5%

Other services involved in the above supply

CGST- 9%

SGST- 9%

IGST – 18%

Calculate the GST payable [CGST & SGST or IGST, as the case may be] on the machinery and support your conclusions with legal provisions in the form of explanatory notes.
Make suitable assumptions, wherever needed.
Answer:
Computation of GST Liability of ABC Ltd.

Particulars	(₹)
Price of machine [Note 1]	40,00,000
Handling and loading charges [Note 2]	10,000
Installation and commissioning charges [Note 3]	1,00,000
Transportation cost [Note 4]	Nil
Additional warranty cost [Note 5]	3,00,000
Grant from DEF Ltd. [Note 6]	2,00,000
Total price of the machine	46,10,000
Less: 2% cash discount on price of machinery = ₹ 40,00,000 × 2% [Note 7]	(80,000)
Taxable value of supply	45,30,000
Tax liability for the month of August 20XX [Note 11]
IGST @ 1296 [Note 8 and Note 9]	5,43,600
Tax liability for the month of October 20XX [Note 11]
Interest collected @ 3% on ₹ 44,10,000 [Note 10]	1,32,300
Cash discount recovered [Note 10]	80,000
Cum-tax value of interest and cash discount	2,12,300
IGST=(₹ 2,12,300/112) × 1296	22,746
Total IGST payable on the machinery	5,66,346

Working Notes:

1. As per section 15(1) of the CGST Act, 2017, the value of a supply is the transaction value i.e., the price actually paid or payable for the said supply when the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply. It is assumed that ABC Ltd. and D Pvt. Ltd. are not related and the price is the sole consideration for the supply.

2. All incidental expenses charged by the supplier to the recipient of a supply are includible in the value of supply in terms of section 15(2)(c) of CGST Act, 2017.

3. Any amount charged for anything done by the supplier in respect of the supply of goods at the time of, or before delivery of goods is includible in the value of supply in terms of section 15(2)(c) of CGST Act, 2017.

4. Transportation cost has not been included in the value of supply of the machinery as it is a separate service contract between the customer and the third-party service provider. The customer pays the freight directly to the service provider.

The supplier (ABC Ltd.), in this case, merely arranges for the transport and does not provide the transport service on its own account. Tax will be separately levied on the supply of service of transportation of goods under reverse charge which will be paid by the customer.

5. Warranty cost is includible in the value of the supply since transaction value includes all elements of the price excluding those that can be specifically excluded as per section 15 of the CGST Act.

6. Subsidies directly linked to the price excluding subsidies provided by the Central Government and State Governments are includible in the value of supply in terms of section 15(2)(e) of the CGST Act, 2017.

7. Cash discount was deducted by ABC Ltd. upfront at the time of supply on August 1,20XX and hence, the same is excluded from the value of supply as it did not form part of the transaction value.

8. In the given case-

The location of the supplier is in Noida (UP); and
The place of supply of machinery is the place of installation of the machinery i.e., Gurugram (Haryana) in terms of section 10(1)(d) of the IGST Act, 2017.

Therefore, the given supply is an inter-State supply as the location of the supplier and the place of supply are in two different States [Section 7(1 )(a) of IGST Act, 2017], Thus, the supply will be leviable to IGST in terms of section 5(1) of the IGST Act, 2017.

9. The given supply is a composite supply involving supply of goods (machinery) and services (handling and loading and installation and commissioning) where the principal supply is the supply of goods.
As per section 8(a) of the CGST Act, 2017, a composite supply is treated as a supply of the principal supply involved therein and charged to tax accordingly. Thus, tax rate applicable to the goods (machinery) has been considered.

10. Interest for the delayed payment of any consideration for any supply is includible in the value of supply in terms of section 15(2)(d) of the CGST Act, 2017. Further, cash discount recovered will also be includible in the value of supply as now the transaction value i.e., the price actually paid for the machinery is devoid of any discount.

The cash discount not allowed and interest have been considered as cum tax value on the logical assumption that tax component could not be recovered from the client. Thus, tax payable thereon has to be computed by making back calculations in terms of rule 35 of CGST Rules, 2017.

11. It has been assumed that the invoice for the supply has been issued on August 1, 20XX, the date on which the supply is made. Thus, the time of supply of goods is August 1,20XX in terms of section 12(l)(a) of the CGST Act, 2017.

As per section 12(6) of the CGST Act, 2017, the time of supply in case of addition in value by way of interest, late fee, penalty etc. for delayed payment of consideration for goods is the date on which the supplier receives such addition in value. Thus, the time of supply of interest received and cash discount recovered on account of delayed payment of consideration is 31st October, 20XX, the date when the full payment was made. The supplier may issue a debit note for such interest and cash discount recovered.

Question 16.
Dev Enterprises is the supplier of water coolers. Dev Enterprises supplied water coolers to Vimal Traders for consideration of ₹ 2,95,000 (inclusive of GST @ 18%). Vimal Traders also gave some materials to Dev Enterprises as consideration for such supply whose value was ₹ 10,000 (exclusive of GST).
Dev Enterprises has supplied the same goods to another person at price of ₹ 2,97,360 (inclusive of GST @ 18%).
You are required to:
(1) Determine the value of goods supplied by Dev Enterprises to Vimal Traders as per the provisions of the CGST Act, 2017.
(2) What would your answer be if price of ₹ 2,97,360 is not available at the time of supply of goods to Vimal Traders? Explain briefly. [May 2019, Old, 4 Marks]
Answer:
(1) As per Rule 27 of the CGST Rules, 2017 (Valuation Rules):

Where the consideration for a supply is not wholly in money, the value will be the open market value.

Open market value of a supply means the full value in money, excluding the applicable GST, where the supplier and the recipient of the supply are not related and the price is the sole consideration, to obtain such supply at the same time when the supply being valued is made.

In the given case, price is not the sole consideration for the supply. Apart from monetary consideration, the buyer has given some material to the supplier as consideration for such supply.

Here, the value will be determined with the help of rule 27 of the CGST Rules, 2017 (Valuation Rules)
Therefore, in the given case, the open market value of the goods supplied is ₹ 2,52,000 (₹ 2,97,360 × 100/118) and is therefore, the value of such goods.

(2) Rule 27 further provides that if open market value of the supply is not known, the value of the supply will be the consideration in money plus the money equivalent to the non-monetary consideration, if such amount is known at the time of supply.
Therefore, the value in the given case will be (₹ 2,95,000 × 100/118) + ₹ 10,000, which is ₹ 2,60,000.

Question 17.
Kamal & C». Manufacture customized products at its units situated in Rajasthan. Cost of production for Kamal & Co. For 1000 product is ₹ 20,00,000. These product required further processing before sale & for these purpose products are transferred from its Rajasthan unit to its another unit in Punjab. The Punjab unit, apart from processing its own products engages in processing of similar product of other person who supply the product of same kind and quality thereafter sells these processed products to wholesalers.

There are no other factories in the neighbouring area which are engaged in same business as that of its Punjab units product of the same kind and quality are supply in lots of 1000 each time by another manufacturer located in Punjab. The price of such goods is ₹ 19,00,000. Determine the value of 1000 product supplied by Kamal & Co. to its Punjab units as per the provision of CGST Act, 2017. [May 2018, 5 Marks]
Answer:
Statutory Provision

As per section 25(4) of the CGST Act, 2017:
A person who has obtained or is required to obtain more than one registration
whether in one State or Union territory or more than one State or Union territory
shall, in respect of each such registration, he treated as distinct persons for the purposes of this Act.

(a) As per rule 28 of CGSTRu1es, 2017:

the value of the supply of goods between distinct persons
other than where the supply is made through an agent
shall –

(a) be the open market value of such supply;
(b) if open market value is not available, be the value of supply of goods of like kind and quality;
(c) if value cannot be determined under the above methods, be cost of the supply plus 10% mark-up or be determined by other reasonable means, in that sequence.

In the given case study

As per section 25(4), units of Kamal & Co. in Rajasthan and Punjab are distinct persons.
Rule 28 is applicable.

Step 1 To ascertain Open Market Value:

The open market value of the 1000 products being supplied to Punjab unit is not available since the supplier
manufactures customized products.

Step 2 To ascertain like kind & quality:
The value of 1000 products supplied by Rajasthan unit of Kamal & Co. to Punjab unit will be the value of the goods of like kind and quality supplied to Punjab unit by other customers which is 19,00,000.

90% criterion:
Since goods are not supplied as such by the Punjab unit, goods cannot be valued @ 90% of the price charged for the supply of like goods b the Punjab unit to its unrelated customers in terms of first proviso to rule 28 of CGST Rules, 2017.

ITC:
If Punjab unit is entitled for full ITC, the value declared in the invoice of Rajasthan unit will be deemed to be the open market value of the goods vide second proviso to rule 28 of CGST Rules, 2017.

Question 18.
Jaskaran, registered supplier of Delhi, has made the following supplies in the month of January, 2OXX:

Particulars	Amount
(i) Supply of 20,000 packages at ₹ 30 each to Sukhija Gift Shop in Punjab [Each package consists of 2 chocolates, 2 fruit juice bottles and a packet of toy balloons]	6,00,000
(ii) 10 generators hired out to Morarji Banquet Halls, Chandigarh [including cost of transporting the generators (₹ 1,000 for each generator) from Jaskaran’s warehouse to the Morarji Banquet Halls]	2,50,000
(iii) 500 packages each consisting of 1 chocolate and I fruit juice bottle given as free gift to Delhi customers on the occasion of Diwali [Cost of each package is 12, but the open market value of such package of goods and of goods of like kind and quality is not available. Input tax credit has not been taken on the items contained in the package]
(iv) Catering services provided free of cost for elder son’s business inaugural function in Delhi [Cost of providing said services is ₹ 55,000, but the open market value of such services and of services of like kind and quality is not available.]

*excluding GST
You are required to determine the GST liability [CGST & SGST and/or IGST, as the case may be] of Jaskaran for the month of January, 2OXX with the help of the following additional information furnished by him for the said period:

1. Penalty of ₹ 10,000 was collected from Sukhija Gift Shop for the payment received with a delay of 10 days.
2. The transportation of the generators from Jaskaran’s warehouse to the customer’s premises is arranged by Jaskaran through a Goods Transport Agency (GTA) who pays tax @ 12%.
3. Assume the rates of GST to be as under:

Goods/services supplied	CGST	SGST	IGST
Chocolates	9%	9%	18%
Fruit juice bottles	6%	6%	12%
Toy balloons	2.5%	2.5%	5%
Service of renting of generators	9%	9%	18%
Catering service	9%	9%	18%

Answer:
Computation of GST liability of Jaskaran for the month of January, 20XX

Particulars	CGST (₹)	SGST (₹)	IGST (₹)
Supply of 20,000 packages to Sukhija Gift Shop, Punjab [Note- 1][6,08,475 × 18%]			1,09,526
Renting of 10 generators to Morarji Banquet Halls, Chandigarh [Note-2][2,50,000 × 18%]			45,000
500 packages given as free gift to the customers [Note-3]	Nil	Nil	Nil
Catering services provided free of cost for elder son’s business inaugural function in Delhi [Note-3][60,500 × 9%]	5,445	5,445
Total GST liability (rounded off)	5,445	5,445	1,54,526

Notes:
1. Supply of a package containing chocolates, fruit juice bottles and a packet of toy balloons is a mixed supply as each of these items can be supplied separately and is not dependent on any other [Section 2(74) of the CGST Act, 2017]. Consequently, being an inter-State supply of goods, supply of packages to Sukhija Gift Shop of Punjab is subject to IGST @ 18% each.

Further, Penalty of ₹ 10,000 [considered as inclusive of GST] collected from Sukhija Gift Shop for the delayed payment will be included in the value of supply [Section 15(2)(d) of the CGST Act], The total value of supply is ₹ 6,08,475 [₹ 6,00,000 + (₹ 10,000 × 100/118)]

2. Jaskaran is not a GTA, transportation services provided by him are exempt from GST [Notification No. 9/2017]. However, since the generators are invariably hired out along with their transportation till customer’s premises, it is a case of composite supply under section 2(30) of the CGST Act, 2017 wherein the principal supply is the renting of generator.

Consequently, being an inter-State supply of service, service of hiring out the generators to Morarji Banquet Halls of Chandigarh is subject to IGST @ 18% each.

3. As per section 7(1)(c) of the CGST Act, 2017 Para 2 of Schedule I of CGST Act provides that supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business, are to be treated as supply even if made without consideration.

However, since the question does not provide that customers are related to Jaskaran, free gifts given to the customers cannot be considered as a supply under section 7. Consequently, no tax is leviable on the same.

Further, the catering services provided by Jaskaran to his elder son without consideration will be treated as supply as Jaskaran and his elder son, being members of same family, are related persons.

4. As per rule 28 of the CGST Rules, 2017.

The value of supply is the open market value of such supply; if open market value is not available, the values of supply of goods or services of like kind and quality.
However, if value cannot be determined under said methods, it must be worked out based on the cost of the supply plus 1096 mark-up.
Thus, in the given case, value of catering services provided to the elder son of Jaskaran is ₹ 60,500 [₹ 55,000 × 110%],
Further, being an intra-State supply of services, catering services are subject to CGST and SGST @ 2.596 each.

5. Jaskaran has received services from a GTA who has paid GST @ 1296, reverse charge provisions will not be applicable.

Question 19.
Power Engineering Pvt. Ltd., a registered supplier, is engaged in providing expert maintenance and repair services for large power plants that are in the nature of immovable property, situated all over India. The company has its Head Office at Bangalore, Karnataka and branch offices in other States. The work is done in the following manner.

The company has self-contained mobile workshops, which are container trucks fitted out for carrying out the repairs. The trucks are equipped with items like repair equipments, consumables, tools, parts etc. to handle a wide variety of repair work.

The truck is sent to the client location for carrying out the repair work. Depending upon the repairs to be done, the equipment, consumables, tools, parts etc. are used from the stock of such items carried in the truck.

In some cases, a stand-alone machine is also sent to the client’s premises in such truck for carrying out the repair work.

The customer is billed after the completion of the repair work depending upon the nature of the work and the actual quantity of consumables, parts etc. used in the repair work.

Sometimes the truck is sent to the company’s own location in other State(s) from where it is further sent to client locations for repairs.

Work out the GST liability [CGST & SGST or IGST, as the case may be] of Power Engineering Pvt. Ltd., Bangalore on the basis of the facts as described, read with the following data for the month of November 20XX.

Particulars	₹
A. Truck sent to own location in Tamil Nadu (i) Value of items contained in the truck – ₹ 3,00,000 (ii) Value of truck – ₹ 25,00,000
B. Truck sent to a client location in Tamil Nadu for carrying out repairs. Stand- alone machine is also sent in the truck to client location for repairs (i) Value of items contained in the truck – ₹ 2,85,000 (ii) Value of stand-alone machine – ₹ 4,00,000 (iii) Value of truck – ₹ 20,00,000 (Billing for repairs to be done afterwards depending upon the actual items used)
C. Truck sent to a client location in Karnataka for carrying out repairs (i) Value of items contained in the truck – ₹ 1,06,000 (ii) Value of truck – ₹ 20,00,000 (Billing for repairs to be done afterwards depending upon the actual items used)
D. Invoices raised for repair work carried out in Tamil Nadu [including the invoice for repair work done in ‘B’] –	70,00,000
E. Invoices raised for repair work carried out in Karnataka [including the invoice for repair work done in ‘C’]	12,00,000

Also, specify the document(s), if any, which need to be issued by Power Engineering Pvt. Ltd., Bangalore for the above transactions.
All the given amounts are exclusive of GST, wherever applicable. Assume the rates of taxes to be as under:
Items used for repairs

CGST – 6%

SGST – 6%

IGST – 12%

Container truck. Stand-alone machines

CGST – 2.5%

SGST – 2.5%

IGST – 5%

Works contract for repairs and maintenance of immovable property

CGST- 9%

SGST – 9%

IGST – 18%

You are required to make suitable assumptions, wherever necessary. [MTP, Nov. 2019,14 Marks!
Answer:
Computation of GST Liability of Power Engineering Pvt. Ltd., Bangalore for the month of November 20XX

Particulars	Amount
A. Items sent in container truck to own location in Tamil Nadu – IGST @ 12% [Note 1]	36,000
Container truck sent to own location in Tamil Nadu [Note 2]	–
B. Stand-alone machine sent in container truck to client location in Tamil Nadu, for carrying out repairs [Note 3]	–
Container truck sent to client location in Tamil Nadu [Note 3]	–
Items sent in container truck to client location in Tamil Nadu, for carrying out repairs [Note 4]	–
C. Container truck sent to client location in Karnataka [Note 3]	–
Items sent in container truck to client location in Karnataka, for carrying out repairs [Note 4]	–
D. Invoices raised for repair work carried out in Tamil Nadu: IGST @18% [Note 5 and Note 6]	12,60,000
E. Invoices raised for repair work carried out in Karnataka: CGST 9% + SGST 9% [Note 5 and Note 7]	2,16,000
Total GST liability	15,12,000

Notes:
(1) Movement of goods without any consideration to a ‘distinct person’ as specified in section 25(4) of the CGST Act, 2017 is deemed to be a supply in terms of Schedule I of the said Act. The purchase value is taken as taxable value, being the open market value in terms of rule 28(a) of the CGST Rules 2017. (However, if the regional office is eligible to take full input tax credit, any value may be declared in the tax invoice and that will be taken to be the open market value in terms of the second proviso to the same rule.)

In the given case –

the location of the supplier is in Bangalore (Karnataka); and

the place of supply of items contained in the truck is the location of such goods at the time at which the movement of goods terminates for delivery to the recipient ie., Tamil Nadu in terms of section 10(1)(a) of the IGST Act, 2017.

Therefore, the given supply of items is an inter-State supply as the location of the supplier and the place of supply are in two different States [Section 7(l)(a) of IGST Act, 2017], Thus, the supply is leviable to IGST in terms of section 5(1) of the IGST Act, 2017.
Since the activity is a supply, a tax invoice is to be issued by Power Engineering Pvt. Ltd. in terms of section 31(1)(a) of the CGST Act, 2017 for sending the items to its own location in Tamil Nadu.

(2) Schedule I to the CGST Act, 2017 specifies situations where activities are to be treated as supply even if made without consideration. Supply of goods and/or services between ‘distinct persons’ as specified in section 25 of the CGST Act, 2017, when made in the course or furtherance of business is one such activity included in Schedule I under para 2.

However, in view of the GST Council’s recommendation, it has been clarified that the interstate movement of various modes of conveyance between ‘distinct persons’ as specified in section 25(4), not involving further supply of such conveyance, including trucks carrying goods or passengers or both; or for repairs and maintenance, may be treated ‘neither as a supply of goods nor supply of service’ and therefore, will not be leviable to IGST. Applicable CGST/SGST/IGST, however, shall be leviable on repairs and maintenance done for such conveyance [Circular No. 1/1/2017 IGST dated 07.07.2017].

Since the activity is not a supply, tax invoice is not required to be issued by Power Engineering Pvt. Ltd. However, a delivery challan is to be issued by the company in terms of rule 55(1)(c) of CGST Rules, 2017 for sending the truck to its own location in Tamil Nadu.

(3) Supply of goods without consideration is deemed to be a supply inter alia when the goods are supplied to a ‘distinct person’. However, in this case, stand-alone machine and container truck are moved to client location and not between ‘distinct persons’. Hence, the same will fall outside the scope of definition of supply and will not be leviable to GST.

Here again, a delivery challan is to be issued in terms of rule 55(1)(c) of CGST Rules, 2017 for sending the stand-alone machines and container truck to client location.

(4) The items used in relation to the repair and maintenance work could be consumables or could be identifiable items/parts. In either case, the transfer of property in goods is incidental to a composite supply of works contract service. Thus, the value of the items actually used in the repairs will be included in the invoice raised for the service and will be charged to tax at that point of time.

Here again, a delivery challan is to be issued in terms of rule 55(1)(c) of CGST Rules, 2017 for sending the items for carrying out the repairs.

(5) The activity is a composite supply of works contract, which is treated as supply of service. As per section 8(a) of the CGST Act, 2017, a composite supply is treated as a supply of the principal supply involved therein and charged to tax accordingly.

Since the activity is a supply of service, a tax invoice is to be issued by Power Engineering Pvt. Ltd. in terms of section 31(2) of the CGST Act, 2017.

(6) In the given case –

the location of the supplier is in Bangalore (Karnataka); and

the place of supply of works contract services relating to the power plant (immovable property) is the location at which the immovable property is located i.e., Tamil Nadu in terms of section 12(3)(a) of the IGST Act, 2017.
Therefore, the given supply is an inter-State supply as the location of the supplier and the place of supply are in two different States [Section 7(1 )(a) of IGST Act, 2017]. Thus, the supply will be leviable to IGST in terms of section 5(1) of the IGST Act, 2017.

(7) In the given case, the location of the supplier and the place of supply of works contract services are within the same State. Therefore, the given supply is an intra-State supply in terms of section 8(1) of IGST Act, 2017 and thus, chargeable to CGST and SGST.

Question 20.
Honeycure Laboratories Ltd. is a registered supplier of bulk drugs in Delhi. It manufactures bulk drugs and supplies the same in the domestic and overseas market. The bulk drugs are supplied within Delhi and In the overseas market directly from the company’s warehouse located in South Delhi.

For supplies in other States of India, the company has appointed consignment agents in each such State. However, supplies in Gurgaon (Haryana) and Nolda (U.P.) are effected directly from South Delhi warehouse. The drugs are supplied to the consignment agents from the South Delhi warehouse.

Honeycure Laboratories Ltd. also provides drug development services to drug manufacturers located in India, including testing of their new drugs In its laboratory located In Delhi.
The company has furnished the following information for the month of January, 20XX:

Particulars	Amount
Advance received towards drug development services to be provided to Orochem Ltd., a drug manufacturer, located in Delhi [Drug development services have been provided in February, 20XX and invoice is issued on 28.02.20XX]	5,00,000
Advance received for bulk drugs to be supplied to Novick Pharmaceuticals, a wholesale dealer of drugs in Gurgaon, Harvana [Invoice for the goods is issued at the time of delivery of the drugs in March,20XX]	6,00,000
Supply of bulk drugs to wholesale dealers of drugs in Delhi	60,00,000
Bulk drugs supplied to Anchor Pharmaceuticals Inc., USA under bond [Consideration received in convertible foreign exchange]	90,00,000
Drug development services provided to Unipharma Ltd., a drug manufacturer, located in Delhi	6,00,000

You are required to determine the GST liability [CGST & SGST or IGST, as the case may be] of Honey cure Laboratories Ltd. for the month of January, 20XX with the help of the following additional information furnished by it for the said period:

1. Consignments of bulk drugs were sent to Cardinal Pharma Pvt. Ltd. and Rochester Medicos – agents of Honeycure Laboratories Ltd. in Punjab and Haryana respectively. Cardinal Pharma Pvt. Ltd. and Rochester Medicos supplied these drugs to the Medical Stores located in their respective States for ₹ 60,00,000 and ₹ 50,00,000 respectively.

3. Bulk drugs amounting to ₹ 50,00,000 were sent under delivery challan to Sudha Bottlers, Noida (U.P.) for filling the same in the glass bottles. The bottled drugs were sent back to Honeycure Laboratories Ltd. after 1 month. The consideration charged for the bottling activity (including bottles) is ₹ 5,00,000.

4. The turnover of Honeycure Laboratories Ltd. in the preceding financial year was ₹ 70 lakh with regard to supply of bulk drugs and ₹ 45 lakh with regard to supply of drug development services.

Note:
(i) All the given amounts are exclusive of GST, wherever applicable.
(ii) Assume the rates of GST to be as under:

Goods /services supplied	CGST	SGST	IGST
Hulk drugs	2.5%	2.5%	5%
Drug development services	9%	9%	18%

You are required to make suitable assumptions, wherever necessary. [MTP, May 18,12 Marks]
Answer:
Computation of GST Liability of Honeycure Laboratories Ltd. for the month of January, 20XX

Particulars	CGST (₹)	SGST (₹)	IGST (₹)
Advance received for drug development services supplied to Orochem Ltd., a drug manufacturer, located in Delhi [Note -1 ] [5,00,000 × 9%] for CGST & SGST both	45,000	45,000
Advance received for bulk drugs to be supplied to Novick Pharmaceuticals, a wholesale dealer of drugs in Gurgaon, Haryana [Note – 2]			Nil
Supply of bulk drugs to wholesale dealers of drugs in Delhi [Note – 3][60,00,000 × 2.5%] for CGST & SGST both	1,50,000	1,50,000
Bulk drugs supplied to Anchor Pharmaceuticals Inc., USA [Note – 4]			Nil
Supply of drug development services to Unipharma Ltd., a drug manufacturer, located in Delhi [Note – 5][6,00,000 × 9%] for CGST & SGST both	54,000	54,000
Supply of bulk drugs to consignment agents – Cardinal Pharma Pvt. Ltd. and Rochester Medicos of Punjab and Haryana [Note – 6 [99,00,000 × 5%]			4,95,000
Supply of bulk drugs to Ronn Medicos of Gurgaon, Haryana [Note – 7] [30,00,000 × 5%]			1,50,000
Supply of bulk drugs for job work to Sudha Bottlers in Noida, U.P. [Note – 8]			Nil
Total GST liability	2,49,000	2,49,000	6,45,000

Notes:
1. As per Section 13(2) of the CGST ActThe time of supply of services is the earlier of the date of invoice or date of receipt of payment, if the invoice is issued within 30 days of the supply of service. In the given case, invoice is issued within 30 days of the supply of service. Therefore, time of supply of services will be date of receipt of advance and hence, GST is payable on the advance received in January, 20XX.

2. As per Section 12(2) of the CGST ActThe time of supply of goods is the earlier of the date of issue of invoice/last date on which the invoice is required to be issued.
The time of supply of the advance received for bulk drugs to be supplied to Novick Pharmaceuticals is the time of issue of invoice, which is in March, 20XX. Thus, said advance will be taxed in March, 20XX and not in January, 20XX.

3. Being an intra-State supply of goods, supply of bulk drugs to wholesale dealers of drugs in Delhi is subject to CGST and SGST @ 2.5% each.

4. Section 2(5) of the IGST Act defines export of goods as taking goods out of India to a place outside India. In view of the said definition, supply of the bulk drugs to Anchor Pharmaceuticals Inc. of USA under bond is export of goods.
Export of goods is a zero-rated supply [Section 16(1) of the IGST Act], A zero-rated supply under bond is made without payment of integrated tax [Section 16(3)(a) of IGST Act],

5. Being an intra-State supply of services, supply of drug development services to Unipharma Ltd. of Delhi is subject to CGST and SGST @ 996 each.

6. As per Rule 29 of the CGST RulesThe value of supply of goods between the principal and his agent is the open market value of the goods being supplied, or at the option of the supplier, is 9096 of the price charged for the supply of goods of like kind and quality by the recipient to his unrelated customer, where the goods are intended for further supply by the said recipient.

In the given case, since open market value is not available, value of bulk drugs supplied to consignment agents – Cardinal Pharma Ltd. and Rochester Medicos – will be ₹ 99,00,000 [90% of (₹ 60,00,000 + ₹ 50,00,000)]. Further, being an inter-State supply of goods, supply of bulk drugs to the consignment agents is subject to IGST @ 5%.

7. If any person directly or indirectly controls another person, such persons are deemed as related persons. [Clause (a)(v) of explanation to section 15 of the CGST Act], In the given case, since Honeycure Laboratories Ltd. owns 6096 shares of Ronn Medicos, both are related persons.

As per Rule 28 of CGST Rules: – The value of supply of goods between related persons is the open market value of such goods and not the invoice value. Furthermore, since Ronn Medicos is not eligible for full input tax credit, value declared in the invoice cannot be deemed to be the open market value of the goods. Thus, open market value of the bulk drugs supplied to Ronn Medicos i.e., ₹ 30,00,000 is the value of supply of such goods.
Further, being an inter-State supply of goods, supply of bulk drugs to Ronn Medicos is subject to IGST @ 596.

8. Section 143(1) of the CGST Act permits a registered person (principal) to send any inputs without payment of tax to a job worker for job work under an intimation and subject to prescribed conditions, provided such inputs, after completion of job work or otherwise, have been received back within 1 year of their being sent out, in any of his place of business. Thus, tax is not payable on the bulk drugs sent under the delivery challan to Sudha Bottlers for job work.

Question 21.
Mr. X, a money changer, has exchanged US $ 10,000 to Indian rupees @ ₹ 64 per US $. Mr. X wants to value the supply in accordance with rule 32(2)(b) of CGST Rules.
Determine the value of supply made by Mr. X. [MTP Nov. 2019, 4 Marks]
Answer:
As per rule 32(2)(b) of CGST Rules The value in relation to the supply of foreign currency,
including money changing, is deemed to be-

1% of the gross amount of currency exchanged for an amount up to ₹ 1,00,000, subject to a minimum amount of ₹ 250;
₹ 1,000 and 0.5% of the gross amount of currency exchanged for an amount exceeding ₹ 1,00,000 and up to ₹ 10,00,000.

Therefore, the value of supply, made by Mr. X, under rule 32(2)(b) of CGST Rules is computed as under:
Value of currency exchanged in Indian rupees = US $ 10,000 × ₹ 64 = ₹ 6,40,000

(a) Up to ₹ 1,00,000 =	1,000
(b) For ₹ 5,40,000 [0.50% x ₹ 5,40,000]=	2,700
Value of supply=	₹ 3,700

Question 22.
Rolex Forex Private Limited, registered in Delhi, is a money changer. It has undertaken the following purchase and sale of foreign currency:
(i) 1,000 US $ are purchased from Rajesh Enterprises at the rate of ₹ 68 per US $. RBI reference rate for US $ on that day is ₹ 68.60.
(ii) 2,000 US $ are sold to Sriniti at the rate of ₹ 67.50 per US$. RBI reference rate for US $ for that day is not available.
Determine the value of supply in each of the above cases in terms of:
(A) Rule 32(2)(a) of the CGST Rules, 2017
(B) Rule 32(2)(b) of the CGST Rules, 2017. [RTPNov. 18/19]
Answer:
As per Rule 32(2)(a) of CGST Rules, 2017:- If foreign Currency Converted into Indian Rupee or vice versa, the value shall be

1. IF RBI RATE AVAILABLE : – The value of supply is difference between buying rate or selling rate of currency and RBI reference rate for that currency at the time of exchange multiplied by total units of foreign currency.
= (RBI reference for US $ – Buying rate of US $) × Total number of units of US $ bought
= (₹ 68.6 – ₹ 68) × 1,000 = ₹ 600

2. IF RBI RATE NOT AVAILABLE : – Value = 1% of the gross amount of Indian Rupees provided or received by the person changing the money.
= 1% of the gross amount of Indian Rupees received
= 1% of (₹ 67.50 × 2,000)
= ₹ 1,350

(B) Determination of value under rule 32(2)(b) of the CGST Rules, 2017
Rule 32(2)(b) provides that value in relation to the supply of foreign currency, including money changing shall be deemed to be –

Currency exchanged	Value of supply
1. Upto ₹ 1,00,000	1% of the gross amount of currency exchanged OR ₹ 250 whichever is higher
Exceeding ₹ 1,00,000 and upto ₹ 10,00,000	₹ 1,000 + 0.50% of the (gross amount of currency exchanged – ₹ 1,00,000)
Exceeding ₹ 10,00,000	₹ 5,500 + 0.1% of the (gross amount of currency exchanged – ₹ 10,00,000) OR ₹ 60,000 whichever is lower

Thus, the value of supply in the given cases would be computed as under:

(i) Gross amount of currency exchanged = ₹ 68 × 1,000 = ₹ 68,000. Since the gross amount of currency exchanged is less than ₹ 1,00,000, value of supply is 1% of the gross amount of currency exchanged [1% of ₹ 68,000] or ₹ 250, whichever is higher.
= ₹ 680

(ii) Gross amount of currency exchanged = ₹ 67.50 × 2,000 = ₹ 1,35,000. Since the gross amount of currency exchanged exceeds ₹ 1,00,000, but less than ₹ 10,00,000, value of supply is ₹ 1,000 + 0.5096 of (₹ 1,35,000 – ₹ 1,00,000).
= ₹ 1,175

Question 23.
Zindagi Life Insurance Company Limited (ZLICL) has collected premium from subscribers and it intimates the amount allocated for investment to subscribers at the time of collection of premium. During the month of September 2018, it has collected the following receipts:

Particulars	Amount
1. Premium for only risk cover	25,00,000
2. Premium from new subscribers	40,00,000
3. Renewal Premium	80,00,000
4. Single premium on an annuity policy	1,00,00,000

All amounts are exclusive of tax. You are required to compute the value of supply by ZLICL in accordance with GST laws. [May 2019]
Answer:
As per Rule 32(4) of CGST Rules, 2017, the value of the service provided by ZLICL will be computed as under:
Computation of value of supply for ZLICL for the month of September 2018

Particulars	Amount (₹)
Premium for only risk cover [Note 1]	25,00,000
Premium from new subscribers	10,00,000
25% of ₹ 40,00,000 [Note 2]
Renewal Premium	10,00,000
12.5% of ₹ 80,00,000 [Note 2]
Single premium on annuity policy	10,00,000
10% of ₹ 1,00,00,000 [Note 3]
Total value of supply	55,00,000

Note 1: In case the entire premium paid by the policy holder is only towards the risk cover in life insurance, the premium so paid;
Note 2: In all other cases, 25% of the premium charged from the policy holder in the first year and 12.5% of the premium charged from the policy holder in subsequent years;
Note 3: In case of single premium annuity policies, 10% of single premium charged from the 1 policyholder;

Question 24.
Rolly Polly Manufacturers Ltd., registered in Mumbai (Maharashtra), is a manufacturer of footwear. It imports a footwear making machine from USA. Rolly Polly Manufacturers Ltd. avails the services of Rudra Logistics, a licensed customs broker with its office at Ahmedabad (Gujarat), in meeting all the legal formalities for getting the said machine cleared from the customs station.

Rolly Polly Manufacturers Ltd. also authorises Rudra Logistics to incur, on its behalf, the expenses in relation to clearance of the imported machine from the customs station and bringing the same to its warehouse at Mumbai. These expenses would be reimbursed by Rolly Polly Manufacturers Ltd. to Rudra Logistics on actual basis. In addition, Roily Polly Manufacturers Ltd. will also pay the agency charges to Rudra Logistics for the services rendered by it.

Rudra Logistics raised an invoice in July, 20XX as follows:

Particulars	Amount* (₹)
(i) Agency charges	5,00,000
(ii) Unloading of machine at Kandla port, Gujarat	50,000
(iii) Charges for transport of machine from Kandla port, Gujarat to Rudra Logistics’ godown in Ahmedabad, Gujarat	25,000
(iv) Charges for transport of machine from Rudra Logistics’ Ahmedabad godown to the warehouse of Roily Polly Export Import House in Mumbai, Maharashtra	28,000
(v) Customs duty on machine	5,00,000
(vi) Dock dues	50,000
(vii) Port charges	50,000
(viii) Hotel expenses	45,000
(ix) Travelling expenses	50,000
(x) Telephone expenses	2,000

*exclusive of GST wherever applicable
Compute the value of supply made by Rudra Logistics with the help of given information. Would your answer be different if Rudra Logistics charges ₹ 13,00,000 as a lump sum consideration for clearing the imported machine from the customs station and bringing the same to the warehouse of Rolly Polly Manufacturers Ltd ? [MTP, Nov. 2019, 9 Marks]
Answer:
Statutory Provision:
(а) Meaning of Pure Agent:

Neither intends to hold nor holds any title to the supplies
Does not have any personal interest in the supplies procured

(b) Value of Supply:
Expenditure or costs incurred by a supplier as a pure agent of the recipient of supply shall be excluded from the value of supply If all the 3 conditions are satisfied:

Payment to the third party on authorisation by such recipient.
Payment made in capacity of pure agent on behalf of the recipient of supply has been separately indicated in the invoice
Supplies procured by the pure agent from the third party as a pure agent of the recipient of supply are in addition to the services he supplies on his own account.

(c) Rule 33 of the CGST Rules, 2017 stipulates that notwithstanding anything contained in the provisions of Chapter IV – Determination of Value of Supply, the expenditure or costs incurred by a supplier as a pure agent of the recipient of supply shall be excluded from the value of supply, if all the following conditions are satisfied, namely-

(I) the supplier acts as a pure agent of the recipient of the supply, when he makes the payment to the third party on authorisation by such recipient;
(II) the payment made by the pure agent on behalf of the recipient of supply has been separately indicated in the invoice issued by the pure agent to the recipient of service; and
(III) the supplies procured by the pure agent from the third party as a pure agent of the recipient of supply are in addition to the services he supplies on his own account.

In the given case

1. Rudra Logistics has been authorised by the recipient of supply – Roily Polly Manufacturers Ltd. – to incur, on its behalf, the expenses incurred in relation to clearance of the imported machine from the customs station and bringing the same to the warehouse of the recipient, Le. expenses mentioned in S. Nos. (ii) to (vii).

2. Rudra Logistics does not hold any title to said services and does not use them for his own interest.

3. Lastly, Rudra Logistics receives only the actual amount incurred to procure such services in addition to agency charges. Thus, Rudra Logistics qualifies as a pure agent.

4. Since conditions (I) to (III) of Rule 33 are satisfied in the given case, expenses (ii) to (vii) incurred by Rudra Logistics as a pure agent of Roily Polly Manufacturers Ltd. shall be excluded from the value of supply.
Accordingly, value of supply made by Rudra Logistics will be computed as under:

Computation of value of supply

Particulars	Amount (₹)
Agency charges	5,00,000
Add: Unloading of machine at Kandla port, Gujarat	Nil
Add:Charges for transport of machine from Kandla port, Gujarat to its Rudra Logistics’ godown in Ahmedabad, Gujarat	Nil
Add: Charges for transport of machine from Rudra Logistics’ Ahmedabad godown to the warehouse of Roily Polly Export Import House in Mumbai, Maharashtra	Nil
Add: Customs duty	Nil
Add: Dock charges	Nil
Add: Port charges	Nil
Add: Hotel expenses	45,000
Add: Travelling expenses	50,000
Add: Telephone expenses	2,000
Value of supply	5,97,000

However, if Rudra Logistics charges ₹ 13,00,000 as a lump sum consideration for getting the imported machine cleared from the customs station and bringing the same to the warehouse of Rolly Polly Manufacturers Ltd., Rudra Logistics would incur expenses (ii) to (vii) for its own interest (as the agreement requires it to get the imported machine cleared from the customs station and bring the same to the Roll Polly Manufacturers Ltd.’s warehouse). Thus, Rudra Logistics would not be considered as a pure agent of Rolly Polly Manufacturers Ltd. for said services.

Consequently, in that case, value of supply will be ₹ 13,00,000.

Valuation under the Customs Act, 1962 – CA Final IDT Study Material

Leave a Comment / CA Final / By Murali / April 11, 2023 May 10, 2023

Valuation under the Customs Act, 1962 – CA Final IDT Study Material is designed strictly as per the latest syllabus and exam pattern.

Valuation under the Customs Act, 1962 – CA Final IDT Study Material

Question 1.
Examine the validity of the following statements with reference to the Customs Act, 1962:
(i) Service charges paid to canalizing agent are not includible in the assessable value of imports.
(ii) Inspection charges are not includible in the assessable value of the imported goods if contract does not specify for certification by an independent agency.
[May 2013, 3 Marks]
Answer:
(i) The statement is not valid

Since canalizing agent is not the agent of the importer nor does he represent the importer abroad.
Purchases by canalizing agency from foreign seller and subsequent sale by it to Indian importer are independent of each other.
Hence, the service paid to canalizing agent cannot be termed as buying commission.

Therefore, the commission or service charges paid to the canalizing agent are includible in the assessable value. [Hyderabad Industries Ltd. v. 1/0/2000 (115) E.L.T. 593 (S.C.)].

(ii) The statement is valid
As per Rule 10(1) of the Customs (Determination of Value of Imported Goods) Rules, 2007 only the payments actually made as a condition of sale of the imported goods by the buyer to the seller are includible in the assessable value.

Thus, if there is no requirement in the contract for independent inspection and
The inspection is carried out by foreign supplier on its own and
Is not required for the purpose of fulfilling the condition of the contract, then
charges incurred on such inspection are not includible in assessable value
[Bombay Dyeing & Mfg. v. CC 1997 (90) E.L.T. 276 (S.C.)]

Question 2.
The importer entered into contract for supply of crude sunflower seed oil @ U.S. $ 435 C.I.F./ Metric ton. Under the contract, the consignment was to be shipped in the month of July, 2017. The period was extended by mutual agreement and goods were shipped on 5th August, 2018 at old agreed prices. In the meanwhile, the international prices had gone up due to volatility in the market and other imports during August, 2018 were at higher prices. Department sought to increase the assessable value on the basis of the higher prices as contemporaneous imports.
Decide whether the contention of the department is correct. You may refer to decide case law, if any, for your decision. [May 2013, 3 Marks]
Answer:
No, the contention of the Department is not Correct.

The facts of the given case are similar to the case of CCus. Vishakhapatnam v. Aggrawal Industries Ltd. 2011 (272) E.L.T. 64 (S.C.). The Supreme Court, in the instant case, observed that since the contract entered into for supply of crude sunflower oil @ US $ 435 CIF/ metric ton could not be performed on time, the extension of time for shipment was agreed upon by the contacting parties.

The Supreme Court pointed out that the commodity involved had volatile fluctuation in its price in the international market, but having delayed the shipment; the supplier did not increase the price of the commodity even after the increase in its price in the international market.

Further, these was not allegation the supplier and importer being in collusion. Thus, the appeal was allowed in the favour of the assessee and the contract price was accepted as the ‘transaction value’.

Question 3.
XYZ Industries Ltd., has imported certain equipment from Japan at an FOB cost of 2,00,000 Yen (Japanese). The other expenses incurred by M/s XYZ Industries in this connection are as follows:
(i) Freight from Japan to Indian port: 20,000 yen
(ii) Insurance paid to Insurer in India: 10,000
(iii) Designing charges paid to Consultancy firm in Japan: 30,000 yen
(iv) M/s XYZ Industries had expended ₹ 1,00,000 in India for certain development activities with respect to the imported equipment
(v) XYZ Industries had incurred road transport cost from Mumbai port to their factory in Karnataka: 30,000
(vi) Central Board of Indirect Taxes and Customs had notified for purpose of Sec. 14(3) of the Customs Act, 1962 exchange rate 1 yen = 1.3948.
(vii) M/s XYZ Industries had effected payment of the Bank based on exchange rate 1 Yen = 0.4150
(viii) The commission payable to the agent in India was 5% of FOB cost of the equipment in Indian Rupees.
Arrive at the assessable value for purposes of Customs duty under the Customs Act, 1962 providing brief flotes whenever required with appropriate assumptions. [May, 2008]
Answer:
Computation of assessable value

Particulars	Amount
FOB Value given in question	2,00,000 yen
Add: Designing charges	30,000 yen
Add. Freight upto the place of Importation	20,000
Total (A)	2,50,000 yen
Value in Yen converted into Indian Rupees	98,700
(At the CBIC notified Rate 0.3948) (Yen 2,50,000 × 0.3948)
Add: Insurance (Actual)	10,000
Add : Commission to Agent (596 of FOB) (Yen 2,50,000 × 0.3948 × 596)	3,948
CIF in INR	1,12,648
Assessable Value u/s 14(1)	1,12,648

Working Notes:

Designing charges will be includible in the value of imported goods.
Local transportation charges will not be included for the purpose of computation of Av.

Question 4.
From the following particulars determine the assessable value of the Imported equipment
giving explanation for each Item:
(i) FOB cost of equipment (Japanese Yen) 2,00,000 Yen
(ii) Freight charges In Japanese Yen 20,000 Yen
(iii) Charges for development connected to equipment paid In India 60,000
(iv) Insurance charges paid in India for transportation from Japan 15,000
(v) Commission payable to agent In India 15,000
Exchange rate as per RBI Is 1 Yen = 0.45
Exchange rate as per CBIC is 1 Yen = 0.50 [May 2009, 5 Marks]
Answer:
Statement Showing Computation of Assessable Value as per Section 14 of Customs Act, 1962

Particulars	Amount
FOB value given in question	2,00,000 yen
Add: Freight	20,000 yen
Total	2,20,000 yen
Total sum in Indian Rupees	1,10,000
(Yen 2,20,000 × 0.50 Notified rate by CBIC)
Add: Insurance (Actual Expenditure)	15,000
Add: Commission	15,000
(We presume it is not a buying commission)
CIF in Indian Rupees	1,40,000
Total Assessable Value	1,40,000

Question 5.
T Ltd. Imported some goods from LMP Inc. of United States by air freight. You are required to compute the value for purposes of customs duty under the Customs Act, 1962 from the following particulars:

CIF value	US$ 6,000
Freight paid	US$ 2,000
Insurance cost	US$700

The bank had received payment from the Importer at the exchange rate of US$ 1 =46 while the CBIC notified exchange rate on the relevant date was US$ 1 = 45.5 (Make suitable assumptions where required and provide brief explanations to your answer). [Nov. 2010, 5 Marks]
Answer:
Computation of Assessable value for Customs purpose

PARTICULARS	AMOUNT
CIF value	6000 US $
Less: Freight	2000 US $
Less: Insurance	700 US $
FOB value	3300 US $
Add: Freight (20% of FOB value) [Note 1]	660 US $
Add: Insurance (actual)	700 US $
CIF for customs purpose	4660 US $
Exchange rate as per CBIC [Note 2]	₹ 45.50 per US $
Assessable value (₹ 45.50 × 4660 US $)	₹ 2,12,030

Working Notes:

1. If the goods are imported by air, the freight cannot exceed 20% of FOB price [Fifth proviso to rule 10(2) of the Customs (Determination of Value of Imported Goods) Rules, 2007],
2. Rate of exchange determined by CBIC is considered [clause (a) of the explanation to section 14 of the Customs Act, 1962].

Question 6.
Compute the assessable value of the machine imported by M/s. Exports India Pvt. Ltd., under the Customs Act, 1962.

	US$
FOB price of the machine	10,000
Air freight paid	2,500
Insurance for transit of machine	Not Ascertainable
Cost of development work in India	40,000
Local agent’s commission	10,000
Cost of local transport	5,000

Answer:
Computation of assessable value as per Section 14 of Customs Act, 1962

Particulars	Amount (₹)
FOB price of the machine ($ 10,000 × Rate Notified by CBIC) [$ 10,000 × 45]	4,50,000
Add : As per Rule 10(1) of Import Valuation Rules, 2007	10,000
(i) Local agent commission (WN 1) 10,000
(ii) Cost of development work in India [As per Rule 10(1)]
Value as per Customs	4,60,000
Add : As per Rule 10(2) of Import Valuation Rules, 2007
(i) Air Freight
a. [Actual or 20% of FOB Whichever is less]	92,000
b. (20% of 4,60,000)
(ii) Insurance [1.125% of FOB] = (1.125% of 4,60,000)	5175
CIF value/Assessable value	5,57,175

Working Notes:
1. We presume local agent commission is related to FOB Value.
2. Cost of local transport is not includible in assessable value as it is a post importation activity.
3. No landing charges should be added for CIF value [Rule 10(2)].

Question 7.
Determine the assessable value for the purpose of Customs Act, 1962 from the following information in respect of import of a Machine from UK:

(i) FOB Value	£ 6,000
(ii) Air Freight	£ 1,500
(iii) Design and development charges paid in UK	500
(iv) Design and development charges paid in India	10,000
(v) Commission paid to local agents 1% of FOB Value
(vi) Date of Bill of Entry 10-4-2018
(Exchange rate notified by CBIC £ 1 = 70)
(vii) Date of entry Inward 20-4-18

(Exchange rate notified by CBIC £ 1 = 65)
Insurance charges are not ascertainable.
Make assumptions where required and provide suitable explanations. [Nov 201 1,5 Marks]
Answer:
Computation of assessable value as per Section 14 of Customs Act, 1962

Particulars	Amount
FOB price of the machine	£ 6000
Add : As per Rule 10(1) of Import Valuation Rules, 2007
(i) Local agent commission (1% of £ 6000)	£ 60
(ii) Cost of Design and Development Charges Paid in UK [As per Rule 10(1)]	£ 500
Value as per Customs	£ 6,560
Add : As per Rule 10(2) of Import Valuation Rules, 2007
(i) Air Freight
a. [Actual or 20% of FOB Whichever is less]	£ 1321
(20% of £ 6,560)
(ii) Insurance [1.125% of FOB] = (1.125% of £ 6,560)	£73.8
CIF value/Assessable value	£ 7954.8
Assessable value (₹) £ 7954.8 × ₹ 70 (WN 1)	5,56,836

Working Note

1. Exchange Rate of ₹ 70 notified by the CBIC on the date of presentation of bill of entry has been considered for currency conversion purposes as per Sec. 14 of the Customs Act, 1962
2. Design & development charges paid in India have not been considered on the presumption that the same have been paid, for design & development work undertaken in India. Rule 10(1)(b) of the Customs Valuation Rules provides for inclusion of only those design & development charges which have been paid for design & development work undertaken elsewhere than in India.

Question 8.
PQR Industries Ltd., has imported certain equipment from Japan at an FOB cost of 2,00,000 yen (Japanese). The other expenses incurred by M/s. PQR Industries Ltd. in this connection are as follows:
(i) Freight from Japan to Indian Port : 20,000 yen
(ii) Insurance paid to insurer in India (for the importation of the machine) : 10,000
(iii) Designing charges paid to consultancy in Japan : 30,000 yen
(iv) M/s. PQR Industries Ltd. had expended 1,00,000 in India for certain developmental activities with respect to the imported machine.
(v) PQR Industries Ltd. had incurred road transport cost from Mumbai port to their factory in Karnataka. 30,000
(vi) CBIC had notified for purposes of Sec. 14 of the Customs Act, 1962 exchange rate of 1 yen = 0.3948. The interbank exchange rate as announced by the authorized dealer was 1 yen = 40
(vii) M/s. PQR Industries Ltd. had effected payment based on exchange rate 1 yen = 0.4150
(viii) The commission payable to the agent in India was 5% of the FOB cost of the equipment in Indian rupees.
Arrive at the assessable value for purposes of valuation under the Customs Act, 1962 with brief notes wherever necessary for each of the adjustments at (i) to (viii) above. [May 2012, 5 Marks]
Answer:
Computation of assessable value as per Section 14 of Customs Act, 1962

PARTICULARS	AMOUNT
FOB Value	¥ 2,00,000
Add: Design and development charges [Note 2]	¥ 30,000
Total	¥ 2,30,000
Total in rupees @ ₹ 0.3948 per pound [Note 1 ]	₹ 90804
Add: Local agency commission [Note 6] (5% of ¥2,00,000) = ¥ 10,000 × ₹ 0.3948	₹ 3948
FOB value as per Customs	₹ 94752
Add: Freight (¥ 20,000 × 0.3948)	₹ 7896
Add: Insurance @ 1.125% of customs FOB [Note 5]	₹ 10,000
CIF Value	₹ 112648
Assessable value (rounded off)	₹ 112648

Notes:

(1) As per Section 14 of the Customs Act, 1962 Rate of exchange notified by the CBIC has been considered.

(2) Value of design work undertaken elsewhere than in India is includible in the value of the imported goods.

(3) Value of development work undertaken in India is not includible in the value of the imported goods. Hence, ₹ 1,00,000 expended in India for development activities have not been considered.

(4) Only the cost of transport of the imported goods up to the place of importation is includible for the purpose of valuation. Thus, transport Cost from Mumbai port (place of importation) to the factory in Karnataka has not been included in the assessable value.

(5) Insurance of the machine is includible in the assessable value.

(6) Any Commission except Buying Commission will be included in the Assessable Value as per Rule 10(1) of Import Valuation Rules, 2007.

(7) No landing charges are to be added to the CIF value to amendment in Rule 10(2) of Valuation Rules.

Question 9.
M/s. Foreign Trade International Ltd. have imported one machine from England. They have given the following particulars:
(i) FOB value of Machine : £ 8,000
(ii) Air freight paid £ 2,500
(iii) Design and development charges paid in England : £ 500
(iv) Commission @ 2% of F.O.B. value paid to local agent in Indian Currency.
(v) Date of Bill of Entry is 24-10-2017 [rate of basic Customs Duty is 20%. Exchange rate as notified by C.B.I.C. is 68 per Sterling Pound]
(vi) Date of arrival of aircraft is 20-10-2017 when rate of basic Customs Duty was 18%, exchange rate as notified by C.B.I.C. was 70 per Sterling Pound.
(vii) Integrated tax leviable under Sec. 3(7) of Customs Tariff Act, 1975 is 12%.
(viii) Insurance charges, though actually paid, details are not available.
Compute the assessable value and determine the Customs Duty payable by M/s. Foreign Trade International Ltd. Give brief notes also wherever necessary.
Answer:
Computation of assessable value as per Section 14 of Customs Act, 1962

Particulars	Amount
FOB Value	£ 8000
Add : As per Rule 10(1) of Import Valuation Rules, 2007
(i) Local agent commission (2% of £ 8000)	£ 160
(ii) Cost of Design and Development Charges Paid in England [As per Rule 10(1)]	£ 500
Value as per Customs	£ 8660
Add : As per Rule 10(2) of Import Valuation Rules, 2007
(i) Air Freight
a. [Actual or 2096 of FOB whichever is less]	£ 1732
(20% of £ 8660)
(ii) Insurance [1.125% of FOB] = (1.125% of £ 8,660)	£ 97.425
CIF value/Assessable value	£ 10489.425
Assessable value (₹) £ 10489.425 × ₹ 68 (Note 2) (Rounded off)	713281

Computation of customs Duties As per customs Tariff Act, 1975

Particulars	Amount (₹)
Assessable value (rounded off)	₹ 713281
Add: Basic custom duty @ 2096 [Note 3]	₹ 1,42,656
Add: Social Welfare Surcharge @ 1096 on ₹ 1,42,656	₹ 14,266
Total value for levy of Integrated Tax u/s 3(7)	₹ 8,70,203
Add: Integrated tax leviable under section 3(7) @1296	₹ 104424
Total duty and integrated tax payable (Rounded off) (₹ 142656 + ₹ 14266 + ₹ 104424)	₹ 261346

Notes:
1. As per Rule 10 of the Customs (Determination of Value of Imported Goods) Rules, 2007:

if the goods are imported by air, the freight cannot exceed 20% of FOB price.
insurance charges are to be taken at 1.125% of FOB price if actual charges are not known.
the commission paid to local agent is ineludible as it is not a buying commission.

2. The rate of exchange notified by the CBIC on the date of presentation of bill of entry has been considered [Sec. 14 of the Customs Act, 1962].

3. Rate of duty prevalent on date of presentation of bill of entry, which later than the date of arrival of the aircraft, has been considered [Sec. 15 of the Customs Act, 19621.

Question 10.
BSA & Company Ltd. have imported a machine from UK. From the following particulars furnished by them, arrive at the assessable value for the purpose of customs duty payable:

i. FOB cost of the machine	10,000 U.K. Pounds
ii. Freight (air)	3,000 U.K. Pound
iii. Engineering and design charges paid to a firm in UK	500 U.K. Pounds
iv. License fee relating to imported goods payable by the buyer as a condition of sale	20% of F.O.B. cost
v. Materials and components supplied by the buyer free of cost valued	20,000
vi. Insurance paid to the insurer in India	6,000
vii. Buying commission paid by the buyer to his agent in UK	100 U.K. Pounds

Other Particulars:

i.	Inter-bank exchange rate as arrived by the authorized dealer: 72.50 per U.K. Pound
ii.	CBIC had notified for purpose of Sec. 14 of the Customs Act, 1944, Exchange rate of 70.25 per U.K. Pound.
iii.	Importer paid 5,000 towards demurrage charges for delay in clearing the machine from the Airport

[Make suitable assumptions wherever required and show workings with explanations) [May 2013, 5 Marks]
Answer:
Computation of assessable value of machine Imported by BSA & Co.

PARTICULARS	AMOUNT
Price of the machine	£ 10,000
Add: Engineering and design charges paid in UK [Note 1]	£500
Add: Licence fee relating to imported goods payable by the buyer as a condition of sale (20% of Price of machine) [Note 1]	£ 2,000
Total	£ 12,500
Value in Indian currency [£12,500 × ₹ 70.25] [Note 2]	₹ 8,78,125
Add: Materials and components supplied by the buyer free of cost [Note 1]	₹ 20,000
FOB (As per Customs)	₹ 8,98,125
Add: Freight (20% of 898125) [Note 3]	₹ 1,79,625
Add: Insurance paid to the insurer in India [Note 1 ]	₹ 6,000
CIF value	₹ 10,83,750
Assessable value (rounded off)	₹ 10,83,750

Working Notes:
1. Engineering and design charges paid in UK, licence fee relating to imported goods payable by the buyer as a condition of sale, materials and components supplied by the buyer free of cost and actual insurance charges paid are all ineludible in the assessable value [Rule 10 of the Customs (Determination of Value of Imported Goods) Rules, 2007].

2. As per Explanation to section 14(1) of the Customs Act, 1962, assessable value should be calculated with reference to the rate of exchange notified by the CBIC.

3. If the goods are imported by air, the freight cannot exceed 20% of FOB price [Fifth proviso to rule 10(2) of the Customs (Determination of Value of Imported Goods) Rules, 2007].

4. Buying commission is not included in the assessable value [Rule 10(1)(a) of the Customs (Determination of Value of Imported Goods) Rules, 2007].

5. Only ship demurrage charges on chartered vessels arc included in the cost of transport of the imported goods. Thus, demurrage charges for delay in clearing the machine from the Airport will not be includible in the assessable value [Explanation to Rule 10(2) of the Customs (Determination of Value of Imported Goods) Rules, 2007]

Question 11.
A machine was originally imported from Japan at 250 lakh in August, 2017 on payment of all duties of customs. The said machine was exported (sent-back) to supplier for repairs in January, 2018 and re-Imported without any re-manufacturing or re-processing in October 2018 after repairs. Since the machine was under warranty period, the repairs were carried out free of cost.

However, the fair cost of repairs carried out (including cost of material < 6 lakh) would have been 9 lakh. Actual insurance and freight charges (to and fro) were 3 lakh. The rate of basic customs duty is 10% and rate of IGST on like article is 12%

Compute the amount of customs duty payable (If any) on re-import of the machine after repair. The ownership of the machine has not been changed during the period. (Ignore GST compensation cess) [Nov. 2014, 5 Marks]
Answer:
As per Notification No. 46/2017 Cus. dated 30-6-2017 Duty of customs which would be leviable if the value of re-imported goods after repairs were made up of the fair cost of repairs carried out including cost of materials used in repairs (whether such costs are actually incurred or not), insurance and freight charges, both ways. However, following conditions need to be satisfied for availing this concession:

Since all the conditions specified above are fulfilled in the given case, the customs duty payable on re-imported goods will be computed as under:

Particulars	Amount (₹)
Value of goods re-imported after exports [₹ 9 lakh (including cost of materials) + ₹ 3 lakh]	12,00,000
(A) Add: Basic customs duty @ 10%	1,20,000
(B) Add: Social Welfare Surcharge @ 10% on ₹ 1,20,000	12,000
Value for computing integrated tax under section 3(7) of Customs Tariff Act, 1975	13,32,000
(C) Integrated tax @ 12% (₹ 13,32,000 × 12%)	1,59,840
Customs duty and integrated tax payable [(A) + (B) + (C)]	2,91,840

Question 12.
Maxiline Corp., not being an EOU, had imported technical instruments from USA for ₹ 180 lakh on payment of duty. It had to subsequently send back the same to the supplier for repair. The supplier has agreed to provide discount of 50% of the fair cost of repairs, resulting in Maxiline Corp. paying USD 15,000.
Following further particulars are available:

Particulars	Date	Rate of Duty	Inter Bank Exchange rate	Rate notified by CBEC
Bill of Entry	21-02-2018	20%	60	62
Aircraft arrival	26-02-2018	15%	62	61

IGST u/s 3(7) of Customs Tariff Act, 1975 -12%.

	Outwards (Amt. in ₹)	Inwards (Amt. in ₹)
Insurance	20,000	30,000
Air Freight	80,000	1,20,000

Other details available on records:

(a) Goods are re-imported within 3 years of despatch for repair.
(b) Both the exported and imported goods are the same.
(c) There is no change in the ownership of technical instruments.
(d) The export is not from a public/private warehouse and repairs does not amount to manufacture.
Determine total duty payable with appropriate notes for your computation. [May 2018, 5 Marks]
Answer:
As per Notification No. 46/2017-Cus. dated 30-6-2017 Duty of customs which would be leviable if the value of re-imported goods after repairs were made up of the fair cost of repairs carried out including cost of materials used in repairs (whether such costs are actually incurred or not), insurance and freight charges, both ways. However, following conditions need to be satisfied for availing this concession:

(a) goods must be re-imported within 3 years, extendable by further 2 years, after their exportation;
(b) exported goods and the re-imported goods must be the same;
(c) ownership of the goods should not change.
Since all the specified conditions are fulfilled in the given case, total duty payable will be computed as under:
Computation of total duty payable by Maxiline Corp.

Particulars	Amount (₹)
Fair cost of repairs (in dollars) = $15,000/50%	$ 30,000
Fair cost of repairs (in rupees) = $30,000 × ₹ 62 [Note-1]	18,60,000.00
Add: Inward and outward insurance [₹ 20,000 + ₹ 30,000]	50,000.00
Add: Inward and outward air freight [₹ 80,000 + ₹ 1,20,000]	2,00,000.00
Assessable Value	21,10,000.00
Add: Basic customs duty (BCD) @15% [Note-2]	3,16,500.00
Add: Social Welfare Surcharge	31650.00
Value for computing IGST	21,10,000.00
IGST @ 12%	2,94,978.00
Total duty and tax payable= [₹ 3,16,500 + ₹ 31,650 + ₹ 2,94,978]	6,43,128

Notes:
1. Rate of exchange notified by the CBIC on date of presentation of bill of entry would be the applicable rate in terms of third proviso to section 14(1) of the Customs Act, 1962.
2. Rate of duty is the rate in force on date of presentation of bill of entry or arrival of aircraft, whichever is later in terms of proviso to section 15(1) of the Customs Act, 1962.

Examiner’s Comment
Most of the examinees committed mistake by wrongly considering fair cost of repairs to be $ 15,000 instead of $ 30,000 resulting into incorrect computation of total duty payable by Maxiline Corp.

Question 13.
(1) Vishal Industries imported goods from U.S.A., CA.F. value bearing US $ 2600. Air freight 500 US $. insurance cost 100 US $. landing charges are not ascertainable
(2) Date of bill of entry is 25-9-2018 and basic custom duty on this date is 10% and exchange rate notified by Central Board of Excise and Customs in US $ 1 = 62
(3) Date of entry inward is 21-10-2018. Basic customs duty on this date is 20% and exchange rate notified by Central Board of Excise and Customs is US $ 1 = 60
(4) Integrated tax payable u/s 3(7) of the Customs Tariff Act is 12%, Social Welfare Surcharge is 10% on duty. Compute the assessable value and amount of total customs duty payable under the Customs Act, 1962
Make suitable assumptions, where required. Working notes should form part of your answer (Ignore GST compensation cess) [May 2015, 5 Marks]
Answer:
Computation of assessable value and customs duty payable:

CIF Value		US $ 2,600
Less Air Freight	US $ 500
Less Insurance Charge	US $ 100	US $ 600
FOB Value (As per Customs)		US $ 2,000
Add:
i. Air Freight restricted to 20% of FOB Value		US $ 400
ii Actual Insurance Charges		US $ 100
CIF Value/Assessable Value		US $ 2,500
Assessable value in Indian ₹ (US$ 2,500 × 62)		₹ 1,55,000

Computation of imported cost and customs duty (Amounts in ₹ ) :

Particulars	Amount
Assessable Value	1,55,000
(A) Add: Basic Customs duty (a> 20% of Assessable Value (20% of 1,55,000)	31,000
(B) Add: Social Welfare Surcharge @ 10% of A (10% of 31,000)	3,100
(C) Total value for levy of Integrated Tax u/s 3(7) of CTA, 1975	1,89,100
(D) Add: Integrated tax under section 3(7) @ 12% of C (12% of 1,89,100)	22,692
Total cost of imported goods	2,11,792
Total Customs Duty [A+B+D](Rounded off)	56,792

Note: Integrated tax leviable under section 3(7) of the Customs Tariff Act, 1975 is levied on the sum total of the assessable value of the imported goods, customs duties and applicable Social Welfare Surcharge.

Question 14.
15,000 Chalices were imported for charitable distribution in India by XY Charitable Trust. The Trust did not pay either for the cost of goods or for the design and development charges, which was borne by the supplier Customs officer computed its FOB value at USD 20,000 (including design and development charges), which was accepted by the Trust Other details obtained were as follows:

Particulars			Amount
1. Freight paid (air) (in USD)			4,500
2. Design & Development charges paid in USA (USD)			2,500
3. Commission payable to an agent in India (in ₹)			12,500
4. Exchange rate and rate of basic duty notified by CBIC is as follows:
Date of Bill of Entry	BCD	Exchange Rate in ₹
08-09-2018	20%	60
30-09-2018	10%	62
While the inter-bank rate was 1 USD = 63
5. Integrated tax payable u/s 3(7) of the Customs Tariff Act, 1975			12%
6. Social Welfare Surcharge as applicable

Compute the Assessable value and amount of total customs duty payable under the Customs Act, 1962. Make suitable assumptions where required Wrong notes should form part of your answer. (Ignore GST Compensations cess) [Nov. 2015, 5 Marks]
Answer:
Computation of total customs duty and integrated tax payable

PARTICULARS	AMOUNT
FOB value computed by Customs Officer (including design and development charges)	20,000 US $
Exchange rate [Note 1]	₹ 60 per $
FOB value computed by Customs Officer (in rupees)	12,00,000
Add: Commission payable to agent in India	12,500
FOB value as per customs	12,12,500
Add: Air freight (₹ 12,12,500 × 20%) [Note 2]	2,42,500
Add: Insurance (1.125% of ₹ 12,12,500) [Note 3]	13,640.63
CIF value for customs purposes	14,68,640.63
Assessable value	14,68,640.63
Add: Basic custom duty @ 1096 (₹ 1468640.63 × 1096) – rounded off [Note 4]	1,46,864.06
Add: Social Welfare surcharge @ 10% on ₹ 146864.06 rounded off	14,686.04
Total	16,30,190.73
Integrated tax leviable under section 3(7) of Customs Tariff Act, 1975 @ 12% (₹ 1630190.73 × 12%) [Rounded off] [Note 5]	1,95,622.89
Total customs duty and integrated tax payable (₹ 146864.06 + ₹ 14686.04 + ₹ 195622.89)	3,57,173

NOTES:

1. Rate of exchange notified by CBIC on the date of filing of bill of entry has to be considered [Third proviso to section 14 of the Customs Act, 1962].
2. In case of goods imported by air, freight cannot exceed 20% of FOB value [fifth proviso to rule 10(2) of the Customs (Determination of Value of Imported Goods) Rules, 2007].
3. Insurance charges, when not ascertainable, have to be included @ 1.125% of FOB value of goods [Third proviso to rule 10(2) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007].
4. Rate of duty will be the rate in force on the date of presentation of bill of entry or on the date of arrival of the aircraft, whichever is later [Proviso to section 15 of the Customs Act, 1962],
5. Integrated tax leviable under section 3(7) of the Customs Tariff Act, 1975 is levied on the sum total of the assessable value of the imported goods, customs duties and applicable social welfare surcharge.

Question 15.
Mr. Backpack imported goods from a UK supplier by air was contracted CIF basis. However, there were changes in prices the international market between date of contract and actual importation. As result of several negotiations, the parties agreed for a negotiated price payable as follows:

Particulars	Contract Price (£)	Changed Price (£)	Negotiated Price (£)
CIF Value	5,000	5,800	5,500
Air Freight	300	800	500
Insurance	500	650	600

Other details for computing assessable value and duty payable are as ‘tabled below:

Particulars	Amount
Vendor inspection charges (not required for making the goods ready for shipment)	£600
Commission payable to local agent 1% of FOB in local currency

Date of Bill of Entry	Basic Customs Duty	Exchange rate in (notified by CBIC)
18-02-2018	10%	102
Date of arrival of aircraft	Basic Customs Duty	Exchange rate in (notified by CBIC)
15-02-2018	15%	98

Inter-bank rate 1 UK Pound = 106
Compute the assessable value and calculate basic customs duty payable by Mr. Backpack [May 2016, 5 Marks]
Answer:
Computation of total customs duty payable

PARTICULARS	AMOUNT
CIF value (negotiated price) [Note-1]	£ 5,500
Less: Air freight	£500
Less: Insurance	£600
FOB value	£ 4,400
Add: Vendor inspection charges [Note-2]	Nil
FOB value as per Customs	£ 4,400
Add: Freight [Note-3]	£500
Add: Insurance [Note-4]	£600
	£ 5,500
Value in rupees [5,500 × ₹ 102] [Rate of CBIC on the date of filing of Bill of Entry]	₹ 5,61,000.00
Add: Commission payable to local agent [1% of FOB value] [Note-6] = (US $ 4,400 × ₹ 102) × 1%	₹ 4,488.00
Total	₹ 5,65,488.00
Assessable value	₹ 5,65,488.00
Add: Basic custom duty @ 10% [Note-6] – rounded off	₹ 56,548.80
Social Welfare Surcharge (10% of ₹ 56,548.80) [rounded off]	₹ 5,655.00
Customs duty payable [rounded off]	₹ 62,203.00

Notes:

1. In this case, since the contract was re-negotiated and the importer paid the re-negotiated price, the transaction value would be such re-negotiated price and not the contract price.
2. Charges of vendor inspection on the goods carried out by foreign supplier on his own and not required for making the goods ready for shipment, are not includible in the assessable value of the imported goods [Bombay Dyeing & Mfg. v. CC 1997 (90) ELT 276 (SC)].
3. Actual amount incurred towards freight will be considered since freight is not more than 20% of FOB value [Fifth proviso to rule 10(2) of Customs Valuation Rules].
4. Actual insurance charges paid are includible in the assessable value as per rule 10(2)(b) of the Customs Valuation Rules.
5. Commission paid to local agent (since it is not buying commission) is includible in the assessable value on the presumption that local agent has been appointed by the exporter [Rule 10(1)(a)(i) of the Customs Valuation Rules],
6. As per proviso to section 15 of the Customs Act, 1962, rate of duty will be the rate in force on the date of presentation of bill of entry or on the date of arrival of the aircraft, whichever is later.

Question 16.
F. Ltd. imported a machine from UK in May, 18. The details in this regard are as under :
i. FOB value of the machine: 10000 UK Pound
ii. Freight (AIR): 3000 UK Pound
iii. Licence fee, the buyer was required to pay in UK: 400 UK Pound
iv. Buying commission paid in India 20,000
v. Date of bill of entry 20-5-2018 and the rate of exchange notified by CBIC on this date was 99.00 per one pound. Rate of BCD was 7.5%
vi. Date of arrival of aircraft was 25-5-2018 and the rate of exchange notified by CBIC on this date was 98.50 per pound and rate of BCD was 10%
vii. Integrated tax leviable under section 3(7) of Customs Tariff Act, 1975 is 12.5% (ignore GST Compensation cess)
viii. Insurance premium details were not available.
You are required to compute the assessable value of the machine for valuation of customs duty and the total duty payable. You may make suitable assumptions wherever required [Nov. 2016 5 Marks]
Answer:
Calculation of Assessable value and total duty payable by Mr. Backpack:

Particulars	Amount
FOB value	£10,000
Add: Charges for costs and services as per Rule 10(1) i.e.
Licence fees	£400
Customs FOB value	£ 10,400
Add: Air freight (20% of customs FOB or Actual whichever is less) [As per Rule 10(2)]	£2,080
Add: Insurance (Actual is not available, so 1.125%) [As per Rule 10(2)]	£117
CIF Value	£12,597
CIF Value in Indian rupees i.e. 12,597 @ 99 (Working Note 3)	₹ 12,47,103
Assessable value
Add: Basic Custom Duty @10%	[A]	₹ 1,24,710.30
Add: SWS [@ 10% of 1,24,710.30]	[B]	₹ 12,471.03
Total value for IGST		₹ 13,84,284.33
IGST @ 12.5% of 13,84,284.33 [Working Note 4]	[C]	₹ 1,73,035.54
Total duty and integrated tax payable (A+B+C)	₹ 3,10,216.87

Working Notes:

Licence fees will be included in FOB value as per Rule 10(1) of valuation Rules.
Buying commission is excluded as per Rule 10(1).
Rate of Exchange (Rate of Notified by CBIC on the date of filing of Bill of Entry) and Rate of duty have been ascertained as per Sections 14 & 15 of Customs Act, respectively.
Integrated tax leviable under section 3(7) of the Customs Tariff Act, 1975 is levied on sum total of the assessable value of the imported goods customs duties and applicable Social Welfare Surcharge.

Question 17.
M/s. AMTL Ltd., Kolkata imported CNC Grinding machine from Catalyst Inc. USA, complete with accessories and spares in October 2018 for use in the manufacture of high precision micro tools. Basic cost of machine with accessories US $ F.O.B. 50,000. Catalyst Inc. supplied one extra set of accessories valued at US $ 2000 free of cost to over for transit damage.
Other details available were as follows:

Particulars	Amount
1. Warranty Cost payable to Catalyst Inc. (Not included in the cost of the Machine Le. US $ 50000)	US $ 4,500
2. Design and Development charges paid in USA (not included in the cost of the Machine i.e. US $ 50000)	US $6,000
3. Licence Fee, AMTL is required to pay in USA	US $ 1,000
4. Value of Drawings supplied by AMTL Ltd. Kolkata free of cost and is necessary for customising machine to the needs of AMTL Ltd. Kolkata	US$ 1,000
5. Freight by AIR	US$ 15,000
6. Buying Commission paid to Indian Agent in India	3,00,000

Bill of Entry presented on 10-11-2018 and the rate of exchange notified by CBIC on this date was 66.25 per US $ and rate of BCD was 7.5%. Date of arrival of aircraft was 6-11-2018 and rate of exchange notified by CBIC on this date was 66.50 per US $ and rate of BCD was 7.5%, Machine was insured but insurance premium was not shown/available in/from the invoice.

From the above particulars, compute the assessable value for purpose of customs duty payable. Make suitable assumptions wherever required.
Working notes should form part of your answer.
Note: Customs duty calculation need not be shown. [May 2017, 5 Marks]
Answer:
Calculation of Assessable Value (As per the Customs Act, 1962)

Particulars		Amount
FOB Value		$ 50,000
Add: As per Rule 10(1) of Import Valuation Rules, 2007
i Design and Development Charges	$ 6000
ii License fee AMTL	$ 1000
iii Value of Drawing supplied by Purchaser	$ 1000	$ 8000
FOB as per Customs		$ 58000
Add: As per Rule 10(2) of Import Valuation Rules, 2007
i. Air Freight [Actual or 20% of FOB Whichever is less] (20% of $ 58,000)		$ 11600
ii Insurance [1.125% of FOB] = (1.125% of $ 58000)		$ 652.5
CIF value/Assessable value		$ 70252.5
Assessable value $ 70252.5 × ₹ 66.25 [As per Section 14 Exchange Rate (Rate of CBIC prevailing on the date of filing of Bill of Entry)]		₹ 4654228

Question 18.
Pyramid Expo Ltd. has exported some goods by air. The FOB price of goods exported is US $ 50.000. The shipping bill was presented electronically on 7-3-2019 and Let Export Order passed by proper officer on 19-4-2019. The rate of exchange notified by CBIC on 7-3-2019 and 19-4-2019 are 1 US$ 65 and 1 US $ = 64 respectively.
Compute the export duty payable by Pyramid Expo with the help of following details provided.

Particulars	Date	Rate of Duty
Presentation of shipping bill	7-3-2019	12%
Let Export order	19-4-2019	10%

[Nov. 2017, 4 Marks]
Answer:
Computation of Export Duty

Particulars	Amount (US $)
Assessable Value	50,000
	Amount
Assessable Value = US $ 50,000 × 65 (Working Note 1)	32,50,000
Export duty @ 10% (Working Note 2)	3,25,000

Working Notes:

1. As per Section 14(1) of the Customs Act, 1962 the transaction value ie., FOB price of export goods is considered as assessable value has to be calculated with reference to the rate of exchange notified by CBIC on date of presentation of shipping bill of export.
2. The rate of duty prevalent on the date of let export order is considered for computing export duty vide Section 16(1)(a) of the Customs Act, 1962.

Question 19.
Niketan Industries Ltd., New Delhi has imported certain machine (by sea) from Japan.
From the following particulars furnished by it, work out the assessable value of the machine and customs duty payable by Niketan Industries Ltd. with appropriate working notes:

Particulars	Amount in (₹)
i. CIF value of the machine	4,23,379.69
ii. Freight incurred from port of entry to Inland Container depot	25,000.00
iii. Unloading and handling charges paid at the place of importation	40,000.00
iv. Designing charges paid to Consultancy firm in Mumbai	10,000.00

1. Basic Customs Duty leviable	10% ad valorem
2. Integrated tax leviable under section 3(7) of the Customs Tariff Act, 1975 is 18%.
3. Note: Ignore GST Compensation Cess.

[May 2018, 4 Marks]
Answer:
Computation of Assessable Value and customs Duty payable

Particulars		Amount
CIF value of the machine		4,23,379.69
Freight incurred from port of entry to inland container depot [Working Note 1]		—
Unloading and handling charges paid at the place of importation [Working Note 2]		—
Designing charges paid to Consultancy firm in Mumbai [Working Note 3]		—
Assessable Value		4,23,379.69
Add : Basic custom duty @ 10%	[A]	42,337.97
Add: Social welfare surcharge @ 10% of BCD	[B]	4,233.80
Total value for charge of IGST		4,69,951.46
IGST @ 18% u/s 3(7) of Customs Tariff Act, 1965	[C]	84,591.26
Total customs duties (A+B+C)		1,31,163

Working Notes:

As per Rule 10(2)(a) of Import Valuation Rules, 2007 Freight incurred from port of entry to England Container Depot specifically excluded.
Unloading or handling “at” the place of importation is not includible in value. Only charges “up to” i.e., prior to the place of importation are includible in value.
As per Rule 10( 1)(b), engineering, development, art work and plans and sketches undertaken elsewhere than in India are includible; since design is carried out in India, hence, not includes.

Examiner’s Comment
Most of the examinees were ignorant about the treatment of unloading and handling charges paid at the place of importation. They were not aware that only charges incurred for delivery of goods “to” the place of importation are includible in the transaction value vide rule 10(2)(a) of Customs Valuation (Determination of Value of Imported Goods) Rules, 2007. Further, they also wrongly added landing charges to the CIF value of machine.

Question 20.
Jolly overseas Ltd. of Hyderabad has imported a machine from UK (England) through the sea route by a vessel. The details of the import transaction are as follows:

Particulars	Amount in UK (£)
(i) Cost of the machine at the factory of the exporter	20,000
(ii) Transport charges from the factory of exporter to the port for shipment	600
(iii) Handling charges paid for loading the machine on the ship at the port of exportation	500
(iv) License fee relating to the imported goods payable by the importer as a condition of sale	900
(v) Actual freight charges from the port of export to the port of import are not ascertainable
(vi) Actual insurance charges paid	200
(vii) Landing charges paid at the place of Importation are not ascertainable	—–
(viii) Handling charges associated with the delivery of the imported goods at the place of importation	15,000

The following exchange rates are available.

	Dated	Exchange rate on that day:
(i) Bill of entry:	21-1-2019	(a) Notified by CBEC 1 UK £ = 101 (b) prescribed by RBI 1 UK £=100
(ii) Entry inward:	26-1-2019	(a) Notified by CBEC 1 UK £ = 102 (b) prescribed by RBI 1 UK £ = 103

Compute the assessable value of the machine (In rupees) for the purpose of levy of Customs Duty. [Nov. 2018, 5 Marks]
Answer:
Computation of assessable value of machine

Particulars	Amount in UK (£)
Cost of the machine at the factory of the exporter	20,000
Add: Licence fee relating to the imported goods payable by the importer as a condition of sale [Note 1]	900
Add: Cost of transport, loading, unloading and handling charges associated with the delivery of the imported goods to the place of importation [20% of £22,000] [Note 2] (It includes all cost of transportations, loading, unloading and handling expenditure from the factory of exporter to the place of importation)	4,400
Insurance charges	200
CIF value	25,500
Add: Landing charges paid at the importation and handling charges associated with the delivery of the imported goods at the place of importation [Note 3]	Nil
Assessable value	25,500
Assessable value In Indian rupees @ 101/per £ [Note 4]	25,75,500

Notes:
1. As per rule 10 of the Customs Valuation (Determination Imported Goods) Rules, 2007-
Licence fees related to the imported goods payable as a condition of the sale of the goods being valued is includible in the assessable value.

2. As per rule 10 of the Customs Valuation (Determination Imported Goods) Rules, 2007-
The cost of transport, loading, unloading and handling charges associated with the delivery of the imported goods to the place of the importation are includible in the assessable value.

Where such cost is not ascertainable, it shall be 20% of the free on board (FOB) value of the goods.

FOB value will be sum total cost of machine, transport charges from factory to port of exportation, handling charges at the port of exportation and license fee paid as a condition of sale of imported goods, which will be £22,000 (€20,000 + £600 + 500+£900]

3. As per rule 10 of the Customs Valuation (Determination Imported Goods) Rules, 2007-

Only charges incurred for delivery of goods “to” the place Importation are includible in the transaction value. The loading, unloading and handling charges associated with the delivery of the Imported goods at the place of importation are not to be added to the CIF value of the goods.

4. As per Section 14 of the Customs Act, 1962, the rate of exchange notified by the CBIC on the date of presentation of bill of entry is to be considered for the purpose of conversion of assessable value into Indian currency.

Examiner’s Comment
Some examinees were not aware that notional landing charges are no longer required to be added to the CIF value of machine.

Question 21.
ABC Industries Ltd. of Mumbai imported one machine through vessel from Japan, in the month of September, 2018. The following particulars are made available:

Particulars	Amount in Japanese Yen (¥)
(i) Cost upto port of exportation incurred by exporter	6,00,000
(ii) Loading charges at port of exportation	25,000
(iii) Freight charges from port of export to port of import in India.	1,00,000

Following additional amounts paid by ABC Industries Ltd.:-

Particulars	Amount in Japanese Yen (¥)
(i) Designing charges, necessary for such machine, paid to consultancy firm in New Delhi	8,00,000
(ii) Commission paid (not the buying commission) to local agent of exporter,	1,25,000
(iii) Actual landing charges paid at the place of importation	15,000
(iv) Actual insurance charges paid to the place of importation are not ascertainable.	–
(v) Lighterage charges paid at the port of importation	20,000

Other Information :

Rate of basic customs duty is 10%
Rate of social welfare surcharge is 10%
Integrated tax leviable under section 3(7) of Customs Tariff Act, 1975 is 12%.
Ignore GST compensation cess.
Rate of exchange to be taken is 1 Japanese Yen (¥) = ₹ 0.65

Arrive at the total customs duty, including integrated tax payable under section 3(7) of the Customs Tariff Act, 1975 with appropriate working notes. [May 2019, 5 Marks]
Answer:
Computation of assessable value of the imported goods

	Japanese Yen
Cost upto port of exportation	6,00,000
Add: Loading charges at the port of exportation [Note-1]	25,000
Total in Japanese Yen	6,25,000
	Amount
Total in Indian rupees @ ₹ 0.65 per Japanese Yen	4,06,250.00
Add: Commission paid to local agent of exporter [Note-3]	1,25,000.00
FOB value as per customs	5,31,250.00
Add: Freight charges from port of export to port of import in India [Note-1] [1,00,000 Japanese Yen × 0.65 = ₹ 65,000]	65,000.00
Add: Lighterage charges paid by the importer at port of importation [Note-1]	20,000
Add: Insurance charges @ 1.125% of FOB [₹ 5,31,250 × 1.125%] [Note-4]	5,976.56
CIF value	6,22,226.56
Assessable Value (rounded off)	6,22,227
Add: Basic customs duty @ 10% of ₹ 6,22,227(rounded off)	62,223
Add: Social welfare surcharge @ 10% of ₹ 62,223(rounded off)	6,222
Total	6,90,672
Add: Integrated tax @ 12% of ₹ 6,90,672 (rounded off)	82,881
Total custom duty and integrated tax payable (rounded off) (BCD + SWS + IGST)	1,51,326

Notes:
(1) [Rule 10(2) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 (CVR)] : The cost of transport, loading, unloading and handling charges associated with the delivery of the imported goods to the place of importation are includible in the assessable value

The cost of transport of imported goods referred above includes the ship demurrage charges on charted vehicles, lighterage or barge charges.

(2) As per Rule 10(1) of the CVR, 2007: Design and engineering work is includible in the assessable value only when the same is undertaken elsewhere than in India and necessary for the production of the imported goods.

(3) As per Rule 10(1) of the CVR, 2007: Buying commission is not included in the assessable value. Commission paid to local agent of exporter is includible in the assessable value since it is not buying commission.

(4) As per Rule 10(2) of the CVR, 2007: If insurance cost is not ascertainable, the same shall be added @ 1.125% of FOB value of the goods.

(5) As per Rule 10(2) of the CVR, 2007 : Cost of insurance, transport, loading, unloading, handling charges associated with transshipment of imported goods to another customs station in India is not included in the assessable value .

Question 22.
A consignment of 800 metric tonnes of edible oil of Malaysian origin was imported by a charitable organization in India for free distribution to below poverty line citizens in a backward area under the scheme designed by the Food and Agricultural Organization. This being a special transaction, a nominal price of US$ 10 per metric tonne was charged for the consignment to cover the freight and insurance charges. The Customs House found out that at or about the time of importation of this gift consignment there were following imports of edible oil of Malaysian origin:

QUANTITY IMPORTED IN METRIC TONNES	UNIT PRICE IN US $ (CIF)
1. 20	260
2. 100	220
3. 500	200
4. 900	175
5. 400	180
6. 780	160

The rate of exchange on the relevant date was 1 US $ = ₹ 70.00 and the rate of basic customs duty was 10% ad valorem. Ignore Integrated tax and GST Compensation Cess. Calculate the amount of duty leviable on the consignment under the Customs Act, 1962 with appropriate assumptions and explanations, where required. [Nov 2008]
Answer:
DETERMINATION OF TRANSACTION VALUE OF THE SUBJECT GOODS: In the instant case, while determining the transaction value of the goods, following factors need consideration:

1. In the given case, US$10 per metric tonne has been paid only towards freight and insurance charges and no amount has been paid or payable towards the cost of goods. Thus, there is no transaction value for the subject goods. Consequently, we have to look for transaction value of identical goods under rule 4 of Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 [Customs Valuation (DVIG) Rules, 2007].

2. Rule 4(1 )(a) of the aforementioned rules provides that subject to the provisions of rule 3, the value of imported goods shall be the transaction value of identical goods sold for export to India and imported at or about the same time as the goods being valued. In the six imports given during the relevant time, the goods are identical in description and of the same country of origin.

3. Further, clause (b) of rule 4(1) of the said rules requires that the comparable import should be at the same commercial level and in substantially same quantity as the goods being valued. Since, nothing is known about the level of the transactions of the comparable consignments, it is assumed to be at the same commercial level.

4. As far as the quantities are concerned, the consignments of 20 and 100 metric tonnes cannot be considered to be of substantially the same quantity. Hence, remaining 4 consignments are left for our consideration.

5. However, the unit prices in these 4 consignments are different. Rule 4(3) of Customs Valuation (DVIG) Rules, 2007 stipulates that in applying rule 4 of the said rules, if more than one transaction value of identical goods is found, the lowest of such value shall be used to determine the value of imported goods. Accordingly, the unit price of the consignment under valuation would be US $ 160 per metric tonne.

Computation Of Amount Of Duty

Payable CIF Value of 800 Metric Tonnes (800 tonnesX US $ 160 per tonne)	US $ 1,28,000
CIF Value (in Rupees) [At the exchange rate of $ 1 = ₹ 70]	₹ 89,60,000
Assessable Value	₹ 89,60,000
10% of Ad Valorem duty on ₹ 89,60,000	₹ 8,96,000
Add: Social Welfare Surcharge @ 10% (rounded off)	₹ 89,600
Total custom duty payable	₹ 9,85,600

Question 23.
M/s IES Ltd. (Assessee) imported certain goods at US $ 20 per unit from an exporter, who was holding 30% equity in the Share Capital of the importer company. Subsequently the assessee entered into an agreement with the same exporter to import the said goods in bulk at US $ 14 per unit.

When imports at the reduced price were effected pursuant to this agreement of the Department rejected the transaction value stating that the price was influenced by the relationship and completed the assessment on the basis of transaction value of the earlier imports i.e. at US $ 20 per unit under Rule 4 of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007, viz. transaction value of identical goods. State briefly whether the Departments action is sustainable in law with reference to decided cases, if any. [Nov. 2008, 5 Marks]
Answer:
The action taken by Department is not correct, which can be supported by following reasons :
(i) Importer-exporters are not relative: Here exporter holds 30% equity shares in the share capital of the importer company but importer doesn’t hold shares in the exporter company. The relationship between two artificial entities in deemed to be Present:

When one entity holds 51% or more equity shares into other entity or
One entity directly or indirectly controls other.
Here, the holding is just 30%, so the importer and exporter are not related person.

(ii) Transaction Value = Assessable Value: When importer and exporter are not related person and price is the sole consideration, department can’t reject the T.1v. and claim that price is influence further the present import is a bulk import i.e. for huge quantity and price reduction is justified here.
Hence, Department action is not sustainable in Law.

Question 24.
Kaveri Enterprises imported some goods from Italy. On the basis of certain information obtained through computer printouts from the Customs House, Department alleged that during the period in question, large number of consignments of such goods were imported at much higher price than the price declared by Kaveri Enterprises.

Therefore, Department valued such goods on the basis of transaction value of identical goods as per Rule 4 of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 and demanded the differential duty along with penalty and interest from the Kaveri Enterprises.

However, Department did not provide these printouts to Kaveri Enterprises. Kaveri Enterprises contended that Department’s demand was without any basis in law, without any legally admissible evidence and opposed to the principles of natural justice as the computer printouts which formed the basis of such demand had not been supplied to them. Resultantly, they had no means of knowing as to whether any imports of comparable nature were at the relevant point of time.
You are required to examine the contention of Kaveri Enterprises, with the help of a decided case law, if any. [May 2016, 4 Marks]
Answer:
The fact of the given case is based on the decision of Supreme Court in M/s. Gira Enterprises & Another (S.C.) 2014.
The hon’ble Supreme Court in the above case observed that the action of the revenue claiming further duty, interest and penalty are not sustainable under law for two reasons:

1. There is no plausible proof from the Department; mere existence of an alleged computer printout is not proof of the existence of comparable imports.

2. Assuming such a printout exists and the contents thereof are true, the question still remains whether the transaction evidenced by the said computer printout are comparable to the transactions of the appellant. The appellant will have to be given reasonable opportunity to establish that the transactions are not comparable.

Question 25.
A Malaysian company donated 1,000 metric tons of palm oil to a charitable trust in India for free distribution to the poor and the needy citizens. The trust in India had to meet the expenditure towards freight and insurance only which came to US $ 20 per metric ton. The Custom Department found that at or about the same time of importation of this consignment, there were following imports of palm oil of Malaysian origin into India.

Quantity imported in metric tons	Unit price in US Dollars(CIF)
1. 500	400
2. 900	350
3. 780	300

The rate of exchange on the relevant date was 1 US $ = ₹ 65 and the rate of customs duty was 20% ad valorem. Calculate the amount of customs duty payable on the consignment under the Customs Act, 1962 with appropriate assumptions and explanations. It would be sufficient if only basic customs duty is calculated. [Nov. 2018 (Old) 5 Marks]
Answer:
Statutory Provision:
In the given case, there is no transaction value for the subject goods. Therefore, value has to be determined in accordance with rule 4 of Customs Valuation (Determination of Value of Imported Goods) Rules, 2007.

As per Rule 4
1. Where T.V. of imported goods is rejected then such goods shall be valued at par with the identical goods, imported at or about the same time in same or closest quantity at a same Commercial Level.

2. Adjustments are allowed to be made for
a. Time gap
b. Quantity difference
c. Difference of commercial level

Notes: After determining comparable values, the lowest of them shall be adopted.

In the given case:
The consignment of 500 tonnes cannot be considered to be of substantially the same quantity. Hence, remaining 2 consignments will only be relevant.

If more than one transaction value of identical goods is found, the lowest of such value shall be used to determine the value of imported goods.
Accordingly, the unit price of the consignment under valuation would be US $ 300 per metric tonne.

Computation of amount of duty payable

Particulars	Amount ₹
CIF value of 1000 metric tonnes [1,000 × $ 300]	US $ 3,00,000
CIF Value (in Rupees) at the exchange rate of $ 1 = ₹ 65	1,95,00,000
Assessable value	1,95,00,000
Customs duty @ 20%	3,90,000

Examiner’s Comment
Many Candidates did not arrive at the correct transaction value of identical goods and mistakenly took the unit price of the consignment under valuation to be US $ 350 per metric tonne.

Question 26.
Mr. X imported certain goods from a related person Mr. 0 of US and transaction value has been rejected. Rules 4 and 5 of the Import Valuation Rules are found in applicable, as no similar/ identical goods are imported in India. Mr. X furnishes cost related data of imports and requests Customs Authorities to determine value accordingly as per Rule 8. The relevant data are:

(1) Cost of materials incurred by Mr. Q $ 2000
(2) Fabrication charges incurred by Mr. Q $ 1000
(3) Other chargeable expenses incurred by Mr. Q $ 400
(4) Other indirect costs incurred by Mr. Q $ 250
(5) Freight from Mr. Q’s factory to US port $ 250
(6) Loading charges at US port $ 100
(7) Normal net profit margin of Mr. Q is 20% of FOB
(8) Air freight from US port to Indian port $ 1,500
(9) Insurance from US port to Indian port $ 50
(10) Exchange Rate 70 per $

The Customs Authorities are of the opinion that since value as per rule 7 can be determined at, 4,00,000, there is no need to apply rule 8.
Can the request of Mr. X be legally acceptable? If so compute the Assessable value under the Customs Act, 1962. [Nov 2019, 5 Marks]
Answer:
As per rule 6: Change of Order
1. If the value of imported goods cannot be determined under the provisions of rules 3, 4 and 5, then the value shall be determined under provisions of rules 7 and 8.
2. At the request of importer, and with the approval of the proper officer, the order of applicability of rules 7 and 8 can be reversed.
As per rule 8: Computed Value

If valuation is not possible by deductive method, computing the value can be used.
This method can be used before deductive value method. If Customs Officer approves,
In this method, value is the sum of –

(a) Cost of Value of materials, labour and processing charges for producing the imported goods.
(b) Amount of General expenses and profit.
(c) The cost or value of all other expenses under rule 10: transport, insurance, loading, unloading and handling charges.

1. Cost of materials incurred by Mr. Q	$	2000
2. Fabrication charges incurred by Mr. Q	$	1000
3. Other chargeable expenses incurred by Mr. Q	$	400
4. Other indirect costs incurred by Mr. Q	$	250
5. Freight from Mr. Q’s factory to US port	$	250
6. Loading charges at US port	$	100
Total cost incurred by Mr. 0	$	4000
7. Normal net profit margin of Mr. Q [20% of FOB or 25% of cost = 25% of $ 4,000]	$	1000
FOB price	$	5000
8. Air fright from US port to Indian [Air freight cannot exceed 20% of FOB, hence, restricted to 20% of $ 5000] [rule 10(2) (a)] ($1000 – $250 – $100)	$	650
9. Insurance from US port to Indian port [Rule 10(2)(&)]	$	50
CIF/Assessable Value under Customs	$	5700
10. Exchange rate	$	₹ 70
Assessable Value under Customs		3,99,000

Question 27.
Write a brief note on the ‘residual method’ of determination of value of imported goods under the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007. [Nov. 2009, 2 Marks]
Answer:
Rule 9: Residual Method

Similar to ‘best judgment method’.
This method can be considered if valuation is not possible by rules 3 to 8.
Mix of the all other rules and general provisions of all rules.
Assessment will be done based on with available data in India.

Residual Value Cannot Be Determined On The Basis Of:

Sale price in India of the goods produced in India.
Sale price of the goods on the domestic market of the Country of Exportation;
Sale price of the goods for the export to a Country other than India;
Cost of production of identical or similar goods if that is not computed as per provisions of Rule 8 (ie. if it does not cover all the elements as mentioned in Rule 8):
A system which provides for the acceptance, for customs purposes, of the highest of the two alternative values;
Minimum customs values; or
Arbitrary or fictitious Values.

Question 28.
Explain briefly with respect to the provisions of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 the chief reasons for which the proper officer could raise doubts on the truth accuracy of the declared value? [May 2015, 4 Marks]
Answer:
As per Explanation to Rule 12 of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007: The importer is required to make a declaration that the details furnished by him are Correct.

If the Customs Officer is not satisfied, he may reject the Value declared by the importer but before rejection, he shall give an opportunity of making representation to the importer.
The proper officer can raise doubts on the truth or accuracy of the declared value based on certain reasons, which may include followings:

significantly higher value at which identical or similar goods imported at or about the same time in comparable quantities in a comparable commercial transaction, were assessed;
sale involves an abnormal discount or abnormal reduction from the ordinary competitive price;
sale involves special discount limited to exclusive agents;
mis-declaration of goods in parameters such as description, quality, quantity, country of origin, year of manufacture or production;
non-declaration of parameters such as brand, grade, specifications that have relevance to value;
fraudulent or manipulated documents.

Question 29.
Compute export duty from the following data:
1. FOB price of goods : US $ 1,00,000.
2. ShippIng bill presented electronically on 26-02-2019, for export on 4-03-2019.
3. Proper officer passed order permitting clearance and loading of goods
4. Rate of exchange and rate of export duty are as under:

	Rate of Exchange	Rate of Export Duty
On 26-02-2019	1 US $ = 55	10%
On 4-03-2019	1 US $= 56	8%

5. Rate of exchange is notified for export by Central Board of Excise and Customs. (Make suitable assumptions wherever required and show the workings.) [Nov. 2013, 5 Marks]
Answer:
Computation of Export Duty

PARTICULARS	AMOUNT
FOB price of goods [Note 1 ]	$ 1,00,000
Value in Indian currency (US $ 1,00,000 × ₹ 55) [Note 2]	₹ 55,00,000
Export duty @ 8% [Note 3]	4,40,000

NOTES:

1. As per section 14(1) of the Customs Act, 1962, assessable value of the export goods is the transaction value of such goods which is the price actually paid or payable for the goods when sold for export from India for delivery at the time and place of exportation.

2. As per third proviso to section 14(1) of the Customs Act, 1962, assessable value has to be calculated with reference to the rate of exchange notified by the CBIC on the date of presentation of shipping bill of export.

3. As per section 16(1 )(a) of the Customs Act, 1962, in case of goods entered for export, the rate of duty prevalent on the date on which the proper officer makes an order permitting clearance and loading of the goods for exportation, is considered.

Question 30.
Determine the Assessable value under customs law of an imported machine based on the following information.

(1) Cost of machine(Contract price = 1,00,000, Revised price = 2,00,000 Negotiated & Agreed price 1,50,000)
(2) Freight from the factory of the exporter to the port for shipment	20,000
(3) Freight incurred from port of entry to inland container depot	60,000
(4) Handling charges paid for loading the machine in the ship	5,000
(5) Demurrage charge paid at port	30,000
(6) Buying commission paid by importer	50,000
(7) Commission paid to local agent appointed by exporter	1,000
(8) Vendor inspection charges (not required under contract)	8,000

[May 2019, 5 Marks]
Answer:
Computation of assessable value as per Section 14 of Customs Act, 1962

Particulars	Amount (₹)
Cost of Machine (Transaction value is a value)	1,50,000
Add : Local agent commission (It is not a Buying Commission)	1000
Add : Cost of transport, loading, unloading and handling charges associated with the delivery of the imported goods to the place of importation- 20% of FOB [Working Note 2]	35,200
Add : Insurance [1.125% of FOB] = (1.125% of ₹ 1,76,000)	1,980
CIF value/Assessable value	1,88,180

Notes:
1. As per Rule 10(2) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 : The cost of transport, loading, unloading and handling charges associated with the delivery of the imported goods to the place of importation are includible in the assessable value. Further, where such cost is not ascertainable, it shall be 20% of the free on board (FOB) value of the goods which would also include demurrage charges. It has been assumed that the demurrage charges have been paid at the port of importation.

2. FOB value will be sum total cost of machine, freight from factory of exporter to port for shipment, handling charges paid for loading the machine in the ship and commission paid to local agent appointed by exporter, which will be ₹ 1,76,000 [(₹ 1,50,000 + ₹ 20,000 + ₹ 5000 + ₹ 1,000)].

3. As per Rule 10(2) of the Customs Valuation Determination of Value of Imported Goods) Rules, 2007: Freight incurred from port of entry to Inland Container depot is not includible in assessable value

4. As per Rule 10(1) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007: Only the payments actually made as a condition of sale of the imported goods by the buyer to the seller are includible in the assessable value. Vendor inspection charges not required under contract are thus, not includible in the assessable value.

Note: In the above answer, demurrage charges have not been added separately in the cost of transport, loading, unloading and handling charges by taking a view that where unascertainable cost of transport etc. has been computed as 20% of FOB value, the same includes all elements of costs of transport.

However, it is also possible to take an alternative view that actual demurrage charges should be separately added in the cost of transport by virtue of explanation to rule 10(2) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 irrespective of whether the cost of transport has been computed as 20% of FOB value or on the basis of actual values.

Performance Measurement and Evaluation – CA Final SCMPE Question Bank

Leave a Comment / CA Final / By Raju / April 11, 2023 April 11, 2023

Performance Measurement and Evaluation – CA Final SCMPE Question Bank is designed strictly as per the latest syllabus and exam pattern.

Performance Measurement and Evaluation – CA Final SCMPE Question Bank

Question 1.
Write short note on:
Balanced Score Card; (Dec 2008, 5 marks) [CMAFG IV]
Answer:
Balanced Score Card:

Balanced Score Card is a performance management and strategy development methodology that helps executives translate an organization’s mission statement and overall business strategy into specific, qualifiable goals and monitors the organization’s performancfe in terms of these goals.
Balanced Score Card also aligns budgets to strategy and helps in developing an enterprise performance management system.
It is a set of financial and non-financial measures relating to company’s critical success factors.
As a management tool it helps companies to assess overall performance, improve operational processes and enable management to develop better plans for improvements.
It offers managers a balanced view of their organization upon which they can base real change.

Balanced Score Card has the following four perspectives:

Customer Perspective: i.e., How customers see us? The Customer Perspective considers the business through the eyes of the customers, measuring and reflecting upon customer’s satisfaction.
Internal Business Perspective: i.e., In what processes must the firm excel? The Internal Business Perspective focuses attention on the performance of the key internal processes of the business.
Learning and Growth Perspective: i.e., Can we continue to improve and create value? This perspective is a measure of potential future performance. It drives attention to the basis of all future success the organization’s people and its infrastructure.
Financial Perspective: i.e., How do we look at our shareholders? The Financial Perspective measures the results that the organization delivers to its stakeholders.

Question 2.
Write short note on the following;
Advantages of balanced score card (Dec 2010, 5 marks) [CMAFG IV]
Answer:
Advantages of Balanced Score Card:

1. Wholistic approach	It brings strategy and vision as the center of management focus. It helps companies to assess overall performance, improve operational processes and enable management to develop better plans for improvements. It provides management with a comprehensive picture of business operation.
2. Overall agenda	It brings together in a single management report, various aspects like customer oriented, shortening response time, improving quality, etc, of a competitive agenda.
3. Objectivity	It emphasizes the need to provide the user with a set of information, which addresses all relevant areas of performance in an objective and unbiased manner.
4. Management by objectives	The .methodology of BSC facilities communication and understanding of business goals and strategies at all levels of the firm. Thus it enables management by objectives.
5. Feedback and learning	It provides strategic feedback and learning. BSC guards against sub-ordination. It emphasizes an integrated combination of traditional and non-traditiopal performance measures.
6. System approach	It helps senior managers to consider all the important performance measures together, and allows them to see whether an improvement in one area has been achieved at the expense of another.

Question 3.
Benchmarking exercise is based on “best exercise”and not on “best performances”. Explain. Also state briefly the important bench marking processes used in strategy implementation. (June 2009, 3 ÷ 8 = 11 marks) (CMAFG IV)
Answer:
The practice of setting targets, using external information is known as ‘Bench marking”. Bench marking is the establishment of targets, with which performance ¡s sought to be assessed. It is a continuous process of enlisting the best practices in the world for the process, goals and objectives, leading to world-class levels of achievement.

Benchmarking can be defined as a tool for improving performance by continuously identifying, understanding, adopting and adapting best practices and processes followed by an entity internally and externally of a company.
A benchmarking exercise is based on “best practices” and not on “best performances”.
Best practice is a continuous process of learning, feedback, reflection and analysis of what works (or does not work) and why.

Types of Bench marking:
1. Strategic Benchmarking :
This aims at enhancing a company’s holistic performance by analyzing the long-term approaches and strategies adopted by the “best practice companies” for their success in any sector across the globe.

2. Product Benchmarking :
This is an age old practice of product oriented reverse engineering. Every organization buys its rival’s products and tears them down to find out the features and performances etc. compared with its products. This could be the starting point for improvement. When Ford Motor Company redesigned the Tauras in 1992, it benchmarked 209 features on the Car against 7 competitors.

The company then worked to match / excel the higher standard set by any of its rival, in each of these features with its own product.

Japanese seemed to have excelled at this practice but to their credit it must be said that they just do not imitate, but ingeniously innovate.

3. Competitive Benchmarking :
“A measure of organizational performance compared against competing organization; studies the target specific product designs, process capabilities or administrative methods used by a company’s direct competitors”. This is confined to the area relating to the performance characteristics of the company’s key products and services. So competitive benchmarking will involve the best practices of the companies in the same sector.

4. Process Benchmarking :
‘The activity of measuring discrete performance and functionality against organizations through performance in excellent analogous business processes”.

This is attempted to improve specific key activities and operations culminating into processes with the help of best practice organizations that are engaged in similar activities and services.

5. Functional Benchmarking :
Optimization of functional processes or activities through benchmarking can be done by comparing with different business sectors but engaged in similar functions or processes.

6. Internal Benchmarking :
This involves benchmarking against the company’s own divisions or branches or strategic business units situated at different locations. The purpose is to develop a database which gives access to information and a cross fertilization of the managerial acumen within the company.

7. Global Benchmarking :
It is an extension of Strategic Benchmarking to include benchmarking partners on a global scale. E.g. Ford Co. of USA benchmarked it’s a/c payable functions with that of Mazda in Japan and found to its astonishment that the entire function, was managed by 5 persons as against 500 in Ford.

Question 4.
State briefly the shortcomings of Balance Scorecard. (Dec 2009, 5 marks) [CMAFG IV]
Answer:
Shortcomings of the Balanced Score Card: .
1. Community and environmental issues are missing ¡n BSC. These are very vital and critical issues today.

2. Competitors have not been included. Companies need to monitor the environment to track competitor’s activities and technological developments. These criticisms mainly stem from the fact that the BSC is not multiple stakeholders’ framework. Any performance measurement framework needs to reflect the needs of all the important stakeholders.

Conclusion: These shortcomings, however, should not detract from the inherent merits of the BSC, which helps to clarify, consolidate and gain consensus around the strategy of the organization. BSC is a powerful tool for strategy implementation. The shortcomings as pointed out may be added as its additional perspectives.

Question 5.
Attempt:
Explain the major components of balanced score card. (Nov 2010, 4 marks)

Question 6.
What are the stages involved in the creation of a Balanced Score Cara? Explain them briefly. (Dec 2010, 6 marks) [CMAFG IV]
Answer:
The stages involved in the creation of a Balanced Score Card are enumerated below:

Identify a vision i.e. where an organization is going to?
Identify organisation’s strategies: i.e. how. an Organization is planning to go there?
Define Critical Success Factors and perspectives: i.e. what we have to do well in each Perspective-Customer perspective, Internal perspective, Innovation and Learning perspective and Financial perspective.
Identify measures which will ensure that everything is going in the expected way.
Evaluation of Balanced score card, i.e, ensuring what we are measuring is right.
Create action plans and plan reporting of the Balanced score Card.
Follow up and manage i.e, which person should have reports and what reports should look like

The diagram given below depicts various stages involved to create a balanced score Card:

Although the process to create Balance Score card is the same for all organizations. However, each organizations must decide what are its critical success factors and what are its performance measures.

Question 7.
State whether each of the following independent activities is value-added or non-value-added:
(i) Polishing of furniture used by a systems engineer in a software firm.
(ii) Maintenance by a software company of receivables management software for a banking company.
(iii) Painting of pencils manufactured by a pencil factory.
(iv) Cleaning of customers’ computer key boards by a computer repair centre.
(v) Providing brake adjustments in cars received for service by a car service station. (May 2012, 5 marks)
Answer:

Item	Activity
(i) Polishing furniture used by a Systems Engineer in a software firm	Non-value added
(ii) Maintenance by a software company of receivables management software for a banking company	Value-added
(iii) Painting of pencils manufactured by a pencil factory	Value-added
(iv) Customers’ computer key board cleaning by a computer repair centre	Value-added
(v) Providing brake adjustments in cars for repairs by a care service station.	Value-added

Question 8.
Explain the features of a balanced score card. (May 2012, 4 marks)
Answer:
A Balanced score card includes information, both financial and non-financial elements under 4 perspectives with a long term goal of improved financial performance.

Perspective	Parameters
Customer	Sales % Delivery time New product information
Internal business perspective	Business process to be adopted Technological capability Internal efficiency parameters ‘
Innovation/ learning perspective	How a company should sustain its ability to change and innovate Technology leadership Product focus Kaizen approach
Financial perspective	Sales growth How the company should appear to its shareholders Operating income by segments

Question 9.
Explain briefly the major components of a Balanced Score Card. (Dec 2012, 5 marks) [CMAFG IV]

Question 10.
State the different types of Bench-marking, with a small write-up on each? (June 2016, 10 marks) [CMAFG IV]

Question 11.
What is ‘Bench Marking’? Describe briefly the different types of ‘Bench Marking’. (June 2017, 2 + 8 = 10 marks) [CMAFG III]

Question 12.
Based on the above information and using a Strategy Map tabulate two objectives and two measures for each perspective across the four dimensions of a balanced scorecard in the following format: (Nov 2019, 8 marks)

Perspective	Strategic Objective	Measure

Answer:

Perspective	Strategic Objective	Measure
Learning and Growth perspective	Increase the Number of New Products or Services sold	Number of customers Buying the New products or services
Customer perspective	Increase Customer Loyalty	Number of Account closed or closure Request Received

Question 13.
Sure Success & Co. is a team of professionals engaged in coaching the students of CMA Final Examinations. They offer coaching facilities in the main cities of the country. Though they have been in this profession for a long time, there is a lot of competition from many o+her coaching centres.

You are required to design a Balanced Score Card for Sure Success to readily read the parameters and implement its performance. (June 2015, 20 marks) [CMAFG IV]
Answer:
The Balanced Score Card suggests that we view the organization from 4 perspectives and to develop metrics, collect data and analyze it relative to each of the following perspectives:
(i) Customer Perspectives: Recent management philosophy has shown an increasing realization of the importance of customer focus and customer satisfaction in any business. This is the leading indicator. If the customers are not satisfied, they will eventually find other suppliers that will meet their needs. In developing metrics for satisfaction, customers should be analyzed in terms of customers and the kinds of processes for which we are providing a product or service to those customer groups.

(ii) Financial Perspectives/Owner’s Perspectives: There is always the traditional need for financial data. Timely and accurate funding data will always remain to be a. priority and the managers will do whatever necessary to provide it.

(iii) Learning and Innovative Perspectives: This perspective includes employees training and the corporate cultural attitudes related to both individual and corporate self-improvement. In all organization, People are the only repository of knowledge and remain the main resource.

(iv) Internal Business Perspectives: Metrics based on this perspectives allow the managers to know how well their business is running and whether its products and services conform to customer requirements. These metrics have to be carefully designed by those who know these processes most intimately.

Based on the above, we have designed a Balance Score Card for the Coaching Centre namely Sure Success & Co., as per below:

Perspective	Key Performance Indicator	Target	Actual	Deviation
1. Customer Perspective (Customers are the Students and their Parents)	No. of Students enrolled No. of Passes per class No. of Marginal failures No. of Good students who have failed No. of Rank holders No. of Students who drop out midway Increase in Student Strength over last period No. of Cancelled classes No. of Delayed classes due to late coming of faculty
2. Financial Perspectives/ Owners’ Perspectives	Revenue per person Gross Revenue Direct Expenses-like Study material, Remuneration Rental of the premises Gross and net margin Returns after taxes Growth of returns
3. Learning and Innovation Perspectives	New subjects offered E-learning growth Video lessons offered No. of faculty added Capital/Infrastructure expenditure Training & Development of Faculty
4. Internal Business Perspectives	Average no- of hrs/session. No, of sessions Seating conveniences Optimality of batch size Effectiveness of batch size

The Balanced Score Card Implementation process is quite simple in so far as it involves:

Agreeing to a set of performance measures as per above.
Agreeing to a performance targets for each measure.
Recording actual performance for each performance measure and
Regularly reporting and acting on any performance deviation.

Question 14.
Answer the following:
In the context of a balanced scorecard, identify the perspectives of the following independent situations: (May 2015, 4 marks)

Organization	Target Parameter	Perspective
(i) Courier Company	100% on-time delivery of priority dispatches
(ii) Tuition Centre	Set up class-on-internet facility for better reach of more number of students and absentees.
(iii) Computer Manufacturing Company	Set up service centres is all major cities for after sales support.
(iv) Government Taxation Department	Ensure Computer training to all officers above a certain rank to improve their capabilities.

(Candidates need to only write the 1^st and last columns in the answer books.)
Answer:
Identification of Perspectives of Independent Situation – ‘Balance Scorecard’:
Answer:

Organisation	Perspective
(i) Courier Company	Customer Perspective
(ii) Tuition Centre	Learning and Growth Perspective
(iii) Computer Manufacturing Company	Internal Business Perspective
(iv) Government Taxation Department	Learning and Growth Perspective

Question 15.
ABC Airlines has two divisions organized as profit centres, the Passenger Division and the Cargo Division. The following divisional informations were given for the year ended 31^st March 2018 : (May 2018)

	Cargo Division	Passenger Division	Total
Number of personnel trained	200	800	1000
Number of flights	350	250	600
Number of reservations requested	NIL	7000	7000
Revenue	₹ 42,00,000	₹ 42,00,00	₹ 84,00,000
Operating Expenses (excluding service department charges)	₹ 36,00,000	₹ 28,50,000	₹ 64,50,000
Service Department Charges
Training	₹ 3,20,000	₹ 3,20,000	₹ 6,40,000
Flight Scheduling	₹ 1,50,000	₹ 1,50,000	₹ 3,00,000
Reservation	₹ 1,05,000	₹ 1,05,000	₹ 2,10,000

The service department charge rate for the service department costs was based on revenue. Since the revenue of both the divisions were the same, the service department charges to each to division were also the same.

Required:
(i) Does the income from operations for the two divisions accurately measure performance? (3 marks)
(ii) Prepare the divisional income statement using activity bases provided. above in revising the service department charges. (7 marks)
Answer:
(i) The reported income from operations does not accurately measure performance because the service department charges are based on revenue. Revenue is not associated with the profit centre manager’s use of the service’ department services. For example, the Reservations Department serves only the Passenger Division and number of reservation requested by Cargo Division is NIL.

Thus, by charging this cost based on revenue, these costs are incorrectly charged to the Cargo Division. Further, the Passenger Division requires additional personnel. Since these personnel must be trained, the training costs assigned to the Passenger Division should be greater than the Cargo Division.

(ii) ABC Airlines Divisional Income Statement For the Year Ended March 31, 2018

Question 16.
Cure Hospital is running under private-public-partnership (PPP) model-providing treatment for non-communicable diseases. ABCO Hospitals Limited is the private partner which runs a chain of hospitals on profit basis in major cities in India. The public partner is the State Government. Cure Hospital is a “not- for-profit” hospital. (Nov 2019)

Private partner is to invest in upgrading and equipping the facility and responsible for operational management and service delivery. Government to provide physical space and other infrastructure in “as is where is” condition, provide support facilities and hospital amenities. Private partner assumes the entire responsibility for a full range of investment, operation and maintenance functions. Private partner has the authority to make daily management decisions.

The hospital is funded to a great extent by the State Government and a fixed level of funding is received from the government each year out of the State budgetary allocation. It is up to the hospital to allocate this fund to different areas such as doctors’ and other staff salaries, medicines and all other costs required to run a hospital.

Cure Hospital’s objectives are:

to give prompt access to high quality medical treatment for patients.
to provide free treatment to poor patients in line with government policy of inclusive development.
to provide value for money for the taxpayer-measured by the 3 Es framework of Economy, Efficiency and Effectiveness.
to contribute to medical science by developing innovative ways to deliver treatment to patients.

Except select surgeries, all services are free for poor patients that are below poverty line (BPL) card holders. 40% beds are reserved for poor patients. Free out patient department (OPD) services to poor. CT Scan and MRI diagnostics are free for poor patients, subsidised rates for others. Cure Hospital also runs a generic medicine shop inside the hospital premises which sells medicines to all patients at discount ranging from 40% to 56% – the only shop of this kind in the city.

WHO has agreed to provide financial and technical support to the neonatal care unit. The hospital enabled it to obtain five accreditation certificates from various leading authorities On different aspects of hospital management. Feedback is taken from each in-patient about the quality of service provided by the hospital and the satisfaction level is taken in 1 to 10 point scale. 1 being the least satisfied and 10 represents totally satisfied.

In.a recent meeting of the managing committee of the hospital, discussions were held about inadequate performance measurement systems in place to assess whether the hospital is achieving its objectives and that insufficient attention is given to the importance of non-financial performance indicators. A four member team consisting of a performance management expert and three senior doctors was created to give their advice in these aspects.

The four member team met with doctors, staff and other stakeholders at length and breadth. Some of the conversations were as below :
Doctor A : I think the hospital always delivers value for money. We have always achieved our total financial budgets.
Doctor B : We work here much longer hours than doctors in other hospitals, often without being paid for working overtime.
Doctor C : There is not enough government and private partner funding to recruit more doctors and paramedic staff.
Doctor D : Number of out-patients has increased considerably. Earlier an out-patient had to wait for an average period of 2 hours 20 minutes and now the same has increased to 3 hours.
Senior Doctor K : I do not know how much time we spend developing innovative ways to deliver treatment to patients though, as most of the performance data we doctors receive relates to financial targets.
In-patient H : Incompetent paramedic staff, poor quality of food and bed linen. Staff M : Management undermines our role in running the hospital.

Recent performance data of the hospital vis-a-vis national average are as follows:

	Cure Hospital	National average of other PPP run hospitals
Number of doctors	80	76
Average doctors salaries per month including overtime	₹ 1,20,000	₹ 1,60,000
Average doctors salaries including overtime as per budget	₹ 1,20,000	₹ 1,25,000
Number of in-patients treated	8,360	6,369
Average satisfaction rating of in- patients	6	9
Number of patients readmitted for treatment of the same ailment within short period of time after discharge from the hospital	627	128
Average staff satisfaction rating (0% represents totally dissatisfied and 100% represents totally satisfied)	16%	86%
Number of out-patients treated	76,212	63,318

Required :
(a) Explain why non-financial performance indicators are particularly important
to measure the performance of “not-for-profit” organisations such as Cure Hospitals. (4 marks)
(b) Evaluate whether Cure Hospital is delivering value for money for each of the components of the value for money framework. (12 marks)
(c) The CEO of the hospital intends to introduce a nominal fee for out patient treatment given to poor patients and remove subsidised rate of CT Scan and MRI diagnostic for other patients in order to achieve its objectives in a better way ‘Evaluate the proposal of the CEO. (4 marks)
Answer:
(a) Lack of profit-making objective:
Not-for-profit organisations do not, by definition, have profit as an overriding motive. Patients are not charged for receiving treatment, so Cure Hospital does not have a revenue stream. It may also be difficult to define a cost unit as this could be cost per patient arriving at hospital or cost per patient successfully treated.

Not-for-profit public sector organisations, such as Cure Hospital, have strict constraints on the amount of funding they receive, such as a fixed, amount of funding received entirely from the State Government. They cannot obtain funding from elsewhere, so financial measures cannot be ignored completely. Cure Hospital must exist within its financial means, and the use of budgets to control costs is critical.

Cure Hospital provides an essential public service. Political, legal and social influences would prevent it from closing down a service just because it became more expensive or uneconomic to provide it. For all of these reasons, financial objectives are less relevant than for most commercial organisations, and its objectives are mainly non-financial in nature.

Not-for-profit organisations also undergo more public scrutiny and have multiple stakeholders, so non-financial indicators will be necessary to manage expectations. For example, patients are stakeholders who will have relatively little interest in how Cure Hospital exists within its financial constraints.

They will have much more interest in non-financial performance, such as how quickly and successfully they are treated.

Due to its objective of public service, measurement of appropriate non-financial metrics are equally important. The reasons are:
(i) Benefits cannot be quantified: Cure Hospital essentially provides public healthcare service to the economically weaker sections of the society. Due to political, legal, and social reasons, not-for-profit organizations like Cure Hospital cannot be shut down merely for not being economically / financially viable. Therefore, financial measures are less relevant. Due to its non-financial objective, -appropriate non-financial measures become more important. For example, the benefits of saving lives cannot be quantified in financial terms.

(ii) Benefits may accrue over long term: The expenditure incurred in one year may yield benefits over several years. For example, the investment in an Intensive Care Unit (ICU) facility may accrue of multiple years. Neonatal care unit have been given financial and technical support from WHO which will give long term benefits to hospital.

(iii) Measurement of utilization of funds and expenditure: In the case of Cure Hospitals, many hospital services are free, allocation of capacity is aimed at providing free service to the BPL section of the society, medicines are provided at discounted rates. Therefore, Cure Hospital does not have a substantial revenue stream to earn from its patients. It gets a fixed budget allocation from the State Government, while ADCO Hospital allocates these funds for various investments and expenditures.

The assessment whether the spending have been appropriate is a key challenge. Defining cost per unit would be subjective since it could be cost of patients arriving at the hospital or cost of patients successfully treated at the hospital. Either figure could be tweaked to make it seem that the objectives are being met. The management may resort to rampant spending simply to meet the expenditure targets. Therefore, non-financial measure need to be put in place help stakeholders scrutinize whether the objectives for which funds have been given are being met.

(iv) Multiple objectives: Not-for-profit organizations have multiple objectives. It may be unclear which are the most important. Cure Hospital aims at . providing high quality treatment to its patients while also’ developing innovative ways to deliver treatment to its patients. Both objectives are equally important and inter-related. Non-financial measures provide better information about how each of these objectives have-been met. The benefits of organizations like Cure Hospital are non-financial in nature. Except for providing fiduciary information to the stakeholders, all other objectives of Cure Hospital can be measure only using non-financial measures.

(b) Value for money in public sector organisations can be measured using the ‘three Es’; economy, efficiency and effectiveness.
(i) Economy:
Economy means obtaining resources at the lower cost. Doctors’ salaries will be a significant expense for Cure Hospital and salary per doctor is a suitable measure of economy. Doctors at Cure Hospital have an average salary of ₹ 18,000 (₹ 1,20,000 × 12/80), compared to the national average of ₹ 25,263 (₹ 1,60,000 × 12/76).

The relatively lower salaries of doctors may be due to differences in levels of experiences or they work unpaid overtime. It may also be one of the reasons why the staff Satisfaction is so much lower at 16% as compared to the national level of 86%.

(ii) Efficiency:
Efficiency refers to obtaining the greatest possible outputs from the resources available. Treating patients is a key objective of Cure Hospital, and the number of doctors is important resource. The number of patients treated per year by each doctor is a good measure of efficiency. In Cure Hospital, each doctor treats an average of 952 (76,212/80) patients per year, 14.29% more than the national average 833 (63,318/76). This may be because they work longer hours than their colleagues in other hospitals.

(iii) Effectiveness:
Effectiveness means how well Cure Hospital achieves its objectives. Cure Hospital has multiple objectives, one of which is to provide high quality medical treatment for patients. Where patients are re-admitted to Cure Hospital because their treatment had failed, this represents a failure to provide high quality medical care, so the rate of re-admission of patients is a measure of effectiveness. The rate of readmission at Cure Hospital is 0.82% (627/76,212) much higher than the national average of 0.20% (128/63,318). Cure Hospital seems to have performed relatively very poorly in this respect.

Summary:
Overall, the results from the measurement of the 3Es are consistent with the doctor’s comments that they are working without being paid overtime and treating more patients than their colleagues in other hospitals. Cure Hospital appears to deliver better economy and efficiency than the national average. This seems to be reducing performance, however, in respect of providing high-quality medical treatment for patients, where Cure Hospital is less effective than the national average.

(c) A budget constrained management style emphasises the need to achieve short-term performance measures, for example, the annual financial budgets.

The doctor said that Cure Hospital has always achieved its total financial budgets,, and this is supported by the fact that the doctor’s salaries equalled the budget set for the period. Though it is unclear what NFPIS are measured at Cure Hospital as a whole, doctors receives only a limited set of financial and non-financial performance data.

The discussion about this data, however, is mainly related to financial targets. This implies greater emphasis is given to performance against financial targets, rather than non-financial ones.

Ali of this suggests that Cure Hospital has a budget constrained management style. An advantage of this is that it ensures Cure Hospital operates with the financial constraints of the fixed amount of funding received from the Government.

This management style encourages short-termism, by encouraging doctors to work long hours without being paid overtime, or not making funding available to recruit new doctors to alleviate the situation.

An implication of this is that Cure Hospital may reduce its performance against its objectives, and this is already seen by the relatively high rates of re-admission as an indicator of a reduced quality of medical treatment. Job-related tension is a consequence of a budget-constrained management style, and the low staff satisfaction score could have resulted from this.

This management style encourages manipulation of results, or the way they are measured, to show better performance. At busy times, more patients are referred to the nearby larger hospital. There is apparently no medical need for this, which is inconsistent with the objective to deliver high-quality treatment. It appears to be a way to distrot waiting times to demonstrate improved performance in treating patients promptly. From patients perspective, though, this will mean they are treated less promptly than if treated at Cure Hospital.

Being unable to recruit new doctors reduces Cure Hospital’s flexibility in reducing waiting times at busy periods, as the steps already taken seem to have minimal effect.

This management style does not encourage innovation, probably because doctors have insufficient time for this. Though this may have long-term benefits, it seems to be taken as less important than the other key objectives, to provide prompt high quality treatment.

Question 17.
AKG Limited has three autonomous divisions. The divisions are evaluated on the basis of ROI, with year end bonuses given to divisional managers who have the highest ROI. Operating results of Division II for the last year are given below: (Nov 2019)

The company’s overall ROI for the last year was 18% (considering all divisions). Division II has an opportunity to add a new product line that would require an investment of ? 30,00,000. Other details of the new product line are as follows:
Sales – ₹ 90,00,000 per annum
Variable Expenses – 65% of sales
Fixed Expenses – ₹ 25,20,000 per annum
Life cycle of the product line 5 years

Though Division II is performing well, but many a times, the customers complained that they had to wait for long after placing the orders. The company is interested in cutting the amount of time between when a customer places an order and when the order is completed. For the last year, the following data were reported in respect of Division II
Inspection time = 0.5 days per batch
Process time = 2.8 days per batch
Wait time = 16.0 days per batch
Queue time = 4.0 days per batch
Move time = 0.7 days per batch
In addition to financial performance measures, the company wishes to introduce a variety of non-financial performance measures.

The company has set aggressive targets in both sales growth and ROI for the coming year. The company’s strategy for achieving these goals includes a campaign aimed at building brand recognition, customer retention, improvement in product quality, on time delivery to customers, expansion of eco-friendly product line and introduction of limited edition items.

Required:
(i) Calculate last year’s ROI of Division II (1 mark)
(ii) Discuss whether the manager of Division II would accept or reject the new product line, if he takes his decision based solely on divisional ROI. (2 marks)
(iii) Advise how residual income approach can be used as an alternative financial measure for evaluation of managerial performance in the best interest of the company. , (2 marks
(iv) Calculate Manufacturing Cycle Efficiency (MCE) and interpret the result. (3 marks)
(v) State what percentage of the production time is spent in non-value added activities. (1 mark)
(vi) Calculate the delivery cycle time. (1 mark)
(vii) Calculate the new MCE if by using Lean Production all queue time can be eliminated. (2 marks)
Answer:
(i) Last year’s ROI of Division II:
= $\frac{\text { Net Operating Income }}{\text { DivisionalOperating Assets }}$
= $\frac{₹ 16,80,000}{₹ 52,50,000}$
ROI = 32%

(ii) Calculation of ROI of new product line:

	₹
Sales Less: Variable Expenses Contribution Less: Fixed Expenses Operating Income (Net) Investment New product line ROI (%) ‘	90,00,000 58,50,000
	31,50,000 25,20,000
	6,30,000 30,00,00021%

The manager of Division II should reject the new product line as the ROI of new product line i.e. 21% ¡s less than last year ROI of Division II i.e. 32%.

(iii) To overcome some of the dysfunctional consequences of ROI, the residual income approach can be used. For the purpose of evaluating the performance of divisional managers, residual income is defined as controllable contribution less a cost of capital charge on the investment controllable by the divisional manager. For evaluating the economic performance of the division residual income can be defined as divisional contribution less a cost of capital charge on the total investment in assets employed by the division.

If residual income is used to measure the managerial performance of investment centres, there is a greater probability that managers will be encourged, when acting in their own best interests, also to act in the best interests of the company.

Here, the AKG Limited should follow the residual income approach, as considering the following:
Proposed Investment = ₹ 30,00,000
Controllable = ₹ 31,50,000
Cost of Capital (21%) = ₹ 6,30,000
Residual Income = ₹ 25,20,000

(iv) Manufacturing Cycle Efficiency = $\begin{aligned}
& \frac{\text { ProcessingTime }}{\text { ProcessingTime+Inspection Time }} \\
& \text { Waiting Time + Move Time Queue Time }
\end{aligned}$
= $\frac{2.8}{2.8+0.5+16+0.7+4}$
= $\frac{2.8}{24}$ × 100
= 11.67%

(v) Non-Value added Activities = InspectionTlme + WaitingTime – MoveTime + QueueTime
= 0.5 days + 16 days + 0.7 days + 4 days
= 21.2 days
Total Production Time = 0.5 + 2.8 + 16 + 4 + 0.7
= 24 days
% = $\frac{21.1}{24}$ × 100
% of production time spent on non-value added activities = 88.33%

(vi) Delivery Time Cycle = Inspection Time + Processing Time + Waft Time + Queue Time + Move Time
= 0.5 days + 2.8 days + 16 days + 4 days + 0.7 days
= 24 days

(vii) MCE if Queue time is eliminated = $\frac{2.8 \text { days }}{2.8+0.5+16+0.7}$
= $\frac{2.8}{20}$ × 100
= 14%

Question 18.
The triple bottom line recognises that a company’s performance should not only be viewed in terms of its ability to generate economic profits for its owners, but also by its impact on people and the planet (Nov 2019, 5 marks)
(i) Reduced the amount of plastic usage in the peanut butter jars.
(ii) Provided financial support to hospital run by local authority in the vicinity of the factory.
(iii) Constructed solar powered warehouse.
(iv) Generated profit for the company’s shareholders.
(v) Started child care unit for the benefit of women employees as well as for the neighbourhood community.
Required:
Identify whether this initiative would primarily impact people, planet or profit.
Answer:

Initiatives	Impact
(i) Reduced the amount of plastic usage in the peanut butter jars	Planet
(ii) Provided financial support to hospital run by local authority in the vicinity of the factory	People
(iii) Constructed solar powered warehouse	Planet
(iv) Generated profit for the company’s shareholders	Profit
(v) Started child care unit for the benefit of women employees as well as for the neighbourhood community	People

Question 19.
The world fame Taj Mahal is situated on the banks of Yamuna River in the city of Agra, Uttar Pradesh, known for its beautiful design and is counted as one of the Seven Wonders of the World; the city attracts a lot of tourist from all around the world. The Tourism is one of the main sources of livelihood for its residents. Consequently, cleanliness and maintenance of garden area within the Taj Mahal campus is of prime importance in order to sustain and develop this industry. (Nov 2020)

The local government has recently employed a contractor to clean and maintain the garden area within the Taj Mahal campus. The contractor uses cleaning machines pulled by horses to avoid pollution. The contractor has been selected through an online competitive tendering/bidding process. Majority of the litter comprises of plastic waste (bags, bottles etc.) while some portion also includes glass, aluminium cans, paper and cardtoard. A detailed log is held by the contractor about the waste that has been cleaned, time taken for the cleanup, number of horses used, etc. This log is also checked and signed by local government officials. This record is used to process payments at the end of the month.

In addition to contracting, the local government has also placed bins at various locations within the campus for the public to dispose their waste. The Nagar Nigam’s workers clean these bins every morning. Again, detailed logs of the man power and other resources employed are kept by the respective department. In addition, the government has started a mobile messaging system, whereby the public can message the concerned department if they find litter anywhere in the campus. Depending on whether it is from overflowing bins or scattered waste, the Nagar Nigam’s workers will take action to clean it within 12 hours. A detailed log of these operations is also maintained. Patrons can also suggest measures for improving cleanliness on the above mentioned areas.

Due to its importance to the economy, the local government has allotted substantial budget for these operations. At the same time, it is essential to know if this is sufficient for the purpose of maintaining the cleanliness of the campus. Therefore, the government wants to assess whether the city is getting “good value for money” from expenditure.

The “value for money” concept can be looked at from three perspectives: (i) economy, (ii) efficiency and (iii) effectiveness. The internal audit department that has been requested to undertake this study has requested for guidelines on whether the audit should focus on economy and efficiency of the Taj Mahal campus cleaning operations or on effectiveness of the same. Economy and efficiency audit assess whether the same level of service can be procured at lower cost or resources while effectiveness audit assess whether better service can be procured at same cost.

Depending on the outcome of the audits, if required, policy decisions like requesting for additional funding from the state government, alternate policy measures like levying penalty for littering etc. can be taken.

Required:
(i) Recommend guidelines to assess economy, efficiency and effectiveness of Taj Mahal and campus cleaning operations. (8 marks)
(ii) Identify challenges involved in assessment of effectiveness. (6 marks)
(iii) Recommend general guidelines, how the audit team may conclude the audit based on the combined outcomes of economy, efficiency and effectiveness. . (6 marks)

Question 20.
Jal Cleaning and Distribution Services Ltd. (JCDSL) was established with an aim for supply and distribution of water in Nagpur and as well as supply of water to the various local authorities for distribution to villages and other small cities adjacent to Nagpur under “MISSION PAANI”. This involved planning, operating, treating, maintaining, and distributing water resources in the country’s urban centres and other areas mandated by State Government. The mission statement is “To provide clean and economical water for healthy life to the public”. (Nov 2020)

There are two operational divisions of JCDSL viz Water Distribution Operation (WDO) for distribution of water through pipes and Water Packaging Operation (WPO) for supplying water in packaged drinking water bottles. The state government ensures that JCDSL does not take advantage of its monopoly position in the regional area by increasing prices.

The government controls majority of services through its water regulatory body which determines an acceptable margin level (ROCE) and ensures that the pricing of JCDSL within these areas does not break this level. The other operation i.e. Water Packing Operation (WPO) is not regulated by government and JCDSL is free to charge a market rate for water supply in bottles.

The company is free to use water for Water Packaging Operation but the total use of water for Water Packing Operation (WPO) cannot exceed 35% of the total supply of water by the company. The company is presently using 20% of total water supply for packaging operation. The brand name of packaged drinking water is “Swachh- Jai” which is packed in transparent plastic bottles.

The water regulator calculates Return on Capital Employed (ROCE) of JCDSL based on its own valuation and assessment of the capital assets which are used in operation and profit from these services. Acceptable level of ROCE set by the regulator is 6.50%. If JCDSL breach this level, then the company would be heavily penalized. JCDSL board is making sincere efforts to improve the performance of the company for the benefit of the shareholders. The board of directors have decided to consider economic value added (EVA) as the key performance indicator, in order to meet the objective of maximizing shareholders’ wealth.

Key Financial data for the year ending 31^st March, 2020 is given below:

Particulars	Water Distribution Operation (₹ In Crore)	Water Packing Operation (₹ In Crore)	Total (₹ In Crore)
Revenue	585.00	212.00	797.00
Less: Operating Cost	475.00	146.00	621.00
Operating Profit	110.00	66.00	176.00
Less: Interest Cost			42.00
Profit before tax			134.00
Less: Tax @ 30%			40.20
Profit after tax			93.80

Capital Employed for the last two years	2019-20 (₹ In Crore)	2018-19 (₹ In Crore)
As per Audited Accounts	2,040.00	1,940.00
As calculated by Water Regulator (for WDO operations only)	1,812.00	1,760.00

The following notos are to be taken into consideration in the analysis:
1. Operating Cost includes:

Particulars	2019-20 (₹ In Crore)	2018-19 (₹ In Crore)
Depreciation	124.00	118.00
Provision for bad and doubtful debts	6.00	2.00
R&D Cost ‘	20.00	—
Other Non-Cash items	22.00	11.00

2. Economic depreciation is ₹ 156.00 Crore in 2019-20. In the F.Y. 2018-19, economic and accounting depreciation were assumed to be the same.

3. Current year’s tax paid is ₹ 23.00 Crore and deferred tax provisions of ₹ 2.00 Crore have been adjusted. There was no deferred tax balance before 2019-20.

4. The provision for doubtful debts was ₹ 12.00 Crore in the 2019-20 Balance Sheet.

5. Research and development has been non-capitalized. It belongs to a new project that will be developed over six years and is expected to be of long-term benefit to the company. 2019-20 is the first year of this project.

6. Cost of Capital:

Equity	15%
Debt (Post Tax)	5%

7. Gearing of JCDSL

Equity	30%
Debt	70%

Required :
(i) Calculate EVA of JCDSL for the year ending 31 March, 2020 based on the above information. (6 marks)
(ii) Evaluate the financial performance of JCDSL using EVA. (4 marks)
(iii) Assess whether JCDSL comply with its acceptable ROCE level. (3 marks)
(iv) Advise how JCDSL can improve its performance in terms of profitability and EVA in future. (7 marks)

Question 21.
Osaka Tea Co. manufactures and distributes finest quality black tea to hotels, restaurants and retailers. The company has wide presence in tea market. It has become one of the largest premium brands. The customers are very happy with the finest quality of tea. (Nov 2020)

Osaka Tea Co. never compromise with the quality of the tea. The aim of the company is to deliver finest black tea to keep the customers’happy. It has tied up with big tea estates for procurement of finest tea leaves directly from the estate for processing in its own plants. The tea leaves go through various processes like plucking, withering, brushing, oxidising, grading, drying, sorting and shaping etc. Then these are packed in beautiful plastic jars for distribution to the hotels, restaurants and retailers.

During the meeting of the management, it has been decided to reduce the price per kg by 5% to increase the volume of sales. The following variances pertain to last month’s operations, arose as a consequence of implementation of above decision.

Sales Price Variance	24,500 (A)
Sales Volume Variance	20,600 (F)
Purchase Price Variance	15,500 (A)
Labour Efficiency Variance	14,300 (A)
Fixed Cost Expenditure Variance.	11,100(A)

Required :
(i) Identify the ‘Critical Success Factor’ for Osaka Tea Co. (1 mark)
(ii) Evaluate the management’s decision with the ‘Overall Corporate Strategy’ and ‘Critical Success Factors’. (9 marks)

Question 22.
Mr. Benn, oversees the diverse operations of Bennsys, a large multinational company by using a much decentralized management structure. According to its 2019 annual report, Bennsys had 1,25,000 employees and earned over $100 billion in revenue. Mr. Benn managed this empire from his headquarters in London, that consists of 20 employees and occupies only 10,000 square feet, although the company’s vice-chairman, Simon, who works out of London, occupies another 600 square feet.

The total payroll, including benefits, of both locations was only just above $2 million in 2019. Mr. Benn was invited as the chief guest in a business summit organized at New Delhi during March, 2020. Asked about how an organization of that magnitude could be managed with such a small resources as to space and manpower. Mr. Benn’s own description about his and Mr. Simon’s management style is, “we delegate almost to the point of abdication (renouncing everything).”

An exaggeration perhaps, but clearly a decentralized style and he and his deputy are the stable believers of FOUR recognized levels of decentralization. In the context of responsibility accountings discuss th levels of decentralization which Mr. Benn was referring to and do you concede to the view that Mr. Benn is exaggerating the success of his Divisional organization structure. (Jan 2021, 10 marks)

Pricing Decision – CA Final SCMPE Question Bank

Leave a Comment / CA Final / By Raju / April 10, 2023 April 10, 2023

Pricing Decision – CA Final SCMPE Question Bank is designed strictly as per the latest syllabus and exam pattern.

Pricing Decision – CA Final SCMPE Question Bank

Question 1.
Answer the following question:
Distinguish clearly between the skimming pricing policy and penetration pricing policy. (Nov 2016, 4 marks)
Answer:
Concept of Skimming Pricing Policy:
Skimming pricing is a policy of charging high prices during the early period of a product’s existences and in the later years the prices are gradually reduced. The reasons for following such a policy are:

Inelastic Demand:
The demand is likely to be inelastic in the earlier stages till the product is established in the market. The firm can take advantage of high prices.

Sales Boost:
The change of high price in the initial periods serves to skim the cream of the market that is relatively insensitive to price. The gradual reduction in price in the later year will tend to increase the sales.

Assured Profit:
This method is preferred in the beginning because in the initial periods when the demand for the product is not known, the price covers the initial cost of production contribution is guaranteed.

Cost-Revenue Matching:
High initial capital outlays needed for manufacture, results in high cost of production. Also, the manufacturer has to incur huge promotional activities resulting in increased costs. High initiaJ prices will be able to finance the cost of production gradually, the economies of scale and savings in costs are passed on to customers.

Penetration Pricing Strategy:
1. Penetration pricing is a policy of using a low price as the principal instrument for penetrating mass market method is used for pricing a new product and to popularise it initially.

2. Profit may not be earned in the initial stages. However, prices may be increased as and when the established and its demand picks up.

3. The low price policy is introduced for the purpose of Long-term survival and profitability. Hence, careful analyses scope for market expansion and considerable amount of research and forecasting are necessary before determining price under this strategy.

4. The circumstances in which Penetrating Pricing can be adopted are:
Elastic demand:
The demand of product is high when price is low. Hence, lower prices means large and so more profits.

Mass production:
When there are substantial savings in Large-scale production, increase in demand by the adoption of low pricing policy.

Frighten off competition:
The prices fixed at a Low-level act as an entry barrier to the prospectiveness. The use of this policy by existing firms will discourage the new firms to enter the market. This pricing policy known or “stay-out-pricing”.

Question 2.
Briefly explain skimming pricing and penetration pricing policies. (Nov 2008, 4 marks)
Answer:
Skimming Pricing Policy: It is the pricing policy adopted for fixing the price of a new product. It is a policy where the prices are kept high during the early period of a products existence. This is due to the reason that whenever a product is launched the firm has to ihcur heavy promotional expenses on the product which it tries to recover by keeping the price high. In the later years the price is gradually reduced. It is called skimming price policy as charging of high prices during the initial period serves to skims the cream of the market that is relatively in sensitive to price..The gradual reduction of price is the later years will tend to increase the sales.

Circumstances in which it should be adopted
This policy is however preferable only in the initial years as during this period when the demand of the product is not known the high price covers the cost of production and other associated costs.

High initial capital outlays, needed for manufacture result in high cost of production. Added to this, the manufacturer has to incur huge promotional activities resulting in increased costs. High initial price will be able to finance the cost of production particularly when uncertainties block the usual sources of capital.

Penetration Pricing Policy : In order to popularize a new product and to penetrate mass market as quickly as possible firms tend to fix the selling price relatively low. This policy is known as Penetration Pricing Policy.

The firm may not earn profit by resorting to this policy at the initial stage. The low pricing policy is introduced for the sake of long-term survival and profitability and hence it has to receive careful consideration before implementation. Later on the price may be increased as and when the demand increases. It is opposite of skimming price policy. It needs an analysis of the scope for market expansion and hence considerable amount of research and forecasting are necessary before determining the price.

Features:

This strategy favours using a low price as a principal instrument for penetrating mass markets early.
It is generally used for a new product.
The strategy is for long time survival.
It requires considerable amount of research.
Once the product establishes itself in the market, the price may be increased.
Also known as stay out pricing when used for an established product at any stage of product life cycle to avoid competition.

Circumstances in which this policy can be adopted:
1. Elastic demand:
The demand of product is high when price is low. Hence, lower prices means large and so more profits.

2. Mass production:
When there are substantial savings in Large-scale production, increase in demand by the adoption of low pricing policy.

3. Frighten off competition: .
The prices fixed at a Low-level act as an entry barrier to the prospectiveness. The use of this policy by existing firms will discourage the new firms to enter the market. This pricing policy known or “stay-out- pricing”.

Question 3.
Explain briefly the concept of skimming pricing policy. (Nov 2009, 2 marks)

Question 4.
What is Price Discrimination? Under what circumstances it is possible? (May 2010, 4 marks)
Answer:
Price discrimination is charging different prices of the same product with respect to customers, products, places and time.
It is possible when

The market being capable of being segmented
The customers is not able to resell the product at a higher price
The competitors’ underselling is not possible.

Types:

1. Price Discrimination on the Basis of Customer	In this case, the same product is charged at different prices to different customers. It is, however, potentially disruptive of customer relations.
2. Price Discrimination Based on Product Version	In this case, a slightly different product is charged at a different price regardless of its cost-price relationship.
3. Price Discrimination Based on Place	An example of this method is the seats in cinema theatre where the front seats are charged at lower rates than the back seats.
4. Price Discrimination Based on Time	An example of this method is the practice of giving off-season concession in sale of fans or refrigerators just after the summer season.

Question 5.
What are the disadvantages of Cost Plus Pricing? (May 2011, 5 marks)
Answer:
Disadvantages of Cost Plus Pricing:

In many decision, incremental costs are more relevant than full cost. This is ignored.
Fails to reflect competition adequately.
Fixed Overheads depends on volume if volume is more cost is less, and vice-versa Increase/decrease in sales volume depends on price. Therefore it is a vicious circle- cost plus markup is a price based on sales volume & sales volume is based on price.
It ignores demand, facts to take into account buyers’ needs and willingness to pay.
Assumes correct cost estimation, whereas in multi product firm, costs may be arbitrarily allocated.

Question 6.
State the pricing policy most suitable in each of the following independent situations: (Nov 2011, 4 Marks)
(i) The company makes original equipments and does defense contract work. There are other companies which also undertake such projects.
(ii) The product made by a company is new to the market. It is expected to enjoy a long-term demand. Competition is expected very soon, since the product will be desirable to most customers.
(iii) Stock of processed ready-to-eat products, whose shelf-life will soon be over in the next 2 months. The product is going to be discontinued.
(iv) A company sells a homogeneous product in a highly competitive market. (Candidates need to only write the pricing policy with the corresponding sub¬division numbers of the questions. The situations need not be copied into the answer books).
Answer:
(i) Sealed Bid Pricing
(ii) Penetration Pricing
(iii) Any price that the market will pay (even below variable cost any cash received)
(iv) Going rate pricing or market price

Question 7.
Answer the following:
Explain briefly Pareto analysis and mention some of its uses. (Nov 2011, 4 marks)
Answer:
Pareto Analysis:
Pareto Analysis is a rule that emphasizes to focus on the most important aspects of decision making in order to simplify the process of decision making. Pareto Analysis is based on the 80 : 20 rule that was a phenomenon first observed by Vifredo Pareto, a nineteenth century Italian economist. He noticed that 80% of the wealth of Milan was owned by 20% of its citizens.

This phenomenon can be observed in many different business situations. The analysis of the total sales revenue might indicate that approximately 80% of its total sales revenue is earned from 20% of its products. Pareto Analysis provides the mechanism to control and direct effort by fact, not by emotions. It helps to clearly establish top priorities and to identify both profitable and unprofitable targets.

Usefulness of Pareto Analysis:

To prioritize problems goals and objectives.
To identify root causes.
To select and define key quality improvement programs.
To select key customer relations and service programs.
To select key employee relations improvement programs.
To select and define key performance improvement programs.
To maximize research and product development time.
To verify operating procedures and manufacturing processes.
To allocate physical, financial and human resources.

Question 8.
Answer the following:
List out the qualities required for a good pricing policy. (May 2013, 4 marks)
Answer:
Qualities required for a good pricing policy:
The pricing policy plays an important role in a business because the long run survival of a business depends upon the firm’s ability to increase its sales and device the maximum profit from the existing and new capital investment.

Whereas cost is an important aspect of pricing, consumer demand and competitive environment are frequently far more significant in pricing decisions.

The pricing policy structure should:

encourage optimum utilisation of resources;
work towards better balance between demand and supply;
avoid adverse effects on the rest of the economy;
provide an incentive to producer for adopting improved technology and maximising production;
promote exports.

Question 9.
Answer the following:
How is Pareto analysis helpful in pricing of products in the case of a firm dealing with multiple products? (May 2014, 4 marks)
Answer:
In the case of firm dealing with multi-products, it would not be possible for it to analyse price-volume relationship for all of them.

Pareto analysis is used for analysing the firms estimated sales revenue from various products and it might indicate that approximately 80% of its total sales revenue is earned from about 20% of its products. Such analysis helps the top management to delegate the pricing decision, for approximately 80% of its product to the lower level of management, thus freeing them to concentrate on the pricing decisions for products approximately 20% of which is essential for the company’s survival.

Therefore, a firm can adopt more sophisticated pricing methods for small proportion of products that jointly account for 80% of total sales revenue.

For the remaining 80% products, which account for 20% of the total sales value the firm may use cost based pricing method.

Question 10.
Answer the following:
What are the applications of Pareto Analysis in customer profitability analysis? (May 2015, 4 marks)
Answer:
Application of Pareto Analysis in Customer Profitability Analysis:

In practice, it is generally found that 20% of customers generate 80% of the profit.
There are always be some customers who are less profitable than others.
Pareto Analysis is useful for evaluation of the portfolio of customer profile.
Management can plan accordingly in which area and which product is to be produced and distributed.

Pareto Analysis can be applied in customer profitability analysis in the following manner:

Identify most profitable customers.
Manage each customer’s costs-to-serve.
Discontinue unprofitable customer segment.
Shift a customer’s purchase mix towards higher- margin products and service lines.
Offer discounts to attract profitable customers.
Choose types of after sale services to provide.

Question 11.
Answer the following:
State the most appropriate pricing policy to be adopted in the following independent situations: (Nov 2015, 4 Marks)
(Situations need not be copied. Only the Roman numeral and policy need to be mentioned in the answer book.).
(i) Modern patented drug entering the market.
(ii) The latest version Of a mobile phone is being launched by an – established, financially strong company.
(iii) An established company has recently entered the stationery market segment and launched good quality paper for printing at home and office.
(iv) A car manufacturer is launching an innovative, technologically advanced car in the highly priced segment.
Answer:
Pricing Policy
(i) Skimming Pricing
(ii) Penetration Pricing
(iii) Market Price
(iv) Skimming Pricing

Question 12.
Answer the following question:
What is penetration pricing? What are the circumstances in which this policy can be adopted? (May 2016, 4 marks)

Question 13.
Answer the following question:
Enumerate the uses of Pareto Analysis. (Nov 2016, 4 marks)

Question 14.
Answer the following: (Nov 2017, 4 Marks)
(a) (i) Define Pricing Strategy
(ii) State the Market Entry Strategies of pricing applicable in the following situations:
(1) Inelastic demand
(2) Mass Production
(3) Assured profit
(4) Elastic demand
Answer:
(i) Pricing Strategy:
Pricing strategy is defined as a broad plan of action by which an organization intends to reach its goal. Some illustrative strategies are:

Expanding product lines that enjoy substantial brand equity.
Offer quantity discounts to achieve increase in sales volume.

(ii) Market Entry Strategy applicable In following situations:

Situation

Strategy

1. Inelastic Demand

2. Mass Production

3. Assured Profit

4. Elastic Demand

Skimming Pricing

Penetration Pricing

Skimming Pricing

Penetration Pricing

Question 15.
(i) Name any two competition-based pricing methods. (May 2019, 2 marks)
Answer:
Competition based Pricing’methods:

Going Rate Pricing.
Sealed Bid Pricing

Question 16.
State the most appropriate pricing policy to be adopted in the following independent situations : (Nov 2020, 5 Marks)
(Situations need not be copied. Only policy name is required.)
(i) The company manufactures original equipment and does railways contract work. Other companies are also there in the market who also undertake similar projects.
(ii) Patented Drug for COVID 19 ready to be launched in the market.
(iii) A bike manufacturer is launching an innovative, technologically advanced bike in the highly priced segment.
(iv) A company making a variant of sanitizers, trying to enter the market, the same varieties of sanitizers are already successfully capturing the market.
(v) A successful mobile manufacturing company has built into its latest tablet, an additional sliding screen and improved processing capabilities so that the tablet is almost a laptop.

Question 17.
A company has prepared the following budget for the forthcoming year: (Nov 2008, 7 Marks)

The policy of the company in fixing selling prices is to charge all overheads other than the prime costs on the basis of percentage of direct wages and to add a mark up of one-ninth of total costs for profit.

While the company is confident of achieving the budget drawn up as above, a new customer approached the company directly for execution of a special order. The direct materials and direct labour costs of the special order are estimated respectively at ₹ 36,000 and ₹ 64,000. This special order is in excess of the budgeted sales as envisaged above. The company submitted a quotation of ₹ 2,00,000 for the special order based on its policy. The new customer is willing to pay a price of ₹ 1,50,000 for the special order. The company is hesitant to accept the order below total cost as, according to. the company management, it will lead to a loss.

You are required to state your arguments and advise the management on the acceptance of the special order.
Answer:
Analysis of Cost and profit:

Rate of profit on costs (2/18) = 1/9
Overhead absorption rate based on direct wages = (8.00/6.40) × 100 of direct wages
Break up of new order :

The following points emerge:

Factory overheads only are to be recovered on the basis of direct wages.
The special order is a direct order. Hence commission is not payable.
The budgeted sales are achieved. Hence all fixed overheads are recovered. Hence, no fixed overheads will be chargeable to the special order.

Based on the above, the factory variable overheads recovery rate may be calculated as under:
Total variable factory overheads – ₹ 2.20 lakhs
Direct wages – ₹ 6.40 lakhs
Factory overhead rate = (2.20 / 6.40) × 100 = 34.375%

Applying this rate the cost of the special order will be as under:

Hence, the order is acceptable at the price of ₹ 1,50,000.

Question 18.
Hind Metals Manufactures an aHoy product ‘Incop’ by using iron and Copper. The metals pass through two plants, X and Y. The company gives you the following details for the manufacture of one unit of Incop: (Nov 2009, 6 marks)
Materials : ron 10 kgs. @ 5 per kg.
Copper : 5kg @ 8 per kg.
Wages : 3 hours @ 15 per hour in Plant X.
5 hours @ 12 per hour in Plant Y.
Overhead recovery : On the basis of direct labour hours.
Fixed overhead : ₹ 8 per hour in Plant X.
₹ 5 per hour in Plant Y.
Variable overhead : ₹ 8 per heur in Plant X.
₹ 5 per hour in Plant Y.
Selling overhead : (fully variable) – ₹ 20 per unit.

(i) Find out the minimum price to be fixed for the alloy, when the alloy is new to the market. Briefly explain this pricing strategy.
(ii) After the alloy is well established in the market. What should be the minimum selling price? Why?
Answer:

(i) If pricing strategy is to penetrate the market, the minimum price for a new product should be the variable cost i.e. ₹ 264/-. In some circumstances, it can also be sold below the variable cost, if it is expected to quickly penetrate the market and later absorb a price increase. Total Variable Cost is the penetration price.

(ii) When the alloy is well established, the minimum selling price will be the total cost – including the fixed cost i.e. ₹ 313 per unit. Long run costs should cover at least the total cost.

Question 19.
Attempt:
Calculate the selling price per unit to earn a return of 12% net on capital employed (net of tax @ 40%). The cost of production and sales of 80,000 units are: (Nov 2010, 4 marks)
Variable cost including material cost : ₹ 9,60,000
Fixed overheads : ₹ 5,00,000
The fixed portion of capital employed is X 12 lakhs and the varying portion is 50% of sales turnover.
Answer:
Let ‘X’ be the selling price per unit, Therefore, Turnover = 80,000 x
Capital Employed = 12,00,000 + 8,000 x
Return on capital employed after tax = 12%
Therefore,
Return on capital employed before tax = 12/0.6 = 20%
Therefore,
Return on capital employed before tax = 20% of (12,00,000 + 40,000x)
= 2,40,000 + 8,000X
Sales = 80,000x
Variable Cost = 9,60,000
Fixed Cost = 5,00,000
Profit = 80,000 x – 14,60,000
Therefore
80,000 x – 14,60,000 = 2,40,000 + 8,000 x
72,000 x = 17,00,000
x = ₹ 23.61

Alternative Answer:
Selling price per unit should cover Variable cost unit, Fixed Cost per unit and ROCE per unit.
Fixed Capital Employed = ₹ 12 lacs
Required Return (net of tax) = 12% = ₹ 1,44,000
Pre tax return = 1,44,000 / 0.6 = ₹ 2,40,000
Let Selling Price per unit = x
X = (14,60,000 + 2,40,000)/80,000 + (12% of 50% of X)/0.6
= 17,00,000/80,000 + (6/100 × 1/0.6) x
X(1 – 0.1) = 21.25
X = 21.25/0.9 = ₹ 23.61 per unit
Required Selling price = ₹ 23,61
If a student has arrived at ₹ 23.61, full 4 marks may be given even if the intermediary steps are not adequately shown.

Question 20.
Answer the following:
6000 pen drives of 2 GB are to be sold in a perfectly competitive market to earn ₹ 1,06,000 profit, whereas in a monopoly market only 1200 units are required to be sold to earn the same profit. The fixed costs for the period are ₹ 74,000. The contribution per unit in the monopoly market is as high as three fourths its variable cost. Determine the target selling price per unit under each market condition. (May 2011, 4 marks)
Answer:

Question 21.
The Board of Directors of XY Company Limited are considering a new type of handy sewing machine which their R & D Department has developed. The expenditure so far on research has been ₹ 95,000 and a consultant’s report has been prepared at a cost of ₹ 22,500. The report provides the following information: (Nov 2012, 12 marks)
Cost of production per unit:

Anticipated additional fixed costs:
Rent for additional space ₹ 1,25,000 per annum
Other additional fixed costs ₹ 70,000 per annum
A new machine will be built with the aiailable facilities with a cost of ₹ 1,10,000 (material 90,000 and labour ₹ 20,000). The materials are readily available in stores which are regularly used. However, these are to be replenished immediately. The price of these materials have since been increased by 50%. Scrap value of the machine at the end of the 10^th year is estimated at ₹ 20,000. The product scraps generated can be disposed off at the end of year 10 for a price of ₹ 1,43,000.

It is estimated that the commercial life of the machine will be no longer than 10 years and the after tax cost of capital is 10%. The full cost of the machine will be depreciated on straight line basis, which is allowed for computing the taxable income, over a period of 10 years. Tax rate is 30%.
DCF factors at 1 0%:
1 – 5 years (cumulative) – 3.79
6 – 10 years (cumulative) – 2.355
10^th year – 0.386

Required:
Compute minimum selling price for the handy sewing machine.
Answer:
(i) Expected Sales Volume:
Years 1-5: (40,000 × 0.15 + 20,000 × 0.60 + 12,000 × 0.25) = 21,000 units
Years 6-10: (24,000 × 0.30 +1 6,000 × 0.50 + 4,000 × 0.20) = 16,000 units

(ii) Capital Cost:

(iii) Production Variable Cost:

(iv) Profitability:

(v) Cash inflow in the Terminal Year (year 10)

	₹
Sale Value of the Machine Scrap Realization Total Tax@ 30% After Tax Cash Inflow	20,000 1.43.000
	1,63,000 48,900
	1.14.100

(vi) Present Value of Cash Flows:

Details	Year 0	Year 1-5	Year 6-10	Year 10
Capital Cost	1,55,000	–		–
Cash Flow from Operation	–	14.700X – 18,95,850	11.200X – 14,75,850	–
Cash Flow Terminal Year	“	–	–	1,14,100
Discount Factor	1	3.79	2,355	0.386
Present Value of Cash Flows	-1,55,000	55,713X – 71,85,271.50	26,376X – 34,75,626.70	44,042.6

(vii) Net Cash Inflows:
= (-1,55,000) + (55,713X – 71,85,271,50) + (26,376X – 34,75,626.70) + (44,042.60)
= 82,089X – 1,07,71,855.60

(viii) Computation of Minimum Selling Price
For determining Minimum Selling Price, Net Cash Inflows should be equal to zero:
82,089 X – 1,07,71,855.60 = 0
Or X = 131.22
Minimum selling price is ₹ 131.22
Note:
(a) R&D expenses of ₹ 95,000 is not relevant.
(b) Fee for consultant’s report of ₹ 22,500 is not relevant.
(c) Tax element on irrelevant costs not considered, since the benefit will arise even without this product.

Question 22.
HTM Ltd., by using 12,00,0000 units of a material M produces jointly 2,00,000 units of H and 4,00,000 units of T. The costs and sales details are as under: (May 2013, 5 Marks)

Direct material M @ X 5 per unit – ₹ 60,00,000
Other variable costs – ₹42,00,000
Total fixed costs – ₹ 18,00,000
Selling price of H per unit – ₹ 25
Selling price of T per unit – ₹ 20

The company receives an additional order for 40,000 units of T at the rate of ₹ 15 per unit. If this order has been accepted, the existing price of T will not be affected. However, the present price of H should be reduced evenly on the entire sale of H to market the additional units to be produced.

Find the minimum average unit price to be charged on H to sustain the increased sales.
Answer:
Product H & T are joint products and produced in the ratio of 1:2 from the same direct material- M.

Production of 40,000 additional units of T results in production of 20,000 units of H.

Computation of contribution under existing situation

Let Minimum Average Selling Price per unit of H is ₹ X
Computation of contribution after acceptance of additional order of ‘T’

Minimum Average Selling Price per unit of H
Contribution after additional order of T = Contribution under existing production
⇒ 2,20,000 X – 26,20,000 = 28,00,000
⇒ 2,20,000 X = 54,20,000
⇒ X = $\frac{54,20,000}{2,20,000}$ = ₹ 24.64
Minimum Average Selling Price per unit of H is ₹ 24.64

Question 23.
State the appropriate pricing policy in each of the following independent situations: (Nov 2013, 4 marks)
(i) ‘A’ is a new product for the company and the market and meant for large scale production and long term survival in the market. Demand is expected to be elastic.
(ii) ‘B’ is a new product for the company, but not for the market. B’s success is crucial for the company’s survival in the long term.
(iii) ‘C’ is a new product to the company and the market. It has an inelastic market. There needs to be an assured profit to cover high initial costs and the ususal sources of capital have uncertainties blocking them.
(iv) ‘D’ is a perishable item, with more than 80% of its shelf life over.
Answer:
(i) Penetration Pricing.
(ii) Market Price or Price just below market price.
(iii) Skimming Pricing.
(iv) Any cash realizable value.

Question 24.
A shoe manufacturer has a net profit of ₹ 25 per pair on a selling price of ₹ 143. He is producing 6,000 pairs per annum which is 60% of the potential capacity. The cost per pair is as under: (Nov 2014, 5 marks )
Direct materials – ₹ 35.00
Direct wages – ₹ 12.50
Work overheads (50% fixed) – ₹ 62.50
Administrative overheads (75% fixed) – ₹ 6.00
During the current year the manufacturer also estimates demand of 6,000 pairs but anticipates that the fixed charges to go up by 10% while the rate of direct labour and direct materials will increase by 8% and 6% respectively. But he has no option of increasing the selling price. Under this situation he obtains an offer to utilise further 20% of capacity. What minimum price will you recommend to ensure an overall profit of ₹ 1,67,300?
Answer:
Calculation of Profitability at 6,000 Pairs Activity

Particulars	Existing Price Level Amount (₹)	Revised Price Level Amount (₹)
Selling Price per pair (A)	143.0C	143.00
Variable Costs:
Direct Materials	35.00	37.10 (₹ 35 × 1.06)
Direct Wages	12.50	13.50 (₹ 12.5 × 1.08)
Works Overhead (50% of ₹ 62.50)	31.25	. 31.25
Administration Overhead (25% of ₹ 6)	1.50	1.50
Total Variable Cost per pair (B)	80.25	83.35
Contribution per pair (C) = (A) – (B)	62.75	59.65
Total Contribution (O)	3,76,500	3,57,900
Fixed Costs
Works Overhead (6,000 pairs × ₹ 31.25)	1,87,500	2,06,250 (₹ 1,87,500 × 1.1)
Administration Overhead (6,000 pairs × ₹ 4.50)	27,000	29,700 (₹ 27,000 × 1.1)
Other Fixed Overheads (Note)	12,000	13,200 (₹ 12,000 × 1.1)
Total Fixed Costs (E)	2,26,500	2,49,150
Profit (D) – (E)	1,50,000	1,08,750
Desired Profit	—	1,67,300
Additional Profit (₹ 1,67,300 – ₹ 1,08,750)	—	58,550
Additional Offer ($\frac{6,000}{60 \%}$ × 20%)		2,000 Pairs
Profit per pair		29.275

Note:
Other Fixed Overhead = Contribution – Profit – (Fixed Works Overheads + Fixed Administration Overheads)
Selling Price per pair = Variable Cost per pair + Profit per pair
= ₹ 83.35 + ₹ 29.275 = ₹ 112.625 or ₹ 112.63
Therefore, minimum selling price per pair for the additional offer shall be ₹ 112.63

Important Note:
Selling price is ₹ 143 per pair and net profit is ₹ 25 per pair, hence, total cost per pair at the existing level should be ₹ 118 (₹ 143 – ₹ 25). However, the total cost per pair given is ₹ 116. It is assumed that balance ₹ 2 per pair (₹ 118 – ₹ 116) is Other Fixed Overheads.

Alternative Treatment: This problem can also be solved by assuming the difference of ₹ 2 as Other Variable Costs with an anticipation that it will not change in the revised situation.

Question 25.
An IT company produces a CD, particulars of which are detailed below: (Nov 2014, 5 marks)
Annual Production (Units) – 40,000
Cost per Annum (₹)

Material – 1,00,000
Other variable cost – 1,20,000
Fixed cost – 80,000
Apportioned Investment (₹) – 3,00,000

Determine the unit selling price under two strategies mentioned below.
Assume company’s tax rate as 30%
(i) 20% return on investment.
(ii) 6% profit on list price, when trade discount is 40%.
Answer:
Calculation of Selling Price:
(i) Selling price to yield 20% return on investment:
Investment – 3,00,000
ROI 20% – 60,000
Tax – 30%
= PAT 100 – 30 = 70%
Pretax Profit $\frac{60,000}{70}$ × 100 = 85,714
Sales = Cost + Return
= 3,00,000 + 85,714 = ₹ 3,85,714
Output = 40,000
Sales 1 unit
= 3,85,714/40,000
= 9.64 per unit.

(ii) Selling price to yield 6% profit on list price:
Let ‘K’ be the List Sales
{List Sales (1 – trade Discount)- Total Cost} × (1 – Tax Rate) = 0.06K
{K(1 – 0.40) – 3,00,000} × (1 – 0.30) = 0.06K
{0.60 K – 3,00,000} × 0.7 = 0.06 K
0.36 K = 2,10,000
K = ₹ 5,83,333.33
List Sales Price per unit is ₹ 14.58 $\left(\frac{₹ 5,83,333.33}{40,000 \text { units }}\right)$
Net Selling Price per unit is ₹ 8.75 (₹ 14.58 – 40% of ₹ 14.58)

Question 26.
A company produces a single product ‘Impex’.
For an annual sales of 40,000 units of Impex, fixed overhead is ₹ 5,50,000. The variable cost per unit is ₹ 60. Capital employed in fixed assets is ₹ 8,00,000 and in current assets is 50% of net sales (i.e. sales less discount). The company sells goods at 20% discount on the maximum retail price (M.R.P.),which is ₹ X per unit. The company wants to earn a return of 25% before tax on capital employed in fixed and current assests. (May 2015, 5 marks)
Answer:
Selling Price p. u. = x
Total Sales = 40,000 x
Selling price after discount = 0.80 x [x – 0.2x]
Units = 40,000
Variable Cost = 40,000 × 60
= 24,00,000
Capital Employed = Fixed Assets + Current Assets
= 8,00,000 + 0.5 (40,000 × 0.8x)
Fixed Cost = 5,50,000
Total Cost = 24,00,000 + 5,50,000
= 29,50,000
Required Return = 0.25 [8,00,000 + 0.5 (40,000 × 0.8x)]
Now,
Sales = Total cost + Required return
∴ 40,000 × 0.88x = 29,50,000 + 0.25 [8,00,000 + 0.5 (40,000 × 0.8x)]
∴ 32,000 x = 29,50,000 + 0.25 [8,00,000 + 16,000x]
= 29,50,000 + 2,00,000 + 4,000x
∴ x = 112.50
After Discount Sales Price = 112.50 – 20% of 112.50
= ₹ 90

Question 27.
The budgeted cost data of a product manufactured by XYZ Co. Ltd. is furnished as below: (Nov 2015, 4 marks)
Budgeted units to be produced – 200000
Variable cost (₹) – 32 per unit
Fixed cost (₹) – 16 lacs
It is proposed to adopt cost plus pricing approach with a mark up of 25% on full budgeted cost basis.

However, research by the marketing department indicates that demand of the product in the market is price sensitive. The likely market responses are as follows:

Selling price (₹ per unit)	44	48	50	56	60
Annual Demand (units)	168000	152000	140000	128000	108000

Analyse the above situation and determine the best course of action.
Answer:
Analysis of Cost plus Pricing Approach
The company has a plan to produce 2,00,000 units and it proposed to adopt Cost plus Pricing approach with a markup of 25% on full budgeted cost. To achieve this pricing policy, the company has to sell its product at the price calculated below:

Quantity	2,00,000 units
Variable Cost (2,00,000 units × ₹ 32)	64,00,000
Add: Fixed Cost	16,00,000
Total Budgeted Cost	8000000
Add: Profit (25% of ₹ 80,00,000)	20,00,000
Revenue (need to earn)	1,00,00,000
Selling Price per unit $\left(\frac{₹ 1,00,000}{2,00,000 \text { units }}\right)$	50 p.u.

However, at selling price ₹ 50 per unit, the company can sell 1,40,000 units only, which is 60,000 units less than the budgeted production units.

After analyzing the price-demand pattern in the market (which is price sensitive), to sell all the budgeted units market price needs to be further lowered, which might be lower than the total cost of production.

Statement Showing “Profit at Different Demand & Price Levels”

	I	II	III	IV	Budgeted
Qty. (units)	168000	152000	140000	128000	108000
	₹	₹	₹	₹	₹
Sales	7392000	7296000	7000000	7168000	6480000
Less: Variable Cost	5376000	48,64,000	44,80,000	4096000	3456000
Total Contribution	2016000	2432000	25,20,000	30,72,000	3024000
Less: Fixed Cost	1600000	1600000	1600000	16,00,000	1600000
Profit (₹)	416000	832000	920000	1472000	1424000
Profit (% on total cost)	5.96	12.87	15.13	25.84%	28.16%

(i) Taking the above calculation and analysis into account, the company should produce and sell 1,28,000 units at ₹ 56. At this price company will not only be able to achieve its desired mark up of 25% on the total cost but can earn maximum contribution as compared to other even higher selling price.

(ii) If the company wants to uphold its proposed pricing approach with the budgeted quantity, it should try to reduce its variable cost per unit for example by asking its supplier,to provide a quantity discount on the materials purchased.

Question 28.
The following independent situations relate to new product pricing. Classify the products into the appropriate category: Revolutionary Product (RP), or Evolutionary Product (EP) or a Me-Too Product (MP) and state the corresponding pricing to be followed: (May 2017, 5 marks)

Answer:

SI. No. I	RP/EP/MP III	Pricing IV
(i)	Me – too Products (MP)	The me – too products are price takers as the price is determined by the market mainly by the competitive forces.
(ii)	Revolutionary Product (RP)	Revolutionary Product may enjoy the premium price as a reward for its innovation and taking first initiative.
(iii)	Evolutionary Product (EP)	The Evolutionary Products are price takers as the price is determined by the market mainly by the competitive forces.

Question 29.
The following information is given about the type of defects during a production period and the frequencies of their occurrence in a spectacle manufacturing company: (May 2017, 4 marks)(5 marks)
Defect – No. of items
End Frame not equidistant from the centre – 10
Non-uniform grinding of lenses – 60
Power mismatches – 20
Scratches on the surface – 110
Spots/Stains on lenses – 5
Rough edges of lenses – 70
Frame colours-shade differences – 25
Construct a frequency table so that a Pareto Chart can be constructed for the defect type. Which areas should the company focus on?
Answer:
The Frequency table indicating the frequency of occurrence of defects in decreasing order of their occurrence will be as follows:

Defect Type	No. of Items	(%)	Cumulative (%)
Scratches on the surface	110	36.6667	36.6667
Rough edges of lenses	70	23.3333	60.0000
Non uniform grinding of lenses	60	20.0000	80.0000
Frame colors shade differences	25	8.3333	88.3333
Power mismatches	20	6.6667	95.0000
End frame not equidistant from the centre	10	3.3333	98.3333
Spots/Stains on lenses	5	1.6667	100.00

The Pareto Chart is constructed for defect type:

The purpose of Pareto Chart in this example is to direct attention to area where best returns can be achieved by solving most of the quality problems, perhaps just with a single action. In this case, use of good quality raw material say plastic may solve some percentage and handled property some percentage may be overcome.

Question 30.
Sun Chemicals Co., is engaged in manufacturing many chemical products. It is using many chemicals some of which are fast moving, some are slow moving and few are in .non-moving category. The company has a stock of 10 units of one non-moving toxic chemical. Its book value is ₹ 2400, realizable value is ₹ 3,500 and replacement cost is ₹ 4,200. (Nov 2018)

One of the customers of the company asks to supply 10 units of a product which needs all the 10 units of the non-moving chemical as an input. The other costs associated with the production of the product are:
Allocated overhead expenses ₹ 16 per unit.
Out of pocket expenses ₹ 50 per unit.
Labour cost ₹ 40 per hour. For each unit two hours are required.
Other material cost ₹ 80 per unit.
The labour force required for the production of the product will be deployed from among the permanent employees of the company. This temporary deployment will not lead to any loss of contribution.

Required:
(i) Recommend the minimum unit price to be charged to the customer without any Eoss to the company. (4 marks)
(ii) Analyse with reasons for the inclusion or exclusion of each of the cost associated with the production of the product. (4 marks)
(iii) Advice a pricing policy to be followed by Sun Chemical in perfect competition. (2 marks)
Answer:
(i), (ii) Since minimum price is to be calculated, it means Recovery of Relevant Costs.
Statement of Relevant Cost

Notes:

Book value is always irrelevant as it is historical and sunk cost.
Replacement Cost:

Since stock is available, and no excess is required, we will not purchase anything from outside and hence Replacement Cost is irrelevant.

(iii) Under Perfect Competition, firm has no pricing policy of its own as the sellers are price takers, i.e. to accept the price determined by the market. There ¡s no control over market price which the buyers are willing to buy. The firm has to take a decision in favour of the quantity to sell. The firm can continue to produce as long as its marginal cost is less than or equal to its selling price, upto the point at which the marginal cost is equal to price, increase in output will add to revenue and thereafter the increase will be added to cost.

Question 31.
Amber Ltd. is a leading company in the Footwear Industry. The company has four factories in different locations with state of the art equipments. Due to competition in the market, company is continually reviewing its product range and enhancing its existing products by developing new models to satisfy the demands of its customers. (May 2019)

The company currently has a production facility which has a capacity of 3500 standard hours per week.

Product ‘Comfort’ was introduced to the market six months ago and is now about to enter the maturity stage of its life cycle.

However, research by the marketing department indicates that demand of the product ‘Comfort’ in the market is price sensitive. The likely market responses are as follows:

The variable cost per unit of manufacturing ‘Comfort’ is ₹ 750.
Standard hours used to manufacture one unit is 2 hours.

Product 1 Sports’ was introduced to the market two months ago using a penetration pricing policy and is now about to enter its growth stage, Each unit has a variable cost of ₹ 545 and takes 2.50 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 ₹ 1,000 per unit demand is expected to be 1000 units per week. For every ₹ 100 increase in selling price the weekly demand will reduce by 200 units and for every ₹ 100 decrease in selling price the weekly demand will increase by 200 units.

Product ‘Ethnic’ is currently being developed and which is about to be launched in the market. This is a highly innovative designer product which the company believes that it will have a revolutionary impact on the market and consumer behaviour. The company has decided to use a market skimming approach to pricing this product during its introduction stage.

Required:
(a) (i) Advise which of the above five selling prices should be charged for product ‘Comfort’, in order to maximize its contribution during its maturity stage. (3 marks)
(ii) Calculate the number of units to be produced of product ‘Sports in order to utilize all of the spare capacity from your answer to (i) above and the selling price per unit of product ‘Sports’ during its growth stage. (2 + 3 = 5 marks)
(b) Compare penetration and skimming pricing strategies during the introduction stage, using product ‘Ethnic’ to illustrate your answer. (4 marks)
(c) Explain with reasons, for each of the stages of ‘Ethnic’s product life cycle, the changes that would be expected in the
(i) average unit production cost
(ii) unit selling price. (4 + 4 = 8 marks)
Answer:
(a)
(i) Statement Showing Contribution at Different levels:

Since there is maximum contribution in (4) above, so selling price should be charged for product ‘Comfort’ is ₹ 1,450 per unit.

(ii) Capacity in terms of standard hours per week is 3,500 hrs.
To produce product comfort as per (i) above that is for selling price per unit ₹ 1,450 and sales demand per week of 1,150 units, total standard hours required are = 1,150 units × 2 hours per unit
= 2,300 standard hours
So, spare capacity in terms of hrs
= 3,500 hrs – 2,300 hrs
= 1,200 standard hours
Each unit of Product ‘Sport’ takes 2.50 standard hours to produce,.
So, No. of units of ‘Sport’ Produced = $\frac{1,200 \text { standard hrs }}{2.5 \text { std. hrs Perunit }}$
No. of units of product ‘Sport’ = 480 units produced.
From the given sensitivity we analyse that:
a = 1500
b = 0.5
x = 480 Units
So, Selling Price = P = a – bx
= 1,500 – 0.5 (480)
P = ₹ 1,260

(b) During the introduction stage, skimming policy with high prices, but low profit margin due to high fixed costs. Growth stage – Re duce price to penetrate market further. Maturity stage – Price to match or beat competitor. Decline Stage – cut price if not responding.

In case of product Ethnic which is newly launched in the market the company can higher the prices and will have to keep profit margin to be low due to high fixed costs
For Penetration Policy to enter the market and gain a high share quickly or to prevent competitors from entering. Maturity stage – Retain higher prices in some market segments Decline stage – Some increases in prices may occur in the late decline stage.

These are likely to reduce for a number of reasons:
Direct Materials are being bought in larger quantities and therefore Amber Ltd. may be able to negotiate better prices from its suppliers thus causing unit material costs to reduce.
Direct labour costs may be reducing if the product is labour intensive due to the effects of the learning and experience curve.
Other variable overhead costs may be reducing as larger batch, sizes reduces the cost of each unit.
Fixed production costs are being shared by a greater no. of units.

(ii) Unit Selling Price:

These are likely to be reducing for a number of reasons:
The product will become less unique as competitors use reverse engineering to introduce their versons of the product.
Amber Ltd. may wish to discourage competitors from entering the market by lowering the price and thereby lowering the unit profitability.
The price needs to be lowered so that the product becomes attractive to different market segments thus increasing demand to achieve the growth is sales volume.

2. Maturity Stage:
Compared to the growth stage the likely changes are as follows
(i) Unit Production Cost:
Direct material costs are likely to be fairly constant in this phase and may even rise as the quantities required dimish compared to those required in the growth stage with the consequential loss of negotiating power.

Direct labour costs are unlikely to be reducing any longer as the effects of the Learning and Experience Curves have ended. Indeed the workers may have started working on the next product so that their attention towards his product has dimished with the result that these costs may increase.

Overhead costs are likely to be similar to those of the end of the growth phase as optimum batch sizes have been established and are more likely to be used in this maturity stage of the product life cycle where demand is more easily predicted.

(ii) Unit Selling Price:
These are unlikely to be reducing any longer as the product has become established in the market place. This is a time for consolidation and whilst there may be occasional offers to attempt customers to buy the product the selling price is likely to be fairly constant during this period.

3. Introductory stage:
As the company has adopted skimming strategy the price at introductory stage is higher but low profit margin is due to high fixed cost.

4. Decline stage:
In this case during decline stage the company cut down the prices if not repositioning.

Question 32.
DK International is developing a new product. During its expected life, 16,000 units of the product will be sold for ₹ 102 per unit. Production will be in batches of 1,000 units throughout the life of the product. The direct labour cost is expected to reduce due to the effects of learning for the first eight batches produced. Thereafter, the direct labour cost will remain constant at the same cost per batch as in the 8^th batch. (May 2019)

The direct labour cost of the first batch of 1,000 units is expected to be ₹ 55,00Q and a 90% learning effect is expected to occur. The direct material and other non-labour related variable costs will be ₹ 50 per unit throughout the life of the product.
There are no fixed costs that are specific to the product.
The learning index for a 90% learning curve = – 0.152; 8^-0.152 = 0.729; 7^0.152 = 0.744

Required:
(i) Calculate the expected direct labour cost of the 8th batch. (3 marks)
(ii) Calculate the expected contribution to be earned from the product over its lifetime. (3 marks)
(iii) Calculate the rate of learning required to achieve a lifetime product contribution of ₹ 5,00,000, assuming that a constant rate of learning applies throughout the product’s life. (4 marks)
Answer:
(i) Total direct Labour Cost for first 8 batches based on learning curve of 90% (When the direct labour cost for the first batch is ₹ 55,000.)
The usual learning curve model is Y = aX^b
Where,
Y = Average direct labour cost per batch for x batches
a = Direct Labour Cost for first batch
x = Cumulative no. of batches produced,
b = Learning Coefficient / Index
Y = ₹ 55,000 × (8)^-0.152
= ₹ 55,000 × 0.729
y = ₹ 40,095
Total direct labour cost for first 8 batches
= 8 batches × ₹ 40,095
= ₹ 3,20,760
Total direct Labour Cost for first 7 batches based on 90% learning curve of (When the direct labour cost for first batch is ₹ 55,000).
y = ₹ 55,000 × (7)^0.152
= ₹ 55,000 × 0.744
= ₹ 40,920

Total direct labour cost for first 7 batches
= 7 batches × ₹ 40,920
= ₹ 2,86,440
Direct labour Cost for 8th Batch = ₹ 3,20,760 – ₹ 2,86,440
= ₹ 34,320

(ii) Statement Showing Contribution to be earned from the product over its lifetime:

(iii) In order to achieve a contribution of ₹ 5,00,000 , the total direct cost have to equal ₹ 3,32,000
Statement Showing life time Direct Labour Cost:

Particulars	Amt. (₹)
Sales (16,000 units × ₹ 102)	16,32,000
Less: Direct Material & Other non variable Cost (16,000 units × ₹ 50)	8,00,000
Less: Contribution	5,00,000
Direct Labour Cost	3,32,000

Average Direct labour cost per batch for 16 batches is ₹ 20,750 (₹ 3,32,000/16 batches).

Total direct labour cost for 16 batches based on learning Curve of r% (when the direct labour Cost for first batch is ₹ 55,000)
y = ₹ 55,000 x(16)^b
₹ 20750 = ₹ 55,000 × (16)^b
0.3773 = (16)^b
log 0.3773 = b × log 2⁴
log 0.3773 = b × log 2
log 0.3773 = $\left(\frac{\log r}{\log z}\right)$ × 4 log 2
log 0.3773 = log r⁴
0.3773 = r⁴
r = $4 \sqrt{0.3773}$
= 78.37%

Question 33.
Recommend the Pricing Strategy to be adopted with reference to the following situations. You are not required to explain the reasons for your answer. (May 2019) (1 × 8 = 8 marks)
(a) Star Coffee Shop follows the practice of keeping the price of its coffee or service artificially high in order, to encourage favourable perceptions among buyers, based solely on the price.
(b) Sky TV gave away their satellite dishes for free in order to set up a market for them.
(c) Princeton Hotels Ltd. follows a competitive pricing method under which it= tries to keep its price at an average level charged by the Industry.
(d) Eddisson Enterprises has piled up stocks in large quantities and the market price has fallen.
(e) Acqua LLP follows a new product pricing strategy through which company makes profitable sales by selling out few units.
(f) X Ltd. produces Product X a revolutionary product and as a reward for innovation and for taking first initiative which pricing strategy should X Ltd. adopt ?
(g) An established company has recently entered the stationery market segment and launched quality paper for printing at home and office.
(h) D is a perishable item, with more than 80% of its shelf life is over.
Answer:
(a) Premium Pricing
(b) Penetration Pricing
(c) Going Rate Pricing
(d) Pricing Below Marginal Cost
(e) Skimming Pricing
(f) Premium Pricing
(g) Market Price
(h) Any Cash Realizable Value

Question 34.
RK Ltd., which is producing a product, prepared a budget for the next year as follows : (May 2019, 10 marks)
Fixed Cost p.a. – ₹ 12,60,000
Variable Cost p.u. – ₹ 25
Production – 180000 units
Selling price – Cost plus 25% mark-up on total budgeted cost

When these budgeted figures and the pricing approach were informed to the Marketing Manager he came put with a remark that the demand for the product is more price sensitive and he expected the demand under various prices as given below :

Selling Price p.u. (₹)	36	38	40	42	44
Annual Demand (units)	174000	162000	150000	138000	125000

The Marketing Manager further informed that a wholesale dealer is ready to buy the entire production of the company at a price of ₹ 32 p.u. In that situation he expected a savings of ₹ 2 p.u. in the selling expenses which are a part in the above stated variable cost.

Required:
Evaluate the situation and advice the most profitable course of action.
Answer:
The company has a plan to produce 1,80,000 units and it produced to adopt cost plus pricing approach with a markup of 25% on full budgeted
cost. To achieve this pricing policy, the company has to sell its product at price calculated below:

However at Selling price of ₹ 40 per unit, the company can sell 1 50,000 units only, which is 30,000 units less than the budgeted production units.

After analyzing the price-demand pattern in the market(which is price sensitive), to sell all the budgeted units market price needs to be further lowered, which might be lower than the total cost of production:
Statement Showing “Profit at Different Demand & Price Levels.

	I	II	III	IV	V
Qty(units)	1,74,000	1,62,000	1,50,000	1,38,000	1,25,000
	₹	₹	₹	₹	₹
Sales	62,64,000	61,56,000	60,00,000	57,96,000	55,00,000
Less: V.C	43,50,000	46,50,000	37,50,000	34,50,000	31,25,000
Contribution	19,14,000	21,06,000	22,50,000	23,46.000	23,75,000
Less: F.C.	12,60,000	12,60,000	12,60,000	12,60,000	12,60,000
Profit	6,54,000	8,46,000.	9,90,000	10,86,000	11,15,000
Profit (% on total cost)	11.66	15.93	19.76	23.06	25.43

Under the existing situation, the company should produce on sell 1,25,000 units at ₹ 44. At this price company will not be able to achieve its desired mark up of 25% on the total cost but can earn maximum contribution as compared to other even higher selling prices

Now if the Marketing manager wishes to sell the above production to a whole seller at 32 then, best possible and profitable course of option will be

Now if entire production of the company at ₹ 32, the Profitability earned is:

	₹
Sales (₹ 32 × 1,80,000 units) Less: Variable cost (₹ 25 – ₹ 2) × 180000 units Contribution	5,7,60,000 41,40,000
	16,20,000
Less: Fixed Cost	12,60,000
Profit	3,60,000
Profit (1 on Total Cost)	6.67%

Since the company can not achieve desired results by way of Selling entire product to whole seller, as the profit per percentage and contribution level both are below as compared to above 1,38,000 units Sales analysis.

So, the best and most profitable course of action is selling 1,38,000 units at ₹ 42 Per unit as calculated above.

Foreign Trade Policy – CA Final IDT Study Material

Leave a Comment / CA Final / By Murali / April 10, 2023 May 10, 2023

Foreign Trade Policy – CA Final IDT Study Material is designed strictly as per the latest syllabus and exam pattern.

Foreign Trade Policy – CA Final IDT Study Material

Question 1.
What is the basic difference between ‘Duty Exemption Schemes’ and ‘Duty Remission Schemes’ under Foreign Trade Policy (FTP) ? Name the schemes available under these two schemes for FTP 2015-20. [Nov. 2014, 4 Marks]
Answer:
The difference between ‘Duty Exemption Scheme’ and ‘Duty Remission Scheme’ can be summarized as:

Basis of Diff.

Duty Exemption Scheme

Duty Remission Scheme

Meaning

Pre-Export Exemption
These schemes enable duty free import of inputs required for export production, including replenishment of input.

Post-Export Exemption
These scheme enable post export remission/refund of duty on inputs used export product.

Schemes

available

Duty Exemption Schemes consist of:

Advance Authorization Scheme
Duty Free Import Authorization Scheme

Duty remission schemes consists of:

Duty Drawback (DBK) Scheme; and
Duty Entitlement Passbook (DEPB) Scheme.

Question 2.
Briefly explain the salient features of the duty-free import authorization scheme under Foreign Trade Policy. [May 2015, 4 Marks]
Answer:
The following are salient features of duty free import authorization (DFIA) Scheme:

Duty Free: DFIA is issued to allow duty free import of inputs, oil and catalyst which are required for production of export product.
Type of duty exempted: The goods imported are exempt ONLY from basic customs duty. IGST will be payable on imports
SION Condition: DFIA shall be issued on post export basis for products for which SION have been notified. Separate DFIA shall be issued for each SION and each port.
Actual user Condition: No DFIA shall be issued for an export product where SION prescribes ‘Actual User’ condition for any input.
Inputs from indigenous manufacturer: Holder of DFIA has an option to procure the materials/inputs from indigenous manufacturer/STE in lieu of direct import against Advance Release Order (ARO)/Invalidation letter/Back to Back Inland Letter of Credit.

However, DFIA holder may obtain supplies from EOU/EHTP/BTP/STP/ SEZ units, without obtaining ARO or Invalidation letter.

Question 3.
Explain the conditions for redeeming authorization under duty free import authorization scheme as per Foreign Trade Policy 2015-2020. [Nov. 2016, 4 Marks]
Answer:
Condition for redeeming authorization under duty free import authorization scheme:

(i) Duty free import authorization is issued to allow duty free import of inputs.

(ii) Duty free import authorization scheme shall not be available for import of raw sugar. Drawback as per rate determined by Central Excise authority shall be available for duty paid inputs, whether imported or indigenous, used in the export product.

(iii) Export shall be complete within 12 months from the date of filing of online application and generation of file number.

(iv) Duty free import authorization shall be issued on post export basis for Products for which standard input output norms have been notified.

(v) Minimum value addition of 20% shall be required to be achieved.

Question 4.
Jigsaw Puzzle has imported inputs, having CIF value of ₹ 25,00,000 without payment of duty under Advance Authorization. Inputs are supplied free of cost valued at ₹ 5,00,000 to meet eventualities of quality issues arising during manufacture. On manufacturing, the products are supplied to units in SEZ and realisation is in Indian currency. Jigsaw Puzzle wants to know whether it is entitled to Advance Authorization scheme and what should be the minimum value addition.

And you are required to compute FOR value of supplies to SEZ.
Jigsaw Puzzle has manufactured and supplied goods to international organisations in India from imported inputs for their office use. The payment for such supply is received in Indian currency. Can Advance Authorization be denied as payment has not been received in free foreign exchange? [May 2018, 4 Marks]
Answer:
Statutory Provision

Advance authorisation (AA) can be issued for supplies made to SEZ units (as supplies made to SEZ units are considered as physical exports).
The minimum value addition required to be achieved under AA is 15%.
The FOR value of supplies made to SEZ units is computed as under:
Value addition = (FOR value of supply received – CIF value of inputs/CIF value of inputs) X 100
Notional value of free of cost inputs supplied by foreign buyer needs to be added to the CIF value of imported inputs to compute FOR value of the supplies made to SEZ units.

In the given case

FOR value of supplies made to SEZ units = 30,00,000 × 115% = ₹ 34,50,000
Jigsaw Puzzles will, however, be not eligible for AA as the payment from SEZ unit is not realised from its Foreign Currency Account.
Supply of goods to international organisations in India from imported inputs for their office use is a deemed export eligible for grant of AA.
However, AA can be issued only when the payment for such deemed exports is realised in free foreign exchange.

Question 5.
Nirav Shah used some duty paid inputs for manufacture of the export products. However, for the rest of the inputs, he wants to apply for advance authorization. Can he do so ? Advise him with reference to foreign trade policy 2015-2020. [May 2019, 5 Marks]
Answer:
Statutory Provision
Drawback can be obtained for any duty paid material, whether imported or indigenous, used in goods exported, as per prescribed drawback rates. Advance authorization can be used for importing duty free material.

Drawback allowed must be mentioned in the application for advance authorization. In such case, All Industry Brand Rates are not applicable. The manufacturer has to get specific brand rate fixed from the Commissioner for these exported goods.

In the given case

Yes, he can do so.
In case of part duty free and part duty paid imports, both advance authorization and drawback are available.

Question 6.
Discuss briefly the similarities and differences between Advance Authorization and DFIA (Duty Free Import Authorization) Schemes. [May 2018, 4 Marks]
Answer:
Similarity: In both the schemes, duty free import of inputs, oil and catalyst required for export products is permitted.
Differences:

Basis	Advance Authorization (AA)	Duty Free Import Authorization (DFIA)
1. Transferability	Not transferable.	Transferable after export obligation is fulfilled.
2. Requirement of Value Addition	15% value addition.	Minimum 20% value addition.
3. For Gem & Jewellery Sector	Available	Not available
4. Where SION prescribes actual user condition	AA Can be issued	DFIA cannot be issued as the material is transferable after fulfilment of export obligation.
5. If SION is not fixed for product to be exported	AA can be issued	DFIA cannot be issued
6. Exemption of IGST on imports	Exempted up to 31-3-2020	There is no such exemption available

Question 7.
Mr. Hasmukh is eligible for reward under ‘Service Exports from India Scheme’ (SEIS). He has earned foreign exchange (net) of ₹ 16 lakh during the financial year 2019-20. Discuss the limit of his duty credit script entitlement. [Nov. 2014, 2 Marks]
Answer:

Mr. Hasmukh is an individual service provider.
He has free foreign exchange earning of atleast $ 10,000 in the year of rendering service (current year).
Hence, he Is eligible for SEIS duty Credit Script.
Duty Credit Scrip would be 5% of ₹ 6,00,000 i.e. ₹ 30,000

Question 8.
Mr. Mukul, a Chartered Accountant received US $ 12,000 (net) during the financial year 2018-19 from M/s. Carter & Company of USA for providing auditing services. Out of this, 1,20,000 equivalents to US $ 2,000 was received in Indian Rupees and US $ 2,000 was received through the credit card of Mr. Romeo, who is the partner of M/s. Carter & Company.

Explain with reference to provisions of new Service Export from India Scheme (SEIS) as provided in new Foreign Trade Policy 2015-2020, whether Mr. Mukul is entitled to avail benefit under SEIS Scheme? If yes, what will be the rate of entitlement of reward? [May 2016, 4 Marks]
Answer:
To check the entitlement to avail benefit under SEIS Scheme

Conditions for entitlement under SEIS	In case of Mr. Mukul
(a) The service provider must be located in India	Fulfilled
(b) It must provide only notified services (auditing services are notified) in specified manner	Fulfilled
(c) In case of individual, he must attain net free foreign exchange earnings, in year of rendering services of US $ 10,000. Payment through credit card is counted. In some cases, payment in Indian Rupee is counted.	Fulfilled
(d) Service provider shall have to have an active IEC at the time of rendering services.	Fulfilled

Since all the above conditions are fulfilled, hence, SEIS benefit is allowable.

Rate of Reward:
The rate of reward in case of auditing services is 5% of net free foreign exchange earnings of 2018-2019.

Question 9.
The objective of MEIS scheme is to neutralize export goods. Whether the statement is correct? What are the ineligible categories for MEIS scheme? Write a brief note with reference to the the customs duties paid What are the ineligible Foreign Trade Policy. [May 2017, May 2019, 4 Marks]
Answer:
(i) Correctness of the given

The objective of MEIS scheme is to neutralize the customs duties paid on inputs used in the export goods.
This statement is Incorrect

Reason:
The objective of “Merchandise Exports from India Scheme (MEIS) is to offset Infrastructural Inefficiency and associated costs involved in export of goods/products, which are produccd or manufactured in India, especially those goods having high export intensity, employment potential and thereby enhancing India’s export competitiveness. So, the given statement that to neutralise the custom duty paid is wrong.

(ii) Exports ineligible for MEIS :The following exports categories/sectors shall be ineligible for Duty Credit Scrip entitlement under MEIS:

EOU/EHTP, BTPs/STPs products exported through DTA units
Supplies made DTA to SEZ
Export of certain Imported Goods
Export through transshipment
Deemed Export
Export Products which are subject to minimum Export Price or Export Duty
Export made by units in FTWZ

It may be noted that exports between SEZ/EOU, etc. on behalf of DTA is eligible.

Question 10.
Explain the significance of duty credit scripts under Merchandise Exports from India Scheme (MEIS). Vasant exports a consignment of handcrafted items through courier using e-commerce of FOB value of 48,000. Determine whether he is eligible for the above benefit. [Nov. 2017, 4 Marks]
Answer:
The significance of duty credit scrips under Merchandise Exports from India Scheme (MEIS) is to compensate infrastructural inefficiencies and associated costs involved in export of goods/ products, which are produced/manufactured in India especially goods having high export intensity, employment potential and thereby enhancing India’s export competitiveness.

The duty credit scrips in goods imported or domestically procured are freely transferable.
Utilisation of duty credit scrip is permitted for payment of excise duty for procurement from domestic sources, only of items permitted for imports under duty credit scrips
The duty credit scrip will be valid for 18 months from the date of issue. Export of handicraft item through courier, using e-commerce, of FOB value upto 5,00,000 per consignment is entitled for rewards under MEIS.

Since the FOB value of handicraft consignment exported by Vasant is not exceeds 5,00,000, he is eligible for the above benefit.

Question 11.
From the following particulars, you are required to determine reward under Merchandise Exports from India Scheme (MEIS) under Foreign Trade Policy 2015-2020:
(1) Exports of handloom products through notified courier with FOB value of ₹ 5,15,000 per consignment.
(2) Exports of goods which are subject to minimum export price with FOB value of ₹ 50,000.
(3) Exports of goods where FOB value declared in shipping bill is ₹ 8,00,000. FOB value realised with exchange gain is ₹ 8,20,000.
(4) Exports of books through foreign post office with FOB value of ₹ 4,95,000 per consignment
(5) Biotechnology Park products exported through DTA units of ₹ 3,00,000
(6) Supplies made from DTA units to SEZ units of ₹ 2,00,000
(7) Rate of reward under MEIS is 7%. [May 2019, 5 Marks]
Answer:
Computation of rewards under METS

Particulars	Amount eligible for reward (₹)
Export of handloom products through courier with FOB value ₹ 5,15,000 [Working Note 1]	5,00,000
Export of goods which are subject to minimum export price [Working Note 2] ‘ “	Nil
Export of goods where FOB value declared in shipping bill is ₹ 8,00,000 and FOB value realized is ₹ 8,20,000 [Working Note 2]	8,00,000
Export of books through foreign post office with FOB value of ₹ 4,95,000 [Working Note 3]	4,95,000
Biotechnology Park products exported through DTA units [Working Note 2]	Nil
Supplies made from DTA units to SEZ units [Working Note 2]	Nil
Total amount eligible for MEIS reward	17,95,000
MEIS reward @ 7%	1,25,650

Working Notes:

Export of handloom products of FOB value upto ₹ 5,00,000 per consignment is entitled for reward under MEIS.
These are ineligible for MEIS.
FOB value declared in the shipping bill or the FOB value realized, whichever is lower is considered for MEIS rewards
It has been assumed that exports have been made using E-Commerce platform

Question 12.
Answer the following questions with reference to the provisions of Duty Credit Scrips under
Export from India Schemes under FTP 2015-2020.

(i) Neha provides services eligible for SEIS Scheme. She wants to sell SEIS scrips earned by her. Can she do so?
(ii) Can a manufacturer, instead of importing the inputs, source the same indigenously without payment of GST?
(iii) An exporter was issued duty credit scrip dated 15.07.2019. What is the period within which he must utilize the scrip?
(iv) An exporter exported leather foot wears through courier using e-commerce of value of ₹ 24,000. Can he apply for duty credit scrips under Merchandise Exports from India Scheme (MEIS)? [RTP, Nov. 19]

Answer:
Solution.

(i) Yes. The duty credit scrips and goods imported or domestically procured against them are freely transferable.
(ii) No. Utilization of duty credit scrip is not permitted for payment of GST for procurement from domestic sources.
(iii) The duty credit scrip issued on or after 1-1-2016 shall be valid for 24 months from the date of issue and must be valid on date on w’hich actual debit of duty is made.
(iv) Yes. Exports of leather foot wears through courier using e-commerce of FOB value of ₹ 5,00,000 per consignment are eligible for MEIS.

Question 13.
Saksham exports a consignment of handicraft items through courier using e-commerce of free on board (FOB) value of ₹ 4,48,000. Determine whether the export consignment of Saksham is eligible for the MEIS benefit.
Answer:
Export of handicraft items through courier, using e-commerce, of free on board (FOB) value up to ₹ 5,00,000 per consignment is entitled for rewards under MEIS.
Therefore, the entire consignment of handicraft items exported by Saksham (FOB value ₹ 4,48,000) is eligible for MEIS benefit.

Question 14.
Define Export Obligation under Export Promotion Capital Goods Scheme (EPCGS) of Foreign Trade Policy 2015-2020. What will be specific export obligation if the Capital Goods are indigenously sourced under EPCG Scheme? [May 2016, 4 Marks]
Answer:
Export Obligation:
Export obligation means obligation to export product(s) covered by authorization/permission in terms of quantity or value or both, as may be prescribed, specified by regional or competent authority. It consists of average export obligation and specific export obligation.

Specific export obligation:
In case of indigenous sourcing of capital goods, specific EO shall be 25% less than the EO applicable for imports under EPCG scheme.
Thus, EO = Duties, taxes and Cess saved × 4.5 times

Question 15.
Which exporters are eligible for Export Promotion Capital Goods Scheme as per Foreign Trade Policy 2015-20? Also describe which capital goods are eligible for import under this scheme? [Nov. 2018, 4 Marks]
Answer:
Following exporters are eligible for Export Promotion Capital Goods Scheme (EPCG) as per Foreign Trade Policy 2015-20:

Manufacturer exporters with or without supporting manufacturer(s),
Merchant exporters tied to supporting manufacturer(s), and
Service providers including service providers designated as Common Service Provider (CSP) subject to prescribed conditions.

Following capital goods are eligible for imports under EPCG schemes:

Capital goods including capital goods in CKD/SKD condition
Catalysts for initial charge plus one subsequent charge
Capital goods for Project Imports notified by CBIC.
Computer systems and software which are a part of capital goods being imported
Spares, moulds, dies, jigs, fixtures, tools & refractories

Question 16.
What do you mean by “Deemed Exports” under Foreign Trade Policy? [Nov. 2015, 2 Marks]
Answer:
Deemed exports referred to those transactions in which goods manufactured in India are supplied to specified projects or to specific categories of consumers. In deemed exports, goods supplied do not leave the country and payment for such supplies is received either in Indian rupees or in free foreign exchange by the recipient of the goods.

Question 17.
Indicate five benefits available to “Status Holders” under the reward scheme of Foreign Trade Policy 2015-2020. There is no need to define the term “status holder”. [May 2018, 5 Marks]
Answer:
The benefits available to Status holders are as under:
(a) Authorization and Custom clearances for both imports and exports on self-declaration basis.
(b) Fixation of Input Output Norms (SION) on priority i.e. within 60 days.
(c) Exemption from compulsory negotiation of documents through banks. The remittance receipts, however, would continue to be received through banking channels.
(d) Exemption from furnishing of Bank Guarantee in Schemes under FTP
(e) Two Star Export Houses and above are permitted to establish export warehouses.
(f) Three Star and above Export Houses shall be entitled to get benefit of Accredited Clients Programme (ACP) as per the guidelines of CBIC.
(g) Grant of double weightage for calculation of Export Performance for Grant of Status

1. Eligible Exports for double weightage:

Micro, Small & Medium Enterprise
Manufacturing units having ISO/BIS
Units located in North Eastern States Including Sikkim, Jammu & Kashmir.
Units located in Agri Export Zones.

2. One Star Export House only eligible: Double weightage shall be available for grant of One Star Export House Category only. Such benefit of double weightage shall not be admissible for grant of status recognition of other categories namely Two Star Export House, Three Star Export House, Four Star Export House and Five Star Export House.
3. A shipment can get double weightage only once in any of above categories.

Question 18.
Payal Company, a unit located in Agri Export Zone has made exports of machineries worth US $ 30 lakh per annum (on an average) during the last three years and in the current year. It wants to export certain goods for export promotion on free of cost basis, which are worth ₹ 25 lakh. 1 US$ = ₹ 50. Examine whether Payal Company can export, export promotion goods on free of cost basis as proposed? [Nov. 2018, 5 Marks]
Answer:
Status holders are entitled to export freely exportable items on free of cost basis for export promotion subject to an annual limit of 2% of average annual export realization during preceding 3 licensing years.
All exporters of goods having an import-export code (IEC), number shall be eligible for reorganization as a status holder. Payal Company, upon achieving export performance of US. $ 12 million [30 lakh × 4] during current and previous 3 financial years, is eligible for status reorganization as One Star Export House.

Being a unit in Agri Export Zone, exports of Payal Company is eligible for grant of double weightage for calculation of export performance for grant of status of One Star Export House. However, the same is not relevant for Payal Company as it is already eligible for grant of One Star Export House on the basis of its export performance without taking the benefit of double weightage.

Therefore, being a Status Holder, Payal Company is entitled to export freely exportable items on free of cost basis for export promotion as under:
2% of 1500 lakh [US $ 30 lakh [Note] × 50] which is 30 lakhs
Thus, Payal Company can export goods worth 25 lakh for export promotion on free of cost basis.

Note: In the above answer, average annual export realization of US$ 30 lakh per annum during preceding 4 years has been assumed to be the average annual realization during preceding 3 licensing years.

Question 19.
Answer the question below.
(i) A star export house wishes to import goods which are exempt under Foreign Trade Policy (FTP) subject to fulfilment of export obligation. However, Customs Notification giving effect to the FTP is yet to be issued. Can the export house import the goods claiming exemption under FTP in the absence of Customs Notification? [Nov. 2017, 2 Marks]
Answer:
No. The exemptions extended by FTP can be taken only when the exemption notification is issued under the relevant tax laws. The provisions of Foreign Trade Policy cannot override tax laws.

Lean System and Innovation – CA Final SCMPE Study Material

Leave a Comment / CA Final / By Raju / April 10, 2023 April 10, 2023

Lean System and Innovation – CA Final SCMPE Study Material is designed strictly as per the latest syllabus and exam pattern.

Lean System and Innovation – CA Final SCMPE Study Material

Question 1.
A manufacturer is considering implementing Just in time inventory system for some of its raw material purchases. As per the current inventory policy, raw materials required for 1 month’s production and finished goods equivalent to the level of 1 week’s production are kept in stock. This is done to ensure that the company can cater to sudden spurt in consumers’ demand. However, the carrying cost of inventory has been increasing recently. Hence, the consideration to move to a more robust just in time purchasing system that can reduce the inventory carrying cost. Details relevant to raw material inventory are given below:

Average inventory of raw material held by the company throughout the year is ₹ 1 crore. Procurement of raw material for the year is ₹ 12 crore. By moving to just in time procurement system, the company aims at eliminating holding this stock completely in its warehouse Instead, suppliers of these materials are ready to provide the goods as per its production requirements on an immediate basis. Suppliers will now be responsible for quality check of raw material such that the raw material can be used in the assembly line as soon as it is delivered at the company’s factory shop floor.
Increased quality check service done by the suppliers as well as to compensate them for the risk of holding the inventory to provide just in time service, the company is willing to pay a higher price to procure raw material. Therefore, procurement cost will increase by 30%, total procurement cost will be ₹ 15.6 crore per year. Consequently, quality check and material handling cost for the company would reduce by ₹ 1 crore per year. Similarly, insurance cost on raw material inventory of ₹ 20 lakh per year need not be incurred any longer.
Raw material is stored in a warehouse that costs the company rent of ₹ 3 crore per annum. On changing to Just in time procurement, this warehouse space would no longer be required.
Production is 150,000 per year. The company plans to maintain its finished goods inventory equivalent to 1 week’s production. Despite this, in order to have a complete cost benelit analysis, the management is also factoring the possibility of production stoppages due to unavailability of raw material from the suppliers. This could happen due to of delay in delivery or non-conformance of goods to the standard required. Labour works in one 8-hour shift per day and will remain idle if there is no material to work on. Due to stoppage of production for the above reason, it is possible to have stockout of 3,000 units in a year. Stockout represents lost sales opportunity due unavailability of finished goods, the customer walks away without purchasing any product from the company. Therefore, in order to reduce this opportunity cost and to make up for the lost production hours, labour can work overtime that would cost the company ₹ 10 lakh per annum. This is the maximum capacity in terms of hours that the labour can work. With this overtime, stockout can reduce to 2,000 units.
Currently, sale price of phone is ₹ 5,000 per unit, variable production cost is ₹ 2,000 per unit while variable selling, general and administration (SG&A) cost is ₹ 750 per unit. Raw material procurement cost is currently ₹ 800 per unit, that will increase by 30% to ₹ 1,040 per unit under Just in time inventory system.
On an average, the long-term return on investment for the company is 15% per annum.

Required
(a) CALCULATE the benefit or loss if the company decides to move from current system to Just in Time procurement system.
(b) RECOMMEND factors that the management needs to consider before implementing the just in time procurement system. [RTPNov. 2018]
Answer:
(a) Benefits due to JIT:

Particulars	Current Purchasing Policy (₹)	JUST IN TIME Procurement System (₹)
Raw material procurement cost per year	12,00,00,000	15,60,00,000
Quality check and material handling cost (No longer required in JIT)	1,00,00,000	—
Insurance Cost on raw material inventory (No longer required in JIT)	20,00,000	—
Warehouse rental for storing raw material (No longer required in JIT)	3,00,00,000	—
Overtime Charges under JIT to reduce Stockouts (Note 1)	—	10,00,000
Stockout Cost (Note 2)	—	40,20,000
Total Relevant Cost	16,20,00,000	160,020,000

Therefore, moving to just in time procurement system results in savings of ₹ 9,80,000 per year for the company. If reinvested, long-term return on investment for the company at 15% would yield a return of ₹ 1,47,000 per year. In addition, by switching over to JIT system, company will also save an investment of ₹ 1 crore ie., average per inventory of raw material held at present. Company can earn further 15% on this investment i.e., ₹ 15,00,000 year.
Therefore, total benefit for the company would be ₹ 26,27,000 per year.

Note 1: Should overtime cost be incurred to reduce Stockouts?
Contribution per unit = Sale price – Variable production cost – Variable selling, distribution cost per unit;
Variable production cost under the just in time system = ₹ 2,000 + ₹ (1,040-800) = ₹ 2,240 per unit; .
Contribution per unit = ₹ 5,000 – ₹ 2,240 – ₹ 750 per unit = ₹ 2,010 per unit.
Overtime cost can reduce stockouts from 3,000 units to 2,000 units that is customers’ demand of 1,000 units more can be met.
Contribution earned from selling these 1,000 units = 1,000 × ₹ 2,010 per unit = ₹ 20,10,000.
Therefore, the contribution earned of ₹ 20,10,000 is more than the related overtime cost of ₹ 10,00,000. Therefore, it is profitable to incur the overtime cost.

Note 2: Stockout Costs
Out of the total shortfall of 3,000 units, by spending on overtime 1,000 units of demand can be met. Therefore, actual stockout units is only 2,000 units. As explained above, contribution per unit is ₹ 2,010 per unit. Therefore, stockout cost = 2,000 units × ₹ 2,010 per unit = ₹ 40,20,000.

(b) Factors to be considered:
The company plans to eliminate its raw material inventory altogether. Raw material will be delivered as per production schedule directly at the factory shop floor, from whence production will begin. The management should therefore carefully consider the following points:
(a) The entire production process has to be detailed and integrated sequentially. This is essential to know because it should be known in advance when in the sub- assembly process is each raw material is required and in what quantity.
(b) Since production is dependent on delivery and quality of raw material, heavy reliance is being placed on suppliers. They should be able to guarantee timely delivery of raw material of the appropriate quality. The company is paying a premium of 30% of original cost, that is ₹ 240 per unit (₹ 1,040 -1800 per unit) in order to ensure the same. Each unit gives a contribution of ₹ 2,010 per unit, which is 40.2% of the sale price per unit. Lost sales opportunities due to unavailability of raw material or non-conformance of the material can result in substantial losses to the company. While, portion of this has been factored while doing the cost benefit analysis of implementing Just-in-time systems, it needs careful consideration and monitoring even after implementation. Therefore, to hedge its loss, the management and suppliers should agree on penalties or costs the supplier should incur should there be any delay or non-conformance in quality of materials beyond certain thresholds.
(c) Accurate prediction of sales trends is important to determine the production schedule and finished goods planning.
(d) Continuous monitoring of the system even after implementation is essential to ensure smooth operations. Management commitment and leadership support is essential for its successful implementation and working.

Question 2.
Coup Ltd. has entered into a contract to supply a component to a company which manufactures electronic equipments. Expected demand for the component will be 35,000 units totally for all the periods. Expected sales and production cost will be

Total fixed overheads are expected to be ₹ 7 lakhs for all the periods. The production manager has to decide about the production plan.
The choices are:
Plan 1: Produce at a constant rate of 8,750 units per period. Inventory holding costs will be ₹ 3.25 per unit of average inventory per period.
Plan 2: Use a just-in-Time (JIT) system
Maximum capacity per period normally 9,000 units
It can produce further up to 5,000 units per period in overtime.
Each unit produced in overtime would incur additional cost equal to 30% of the expected variable cost per unit of that period.
Assume zero opening inventory.
Required
(i) CALCULATE the incremental production cost and the savings in inventory holding cost by JIT production system.
(ii) ADVISE the Coup Ltd, on the choice of a plan. [RTP May 2019]
Answer:
(i) Calculation of Incremental production cost and savings:
Workings
Statement Showing ‘Inventory Holding Cost’ under Plan 1

Inventory Holding Cost for the four periods = (₹ 6,500 + ₹ 13,406.25 + ₹ 13,000 + ₹ 6,093.75)
= ₹ 39,000

Statement Showing ‘Additional Cost-Overtime’ under Plan 2 (JIT System)

Statement Showing ‘Additional Variable Cost*’ under Plan 2 (JIT System)

* excluding overtime cost

Incremental Production Cost in JIT Svstem = ₹ 19,595 + ₹ 10,000 = ₹ 29,595
Therefore, Saving in JIT System (Net) = ₹ 39,000 – ₹ 29,595 = ₹ 9,405

(ii) ADVISE to the Coup Ltd.
Though Coup Ltd is saving ₹ 9,405 by changing its production system to Just-in- time but it has to consider other factors as well before taking any final decision which are as follows:

Coup Ltd. has to ensure that it receives materials from its suppliers on the exact date and time when they are required. Credentials and reliability of supplier must be thoroughly checked.
To ensure quality, there is requirement of engineering staff, so that if required they may visit the supplier’s site and examine their processes, to see if the supplier can reliably ship high quality parts and also provide them engineering assistance to bring up high standard of product.
Coup Ltd. should also aim to improve quality at its process and design levels with the purpose of achieving “Zero Defects” in the production process.
Coup Ltd. should also keep in mind the efficiency of its workers. Coup Ltd. must ensure that labour’s learning curve has reached at steady rate so that they are capable of performing a variety of operations at effective and efficient manner. The personnel must be completely retrained and focused on a wide range of activities.

Question 3.
BP Ltd. (KPL) manufactures and sells one product called “EIAM”. Managing Director is not happy with its current purchasing and production system. There has been considerable discussion at the corporate level as to use of ‘Just in Time’ system for “EIAM”. As per the opinion of managing director of BPL Ltd.
“Just-in-time system is a pull system, which responds to demand, in contrast to a push system, in which stocks act as buffers between the different elements of the system such as purchasing, production and sales. By using Just in Time system, it is possible to reduce carrying cost as well as other overheads”.
BPL is dependent on contractual labour which has efficiency of 95%, for its production. The labour has to be paid for minimum of 4,000 hours per month to which they produce 3,800 standard hours.
For availing services of labour above 4,000 hours in a month, BPL has to pay overtime rate which is 45% premium to.the normal hourly rate of ₹ 110 per hour. For avoiding this overtime payment, BPL n its current production and purchase plan utilizes full available normal working hours so that the higher inventory levels in the month of lower demand would be able to meet sales of month with higher demand level. BPL has determined that the cost of holding inventory is ₹ 70 per month for each standard hour of output that is held in inventory.
BPL has forecast the demand for its products for the first six months of year 2019 as follows:

Month	Demand (Std. Hrs.)
Jan’19	3,150
Feb’19	3,760
Mar’!9	4,060
Apr’19	3,350
May’19	3,650
Jun’19	4,830

Following other information is given:
(i) All other production costs are either fixed or are not driven by labour hours worked.
(ii) Production and sales occur evenly during each month and at present there is no stock at the end of Dec’18.
(iii) The labour are to be paid for their minimum contracted hours in each month irrespective of any purchase and production system.
Required
As a chief accountant you are requested to COMMENT on managing director’s view.
Answer:
Statement Showing ‘Inventory Holding Cost’ under Current System

(*) in terms of standard labour hours
Total Overtime payment = ₹ 43,652 + ₹ 1,72,931 = ₹ 2,16,583
Therefore, saving in JIT system = ₹ 2,57,600 – ₹ 2,16,583 = ₹ 41,017
(*) in terms of standard labour hours
Inventory Holding Cost for the six months = ₹ 2,57,600
(₹ 22,750 + ₹ 46,900 + ₹ 39,200 + ₹ 45,850 + ₹ 66,850 + ₹ 36,050)

Calculation of Relevan Overtime Cost under JIT System

(*) in terms of standard labour hours
Total Overtime payment = ₹ 43,652 + ₹ 1,72,931 = ₹ 2,16,583
Therefore, saving in JIT system = ₹ 2,57,600 – ₹ 2,16,583 = ₹ 41,017

Comments
Though BPL is saving ₹ 41,017 by changing its production system to Justin-time but it has to consider other factors as well before taking any final call which are as follows:-
(i) BPL has to ensure that it receives materials from its suppliers on the exact date and at the exact time when they are needed. Credentials and reliability of supplier must be thoroughly checked.
(ii) To remove any quality issues, the engineering staff must visit supplier’s sites and examine their processes, not only to see if they can reliably ship high-quality parts but also to provide them with engineering assistance to bring them up to a higher standard of product.
(iii) BPL should also aim to improve quality at its process and design levels with the purpose of achieving “Zero Defects” in the production process.
(iv) BPL should also keep in mind the efficiency of its work force. BPL must ensure that labour’s learning curve has reached at steady rate so that they are capable of performing a variety of operations at effective and efficient manner. The workforce must be completely retrained and focused on a wide range of activities.

Question 4.
Olivware Limited is a toy manufacturing company. It sells toys through its own retail outlets. It purchases materials needed to manufacture toys from a number of different suppliers. Recently, due to the entity of few reputed foreign brands in the toy market and particularly in the segment in which Oliveware Ltd. is doing business, it is facing a threat to operate profitably.
Each toy requires 4 kg. of materials at ₹ 19 per kg. and 5% of all materials supplied by the suppliers are found to be sub-standard. Labour hour requirement for each toy is 0.4 hour at ₹ 120 per hour.
Market research has determined that the selling price will be ₹ 240 per toy. The company requires a profit margin of 15% of the selling price. Expected demand for toy in the coming year will be 50,000 toys. Sales and variable overhead per unit for the four quarters of the year will be as follows:

Total fixed overheads are expected to be ₹ 6,25,000 for each quarter.
The production manager has decided to produce 12,500 units in each quarter. Inventory holding costs will be ₹ 18 per unit of average inventory per quarter. Inventory holding costs are not included in above.
Normal production capacity per quarter is 15,000 toys. The company can produce further up to 6,000 units per quarter by resorting to overtime working. Overtime wages will be at 150% of normal wage rate.
Assume zero opening inventory.
Required
(a) (i) CALCULATE the cost gap that exists between the total cost per toy as per the production plan and the target cost per toy, (9 Marks)
(ii) DISCUSS how just-in-time purchasing and just-in-time production will remove the cost gap calculated in (i) above. Show calculations in support of your answer. (7 Marks)
(b) EXPLAIN, how implementation of JIT production method can be a major source of competitive advantage and success of the company. (4 Marks) (9+7-h4 Marks)
Answer:
(a) (i) Cost gap between Total Cost per toy as per the production plan and the Target Cost per toy

Target Cost per toy

Sr.No.	Particulars	7 per unit	For Annual Sales of 50,000 units
1	Selling Price per toy	240	1,20,00,000
2	Required Profit Margin (15% of selling price = 15% × 7 240 per unit)	36	18,00,000
3	Target Cost per annum (Step 1 – 2)		1,02,00,000
4	Target Cost per toy (Step 3/50,000 units)		204.00

Therefore, Target Cost is ₹ 204 per toy.

Total Cost as per production plan
Oliveware Ltd. has an annual production requirement of 50,000 toys, which is also its annual sales. Given that opening inventory for the first quarter is nil. The production manager wants to produce 12,500 units per quarter irrespective of the sales demand for the quarter. This implies that during some quarters, there might be unsold inventory, for which inventory holding cost has to be borne. This type of production is called “produce to stock”.

Production Schedule and Inventory Holding Cost for the year

Total Cost of Production per toy as per production plan

Note 1
Each toy requires 4 kg of material, 5% of all materials is sub-standard. Therefore, procurement should factor this sub-standard quality.
Material required per unit= 4 kg/95% = 4.21 kg
Material Cost per toy produced = 4.21 kg × ₹ 19 per kg = ₹ 80 per unit

Note 2
Each toy requires 0.40 hours. Rate per hour is ₹ 120 per hour. Therefore, Cost per toy — 0.40 × ₹ 120 = ₹ 48 per unit
Cost Gap
= Total Cost per toy as per production schedule – Target Cost per toy
= ₹ 208.09 – ₹ 204.00 per toy
= ₹ 4.09 per toy

(a) (ii) JIT Purchasing
Just in Time Purchasing and Just in Time Production is aimed at eliminating inventory holding of raw material and finished goods respectively. Components are purchased only when there is a requirement in the production process. Similarly, finished goods are produced only when there is a demand for them. This type of production is called “produce to order”. Hence, there is neither any opening inventory nor any closing inventory, thereby no inventory holding cost.
In the given problem, this savings is off-set by the extra payment to be made to labour for overtime. Production capacity is 15,000 toys per quarter. This can be increased by 6,000 toys per quarter by incurring additional overtime cost.

The Production Plan under the Just in Time System

Total Cost of Production under JIT System

Note 1
Carefully selected suppliers of delivering high quality materials in a timely manner directly at the shop floor, reducing the material receipt time and loss due to sub-standard material.

Note 2
Overtime wages are 150% of normal wage rate. Therefore, for every toy produced over the quarterly production capacity of 15,000 toys, 50% extra wage over and above the hourly rate has to be paid as overtime wages. Each toy needs 0.40 hours for production. Therefore, overtime cost for excess production = excess production units × 0.40 × 50% × ₹ 120 per hour.
Cost Gap
The cost of production per toy under the JIT system is ₹ 199.38 per toy as compared to the target cost of ₹ 204 per toy and save ₹ 4.62 per toy.
The savings primarily comes from eliminating the inventory holding cost of ₹ 3,42,000 per annum and sub-standard material cost of ₹ 2,00,000 per annum under the previous production system. This is slightly offset by the additional cost of ₹ 84,000 per annum that has to be paid towards overtime labour charges and ₹ 22,500 towards additional variable overheads. However, by switching to the JIT system, Oliveware Ltd. could reduce its production cost below the target cost per toy.

(b) JIT as a major source of competitive advantage
JIT system aims at:

Meeting customer demand in a timely manner.
Providing high quality products and
Providing products at the lowest possible price. The main features of the JIT production system are:
Material handling cost is reduced – materials move from one machine to another in an organized sequence.

The production process is grouped into to manufacturing cells. These can be managed with minimal labour. This reduces material handling costs as also any pile up of inventory in the form of work-in-progress. In JIT procurement process, the raw material is received only when needed. Due to significant reduction in inventory, inventory holding costs, normal wastage cost and spoilage can be avoided. Optimum arrangement of cells can lead to lesser floor space requirement, thereby reducing factory rental and overhead cost.

Multi-skilled labour: Hire and retain multi-skilled workers who are capable of performing a variety in operations including repairs and maintenance. Therefore, a worker is not confined to only one process in the production process. He can contribute towards other processes as well. This reduces the workforce requirement and labour idle time. The company can have a more efficient workforce, with lesser number of workers. There is potential to reduce labor cost on account of this.

Minimizing defects rework and scrap: Each stage of the production process is tightly linked in a sequential manner. Defective output from one stage will stop the work at the next stage. Due to this, workers can identify and correct errors or defects instantaneously. JIT creates urgency for eliminating defects as quickly as possible since the downstream work also stops due to error in any workstation. Production process efficiency improves and reduces rework or scrap. The overall quality of production improves. There are other benefits to streamlining production process: lesser need for inspection of final output and lesser sales returns due to defects. This would contribute to the product’s brand value.

Reduced set-up time: Streamlined production process under JIT reduces set-up time at the workstations. When the production process has to change to make the product per the customers’ demands, set-up time is incurred at the workstation. By streamlining operations, JIT system aims at reducing the set-up time, so that production can continue with the least possible interruption. This brings flexibility in the operations since the company can quickly change the production requirement, to make products to meet the customer’s demand. Quick turnover improves productivity of the machine, thereby increasing the production capacity. Lesser time is spent on set-up which is not a value adding activity.

Reduces lead time for receiving materials since the suppliers of raw material are capable of delivering high quality materials in a timely manner directly at the shop..Proper selection of such suppliers is imperative for the JIT system to be successful. If this can be achieved, then it is beneficial for the company since inventory holding of material is eliminated along with receiving better quality of raw material in a timely manner.
Eliminating inventory holding, scrap, material wastage, flexibility in operations by reducing set-up time, better response time to customer’s demands, better skilled workforce, better quality of production, lower workforce requirement, lower floor space requirement all of these contribute towards lowering working capital requirements. These contribute to a company’s competitive edge and success.

Question 5.
Mr. Rakesh is a newly appointed Managing Director of Mars company. He is not satisfied with the performance of the company so in order.to reduce the costs, improve the inventory cost and to improve service. Mr. Rakesh along with the consent of Costing Department has undertaken a decision to implement a JIT System.
The production management of Mars is satisfied with the benefits of their changes, while Supplies department is worried and have doubt with this decision.
They argued that
“Weave dealing with the suppliers for many years… they would insist that we could only purchase in thousands, that we would have to wait for every second week of months, or that they would only deliver on Saturdays!”
Required;
Is Mr Rakesh view- point is correct? COMMENT. [MTP Oct. 2020] (5 Marks)
Answer:
“For Successful implementation of JIT inventory system, the key not point is that, the suppliers must be willing to make frequent deliveries in small lots. Rather than deliver every second week of month’s or a month’s material at one time, suppliers must be willing to make deliveries several times a day and in the exact quantities specified by the buyer”.
It is mention in the problem that suppliers are not willing to

make frequent deliveries and
– and supply the product in the exact quantities as required Accordingly, Mr. Rakesh will fail on successful implementation of JIT System.

Question 6.
Caliber Metal and Motor Works (CM2W) deals in manufacturing of the copper wired electronic motor, which is specifically designed. CM2W is thinking to shift from traditional system to JIT system as part of process innovation.
CEO among the other top bosses at CM2W are hopeful that implementation of JIT will not only improve value in value chain for end consumer, but also improve overall manufacturing cycle efficiency. JIT pre-implementation team was formed to evaluate the probabilities, which collects following actual and estimated data about process;

Activity Category	Traditional System (Actual) (in minutes)	JIT System (Estimated) (in minutes)
Inspection	45	30
Storage	80	20
Moving	25	10
Processing	70	50

Further, CM2W decided to practice single piece flow under JIT. CM2W received an order which is due to manufacture and delivered for 10 such motors. Total available production time to produce what customer demands is 490 minutes out of which it normal practice that 40 minutes will be spent in shutdown and cleaning. CEO is also considering JIT purchase apart from JIT production.
Required
(i) EXPLAIN just in time.
(ii) CALCULATE the ‘takt time’ and INTERPRET the results.
(iii) ADVISE whether company should shift to JIT. [RTP May 20201
Answer:
(i) Just in Time: It is a collection of ideas that streamline an organisation’s production process activities to such an extent that wastage of 0 all kind viz., of time, labour and material systematically driven out of the process activities with single piece flow after considering takt time.
In Just-in-time, Manufacture facility is required to be integrated with vendor system for signal (Kanban) based automatic supply which depends upon demand based consumption. Under JIT system of in-ventory storage cost is at lowest level due to direct issue of material to manufacturing department as and when required and resultantly less/no material lying over in store or production floor.
Prerequisite of Just-in-time system is integration with vendor, if vendor isn’t integrated properly or less reliable, then situation of stock out can arise and which may result into loss of contribution.
Multitasking by employee is another key feature of Just-in-time, group of employees should be made based upon product instead based upon function. Hence, functional allocations of cost become less appropriate.
Overall, Just-in-time enhance the quality into the finish goods by eliminating the waste and continuous improvement of productivity.

(ii) ‘fakt Time is the maximum available time to meet the demands of the customer; this will help to decide the speed of/at manufacturing facility.
Takt time is the average time between the start of production of one unit and the start of production of the next unit, when these production starts are set to match the rate of customer demand.
Takt Time = $\frac{\text { Available Production Time }}{\text { Total Quantity Required }}$
Here,
Available Production Time is ‘total available time for production’ – ‘planned downtime i.e. spent in shutdown and cleaning’ i e. 450 minutes = 490 minutes – 40 minutes.
Total Quantity Required is 10 units
Takt Time = $\frac{450 \text { Minute }}{10 \text { Units }}$
= 45 Minutes
Note – Heijunka can be applied in order to reduce variation between ‘Takt times’ over the production.

Interpretation
Customer’s demand is 10 units, to calculate the takt time, divide the available production time (in minutes) by the total quantity required. The takt time would be 45 minutes. This means that process must be set up to produce one unit for every 45 minutes throughout the time available. As order volume increases or decreases, takt time may be adjusted so that production and demand are synchronized.

(iii) Advise on Shifting to JIT
To evaluate the proportion of “the old cycle time was spent in inventory”, we need to understand how organizations asses the efficiency of their production processes.
One commonly used measure is process cycle efficiency and to calculate the same every process activity is require to breakdown into combination of activities such as value added activities, non-value added activities and non-value added activities but strategic activities. In order to generate highest value to customer, only value added activities are
included in process. But those non-value added activities, which are strategic in nature, also need to be part of process. Therefore, it may be possible that entire process is not efficient.
To measure efficiency of process, managers keep track of the relation between ‘times taken by value added activities’ in comparison ‘total cycle time’. Such relation/ratio is processing cycle efficiency.
Process Cycle Efficiency = $\frac{\text { Value Added Time }}{\text { Cycle Time }}$

Processing time is considered as value added time, whereas time spend on inspection, storage and moving is non-value added time and included in cycle time. The higher the percentage, less the time (and costs) needs to be spent on non- value added activities for inspection, storage and moving.

Computation of Processing Cycle Efficiency

Sr.No.	Activity Category	Traditional System (Actual)	JIT System (Estimated)
A.	Inspection	45	30
B.	Storage	80	20
C.	Moving	25	10
D.	Processing	70	50
E.	Value Added Time .. .(D)	70	50
F.	Cycle Time … (A)+(B)+(C)-T(D)	220	110
G.	Process Cycle Efficiency ,..(E)/(F)X100	31.82%	45.45%

Of the 220 minutes required for manufacturing cycle under CM2W’s traditional system, only 70 minutes were spent on actual processing. The other 150 minutes were spent on non-value added activities, such as inspection, storage, and moving. The process cycle efficiency formula shows that processing time equaled to 31.82% of total cycle time. The cycle time is reduced substantially in the Just-in-time system from 220 minutes to 110 minutes. In addition to this, the amount of time that used up in inventory ie. non-value-added activities is also reduced. Therefore, process cycle efficiency has been increased from 31.82% to 45.45%. This significant improvement in efficiency over the previous system comes from the implementation of Just-in-time system. Therefore, it is advantaged to shift to Just-in-time system.

Question 7.
Glee tech solution is a producing CAP-10 from use of a single raw material Sillicon-12. The two major departments operating in Glee tech solution are purchase and production department. The market is very competitive and Glee tech is facing fluctuation in demand of CAP-10, so the high storage cost is the prime cause of low financial performance which is the major concern of the company. Glee tech solution has decided to move from Traditional to Just in time system.
From purchase and store following data is collected. Annual consumption is of 1,800 units of Sillicon-12. List Price of each unit of Sillicon-12 is ₹ 4,000. The cost of placing order is ₹ 2,000 and cost of carrying one unit of Sillicon-12 for a year is 2%. Company presently use EOQ model of ordering.
Purchase Manager further estimated that, if Just in time system of inventory is implemented, ordering cost will increase by 50% from current level, whereas carrying cost can be avoided up-to 90%. But there is prospective order of 5 units of CAP-10 which can’t be served, due to non-availability of stock and failure of delivery by supplier. Contribution from each unit of CAP-10 is 1,200. Stock insurance cost will reduce by ? 400 on annual basis. There will also be reduction in working capital requirement, which will result in interest saving of ? 500 on annual basis.
Further, Production and Engineering department supported by marketing department provide details that presently average production of CAP-10 is 150 units of per month, although for next 4 months expected demand will be 120, 160, 140, 180 units. Maximum capacity from man-hours perspective is 150 units. 20 man-hours required for producing each unit and labour rate per hour is 3. Casual labour is not available in market. Overtime rate will be 200%. Average monthly cost of storage of each item of CAP-10 is 65.
Requirement;
(i) EXPLAIN the JIT purchasing and JIT production and the effect of its introduction.
(ii) COMPUTE cost savings if it moves to JIT Purchasing.
(iii) COMPUTE cost savings if it moves to JIT Production
Answer:
(i) JIT purchasing and JIT production
(a) Just-in-time is a collection of ideas that streamline an organisation’s production process activities to such an extent that wastage of all kind viz., of time, material and labour are systematically driven out of the process.
(b) Just in time purchasing suggests that materials should only be purchased as and when required. While JIT production shows that finished products should only be produced as and when required by customers. Whereas in traditional manufacturing system, to smooth out production and to meet forecasted demand, materials and finished goods are stored in advance.
(c) JIT Purchasing reduces the inventory level which will result in reduction of carrying cost of inventory, as well as reduces the level of working capital which will save the opportunity cost in form of interest expenditure. On the other hand, JIT Production gives opportunity to customize the product as per customers’ needs, conformance to customers’ need is essential to quality. It also reduces the level of working capital which save the opportunity cost in form of interest expenditure.
(d) Prerequisite of JIT purchasing or production is integration with vendor, if vendor is not integrated properly or less reliable, then situation of stock out can arise and which can result into loss of contribution.
(e) Multitasking by employee is another key feature of JIT, group of employees should be made based upon product instead based upon function. Hence, functional allocations of cost become less appropriate.

(i) Overall, JIT enhance the quality into the product by eliminating the waste and continuous improvement of productivity.
(ii) Cost Savings in JIT Purchasing:
Reorder Size under present regime:
Under current scenario reorder size of Sillicon-’l 2 will be EOQ. Formula for EOQ is mentioned below—
EOQ = $\sqrt{\frac{2 \times A \times O}{C}}$
Where
A = Annual Consumption i.e., 1,800 units of Sillicon-12
O = Ordering Cost per order i.e., ₹ 2,000 per order
C = Carrying Cost per unit per annum i.e., 80 (2% of 4,000) per unit per annum
EOQ = $\sqrt{\frac{2 \times 1,800 \times 2,000}{80}}$ = 300 units
EOQ (reorder size under present regime) of Sillicon-12 is 300 Units

Cost Comparison under present and JIT regime (annual basis)

Since implementation of JIT Purchasing results in incremental cost of ₹ 300 per annum basis, hence it is not economically worth to move to JIT system of inventory purchase.

(iii) Cost Savings in JIT Production:
Carrying Cost in Present Scenario (for next four months)

*Average Stock = Opening Stock + Closing stock/2

Overtime Cost in JIT Scenario (for next four months)
im-14
*Shortfall good need to produce in overtime, due to limited man-hour available and casual labour is not available in market.

Based upon comparative cost for upcoming four month under present and JIT scenario, there is cost saving of ₹ 400 (₹ 5,200 vs. ₹ 4,800) in move to JIT system production. Hence, it is economically worth to move to JIT Production.

Question 8.
(Case Scenario)
Road Cable Cars (RCC) engaged in assembly of cabin used on ropeways. In order to assemble cabin, 3 major parts of different shapes and sizes are used. These parts
are assembled with help of specially designed dome nut and bolt made of brass (Product Code – Brass DIN 85), which are manufactured by Reliable Hardware and Metal Works, Plant layout design of RCC comprises assembly line, where multiple products are assembled at one point of time. Hence there are multiple workers, who are using such nut and bolts simultaneously. Such nut and bolts com$ in set along with washer and all three spares collectively consider as set.
Since the plant facility of RCC is situated in remote area hence majority of worker
are either unskilled or semi-skilled and literacy rate is also low among workers. This causes variety of problems including not informing production supervisor, about the re-ordering of such (Brass DIN 85), a class of store and spares items. Due to ignorance in workers towards understanding of the stock levels and their relevance, many a times stock of such spares ordered later then it should be, hence got out of stock. This further leads to stock out situation in some of the cases, which result in contribution loss.
Reliable Hardware and Metal Works (RHMW) is long standing supplier of Brass DIN 85 to RCC, hence reliable in term of both quality and delivery time. RHMW took isingle day as lead- time to deliver the re-ordered quantity. Despite the reliability of supplier RCC wish to maintain safety stock equivalent to 3 (three) days consumption for production facility. RCC is using latest version of SAP as enterprise resource planning, which is installed just 3-4 month back. Employees are being trained to use the respective modules of SAP and integration among various function/modules is ongoing.
Plant of RCC works for 6 days in a week and during a week period 1,200 units of Brass DIN 85 is required for production. Consumption of Brass DIN 85 in order to assemble the cabin cars are constant through-out the year. RCC during first phase of its drive to implement lean manufacturing, is working on its operational efficiency and tries to reduce inventory by introducing a Kanban system.
Requirement:
(i) EXPLAIN the Kanban in inventory management for entity like RCC? Also, EXPLAIN Kanban be applied to non-manufacturing entities?
(ii) CALCULATE is Kanban size and number of Kanban required in case of RCC?
(iii) LIST the factors to be considered and specific precautions/pre-requisites, prior to RCC took task of applying Kanban system
Answer:
(i) Kanban system is a visual signal-based workflow management tech-niQuestion Taiichi Ohno an industrial engineer, developed the first Kanban system for Toyota automotive in Japan.

Kanban in inventory management
Kanban can be used in pull system of inventory, where supplier sup-plies the material based upon consumption. Kanban (a yellow line, originally used in Toyota) is visual cue to worker (may be unskilled or even illiterate) to understand that further material is required. Kanban reduce the cycle time and enhance the predictability, in order to promote value to customer. Kanban system hold specific amount of material (divided in Kanban Size). Kanban system also maintain information regarding quantity, storage location, vendor and details on product/part.

While calculating Kanban size and number of Kanban required following assumption need to be taken-

Consumption is constant throughout the period; else smoothing factor need to be used in calculation of Kanban size.
The supplier will deliver material directly to the point of use area (assembly line) and
Requirement in term of space to store number of Kanban is met.

Kanban in non-manufacturing facilities
Kanban originally designed for manufacturing entities but can be applied to non- manufacturing concern as well, for smoothening of workflow rather inventory management. In Kanban, signal based dashboard is used to manage and improve the flow of work to be followed and also categories the work into to do, on-going and done (in some of cases backlog category also be added).

(ii) Kanban Size and Number of Kanban
Kanban Size can be calculated using formula ie. (C) × (LT) × (L) × (SF)
Whereas C stands for consumption,
LT stands for lead time (Note – Lead Time should be in terms of con-sumption pattern means if consumption is considered for week/s time then lead time shall also be considered in term of week/s)
L stands for location of Kanban (Note – When so even any entity implement the Kanban then keep one container of material at both the location (entity it-self and supplier), hence L is 2 unless otherwise provided)
SF stands for smoothing factor, which is used to set-off seasonal vari-ations in consumption; obviously if consumption and level of stock throughout the period remain same then smoothing factor can be one.
Calculation of Kanban Size
C – Consumption per day is 200 ie., 1,200/6
LT – Lead time is 1 days
L – Locations are 2 (RHMW and RCC) and
SF – Smoothing Factor is 1
Therefore, the Kanban Size is 200 × 1 × 2 × 1 = 400 Units in each Kanban. Note – EOQ can also be practice as Kanban size

Number of Kanban depends upon the maximum quantity of inventory which comprises of demand/consumption during lead period and quantity of safety stock. It can be determined using following formula-
im-15

Calculation of numbers of Kanban
Quantity of safety stock in given case is 3 days × 200 (daily consumption) i.e., 600 Consumption/demand during lead period is 1 days × 200 (daily consumption) i.e., 200 Therefore, maximum inventory under Kanban system is 800 i.e. (600+200)
Number of Kanban is 2 i.e., 800/400

(iii) Factors to be considered and specific precautions/pre-requisite to Kanban system
Kanban try to smoothen the workflow process by ‘visualise the flow of the work, reducing WIP, managing process, making process policies explicit, incorporate feedback and using scientific techniques’. In order to do so, while applying Kanban system RCC need to consider following factors-
1. Will supplier ready to supply material in the lot size equal to Kanban Size?
2. Will supplier participate in pull system of inventory and agree I upon Kanban Stocking program? – reliability on supplier.
3. Will supplier agree to supply material directly at point of use i.e. assembly line?
4. Is the consumption pattern comprising significant variations or constant throughout?
5. What is requirement regarding handling and storage of material?
6. Contribution margin on sale of product in which raw material is used. Note – these factors have major impact on calculation of Kanban size as well.

Some specific precautions for RCC
1. Since the worker are unskilled andliteracy rate is low among them hence it is needed to be assured that worker must understand the visual cue. Training can be provided to them.
2. Demand/Consumption need to be predicted with reasonable assurance in order to implement Kanban, although one thing, j which is in favour to RCC is that it knows the consumption j of Brass DIN 85 is constant throughout the period.
3. SAP which is used as ERP system in RCC, need to be integrated with suppliers system in order to practice pull system of inventory and various modules of SAP need to be tightly integrated.

Question 9.
Luminous Pvt Ltd. is producing wide verities of wide verities of torches operated on power batteries, specially designed for trekking and travellers, apart from domestic use. For which they purchase bulbs from Glow Lights and Bulbs (GLB), mostly G3 1M Screw 7.5V bulb is used in torches. Due to lockdown and outbreak of COVID the demand of torch falls significantly, and factories allowed to work at l/3rd of capacity. Considering the same production department slows down the production, causing a huge piled-up inventory of raw material. This will be expected to result in high storage costs. Hence to attain cost-effectiveness; LPL decided to move from tradition system to Just-in-Time (JIT) system in a phased manner. There are two major departments operating in LPL, purchase, and production. In the first phase, the purchase department is considering the adoption of JIT purchasing.
The annual demand for G3 1M Screw 7.5V bulb (bulb) is 24,000 units at LPL. Presently, the purchase price is ₹ 80 per bulb. Currently, the annual demand is ordered in 24 orders of equal size, and the cost of placing an order is ₹ 10 which is expected to remain same in JIT regime too. Material handling, insurance, and other carrying cost is ₹ 2, ₹ 1, and ₹ 1.5 respectively per unit per annum.
Under the JIT system, the price expected to increase to 80.05 per bulb. GLB is a reputed company for the quality of its products and timely delivery. As a result of frequent orders, the number of orders increased to 120 under the JIT regime, and order size decrease proportionally. Material handling cost is expected to reduce to ₹ 1.2, whereas other carrying costs will reduce by ₹ 0.5 and insurance costs remain at the same level. Lower inventory level will cause a stock-out cost of ₹ 5 per unit on 0.25% of annual demand.
The required rate return for LPL is 16%.
Required:
(i) (a) Is the JIT process is different for the purchase and production department? STATE the reason to support your opinion.
(b) STATE any three areas in which JIT purchasing may reduce cost significantly to bring the cost efficiency.
(ii) COMMENT, whether purchase department of LPL should move to JIT Purchasing, presuming the same annual demand.
Answer:
(i) (a) Just-in-time (JIT) is the management philosophy based upon demand pull system (rather than supply-push) throughout the plant in order to reduce cost, with a single piece flow after considering takt time.
JIT process is different for purchase and production department, due inherent nature of the function they render; despite the purpose of both is to de-clutter store/assembly line at the production floor and reduce the cost.
JIT if applied in purchases by purchase department then known as JIT [purchasing, which meant materials should only be purchased, when required for production.]
Whereas if JIT applied by the production department, it will be termed as JIT production and meant that finished products should only be | produced, as needed to meet actual customer demand.

(b) The areas, where JIT purchasing expected to reduce cost significantly are:
1. Interest cost of working capital – JIT purchasing will reduce the level of raw materials, which cause a reduction in the amount blocked as working capital; hence interest cost (either actual or opportunity) will reduce too.
2. Reduction in storage cost – As we know JIT purchasing reduce the level of raw material stored, hence storage cost is expected to reduce.
3. Since JIT purchasing reduced the inventory level of raw material, hence sorting (first S out of 5S) become easy and motions (as per motion study) also reduced, which reduce labour and overhead cost as well.
4. Material is purchase as and when required hence wastage and scarp will be less due to a relative reduction in evaporation and tendency to obsolete.

(ii) Chart of cost comparison under present and’JIT regime (annual basis)
im-16

Decision
Since the implementation of JIT Purchasing results in an incremental savings of ₹ 4,589.20 on a per annum basis, hence it is economically viable to move to JIT system of inventory purchase.

Working Note 1 – Average Inventory

Particulars	Present	JIT system
Annual Consumption …..(A)	24,000	24,000
Number of orders ……-(B)	24	120
Order Size …(C = A/B)	1,000	200
Average Inventory …(D = C/2)	500	100

Working Note 2 – Carrying Cost per unit

Particulars	Present (₹)	JIT System (₹)
Material handling (reduction of 0.8)	2	1.2
Insurance	1	1
Other carrying cost (reduction of 0.5)	1.5	1
Carrying Cost per unit per annum	4.5	3.2

Question 10.
(Cellular Manufacturing) Melton Limited engaged in manufacturing of casting and capping of PVC pipes used for electronic fittings, which they supplied to various part of country using a well- diversified network of distributors. Melton Ltd. was established by Mr. Rejul Sharma around 10 year back, since then competition is continually increasing in market as new players entered in market who are ready to sell similar product at relatively lower prices. Mr. Sharma is actively participating in business and hold position of CEO and being a CA by profession; he conducts regular meetings with management accounting department.
In order to beat the competition, Melton Ltd. decided to reduce the cost and enhance the efficiency by implementing the strategic cost management techniques, such as cellular manufacturing using lean manufacturing.
Mr. Pankaj who joined the company recently as management accountant, is very enthusiastic about cellular manufacturing and consider same as scientific way of production. He added it will enhance the value creation ( over value chain. According to him, cellular manufacturing is significant tool to achieve process cycle efficiency.
Mr. Pankaj makes a plan of rearranging the existing machine and human resources who are working on these machines. He tenders such plan (of implementing cellular manufacturing) to Mr. Sharma. Process is also reengineered along with restructuring of production layout. Mr. Pankaj is of belief that with minimal cost (including loss of contribution on account of down time) on rearranging existing resources processing cycle
efficiency can be enhanced.
Mr. Sharma is skeptical in respect of expected benefit, so in his reply to Mr. Pankaj agreed to rearrangement plan, but in phased manner rather than pilot implementation. Mr. Pankaj asked -to implement his plan (on test run basis) to the one of production engineering department, which is tiny in comparison to other 3 production engineering department. Such selected department is contributing around 12% of total production capacity of Melton Ltd. Mr. Sharma in his reply also quoted that go green for next phase will be granted only if during testing phase processing cycle efficiency improved by minimum of 15%.
Mr. Pankaj and his team implement the rearrangement plan on such selected department and practice the reengineered process and rearrangement of machines along with men for 30 days. Recordkeeper provide following PCE data before and after rearrangement.

Activity (part of process)	Before (in minutes)	After (in minutes)
Moving	75	25
Inspection	40	15
Storage	65	15
Processing	90	45

Required
(i) EXPLAIN why Mr. Pankaj considers cellular manufacturing as scientific way of production?
(ii) ASSESS, whether out-come of testing phase at Melton Ltd is sufficient or not as to expectation of Mr. Sharma, for implementation similar rearrangement (cellular manufacturing) to remaining production departments.
Answer:
(i) Cellular manufacturing as scientific way of production
In cellular manufacturing, production workstations and machines are queued in specified sequence to ensure seem-less flow of material over entire production line (Straight Line, U-Shaped or Inverted U-Shaped etc.) to eliminate delay (Time) in production and also to eliminate the transportation (Motion) of various parts of single product from one production facility to another.
Hence Mr. Pankaj is right in equating ‘cellular manufacturing’ as a ‘scientific way of production’ because, it largely rests upon principles of scientific management, suggested by Fredric Winslow Taylor based upon ‘Time Study’ and ‘Motion Study’.
Since in cellular manufacturing one-piece at a time moves across production line, hence provide the scope for customisation to product features on the production line in view of specific customer demands. Hence in this cellular manufacturing add value to customer over value chain.

(ii) Assessment of Mr. Pankaj’s plan (cellular manufacturing) for further implementation (to remaining production departments)
Mr. Sharma seeks 15% improvement in PCE during testing phase, in order to implement the same for remaining production department. Means if PCE is 10% in existing layout, it shall increase to 11.5% or beyond in cellular manufacturing environment.
There is improvement in Process Cycle Efficiency by shifting to cellular manufacturing system from existing system by 11.67% in absolute term. If we measure percentage increase (relative measure), it will be 35.01% (ie., 11.67%/33.33%).
Since relative improvement in PCE is by 35.01% against the yardstick of 15% hence it is advantaged to implement cellular manufacturing to remaining production department also.

Workings
Computation of the PCE (Time in minutes)

SrNo.	Activity Category	Before Rearrangement	After Rearrangement
A.	Moving	75	25
B.	Inspection	40	15
C.	Storage	65	15
D.	Processing	90	45
E.	Value added time …(D)	90	45
F.	Cycle time …(A+B+C+D)	270	100
G.	Process Cycle Efficiency …(E/F)	33.33%	45%

Question 11.
XoX Pvt. Ltd. is a leading mobile manufacturing company and 1 sells its mobile phone across the world. In a fast-changing technological
environment, XoX has been able to maintain its leadership in smartphones segment for third year in a row now. Though the revenues have grown year on year, the costs have increased at a higher rate in the mobile phone industry as a whole.
“We have been leaders in revenue. We must lead in cost reduction front as well. I believe we can achieve this with improvements overtime, however minor they might be!”
– This is what the CEO of XoX has told its directors in a recently concluded board meeting.
The net profit margins of the company has fallen from 10% in 2018 to 8% in 2019 owing to rise in raw material & repair cost. Another significant rise in the cost was on account of repairs of mobiles which are under warranty. There was an increase in these repair costs by X1.5 crores which represents 1% of the total turnover of the company.

The process of repairs /replacement of under warranty product is outlined below:

The company own 200 repair centres in various cities in India.
A customer whose phone is under warranty and requires replacement/ repair visits any of the 200 centres to deposit the faulty mobile phone.
The technician at service centres examines the phone and the service centre sends the phone to a centralised repair centre at Mumbai.
The phones are sent to Mumbai even for minor repairs which can be done locally if requisite infrastructure is provided to the service centres.
The phones are sent in batches. Each service centre creates 3-4 batches of mobile phones in a day. (A recent study showed that the batches could be combined into a single batch per day)
The phones are repaired in Mumbai’s centralised centres and sent back to the respective service centres for handing them back to the customer. The phones which are repaired are sent in separate batches and those which are replaced are sent in separate batches.

Required
You are working as a Finance Manager in XoX. The finance director has approached you to understand whether the minor improvement § would be useful given the size of the company. The Finance Director has asked you to examine the process of warranty repairs and
replacement and submit a report covering the following aspects:
(i) What is the CEO referring to when he says “minor improvements”? EXPLAIN.
(ii) LIST the benefits of such minor improvements.
(iii) APPLY the above process to the warranty claim process and explain how the process can be improved.
(iv) Any other matter which you consider relevant.
Answer:
(Report)
Issue
XoX Pvt Ltd. is a leader in manufacturing of mobiles and is concerned about increasing costs. The increase in warranty related costs has been significant in the current year as compared to previous year. This has reduced the net profit of the company by 196 of sales.

Applicability of Kaizen Costing
“Kaizen” is a Japanese word which means “Change for Better”. In business parlance, Kaizen is used to refer to small and continuous improvement across all functions, processes and employees. Kaizen costing is a cost reduction
system. Yashihuro Moden defines Kaizen Costing as “the maintenance of present cost levels for products currently being manufactured via systematic efforts to achieve the desired cost level.
Toyota Production System is considered as a pioneer in Kaizen Costing. Though the model was used for eliminating wastage from production at factory initially, the concept can be applied in any of the processes in a business. Since Kaizen is a continuous improvement process, a radical change or disruptive innovation is not expected in Kaizen costing.

The following are the key features of Kaizen—

Kaizen processes focus on eliminating waste in the systems and processes of an organisation, improving productivity and achieving sustained continual improvement.
Application of small, incremental changes routinely applied and sustained over a long period can lead to significant improvements.
It aims to involve workers from multiple functions and levels in the organisation.
A value chain analysis helps to quickly identify opportunities to eliminate wastage.
Although incremental changes can often be too small to be seen, Kaizen can be very effective in the long run.

An airline which identified that 75% of its flyers would leave the olive from salad, the airline decided to remove it from its servings. This saved the airline $ 40,000 per year. Another example is where an airline stopped printing its logo in the rubbish bags as it did not add value saved over $ 300,000 per year.
The CEO is referring to Kaizen costing when he mentions minor improvements to save costs over time. Kaizen costing takes into consideration various costs such as costs of supply chain, manufacturing costs, marketing, sales, distribution costs etc.

Benefits of Kaizen Costing

Kaizen reduces waste in areas such as employees waiting time, trans-portation, excess inventory etc., which leads to improved efficiency in overall business processes and systems.
A company applying Kaizen philosophy can achieve cost reduction through small incremental improvements and cost savings.
Kaizen looks at functions and processes at all levels of organisation and requires participation of all employees and massive as well as open communication system. This participative approach improves teamwork across the organisation.
Product improvement using Kaizen is likely to result in less number of defective products leading to customer satisfaction and reduction in warranty related costs.
The reduction in wastage, improved efficiency and cost reduction improves the overall profitability of the company.

Implementation of Kaizen in the Current Case
The implementation of Kaizen as a cost reduction techniques can take several forms. The key question to ask for implementation is – “Can we eliminate waste?”. The waste can take several forms like—

Unnecessary movement of material and men – Travelling for meeting in cases where a video conferencing could help.
Unwanted part in a product which if removed is not likely to impact the performance of the product. (Nano sim card has reduced a significant portion of use fibre boards as compared to the traditional sim cards.)
Defects which involve extra cost in terms of reworks.
Waiting time – A simple example could be locating for files in your computer which has not be arranged properly. This leads to waste of time.

The above is just an indicative list where improvements can be made. However, an important point to note is that reduction of waste should not be done by compromising the quality of product. Apple launched iPhone 5c as a budget phone by using plastic material instead of Aluminium. The market did not like the product as it was considered to be an inferior product as compared to iPhone 5s.

Another way of looking at Kaizen is asking following questions—

Can we eliminate functions from the production process without compromising the quality and utility of end products? – Removing unnecessary movements of material and men.
Can we eliminate some durability? – Use of unbreakable plastic for producing disposable glasses would be waste of resources
Can we minimise design? – e.g. use of Nano Sims.
Can we substitute parts of the product being manufactured?
Can we take supplier’s assistance to get better quality parts?
Is there a better way? – This is a question which must be asked continuously to ensure that the improvement is not a one-time exercise.

(The above questions also form a part of the Value Engineering Process)
Application of Kaizen at XoX Pvt Ltd.

The current warranty claim process at XoX involves movement of mobile phones from various service centres across the country to a centralised centre in Mumbai. The possible improvements in the claim process is explained below
The company needs to analyse whether it requires to own 200 centres by itself across the country. The company can evaluate closing down centres with less customer footfalls or outsource the ones which are not located at the strategic location. This would save some cost to the company.
The current process requires each service centre to send the faulty mobile phones back to Mumbai for repair or replacement. This is done even in case of minor repairs which can be handled locally. The company can provide necessary infrastructure to the service centres to carry out minor repairs locally. This would save logistics cost of sending the phones to Mumbai and back to service centre. The company should analyse the past data to understand the proportion of phones which require minor repair. Repairing the phones locally would also reduce the turnaround time and the customer will get back the phone faster.
The current process is to send phones in 3-4 batches in a day. This effectively means creating 3-4 consignments, documents for dispatches and incurring extra costs for transportation. Combining the phones in a single batch would reduce the cost of transportation and administrative cost as well.
The phones can be sent back from Mumbai in single batch instead of creating multiple batches to save transportation costs.
The above improvements must be revisited continuously to derive required benefit from Kaizen process.
Apart from eliminating waste in the warranty claim process, the com-pany must also identify root causes of increase in warranty claims in the current year as compared to previous year. Every phone being sent back for repair/replacement involves avoidable cost. The company must also revisit the manufacturing process and quality control processes to eliminate wastage in production process and improve quality.
XoX can consider producing better quality mobiles at the manufac-turing process to reduce the warrant)’ claims.
The pattern of warranty claim must be analysed to understand whether there is certain common problem related to repair claims. If the issue has some relation with parts used in mobile, the issue can be taken up with supplier of such parts.

Question 12.
Bo. Ltd. (BoL) is an automobile manufacturer in India and a subsidiary of Japanese automobile and motorcycle manufacturer Leon. It manufactures and sells a complete range of cars from the entry level to the hatchback to sedans and has a present market share of 22% of the Indian passenger car markets. BoL uses a system of standard costing to set its budgets. Budgets are set semi-annually by the Finance 1 department after the approval of the Board of Directors at BoL. The Finance department prepares variance reports each month for review in the Board of Directors meeting, where actual performance is compared with the budgeted figures. Mr. Suzuki, group CEO of the Leon is of the opinion that Kaizen costing method should be implemented as a system of planning and control in the BoL.
Required
RECOMMEND key changes vital to BoL’splanning and control system 5 to support the adoption of ‘Kaizen Costing Concepts’.
Answer: Kaizen Costing emphasizes on small but continuous improvement, Targets once set at the beginning of the year or activities are updated : continuously to reflect the improvement that has already been achieved and that are yet to be achieved.
The suggestive changes which are required to be adopted Kaizen Costing concepts in BoL are as follows:
Standard Cost Control System to Cost Reduction System: Traditionally Standard Costing system assumes stability in the current manufacturing process and standards are set keeping the normal manufacturing process into account thus the whole effort is on to meet performance cost standard.
On the other hand Kaizen Costing believes in continuous improvements in manufacturing processes and hence, the goal is to achieve cost reduction target. The first change required is the standard setting methodology ie. from earlier Cost Control System to Cost Reduction System.
Reduction in the periodicity of setting Standards and Variance Analysis: Under the existing planning and control system followed by the BoL, standards are set semi-annually and based on these standards monthly variance reports are generated for analysis. But under Kaizen Costing system cost reduction targets are set for small periods say for a week or a month. So the period covered under a standard should be reduced from semi-annuaily to monthly and the current practice of generating variance reports may be continued or may be reduced to a week.
Participation of Executives or Workers in standard setting: Under the Kaizen Costing system participation of workers or executives who are actually involved in the manufacturing process are highly appreciated while setting standards. So the current system of setting budgets and standards by the Finance department with the mere consent of Board of Directors required to be changed.

Question 13.
(Cost of quality, Kaizen costing & JIT)
MAX is a multinational automotive manufacturer. It is based in Qatari, a country whose economy was affected badly after the recent global economic recession. Manufacturing powerhouse of Qatari would have suffered because it has vast number of trade with the rest of the world. To revive the country’s situation the government has taken many initiatives including, they have stipulated guidelines for production and employment targets on Industries engage in business activities while ignored profit as a performance measure, While, Company has recently set a goal statement mentioning that z “company’s first goal is growth (Profitability) and second goal is quality”, S for achieving first goal company has reduced employee engagement and z start cost cutting. While few of the experts argued that Company has i broken the quality rule.
MAX has always been among the country’s smartest organizations, yet here, in its pursuit of ever greater global growth, it wasn’t so smart.
Within few months of setting new goal statement MAX’s recalled 9 million cars. It was apparently the largest recalls in history. The floor mats were found to move and wedge the accelerator in position, causing it to stick and lead to a potential crash. When the recall was announced, 52 death had been attributable. Despite proactively cancelling the sales and production of the recalled models, MAX’s reputation as a Market leader was damaged.
While pursuing growth the company has failed by neglecting to pay attention to things it already knew as an organization.
One of the things that MAX knew and yet forgot was that, in the words of Genichi Taguchi, “Cost is more important than quality but quality is the best way to reduce cost” MAX’s management recognizes that it needs to make fundamental changes to its production approach in order to combat increased competition in the market. MAX’s cars are now seen as dreadful having poor safety features as compare to other competitors. Management plans to address this problem by improving the quality of its cars through the use of quality management techniques. It is planning to introduce Leans system i.e., JIT and Kaizen costing to improve its quality and financial performance both.
Currently MAX organization is using standard costing and budgetary variance analysis in order to monitor and control production activities.
The board of director has appointed an Expert to obtain understanding of Lean System, importance of quality management, impact of using quality costs and kaizen costing approach over the traditional standard costing at MAX.
Required:
(a) Discuss the impact of considering quality costs on the Proposed system and explain them in brief.
(b) Discuss and evaluate the impact of the kaizen costing on the current costing system.
Answer:
(a) To increase the quality while at the same time reducing both confor-mance and non-conformance costs is a programme of aiming for zero defect/and or continuous improvement is followed. To implement this elimination of all forms of waste is necessary. For this bifurcation of cost of quality is important, in the current standard costing system. At MAX Cost of quality will probably be hidden in Overheads, the existing system will need to be modified to separate these costs.

Quality costs:
Internal failure costs:
Internal failure cost associated with defects found before the customer receives the product or service. These costs occur when the product is not as per design quality standards and they are detected before they are transferred to the customer. E.g.: waste(occurs when unnecessary work is done or holding of stock as a result of errors, poor organization, or communication), Scrap (defective product or material that cannot be repaired, used, sold), Rework or rectification (when the work needs to be rectified for defective material or errors), Delays, Re-designing, Failure analysis, Re-testing

External failure costs
External failure costs are incurred to medicate defects discovered by customers. These costs occur when products or services that fail to reach design quality standards are not detected unit after transfer to the customer. After the product or service is delivered and then he defects is found then it is an external failure. E.g.; Repairs and servicing, Warranty claims, Complaints (all work and costs associated with handling and servicing customer’s complaints), Returns (handling and investigation of rejected or recalled products, including transport costs) etc.

Prevention Costs
The costs incurred for preventing the poor quality of products and service may be termed as Prevention Cost. These costs are incurred to avoid quality problems. They are planned and incurred before actual operation and are associated with the design, implementation, and maintenance of the quality management system.
E.g. Quality planning cost (creation of plans for quality, reliability, operations, production, & inspection),Quality assurance cost (creation and maintenance of the quality system, Supplier evaluation, New product review, Error proofing, Capability evaluations etc.

Appraisal costs
This means money spent AFTER products are made to check quality is acceptable. These are costs associated with measuring and monitoring activities related to quality.
The need of control in product and services to ensure high quality level in all stages, conformance to quality standards and performance requirements is Appraisal Costs. E.g.: Verification (checking of incoming material, process setup, and products against agreed specifications), Quality audits (confirmation that the quality system is functioning correctly), Supplier rating etc.
The identification and understanding of these costs will help MAX to raise the quality of its products in order to compete more effectively in the market.

(b) Kaizen costing
The Kaizen costing process is small, incremental changes routinely applied for cost reductions throughout the production process during the product’s life. In Japanese language Kaizen means continuous improvement
The kaizen strategy aims to involve workers from multiple functions and levels in the organization in working together to address a problem or improve a particular process.
Some of the activities in the kaizen costing methodology include the elimination of waste in the production, assembly, distribution processes, as well as elimination of work steps in any of these area.

Control VS Reduction
Standard costing is used to control costs while Kaizen costing focuses on cost reduction.
In the standard costing system, employees are seen as cost burden. In the Kaizen system, the employees often work in teams and encouraged to make changes to production in order to make it more efficient. And hence the change in the current costing system would require a change in the corporate culture, Le., from workers are getting command to workers are actively looking for problems.
Kaizen costing can response more easily to a dynamic business environment, standard costing are fix while kaizen costing are continually improving hence due to all these reasons standard costing have much less relevance.

Question 14.
(Case Scenario)
A-One Automobile is manufacturer of Motor Bikes. A-one is based in a country which recently became liberal and global economy. Hence till the time, when businesses in country was controlled by government and the government, in order to maintain price and domestic demand, regulates the market to maintain the uniformity in the prices determined by the entities.
The country is large enough with widespread populations with high density; there is high demand for motor bike as large population of country is in the age group of 18-24 years. A-one automobile enjoys reasonable market share. The new government in country believes in deregulating markets and allows the imports of foreign motor bikes.
Management team at A-One acknowledge that it utmost needs to make changes to its process in order to respond the competition from foreign manufacturers. Further, A-One’s Motor Bikes are now being seen as expensive product in comparison to the foreign competition, because A-One motor bikes are costly. Currently, finance department uses traditional standard costing and budgetary variance analysis on the basis of standards
set semi-annually in order to monitor and control production activities. Management at A-One plans to improve its performance through the use of Kaizen costing.
Required:
(i) RECOMMEND key changes significant to A-One’s traditional costing system to support the adoption of ‘Kaizen Costing Concept’.
(ii) LIST the impact of implementation of the Kaizen costing approach on the employee management at A-One.
Answer:
(i) Key changes to support the adoption of ‘Kaizen Costing Concept’
Kaizen Costing implies that small, incremental changes routinely applied and sustained over a long period, results in significant improvements. It aims to involve workers from multiple functions/levels in the organization to work together to address a problem or improve a particular process. In other words, it is a costing technique to reflect continuous efforts to reduce product costs, improve product quality, and/or improve the production process after manufacturing activities have begun.
Adopting Kaizen costing requires a change in the method of setting standards. Kaizen costing focuses on “cost reduction” rather than “cost control”. It emphasizes on small but continuous improvement. Targets are updated continuously to reflect the improvement that has already been achieved and that are yet to be achieved.

The suggestive changes which are required to adopt Kaizen Costing concepts in A-One are as follows:

Cost Control to Cost Reduction System: Traditionally Standard Costing system assumes stability in the current manufacturing process and standards are set keeping the normal manufacturing process into account thus the whole effort is on to meet performance cost standard. On the other hand, Kaizen Costing believes in continuous improvements in manufacturing processes and hence, the goal is to achieve cost reduction target. The first change required is the standard setting methodology i.e., from earlier Cost Control System to Cost Reduction System.
Reduction in the Periodicity of Setting Standards: Under the existing control system followed by the A-One, standards are set semi-annually and based on these standards monthly variance reports are generated for analysis. But under Kaizen Costing system cost reduction targets are set for small periods say for a week or a month. So, the period covered under a standard should be reduced from semi-annually to monthly and the current practice of generating variance reports should be reduced to a month or a week.
Participation of Executives or Workers in Standard Setting: Under the Kaizen Costing system, participation of workers or executives who are actually involved in the manufacturing process are highly appreciated while setting standards. So, the current system of setting budgets and standards by the finance department should be changed.

(ii) Impact of implementation of the Kaizen costing approach on the employee management-

Role of Employees – The relation between management and employees, apart from role of employees will change drastically, because under any system of costing, employees are seen as cost centre and real cause of problem, but in kaizen costing employees are seen as solution provider.
Implementation aspects of Kaizen – It may be possible that at time of implementation of Kaizen due to change in role of employees, they may be not self-motivated to command, control and suggest possible improvement themselves. But this is sure that after reasonable time Kaizen system will increase staff motivation through empowerment.
Changes in Culture – From government regulated culture to employee self-empowered work-culture, will be dramatic change for A-One. Under Kaizen employee group will be assigned with power to make continuous changes rather than just executing the changes approved from management.

Question 15.
R & Co. Chartered Accountants offers a wide range of specialized, multi-disciplinary professional services that meet the immediate as well as the long-term business needs of clients. One of partner ‘E’ was upset with office documentation. ‘E’ argued that a document management solution is needed to maximize efficiency within the firm. The senior partner Mr. Ram has recently attended a seminar on lean system and heard the ‘5S’.
He said that old files hide the key files from the eye and forces staff to ask which to use. Accordingly, he desires to implement ‘5S’.
Required
ADVISE on implementation of ‘5S’ in R & Co. [RTP May 2018]
Answer:
Office processes often have huge amounts of paperwork and this not only makes processes slower but also allows errors to be introduced. 5S is a method of both cleaning out the working area and maintaining the cleanliness to improve process quality. The 5S process is based on:
1. Sort (Seiri):
This is sorting and removal of unnecessary files, papers, books and documents in the work area. Sorting is designed to make the work area neat, organized and arranged so that relevant items can be found easily. If an item is not relevant for the work, then it should not be in the work area.

2. Set in Order (Seiton):
Set in order means systematic arrangement of things ue. arrange all necessary items into most efficient and accessible arrangement so that they can be easily be identified for use. It is advisable to have proper indexing of files and proper documentation i e. proper index should be made and pasted on each file about its contents and in that pattern of contents, documents should be kept inside the files so that specific document can easily be traced and withdrawn on time. Even inside cupboard, paper of indexing about files with its name should be pasted so that specific file can easily be traced. Same can be done w.r.t. folders in computer, right file should be saved in right folder with identifiable name so that anyone can easily find any file. Frequent use items should be close by and infrequent use items can be further away in a central area. All storage areas should be clearly labeled to allow items to be put in the correct place, e.g. where did I leave the office stamp again?

3. Shine (Seiso):
After sorting and simplifying, it is necessary to keep the work area clean and safe. Shining is also an inspection process for the area, Le. is everything in good condition. It is desirable to involve employees for 15-20 minutes each day to clean the work area so that they can have the habit of cleanness. In the same way, unimportant files either in desktop or any driver should be permanently deleted.

4. Standardize:
(Seiketsu)
A clean and tidy work area allows the process to be standardized and examined for quality or process improvements. Best practices are documented and rolled out across the work area, standards and process measures are established and displayed in the work area.
For example, red file can be standardized for very important files (can be required anytime), green file for important files and yellow file for unimportant files.

5. Sustain (Shitsuke):
It means to maintain discipline, this can only be achieved by auditing work areas and processes to make sure that the 5S standards are maintained. It is worthwhile to apply 5S standards continuously ie. daily basis and check for any upgradation if needed, so that firm can have good management in terms of documentation, cleanness, time saving of partners as well as clients.

Question 16.
Pavilion limited deals in manufacturing of cycles. Recently apart from manufacturing cycles, P Ltd. enter into the business of assembly of electronic bikes.
Since P Ltd. didn’t expand the factory area, post starting assembly of electronic bikes; hence production floor largely remains over-occupied with all sort of material, jigs, and tools; some of them are frequently useful, some are often and other are less often; even some are quite rare.
Workers usually complaint that all categories of jigs and tools are not available, tools which are available also of those belongs to those product design which are outdated (majority of such product are not further manufactured by P Ltd) accessible. Although floor manager is of opinion instead saying tool are not available, it can be said they are not accessible; because workers pick the tool from too! kit or tool board; but not place it back after use; hence it become difficult to locate such tool later or identify worker; with whom these may available.
On name of maintenance department there are only two staff members, who are responsible for ensuring that every machine or equiprrtent must be in running order and effective. Due to shortage of staff in maintenance department, requests for repairs of plant or machines are not handled within reasonable time frame and same will result in sharp deterioration of utility/effectiveness of such plant or machine. Even in some of circumstances, replacements become/remain only alternative.
P Ltd. has reasonable standardise operating procedure for manufacturing of cycles business, but scenario is worse in case of assembly of electronic bike. Since P Ltd. is recently entered into assembly of electronic bike, hence KPIs are not established for all factors which are part of assembly process including critical success factors.
At P Ltd. the attrition rate at senior management positions is quite high and no formal hierarchy tree is established, which result in drastic shifts in workplace culture (due to frequently changing role & responsibility).
care; which is essential for purpose of eliminating any possibility of workplace accident. But assembly line of electronic vehicle witness an incident recently, where one of vehicle during assembly caught fire because wires set of vehicle come into exposure of sparking from the light point near to such assembly line. Such fire causes burn of some of other material too, which are lying near to such assembly line.
Post such incident, CEO call for meeting with all the top tier executives, majorly including production and operation manager, safety staff, maintenance staff and store manager apart from management accountant. During the meeting while production and operation manager highlights some of problem areas, management accountant quoted 5S as solutions to problems faced by P Ltd.
Required
CEO asked Management Accountant to be ready with report and presentation on 5S, which can highlight the operational aspect of 5S.
You are deputy to management accountant and asked by him to prepare a case, in form of report; in favour of implementing/APPLYING 5S at P Ltd. and EXPLAINING the expected benefit from implementation of 5S. [RTPMay 2020]
Answer:
Report
Addressed to;
Office of CEO,
Pavilion Limited (P Ltd.).
Dated – 07th Jan 2020

Report on operational aspect of 5S and expected advantage
5S represent scientific way of workplace management so that work can be performed effectively, efficiently, and safely. SS was come into practice as part of Toyota Production System in early of mid- 20th century. 5S is usually considered as essential component of lean manufacturing, and foundation of eight pillars of TPM. The 5S refer to five Japanese words- seiri (sort), seiton (set in order), seiso (shine), seiketsu (standardize), and shitsuke (sustain). They define a system for workplace organization and standardization. Sort means to separate needed and unneeded materials and to remove latter. Set in Order means to arrange materials and equipment so that they are easy to find and use. Shine means to conduct a clean-up campaign. Standardize means to formalize procedures and practices to ensure that all steps are performed correctly. Finally, sustain means to form habit of always following first four Ss through training, communication etc.
Note – Later 6th S was also introduced and ie. safety.

SI – Sorting
In order to over-come the problem of ‘idle laying over material’ all across production floor area, sorting of material is need to be done in following categories:

Not needed at all – to be moved to red tag area.
Needed but not now – need to be moved to store with yellow tag.
Needed but not here – to be moved to red tag area.
Needed but not so much quantity.

For purpose of doing sorting P Ltd. need to be answered following questions:

What is required?
How much required?
When it is required?
Where it is required?

Sorted material depending upon category can be separated and made ready for movement/shift, in order to segregate the sorted material; visual aid technique can be used by attaching coloured tags to each category of material (called visual sorting). Following two categories of tag can be used:
Red tag – A card containing detailed information of ‘unwanted things’ with a given time limit for further action to be taken.
Yellow tag – A card containing detailed information of ‘needed things’, but not now with a given time limit for further action to be taken – usually kept in store.

Sorting can help P Ltd. to identify:
(a) Obsolete material; parts (jigs/tooling) not required as the design has become obsolete.
(b) Defective material; part can’t be used as it is.
(c) Scrap material.
(d) Material which not in place – kept at wrong place.
(e) Unnecessary/extra/not useful material.

Sorting can also help P Ltd. in reduction of material lying vacant on production floor, by segregating them into different categories and ensure that rarely used material either removed or tagged in red tape area. If material were sorted than ‘loss of material’ which lying vacant near to assembly line during fire incident could be saved.

S2 – Set in order
Systemic arrangement by ensuring ‘place for everything and everything in its place’. Purpose is to save search time and eliminate motion waste, through visual management; with search-free and count free arrangement.

Colour can be best visual aid – RYGB
R – Red – Critical
Y – Yellow – Reorder
G – Green – Design
B – Blue – Excess
Note – Mapping of RYGB to feature is purely illustrative.

In order to implement systematic arrangement, P Ltd. need to consider and answer;

Analyse Status.
Decide – Which things will belong where?
Decide – How they should be put away?
Get everybody to follow rules through indexing, labelling etc.

Expected benefits of set in order to P Ltd.
(a) Faster retrieval of things results in elimination of search time.
(b) Opportunity to correct the abnormalities faster as visibility improve by system itself.
(c) Space saving by systematic arrangement.
(d) Efficiency of work improves as things are available when they are actually needed.
Thus, S can solve the specifically problem of non-accessibility of tools.

S3 – Shine
Ensure there must be cleanliness ‘in and of’ everything. Obviously, if there less number of items, then there is less to clean.

Cleaning should be with meaning.
Cleaning is inspection (from all aspects – front, rear, left right, top and bottom).

Shine will help P Ltd. to keep things in order with regular cleaning and upkeep, so that maintenance become ‘preventive function’ rather corrective and any incident, likewise fire occurrence on assembly-line; must be avoided. This will ensure larger utility out of Machine and Plants which will increase replacement cycle and save investment by lowering down maintenance; and replacement cost.

S4 – Standardization
Establishing the ‘standards’ and make ‘operating procedure’ to create consistency and ensure that all steps are performed correctly. There are;

Fix responsibilities for implementing & evaluating system.
Integrate these responsibilities into routine work.

Check how well the system is working and sustaining itself.
In order to ensure TPM all 5S are essential, but standardisation is key, P Ltd is facing large set of problem in assembly of electronic bike business and reason being absence of SOPs. Hence, by establishing the standardised process P Ltd can identify Critical Success Factors (CSFs) and benchmark the Key Performance Indicator (KPIs) against each CSFs.

SB – Sustain
In order to sustain with the established standard, it is required to do;

Daily monitoring
Improving ownership by allocating areas
Using ‘red tag campaign’
Communicating visually through fixed point photography
Structured communication
Continuous training of all employees
Periodic audits at all level
Motivating staff through recognition

Since 5S is not a onetime exercise, it is continuous process, hence, it is essential to sustain the practices followed during earlier 5Ss. P Ltd witness the high attrition rate at top management level, hence, it is important that P Ltd must inculcate practice of 5S in the system and work culture and sustain them on continuous basis, irrespective attrition.
Sixth S is ‘safety’ which was added later on, in order to ensure safety while performing all the remaining 5S.
Further details can be tabled on requisition basis.
Closure of Report
Management Accountant
(For Management Accounting Division)
Pavilion Limited

Question 17.
(Case Scenario)
Hammel Pvt Ltd. manufactures toys and games for the children in the age group 6 to 14 years. They have recently shifted to STEM i.e., Science, Technology, Engineering and Mathematics learning approach. The major games under this category are DO IT YOURSELF (DIY) Kits. Each kit is designed with a specific learning objective. This kit comprises of all the elements which are essential to build the specific project. The number of elements in a kit range from 200 to 350 elements. There is an instruction booklet in the kit which guides the user throughout the project. The users can also use the video support which is provided with specific user login.
In last two months, the customer support division has reported a major increase in the consumer complaints. A critical study revealed that the major complaints were under the category “missing elements” in the kits. Further study revealed that most of these complaints were for the products which had some common elements in the kits. On the other hand, the customer feedback and reviews have been very positive on the “quality of the elements” provided with the kits.
Since innovation is the core competency for this game industry, the company has a dedicated Research and Development team which focuses on three areas—
a. Identification of new learning techniques
b. Development of new games
c. Upgradation of existing games
Under the current system, the games are sold online. The final product is delivered from the central warehouse located in Bangalore. The company holds a minimum inventory of the games at the central warehouse.
The manufacturing facility is located in the industrial area which is around 50 kms from the Central Warehouse. The production plan is based on the demand as per the instructions from the Central Warehouse. The Chief Quality Officer is responsible for the quality of the product right from the procurement of the raw material till the final product is delivered to the customer.
The CEO has called a meeting of the heads of all the departments and suggested them to implement of Lean Management and integrated the same with the innovation in the organisation. After a series of brainstorming sessions, they have agreed to implement 5S lean management system.
Required:
ADVISE on implementation of 5S in Hammel Pvt Ltd.
Answer:
The current problem emphasises on “missing elements” in the kits as one of the major reasons of customer complaints. This highlights that there are issues related with workspace organisation. The positive feedback on the “quality of the elements” reflects that the production related process is robust. Considering the above two factors, Hammel Pvt Ltd. is required is to maintain high quality work environment. Therefore, the 5S concept should be used. 5S explains how a workspace should be organized for efficiency and effectiveness by identifying and storing the items used, maintaining the area items, and sustaining the new order. The 5S lean management system comprises of the five S’s Sort, Set in Order, Shine, Standardize, and Sustain.

Question 18.
CRAFT Ind Inc. supplies the following information relating to a vital equipment used in its production activity for April, 2018:
Total time worked during the month 210 hrs.
Total production during the month 2,800 units.
No. of units accepted out of total production 2,520 units.
Standard time for actual production of the month 180 hrs.
Time lost during the month 28 hrs.
Required
(i) STATE an appropriate approach to measure the total productive maintenance performance of an equipment.
(ii) Quantify the total productive maintenance performance of the above- mentioned equipment by using the approach stated in (i) above
(iii) COMMENT on the effectiveness of maintenance of the equipment. [May 2018] (2+6+2 Marks)
Answer:
(i) The most important approach to the measurement of TPM performance is known as Overall Equipment Effectiveness (OEE) measure. The calculation of OEE measure requires the identification of “six big losses”

Equipment Failure/Breakdown
Set-up/Adjustments
Idling and Minor Stoppages
Reduced Speed
Reduced Yield and
Quality Defects and Rework

The first two losses refer to time losses and are used to calculate the availability of equipment. The third and fourth losses are speed losses that determine performance efficiency of equipment. The last two losses are regarded as quality losses.
Performance × Availability × Quality = OEE%
OEE may be applied to any individual assets or to a process. It is unlikely that any manufacturing process can run at 100% OEE.
Availability Ratio = Run Time/Total Planned Production Time × 100%

(ii) The most important approach to the measurement of TPM performance is known as Overall Equipment Effectiveness 210 Hrs.
Availability Ratio per shift = $\frac{210 \text { Hrs. }}{210 \text { Hrs. }+28 \mathrm{Hrs} .}$ × 100 = 88.24%
Performance Ratio = $\frac{180 \mathrm{Hrs} .}{210 \mathrm{Hrs} .}$ × 100 = 85.71%
Quality Ratio = $\frac{2520 \text { Units }}{2800 \text { Units }}$ × 100 = 90.00%
Overall Equipment Effectiveness = 0.8824 × 0.8571 × 0.90 = 0.6807

(iii) Comment
World Class OEE is 85% or greater, CRAFT India Inc’s OEE is somewhere around 68%. It just means that company got some opportunities for improvement. CRAFT India Inc may improve OEE by collecting information related to all downtime and losses on equipment, analyzing such information through graphs and charts, making improvement decisions thereon like autonomous maintenance, preventive maintenance, reduction in set up time etc. and implementing the same.
Note: This question has been solved by considering “Time Available equals to Total Time Worked plus Time Lost”.

Question 19.
PK Pharmaceuticals Ltd. is producing medication products (pills, balms etc.) and can be called high volume based production environment.
There are several different automated production machines located in the plant, through which production of medicines is accomplished and fulfilled the demands. Plant operates in double shift a day each consisting of 8 hours with 30 minutes’ lunch break and tea break of 15 minutes.
Following data pertains to automated machine ‘X-78’.
X-78
14 February 2018, Wednesday

Breakdown, repair and start up time	68 minutes
Standard cycle time	2.5 minutes per tablet
Quality loss due to scrap, rework and rejection	50 tablets
Total quantity produced	280 tablets

Required
COMMENT on OEE. [RTP May 2018/2019] (2+6+2 Marks)
Answer:
Calculation of Loss of Time Per Shift

	Mins.
Lunch Break (planned downtime)	30
Tea Break (planned downtime)	15
Breakdown, Repair, and Startup Time (68 mins/2 Shift) (unplanned downtime)	34
Total Time Loss Per Shift (planned + unplanned downtime)	79

Availability Ratio Per Shift = $\frac{480 \text { mins. }-79 \min s .}{480 \text { mins. }-45 \min s .}$ × 100 = 92.18%

Actual Production	=	140 tablets per shift
Standard time	=	2.5 minutes
Standard Time Required	=	140 units × 2.5 minutes
	=	350 minutes
Actual Time Taken	=	480 mins. – 79 mins.
	=	401 minutes

Performance Ratio = $\frac{350 \mathrm{mins}}{410 \mathrm{mins}}$ × 100 = 87.28%
Quality Ratio = $\frac{140 \mathrm{tab} .-25 \mathrm{tab} .}{140 \mathrm{tab} .}$ × 100 = 82.14%
Overall Equipment Effectiveness = 0.9218 × 0.8728 × 0.8214
= 0.6609 = 66.09%
Since OEE of PK Pharmaceuticals Ltd. is lesser than 85% Le. World Class Performance Level, Company is advised to improve its each ratio ie., availability ratio, performance ratio and quality ratio by collecting information related to all downtime and losses on machines, analyzing such information through graphs and charts, making improvement decisions thereon like autonomous maintenance, preventive maintenance, reduction in set up time etc. and implementing the same.

Question 20.
Goldy Company Ltd. manufactures spare parts. It works in two shifts of 8 hours for 6 days in a week. Lunch break is 45 mins and other miscellaneous breaks add up to 25 minutes. The following details are collected for the last 4 weeks by the TPM team for one of their important equipment

Hours for Planned Preventive Maintenance	15 minutes per shift
For Breakdown Maintenance	6 hours
Total Set up Changes	15 hours
Total Power Failure	4 hours
Total Standard Cycle Time per piece	3 minutes
No of Parts Produced per shift	120
Parts Accepted per shift	115

Required
Calculate ‘OEE’ [RTP May 2018/2019] (2+6+2 Marks)
Answer:
Calculation of Shifts

Days per week (A)	6
Shifts per week (B)	2
Total Working Shifts per week (C) = (A × B)	12
Total Weeks (D)	4
Total Shifts (E) = (C × D)	48

Calculation of Un-planned downtime

Breakdown Maintenance (in Mins)	360
Set up changes (in mins)	900
Power Failure (in mins)	240
Total	1,500
Loss of Minutes per shifts (1,500/48)	31.25

Calculation of Planned Production Time

Total time (8 hrs. × 60 Mins.)	480
Less Planned downtime
Lunch Break	45
Miscellaneous Break	25
Preventive maintenance	15
Planned Production Time	395

Availability Ratio per shift = $\frac{395 \text { mins. }-31.25 \text { mins. }}{395 \text { mins. }}$ × 100 = 92.09%

Actual Production		120 Units per shift
Standard time	=	3 minutes
Standard Time Required	=	120 units × 3 minutes
	=	360 minutes
Actual Time Taken	=	395 mins. – 31.25 mins.
	=	363.75 minutes

Performance Ratio = $\frac{360 \text { mins. }}{363.75 \text { mins. }}$ × 100 = 98.96%
Quality Ratio = $\frac{115 \text { parts }}{120 \text { parts }}$ × 100 = 95.83%
Overall Equipment Effectiveness = 0.9209 × 0.9896 × 0.9583
= 0.9733 = 97.33%

Connection Between TQM and TPM
The connection between TQM and TPM are summarized below:

TQM and TPM make company more competitive by reducing costs, improving customer satisfactions and slashing lead times.
Involvement of the workers into all phases of TQM and TPM is necessary.
Both processes need fundamental training and education of participants.
TPM and TQM take long time to notice sustained tangible benefits.
Commitment from top managements are necessary for success of the implementation.

Question 21.
Desii Company Ltd. manufactures spare parts and can be called “high volume based” manufacturing environment. The company is using the system of Total Productive Maintenance for maintaining and improving the integrity of manufacturing process. There are several different automated manufacturing machines located in the plant, through which manufacturing of spare parts are done and supplied to cater the demand in the market.
A 12 hour shift is scheduled to produce a spare part in Desii Company Ltd. as shown in the schedule below. The shift has three 15 minute breaks and a 10 minute clean up period.
Production Schedule for Automated machine M1:
Cycle: 10 (seconds), Spare parts Manufactured: 3,360, SCRAP: 75, Unplanned Downtime: 36 minutes
Required
(i) CALCULATE OEE (Overall Equipment Effectiveness) and comment on it.
(ii) The management of company has decided to ensure that things are done right the first time and that the defects and waste are eliminated from operations. Thus, they are planning to implement Total Quality Management (TQM) also. SUMMARIZE the connection between Total Quality Management (TQM) and Total Productive Maintenance (TPM). [Nov. 2019](6+4 Marks)
Answer:
(i) Calculation of Loss of Time Per Shift

	Mins.
Break (3 × 15 Mins.)	45
Clean up time	10
Unplanned Downtime	36
Total Time Loss Per Shift	91

Availability Ratio per shift = $\frac{720 \text { mins. }-91 \text { mins. }}{720 \text { mins. }-45 \text { mins. }-10 \text { mins. }}$ × 100 = 94.59%

Actual Production	=	3,360 parts
Standard time	=	10 seconds
Standard Time Required	=	3,360 parts × 10 seconds/60
	=	560 minutes
Actual Time Taken	=	720 mins. – 91 mins.
	=	629 minutes

Performance Ratio = $\frac{560 \text { mins. }}{629 \text { mins. }}$ × 100 = 89.03%
Quality Ratio = $\frac{3,360 \text { parts }-75 \text { parts. }}{3,360 \text { parts }}$ × 100 = 97.77%
Overall Equipment Effectiveness = 0.9459 × 0.8903 × 0.9777
= 0.8234 = 82.34%

Comment
Since OEE of Desii Company Ltd. is lesser than 8596 Le. World Class Performance Level, Company is advised to improve its each ratio Le. availability ratio, performance ratio and quality ratio by collecting information related to all downtime and losses on machines, analyzing such information through graphs and charts, making improvement decisions thereon like autonomous maintenance, preventive maintenance, reduction in set up time etc. and implementing the same.

(ii) The connection between TQM and TPM are summarized below:

TQM and TPM make company more competitive by reducing costs, improving customer satisfactions and slashing lead times.
Involvement of the workers into all phases of TQM and TPM is necessary.
Both processes need fundamental training and education of participants.
TPM and TQM take long time to notice sustained tangible benefits.
Commitment from top managements is necessary for success of the implementation.

Question 22.
Portrait Ltd. manufactures spare parts and can be called “high volume based” manufacturing environment. The company is using the system of TPM for maintaining and improving the integrity of manufacturing process. There are several different automated manufacturing machines located in the plant, through which manufacturing of spare parts are done and supplied to cater the demand in the market.
A 12- hour shift is scheduled to produce a spare part in Portrait Ltd. as shown in the schedule below. The shift has three 15- minute breaks and a 10- minute clean up period.

Production Schedule for Automated machine NZ 10:

Cycle	10 seconds
Spare parts Manufactured	3,360
SCRAP	75
Unplanned Downtime	36 minutes

Required
CALCULATE ‘PEE’ (Overall Equipment Effectiveness) and comment on it.
Answer:
Calculation of Planned Production time

	Mins.
Total time (12 hrs. × 60 Mins.)	720
Less Planned downtime
Break (3 × 15 Mins.)	45
Clean up time	10
Planned Production Time	665

Availability ratio per shift = $\frac{665 \text { mins. }-36 \text { mins. }}{665 \text { mins. }}$ × 100 = 94.59%

Performance Ratio = $\frac{560 \text { mins. }}{629 \mathrm{mins}}$ × 100 = 89.03%
Quality Ratio = $\frac{3,360 \text { parts }-75 \text { parts. }}{3,360 \text { parts }}$ × 100 = 3,360 parts
Overall Equipment Effectiveness = 0.9459 × 0.8903 × 0.9777 = 0.8234 = 82.34%

Comment
Since the OEE of Portrait Ltd. is very close to 85% i.e. world class performance level, company should take measures to improve it and strive to attain 85% level. Availability Ratio of machine NZ 10 is 94.59% exceeding the ideal value of > 90% which is good but the Performance and Quality Ratios need attention as they are below their ideal values of > 95% and > 99% respectively.
Question 23. Pacific Coast Company Ltd. manufactures spare parts. It works in two shifts of 9 hours for 6 days in a week. Lunch break is 30 mins and other miscellaneous breaks add up to 15 minutes. The following details are collected for the last 4 weeks by the TPM team for one of their important equipment.

Hours for Planned Preventive Maintenance	15 minutes per shift
For Breakdown Maintenance	6 hours
Total Set up Changes	14 hours
Total Power Failure	4 hours
Total Standard Cycle Time per piece	3 minutes
No. of Parts Produced per shift	140
Parts Accepted per shift	131

Required
CALCULATE OEE’.
Answer:
Calculation of Shifts

Days per week (A)	6
Shifts per week (B)	2
Total Working Shifts per week (C) = (A × B)	12
Total Weeks (D)	4
Total Shifts (E) = (C × D)	48

Calculation of Un-planned downtime

Breakdown Maintenance (in Mins)	360
Set up changes (in mins)	840
Power Failure (in mins)	240
Total	1,440
Loss of Minutes per shifts (1,440/48)	30

Calculation of Planned Production time

	Mins.
Total time (9 hrs. × 60 Mins.)	540
Less Planned downtime
Lunch Break	30
Miscellaneous Break	15
Preventive maintenance	15
Planned Production Time	480

Avadabdity Ratio per shift = $\frac{480 \text { mins. }-30 \text { mins. }}{480 \text { mins. }}$ × 100 = 93.75%

Actual Production	=	140 Units per shift
Standard time	=	3 minutes
Standard Time Required	=	140 units × 3 minutes
	=	420 minutes
Actual Time Taken	=	480 mins. – 30 mins.
	=	450 minutes

Performance Ratio = $\frac{420 \mathrm{~min} \mathrm{~s}}{450 \mathrm{mins}}$ × 100 = 93.33%
Quality Ratio = $\frac{131 \text { parts }}{140 \text { parts }}$ × 100 = 93.57%
Overall Equipment Effectiveness = 0.9375 × 0.9333 × 0.9357
= 0.8187
= 81.87%

Question 24.
GVK Pharmaceuticals Ltd. is producing medication products {pills, balms etc.) and can be called high volume based production environment. There are several different automated production machines located in the plant, through which production of medicines is accomplished and fulfilled the demands. Plant operates in double shift a day each consisting of 8 hours with 25 minutes’ lunch break and tea break of 10 minutes. Following data pertains to automated machine ’X-78’.
X-78
14 February 2020, Friday

Breakdown, repair and start up time (unplanned)	90 minutes
Standard cycle time	2.5 minutes per tablet
Quality loss due to scrap, rework, and rejection	40 tablets
Total quantity produced	280 tablets

Answer:
Calculation of Planned Production time

	Mins.
Total time (9 hrs. × 60 Mins.)	480
Less Planned downtime
Tea Break	10
Lunch Break	25
Planned Production Time	445

Availability Ratio per shift = $\frac{445 \text { mins. }-45 \text { mins. }}{445 \text { mins.. }}$ = 89.89%

Actual Production	=	140 tablets per shift
Standard time	=	2.5 minutes
Standard Time Required	=	140 units × 2.5 minutes
	=	350 minutes
Actual Time Taken	=	445 mins. – 45 mins.
	=	400 minutes

Performance Ratio = $\frac{350 \text { mins. }}{400 \text { mins. }}$ × 100 = 87.50%
Quality Ratio = $\frac{140 \mathrm{tab} .-20 \mathrm{tab} .}{140 \mathrm{tab} . .}$ × 100 = 85.71%
Overall Equipment Effectiveness = 0.8989 × 0.8750 × 0.8571
= 0.6741 = 67.41%

Question 25.
(Case Study)
Sohana Refineries Limited is a leading oil refining company operating in India. The company has three plants – one each situated in North, South and West. The company has a refining capacity of 30 million barrels. The company currently enjoys a 40% share of the domestic market. The plants run on all 365 days in a year and operate at 100% of the capacity. The company currently does not have any maintenance schedule in place for its plant and machinery. Any repair requirement of plant and machinery is carried out on ad hoc basis.
The company has implemented Total Quality Management (TQM) to ensure that the company rolls out top quality products. The company did not receive any complaints from its customers regarding poor quality of products or products not meeting the specifications. The entire production team is quite excited with superior quality of products.
However, in the last three months, about 30% of the dispatches to customers were delayed. This comes at a time when the entire plant had to be shut for maintenance activity due to breakdown in the machineries for a week. The company also witnessed 20% rejection of the final products. The customers claimed that the products did not meet the specification agreed by them with the company. The Director of Refineries is worried about the worsening situation of production at plants. Another concern for the director is the increase in number of accidents and loss of productive time due to this.
The chairman of the company convened an urgent meeting of the Board of Directors to understand the impact and reasons of the situation at production plants. A key issue highlighted by plant supervisors is that the scheduled maintenance activity for plants was never carried out. The underlying assumption for not carrying out such maintenance activity was – “Since the plant is running smoothly, there is no requirement of preventive maintenance activity. Such activities cost a lot in terms of money and also cause loss of productive time which could otherwise be used for production”. The maintenance departments and production department functioned in silos with almost no co-ordination amongst themselves. The most critical parts of the plant were not maintained for a long time.
The chairman called you after the meeting and asked you to help him understand the current issue at the plant. “We had Total Quality Management (TQM) in place at all our plants. I understand from the production director that TQM is working as intended. Why are we facing the breakdown problem inspite of having a TQM in place” – said the Chairman?
Required
The Chairman has asked you to quickly prepare a note highlighting the following points –
(i) LIST the likely losses arising due to breakdown of machinery due to non-maintenance.
(ii) EXPLAIN the key features of such programme.
(iii) COMPARE the programme identified above and TQM.
(iv) ADVISE the various types of maintenance practices that the company can implement. (5 Marks each part)
Answer:
Issue
Sohana Refineries Limited has implemented a Total Quality Management and is known for producing top quality products. The company enjoys 40% market share in the domestic market. The plants operate at 100% capacity and on all days of the year. This indicates that the company does not carry out preventive and corrective maintenance. The company has not received any complaints with respect to quality from its customers. This can be attributed a solid TQM in place. However, in the last three months, the company has faced delayed in supplies and customer rejections. The delay in supplies could be attributed to the breakdown in the machineries. The production could have been of an inferior quality if the production managers would have rushed to meet the production deadlines

due to loss of production time owing to breakdown.
The discussions at the board meeting indicate that the company has not prioritized preventive maintenance. Maintenance is being carried out on an ad hoc basis with a proper preventive maintenance schedule. The company is concerned about costs of maintenance and hence no preventive maintenance was carried out. Further, there is no co-ordination between the production team and maintenance team.

Losses Arising Due to Breakdown
The following are the losses which can be associated with the breakdown of machinery at Sohana Refineries Limited –

Equipment failure leading to unexpected loss of time – The production at plants was interrupted and the supplies to customers were delay in case of Sohana Refinery Limited.
Idle waits and stoppages due to ad hoc maintenance requirements. Since the interruption is unplanned, the productive labour time is wasted.
Production of inferior quality products causes financial losses. The company would also incur additional costs to remake the product without any additional revenues.
The company would also incur losses in terms of additional set up costs. Every time a machine breaks down, a significant amount of time would be wasted in setting up the production processes again.

Total Productive Maintenance (TPM)
Based on the facts of the case, it is very clear that the company has not prioritized maintenance. The company can use TPM philosophy to address the issue.
TPM is a maintenance philosophy aimed at eliminating production losses due to faulty equipment. The objective of TPM is to keep equipment (plant, machinery etc.) in such a position to produce expected quality products at the maximum capacity with no unscheduled stops. This also includes attaining:

Zero breakdowns.
Zero downtimes. ’
Zero failures attributed to poor condition of equipment.
No loss of efficiency or production capacity due to the equipment.

The concept was initially applied to equipment ie., plant and machinery. Of f late, the concept has also been extended to processes and employees. TPM focusses in keeping equipment and employees in top working condition to avoid any breakdowns and delays in manufacturing process.

Traditionally, maintenance work has been considered as a responsibility of the Maintenance Team which is different from the production team. Total Productive Maintenance seeks to involve workers in all departments and levels in ensuring the effective operations of the plant. When both the teams work in alignment, learnings can be shared with each other. The production team also takes ownership of maintenance requirement. A sole focus on higher production without taking care of maintenance requirement can hamper the long-term production requirements, as could be seen in the case of Sohana Refinery Limited.

Features
Traditional maintenance is centred in the maintenance department. However, TPM seeks to involve workers at all departments and levels. There is a great amount of co-ordination between the production and maintenance team in TPM.

Autonomous maintenance focusses on training operators to be able to take care of minor maintenance tasks. This relieves specialised maintenance staff to focus on critical issues.
TPM focusses on achieving and sustaining zero loses with respect to minor stops, measurement and adjustments, defects, and unavoidable downtimes.
Planned Maintenance is aimed to have trouble free machines and equipment producing defect free products for total customer satisfaction. The approach here is proactive maintenance instead of reactive maintenance. Sohana Refinery limited had a reactive approach to maintenance where maintenance was carried out on an ad hoc basis.
TPM emphasises on training of workers across all levels and departments. The ultimate objective is to have a factory full of skilled workers.

The issues faced by Sohana Refinery Limited due to unplanned shutdowns can be addressed using a Total Productive Maintenance philosophy.

The following are the Eight Pillars or Principles of TPM—

Autonomous Maintenance
Focused Improvement
Planned Maintenance
Early Equipment Management
Quality Maintenance
Education and Training
Office TPM
Safety, Health and Environment

TQM and TPM
Total Quality Management (TQM) and Total Productive Maintenance are often used interchangeably. However, TQM and TPM are considered as two different approaches. TQM attempts to increase the quality of goods, services and concomitant customer satisfaction by raising awareness of quality concerns across the organisation. In other words, TQM focuses on the quality of the product, while TPM focuses on the equipment used to produce the products. By preventing equipment break-down, improving the quality of the equipment and by standardising the equipment, the quality of the products increases. TQM and TPM can both result in an increase of quality. However, the approach of each is different. TPM can be seen as a way to help achieving the goal of TQM.

Sohana Refinery Limited has implemented TQM and is delivering high quality products to its customers. TQM focusses on the end product being supplied to the customer. In the process of producing high quality and volumes of products, the maintenance aspect of plant and machinery was ignored by all. This led to breakdowns and unplanned shutdown of the plant and machineries. The TPM philosophy would focus on the equipment which support production of high quality products under TQM.

Types of Maintenance under TPM
The following are the types of Maintenance Programmes which Sohana Refineries Limited can implement:
1. Breakdown Maintenance:
No maintenance is carried out unless the equipment actually fails. This is the approach taken by Sohana Refineries Limited currently. This type of maintenance is used when the equipment failure does not impact the operations and production significantly and the only cost incurred is the cost of repair. This is not advisable in case of Sohana Refineries as breakdown of machineries have led to significant delays in deliveries and poor quality of production.

2. Preventive Maintenance:
It is a daily maintenance (cleaning, inspection, oiling and re-tightening), designed to retain the healthy condition of equipment and prevent failure through the prevention of deterioration, periodic inspection or equipment condition diagnosis, to measure deterioration. This can be compared with a routine and periodic maintenance activity of a vehicle.

3. Corrective Maintenance:
Corrective maintenance focusses on making machines easier to clean and maintain. There could be reconfiguration of certain parts of the machines (say, a lubricating pipe) to ensure that the maintenance staff can carry out maintenance effectively and easily.

4. Maintenance Prevention:
Through the analysis of maintenance data, the maintenance technicians can work with the designers of our machines to create machines that are more reliable. Maintenance and repairs that are required can be made as simple and as easy as possible to reduce time, save money and improve safety.

5. Autonomous Maintenance:
In case of autonomous maintenance, minor and day to day repairs are carried out by the operators of plant themselves instead of waiting for technicians. Activities like lubricating, bolt tightening etc. are done along with minor repairs by the floor workers or operators. Maintenance team is called only when sophisticated and highly technical maintenance work is required. You may change the tires of your car on your own but to repair a puncture or wheel alignment, you visit a technician.

Conclusion
Sohana Refinery Limited should implement a TPM which would complement and support the TQM philosophy. This would also address the issue of the production team and maintenance team not working in co-ordination. Down time for maintenance should not be considered as a cost or unproductive activity. This should be an integral part of the overall manufacturing plan. This would ensure that emergency and unplanned downtime are kept to a minimum.

Question 26.
Singapore Air Ltd. (SPAL) manufactures electronic components for washing machines in an assembly line. Recent market survey reports indicate erosion of its clientele. Feedback taken from customers suggest that the company’s products were not of good quality. SPAL is concerned because its competitors have been able to achieve zero defect performance in terms of nil sale returns on account of quality and nil subsequent warranty cost. Therefore, the competitors enjoy huge customer loyalty.
To satisfy its customers, the company SPAL wants to improve its product quality. Consequently, it has decided to undertake Six Sigma study of its operations.
Below is the additional information given about SPAL’s operations:
Yearly sales of electronic components are 25,000 units at ₹ 20,000 each. Of these, 1% sales are returned due to quality issues. These are scrapped and a replacement is made by the company. In addition, each product is under warranty for one year after sale. If a claim is accepted under warranty, service and replacement of parts is done free of cost. Current yearly warranty claims (these are separate from sales returns), which is also representative of the average yearly warranty claims, amount to ₹ 30,00,000 per annum.
Quality control check and inspection is carried out directly at the assembly line. There is no quality check done at any other point in the entire work flow. Total time spent on inspection is 2,000 hours in a year which costs the company ₹ 10,00,000 per annum. Inspection leads to 10% rejection i.e. 2,525 units. These units require only one cycle of rework, after which they are ready for sale. Rate of rework in the units rejected on inspection at the assembly line is 5 units in 1 hour. Cost of rework is ₹ 6,250 per hour.

The variable cost of electronic component is ₹ 12,500.
The Six Sigma team as part of its study found that rework on products was mainly due to the following reasons:
(1) Assembly line workers, including new hires, learnt on the job as to how to assemble the input material to produce the final electronic component. This lead to many errors due to lack of proper standardized training. Therefore, on account of these errors, the entire electronic component has to assembled again.
(2) Sub-standard quality of raw material is detected on inspection only at the assembly line. By this time, the defective material is already fitted into the final electronic component. Therefore, entire component has to be reworked upon to replace the defective raw material input.
(3) Machines are outdated and are not entirely suitable for the current’ production methodology.
Proposed solutions to tackle these issues are as follows:
(1) Provide training to assembly line workers to train them on the production methodology. This training is expected to standardize work flow, thereby reducing errors. Such training programs will be held regularly to update the workers on new methodologies. These programs can also serve as employee feedback sessions about the actual working conditions at the assembly line. This two-way communication can improve and streamline the production process. Brainstorming can help detect or give heads up about potential problems in the production process. Total training hours in a year are expected to be 5,000 hours, costing ₹ 1,000 each hour.

(2) Currently poor quality of raw material input is detected only on inspection at the assembly line. This results in wastage of resources in terms of material, time and capacity. In addition to the existing inspection at the assembly line, a new functional area for quality planning and improvement is proposed to be set up. At the time of procurement, the department will determine the appropriate quality of raw material input, ensure that suppliers supply material as per these requirements as well as suggest alternatives that can help im-prove product quality. By ensuring quality of raw materials at the beginning of the production process, wastage of resources is reduced, if not can be eliminated. Cost of setting up such a facility will be ₹ 1,50,00,000. In addition to this facility, inspection will continue at the assembly line. This ensures complete quality check during the entire production cycle. At the same time, due to the introduction of this new functionality for quality control, the pressure on resources for inspection at the assembly line would reduce.

(3) Current machines should be replaced entirely with new machines. Old machines can be sold for negligible amount as scrap. New machines would cost ₹ 3,60,00,000 having a life of three years.
Implementation of the above three solutions can have the following impact:

Rework of products can be entirely eliminated.
Sale returns will reduce from 1% to 0% due to better quality of products.
Yearly warranty claims will reduce from ₹ 30,00,000 to nil per annum.
With the introduction of the new facility, time required for inspection at the assembly line would reduce from 2,000 hours to 1,200 hours. Cost of inspection to do quality check at the assembly line would reduce from ₹ 10,00,000 per annum to ₹ 600,000 per annum.
Due to better quality, SPAL can build better reputation with the customers which can further yield additional sales of 5,000 units per year.

Required
You are the management accountant at SPAL. As part of the Six Sigma project implementation team, you are requested to EVALUATE proposals suggested by the Six Sigma team. The team has used the DMAIC technique to assess quality improvements.
Answer:
DMAIC technique analyses operational problems by assessing them in the following phases
(1) Define;
(2) Measure;
(3) Analyze
(4) Improve and
(5) Control.

1. Define the problem, project goals and customer requirements: Poor quality leading to erosion of clientele.
Customers feedback indicates that product quality requires improvement. Dissatisfaction is reflected in the form of sale returns and warranty claims. Competitors have no sale returns on account of poor quality as well as no warranty claims on its products. Hence, in an environment where 100% quality can be achieved, SPAL is facing quality issues. This is the problem to be addressed. Failure to do so would result in loss of clientele, leading to a possibility of going out of business. The goal of the project is to identify what is the sigma level at which the company is operating and to suggest improvements to the production process it achieve 6o level of operations.

2. Measure current performance: Indicators of poor quality to find out what is the sigma level of the current operations?
Current performance focusing on quality can be determined based on the cost incurred in the following phases:
(a) Sale returns: Sale returns are 1% of total sales. Gross sales are 25,000 units per annum at selling price of ₹ 20,000 each, therefore having a value of ₹ 50,00,00,000. Sales returns @1% amount to ₹ 50,00,000 that represent the return of 250 units per annum. The cost of poor quality on account of these sale returns is the variable cost of the product ₹ 12,500 per unit. This is an avoidable cost amounting to ₹ 31,25,000 per annum that is 0.63% of sales (₹ 31,25,000/₹ 50,00,00,000).

(b) Warranty claims: Warranty is an undertaking given by the company to repair the electronic component free of cost if defect occurs within a specific period of time. Hence, when the customer files a claim that is accepted by the company, it means that there has jg been an issue with the quality of the product. This is liability/ cost that should ideally be kept minimum, if not nil like SPAL’s § competitors.
Warranty for the product is for one year from the date of sale. Warranty claims this year is ₹ 30,00,000, which is given to be representative of the average yearly warranty cost. Therefore, currently this cost amount to 0.60% of sales (₹ 30,00,000/₹ 50,00,00,000).
Summarizing sale returns and warranty claims alone represent 1.23% of current sales. Considering the current percentage of deficiency, the
company is operating between 3σ and 4σ level. The rest of the industry is able to achieve 6σ level of operations. At zero defective production, there are no sale returns on account of quality and no warranty claim costs. Therefore, is tremendous scope for improvement in SPAL’s operations.

3. Analyze: What is the cause of poor quality? What is the cost of resources focused on quality?
Six sigma team studied the production process in detail. Replicating the issues detailed in the given problem:
(a) Problem 1: Assembly line workers, including new hires, learnt on the job as to how to assemble the input material to produce the final electronic component. This lead to many errors due to lack of proper standardized training. Therefore, on account of these errors, the entire electronic component has to assembled again.
(b) Problem 2: Sub-standard quality of raw material is detected on inspection only at the assembly line. Inspection leads to 10% rejection of units. By this time, the defective material is already fitted into the final electronic component. Therefore, to entire component has to be reworked upon to replace the defective raw material input.
(c) Problem 3: Machines are outdated and are not entirely suitable for the current production methodology.
The above factors result in rework on products, an internal failure cost, that lead to wastage of material, resources and capacity.
Two costs incurred to focus on quality are cost of inspection and cost of rework, 2,525 units are reworked upon. Time required to rework 2,525 units per year = 2,525 units/5 units per hour = 505 hours per year. Cost of rework is given to be ₹ 6,250 per hour. Therefore, total cost of rework per year = ₹ 31,56,250.
Inspection cost for 2,000 hours at the assembly line is given to be ₹ 10,00,000 per annum.
Therefore, total cost of resources currently incurred for quality = ₹ 41,56,250 per annum.

4. Improve: Reduce errors and improve quality of the product
While cost of resources currently incurred for quality is only 0.83% of sales (₹ 41,56,250/₹ 50,00,00,000), a detailed analysis brings forth many qualitative aspects that SPAL needs to be address. If its competitors are able to achieve excellence in quality, so must SPAL, in order to remain in business. Therefore, following are the proposals that can provide solutions to the problems referred to above:
(a) Solution to Problem 1: Periodic training sessions to educate new hires and update workers in the assembly line on the latest techniques in production. Standardized and informed working will lead to lower errors and thereby improving product quality. Cost per year = 5,000 hours yearly training X ₹ 1,000 per hour = ₹ 50,00,000.
(b) Solution to Problem 2: Delay in detection of poor quality input can be resolved by streamlining the work flow. New function for quality planning and improvement, at the beginning of the process helps in early detection, without wastage of resources. Cost per year for introducing this functionality = ₹ 1,50,00,000.
(c) Solution to Problem 3: Replace old machines with newer ones. Machine upgrade will align the resource with the production requirements. This reduce chances of errors in the production process.
Cost of procurement: ₹ 3,60,00,000 has a life of 3 years. Therefore, annual depreciation is ₹ 1,20,00,000.
(d) Consequences of implementing these proposals, as given in the problem, can result in the following improvements:
(i) Rework of products can be entirely eliminated.
(ii) Sale returns will reduce from 1% to 0% due to better quality of products.
(iii) Yearly Warranty claims will reduce from ₹ 30,00,000 to nil per annum.
(iv) With the introduction of the new facility, time required for inspection at the assembly line would reduce from 2,000 hours to 1,200 hours. Cost of inspection at the assembly line would reduce from ₹ 10,00,000 per annum to ₹ 6,00,000 per annum.
(v) Due to better quality, SPAL can build better reputation with the customers which can further yield additional sales of 5,000 units per year.
When the company is capable to achieve points (i), (ii) and (iii) mile-stones, it would have achieved 6a operational level. The cost of quality report summarizes the above discussion: –

(a) Cost of quality is 2.06% of sales of which 1.23% alone is external failure cost. This has an impact on the customer experience and can erode | customer base. By implementing the six sigma team’s proposal, this external failure cost on account of sale returns and warranty costs, can completely eliminated. Internal failure cost can also be eliminat- i ed. The increase in cost of quality proposed to be made would be a preventive cost to avoid failure of quality. The company should focus on preventing the error such that it ensures that product is of good quality when it reaches the customer at the very first instance. This enhances the customer experience and therefore eliminating the scope for external failures like sales returns and warranty claims. Better quality can yield further sales of 5,000 units per year. Therefore, an increase in spending on quality measures is justified since it not only yields significant improvements to quality but also brings in more sales orders.

Improvement to the financial position of the firm is summarized below:

Particulars	Amount ₹
Improved Contribution Margin (Ref. note 1)	3,75,00,000
Elimination of Goods Replacement	31,25,000
Elimination of Warranty Claims	30,00,000
Elimination of Rework	31,56,250
Savings in Inspection Cost	4,00,000
Total Benefit … (A)	4,71,81,250
Additional Costs Incurred
Training	50,00,000
Quality Planning and Improvement	1,50,00,000
Increase in Fixed Cost (Yearly Depreciation of Upgraded Machines)	1,20,00,000
Total Additional Cost ……(B)	3,20,00,000
Net Benefit … (A) – (B)	1,51,81,250

Note 1: Incremental Contribution:
Sales have increased by 5,000 units. Selling Price is ₹ 20,000 per unit while variable cost is ₹ 12,500 per unit. Contribution is ₹ 7,500 per unit.
Conclusion: Six Sigma team’s proposals are focused on preventing the error from occurring. Consequently, quality improves, sale improves and thereby can yield a net benefit of ₹ 1,51,81,250 per year to the company

5. Control: Maintain quality at 6o level and keep the production facilities updated.
(i) Training sessions with workers can serve as two way communication platform to detect other problems that can be resolved in more timely manner. Inputs received can also be used to improve the production work flow as well.
(ii) New function of quality planning and improvement can help the company be better informed about the latest production methodologies.
(iii) Updated machines are better equipped to handled changes in the production process since they are built with the latest technology. SPAL should do a continuous assessment of the state of its machines and upgrade them when necessary.

Question 27.
(Case study)(Six Sigma)
Aircase Ltd. is leading manufacturer of leather luggage bags (up to 62”) for the style -conscious people around the globe. It is made up of two independent divisions in New Delhi. The division ‘Mx’ performs all manufacturing and packaging operations. All sales are made through the division ‘Rx’ which has 11 retail stores in New Delhi, as well as through Aircase Ltd.’s own well – developed website. Aircase Ltd has also retail operations in Dubai, Kuala Lumpur, Bangkok as well as in Singapore. These overseas businesses operate as independent subsidiaries within the Division ‘Rx’.
Aircase Ltd. revolutionized the industry by offering cheap but stylish luggage bags. Aircase Ltd. is able to keep its prices low by offering a very basic level of service. Luggage Bags are sold in boxes for customers to assemble themselves and all deliveries are made through third party distributor ‘Qosta Cruise’.
Dr. Philips (Managing Partner) is bothered about increasing sales returns and massive complaints about product purchased from Aircase Ltd. on social media. With this concern, Dr. Philips has appointed you as performance management expert to help the firm to execute six sigma technique to reduce number of sales returns and to evaluate firm’s existing performance.
Dr. Philips has heard that Six Sigma analysis involves large quantities of data. Dr. Philips stated-“I’m not confident on our current IT systems. I doubt whether system would be able to identify the required data related to cutting, preparation, closing, lasting etc. These manufacturing sub-divisions may be the root causes of the problem. Further, quarterly compiled sales return data has not enough detail. We may need to do more analysis on customer satisfaction and manufacturing quality.”
You have been given access to feedback given by customers for returning goods to measure existing performance in this area (refer below):
Difficult to assemble or pieces missing (47%) – Bags were not as demanded (24%) – Poor Quality (19%) -Arrived damaged (9%) – Arrived late (1%)
Required
ADVISE Managing Partner on Six Sigma implementation to reduce number of sales return using DMAIC method.
Answer:
DMAIC is a methodology of Six Sigma used to improve existing business process. It is advisable to Managing Partner to execute following phases of DMAIC:

1. Define the process:
This phase emphases exactly what customer’s requirements are? In this case focus is precisely on why bags are returned. The objective of the process needs to be clear as in this case to reduce the number of customer returns. Customers expect certain minimum requirements from the manufacturing and packaging process, for example, that the bags are properly packed in boxes. They also expect the goods be delivered undamaged within a reasonable time and delivered at the time and date when committed. Further, customer’s perceptions of quality should coincide with the price paid, though different customers may have different expectations.

2. Measure the existing process:
This phase measure the process to determine existing performance. In this case, the sales returns figures do not show complete picture as to why customers return bags, which of the class belong to ‘poor packing’, which one belong to ‘defective item’, which one belong to ‘activities of other sub-divisions’ etc. The ambiguity of the data and classification of definitions will need to be addressed as to enable the process to be measured effectively.

3. Analyse:
This phase detects the root cause of the problems. Possible root cause of sales return are as follows:

Difficult to assemble or pieces missing (4796) – Returns could be because the bags were not manufactured or packed properly in the ‘Mx’ division, but could also be due to poor design, customers losing pieces or simply being unable to assemble bag.
Bags were not as demanded and of poor quality (4396) – Returns could be due to defective manufacture or if the customer had merely changed their minds and no longer required the bag. In ‘bags were not as demanded’, the identification of ‘defective items’ are too vast.
Arrived damaged (996) – It may be that customers wrongly classified defective bags as damaged. Though bags may become damaged by the ‘Qosta Cruise’, only a small number of returns relate directly to them.
Arrived late (196) – Reasons of arrived late could be either ‘Costa Cruise’ could not make delivery on time or ‘Mx’ division could not complete order on time and this causes only 196 of returns, is relatively insignificant.

Further, information could be analysed, like country wise sales returns, product wise sale, or with more clear definition of ‘defective items’ from customer’s perspective. By doing so, firm may easily get information related to areas of the business where sales returns are high and hence be able to focus on.

4. Improve In this phase, recommendations are made to minimize or eliminate the root cause of the problem and then those recommendations are implemented to improve the process in a systematic manner. Aircase Ltd. is required to consider aspects of production or packaging which could be improved, for example, timely repair and maintenance of equipment or training to existing staff etc. Further, availability of resources and likely costs of making the improvements need to be carefully considered.

Question 28.
(Case Study)
Chipotle Foodies (CF) was a small restaurant in and around the busy city of Newtown. The city was located in the banks of river Terresa and was known for its tourism value. The visitors often passed days visiting the prominent natural attractions and the scenic beauty brought them back again. They also treasured the culture of the town and adolescence of the local surroundings. It was simple down to earth. It was untouched by man-made interventions like infrastructures and celestial buildings. The people down there had the culture of visiting bars and restauranis at the evening time to undo the monotony of the day. They liked sitting with their friends, close relatives and chit chatting their busy schedules and what special they did throughout the day, how things went fuzzy, which ought to have been straightforward. The not so civilized ‘life’ went calm until the development of a highway that connected Newton city to the “infrastructural sound” city called Angel. In no time, the Newtown found itself crowded and overburdened to accommodate the daily passengers from highway and near surroundings. This made the State government consider the development of infrastructure in the Newton and additional hotels to welcome the growing tourism business. This led to a drastic changeover in the restaurant business of Chipotle Foodies.
It started getting busier and was brimming with food lovers all over the day. CF being a family owned and self-funded business took this ambience as a door of opportunities to recover the previous losses it had to book long back at its outset. It was thinking to expand its business and open new restaurants in the town, but the funding was yet a trouble since its credibility was questionable to lenders. CF could borrow just enough funds from its familiars to hire additional staffs to serve the growing crowd. Albeit the new staffs were recruited, they lacked proper skill and knowledge of the service industry that CF was into. Most of the staffs were the local people of the city who knew no fancies of alluring the customers with their smiles and warm heartedness. They had to work overtime for low pays since CF was in debt, paying the peaking expenses of production and processing of food items. Given the rising bills and heightening cost , of raw materials, it had to escalate the prices of the items served in the menu card. Notwithstanding the rise, the CF chain was easy on their guests’ pockets compared to other posh dine place out in the city and so the customers resisted subtly and then continued to walk in as before.
The operating efficiency of the restaurant began to decline with the increasing numbers, also somewhat perceived by the incoming customers. The owner heard his customers’ conversation:
Customer Mike: Hey there how are you doing? Well! I wonder why we i have to wait so long when many tables are lying empty. Doesn’t the restaurant feel like harassing their customers without any cause? My mood gets ruined for the wait and plan to seek other nearby places to dine. What about you?
Customer Davin: Yes, you are right. I also feel like claustrophobic having to dine among the proliferating crowd. Hey, guess what, I heard the owner is short on finances and he could hardly do anything to get himself out of this hell, at least not in the near future.
Customer John: The waiting time is ridiculously long. I mean I had to wait 20 minutes on a peak Friday, which I do not mind but here I believe they hardly care to manage this.
The lines got bigger on the Fridays and weekends since the cleaning boy and his partner used old cleaning techniques and were reasonably slow. Several people went ahead and decided to leave rather than wait any further.
The hospitality business demanded unwavering flawless customer service which started to shake. Because of dearth in finances, enough staff could not be placed at required locations which turned things chaotic.
The kitchen environment was not sound either. They used outdated equipment to prepare the food stuff and the manual cleaning of dishes was a big trouble altogether. With the increasing demand for service, no adjustment was made to the number of kitchen equipment. The short number of kitchen staff tried their best to manage things in order, but they could not help to deliver with required speed since they had to clean the equipment manually before every use. The ingredients of the items were not well arranged adding to stress and the wait time of service. Some items like onion garlic paste, boiling of vegetables, chilies, sauces and pickles ought to have been prepared before the restaurant opened for guests. No such arrangement was in place. Some raw materials were in short supply while some were more than the demand, which perished. There were three chefs in the kitchen each specialized in a given cuisine. However, they were not groomed to switch efforts in times of necessity, they but were asked to do this anyways and the results were atrocious.
Sometimes the guests found their tomato soup containing odd ingredients like mushrooms or potatoes and sometimes the guests so claimed 100% vegetarian dish was found to comprise fish or chicken remnants. This situation called for significant quality issues on the processing of food in the most unexpected manner one could think of.
Moreover, the lax kitchen staff had the customer request on their table, which they did not accede in the order received. Some orders were served early while some customers kept seating for long time, waiting for their food to show up on the plates.
The billing machine was not modern and cashier had to manually enter price and other specifications of each item ordered and served.
Most of the times, the only supervisor was found snuggling in his chair. He did not care to advice the waiters and other assistant staffs to improve. As a result, staffs persistently made same mistakes and guests were forced to report the complaints to the restaurant manager, who was also the owner. No leadership role was identified among the staffs.
Some staff took leave on weekends and returned on Tuesdays. They lacked motivation to stay during the peak weekends. When any staff was missing from his respective role, the manager replaced the position since he wanted to save on currency.
The hygiene of the place was also questionable. The floors were watery and smelt nasty, the tables seemed to have contained foods, oils and spilled over sauces. The guests carrying their kids were nervous about their small ones slipping over the floor. On a total, it raised concerns about cooking and cleaning habits of the staffs working there, thereby escalating the health risk of the guests.
The business saw its doom and the customers began looking for dining options in the surrounding area.
Consider yourself as the family advisor of Mr. Bean, the owner and successor of his father’s business. He is aware that you have a cost management degree and are working in one of the multinational firm’s accounting department. Luckily, he has had the chance to hear about your achievements of successfully implementing strategies to assist the firm in rejuvenating its struggling business and now he wants you to work
on turning things around for his restaurant business. He had tears in his eyes while narrating the entire story.
Required:
(i) DISCUSS which managerial technique could be used to “turn things around” as Mr. Bean wants?
(ii) How could this be done? RECOMMEND improvement techniques in each area of disparity.
Answer:
The current situation of Chipotle Foodies, a small family-owned restaurant, resembles lot like that of dissociation of staff efforts, unplanned activities and need for reengineering of business activities. The processes there contain lot of known defects that are being continuously overlooked. There are several quality issues as well, not just in some phases of the service but holistically in series of activities. So, when defect is the prime issue to focus upon, we look for total quality management to render the product/ service defect free to ensure the long run success of the business, but here we need to take a step further discussing the roots of the issue rather than just simply working on the symptoms. For example, long wait time of guests is considered as symptom, while the root cause is disorganized staff team and non-strategic output towards a destined focus, ie., customers. Frankly, we are talking about Six Sigma strategy to get the changeover done.

While people often relate six sigma methods to manufacturing firms and the industry itself, service industry could very well adapt it pragmatically. The forerunners of the technology were Motorola and General Electric who gave a scientific solution to the all-pervasive quality issue evidenced in the day today businesses. Quality issue in physical product means compromise in the shape, size, color, design, taste, or any other form that reduces its true expected utility. Quality issue in service on the other hand means variation in the customer’s standard experience set as per industry norms. Defect therefore means a quality issue that leads to the failure of any product or process. Six Sigma entices one not just to deliver defect free product/ services but also to reduce waste by eliminating errors. The steps involved to improve existing business processes are define phase, measure phase, analyze phase, improve phase, control phase. Now let us see how we can implement each phase to improve the CF’s business situation.

Define Phase
This is the foundation of other phases of the methodology on which they rest. Under this phase, we identify the processes that need improvement, the goals and scope of improvement. In CF’s case, the goals of improving the service process are below:
(a) Exuberating the customers’ overall dining experience including re-duction of total wait time.
(b) Achieving enhanced staff communication and coordination ensuring unclogged flow of information.
(c) Ensuring the rendering of ordered food items as per description in the menu card.
(d) Kitchen chefs to prepare and process food items as per their skill set.
(e) Reduction of the overall processing time of food items once orders are received.
(f) Resolving hygiene concerns.

Measure Phase
Under this phase, we are primarily concerned with gauging the problem, meaning seeking a quantitative tool to define the problem so that it can be used to measure the current performance.
Moreover, we also need to employ effective data collection techniques to obtain data about the current performance. The success of this phase 2; depends on the validity of the data collected.
We must keep in mind that only when the current performance is quantifiable, we could compare it against the standards to identify the variation. These are the traditional steps to bring about an improvement in any process.

We catalogue numerous basis to measure each issue to be improved as indicated in the goals above.
(a) Number of customers leaving the restaurant for having to wait too long.
(b) Number of unhappy customers not returning back,
(c) Number of complaints reported against staff misbehaviour.
(d) Average wait time per customer.
(e) Average food processing time per simple item and per complex item.
(f) Number of accidents due to nasty floors.
(g) Number of complaints against food quality and order mismatch to description in the menu card.

Analyze Phase
This phase involves establishing the root cause of the symptoms palpable in the deficient service process.
In CF, it would be vital to itemize the entire restaurant service processes in the order of their occurrence. This can help firm to look at things in a serial manner rather than taking plethora of activities all at once.
a. Customers enter the restaurant.
b. Receptionist greets and asks them to wait in the waiting area until their names are called upon.
c. Cleaning team clean the tables once the guests are done eating.
d. Receptionist calls the guests in the order of their arrival.
e. They enter the dining area, seat on the indicated table, place order of the food items of their choice from the menu card.
f. The waiters take the order to the chefs in the kitchen for preparing the ordered stuff.
g. Kitchen chefs prepare and process the food ordered, served on plate, to be taken up by waiters.
h. Waiters serve the food to the guests and check with them for coming requests.
i. Waiters keep visiting kitchen and serving stations to get the requested stuff on the table.
j. Finally, guests finish their dine; request the staffs to furnish the bill of the service.
k. The cashier prepares the bill, taken to the guests for payment.
L Guests pay the bill and leave the restaurant.
m. Cleaning team again starts the cleaning process to make room for other guests in the waiting area.

In this way, the whole process gets broken down into small sub-processes. This is the true effort involved in analyze phase. Once all the activities carried out are identified we need to bifurcate them into value added and non-value-added activities, basically we need to pull the bottlenecks out of the entire process to bring efficiency.

Improve Phase
This phase is all about recommending alternatives and implementing them to resolve the established issues. For example, if the issue at hand is about two cars falling short for picking up the employees to render an effective pick drop facility, the alternative is to employ more buses or cars to do the same. Where the firm is unable to do so, it can resort to third party services who deliver this form of service. It will end up in choosing the alternative that is financially more feasible.

In our case, we can clearly perceive humungous scope of improvement. First of all, we must keep in mind that the effective wait time of customers in the service business is a critical factor for success. The long wait time of customers in the waiting area can be directly ascribed to age old cleaning techniques of the staff. The idea here is to introduce innovative techniques of cleaning the tables such that it takes hardly any time to get the table ready for oncoming guests.

Next it is also evident that staffs of CF are not well groomed and lack appealing strategies to enhance the dining experience of their guests. Organizing frequent training sessions to boost their marketing skills like placid smile and greeting the guests with warm-heartedness; keeping up a continuous check of their requests and fulfilling them on timely basis; making them aware of any special coupon or discount that the restaurant puts up; can all bring a drastic change in the customer’s apprehension of staff to meet the growing need of the city such that manager can dedicate himself to the top priority matters rather than playing multiple roles. An efficient reward system should be put in place to ensure each staff’s effort in the process is recognized and rewarded for. This will motivate them and push their determination to work productively rather than missing on peak weekends and returning on Tuesdays. If they work with efficacy during their normal hours, the need of overtime would also reduce.

Finance requirements can be fulfilled by building up good creditability among customers such that an effective business plan itself can propel the lender to provide the required finances.

Further, more kitchen equipment will have to be purchased and cleaning techniques have to be explored such that kitchen staff work productively rather than working laboriously. Just three chefs sound like a real short supply of cooks, driving them to prepare things they are not trained for. The CF should adopt strict food processing policies such that chefs are allowed to prepare only cuisines for which they are groomed. This will ensure complying with strict food quality standards to accentuate no compromise in food quality. Moreover, a fixed processing time of both simple and complex items should be specified and it should be the policy of the restaurant to abide by the same.

Organizing kitchen equipment and food ingredients would eliminate the additional time required to locate them. CF can apply 5S methodology here to cleaning out the working area and maintaining the cleanliness to improve process quality. 5S means sort, set in order, shine, standardize, and sustain. CF needs to ensure that no unnecessary items like perished ingredients/food items, old equipment, and old cleaning tools are seating in the kitchen (Sort).

To bring in more efficiency, we must place frequently used items in easily accessible locations and place occasionally used items at bay (Set in order). For example, a veggie sandwich making store can organize its veggie counters near to its ordering and processing center, so that it takes them less time to prepare sandwiches once order is received. Scientific arrangement helps not just in saving time, it also boosts workplace cleaning. With order comes cleanliness in the workplace (Shine). CF should adopt best practices of the industry or make one to be adopted as the constitution (Standardize). For example, in present case, we need chefs to prepare food items only for they are specialized. Monitoring the adopted practices under 5S model is also no less important. This ensures that we can upgrade those practices if situation demands (Sustain).

Prefixing startup items like sauces, pickles and serving them with starters will help eradicate the wait time once guests are ready with their orders. Employing advanced food processing machineries will drive efficiencies and help meet new standards of CF.
The hygiene concerns can be easily dealt with by applying planned and innovative cleaning ideas to clean the dining and waiting area and using sign boards to warn the subsisting guests of the ongoing cleaning process.
Bringing in automatic scanners and advanced technology will eradicate the
manual entry of order details and their prices to prepare the bills, thereby ruling out the possibility of manual errors and thefts.

The Control Phase
This phase deals with adequate determination to put into practice the policies developed under the “Improve Phase” and ensure its persistent compliance in the rendering of the service. Once the policies become culture of the people, it would be hard to be discern them without such policies. As part of control phase, the changed performance is measured at regular intervals to establish any variances from the expected standards.
No Question from this topic 3.8 BUSINESS PROCESS RE-ENGINEERING

Question 29.
SB is a government-owned bank. The Bank has over 2,500 branches in country ‘A’ spread over all states/union territories including specialized branches. These branches are controlled through 27 Zonal Offices and 4 NBG Offices. As a government owned bank it has usually been the first preference for customers while choosing a bank. In the last six years, the Government has permitted a number of foreign banks to operate within the country in order to solve the problem of foreign exchange shortage and open up foreign trade as an instrument to promote economic development. These foreign banks offer diverse range of services such as direct access to executive management, a single point of contact to coordinate all banking needs, appointment banking to save time, free online banking service 24/7, free unlimited ATM access etc. In contrast, SB has very elementary information systems, covering only for internal transaction handling and accounting activities. Customers have to visit banks to carry out transactions like-checking bank balance, cash deposit and withdrawals, transferring money from one account to another in operational hours. Often customers complain about the amount of time as the employees and clerical staff of the bank can attend only few customers at a time. Customers service evaluation has never been undertaken by SB. Other processes, new account applications, are complex, requiring completion of many documents formalities. Board of Directors were worried from growing popularity of new style banks. The Board of Director of SB has recently held meeting to discuss the shortfalls in its current services and need to re-engineer the SB’s business processes.
Required
ADVISE how Business Process Reengineering (BPR) can be used to improve SB’s current processes. [May 2018] (10 Marks)
Answer:
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 (ie., with those activities that add value to the process). To implement BPR, firstly, each business process of SB 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/ restructured so that can be as efficient as possible. For SB, new technology should be introduced to improve these processes. However, SB must ensure that the statutory compliances regarding these processes are not undermined.

SB is facing a hyper-competitive marketplace where customers expect a superior experience. BPR activities would help SB in understanding those processes which SB’s customers value the most and remove those that are not valued. F oreign banks are offering diverse range of services such as dir ect access to executive management, a single point of contact to coordinate all banking needs, appointment banking to save time, free online banking services 24/7, free ultimate ATM access etc. Clearly these are valuable business processes valued by the customer. SB should incorporate all these facilities in their banking processes to enhance customer satisfaction and service level.

Opening of new accounts in SB is complex processes since it requires multiple forms to be complied with. Through BPR, SB would analyse the whole process and identify the need for only one form that contain all of the necessary customer information. Further, it is also possible to initiate opening of new account through the development of an online application form on SB’s website. Online entry would remove the possibility of forms being lost or incorrect, again enhancing customer satisfaction since customers need not to visit SB’s branch to open account. There should also be online processing authentications/validations as to ensure that data fields are correctly filled by customers that would results in error reduction. This would also remove unnecessary staff activities in checking and re-processing forms.

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 long term, this would result in high levels of efficiency, profitability and better levels of customer satisfaction and retention.

Question 30.
(Case Study)
History:
VRINDE is one of Country ‘Dr’s’ top footwear companies and other equipment. Since its foundation in 1988, VRINDE has been one of the
all-inclusive footwear brand that is committed to nurturing the youth across the world through sports to contribute to society. Over more than three decades, the company inherits its values and provides own products while capturing the changes in the social environment. It’s state-of-the- art production facilities are located strategically across the Country ‘Dr’ and produces all kinds of footwear. VRINDE is best known for its high ethical standards towards its workers, suppliers and the environment and voluntarily publish CSR report every year.
Organizational Structure and Footwear Market
VRINDE is organized into conventional functional departments such as procurement on order basis, sales, and finance, most of which have their non-reliable excel sheet-based systems for planning and reporting. Consequently, it often fails to generate accurate, timely and consistent information to monitor its own performance, thus, company faces failures in achieving the performance and delivery targets set by its retail customers.
In Country ‘Dr’, footwear market is competitive and seasonal. Retailers, who are VRINDE’s customers, for
footwear, they have two main demands, they want –
(i) footwear at lower prices to pass it on to consumers.
(ii) suppliers to meet performance and delivery targets relating to lead times and quality.
In order to comply with the retailer’s demands, VRINDE’s competitors have discontinued all their own manufacturing facilities and outsourced all production to suppliers, who have much larger production lines and lower costs. To reduce the shipment cost over long distances, competitors have invested in advanced procurement software to consolidate orders so that each 40 -foot shipping container gets fully loaded. Purchase invoice processing is also automated via the integration of information systems into the supplier’s software.
Proposal of Outsourcing
In order to mitigate costs, it has been proposed to outsource the manuf acture of footwear, to a Chinese Supplier 3,750 km away. A comparison of the average cost of manufacturing and the cost of outsourcing footwear is given below—

	Manufacturing	Outsourcing
Average manufacturing cost per pair	BND 625	…
Purchase cost per pair	…	CNY28

Notes
1. Country ‘Dr”s home currency is the BND.
2. Exchange Rate 1CNY = 18 BND.
3. In addition to the purchase cost from the supplier, VRINDE will be subject to pay for shipping costs at the rate of BND 40,000 for each large, standard sized shipping container, regardless of the number of units in it. Each container contains 5,000 pairs when fully loaded.
4. Custom tariffs are expected to change soon, footwear imports into VRINDE’s home country might be subject to 10% basic custom duty (plus 10% social welfare surcharge on duty) on the assessable value of imports excluding shipping costs.
Therefore, to implement the proposal, restructuring of functional departments into multi -disciplinary teams are needed to serve major buyer accounts. Each team is required to perform all activities, related to the buyer account management from order taking (sales order) to procurement to arranging shipping and after sales services. Team members dealing with buyers will work in VRINDE’s corporate office, while those like QC etc. managing quality and supplier audits, will work at the manufacturing site of Chinese Supplier. Teams will be given greater independence to selling prices to reflect market conditions or setting a price based on the value of the product in the perception of the customer. Many support staff will work as helper roles, or be offered new jobs opportunities overseas after the restructuring.
Expert Advise
Prof. W, Performance Management Consultant has advised VRINDE that the proposal has features of reengineered processes and can be defined as business process reengineering (BPR). Prof, advised, for evaluating the proposal, VRINDE should consider software development for full front-end order entry, purchasing, and inventory management solution which may be required along with ethical aspect of the proposed changes.
Required
(i) ADVISE on information system which would be required for the reengineering.
(ii) ASSESS the likely impact of reengineering on the VRINDE’s high ethical standards and accordingly on business performance.
(iii) EVALUATE how the BPR proposal can improve VRINDE’s performance in relation to retail customers. [MTP April 2019] (4+6+10 Marks)
Answer:
(i) Advise on Information System
Combining several jobs into one, permitting workers to make more decision themselves, defining different versions of processes for simple cases vs complex ones, minimizing situations when one person check someone else’s work, and reorganizing jobs to give individuals more understanding and more responsibility are characteristics of reengi-neered processes.

In VRINDE, outlays can be saved by rearranging staff into multidisciplinary teams, for example, reducing number of excess staff at different stages – cutting, preparation, finish etc. These savings can be utilized in additional costs such as investment in new information systems. Hammer and Champy stress the use of information technology as a catalyst for major changes. BPR organizes work around customer processes rather than functional hierarchies.

Presently, VRINDE’s departments have their own excel sheet-based systems for planning and reporting which is unreliable and inconsistent. They are inadequate to provide the accurate, timely and consistent data which VRINDE needs to meet its own performance and delivery targets. There must a shared database that should be accessible by §5 all parts of the functional teams. This should have real time updation, so that employees in different time zones can use updated data. The database should include financial data and non-financial data, like cost information, data related to lead times and quality. Information systems must be featured with all required reports like performance report, budget report etc.

In addition, VRINDE is required to invest in special system as advised by Prof. W for full front-end order entry, purchasing, and inventory management solution to minimize shipping costs by ensuring that the shipping containers get fully loaded and to integrate with supplier’s information systems to automate purchase invoicing.

Overall, VRINDE must analyze that whether the benefits due to in-formation technology are worthy.

(ii) Assessment of Likely Impact of Reengineering on Ethical Standards
Workers:
VRINDE is famous for its high ethical standards towards workers and staff. Because of adopting BPR proposal, manufacturing staff are likely to be unemployed. Competitors, have already shutdown their factories, these workers may not be able to find analogous jobs.

Employees who continue in work may become disappointed if they think the application of BPR to all products. This may reduce productivity, increase staff turnover or difficulties in recruiting new staff. In addition, they may also be demotivated if they are appointed in unfamiliar roles, or may not be willing to learn new skills.

Some of staff members may be motivated by the opportunity to perform new types of work, learn new skills or work outside India. This maybe enhance their individual performance.

Suppliers:
Any association with non-ethical practices, for example, if the Chinese supplier is indulged in using non-acceptable working practices, could seriously spoil VRINDE’s reputation for high ethical standards. This could undermine financial performance because customers may not buy its products, or possible investors might refuse from providing capital. Staff members located at the manufacturing site is responsible for supplier audits, which may assist to mitigate this risk.
Environment VRINDE should consider the environmental impact of importing goods from long distances. The environmental related credentials of the Chinese Supplier are not known. Since, VRINDE voluntarily publishes a corporate sustainability report, any distortion in its performance on environmental issues might undermine the financial performance.

(iii) Evaluation of BPR Proposal in relation to Retailer’s Demand Lower Prices
In order to sell footwear at lower prices, there is proposal to reduce costs by outsourcing production to supplier. The current average production cost of manufacturing is BND 625.00 per unit. The cost of purchase from an external supplier is BND 512, which is BND 504 (CNY18 × BND28) purchase cost, plus BND 8 (BND 40,000/5,000) shipping cost. This 18.08% (113/625) saving is a substantial improvement in financial performance, but not a dramatic one. It may be noted that BPR is a methodology that should be applied only when radical or dramatic change is required. Further, exchange rate movements may also slash the cost saving significantly. In the near future, expected changes to international trade tariffs will increase the unit cost to CNY30.83 (CNY28.00 × 110.10%) i.e. 554.94 in BND and reduce the cost saving | to just 11.21% (70.06/625).

Meeting Performance Targets
Lead times
Current lead times for customer orders are not ascertainable. Since the proposed Chinese Supplier is 3,750 km away, consignment will take several weeks to be imported by sea. This may increase lead times substantially, although may be set off by faster production times in supplier’s plant. As VRINDE’s sales are seasonal, retailers may order in advance, decreasing the long lead times. In order to decrease shipping costs, shipping containers must be full, meaning that deliveries must be in larger quantities.

Quality:
VRINDE is already known for manufacturing high quality footwears. The quality of the new supplier’s footwear needs to be checked. Any distortion in the quality of footwear will deteriorate its reputation and decrease long-term business performance since only few customers would order. Quality standards checking is more difficult while using outside suppliers, especially at long distance, than manufacturing in VRINDE’s own factory. In BPR, work is done where it makes most sense to do so. In this aspect, having employees responsible for quality checking and supplier audits (working at the manufacturing site, abroad) will assist VRINDE in sustaining the best supplier relationship management.

Question 31.
OPT is a confectionary manufacturing company, it is founded in 1895. It is one of Maniland’s (country name) oldest existing companies. The company sells its biscuits, breads and dairy products throughout the country. Confectionary market is a highly competitive market. OPT has chosen a strategy of cost leadership.
Since the company has business for 125 years. The company grew significantly during the First World War and again following the Second World War, expanding its offerings. However they are following traditional methodologies which led to a bureaucratic culture, the company faces challenges due to external and internal environmental factors in today’s dynamic and high velocity global market.
The organization has various functional department, such as production, warehouse, accounting, administration, marketing etc. Aiming to become the food industry leader. In order to drive down the costs, The Board of director has decided to re-engineering the processes at OPT.
To gain benefits of BPR the CEO has decided there should be small pilot project. They have selected the manufacturing activity in the production department for this where most of the process was done by labours which can be automated by robotic machineries.
The CEO has appointed a performance management expert to review the post implementation pilot project by assessing what it has delivered in financial terms. The project identified that 10 of its unskilled staff spend about half of their times in selecting the products and mixing it well, due to this 15% of the product wasted. The project has introduced a new robotic machineries and information system which integrate all the activities in manufacturing process.
The new system allow different raw materials in the require proportion to be entered in robotic machinery and then all the process took place automatically in assembly line. The process is monitored at some centralized place by an employee. This increases the efficiency and quality of manufacturing process.
Further details provided below in relation to the project:
Notes relating to old system:

1	Average unskilled staff wage for mixing in production in ₹ 50,000 p.a.
2	Manufacturing expert staff time in handling Mixture (of raw material) queries 8-5 days per week
3	Average expert staff wage in manufacturing is ₹ 64,000 p.a. for working a 5-day week
	Notes relating to new system:
	New system costs:
4	Robotic Machineries for production depts	₹ 440,000
5	IT hardware and Software total cost	550,000
6	On-going servicing cost (p.a.)	45,000
7	It is expected that the new system will last for eight years.

If the pilot project succeed the company wants to apply BPR across the business organization. The CEO is also keen to know the impact of BPR how it will effect the culture and accounting information systems of business organisation. Companies current methodologies are traditional like one of the method is absorption of overheads based on labour hours with variances to budget used as a control indicators but they want to know how to link BPR with the implementation of activity based approach using ERP system.
The CEO is concern that during BPR the employee unrest may be a problem. For example the manager in manufacturing process might be uncomfortable with the cultural change required in the BPR project and decide to leave the job before the project began.
Required
(a) CALCULATE and COMMENT on the financial impact of the pilot business process reengineering (BPR) project in the Production Department.
(b) Determine the impact of BPR on the culture and management information systems at OPT Company.
Answer:
(a) Annual cost benefit of the new system
Benefits of new system (cost savings) ₹

Unskilled staff	10 × 50,000 × 50%	250,000
Manufacturing staff	64,000 × 8.5/5	108,800
Annual costs of new system Depreciation – hardware	440,000/8 years	(55,000)
Depreciation – hardware	550,000/8 years	(68,750)
On-going servicing cost		(45,000)
Net benefit		190,050

OR
Note:
Alternatively- payback period- are equally acceptable.

Payback period

Pay back: 3 Years 2 Months (48,600/3,13,800) * 12 = 2 months
Payback period is 3yrs 2 months which is within the 8 years expected life of new system.
The pilot BPR project will yield a benefit of ₹ 190,050 per year, meaning it is financially successful.
In the given analysis it might be possible that some other cost which might affect the decision has not been consider, such as training costs for staff on the new system. However, the project should still be beneficial even after considering them to the extent of ₹ 190,050.

(b) Business process reengineering (BPR) is the fundamental rethinking and radical redesign of business processes to achieve dramatic
improvements in critical contemporary measures of performance, such as cost, quality, service and speed.

Impact of BPR on Culture of business organisation
Process teams – BPR Will have significant effect on Opt business orga-nization, Traditionally the company has been divided into functional department that is a functional structure but after BPR it has been converted into integrated processed team, in order to get a more efficient delivery of products and services.

Organise around outcomes, not task
An organisation should have one person perform all the steps in a process; design the objectives around the job rather than a single task. Which is possible in the new system one person is responsible for all the activity of manufacturing, this eliminate many handoffs, numerous errors, delays, and misunderstandings, it also eliminate segregation of duties as earlier.
Skills – BPR in the business organisation many lead to multi-skilling; but OPT currently have traditional culture which is bureaucratic, and staff may have specific role in this, rather developing multiple skills.

Organisational hierarchy –
IN BPR the team become responsible for managing the process, the g organisational structure changes from hierarchical to flat. Interdepartmental g issues become matters the team resolves itself, team is responsible for managing the process. As a result managers role is less important.
Though it is not clear the reason why the manager in production department leave the job, but the risk that BPR would diminish their role could be a reason of early retirement.

Change management –
BPR require changes from a well establish functional structure to a process based structure and for successful implementation of BPR in it, effective communication and leadership is required from senior management- they may require to explain their staff benefits of BPR, and overcoming the resistance they face.

Impact of BPR on Management information systems
Performance measures – Under BPR, the Performance measures must be built around business processes rather than departments. Since the OPT have traditional functional structure for BPR company may require a significant changes to management information system.
Focus on value adding – Under BPR the aim of management information system is to identify the value added activities in the process and eliminate all the activities where resources are employed but producing no value outcomes.
Activity-based costing – As the CEO has suggested, activity-based costing (ABC) is often used to model the business processes as part of BPR. Again, however, the change to ABC from OPT’s traditional overhead absorption based on labour hours could be quite significant for the company’s management information system.

ABC will provide a more detailed method for allocating overheads, and in turn, should allow OPT to calculate more accurate product costs, and determine the profitability of each product more accurately.
However, as compared to OPT’s current basis, ABC will be more timeconsuming.

Performance reports:
Since BPR lead to change from the functional to process teams requires the financial reports to be redesign around process teams.
The control indicator that is the variances to budget, also require changes following the introduction of Activity based approach.

Question 32.
(Case study)
Soft Bread Company started its business a couple of years ago down when customers preferred bread to other food items in their breakfast. Today the market has seemingly turned narrow for bread or sandwiches. The high nutrient rich breakfast like corn meal, rice crisps and oats meal are taking over the market share as opposed to bread butter or a simple sandwich which appears to be aged old talks. SBC was about serving the kind of bread their customers wanted. The breads were custom made, ready in no time on order, and delicious, exactly how they need to be. The prices charged for the products offered were on high end since it was the only store of its kind in the area covering 50 kms of east Georgia. Georgians were fond of the unique service offered and the taste filled their morning experience with happiness.
The business prospered and profits increased phenomenally on a year- to-year basis. The prosperity called for additional space and resource requirement. SBC contemplated that since they would have to hire more staff to meet the increasing demand and the space, they were trying to lease was more than what they could use, they planned for add-ons to their current production line “breads and sandwiches”. They started selling
frozen food items, deserts, beverages, and meals for train passengers. The Soft Bread Company was now known as “Just Taste It” (JTI). They started to hire new people with flawless cooking skills. There seemed to be more supply than the demand and it appeared that commoners had great cooking talent and were interested to learn more to take it to an altogether newer level. The staffs were welcomed to share their unique recipes and team gathered to prepare items based on the ones selected and approved. The employees started preparing meals on a prior anticipation of demand including excess meals for any stock outs. In a month or so, the warehouse seemed to be a chaos full of raw materials purchased from various suppliers based on suggestions of staffs and prepacked meals. The kitchen was out of space to accommodate the current staffs comfortably. The myriad ideas took JTI in a mirage creating problem in coordination among staffs since many of their ideas had to be dropped and others that were welcomed created a negative cost benefit equation.
The bread and sandwich business was hit by the negative publicity of the train meals business since JTI had to compromise on quality to earn enough profit to keep the meal business up and running. Gradually the loyal clients turned down on them and started to switch to other caterers. The management of JTI was wondering if at all the business should be continued since there were not enough orders and the pre prepared meals are getting wasted thereby burdening the firm with huge costs. The frozen items, desserts and beverage business were the only support they had. Clients continued to buy those items considering frozen items, desserts and beverages were just bought and served to them on a margin. JTI ended up losing customers trust and had no other option but to stop preparing anything for them. They thought of bringing a changeover and presenting themselves as retailers rather than preparers of meals, breads and sandwiches. The management of the company was in desperate need of a savior that could prevent the demise of JTI.
One of the management people, Mr. Juniorson contacted you and approached you for some valuable ADVICE in this regard. He also came up with their income and expenses (refer Annexure) so that you could provide some insights on how to overcome the loss-making situation and rebound back to a prosperous profit earning history.
Required:
Consider yourself as a management accountant who was referred by one of the friends of Mr. Juniorson. He has following questions in his mind that clogged all doors of ideas to revive.
(i) What are we doing wrong?
(ii) Is there any way JTI could continue its current business?
(iii) We need to save on costs and regain the lost trust of customers. How do we do this? You see there was no dearth of loyal foodies when we use to sell just breads and sandwiches. Even though we charged high prices back then we never had to confront such predicaments we currently are in.
ANNEXURE

1. Since beverage market was competitive commanding high profit was never an expectation.
2. Frozen items were sold at a markup of 10% on purchase cost Geor-gian preferred frozen foods and fresh foods equally.
3. Desserts are all time favourite irrespective of seasonal variations.
4. Of the deserts and frozen revenue, 60% sale was dedicated to desserts.
5. 50% labour was identified towards meal preparation,40% towards sandwich and breads and rest 10% for serving desserts. Beverages did not take labour hours since they could be refilled in self-serving dispensers through which clients were served. Once they served them-selves with their choice of beverage, they stood in lines to complete the billing of the service.
6. Of the cost of food as raw materials, only 40% was dedicated to earning bread and sandwich revenue.
7. Rewards to staffs were paid on basis of their recipes being approved.

Answer:
(i) The idea to expand the business by diversification of product line and adding new products/services like frozen items, train meals, and desserts, delivery of foods to passengers at train were all directed towards growth and a better future for business. This gave an additional edge over other bread manufacturers in the area since the more products offered the more awareness among the customers. However, the manner in which the business was executed seems to lack proper planning and organization which is very much needed for survival of any business. Further a business success depends on the execution of correct strategies meaning doing the right thing at the right time and in the right manner. So, let us see what were we doing and what should have been done.

Manufacturing process in any business is a combination of series of activities, where we need to identify which activities should be chosen and which should be excluded. This calls for application of lean thinking in the conduct of those activities. The concept was originally introduced by producers of a Japanese car manufacturer company named Toyota. They were of the view that to make a production process efficient waste of all forms must be eliminated from such process. They identified those activities as waste which consume resource but are of no value addition from an end consumer perspective, thereby increasing the overall production cost and time.

Basically, they meant that not only the design of the product or the utility of the product but the production process itself should be customer focused. This is possible when we can segregate each activity as value creating and non-value creating activity from customer’s view. In order to do this, we need to list all our production/service activities and then map each activity keeping customers’ value in mind. During this mapping, we consider location of each machine, each human resource and the effort required to move resources in order to be at the production location. Then an attempt is made to eliminate all the non-value creating activities listed.

Having enumerated the idea of lean manufacturing, let us see how this could be applied in JTI’s scenario. There are number of things that need attention. First of all, the lean thinking is based on just in time production whereas JTI is producing on prior unexpected demand basis for the fear of stock outs. We must remember that when operating in service industry and that too when dealing in food items, maintaining quality of the food items (considering the perishable nature of some items) becomes the top priority. We must design the production process in such a manner that safety and retaining the nutrition of the foods to be served remains ahead of everything. Customers always desire their foods to be fresh and to contain all the expected nutrition value. In such a situation, pre preparing the meals and storing them is not only a non-value-added activity but also a prolific challenge to the food safety requirement. Thus, going by the lean concept, JTI should prepare meals based on orders received or should pack meals just enough to serve the customers on the same day. This is one of the mechanisms not only to work smart but also to drive two forms of waste palpable in the production process, one is the cost of storing the pre prepared meals and the other is the wastage of prepared food that was prepared in anticipation of stock outs. Preparing fresh food will not only be a better value addition approach from customers’ perspective, but it will also boost quality and reinforce customers’ trust thereby adding a competitive edge over others.

Next change over required would be to switch the basis of commission paid to staffs. Currently staffs receive commission for the recipes ap-proved irrespective of the cost incurred to JTI in implementing such recipes. Executing any recipes requires assembling of raw materials to prepare the food item, which bears a financial impact on the firm. Purchase of raw materials from various suppliers based on staff recipes and their suggestions have led to huge cost burden on the firm leading to a negative cost benefit ratio. Purchase activity is a significant puller of cost and therefore purchase department is considered as a cost center. Systematic operation of purchase department is highly imperative to control cost and achieve efficiency. Purchase activity should be related to production activity which is a direct factor of demand. Therefore, rather than acting on staff suggestions, purchases should be made based on requisitions from production department which has to operate based on just in time approach. Moreover, it is also felt that staff participation has not been guided in the right manner since it has resulted in more disharmony than teamwork. Rewarding them based on their recipes rather than asking them to redirect their cooking efforts to the financial interest of the firm and to the satisfaction of the customers, sounds an incorrect encouragement. Working at below the optimum coordination levels result in under use of skill and cooking talent which is truly perceived in this situation.

The other issue perceived is the disorganized warehouse due to lack of systematic purchases and over involvement of staff in purchase activity. To achieve maximum production efficiency, building a favourable working environment is utmost necessary. This requires providing cooking staffs with organized clean kitchens and limited access to warehouse. Further limited access to warehouse will help to keep it more organized. Currently it seems storage facilities of raw materials and food items are totally messed up. We need to introduce an effective housekeeping system such that warehouses are organized systematically with all raw materials arranged employing specific techniques like 5S for storage and organization. This will lessen the time required to locate them when on demand thus removing the bottle neck developed due to time consumed for non-organization.

(ii) The current business situation appears to lack planning and systematic approach. With a strategized planning focusing customer satisfaction in mind, JTI will be able to continue its current production activity instead of its planned switch over to just retailing activity. When looking at the financial figures, we have five products to focus on. Currently JTI only manufactures two of those and they are breads & sandwiches and train meals. The other three are just purchased and served at a margin.
It should be noted that sandwich business got a hit due to quality compromise in meals business and thus to revive this business, we must not only control quality of sandwiches but also re boost trust of customers in the train meals.
The beverage business is good and requires a little amendment since beverages will have to purchased and served for a margin. So, it is not a cause of much concern.
Now coming to frozen food items and desserts, it is recommended that JTI should make a detailed financial analysis of buy vs. manufacture option considering all the related costs and revenue. In some cases, in-house production of these items has,proved more profitable to firms rather than just an outright purchase and service. Moreover, JTI would need to keep in mind the current resources available and the possible resources it could gather provided it decides to switch over to in-house production, given the financial positivity.
For the meal business, as suggested above, the production process needs a complete change over right from the just in time production to systematic purchases and implementing housekeeping system for achieving organized storage facilities. These strides will help to reinforce customer trust in the train meals and thereby rebound the entire JTI business. As we can see that meals business will have to be systematized first so that the sandwich business can see a positive business environment. The meal business is directly dependent
on maintaining quality which can be perceived by it turning into a loss-making business of ₹ 1.8 Cr. in year 2019 which used to produce profits of ₹ 6.33 Cr. back in year 2017 and ₹ 3.6 Cr. back in year 2018.

(iii) Regaining customer confidence is no rocket science for JTI since it i had successfully proved its success in past when it was known as the j Soft Bread Company. The company was known for its quality and customers did not resist paying a higher price for celebrating their happiness in the food they want. Due to series of undesired happenings, the focus of JTI shifted from customer, which it needs to bring back. A correct focus can ensure its move in the guided direction.
So JTI needs to perform as per customers’ expectation bringing to their table what they exactly want, also ensuring a positive cost benefit ratio for the firm. It requires reengineering of the way they currently work. This is the key to turn things favourable and ensure business success irrespective of what industry we choose to operate in.
For cost saving strategies, JTI needs to associate some direct cost to the revenue it earns. For example, commission paid to cooking staff should be based on the customer satisfaction which is key to increased revenue in service industry. We can keep a control mechanism for this. % Asking the customers to rate their experience with the food and the I staff service would help the firm to improve with the changing needs ss of customer and rate and reward their staffs. This will ensure that the firm incurs costs towards generation of revenue. We also need to know what kind of transport mechanism is used to deliver the meals to customers on train. To save transportation cost, it is better to use in-house transportation vehicles rather than outsourcing the activity. This will ensure timely and responsible delivery of meals at reasonable cost to the firm. Further we must not forget that redesigning the meal preparation process will call for less storage and therefore less packing. This will save significant packing costs.

Question 33.
RLM is one of several insurance companies which offer insurance policies covering general risks relating to individuals and his/her family members. Since past three years RLM has seen the volume of business increase, but profits have remained static due to declining margins. Cost efficiency is a major factor in the success of the companies in this industry, because competition within the industry is high.
Some of the processes within RLM are computerised. However, many of the processes which involve communication with customers are still paper based. Responses to telephonic queries from customers involve paper-based communications. Additionally, sales staff visits potential customers in their homes to try to sell them insurance policies for their homes and their possessions. These transactions are again paper based. This process is often slow and has led to complaints from both customers and the company’s sales staff. RLM has also been receiving regular complaints from current and potential customers about errors in the paperwork that they receive. The number of complaints is increasing day by day.
The Board is worried about growing popularity of new style of business using the Information Technology. The Board intends to streamline the business model as much as possible, reengineer the business processes and to increase the profitability of the company. It was finally decided that there is a need for a Business Process Reengineering (BPR) programme to be conducted and the Board has asked the management accounting department to help with the planning and implementation of the programme.
RLM intends to computerise fully, all of the work done. However, while some members of the staff are welcoming the BPR programme, others have expressed concern about business process reengineering and its implications for them.
Required:
(i) How BPR can be implemented? ADVISE.
(ii) DISCUSS the improvements that might be expected from introducing BPR.
(iii) RECOMMEND, performance targets which RLM could introduce to ensure that the reengineered processes enable it to achieve its key business objectives.
(iv) Why RLM’s staff might be concerned about BPR and its implications for them? EXPLAIN.
Answer:
(i) To implement BPR, firstly, each business process of RLM 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 remain; require to be reengineered/restructured, so that can be as efficient as possible. For RLM, technology should be introduced to improve these processes. However, RLM must ensure that the statutory compliances regarding these processes are not un-dermined.

RLM is facing a hyper-competitive marketplace where customers expect superior benefits. BPR activities would help RLM in understanding those processes which RLM’s customers value the most and remove those that are not valued. 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 long term, this would result in high levels of efficiency, profitability and better levels of customer satisfaction and retention.

(ii) Improvements expected by implementation of BPR
Fast information processing and error reduction – The processes at RLM have not been updated to take advantage of the Information Technology systems that are widely available today. In particular, re-lying on a predominantly paper-based system makes RLM’s processes much slower than they need to be and it also increases the chances for errors as information is manually recorded and then transferred between departments. A new electronic database-led system is the need of the hour, where any information can be entered into the central database on a real time basis, and the system can then be continually updated for other staff to use. Therefore, no paper-based transfers of information will reduce delays in systems and reduce the risk of errors occurring.
For example, if an enquiry is received over a telephone, staff can access the database and gather all the relevant information of that particular customer. This faster response time and error free feedback should lead to improved customer satisfaction. *
Better facilities for salesperson – Having an online real time database and improved technology might also help the sales staff when they visit potential customers. If the salesperson can access the database remotely from their laptops, they can get every minute detail of policies and premiums and so could potentially make a decision about a policy application then and there. Thus, speeding up the process should directly address the complaints of slow processing of files.
For example, If a sales person goes to sell the X policy to the potential customer, however if the customer is interested in Y policy, the same can accessed immediately online.
Motivating staff leading to overall improvement – The advance tech-nology provided to the salesperson will not only encourage them to do their job more effectively, but it will also motivate them. Moreover, customers are likely to have a more favourable impression of the salesperson if they provide a quick and efficient service more importantly which is error free. This, in turn, will lead to the salesperson making more sales and likely to increase their motivation still further. Therefore, leading an overall improvement.
Parallel processing – The paper-based nature of RLM’s current system means that tasks have to be done sequentially. However, one of the principles of BPR is that linked activities should be conducted in parallel rather than sequentially. In this case, if RLM improves its Information technology systems and stores customer details digitally, staff may be able to deal with different aspects of a customer transaction in parallel, thereby speeding up the transaction process.
For example, if a customer wants to pay premium for its existing policy at the same time wants to enquire about a new policy, both can be done.

(iii) Key business objectives
The areas of concern of RLM are reducing the time taken to process transactions and improving the quality of the paperwork and so it is likely that it will have business objectives relating to these areas.
RLM should have performance measures looking at these areas, in order to assess how well the reengineered processes have helped to improve performance in relation to them.

Performance targets Speeding up the process
The slow speed of the current process is a major source of complaints; therefore, RLM desires to speed up the process. Slow work pace can be among the most difficult problems to resolve unless organisation/(s) have standards or goals against which to compare actual performance. ‘Number of transactions completed within a given time needs to be measured’. For example, Data entry people may be expected to process so many entries each day from the paper-based data however on real time data entry this task will be done immediately without any delay. In changed environment, performance can be measured by computing various metric such as number of policies issued on time, number of transactions completed successfully, number of claims settled on time.

Error free Work
The impact of errors may be in increased cancellations or lapses, finan-cial compensation payments to customers, and a poor market image leading to reduced sales and market share. Reducing the number of complaints about errors in paperwork should be the main motive. One of the key aims behind the BPR exercise is to help RLM reduce the number of errors in the paperwork which a customer receives. Setting a target to reduce the number of complaints about errors will help to achieve its key objective. Target could include a percentage decrease in complaints, lapse rates, or cancellations, an increase in business growth.

(iv) Perception of BPR programmes
Generally, people are not susceptible to change. Although the main aim of BPR programmes is to increase business efficiency, there is often a general perception that organisation just wants to do some cost-cutting exercises and this could lead to redundancies or could threaten jobs and prospects. It is likely that this is a major reason in RLM behind the staff’s concern.

Resistance may be encountered from the staff as they are concerned about the change and are uncertain about their jobs in near future.
Even if the programme does not actually lead to redundancy, the fact that it will result in the fundamental redesign of business processes is still likely to lead to significant changes which affect staff. For instance, BPR may lead to new patterns of work, changes in people’s roles or changes in the composition of work teams or may bring changes in the pattern of working. This uncertainty about how the programme could affect them is likely to make staff concerned about it and may lead them to resist it. Resistance may be’exacerbated because the out-of-date processes are likely to have been in place for quite some time and have therefore become ingrained in the staff. This ingrained habit needs a change, which is not acceptable by the staff.

Question 34.
Case Scenario (Miscellaneous; Study Digest)
Herro Automobile Ltd. (HAL) is a leading battery-based e-rickshaw manufacturing firm, under brand ‘Shah Swaari’ in three models – Super, Star, and Speed. HAL started this business around 5 years back when it was only manufacturer of such e-rickshaw. HAL manufactures all assembly components themselves, irrespective of fact that these components can be acquired from market at a cheaper rate. Major
component of total costs in manufacturing of such e-rickshaw is variable in nature. Company was performing well, earning reasonable and enjoyed large market share up-till two year ago majorly due to first mover advantage. But due to increasing competition as new entrant coming into market and rough macro-economic conditions, market share starts shrinking; resultantly profit starts declining. If no major steps taken, then company may run into red in year to come.
Mr. Pillai, CEO attended some workshop last week, where he learned about the lean management and techniques of cost management. He asked Mr. Reddy, Chief Management Accountant to report on underlying reasons behind current performance with available set of possible solution. Mr. Reddy immediately convened a meeting of top ranked officers, which is chaired by CEO, at meeting.
Mr. Swami, VP Marketing mentioned that it is difficult to maintain same level of sales in upcoming years because price of Shah Swaari is much higher than price offered by all the competitors in market. Quality and features of other are also similar.
Mr. Dutta, Customer Relation Officer also supported Mr. Swami and said that the popularity of their product is declining, he quoted that he receives lot of complaints from buyers in e-mails and tele-calls due to manufacturing defects, which arise in product within a month period of purchase and frequency of such calls and e-mails have increased in recent years. He also mentioned that in some cases, customer reported that assembled part did not belong to model they purchased, and some customers say, assembly is not as per specification provided.
Mr. Sodhi, Head Workshop & Repairs agrees that the repair issues in case of recently sold vehicle have been increased.
Mr. Murthy, VP Production & Operations who recently joined the HAL replied, firstly large percentage of worker are unskilled; secondly due to large amount and categories of raw materials, dumped by store at production floor; that’s too well prior to need. These two reasons cause worker fails to differentiate among parts which appear similar. He also mentioned entire business process, especially production process is quite old and contains certain activities which are purely unnecessary, he also highlight importance of industry 4.0 and give stress on business reengineering through artificial intelligence, machine learning, etc.
Mr. Naidu, VP Purchases immediately responded about economics of discount involved behind purchase of large quantity and also mentioned buying too less may lead to stock-out situation.
Required
You were a Iso presen ted a t meeting as depu ty to Mr. Reddy. Post meeti ng you came back to your desk and start working. Mr. Reddy called to you to his cabin, on reach to his cabin; he asked you to prepare draft of report (ADVISE) seek by CEO; and meet him with copy of draft after half an hour from now.
Answer:
Addressed to:
Office of CEO,
Herro Automobile Ltd. (HAL). Dated – 19th Jan 2021
Report on underlying reasons behind current performance and Lean
Management, Cost Management tools
(i) First reason behind weak financial performance is highlighted by Mr. Swami ie., Price of HAL’s Product Shah Swaari is much higher than price offered by all the competitors in market. Quality and features of other products are also similar.
Target Costing as cost management technique can be applied. Since market condition are stiff and bargaining power of customers is high due to multiple competitors, and these competitors are selling the prod-uct at price lesser then price offered by HAL. Hence, price offered by such vendors should be considered as Target Price’ and after reducing ‘Target Profit’ from same ‘Target Cost’ can be identified. Production, operations facilities along with product need to be reengineered to achieve such ‘Target Cost’.

(ii) Second reason is that HAL manufactures all assembly components themselves, irrespective of fact that these components can be acquired from market at a cheaper rate.
Relevant cost of both, ‘Make or Buy’ needs to be compared. As men-tioned, that major component of total costs in manufacturing of such e-rickshaw is variable in nature, hence, such major component of costs can be controlled if HAL buy the all the components instead of Making them.
Only those products need to be made in house whose variable cost of manufacturing is less then market price and vice versa.

(iii) Third and major reason is popularity of their product is declining, this is evident from declining in market share and lot of complaints from buyers in e-mails and tele-calls for manufacturing defects.
Since these defects arise in product within month period of purchase. Hence, product needs to be looked at. Further, some of cases customer reported that assembled part is not belonging to model they purchased and some customers say assembly is not as per specification provided. Hence, quality is needed to be ensured in the product delivered.
One of way to look at ‘Quality’ is conformance to need of customer, to ensure same Total Productivity Management/Total Quality Man-agement supported by Six Sigma need to be applied as part of Lean System Management.
Total Quality Management is management of entire process, including planning process, to meet customer’s requirements. PRAISE analysis can be used in order to achieve improve quality.
Using DMAIC (Define, Measure, Analyse, Improve and Control) methodology of Six Sigma, existing business process can be improved to ensure customer satisfaction, reducing cycle time and reduction in waste also.

(iv) Fourth reason being large percentage of worker are unskilled. Each worker should be provided with requisite training. Though Kaizen, workers should be involved into improvement of existing process so that they become able to address small problems or improve a process.

(v) Fifth and second major reason is large amount and categories of raw materials, dumped by store at production floor; that’s too well prior to need. This reason may be root cause of one of complaint by customer that assembled part is not belong to model they purchased.
JIT can be implemented as part of lean system. JIT is pull system of production, with single piece flow after considering takt time. In JIT, production facility needs to be integrated with vendor system for signal (Kanban) based automatic supply which depends upon demand-based consumption. Under JIT system of inventory storage cost is at lowest level due to direct issue of material to production department as and when required and resultantly less/no material lying over in store or production floor.
Note – Takt time is the maximum time to meet the demands of the customer, this will help to decide the speed of/at manufacturing fa-cility. Heijunka can be applied in order to reduce variation between takt times over the production.
Cost benefit analysis of ‘reduction in storage cost along with oppor-tunity cost saved’ and ‘increase in ordering cost, purchase cost along with stock-out cost’ need to be made.

(vi) Sixth reason for low performance is old established businesses processes, especially production processes and contains certain activities which are purely unnecessary.
Value Analysis needs to be applied in order to ensure maximum value to customer by eliminating activities which are not value generating, this will control cost also, that’s too strategically.
Process Innovation and Business Process Reengineering can also be applied. Reengineering is rethinking and radical design of business process in order to achieve improvement. It will help the HAL to keep them at par with changing technology by synchronization along with redesign, retool the business process.
Further details can be tabled on requisition basis. Closure of Report
Mr. Reddy,
Chief Management Accountant
(For Management Accounting Division)
Herro Automobile Ltd.

Cost Management Techniques – CA Final SCMPE Question Bank

Leave a Comment / CA Final / By Raju / April 10, 2023 April 10, 2023

Cost Management Techniques – CA Final SCMPE Question Bank is designed strictly as per the latest syllabus and exam pattern.

Cost Management Techniques – CA Final SCMPE Question Bank

Question 1.
Distinguish between Cost Reduction and Cost Control. (June 2015, 7 marks) (CMAFG III]
Answer:
Difference between Co Reduction and Cost Control:

Particulars	Cost Reduction	Cost Control
1. Permanence	Permanent, Real and reflects genuine savings in cost.	Represents efforts made towards achievement of predetermined target or goal.
2. Nature of function	It is a corrective function. It can operate along with an efficient cost control system. This concept Believes that there is always a scope for further reduction in costs.	It is a preventive function, where costs are optimized before these are incurred.
3. Nature of process	It presumes the existence of concerned potential savings in norms or standards and therefore it is a corrective process.	It does not focus on costs independent of revenue nor considers product attributes as given. It is a holistic control process.
4. Performance evaluation	It is not concerned with maintenance of performance according to standards.	The process involves setting up a target, investigating variances and taking remedial measures to correct them.
5. Nature of Standards	Continuous process of critical examination includes analysis and challenge of standards. It assumes the existence of potential savings in the standards and aims at improving them by bringing out more savings.	It accepts the standards, once they have been fixed. In other words, standards shall remain, as it is.
6. Dynamism	Fully a dynamic approach.	It is a routine exercise and lacks dynamic approach.
7. Coverage	Universally applicable to all areas of business. Does not depend upon standards, though target amounts may be set.	Limited applicability to those items of cost for which standards can be set.
8. Basic approach	It is not concerned with maintenance of performance according to standards. It challenges the very standards set.	It involves setting up a target, ascertaining the actual performance and doing the variance analysis, followed by remedial actions.

Question 2.
Explain the essential features of Life-cycle costing. (May 2009, 5 marks)
Answer:
Life-cycle Costing
Meaning: Life cycle costing estimates, tracks and accumulates the costs over a product’s entire life cycle from its inception to abandonment or from the initial R & D stage till the final customer servicing and support of the product. It aims at tracing of costs and revenues on product by product basis over several calendar periods throughout their life cycle.

Costs are incurred along the product’s life cycle starting from product’s design, development, manufacture, marketing, servicing and final disposal. The objective is to accumulate all the costs over a product life cycle to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the pre and post manufacturing stages of product life cycle.

Features:

Product life cycle costing involves tracing of costs and revenues of each product over the several calender periods throughout their entire life cycle.
Product life cycle costing traces research and design and development costs and total magnitude of these costs for each individual product and compared with product revenue.
Report generation for costs and revenues.

Benefits:

The product life cycle costing results in earlier actions to generate revenue or to lower cost than otherwise might be considered.
Better decision should follow from a more accurate and. realistic assessment of revenues and costs, at least within a particular life cycle stage.
Product life cycle thinking can promote long-term rewarding in contrast to short – terms profitability rewarding.
It provides an overall framework for considering total incremental costs over the life span of a product.

Question 3.
Answer the following:
Briefly explain the phases in the life cycle of a product. (Nov 2011, 4 marks)
Answer:
Phases in Life Cycle of a Product

Phase	Characteristics
Introduction	Product is launched. Profits are almost non existent. Competition is almost negligible.
Growth	Sales/Profits rise rapidly. Competition enters. At phase end, profits begin to decline.
Maturity	Sales increases but at a declining rate. Some firms extend their product lines with new models.
Saturation and decline	Drop in sales” volume, need for product demand disappears. Better and cheaper substitutes are available in the market.

Question 4.
Classify the following items under the more appropriate category: (May 2012, 4 Marks)
Category (CC)Cost Control Or Category (CR)- Cost Reduction.
(i) Costs exceeding budgets or standards are investigated.
(ii) Preventive function
(iii) Corrective function
(iv) Measures to standardize for increasing productivity
(v) Provision of proper storage facilities for materials.
(vi) Continuous comparison of actual with the standards set.
(vii) Challenges the standards set
(viii) Value analysis (4 marks)
Answer:
Classification of items under cost reduction/cost control

Item	Category Cost Control (CC) Cost Reduction (CR)
(i) Costs exceeding budgets or standards are investigated	CC
(ii) Preventive function	CC
(iii) Corrective function	CR
(iv) Measures to standardize for increasing productivity	CR
(v) Provision of proper storage facilities for materials	CC
(vi) Continuous comparison of actual with the standards set	CC
(vii) Challenges the standards set	CR
(viii) Value analysis	CR

Question 5.
Answer the following in brief:
What do you understand by the term “Life Cycle Cost? (June 2012, 5 marks) [MAFG III]
Answer:
It focuses on total cost (Capital cost + revenue cost) over the products life including design. CIMA defines life cycle costing as the practice of obtaining over life time, the best use of physical asset at the lowest cost of entity.

“The term “Life Cycle Cost” has been defined as follows, “It includes the cost associated with acquiring, using, caring for and disposing of physical asset including the feasibility studies, research, design, development, Production, maintenance, replacement and disposal as well as support, training and operating cost, generated by the acquisition use, maintenance and replacement of permanent physical assets.”

1. Life cycle costing estimates and accumulates costs over a product’s entire life cycle.

2. The objective is to determine whether costs incurred at different stages of development, (planning, designing and testing) manufacturing (conversion activities) and marketing (advertising distribution, and designing, and testing) manufacturing (conversion activities) and marketing (advertising distribution, warranty) of the product will be recovered by revenue to be generated by the product over its life cycle.

3. Life cycle costing provides an insight, useful for understanding and managing costs over the life cycle of the product.

4. In particular it helps to evaluate the viability of the product, decides on pricing of the product at different stage of product life cycle and often helps to estimate the value of the product to its user.

5. When used in conjunction with target costing, life cycle costing becomes an important tool for cost management.

6. Life cycle costing estimates and accumulates costs over a product’s entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the pre-and post manufacturing stages.

7. Identifying the costs incurred during the different stages of product’s life cycle provides an insight into understanding and managing the costs incurred throughout its life cycle. In particular, Life cycle costing helps management to understand the cost consequences of developing and making a product and to identify areas in which cost reduction efforts are likely to be most effective.

8. Most accounting system report on a period-by-pdriod basis, and products are not monitored over their life cycles. In contrast product life cycle reporting involves tracing costs and revenue on a product-by-product basis over several calendar periods throughout their life cycle.

9. A Typical pattern of cost commitment and cost incurrence during the three stages of a product’s life cycle-the planning and design stage, the manufacturing stage and the service and abandonment stage.

10. Committed or locked in cost that have not been incurred but that will be incurred in the future on the basis of decisions that have already been made. Costs are incurred when resource is used or sacrificed.

11. Costing system record costs-only when they been incurred. It is difficult to significantly alter costs after they have been committed. For example the product design specifications determine a product’s material and labour inputs and the production process. At this stage costs become committed and broadly determine the future costs that will be incurred at the manufacturing stage.

12. That approximately 80% of a product’s costs are committed during the planning and design stage. At this stage product designers determine the product’s design and the production process. In contrast, the majority of costs are incurred at the manufacturing stage, but they have already become locked in at the planning and design stage and are difficult to alter.

Question 6.
Answer the following:
What is target costing? It is said that target costing fosters team work within the organisation. Explain how target costing creates an environment in which team work fosters. (Nov 2012, 4 marks)
Answer:

Target cost is the difference between the estimated selling price of a proposed product with specified functionality and quality and target margin.
This is a cost management technique that aims to produce and sell products that will ensure the target margin.
It is an integral part of the product design. While designing the product the company allocates value and cost to different attributes and quality. Therefore, they use the technique of value engineering and value analysis.
The target cost is achieved by assigning cost reduction targets to different operations that are involved in the production process.
Eventually, all operations do not achieve the cost reduction targets, but the overall cost reduction target is achieved through team work. Therefore, it is said that target costing fosters team work.

Question 7.
Answer the following:
Briefly explain the phases in the life cycle of a product. (Nov 2014, 4 marks)
Answer:
Phases of the product life cycle : A project consist of sequential phases. These phases are extremely useful in planning a project since they provide a framework for budgeting, manpower and resource allocation and for scheduling project milestones and project reviews, the method of division of a project into phases may differ somewhat from industry to industry and product to product.

There are four phases of product life cycle :

Introduction/Initialisation
Growth
Maturity
Saturation and Decline

Phases in Life Cycle of a Product:

Phase	Characteristics
Introduction	Product is launched. Profits are almost non-existent. Competition is almost negligible.
Growth	Sales/Profits rise rapidly. Competition enters.
Maturity	Sales increases but at a declining rate. Some firms extend their product lines with new models.
Saturation and Decline	Drop in sales volume, need for product demand disappears. Better and cheaper substitutes are available in the market.

Question 8.
Answer the following:
State whether and why the following statements are valid or not valid: (Statements need not be copied into answer book.)
(i) Target costing is not applicable to a monopoly market.
(ii) Target costing ignores non-value added activities. (Nov 2015, 4 marks)
Answer:
(i) Statement is valid.
Reason: Target costing has been described as a process, that occurs in a competitive environment. It means in competitive environment, target costing is applicable, in monopoly market, target costing is not applicable.

(ii) Statement is valid.
Reason: The aim of target costing is to confine the total cost to set target and in order to achieve this figure, non value added activities are eliminated and hence ignored.

Question 9.
What are the criteria to be maintained by the companies which want to get maximum benefit from ‘target costing’? (Dec 2015, 4 marks) [CMAFG III]
Answer:
The following criteria are to be maintained by the companies who want to get maximum benefit from ‘target costing’:

Assembly-oriented industries, as opposed to repetitive-process industries that produce homogeneous products.
Industries involved heavily with the diversification of the product lines.
Used technologies of factory automation, including computer-aided design, flexible manufacturing systems, office automation, computer-aided manufacturing etc.
Have experienced shorter product life cycles where the pay-back for factor automation typically must be achieved in short-term period (less than eight years).
Must develop the system for reducing costs during the planning, design and development stages of a PLC.
Able for implementing management methods, such as Just-in-time. Value engineering and Total Quality Control.

Question 10.
State the business situations in which you recommend to apply Pareto Analysis. (May 2019, 5 marks)
Answer:
The Pareto Analysis is generally applicable to the following business situations:
1. Price of a Product:
In the case of a firm dealing with multi products, it would not be possible for it to analyse cost profit – price- volume relationships for all of them, fn practice, in case of such firm approximately 20% of products may account for about 80% of total sales revenue. Pareto Analysis is used for analysing the firm estimated sales revenues from various products and it might indicate that approximately 80% of its total sales revenue is earned from about 20% of its products.

Such analysis helps the top management to delegate the pricing decision for approximately 80% of its products to the lower levels of management, thus freeing themselves to concentrate on the pricing decisions for products approximately 20% which are essential for the company’s survival.

Thus, a firm can adopt more sophisticated pricing methods for small proportion of products that jointly accounts for approximately 80% of total sales revenue. For the remaining 80% of the products which account for 20% of total sales revenue the firm may use cost based pricing method.

2. Customer Profitability Analysis:

Instead of analysing products, customers can be analysed for their relative profitability to the organisation.
Again, it is often found that approximately 20% of customers generate 80% of the profit. There will always be some customers who are less profitable than others, just as some products are less profitable than others.
Such an analysis is useful tool for evaluation of the portfolio of customer profile and decision making such as whether to continue serving a same customer group, what is the extent of promotion expenses to be incurred.

3. ABC Analysis – Stock control:
Another application of Pare to Analysis is in stock control where it may be found that only a few of the goods in stock make up most of the value. In practice, approximately 20% of the total quantity of stock may account for about 80% of its value. The outcome of such analysis is that by concentrating on small proportion of stock items that jointly accounts for 80% of the total value, a firm may well be able to control most of monetary investment in stocks.

4. Application is Activity Based Costing:
In Activity Based Costing it is often said that 20% of an organisation Cost Drivers are responsible for 80% of the total cost. By analysing, monitoring and controlling those cost drivers that cause most cost, a better control and understanding of overheads will be obtained.

5. Quality Control:
Pareto Analysis seeks to discover from an analysis of defect report or customer complaints which “vital few” causes are responsible for most of the reported problems.

Often, 80% of reported problems can usually be traced to 20% of the various underlying causes. By concentrating one’s efforts on rectifying the vital 20% , one can have the greatest immediate impact on product quality.

The Pareto Analysis indicates how frequently each type of failure (defect) occurs. The purpose of the analysis is to direct management attention to the area where the best returns can be achieved by solving most of quality problems, perhaps just with a single action.

Question 11.
UK Ltd. prepared a draft budget for the next year as follows: (May 2016, 5 Marks)
Quantity – 10,000 units
Selling price per unit – ₹ 60
Variable cost per unit

Direct materials – 16
Direct labour (2 hours × 6) – 12
Variable overheads (2 hrs * ₹ 1) – 2

Contribution per unit – 30
Total budgeted contribution – 3,00,000
Total budgeted fixed overheads – 2,80,000
Total budgeted profit – 20,000

The board of directors are not satisfied with this draft budget and suggested the following changes for the better profit:
(i) The budgeted profit is ₹ 50,000,
(ii) The company should spend ₹ 57,000 on advertisement and the target sales price up to ₹ 64 per unit.
(iii) It is expected that the sales volume will also rise, inspite of the price rise, to 12,000 units.

In order to achieve the extra production capacity, however, the work force must be able to reduce the time taken to make each unit of the product. It is proposed to offer a pay and productivity deal in which the wages rate per hour is increased to ₹ 8. The hourly rate for variable overheads will be unaffected. You are required to calculate the target labour time require to achieve the target profit.
Answer:
Statement Showing ‘Target Cost of Direct Labour & Variable Overheads’

Particulars	Amount (₹)
Expected Sales (₹ 64 × 12,000 units)	7,68,000
Less: Direct Material (₹ 16 × 12,000 units)	1,92,000
Advertisement Expenses	57,000
Fixed Overheads	2,80,000
Target Profit	50,000
Target Cost of Direct Labour and Variable Overheads	1,89,000

Target Labour Time Required to achieve Target Profit
= $\frac{\text { Target Cost of DirectLabour and Variable Overheads }}{\text { Wages Rate + Variable OverheadRate }}$
= $\frac{₹ 1,89,000}{₹ 8+₹ 1}$
= 21,000 hrs.

Question 12.
A toy company T expects to successfully launch Toy Z based on a film character. T must pay 15% royalty on the selling price to the film company. T’s targets a selling price of ₹ 100 per toy and profit of 25% selling price. (May 2017, 4 Marks)
The following are the cost data forecast:

In addition, each toy requires 0.6 kg of other materials, which are supplied at a cost of ₹ 16 per kg with a normal 4% substandard quality which is not usable in the manufacture.

You are required to determine if the above cost structure is within the target cost. If not, what should be the extent of cost reduction?
Answer:
Statement Showing Target Cost “Z”

	₹/ Toy
Target Selling Price	100.00
Less: Royalty @ 15%	15.00
Less: Profit @ 25%	25.00
Target Cost	60.00

Statement Showing Cost Structure “Z”

	₹/ Toy
Component A	8.50
Component B	7.00
Labour (0.40 hr. × ₹ 60 per hr.)	24.00
Product Specific Overheads	13.50
Other Material (0.6 kg./96% × ₹ 16)	10.00
Total Cost of Manufacturing	63.00

Total cost of Manufacturing is ₹ 63 while Target Cost is ₹ 60. Company ‘T should make efforts to reduce its manufacturing cost by ₹ 3 to achieve Target Selling Price of ₹ 100.

Question 13.
SRM Ltd. has developed a new product ‘Kent’ which is about to be launched into the market and anticipates to sell 80,000 of these units at a sale pnce of ₹ 300 over the product’s life cycle of four years. Data pertaining to product ‘Kent’ are as follows: (June 2017, 8 marks) (CMAFG III)

Costs of Design and Development of Moulding Dies and Other tools	₹ 10,25,000
Manufacturing costs	₹ 125 per unit
Selling costs	₹ 12,500 per year + ₹ 100 per unit
Administration costs	₹ 50,000 per year
Warranty expenses	5 replacement parts per 25 units at ₹ 10 per part, 1 visit per 500 units (cost ₹ 500 per visit)

Required:
(i) Compute the product Kent’s Life Cycle Cost.
(ii) Suppose SRM Ltd. can increase sales volume by 25% through 15% decrease in selling price, should SRM Ltd. choose the lower price?
Answer:
Statement showing ‘Kent’s Life Cycle Cost (80,000 Units)

Particulars	Amount (₹)
Costs of Design and Development of Moulds, Dies and other tools	10,25,000
Manufacturing Costs (₹ 125 × 80,000 units)	1,00,00,000
Selling Costs (₹100 × 80,000 units + ₹ 12,500 × 4)	80,50,000
Administration Costs (₹ 50,000 × 4)	2,00,000
Warranty: (80,000 units / 25 units × 5 parts × ₹ 10) (80,000 units / 500 units × 1 visit × ₹ 500)	1,60,000 80,000
Total cost	1,95,15,000

Statement showing’Kent’s Life Cycle Cost (1,00,000 Units)

Particulars	Amount (₹)
Costs of Design and Development of Moulds, Dies and other tools	10,25,000
Manufacturing Costs (₹125 × 1,00,000 units)	1,25,00,000
Selling Costs (₹ 100 × 1,00,000 units + ₹ 12,500 × 4)	1,00,50,000
Administration Costs (₹ 50,000 × 4)	2,00,000
Warranty:
(1,00,000 units / 25 units × 5 parts × ₹10)	2,00,000
(1,00,000 units / 500 units × 1 visit × ₹ 500)	1,00,000
Total cost	2,40,75,000

Statement showing “Kents Life Time Profit”

Particulars	Amount (₹) 80,000 units	Amount (₹) 1,00,000 units
Sales	(80,000 × ₹ 300) 2,40,00,000	(1,00,000 × ₹ 255) 2,55,00,000
Less: Total Cost	1,95,15,000	2,40,75,000
Profit	44,85,000	14,25,000

Decision: Reducing the, price by 15% will decrease profit by ₹ 30,60,000. Therefore, SRM Ltd. should not cut the price.

Question 14.
BCG Manufacturers sell their product at ₹ 1,000 per unit. Their competitors are likely to reduce the price by 15%. BCG Manufacturers want to respond aggressively by cutting price by 20% and expect that the present volume of 150000 units per annum will increase to 200000 units. BCGM want to earn a 10% target profit on sales. Based on a detailed value engineering, the comparative position is given below: (June 2017, 4 + 4 = 8 marks) [CMAFG III]

Particulars	Existing (₹)	Target (₹)
Direct Material Cost per unit	400	385
Direct Labour Cost per unit	55	50
Direct machinery costs per unit	70	60
Direct Manufacturing expenses per unit	525	495
Manufacturing Overheads
No. of orders (₹ 80 per order)	22,500	21,250
Testing hours (₹ 2 per hour)	45,00,000	30,00,000
Units reworked (₹ 100 per unit)	12,000	13,000

Manufacturing overheads are allocated using relevant cost drivers. Other operating costs per unit for the expected volume are estimated as follows:

Required:
(i) Calculate target costs per unit and target costs for the proposed volume showing break up of different elements.
(ii) Prepare target product profitability statement.
Answer:
Part 1:
Target Selling Price: ₹ 1000 less 20% – ₹ 800
Less: Target Profit Margin (10% of ₹ 800) – ₹ 80
Target Cost per unit ₹ 720
The breakup of the target cost per unit of ₹ 720 per unit is as follows:

Direct Materials		385
Direct Labour		50
Direct Machinery costs		60
Direct Manufacturing costs		495
Add: Manufacturing Overheads:
Ordering and receiving (21,250 × ₹ 80)/2,00,000	8.50
Testing and Inspection (30,00,000 × ₹ 2)/2,00,000	30.00
Rework (13,000 × ₹ 100)/2,00,000	6.50	45
Other Operating Costs:
Research and Design	50
Marketing and Customer Service	130	180
Full Product Costs		720

Part 2:
Target Product Profitability

Particulars	Per Unit (₹)	Total for 200000 units (₹)
1. Sales	800	16,00,00,000
2. Cost of Goods Sold:
Direct Materials	385	7,70,00,000
Direct Labour	50	1,00,00,000
Direct Manufacturing Costs	60	1,20,00,000
	495	9,90,00,000
Manufacturing Overheads	45	90,00,000
	540	10,80,00,000
3. Gross Margin (1-2)	260	5,20, 00,000
4. Operating Costs:
Research and Design	50	1,00,00,000
Marketing and Customer Service	130	2,60,00,000
	180	3,60,00,000
5. Operating Profit (3 – 4)	80	1,60,00,000

Question 15.
MK international Ltd. has developed a new product ‘RIO’ which is to be launched soon. The company anticipates to sell 1,25,000 of these units at a sale price of ₹ 400 per unit over the product life cycle of three years. The other data pertaining to Product RIO are as under: (Nov 2017, 6 Marks)

Research and development cost	₹ 32,50,000
Manufacturing cost per unit	₹ 175
Fixed manufacturing cost per year	₹ 12,75,000
Marketing cost per unit (including 4% commission on sales)	₹ 90
Fixed marketing cost per year	₹ 6,72,000
Administration cost	₹ 6,60,000 per year
Warranty expenses	4 replacement parts per 50 units at t 30 per part

Calculate:

The life cycle cost of the product ‘RIO’
The revised life cycle cost if the MK international Ltd. increases sales by 12% through 5% reduction in sale price along with increase in fixed manufacturing cost by ₹ 1 ,20,000 per year.
Should the company go for reduction in sale price?

Answer:
Calculation of Income Statement

Note: Marketing Cost per unit (given) is ₹ 90, of which commission as per Budget is 400 × 4% = 16.
Hence, other variable Marketing cost = 90 – 16 = 74 per unit, which will remain constant at reduced prices also.

Observation: Price Reduction decreases Profit by 55,04,000 – 44,45,000
= ₹ 10,59,000, and is hence not desirable.

Question 16.
MNP Co. Ltd. makes digital watches. The company is preparing a product life cycle budget for a new watch. Development on the new watch is to start shortly. Estimates for new watch are as under: (May 2018)

Life Cycle units manufactured and sold	2,40,000
Selling Price Per Watch	(₹) 500
Life Cycle Costs:
R & D and design cost	(₹) 80 Lakh
Manufacturing:
Variable Cost Per Watch	(₹) 120
Variable Cost Per Batch	(₹) 4,000
Watches Per Batch	300
Fixed Costs	(₹) 112 Lakh
Marketing:
Variable Cost Per Batch	(₹) 24
Fixed Costs	(₹) 8 Lakh
Distribution:
Variable Cost Per Watch	(₹) 240
Watches Per Batch	96
Fixed Costs	(₹) 45 Lakh
Customer service cost per Watch	(₹)10

Required:
(i) Calculate the budgeted life cycle operating income for the new watch. (5 marks)
OR
Suggest the strategies to be adopted by the MNP Co. Ltd. to develop a new watch. (5 marks)
(ii) What percentage of the budgeted total product life cycle costs will be incurred by the end of the R & D and design stage? (2 marks)
(iii) An analysis reveals that 75% of the budgeted total life cycle costs of new watch will be locked in at the R & D and design stage. What are the implications for managing costs of the new watch. (3 marks)
Answer:
(i) Statement Showing Budgeted Life-Cycle Operating Income

Particulars	(₹)
Revenues (₹ 500 × 2,40,000 units)	12,00,00,000
Less: R&D and Design Costs	80,00,000
Manufacturing Costs:
Variable (₹ 120 × 2,40,000 units)	2,88,00,000
Batch (24,000 × $\frac{4,000}{3,000}$ × 100)	32,00,000
Fixed	1,12,00,000
Marketing Costs:
Batch (₹ 24 × 2,500* batches) ‘Assuming 1 Batch = 96 Pcs.	60,000
Fixed	8,00,000
Distribution Costs:
Variable (₹ 240 × 2,40,000)	5,76,00,000
Fixed	45,00,000
Customer Service Cost (₹ 10 × 2,40,000)	24,00,000
Total Costs	11,65,60,000
Operating Income	34,40,000

We can see from the above figure that approximately 80% of a product’s cost are committed during the planning and design stage. At this stage product designers determine the product’s design and the production process. In contrast, the majority of costs are incurred at the manufacturing stage, but they have already become locked in at the planning and design stage and are difficult to alter.

The pattern of cost commitment and incurrence will differ based on the industry and specific product introduced. For developing a watch, MNP Co. Ltd. needs to commit around 80,00,000 for its R&D and design Cost. So, Cost Management of MNP Co. Ltd can be most effectively exercised during the planning and design stage of its new watch and not at the manufacturing stage when the product design and processes have already been determined and costs have been committed.

At this latter stage the focus is more on cost containment rather than on Cost Management. An understanding of’ life-cycle costs and how they are committed and incurred at different stages throughout a product’s life cycle of the watch will also led to the emergence of target costing, a technique that focuses on managing costs during a product’s planning and design phase.

(ii) % of Budgeted Total Product Life-Cycle Costs incurred till the R&D and Design Stages:
$\left(\left(\frac{₹ 80,00,000}{₹ 11,65,60,000}\right) \times 100\right)$ = 6.86%

(iii) Implications:
An analysis reveals that 75% of the total product life-cycle costs of the new watch will be locked in at the end of the R&D and design stages when only 6.86% of the costs are incurred (as calculated in the above case). The implication is that it will be difficult to alter or reduce the costs of MNP digital watches once the design is finalised. To reduce and manage total costs, MNP must act to modify the design before costs get (Question states 75% hence 75% is taken).

Question 17.
JK Ltd., is following Life Cycle Costing. Its four products P₄, P₃, P₂₄, and P₁, are in the market respectively in Introduction, Growth, Maturity and Decline stages (phases). The Management wants to analyse the marketing challenges faced by the products to take strategical measures to stabilise the products in the market. For this purpose the Board directed the Secretary to get a product-wise report from the marketing chief of each product.

The chiefs were asked to give one characteristic possessed by the product because of which the product is being classified in the respective stage and two strategical measures to be taken to overcome the market challenges faced at that stage (phase). The Secretary received the report from all the chiefs and handed them over to the computer operator to get it printed in a tabulated form. But the operator, without understanding the significance of the products, phases, characteristics and strategies, mixed all the twelve items [(1 + 2) × 4] and got it printed as a list as given below : (Nov 2018)

(i) Over capacity in the industry.
(ii) The company can continue to offer the product to our loyal customers at a reduced price.
(iii) Few competitors produce basic version of our product.
(iv) Product features may be improved or enhanced to differentiate our product from that of the competitors.
(v) Attracting customers by raising awareness about our product through promotion activities.
(vi) High volume of business and increase in competition.
(vii) Use the present product as replacement product for launching another new product successfully in the market.
(viii) Value-based pricing strategies may be considered.
(ix) Profits start declining and at times become negative.
(x) Maintain control over product quality to assure customer satisfaction.
(xi) Strengthening or expanding channel and supply chain relationships.
(xii) Prices may have to be reduced to attract the price-sensitive customers. The items are required to be tabulated as in the format given below :

Required:
(i) Complete the table given below by entering the twelve items under appropriate category columns. You need not rewrite the items. Write the serial numbers of the items only in columns (3) and (4). (4 + 8 = 12 marks)

Products (1)	Phases (Stages) (2)	Characteristics (3)	Strategies (4)
P₄	Introduction
P₃	Growth
P₂	Maturity
P₁	Decline

(ii) List down the importance (any four) of Product Life Cycle Costing. (4 marks)
(iii) State the benefits (any four) of Product Life Cycle Costing. (4 marks)
Answer:
(i) Statement showing Product Life Cycle Characteristics and Strategies:

Products1	Phases (Stages) 2	Characteristics 3	Strategies 4
P₄	Introduction	(iii)	(v), (xi)
P₃	Growth	(vi)	(viii), (x)
P₂	Maturity	(i)	(iv), (xii)
P₁	Decline	(ix)	(ii), (vii)

(ii) The importance of Product Life Cycle costing are as follows :

The product life cycle costing results in earlier actions to generate revenue or to lower costs than otherwise might be considered. There are a number of factors that need to be managed in order to maximize return on a product.
Better decisions should follow from a more accurate and realistic assessment of revenues and costs, at least within a particular life cycle stage.
It is an approach used to provide a long term picture of product line profitability, feedback on the effectiveness of life cycle planning and cost data to clarify the economic impact of alternatives chosen in the design, engineering phase etc.
As the product life cycle allows the company to measure product performance against similar products launched in the past.
As a planning tool, it characterizes the marketing challenges in each stage and poses major alternative strategies i.e. application of Kaizen.
As a forecasting tool, it is less useful because sales histories exhibit diverse patterns and the stages vary in duration.

(iii) The benefits of Product Life Cycle costing are summarized as follows:
1. Product life cycle thinking can promote long-term rewarding in contrast to short-term profitability rewarding.

2. It provides an overall framework for considering total incremental costs over the entire life span of a product, which in turn facilitates analysis of parts of the whole where cost effectiveness might be improved.

3. It is also considered as a way to enhance the control of manufacturing costs. The thrust of product life cycle is on the distribution of costs. Among categories changes over the life of the product, as does the potential profitability of a product. Hence it is important to track and measure costs during each stage of a product’s life cycle.

4. Product life costing traces research and design and development costs etc., incurred to individual products over their entire life cycles, so that the total magnitude of these costs for each individual product can be reported and compared with product revenges generated in later periods.

Question 18.
Zen Ltd., forms a Committee consisting of its Production, Marketing and Finance Directors to prepare a budget for the next year. The Committee submits a draft budget as detailed below: (Nov 2018)

The Management is not happy with the budgeted profit as it is almost equal to the previous year’s profit. Therefore, it asks the Committee to prepare a budget to earn at least a profit of ₹ 3,00,000. To achieve the target profit, the Committee reports back with the following suggestions:
The unit selling price should be raised to ₹ 55.
The sales volume should be increased by 5000 units.
To attain the above said increase in sales, the company should spend ₹ 40,000 for advertising.
The production time per unit should be reduced.
To win the acceptance of the workers in this regard the hourly rate should be increased by ₹ 3 per unit besides an annual group bonus of ₹ 30,000.
There is no change in the amount and rates of other expenses. The company has sufficient production capacity.
As the implementation of the above proposal needs the acceptance of the work force to increase the speed of work and to reduce the production time per unit, the Board wants to know the extent of reduction in per unit production time.

Required:
(i) Calculate the target production time per unit and the time to be reduced per unit. (14 marks)
(ii) Identify the other problems that may arise in production due to decrease in unit production time and also suggest the remedial measures to be taken. (4 marks)
(iii) State the most suitable situation for the adoption of Target Costing. (2 marks)
Answer:
(i) Target Production lime per unit and Time to be Reduced per unit:

Workings:
Statement Showing Target Cost (Direct Labour and Variable Overhead)

Particulars	Amount (₹)
Target Sales (₹ 55 × 30,000 Units)	16,50,000
Less: Target Profit	3,00,000
Less: Direct Material Cost (₹ 9 × 30,000 Units)	2,70,000
Less: Budgeted Fixed Costs	5,00,000
Less: Proposed Advertising	40,000
Less: Proposed Annual Group Bonus	30,000
Target Cost (Variable Overhead and Direct Labour) for 30,000 units	5,10,000

(ii) (a) Use of target costing may reduce the quality of products in trying to complete the work in quick manner to match the target time which may result in inferior quality.

(b) For every problem area outlined have the dominant solution is retaining strong control over the design terms, which calls for a good team leader. This person must have an exceptional knowledge of the design process, good interpersonal skills, and a commitment to staying within both time and cost budgets for a design product.

(c) The management accountant should work with the design team to help it understand the nature of various costs (such as cost allocations based on an activity based costing system), as well as the cost benefit trade – offs of using different design or cost operations in the new product.

(iii) Target costing is most useful in situations where the majority of product costs are locked in during the product design phase. This is the case for most manufactured products, but few services. Following companies may benefit the most:

Assembly – oriented industries, as opposed to repetitive – process industries that produce homogenous products.

Use technologies of factory automation, including computer aided design, flexible manufacturing system, office automation, and computer – aided manufacturing.

Question 19.
Excel Ltd. is the leading manufacturer and exporter of high quality leather products – Product A and Product B.
Selling price per unit of Product A and Product B is ₹ 620 and ₹ 420 respectively.
Both the products pass through three processes – Tanning, Dyeing and Finishing during manufacturing process. Allocation of costs per unit of leather products manufactured among the processes are given below : (May 2019)

General overheads per unit of leather products manufactured are ₹ 230 which is allocated equally between Product A and Product B. Above CQst allocation is the basis for the decisions regarding pricing of the products.

In this Industry, all the major production processes have environmental impact at all stages of the process, including generation of waste, emission of harmful gases, noise pollution, water contamination etc.

The management of the company is worried about the above environmental impact and has taken initiative to preserve the environment like – research and development activities aimed at reducing pollution level, planting trees, treatment of harmful gases and airborne emissions, wastewater treatment etc. Thamanagement of the company desires to adopt Environmental Management Accounting as a part of strategic decision making process. Pricing of products should also factor in environmental cost generated by each product.

General overheads per unit of leather products manufactured are ₹ 230 which includes:
Treatment cost of harmful gases – ₹ 80
Wastewater treatment cost – ₹ 100
Cost of planting of trees – ₹ 20
Process wise information related to generation of wastewater and harmful gases is given as below :

The remaining overheads cost and cost of planting trees can be allocated equally between Product A and Product B.

Required:
(a) Calculate the product wise profitability based on the original cost allocation. (2 marks)
(b) Recalculate the product wise profitability based on activity based costing (Environment driven costs). (5 marks)
(c) Analyze the difference in product profitability as per both the methods. (2 marks)
(d) Recommend and explain the four management accounting techniques for the identification and allocation of environmental costs. (8 marks)
(e) State why the management of environmental costs is becoming increasingly important in organizations. Give reasons. (3 marks)
Answer:
(a) Product wise Profitability based on Original Cost Allocation Method:

Working Note:
Table 1: Allocation of Direct Materials and Labour as Per Cost Center and Product:

(b) Product wise Profitability (activity based costing using environmental management accounting) requires the following Step:
1. Overhead expenses ₹ 230 per product produced be first bifurcated into treatment cost of harmful gases, waste water treatment cost, cost of planting trees and other overhead costs.

2. The above 3 costs are allocated first to the cost centre. This is done based on the waste generated at each cost center. The individual cost allocated to each cost center is again allocated to products based on the wastage generated at each cost centre by each product. Refer part a of table 2 detailed calculations.

3. As mentioned in the problem, other overhead costs are allocated to each product at each cost center level equally. Refer table 2 for detailed calculations

4. The above allocations to each product at a cost centre level is then summed up to get the product wise overhead cost allocation. Refer part C of table 2 for detailed calculations.

Accordingly, the Revised Product Profitability would be as follows:

Workings:
Table 2: Breakdown of General Overheads per unit

Overhead	Amount (₹)	Allocation basis between products
Treatment Cost of Harmful Gases	80	Emission of Harmful Gases (cc per week)
Wastewater Treatment Cost	100	Wastewater Generated (liters per week)
Cost of Planting Trees	20	Equally between Products A and B
Other Overheads (balancing figure)	30	Equally between Products A and B
Total General Overheads per unit	230

Table 3: Allocation of Treatment Cost to various process: Process Wise Information:

Overhead	Amount (₹)	Allocation Basis Between Products	Tanning	Dyeing	Finishing	Total
Treatment cost of Harmful Gases	80	Emission of Harmful Gases (cc per week)	400 cc	300 cc	100 cc	800 cc
Wastewater Treatment Cost	100	Wastewater Generated (ltr. per week)	900 lt	600 lt.	—	1,500 lt

Cost Allocation to Process :

Overhead	Amount (₹)	Allocation Basis Between Products	Tanning (₹)	Dyeing (₹)	Finishing (₹)	Total (₹)
Treatment cost of Harmful Gases	80	Emission of Harmful Gases (cc per week)	40	30	10	80
Wastewater Treatment Cost	100	Wastewater Generated (Itr. per week)	60	40	0	100

Table 4: Allocation of Treatment Cost to Product A and B:

(c) Analysis of the difference in product profitability as per both the methods:
In the first method, general overhead costs are allocated to the products A and B, irrespective of the environment costs that each product incurs. General overhead costs are to each product equally. The resultant product profitability shows that Product A yields 5:32% and Product B yields 4.05% profitability. Therefore, the Excel Ltd. would conclude that Product A is more profitable.

In the next method, general overhead costs are bifurcated to identify “hidden” environment costs that are incurred on account of manufacturing these products. Environment costs are first traced to the process that generates harmful gases and wastewater, for which treatment is done. It can be seen that Tanning process, followed by Dyeing and Finishing process generates the maximum amount of waste.

Therefore, by proportioning the cost based on the waste generated, more cost is allocated to Tanning the process. Similarly, Dyeing and Finishing are allocated lesser cost since they do not generate as much waste. It is further given that 70% of the cost of Talnning relates to Product A. This is much higher than the 50% that was allocated to the Product as per the first method.

Accordingly, the revised workings show that Product A yields 1.77% and Product B yields 9.29% profitability. The reason being, Product A generates more environment driven costs as compared to Product B. Excel Ltd. would therefore increase the selling price of Product A if it wants to maintain profitability as per the original method. However, the more sustainable approach would be find out ways of reducing wastewater and harmful gases the manufacturing process produces. This would in turn result in reduction of environment driven costs such as wastewater treatment and treatment of harmful gases. This would sustain profits in the long run.

(d) The company can draw a number of conclusions from this analysis of overhead costs as per environmental management accounting. This analysis has helped the company reach the conclusion that Product A produces more waste.
In 2003, the UNDSD identified four management accounting technique for the identification and allocation of Environment Costs:

Input-Output Analysis
Flow Cost Accounting
Life Cycle Costing
Activity Based Costing.

The above techniques are explained as below :
1. Input – Output Analysis :
The technique records material inflows and balances this with outflows on the basis that, what comes in, must go out, So, if 100 kg of materials have been bought and only 80 kg. of materials have been produced, for example, then the 20 kg difference must be accounted for in some way. By accounting for outputs in this way, both in terms of physical quantities and at the end of the process, in monetary terms too, businesses are focused to focus on environmental costs.

2. Flow Cost Accounting:
This technique uses not only material flows but also the organizational structure. Classic material flows are recorded as well as material losses incurred at various stages of production. Flow cost accounting makes materials flows transparent by using various data, which are quantities (physical data), costs (monetary data) and values (quantities x costs) The material flows are divided into three categories, material, system and delivery and disposal.

The material values and costs apply to the materials which are involved in the various processes. The system values and costs are the in-house handling costs, which are incurred inside the company for the purpose of maintaining and Supporting material throughout, e.g. Personnel Costs or depreciation,” (UNDSD, 2003).

The delivery and disposal values and costs refer to the costs of flows leaving the company, for example transport costs or cost of disposing waste. EMA can benefit from flow cost accounting because it aims to reduce the quantities of materials, which leads to increased ecological efficiency (UNDSD, 2003).

3. Life Cycle Costing :
Life Cycle costing considers the costs and revenues of a product over its whole life rather than one accounting period.

Therefore, the full environmental cost of producing a product will be taken into account. In order to reduce life cycle costs an organization may adopt a TQM approach.

It is arguable that TQM and environmental management accounting are inextricably linked in so far as good environmental management is increasingly recognised as an essential component of TQM. Such organizations pursue objectives that may include zero compliants, zero spills, zero pollution, zero waste and zero accidents. Information Systems need to be able to support such environmental objectives via the provision of feedback – on the success or otherwise – of the organizational efforts in achieving such objectives.

4. Activity Based Costing (ABC):
ABC allocates internal costs to cost centres and cost drivers on the basis of the activities that given rise to the costs. In an environmental accounting context, it distinguishes between environmental related costs, which can be attributed to joint cost centres, and environmental, driven costs, which trend to be hidden on general overheads.

The environment – driven costs are removed from general overheads and traced to products or services. The cost drivers are determined based on environment impact that activities have and costs are charged accordingly. This should give a good attribution of environmental costs to individual products and should result in better control of costs.

Schaltegger and Muller (1998) stated ‘ the choice of an adequate allocation key is crucial for obtaining correct information’.
The four main allocation keys are:

Volume of emissions or waste
Toxicity of emission and waste treated.
Environmental impact added (Volume x input per unit of volume) Volume of the emissions treated and.
The relative costs of treating different kinds of emissions.

(e) There are three main reasons why the management of environmental costs is becoming increasingly important in organizations.
1. First, a ‘carbon footprint’ (as defined by the Carbon Trust) measures the total greenhouse gas emissions caused directly and indirectly by a person, organization, event or product. People are now becoming aware about the ‘carbon footprint’ and recycling. Several companies have initiated CSR Committees as they feel that portraying themselves as environmentally responsible makes them popular among consumers.

2. Second, environmental costs are becoming huge for some companies, particularly those operating in highly industrialized sectors such as oil production. In some cases these costs can amount to more than 20% of operating costs. Such significant costs need to be managed.

3. Third, regulation is increasing worldwide at a rapid pace. Penalisation for non- compliance also increasing accordingly. In the largest ever seizure related to an environmental conviction in the UK, a plant hire firm, John Craxford Plant Hire Ltd., had to not only pay ₹ 85,000 in costs and fines but also got ₹ 1.2 m of its assets seized. This company had illegally buried waste and breached its waste and pollution permits. And it’s not just the companies that need to worry, every person found guilty of breaching environmental regulations knowingly are liable to criminal prosecution as per the regulatory laws.

Question 20.
The information given below pertains to ABC Enterprises, a specialized car garage door installation company. ABC Enterprises use to get multiple service calls from the customers with variety of requirements. Jhey may have to Install, Replace, Adjust or Lubricate some part or other to make the door functional. They work with 5 parts as given in the table, namely Door, Motor, Track, Trimmer and T-Lock. (May 2019)

	Parts	Type of Service				Total
	Parts	Install	Replace	Adjust	Lube	Total
1	Door	2	5	1	0	8
2	Motor	3	2	16	9	30
3	Track	5	0	6	6	17
4	Trimmer	14	6	0	0	20
5	T-Lock	5	0	1	0	6
6	Miscellaneous	0	2	1	1	4
7	Total	29	15	25	16	85

Required :
(i) Using the above data, carry out a Pareto Analysis (80/20 rule) of Total Parts. (3 marks)
(ii) Using the same data carry out the second level Pareto Analysis on the type of services with respect to Motors only. (2 marks)
(iii) Give your recommendations on the basis of your calculations in (i) and (ii) above. (5 marks)
(Do calculations to two decimals only)
Answer:
(i) Statement Showing Pareto Analysis of Total Parts:

	Parts	Total	Cumulative	Percentage
2	Motor	30	30	35.29
4	Trimmer	20	50	58.82
3	Track	17	67	78.82
1	Door	8	75	88.23
5	T- Lock	6	81	95.29
6	Miscellaneous	4	85	100

In 80% of the rule consists of Motor, Trimmer and Track. Arid i.n 20% of the rule Consists of Door, T – lock and Misceflaneous.

(ii) Statement showing Pareto Analysis for Car only:

	Motor Type	Total	Cumulative	Percentage
1	Adjust	16	16	53.33%
2	Lube	9	25	83.33%
3	Install	3	28	93.33%
4	Replace	2	30	100

(iii) Pareto Analysis is a rule that recommends focus on most important aspects of the decision making in order to simplify the process of decision making. The very purpose of this analysis is to direct attention and efforts of management to the product area where best returns can be achieved by taking appropriate actions.

Pareto analysis is based on the 80/20 rule which implies that 20% of the products account for 80% of the revenue but this is not the fixed percentage rule; in general business sense, it means that a few of the products, goods or services or customers may make up most of the value for the firm.

In this case for part (i), Motor, Trimmer and Track account for 80% of total parts and Door, T- lock and Miscellaneous account for 20% of total parts.

In Case of (ii) only adjust is account for 80% while lube, Install and Replace account for 20% of the total as per pareto rule (80/20).

Question 21.
A chemical company produces two chemicals SX and ZX. Environmental activities and costs associated with the two chemicals are as follows: (Nov 2019)

Required:
Calculate the environmental cost per kilogram for each chemical produced by the company. (5 marks)
Answer:
Apportionment Cost between Sx and Zx
1. Packing Material Costs = ₹ 3,60,000
Sx = ₹ 3,60,000 × $\frac{80}{120}$ = ₹ 2,40,000
Zx = ₹ 3,60,000 × $\frac{40}{120}$ = ₹ 1,20,000

2. Energy Cost = ₹ 96,000
On the basis of Energy usage (KWH)
Sx = ₹ 96,000 × $\frac{60}{90}$ = ₹ 64,000
Zx = ₹ 96,000 × $\frac{30}{90}$ = ₹ 32,000

3. Fines for release of Toxins into Air = ₹ 48,000
Based on Toxin Release (Pounds)
Sx = ₹ 48,000 × $\frac{200}{240}$ = ₹ 40,000
Zx = ₹ 48,000 × $\frac{40}{240}$ = ₹ 8,000

4. Operating Costs of Pollution Control eq. = ₹ 1,12,000
Based on Pollution Control Machine Hrs
Sx = ₹ 1,12,000 × $\frac{32}{40}$ = ₹ 89,600
Zx = ₹ 1,12,000 × $\frac{8}{40}$ = ₹ 22,400

Calculation of Environmental cost per kg. for each chemical

Costs	Sx (6,00,000)		Zx (15,00,000)
Costs	Total (₹)	Per kg (₹)	Total (₹)	Per kg (₹)
Packing Material cost Energy Cost	2,40,000 64,000	0.4 0.107	1,20,000 32,000	0.08 0.021
Fine for toxin	40,000	0.067	8,000	0.005
Operating Cost for Pollution Control equipment	89,600	0.149	22,400	0.015
Total	4,33,600	0.723	1,82,400	0.122

Question 22.
NEC Furniture Ltd. is a leading manufacturer and supplier of furniture for students of pre-primary classes. The full cost of one set (comprising one Table and one chair) is ₹ 900 per set. The company has fixed its selling price so as to earn 30% return on investment of ₹ 45,00,000. The company produces and sells 6,000 sets per annum. Relevant cost data per annum are as follows: (Nov 2020)

Cost Component	Budget	Actual	Actual Cost P.a. (₹)
Direct Material	90,000 sq. ft.	1,00,000 sq. ft.	16,50,000
Direct Labour	35,000 hrs.	40,000 hrs.	10,32,000
Mechanical Assembly	60,000 hrs.	60,000 hrs,	12,00,000
Machine Setup	5,000 hrs.	5,000 hrs.	1,68,000

It has been revealed that the actual and budgeted operating levels are the same. Actual and standard rates of material purchase and labour rate per hour are also the same. Any variance in cost is solely on account of difference in the material usage and hours required to complete the production. A competitor has introduced a product very similar to product of the company at an aggressive price of ₹ 820 per set which has resulted in downtrend in the sales volume the company. The management has called urgent meeting of the marketing team. After the meeting, following recommendations of the marketing team are approved by the management:

(a) To maintain the company’s existing sales volume and amount of present return on investment, reduce the selling price by 10%.
(b) To make slight improvement in design to have edge over the competitors which will also reduce the direct material cost by ₹ 30 per set.
(c) To make the table and chair more attractive, print picture of Disney character on them, which will cost ₹ 5 per set.

Required:
(i) Calculate the present selling price and profit per unit from the above. Also calculate the mark-up % on the full cost per unit. (4 marks)
(ii) Identify the non-value-added activities in the production process. (2 marks)
(iii) (a) Calculate the new target cost per unit and new revised cost per unit after implementation of above recommendations. (2 marks)
(b) How much reduction in cost is required to achieve the new target cost? (2 marks)
(iv) Recommend what strategy the company should adopt to attain the target cost calculated above. (10 marks)

Question 23.
(a) AMKP International has developed ultra-modern smart LED TV with latest features. It has been developed after extensive research and is ready for manufacturing. The firm has incurred ₹ 6,50,000 as development cost on this LED TV. The firm is deciding on plant capacity, which could cost ₹ 40,00,000 for manufacturing of 600 units. With additional outlay of 40%, plant capacity can be increased by 50%. The relevant data pertaining to the life cycle of the LED TV at different capacity levels is as under: (Nov 2020)

Expected Sales	600 Units	900 Units
Selling Price	₹ 45,000 per unit	₹ 41,400 per unit
Variable Selling Costs	12% of the Selling price	12% of the selling price
Salvage Value of the plant	20% of the total plant cost	20% of the total plant cost
Profit Volume Ratio	30%

Required:
Advise AMKP International regarding the ‘Optimal Plant Capacity’ to install. The LED TVs life cycle is two years. (Note: Ignore the time value of money.) (10 marks)

Question 24.
The newly appointed Finance Director Mr. Preveen, in the month of September wants to make the billing pattern simple and proposed to change the price quoting methodology of the organization. The details of his proposal are listed below :- (Jan 2021)

The target cost for each research work is fixed in consultation with the client and the ABC Ltd. receives a bonus for completing the work below target cost. For a particular research conducted for Mr. Mohan, ABC Ltd has agreed upon a target cost of ₹ 20,00,000 and a target fee of ₹ 1,40,000. If the ABC Ltd completes the research at a lower cost than ₹ 20,00,000 then it will receive an additional profit upto a maximum profit of ₹ 1,80,000. If ABC Ltd completes the work for more than the target cost then it will receive less profit but atleast ₹ 40,000.

If the work is performed below the target cost, the client keeps 80% of the savings and leaves 20% of the surplus to ABC Ltd as an extra profit upto a maximum of ₹ 1,80,000. If the cost of research work exceeds the target cost, the client would bear 80% of the excess costs over and above the target cost and ABC Ltd. would bear 20%, which is subtracted from the target profit as long as the profit is not less than ₹ 40,000.
If the actual work performed amounted to ₹ 19,00,000.

Calculate the following:
(i) Cost saving for the project,
(ii) ABC Ltd.’s share in surplus
(iii) ABC Ltd.’s total profit,
(iv) Total cost to Mr. Mohan for market research work. (1 × 4 = 4 marks)

Now assume the ABC Ltd. spent ₹ 24,00,000 for performing the work to ascertain.
(v) Cost overrun
(vi) Mohan’s burden
(vii) ABC’s burden
(viii) Total Cost to Mr. Mohan for market research work. (1 × 4 = 4 marks)

Refund – CA Final IDT Study Material

Leave a Comment / CA Final / By Murali / April 10, 2023 May 10, 2023

Refund – CA Final IDT Study Material is designed strictly as per the latest syllabus and exam pattern.

Refund – CA Final IDT Study Material

Question 1.
Explain the relevant dates as provided in Section 26A(2) of Customs Act, 1962 for purpose of refund of duty under specified circumstances, namely:
(i) goods exported out of India
(ii) relinquishment of title to goods
(iii) Goods destroyed or rendered valueless. [Nov. 2016, 4 Marks]
Answer:
The relevant dates provided under Explanation to section 26A(2) of the Customs Act, 1962 for the purpose of refund of duty under specified circumstances are as follows:

Specified case	Relevant Date
(i) Goods are exported out of India	Date on which the proper officer makes an order permitting clearance and loading of goods for exportation
(ii) Relinquishment of title to goods	Date of such relinquishment
(iii) Goods destroyed or rendered valueless	Date of such destruction or rendering of goods commercially valueless

Question 2.
State briefly with reference to the provisions of Sec. 27 of Customs Act, 1962 whether the principle of “unjust enrichment” will apply in the following cases:
(i) Refund of wrongly encashed bank guarantee.
(ii) Refund of excess interest paid by the assessee.
(iii) Refund of duty on car imported for personal use. [May 2008, 2 × 3 = 6 Marks]
Answer:

Case	Applicability of Principal of Unjust Enrichment	Reason
(i) Refund of wrongly encashed bank guarantee	No question arises	The Supreme Court in OSWAL Agro mills Ltd. [SC/1994] held that furnishing of a bank guarantee for all or part of the disputed duty is NOT equivalent to payment of “duty”. The furnishing of bank guarantee is only a security to safeguard the interest of the Revenue. Since section 27 governs the refund of ‘duty’, and the bank guarantee is not ‘duty’, the limitation prescribed therein for refund of duty would not apply to refund of a bank guarantee. Also the requirement to establish that the duty incidence had not been passed on by the assessee to any other person would also not get attracted when section 27 is not attracted.
(ii) Refund of excess interest paid by the assessee	Yes but Refund is subject to principle	Sec. 27 provides for refund of custom duty as well as interest if any so in this case the refund will be granted for interest paid in excess, subject to unjust enrichment.
(iii) Refund of duty on car imported for personal use.	Not applicable	Proviso to Sec. 27(2) clearly provides for refund of import duty, if the importer is an individual and has imported the goods for his personal purpose.

Question 3.
Write a brief note on sanctioning of refund of customs duty under Sec. 27(2) of the Customs Act, 1962 under which refunds will not be credited to the consumer welfare fund. [Nov. 2010, 4 Marks]
Answer:
The Sec. 27(2) of the Customs Act, 1962 provides if the Assistant/Deputy Commissioner of Customs is satisfied about the refund claim made by the applicant, then in view of the provisions of unjust enrichment enshrined in the Customs Act, the amount found refundable has to be
credited to the Consumer Welfare Fund.

Cases of direct payment [First Proviso to section 27(2)]:
In the following situations, the amount of duty and interest found refundable, instead of being credited to consumer welfare fund, is to be paid to the applicant:

(a) if the importer has not passed on the incidence of such duty and interest to any other person.
(b) if imports were made by an individual for his personal use.
(c) if the buyer who has borne the duty and interest, has not passed on the incidence of such duty and interest to any other person.
(d) if amount found refundable relates to export duty paid on goods which has returned to exporter as specified in section 26.
(e) if amount relates to drawback of duty payable under sections 74 and 75.
(f) if the duty or interest was borne by a class of applicants which has been notified for such purpose in the Official Gazette by the Central Government.
(g) if the duty paid in excess by the importer before an order permitting clearance of goods for home consumption is made where-

such excess payment of duty is evident from the bill of entry in the case of self- assessed bill of entry; or
the duty actually payable is reflected in the reassessed bill of entry in the case of reassessment.

Question 4.
Discuss briefly the provisions relating to manner of computation of limitation period of one year in three situations contemplated under Sec. 27(1B) of the Customs Act, 1962 for purpose of refund of duty. [May 2012, 3 Marks]
Answer:
The situations require computation of limitation period of one year as contemplated under Sec. 27(1B) of the Customs Act, 1962 are as follows:

Section	Event	Limitation of one year to be computed from the
27(1B)(a)	Exempt from payment of duty by a special order issued under Sec. 25(2) of the Customs Act	Date of issue of such order
27(1B )(b)	When duty becomes refundable on account of any judgment, decree, order or direction of the appellate authority, Court/Tribunal	Date of judgment decree, order or direction
27(1B)(c)	Provisional payment of duty under section 18	Date of adjustment of duty after the final assessment or in case of re-assessment, from the date of such re-assessment.

Question 5.
What is the minimum monetary limit prescribed in the Customs law below which no refund shall be granted? [May 2014, 1 Mark]
Answer:
As per 3rd Proviso to Sec. 2 7(1) of Customs Act, 1962, the minimum monetary limit below which refund cannot be granted is ₹ 100. It means if the amount is less than ₹ 100, no refund will be allowed under Customs Act.

Question 6.
The assessee, an Importer, filed a refund application under Sec. 27 of the Customs Act, 1962. In support of the refund claim, the assessee submitted a Chartered Accountant’s certificate giving the various facts ruling out unjust enrichment under the Customs Act. The department denied the refund on the grounds being insufficient evidence.
Examine the validity of departmental action citing a decided case, if any[May 2014,3 Marks]
Answer:
Facts of the given Case Study

The assessee has submitted a Chartered Accountant’s certificate giving the various facts ruling out unjust enrichment under the Customs Act.
The department denied the refund on the grounds being insufficient evidence.

Related Provisions
(a) The present case is based upon Sec. 27(1A) of the Customs Act, 1962 which provides that refund application shall be accompanied by such documentary or other evidence including documents referred to in Sec. 28C as the applicant may furnish to establish that the amount of duty or interest in relation to which such refund is claimed,

was collected from, or paid by him and
the incidence of such duty or interest, has not been passed by him to any person.

(b) Similar view was given by the High Court in the case of CCus., Chennai v. BPL Ltd. (2010).

Decision
The Chartered Accountant’s Certificate is not sufficient proof for establishing the conditions for refund as given above. Thus, the denial by the department is justified in this case.

Question 7.
Mr. N has imported 1000 units of an article “ZEP”, which has been valued at 1,150 per unit. The customs duty on this article has been assessed 250 per unit and paid by Mr. N. He adds his profit margin 350 per unit and sells the article for 1,750 per unit.
After one month of sale of whole units of article “ZEP”, Mr. N found that there was an error in assessment resulting in excess collection of duty by the Customs Department and such excess collection of 100 per unit is liable to be refunded by department. Mr. N files an application and demands refund.
Calculate the amount of refund to be received by Mr. N. Also mention provisions of the Customs Act, 1962 related to refund in above said situation. [CA-Final, Nov. 2015, 4 Marks]
Answer:
Amount of Refund claimed by assessee = 1000 units @ ₹ 100 per unit = ₹ 1,00,000
Amount of Refund received by assessee = Nil (as it is subject to unjust enrichment)

Facts of the case

The importer has paid @ ₹ 100 per unit due to erroneous assessment by the department.
As it is an error resulting in excess payment of duty, such excess duty is liable to be refunded.
Also, the importer has already collected the duty from the purchaser.

Provision of Customs Act, 1962
Section 27 :

The applicant has to make an application
in such form and manner as may be prescribed for such refund to the AC/DC of Customs
before the expiry of one year from the date of payment of such duty.

As per third proviso to section 27(1), where the amount claimed is less than ₹ 100, it will not be refunded.

Decision/ Comment
Since the importer has passed the burden to the consumers, if any refund is granted to him, it would confer on him a double benefit to which he does not have a valid right.
Therefore, refund will not be given to him but will be credited to consumer welfare fund.

Question 8.
Mr. Varad has, over three consignments of 300, 500 and 600 units, imported a total of 140 units of an article “FIXIT”, which has been valued at ₹ 3,500 per unit. The customs duty on this article has been assessed ₹ 350 per unit. He adds his profit margin @ 20% on cost and sell the article for ₹ 4,620 per unit.

After one month of selling the entire consignment of the article “FIXIT”, Mr. Varad found that there had been an error in payment of amount of duty, in which duty for the consignment of 300 units was paid as if it was 450 units, resulting in excess payment of duty. Mr. N files an application for refund for ₹ 37,500 (150 @ ₹ 250). Is the bar of unjust enrichment attracted?
Answer:
Facts of the case
Mr. Varad has paid customs duty on 1,550 units whereas he had imported 1,400 units only. After one month, he filed application for refund.

Provisions of Customs Act, 1962
Mr. Varad’s invoices show that he collected duty of ₹ 350 per unit on 1,400 items. However he paid duty on 150 items more. This payment, in the normal course, was made before the order permitting the clearance of the goods. It would be evident from the bill of entry that the amount paid was more than the amount of duty assessed. Thus, Mr. Varad’s case falls within the exception to unjust enrichment listed at clause (g) of the first proviso to section 27(2). He will be able to refute the charge of unjust enrichment.

Furthermore, clause (a) of the same sub-section provides that the doctrine of unjust enrichment will not apply to the refund of duty and interest, if any, paid on such duty if such amount is relatable to the duty and interest paid by the importer/exporter, if he had not passed on the incidence of such duty and interest to any other person. Mr. Varad’s invoices will show how much duty he collected from his customers, hence he may be covered by this clause also to escape the bar of unjust enrichment

Decision/ Comment
The bar of unjust enrichment is not attracted.

Question 9.
PQR Ltd. imported certain machine parts and filed a Bill Entry in the usual course. The said machine parts are entitled for concessional rate in terms of a notification. The assessee PQR Ltd. omitted to claim the benefit of the aforesaid notification at the time of filing and assessment of the Bill of Entry. Later when PQR Ltd., discovered about the benefit under the notification as aforesaid they filed a refund claim for the excess amount paid as customs duty under Sec. 27 of the Customs Act, 1962.

There was no assessment order since the duty was paid on the basis of the Bill of Entry filed in the usual course. The refund claim was rejected on the ground that Sec. 27 of the Customs Act, 1962 could be invoked only if an assessment order has been passed and duty payment made pursuant thereto.
Discuss with a brief note and decided case law if any whether the stand of the department is correct in law. [CA-Final, Nov. 2011, 3 Marks]
Answer:
Facts of the given Case Study

PQR Ltd. imported certain machine parts and filed a Bill Entry in the usual course.
The assessee omitted to claim the benefit of concessional rate notification at the time of filing and assessment of the Bill of Entry.
There was no assessment order since the duty was paid on the basis of the Bill of Entry filed in the usual course.
Now assessee has filed a refund claim for the excess amount paid as customs duty under Sec. 27 of the Customs Act, 1962.
The refund claim was rejected

Related Provisions
(a) Sec. 27(1) of the Customs Act, 1962, inter alia provides that any person claiming refund of any duty and interest:

(i) paid by him in pursuance of an order of assessment; or
(ii) borne by him.
may make an application for refund of such duty and interest.

Since clauses (i) and (ii) of sub-sec. (1) of Sec. 27 have the expression ‘or’ in between them, it is clear that application for refund cannot only be made in pursuance of an assessment order but also when the duty is borne by the applicant. In fact, Sec. 27(1 )(n) aims to cover those very cases where the duty is paid by a person without an order of assessment.

(b) Aman Medical Products v.CCus. 2010 (250) E.L.T. 30 (Del.)
In this the High Court has held that it is not necessary that a refund can be claimed only when the duty paid by the importer is in pursuance to an order of assessment. The refund can also be claimed when the duty paid by the importer is ‘borne by him’.

Decision
In view of the above discussion, the stand taken by the Department is not correct in law.
Note: This case has been appealed to Supreme Court and appeal is pending in 2010(256) ELT A57 (Supreme Court).

Question 10.
The assessee had imported capital goods under a licence with a condition to fulfil an export obligation within a certain time limit. The assessee failed to discharge the export obligation within the said time limit. Consequently, the department invoked the bank guarantee and realize the amount. However, subsequently the assessee was able to fulfil the export obligation and the department cancelled the bank guarantee.

The assessee thereafter filed a refund claim for the amount realized by invocation of the bank guarantee by the department. The department rejected the refund claim on the ground that it was barred in terms of Sec. 27(1)(b) of the Customs Act, 1962 as the assessee had not been able to establish that the incidence of duty had not been passed on by him to any other person. Examine briefly with the help of any decided case law whether the stand taken by the department is correct in law. [Nov. 2009, 5 Marks]
Answer:
Facts of the given Case Study

The assessee failed to discharge export obligation.
Department invoked bank guarantee.
Subsequently, the guarantee was cancelled because assessee fulfilled Export Obligation.
The department rejected the claim on the ground of time barred as per section 27(1)(&).

Related Provisions
CCus. (Exports) v. Jraj Exports (P) Ltd. 2007 (217) E.L.T. 504 (Mad.),
The facts of the given case study are similar to above case. In the above cited case, the High Court observed that when the Department had accepted the fulfilment of export obligation, there was no need to invoke the bank guarantee and retain the amount. The High Court opined that the Department’s claim that refund had been time barred was not sustainable as furnishing of bank guarantee in order to fulfil the export obligation could not be regarded as payment of duty.

The High Court relied on the Supreme Court’s ruling in the case of Oswal Agro Mills Ltd. and Another v. Asstt. Collector of Central Excise 1994 (70) ELT 48 (SC), wherein it was held that furnishing of bank guarantee pursuant to an order of the Court/Tribunal would not be equivalent to payment of excise duty. The furnishing of Bank guarantee is only a security to safeguard the interest of the Revenue. Applying the principle laid down in this case, the Court/Tribunal stated that the requirement to establish that the duty incidence had not been passed on by the assessee to any other person would also not get attracted since Sec. 27 has no application to this case.

Decision
Since section 27 is not applicable, no question arises to prove non-transfer of duty incidence. Thus, the stand of the Revenue is not correct in law.

Question 11.
A manufacturer of excisable goods imported epoxy resin under bill of entry dated 28th March, 1992 and put them in a bonded warehouse. He later on cleared it on payment of duty. Subsequently, he realized that there was an excess payment of duty and put in a refund claim.

He used the imported goods in the manufacture of other goods and the burden of duty had not been passed on. The imported goods were not sold to any other buyer. The Customs Department refused the claim to refund on the ground of unjust enrichment. Was the decision justified? Discuss. [May 2000, 4 Marks]
Answer:
Facts of the given Case Study

The assessee failed to discharge export obligation.
Department invoked bank guarantee.
Subsequently, the guarantee was cancelled because assessee fulfilled Export Obligation.
The department rejected the claim on the ground of time barred as per section 27(1)(b).

Related Provisions
The Supreme Court has held in Solar Pesticides case 2000 (116) ELT 401 that the bar of unjust enrichment will apply to refunds even in case of captive consumption of inputs by the importer, as the incidence of duty paid on the inputs are passed on to the customers.

Infact, when imported raw materials are captively consumed in manufacture of finished products, which are sold, duty on such materials is presumed to have been passed on to buyer.

Decision/Comment
The Principle of unjust enrichment applies. Thus, the Customs Department is right in denying refund on such ground.

Duty Drawback – CA Final IDT Study Material

Leave a Comment / CA Final / By Murali / April 10, 2023 May 10, 2023

Duty Drawback – CA Final IDT Study Material is designed strictly as per the latest syllabus and exam pattern.

Duty Drawback – CA Final IDT Study Material

Question 1.
With reference to drawback on re-export of duty paid imported goods, under Sec. 74 of the Customs Act, 1962, answer in brief the following questions:
(i) What is the time limit for re-exportation of goods as such?
(ii) What is the rate of duty drawback, if the goods are exported without use?
(iii) Is duty drawback allowed on re-export of wearing apparel without use? [Nov. 2013, 3 Marks]
Answer:
(i) Time limit for re-exportation of goods

Sec. 74 of the Customs Act, 1962
The goods must be entered for export within 2 years from the date of payment of duty on the importation thereof. However, extension can be granted by the Board on sufficient cause been shown. In the case of goods assessed to duty provisionally u/s 18, the date of payment of the provisional duty shall be deemed to be the date of payment of duty.

(ii) Rate of duty draw back, if the goods are exported without use

98% of the import duty paid is allowed as drawback in case the goods are exported out of India without being put to use. In case the goods are taken into use and then exported, duty drawback shall be allowed at notified rates u/s 74(2) having regard to the duration of use, the depreciation in value and other relevant circumstances.

(iii) duty drawback allowed on re-export of wearing apparel without use

Yes, duty drawback is allowed when wearing apparels are re-exported without being used. However, Notification No. 19/65-Cus., dated 6.2.1965 as amended provides that if wearing apparels have been used after their importation into India, drawback of import duty paid thereon shall not be allowed when they are exported out of India.

Question 2.
M/s. PQR has imported used wearing apparel from USA in April, 2019. After receipt, POR is doubtful that the apparel may not be saleable In India and want to re-export back to USA, without use, which the supplier has accepted. Will PQR be eligible to take Drawback of duty paid on imports? Also list out the conditions for duty drawback. [Nov. 2019, 5 Marks]
Answer:
Solution.

Provision
As per section 74 of Customs Act, 2017
No Drawback in certain cases of “used” goods: In case following goods have been used after their import into India, drawback of import duty paid thereon shall not be allowed when they are exported out of India –

Wearing apparel;
Tea-chests;
Exposed cinematograph films passed by the Board of Film Censors in India;
Unexposed photographic films, paper and plates, and X-ray films.

In the given case

M/s. PQR has imported used wearing apparel from USA and want to re-export back to USA, without use.
It means wearing apparel have not been used after importation & re-export without use.
As per above discussion, M/s. PQR is eligible to take drawback of duty paid on Import (Subject to following conditions). And maximum duty drawback in this case will be 98%.

Conditions for a availing duty drawback.

Easily Identifiable – The Goods should be easily identified (without any testing)
Market Price – Market Price of Goods exported should not be less than amount of Duty Drawback.
Minimum Draw back – Amount of Duty Drawback amount should be atleast ₹ 50.
Time period for re-export – The goods are entered for export –

Within 2 Years
From the date of payment of duty on the importation thereof.

However, in any particular case, aforesaid period of two years may, on sufficient cause being shown, be extended by the Board by such further period as it may deem fit.

Question 3.
State briefly any live illustrative cases under the Customs Central Excise Duties and Drawback Rules, 2017, where the All Industry Drawback Rates will not apply. [May 2008, 5 Marks]
Answer:
Illustrative cases for Non-applicability of All Industry Drawback Rates:

Any commodity exported, after manufacturing in customs bonded warehouse, by following Sec. 65 of the Customs Act, 1962.
Any commodity exported in discharge of export obligation against “Advance Licence” or any other beneficial scheme under Foreign Trade Policy.
Any commodity exported by 100% export-oriented undertaking,
Any commodity exported by a SEZ unit.
Any commodity exported by manufacturer or trader who has claimed rebate.

Question 4.
What are the cases in which no drawback is allowed under Sec. 75 of the Customs Act, 1962 and Customs and Central Excise Duties Drawback Rules, 2017. Also explain the maximum rate of duty drawback. [Nov. 2008, 2 Marks]
Answer:
(I) No Drawback to be Allowed

(а) In Case of Negative Value Addition:
If the export value of such goods or class of goods is less than the value of the imported materials used in the manufacturing, processing of such goods or carrying out any operation on them, then, no drawback shall be allowed.

(b) Minimum Value Addition:
If the export value of such goods is not more than such percentage of the value of the imported materials used in their manufacture etc., as specified by the Central Government, no drawback shall be allowed.

(II) Maximum rate of duty drawback [Rule 9]
The upper limit of drawback money or rate determined under rule 3 should not exceed one third of the market price of the export product.

Question 5.
State briefly the provisions under the Customs Act, 1962 relating to duty drawback on re-export of goods. [May 2016, 3 Marks]
Answer:
Duty Drawback will be allowed on re-export of duty paid goods if following conditions are satisfied:

1. Only imported goods on which duty has been paid on importation are eligible for drawback.

2. The goods so imported must have been entered for exportation either –
a. Under Section 51; or
b. Under Section 77 as baggage; or
c. Under Section 84(a) by Post;
and the proper officer must have made an order for permitting clearance of goods for exportation.

3. Such goods are identified to the satisfaction of the Assistant or Deputy Commissioner as the goods which were imported.

4. 98% of the import duty paid is allowed as drawback in case the goods are exported out of India without being put to use.

5. If goods are exported as baggage, the owner of the baggage makes a declaration of its contents to the proper officer which will be considered as entry for export and such officer permits clearance of the goods for exportation.

6. If exported through post, the Proper Officer makes an order for clearance for export.

Question 6.
Define these terms as per Customs and Central Excise Duties Drawback Rules, 2017. [Nov. 2016, 2 Marks] [Modified]
Answer:
(i) Drawback [Rule 2(a)]: Drawback in relation to any goods manufactured in India and exported, means the rebate of duty excluding IGST leviable under Section 3(7) and the compensation cess leviable under Section 3(9) of the Customs Tariff Act, 1975 chargeable on any imported materials or excisable materials used in the manufacture of such goods. [Amended by Notification No. 88/2017-Cus. (NT), dated 21-09-2017 w.e.f. 01-10-2017]

(ii) Export [Rule 2(c)]: “Export”, means taking out of India to a place outside India or taking out from a place in Domestic Tariff Area (DTA) to a special economic zone and includes loading of provisions or store or equipment for use on board a vessel or aircraft proceeding to a foreign port.

Question 7.
Calculate the amount of duty drawback (if any) allowable under the Customs Act, 1962 and the rules made thereunder in the following independent cases:
(i) Hema Ltd. has exported goods worth ₹ 80,000 (FOB value). Rate of duty drawback on such export of goods is 0.8%.
(ii) High Value Ltd. exported 1,000 kgs. of goods of FOB value of ₹ 1,50,000. Rate of duty drawback on such export is ₹ 50 per kg. Market price of goods is ₹ 48,000 (in wholesale market). [ Nov. 2014, 4 Marks]
Answer:
Amount of duty drawback:

Drawback admissible: In this case the amount of drawback will be 80,000 × 0.8% ie. 640.
Drawback Inadmissible: As per Section 76 of Customs Act, 1962 : No drawback shall be allowed,
In respect of any goods, the market price of which is less than the amount of drawback due thereon,
Where the amount of drawback in respect of any goods is less than fifty rupees.

Since the market price of the exported goods i.e. ₹ 48,000 is less than the amount of drawback i.e. 1000 kg × 50 i.e. ₹ 50,000. So, there will be no drawback in this case due to prohibition of Section 76.

Question 8.
CBZ Ltd. has exported following goods to Germany. Write brief note with reasons whether and duty drawback is admissible under Section 75 of the Customs Act, 1962 in each of the following cases:

Product	FOB value of Exported Goods Amount in ₹	Market Price of Goods Amount in ₹	Duty drawback rate
A	4,30,000	3,50,000	30% of FOB
B	6,00,000	7,00,000	3.50% of FOB
C	1,20,000	60,000	1.75% of FOB
D	3,00,000	3,50,000	1.50% of FOB

Notes:

Imported value of Product B is ₹ 8,00,000.
Product D is manufactured out of duty-free inputs.
Working notes should form part of the answer. [May 2017, 4 Marks]

Answer:
(i) Product A : Drawback is admissible, assuming that all conditions are satisfied, but the amount of drawback will be restricted to 1/3rd of market price. Therefore the amount of drawback will be lower of these two:
(a) 30% of FOB (4,30,000 × 30%) i.e. ₹ 1,29,000; or
(b) 1/3rd of market price (3,50,000 × 1/3) ie. ₹ 1,16,667.
So, the amount of drawback shall be limited to ₹ 1,16,667.

(ii) Product B: Drawback is not admissible, because the value of export goods is not more than the value of imported materials. In this case, imported value of product B is ₹ 8,00,000, while the FOB is just ₹ 6,00,000.

(iii) Product C: Drawback is admissible, assuming that all conditions are satisfied. Drawback amount will be 1.75% of ₹ 1,20,000 i.e. ₹ 2,100.

(iv) Product D: Drawback is not admissible, because “Product D” is manufactured out of duty-free inputs.

Question 9.
Infinity Corporation has imported goods and the following particulars are available for claiming duty drawback under sections 74 & 75 of Customs Act, 1962:

(a) Custom duty has been paid on goods imported for use and have been out of customs control for 14 months – ₹ 14,00,000
(b) Raghuveer exports manufactured goods having FOB value of – ₹ 86,000
Rate of duty drawback on FOB value of – 40%
exports Market value of the export product – ₹ 96,000
Determine duty drawback with explanations in the above cases. [May 2018(Old), 4 Marks]
Answer:
(a) As per section 74(2) of Customs Act, 1962 read with Notification No. 19/65 Cus. dated 06.02.1995 as amended, 65% of import duty is to be paid as duty drawback if goods are used after importation and have been out of customs control for export for a period of more than 12 months but not more than 15 months.
Therefore, amount of duty drawback = ₹ 14,00,000 × 65% = ₹ 9,10,000

(b) As per rule 9 of Customs & Central Excise Duties Drawback Rules, 2017: –
The drawback amount should not exceed one third of the market price of the export product
Amount of duty drawback = ₹ 86,000 × 40% = ₹ 34,400
Thus, upper limit of drawback amount = ₹ 96,000/3 = ₹ 32,000
Thus, the amount of duty drawback in the present case will be restricted to ₹ 32,000

Question 10.
With reference to the Customs & Central Excise Duties Drawback Rules, 2017, briefly state whether an exporter who has already filed a duty drawback claim under All Industry Rates, can file an application for fixation on special brand rate. [RTP, Nov. 19]
Answer:
As per rule 7 of the Customs and Central Excise Duties Drawback Rules, 2017: Application for Special Brand Rate cannot be made where a claim for drawback under rule 3 or rule 4 has been made.

In other words, where the exporter has already filed a duty drawback claim under All Industry Rates (AIR) Schedule, he cannot request for fixation of Special Brand Rate of drawback. Thus, the exporter should determine prior to export of goods, whether to claim drawback under AIR or Special Brand Rate.

Question 11.
Answer the following with reference to the provisions of the Customs Act, 1962 and rules made thereunder:
(1) Mr. A filed a claim for payment of duty drawback amounting to ₹ 50,000 on 30-07-2019. But the amount was received on 28-10-2019. You are required to calculate the amount of interest payable to Mr. A on the amount of duty drawback claimed. [CA-Final, May 2015, 2 Marks]
(2) Mr. X was erroneously refunded a sum of ₹ 20,000 in excess of actual drawback on 2006-2019. The same was returned to the department on 20-10-2019. You are required to calculate the amount of interest chargeable from Mr. X.
Provide brief reasons for your answer. [May 2015, 2 Marks]
Answer:
1. As per Sec. 75A(1) of the Customs Act, 1962, if drawback is not paid to claimant within one month from the date of filing of drawback claim, then interest will be paid to him @ 6% per annum. Interest shall be calculated from the date after expiry of the said period , of 1 month till the date of payment of such drawback. So, the amount of interest payable to Mr. A, will be computed as:

Amount of duty drawback claimed [A]	50,000
No. of days delayed [31.08.2019 to 28.10.2019]	59 days
Rate of Interest [C]	6%
Amount of interest [A × B × C] [Rounded off]	485

2. As per Sec. 75A(2) of the Customs Act, 1962, if drawback has been erroneously paid to claimant, then claimant shall return such amount within 2 months from the date of demand otherwise he will pay an interest @15% per annum. Interest shall be calculated from the date of payment of such drawback to the claimant till the date of recovery of such drawback.

Amount of duty drawback claimed [A]	20,000
No. of days delayed [21.06.2019 to 20.10.2019] [B]	122 days
Rate of Interest [C]	15%
Amount of interest [A × B × C] [Rounded off]	1,003

Question 12.
Abdul Overseas Pvt. Ltd. was erroneously refunded a sum of ₹ 30,000 in excess of actual drawback on 16-06-2017. A demand for recovery of the same was issued by the Department on 24-08-2017. Abdul Overseas Private Limited returned the erroneous refund to the Department on 16-10-2017. You are required to calculate the amount of interest chargeable from Abdul Overseas Pvt. Ltd.
Provide brief reasons for your answer. [Nov. 2018 (Old), 4 Marks]
Answer:
As per Sec. 75A(2) of the Customs Act, 1962, if drawback has been erroneously paid to claimant, then claimant shall return such amount within 2 months from the date of demand otherwise he will pay an interest @15% per annum. Interest shall be calculated from the date of payment of such drawback to the claimant till the date of recovery of such drawback.

Computation of interest chargeable from Abdul Overseas Pvt. Ltd.

Particulars	Amount (₹)
Duty drawback erroneously refunded	₹ 30,000
No. of days of delay [17.06.2019 to 16.10.2019] (Refer Note)	122 days
Rate of interest (Refer Note)	15%
Quantum of interest (rounded off) [₹ 30,000 × 122/365 × 15/100]	1,504

Examiner’s Comment
Some examinees wrongly computed the number of days for which interest is chargeable from Abdul Overseas Pvt. Ltd. As 123 days since they included the date of cause of action while calculating the number of days of delay.

Cost Management for Specific Sector – CA Final SCMPE Question Bank

Leave a Comment / CA Final / By Raju / April 10, 2023 April 10, 2023

Cost Management for Specific Sector – CA Final SCMPE Question Bank is designed strictly as per the latest syllabus and exam pattern.

Cost Management for Specific Sector – CA Final SCMPE Question Bank

Question 1.
Write short note on Structure of Power Sector in India.
Answer:
Power is one of the most critical components of infrastructure crucial for the economic growth and welfare of nations. The existence and development of adequate infrastructure is essential for sustained growth for the Indian economy.

India’s power sector is one of the most diversified in the world. Sources of power generation range from conventional sources such as coal, lignite, natural gas, oil, hydro and nuclear power to viable non-conventional sources such as wind, solar and agricultural and domestic waste. Electricity demand in the country has increased rapidly and is expected to rise further in the years to come. In order to meet the increasing demand for electricity in the country, massive addition to the installed generating capacity is required.

India ranks third among 40 countries in EY’s Renewable Energy Country Attractiveness Index, on back of strong focus by the government on promoting renewable energy and implementation of projects in a time bound manner. India has moved up 73 spots to rank 26,h in the World Bank’s list of electricity accessibility in 2017.

In September 2017, the Government of India launched the Saubhagya Scheme to provide electricity connections to over 40 million families in rural and urban areas by_December 2018 at a cost of US$ 2.5 billion.

The power sector in India is mainly governed by the Ministry of Power. There are three major pillars of power sector. These are Generation, Transmission, and Distribution. As far as generation is concerned it is mainly divided into three sectors. These are Central Sector, State Sector, and Private Sector. Major PSUs involved in the generation of electricity include NHPC Ltd., NTPC Ltd., and Nuclear Power Corporation of India (NPCIL).

Besides PSUs, several state-level corporations are there such as Jharkhand State Electricity Board (JSEB), Maharashtra State Electricity Board (MSEB), Kerala State Electricity Board (KSEB), in Gujarat MGVCL, PGVCL, DGVCL, UGVCL four distribution Companies and one controlling body GU VNL, and one generation company GSEC), are also involved in the generation and intra-state distribution of electricity.

Other than PSUs and state level corporations, private sector enterprises also play a major role in generation, transmission and distribution.

The Power Grid Corporation of India is responsible for the inter-state transmission of electricity and the development of national grid.

The Ministry of Power is the apex body responsible for the development of electrical energy in India. This ministry started functioning independently from 2 July 1992; earlier, it was known as the Ministry of Energy.

Question 2.
Write short note on:
Application of Cost Management Technique in Power Sector.
Answer:
Cost Management Technique in Power Sector is required for:

Determining Prices
Regulation tariffs
Developing a flexible cost allocation system
Distribution loss and inefficiency gap analysis
Multi dimensional costing calculations
Overall analysis and reporting.

Question 3.
Write short note on Activity Based Costing in Agriculture.
Answer:
ABC in Agriculture:
Activity Based Costing is a costing methodology that identifies activities in an organisation and assigns the cost of each activity with resources to all products and services according to actual consumption by each.

Activity Based Costing provides a better manner in which the Indirect costs associated with the processes carried out in the agricultural sector can be carried out in an efficient manner.

It is a step up from the target cost management technique where the fluctuation in the anticipated price which forms part of the formula might not result in appropriate determination of the target costs.

ABC costing helps in allocation of the costs in relation to the various activities associated with the production based upon the cost drives identified in relation to each production activity.

Benefits of using ABC for cost management in the agricultural sector:

Adjustable costing technique
Faster and more accurate
Enables carrying out a more detailed cost analysis.

Question 4.
State the components of Agri supply Chain.
Answer:
Components of an Agri supply chain
Agribusiness, supply chain management (SCM) implies managing the relationships between the businesses responsible for the efficient production and supply of products from the farm level to the consumers to meet consumers’ requirements reliably in terms of quantity, quality and price.

In practice, this often includes the management of both horizontal and vertical alliances and the relationships and processes between firms. Agri-supply chains are economic systems which distribute benefits and apportion risks among participants. Thus, supply chains enforce internal mechanisms and develop chain wide incentives for assuring the timely performance of production and delivery commitments.

They are linked and interconnected by virtue of shared information and reciprocal scheduling, product quality assurances and transaction volume commitments. Process linkages add value to agricultural products and require individual participants to coordinate their activities as a continuous improvement process.

Costs incurred in one link in the chain are determined in significant measure by actions taken or not taken at other links in the chain. Extensive pre-planning and co-ordination are required up and down the entire chain to affect key control processes such as forecasting, purchase scheduling, production and processing programming, sales promotion, and new market and product launches etc.

Following are the components of an organised agri-suppiy chain:
1. Procurement or sourcing
2. Logistic management
(a) Transportation
(b) Material management
(c) On the premise of supplying mostly from production not stock
(d) Warehousing
(e) Logistics Network modelling

3. Organizational management
(a) Contracting
(b) Strategic alliances and partnerships
(c) Vertical integration

Long term storage
Packaging technology
Cold chain management
Energy efficient transport
Quality and safety

4. Application of Efficient Consumer Response (ECR) System
(a) Electronic scanning of price and product at the point of sale
(b) Streamline the entire distribution chain

Question 5.
Discuss the features of Power Sector in India.
Answer:
Features of Power Sector

Limited number of suppliers of electricity.
Tariff determination is based upon the rationality to determine the cost incurred at various points of operation.
Stakeholders are existing and future consumers, industries, government, regulators, and investors.
Continuous growing demand of electricity.
Flexible Cost allocation.
Distribution loss and inefficiency gaps between generation and consumption of electricity.
In-disciplined consumer.
Continuous network between generators, transmitters, distributors, and consumers.
Mostly public sector undertakings closely regulated by government.
Energy subsidies having direct impact on national treasury affecting long term growth potential of the economy.

Question 6.
Explain the 4D IT Cost Optimization Framework.
Answer:
4D IT Cost Optimization Framework Defining Organization Vision
Any amount of spending carried out in relation to the Information Technology requirements of the organization needs to be aligned to the organizational vision and long term objectives. Business owners should have a sense of ownership and thereby control the IT costs in an effective manner. The perspectives of the key stakeholders i.e. CEO, CFO and directors must be taken into consideration when deciding upon the IT consumption within the organization.

The additional visibility through the model needs to determine the appropriate method of cost allocation in relation to the IT cost burden. Thus, the allocation model that is chosen needs to be both flexible and at the same time avoid being too complex in nature. The organization can either opt for a simple method of dividing the entire IT cost by the number of hours consumed by each department or a more complex but accurate method of ABC costing could be used for allocation of the costs based upon the associated cost drivers associated with each set of activities.

Documentation of the current state
The next step involves documentation of the current state of the IT department implemented within the organization in order to identify gaps and potential weaknesses identified in relation to the current state for the purpose of identification of the appropriate pain points as well as identification of areas for potential automation.

Delineation of target business architecture
Once the current state of the IT architecture has been documented, the next step is developing a target business architecture for the purpose of addressing the gaps and limitations identified and laying down the foundation with regards to the formation of the crux of the IT cost management framework.

Decision: Build v/s Buy
The last step understands whether the framework built is bought or custom built internally. The answer to the question involves a great amount of brainstorming and research taking into consideration the view point of all the strategic stakeholders involved.

Question 7.
What are the challengers associated with IT expenditure in MNCs? Which IT cost framework should be adopted?
Answer:
There are a number of challenges associated with the management of the costs associated with the Information Technology expenditures incurred by the Multi-National corporations. Thus, the complexity of the operating structure and the difficulty seen in the implementation of the cost allocation models, it is seen that in order to manage the IT costs, most organizations tend to develop centralized IT departments acting as cost centers for the purpose of managing the IT budgets as well as allocation of costs associated with along with the charging back of expenses that are incurred by the business units.

IT Organization’s Engagement Model
The question that needs to be addressed under the same is that whether the IT organization should be organized as a cost center to the organization or whether it should be seen as a strategic partner to the business. With more and more organizations whether large or small in nature, opting for third party allocation or opting for cloud computing services it can be seen that the internal IT departments are fighting hard for remaining relevant for the organization. In order to stay relevant, what the IT department needs is a better visibility towards the IT needs of the organization. In order to do the same, organizations operating in the given sector can adopt what is referred as to the 4D framework.

Question 8.
Draw a diagram to show the Value Chain Analysis in Power Sector in India.
Answer:
Value Chain Analysis is Power Sector:
This involves ensuring value creation in all the activities both inbound and outbound activities undertaken by the power company starting from electricity generation to the point of supply or distribution of the electricity supply.

Question 9.
What are the key risks in Power Sector in India?
Answer:
Key Risks in the Power Sector are:
1. Highly Capital Intensive
Power sector is a highly capital intensive business with long gestation periods before commencement of revenue streams (construction periods of 7-8 years) and an even longer operating period (over 25 years). Since most of the projects have such a longtime frame, there are some inherent risks in both thb internal and external environment.

2. Coal Supply Position
More than 50 percent of India’s generation capacity is coal based. According to the Integrated Energy Policy, by FY 20 – 21, India requires 2,040 million tonnes of coal for power generation, more than 5 times its current consumption levels. The shortage of coal is so acute that most of the power generation companies are looking at imported coal as a viable alternative to domestic coal.

Question 10.
Discuss the features of Agriculture Sector in India.
Answer:
Features of Agriculture Sector in India:

Challenges associated with structure of the industry which is fragmented and unorganized
Lack of understanding of costs
Understanding the potential of working collaboratively
Use of target costing techniques for price determination
Imbalance of power across the supply chain

1. Fragmented Structure of the Industry
The structure of the agriculture sector is seen to be unorganized and fragmented in nature and thus lack of effective regulation in the given sector is also seen as one of the reasons why farmers seem to be exploited and have been operating at very low margins.

2. Lack of understanding of costs and prices by the farmers
One of the key reasons seen for the lack of appropriate cost management in the given sector is with regards to the lack of prioritization of the cost management among farmers because of lack of knowledge with regards to the same.

3. Understanding the potential to work collaboratively
The farmers need to be open to innovation in cost management and contracting techniques. Though there is scope for cost reduction in order to bring about improvement in the profit margins for the farmers, it is seen that generally the profits tend to get transferred to the customers and the only point of negotiation is in the contract pricing with the retailers which the farmers fail to reach.

4. Target cost. Management
The target costing technique involves determining the cost by subtracting the required margin from the anticipated price for the agricultural produce. However, the anticipated price for the agricultural products fluctuates making the process of cost management using the target cost management system ineffective in the case of the agricultural sector.

5. Imbalance of power distribution
With the fragmentation and the unorganized nature of the farmers operating in the agricultural sector, the power of bargaining seems to lie in the hands of the wholesalers purchasing the produce from the farmers resulting in overall low margins for farmers in comparisons to the margins earned by the wholesalers and the retailers operating in the said sector.

Question 11.
Write a brief note on Minimum Support Price (MSP).
Answer:
Minimum Support Price (MSP)
In India, Minimum Support Price (MSP) was introduced by the Government of India to protect farmers against sharp dip of agricultural prices, which was usually observed during the harvest seasons. The harvest seasons are associated with huge supply, which overshadows the demand, and hence, in most cases the commodity prices hit the bottom.

This forces the farmers, in necessity of money for repayment of debts, in selling their produce at losses or very little profits. Thus, the government fixes the MSP, as a part of government food grain procurement. Selling at MSP ensures profit margins for farmers and avoids distress selling situations.

Decision Making – CA Final SCMPE Question Bank

Leave a Comment / CA Final / By Raju / April 6, 2023 April 12, 2023

Decision Making – CA Final SCMPE Question Bank is designed strictly as per the latest syllabus and exam pattern.

Decision Making – CA Final SCMPE Question Bank

Question 1.
Explain briefly the concepts of Opportunity costs and .Relevant costs. (May 2009, 4 marks)
Answer:
Opportunity cost has been defined as “prospective change in cost following the adoption of an alternative machine, process, raw materials, specification or operation”. In other words, it is the cost of opportunity lost by diversion of an input factor from one use to another. It is the measure of the benefit or opportunity foregone. The opportunity cost or the value of opportunity foregone is taken into consideration when alternatives are compared.

The introduction of opportunity cost concept in making profitability calculations is helpful to the management when one or more of the inputs required by one or more of the alternative courses of action is already available. These inputs may nevertheless have a cost and this is measured by the sacrifice made by the alternative action chosen or the cost that is given up in order to make them available for the current proposal.

Relevant Cost: Business decisions involving planning for the future require consideration of several alternative choices of plans. In making these plans, estimates of future costs and revenues in respect of each alternative are worked out. It should be recognised that the only costs that matter for business decisions are future costs.

Actual costs or current or historical costs are used only for estimating the future costs of each alternative choice. Thus we give consideration to what is known as relevant costs. The contribution approach coupled with the ability to distinguish relevant cost from irrelevant costs will prove to be a boon to the manager in arriving at correct conclusions in the challenging area of decision making.

Relevance means pertinent to the decision at hand. The data given is said to be relevant if it helps the manager in taking a right decision in furtherance of the company’s objectives.

Question 2.
What are the applications of incremental/differential costs? (May 2010, 5 marks)
Answer:
Application of incremental/differential costs:

Whether to process a product further or not.
Dropping or adding a product line.
Optimizing investment plan.
Accepting an additional order from a special customer at lower than existing price.
Make or buy decision.
Opening a new sales territory or branch.
Optimizing investment plan out of multiple alternatives.
Submitting tenders.
Lease or buy decisions.
Equipment replacement decisions.

Question 3.
Two companies, H and L, have the same values for turnover and net profit and make a similar product. H has a higher PN ratio than L. Which company will perform better when:

the market demand is high?
the market demand is low? (Nov 2011, 2 marks)

Answer:

In case Market Demand is High – Product H (Lower Variable Cost and Higher Fixed Cost)
In case Market Demand is Low – Product L.

Question 4.
Answer the following questions:
“Sunk cost is irrelevant in decision making, but all irrelevant costs are not sunk costs.” Explain with examples. (Nov 2012, 4 marks)
Answer:
Sunk Cost:

Sunk costs are costs that have been created by a decision made in the past and that cannot be changed by any decision that will be made in the future.
Example, the written down value of assets previously purchased are sunk cost.
Sunk costs are not relevant for decision making because they are past cost.
But not all irrelevant costs are sunk cost. For example, a comparison of two alternative production methods may result in identical material costs for both the alternatives. In this case, the direct material cost will remain the same whichever alternative in chosen.
In this situation, though direct material cost is the future cost to be incurred in accordance with the production, it is irrelevant, but it is not a sunk cost.
Irrelevant is only with respect to alternatives being considered and not for fund flows whereas for sunk cost there is no further cash flow. Cash flows have already been incurred.

Question 5.
Answer the following question: (Nov 2013, 4 marks)
State the type of cost in the following cases:
(i) Cost associated with the acquisition and conversion of material into finished product.
(ii) Cost arising from a prior decision which cannot be changed in the short run.
(iii) Increase in cost resulting from selection of one alternative instead of another.
(iv) Rent paid for a factory building which is temporarily closed.
Answer:
(i) Product Cost
(ii) Committed Cost
(iii) Differential/Incremental Cost
(iv) Shut Down Cost

Question 6.
Answer the following; (Nov 2014, 4 marks)
Explain the concept of relevancy of cost by citing three examples each of relevant costs and non-relevant costs.
Answer:
Relevant cost are those costs which are affected by a decision. Relevance means pertinent to the decision in hand the expected future cost which are relevant cost.

Example of Relevant Cost:
Material Cost
Labour Cost
Variable Overhead Cost
Example of Non – Relevant Cost:
Past or historical cost (sunk cost)
Purchases price of material cost
Fixed Cost
Book value of equipment.

Question 7.
Answer the following: (Nov 2015, 4 marks)
Proposal A is being evaluated against Proposal B. Fill up column IV of the following table:

Answer:
Analysis of Costs for Evaluation of Proposal A against the proposal B.
Condition under which classification happens

Variable Cost per unit that will not differ between the options Variable Cost has already been incurred in the past.
Fixed Cost that is not committed and differ between the options.
Additional future cost) Differs between alternatives.
Costs already have been incurred and it will not affect any current or future action.

Question 8.
Answer the following question: (May 2017, 4 marks)
Classify the following costs into one or more the following categories Relevant cost, Opportunity cost, Sunk cost, Notional cost and Historical cost.

A company wishes to manufacture ‘Smart’ watches that can be interactive with mobile phones, computers and CCTV systems. It is planning to do research on the compatibility. It has done market survey and is satisfied about the demand being sufficient for making the product profitable. Some facilities can be made available by discontinuing, its existing line of telephone instruments division.
(i) R & D costs indicated above
(ii) Cost -if Market Survey
(iii) The profit of the Telephone Instruments Division
Answer:
A company wishes to manufacture ‘smart’ watches that can be interactive with mobile phone computers and CCTV. It is planning to do research on the compatibility. It has done market survey and is satisfied about the demand being sufficient for making the product profitable. Some facility can be made available by discontinuing its existing line of telephone instruments division. So the classification of R&D costs, cost of Market Survey and the profit of the Telephone Instruments Division are as follows:

Question 9.
Bloom Ltd. makes 3 products A, B and C. The following information is available: (Nov 2008, 12 marks)

Material cost and variable production overheads are the same for the peak-season and off-season. Variable selling overheads are not incurred in the ott-season. Fixed costs amount to ₹ 26,780 for each season, of which ₹ 2,000 is towards salary for special technician, incurred only for product B, and ₹ 4,780 is the amount that will be incurred on after-sales warranty and free maintenance of only product C, to match competition.

Labour force can be interchangeably used for all the products. During peak-season, there is labour shortage and the maximum labour hours available are 1,617 hours. During off-season, labour is freely available, Jut demand is limited to 100 units of A, 115 units of B and 135 units of C, with production facility being limited to 215 units for A, B and C put together.

You are required to:
(i) Advise the company about the best product mix during peak-season for maximum profit.
(ii) What will be the maximum profit for the off-season?
Answer:
Bloom Ltd. Peak Season.
Statement of Contribution and BEP (in units)

Maximum units that can be produced of product C with limited labour hours 1,617
= $\frac{1,617}{7}$ = 231.
Since
231 < Break Even units.
Hence, Bloom Ltd. cannot produce C.
Next rank is of product A
Maximum units of A that can be produced with limited labour hours
= $\frac{1,617}{8}$
= 202 units.
Break Even units of A = 200
∴ Profit if only of A 200

Best strategy is to produce 100 units of product A and 115 units of product B during off-season.
Maximum profit = ₹ 4,375.

Best strategy for peak-season is to produce 202 units of A.
Maximum profit for off-season ₹ 4,375.

Question 10.
Paints Ltd. manufactures 2,00,000 tins of paint at normal capacity. It incurs the following manufacturing costs per unit: (Nov 2008, 6 marks)

Each unit is sold for ₹ 21, with an additional variable selling overhead incurred at ₹ 0.60 per unit.

During the next quarter, only 10,000 units can be produced and sold. Management plans to shut down the plant estimating that the fixed manufacturing cost can be reduced to ₹ 74,000 for the quarter.

When the plant is operating, the fixed overheads are incurred at a uniform rate throughout the year. Additional costs of plant shut down for the quarter are estimated at ₹ 14,000.

You are required:
(i) To advise whether it is more economical to shut down the plant during , the quarter rather than operate the plant.
(ii) Calculate the shut down point for the quarter in terms of numbering units.
Answer:
Contribution per tin = Selling Price – Variable cost
= 21 – (7.8 + 2.1 + 2.5 + 0.6)
= ₹ 8 per tin.
Loss on operation:
Fixed cost per annum = 2,00,000 units × 4 per unit = 8 lakhs.
∴ Fixed cost for 1 quarter = $\frac{8}{4}$ = 2 lakhs

Shut-down point (number of units) = $\frac{\text { Avoidable Fixed Cost }}{\text { Contribution perunit }}$
= $\frac{2,00,000-88,000}{8}$
= $\frac{1,12,000}{8}$ = 14,000 units.

Question 11.
XYZ Ltd, has two divisions, A and B. Division A makes and sells product A, which can be sold outside as well as be used by B. A has a limitation on production capacity, that only 1,200 units can pass through its machining operations in one month. On an average about 10% of the units that A produces are defective. It may be assumed that out of each lot that A supplies, 10% are defectives. (May 2009)

When A sell? in the outside market, the defectives are not returned, since the transportation costs make it uneconomical for the customer. Instead, A’s customers sell the defectives in the outside market at a discount.

But when B buys product A, it has to fix it into its product, which is reputed for its quality. Therefore, B returns all the defective units to A. A can manually rework the defectives, incurring only variable labour cost and sell them outside at ₹ 150 and not having to incur any selling costs on reworked units. If A chooses not to rework, it can only scrap the material at ₹ 30 per unit. B can buy product A from outside at ₹ 200 per unit, but has to incur ₹ 10 per unit as variable transport cost. B can insist to its outside suppliers also that it will accept only good units.

A incurs a variable selling overhead only on units (other than,reworked units) sold outside. The following figures are given for the month:
Variable cost of production – Dept. A (₹/unit) – 120
Variable selling overhead (₹/u) – 20
Selling price per unit in the outside market (₹/u) – 200
Current selling price to B (₹/u) – 190
Additional variable labour cost of reworking defectives (₹/u) – 100
Selling price of reworked detectives (₹/u) – 150
Fixed costs for the month (₹) – 36,000
Maximum demand from B at present (no. of units) – 630
The outside demand can be freely had upto 900 units.

Given the demand and supply conditions, you are required to present appropriate calculations for the following:
(i) Evaluation of the best strategy for A in the present condition.
(ii) If B can buy only upto 540 units and the outside demand is only 600 units, how much should A charge B to maintain the same level of profit as in (i) above? (12 marks)
Answer:
(i) Contribution per unit against sale to outside = ₹ (200 – 120 – 20) = ₹ 60
In case of transfer, good units and rejected units are in proportion of 9 : 1
In case of transfer, contribution per good unit = ₹ (190 – 120) = ₹ 70
In case of transfer, contribution per rejected unit = ₹ (150 – 120 – 100) = – ₹ 70
Thus, effective contribution per unit of transfer = ₹(70 × 0.9 – 70 × 0.1) = ₹ 56
As contribution per unit against outside sale is higher, the best strategy should be to sell maximum number of unit to outside market. ‘
Contribution from outside market from sale of 900 units ₹ (900 × 60) = ₹ 54,000
Contribution from transfer of 300 units to B ₹ (300 × 56) = ₹ 16,800
Total Contribution from best strategy = ₹ 70,800

(ii) If B’s demand is 540 unit, total production required (540/0.9) = 600 units.
Taking outside market demand of 600, it is within production capacity of 1,200 units.
Now contribution from 600 units of outside sale ₹ (600 × 60) = ₹ 36,000
Contribution from rejected 60 units ₹ (60 × – 70) = ₹ (4,200)
= ₹ 31.800
To keep same level of contribution as in (i), the contribution required from transfer of 540 unit to B (₹ 70,800 – 31,800) = ₹ 39,000
Thus, contribution required per unit ₹ 39,000/540 = ₹ 72.22
Hence price to be charged per unit against transfer to B ₹ (120 + 72.22)
= ₹ 192.2

Question 12.
Ret Ltd., a retail store buys computers from Comp Ltd. and sells them in retail. Comp Ltd. pays Ret Ltd. a commission of 10% on the selling price at which Ret sells to the outside market. This commission is paid at the end of the month in which Ret. Ltd. submits a bill for the commission. Ret Ltd. sells the computers to its customers at its store at ? 30,000 per piece. Comp Ltd. has a policy of not taking back computers once despatched from its factory. Comp. Ltd. sells a minimum of 100 computers to its customers. (May 2009, 13 marks)

Comp Ltd. charges prices to Ret Ltd. as follows:
₹ 29,000 per unit, for order quantity 100 units to 140 units.
₹ 26,000 per unit, for the entire order, if the quantity is 141 to 200 units. Ret Ltd. cannot order less than 100 or more than 200 units from Comp Ltd.

Due to the economic recession, Ret Ltd. will be forced to offer as a free gift, a digital camera costing it ₹ 4,500 per piece, which is compatible with the computer. These cameras are sold by another Co., Photo Ltd. only in boxes, where each box contains 50 units. Ret Ltd. can order the cameras only in boxes and these cameras cannot be sold without the computer.

In its own store, Ret Ltd. can sell 110 units of the computer. At another far- off location, Ret Ltd. can sell upto 80 units of the computer (along with its free camera), provided it is willing to spend ₹ 5,000 per unit on shipping costs. In this market also, the selling price that each unit will fetch is ₹ 30,000 per unit.

You are required to:
(i) State what is Ret’s best strategy along with supporting calculations.
(ii) Compute the break-even point in units, considering only the above costs.
Answer:

(i) Upto 110 units, Ret Ltd. will earn a contribution of ₹ 4,000/- per unit
(ii) Between 110 and 140 units, contribution of 4,000 will be wiped out by 5,000 on shipping costs, Hence we should not consider 110-140 range.
(iii) 101 – 110 not to be considered since additional fixed costs 2,25,000 will not be covered by 10 units.
(iv) Valid consideration, 100 units or 141 to 190 units.
Fixed cost of box of 50 cameras is ₹ 2,25,000.

Best strategy buy 150 units from Comp. sell 110 at store and 40 outside.
BEP should be between 151 – 191 units
Extra Camera box cost beyond 150 units = 2,25,000
Less: Profit for 150 units = 1.75.000
Extra profit acquired = 50.000
No. of units to cover this addition costs at contribution 2,000 ₹/u
= $\frac{50,000}{2,000}$ = 25

Question 12.
Lee Electronics manufactures four types of electronic products, A, B, C and D. All these products have a good demand in the market. The following fiqures are given to you: (Nov 2009, 18 marks)

At present, the available production capacity in the company is 4,98,000 machine hours. This capacity is not enough to meet the entire market demand and hence the production manager wants to increase the capacity.

The company wants to retain the customers by meeting their demands through alternative ways. One alternative is to sub-contract a part of its production. The sub-contract offer received is as under.

The company seeks your advice in terms of products and quantities to be produced and/or sub-contracted, so as to achieve the maximum possible profit. You are required to also compute the profit expected from your suggestion.
Answer:

I Decision: It is more profitable to sub-contract B, since contribution is higher subcontract.
1st Level of Operations: 1,50,000 hours, Produce D as much as possible.
Hours required = 30,000 units × 3 = 90,000 hours
Balance hours available: 60,000 hours.
Produce the next best (i.e. A, Since B is better outsourced)
$\frac{60,000 \text { hrs }}{6 \text { hrs/u }}$ = 10,000 units of A
1^st Level of Operation:

2^nd Level of Operation:
Both A and C increase contribution by own manufacture only by ₹ 2/- per unit.
1,50,000 hrs can produce 25,000 units of A.
∴ Contribution increases by 25,000 × 2 = 50,000
(Difference in Contribution sub-contract and own manufacturing) = 2
But increase in fixed Cost = 50,000

At the 2^nd level of operation, the increase in contribution by own manufacturing is exactly set off by increase in fixed costs by ₹ 50,000/-. It is a point of financial indifference, but other conditions like reliability or possibility of the sub-contractor increasing his price may be considered and decision may them but towards own manufacture.

3^rd Level of Operation:
1,50,000 hrs available
Unit of A that are needed = [52,000 – 25,000 (2^nd Level) – 10,000 (1^st Level)]
= 17,000 units × 6 hrs/u = 1,02,000 hrs.
Balance 48,000 hrs are available for C to produce 6,000 units.
Increase in Contribution over Level 1^st or 2^nd:
A : 17,000 × 2 = ₹ 34,000
C : 6,000 × 2 = ₹ 12,00
= ₹ 46,000
Increase in fixed costs = ₹ 50.000
Additional fixed costs = ₹ 4,000

4^th Level of Operation: 1,50,000 hrs can give $\frac{1,50,000}{8}$ = 18,750 unit 0f C.
Increase in Contribution 18,750 × 2 = ₹ 37,500
Increase in Cost = (₹ 50,000)
Level 3^rd loss c/fd = (₹ 4,000)
Level 1^st profit will order by = (₹ 16,500)
Advice: Do not expand capacities; sell maximum

No. of units by operating at 1,50,000 hrs. capacity (level 1^st) and gain ₹ 23,24,000.
Summary.

Question 13.
E Ltd. is engaged in the manufacturing of three products in its factory. The Following budget estimates are prepared for 2009 – 10: (May 2010)

After the finalisation of the above manufacturing schedule, it is observed that presently only 80% capacity being utilised by these three products. The production activities are made at the same platform and it may be interchangeable among products according to requirement. In order to improve the profitability of the company the following three proposals are put for consideration:

(a) Discontinue product A and capacity released may be used for either product B or C or equally shared. The fixed cost of product A is avoidable. Expected changes in material cost and selling price subject to the utilisation of product A’s capacity are as under:
Product B: Material cost increased by 10% and selling price reduced by 2%.
Product C: Material cost increased by 5% and selling price reduced by 5%.

(b) Discontinue product A arid divert the capacity so released and the idle capacity to produce a new product D for meeting export demand whose per unit cost data are as follows:

(c) Product A, B and C are continuously run and hire out the idle capacity fixing a price in such a way that the same rate of profit per direct labour hour is obtained in the original budget estimates.

Required:
(i) Prepare a statement of profitability of products A. B and C in existing situation.
(ii) Evaluate the above proposals independently and calculate the overall profitability of the company under each proposal.
(iii) What proposal should be accepted. if the company wants to maximise its Profit? (10 marks)
Answer:
(i) Budgeted profitability statement under existing situation

(ii) Proposal (a) Alternative use of As Capacity for Product b or C or B C
Equally Hours released for discontinuance of A = 10,000 × 4 = 40,000 hours.

Decision: It is better to produce C
Taking both changes in the selling price and material cost are for the entire
production or the incremental production. Profitability is calculated below:

Proposal (a): Profitability statement if A’s capacity utilized by C

Proposal (b): .
Existing capacity = (4 × 10,000 +6 × 25,000 + 5 × 20000) = 2,90,000 hrs
Then, Idle capacity of 20% = 290000/4 = 72,500 hours
Capacity for product ‘D’ = (idle + A’s spare) capacity = 72,500 + 40,000 = 1,12,500 hours,
No. of units ‘D’ produced = 1,12,500/4 = 28,125 units.
Profitability Statement – proposal (b) –

Proposal (c) HIring Out Idle capacity

Decision on option on the basis of profitability:
(i) If price anc st under proposal (a) is for entire production of C: Proposal (b) of Export
(ii) If price and cost under proposal (a) is for incremental prod C: Proposal (a) – Option 2

Question 14.
X Ltd. supplies spare parts to an air craft company Y Ltd. The production capacity of X Ltd. facilitates production of any one spare part for a particular period of time. The following are the cost and other information for the production of the two different spare parts A and B: (May 2010, 8 marks)

Total hours available: Machine A 4,000 hours
Machine B 4,500 hours
Alloy available is 13,000 kgs. @ ₹ 12.50 per kg.
Variable overheads per machine hours:
Machine A: ₹ 80
Machine B: ₹ 100
You are required to identify the spare part which will optimise contribution at the offered price.

If Y Ltd. reduces target price by 10% and offers ₹ 60 per hour of unutilised machine hour, what will be the total contribution from the spare part identified above?
Answer:
(i) Number of parts to be manufactured:

Question 15.
G Ltd. produces and sells 95,000 units of ‘X’ in a year at its 80% production capacity. The selling price of product is ₹ 8 per unit. The variable cost is 75% of sales price per unit. The fixed cost is ₹ 3,50,000. The company is continuously incurring losses and management plans to shut-down the plant. The fixed cost is expected to be reduced to ₹ 1,30,000. Additional costs of plant shut-down are expected at ₹ 15,000. (Nov 2010, 5 marks)

Should the plant be shut-down ? What is the capacity level of production of shut-down point?
Answer:

A comparison of loss figures indicated as above points out that loss is reduced by (1,60000 – 1,45,000) ₹ 15,000 if plant is shut down.
Shut down point = $\frac{3,50,000-1,45,000}{8-6}$ = $\frac{2,05,000}{2}$ = 1,02,500 units
Capacity level of shut down point:
At 100% level production is $\frac{95,000}{0.80}$ = 1,18,750
Capacity level at shut down = $\frac{1,02,500}{1,18,750}$ =86.31%

Question 16.
E Ltd. manufactures and sells four types of products under the brand names A, B, C and D. On a turnover of ₹ 30 crores in 2009, company earned a profit of 10% before interest and depreciation which are fixed. The details of product mix and other information are as follows: (Nov 2010, 12 marks)

Interest and depreciation amounted to ₹ 225 lakhs and ₹ 115.50 lakhs respectively.

Due to increase in prices in the international market, the company anticipates that the cost of raw materials which are imported will increase by 10% during 2010. The company has been able to secure a license for the import of raw materials of a value of ₹ 1,535 lakhs at 2010 prices. In order to counteract the increase in costs of raw materials, the company is contemplating to revise its product mix. The market survey report indicates that the sales potential of each of the products: ‘A’ ‘B’ and ‘C’ can be increased upto 30% of total sales value of 2009. There was no inventory of finished goods or work in progress in both the year.

You are required to:
Set an optimal product mix for 2010 and find the profitability.
Answer:
(a) Revised P/V ratio and ranking of products:

Maximum Sales Potential
A 30% of ₹ 3,000 = 900
B 30% of ₹ 3,000 = 900
C 30% of ₹ 3,000 = 900
D 40% of ₹ 3,000 =1200
Allocation of raw material whose supply is restricted to ₹ 1,535 lacs in order of raw material profitability.

Balancing figure, hence sales will be restricted to 451** lakhs (297.5/66%)

Balancing figure(Contribution – Profit before Depreciation & Interest)
The increase of contribution of ₹ 85.54 in 2010 will set off loss of ₹ 40.50 lakhs and result in profit of ₹ 45.04 lakhs.

Question 17.
Attempt: (Nov 2010, 4 marks)
(a) The following information is given by Z Ltd:
Margin of safety – ₹ 1,87,500
Total cost – ₹ 1,93, 750
Margin of safety – 7,500 units
Break-even sales – 2,500 units
Required:
Calculate Profit, P/V Ratio, BEP Sales (in ₹) and Fixed Cost.
Answer:
Margin of Safety(%) = MoS Units/Actual Sales Units
= 7,500/(7,500 + 2,500) = 75%
Total Sales = 1,87,500/0.75 = ₹ 2,50,000/-
Profit = Total sales – Total Cost
= 2,50,000 – 1,93,750 = ₹ 56,250
P/V Ratio = Profit/MoS (₹) × 100
= 56,250/1,87,500 × 100 = 30%
BEP Sales = Total Sales/(100- MS)
= 2,50,000 × 0.25 = ₹ 62,500
Fixed Cost = Sales × P/V Ratio- Profit
= 2,50,000 × 0.30 – 56,250 = 18,750

Alternate Answer:
Margin of Safety = Selling Price per unit × (7500 units)
₹ 1,87,500 = Selling Price per unit × (7500 units)
Therefore,
Selling Price per unit = 1,87,500/7,500 = ₹ 25

Question 18.
A company has two divisions: Division A and Division B. Both divisions ot the company manufacture the same product but located at two different places. The annual output of division A is 6,000 tons (at 80% capacity) and that of division B is 7,500 tons (at 60% capacity). The basic raw material required for production is available locally at both the places, but at division A, it is limited to 4,000 tons per annum at the rate of ₹ 100 per ton, at division B, it is limited to 8,000 tons per annum at the rate of ₹110 per ton. Any additional requirement of material will have to be purchased at a rate of ₹ 125 per ton from other markets at either of division. Variable costs per ton at each division remain constant. For every 1,000 tons of output, 800 tons raw material is required. The details of other costs of the divisions are as follows: (Nov 2010, 12 marks)

Required:
(i) Calculate variable cost per ton for each division’s product and decide ranking in order of preference.
(ii) The company desires to fully utilize the available local supplies of raw material to save the overall variable cost of production; keeping the total production of both the divisions putting together is the same as at present level. Calculate the quantity of production (output) that could be transferred between the two divisions and overall saving in variable cost.
(iii) After considering the option (ii), how the balance capacity should be
utilized if company is working at 100% capacity, and also calculate selling price per ton if company mark up 10% on full cost of each division’s product.
Answer:
Variable cost per ton in different alternatives

Maximum production at both division 6,000 + 7,500 = 13,500 tons

Transfer from Division A to Division B 1000 tons output wiN save in variable cost ₹ 27,92,000 – 27,78,000 = 14,000.

At 100% capacity the production is

Question 19.
Pick out from each of the following items, costs that can be classified under ‘committed fixed costs’ or ‘discretionary fixed costs’. (May 2011, 5 marks)
(i) Annual increase of salary and wags of administrative staff by 5% as per agreement.
(ii) New advertisement for existing products is recommended by the Marketing Department for achieving sales quantities that were budgeted for at the beginning of the year.
(iii) Rents paid for the factory premises for the past 6 months and the rents payable for the next six months. Production is going on in the factory.
(iv) Research costs on a product that has reached ‘maturity’ phase in its life cycle and the research costs which may be needed on introducing a cheaper substitute into the market for facing competition.
(v) Legal consultancy fees payable for patent rights on a new product. Patenting rights have been applied for.
Answer:
Committed Fixed Cost
(i) Salary and wage increase
(iii) Rents payable for the next 6 months
(v) Legal fees for filing for patent rights.

Discretionary Fixed Cost
(ii) New Advertisement Cost
(iv) Research cost for substitutes

Question 20.
A company can make any one of the 3 products X, Y or Z in a year. It can exercise its option only at the beginning of each year. Relevant information about the products for the next year is given below: (May 2011, 3 marks)

You are required to compute the opportunity costs for each of the products.
Answer:

Question 21.
Maruthi Agencies has received an order from a valuable client for supplying 3,00,000 pieces of a component at ₹ 550 per unit at a uniform rate of 25000 units a month. (May 2011, 6 marks)

Variable manufacturing costs amount to ₹ 404.70 per unit, of which direct materials is ₹ 355 per unit. Fixed production overheads amount to ₹ 30 lacs per annum, excluding depreciation. There is a penalty/reward clause of ₹ 30 per unit for supplying less/more than 25000 units per month. To adhere to the schedule of supply, the company procured a machine worth ₹ 14.20 lacs which will wear out by the end of the year and will fetch ₹ 3.55 lakhs at the year end.

After this supply of machine, the supplier offers another advanced machine which will cost ₹ 10.65 lakhs, will wear out by the year end and not have any resale value. If the advanced machine is purchased immediately, the purchaser will exchange the earlier machine supplied at the price of the new machine. Fixed costs of maintaining the advanced machine will increase by ₹ 14,200/-per month for the whole year. While the old machine had the capacity to complete the production in 1 year, the new machine can complete the entire job in 10 months. The new machine will have material wastage of 0.5%. Assume uniform production throughout the year for both the machines.

Using incremental cost/revenue approach, decide whether the company should opt for the advanced version.
Answer:

Decision: Buy the advanced version.
Working Note:
1^st machine 25,000 per month, no penalty, no reward
New machine: $\frac{3,00,000}{10}$ = 30,000 per months
advance supply per month = 5,000
= 5,000 × 10 months = 50,000 units reward.

Question 22.
Entertain U Ltd. hires an air-conditioned theatre to stage plays on weekend evenings. One play is staged per evening. The following are the seating arrangements: (May 2011, 11 marks)

VIP rows – the first 3 rows of 30 seats per row, priced at ₹ 320 per seat.
Middle level – the next 18 rows of 20 seats per row, priced at ₹ 220 per seat.
Last level – 6 rows of 30 seats per row, priced at ₹ 120 per seat.

For each evening, a drama troupe has to be hired at ₹ 71,000, rent has to be paid for the theater at ₹ 14,000 per evening and air conditioning and other stage arrangement charges work out to ₹ 7,400 per evening. Every time a play is staged, the drama troupe’s friends and guests occupy the first row of the VIP class, free of charge, by virtue of passes granted to these guests. The troupe ensures that 50% of the remaining seats of the VIP class and 50% of the seats of the other two classes are sold to outsiders in advance and the money is passed on to Entertain U.

The troupe also finds for every evening, a sponsor who puts up his advertisement banner near the stage and pays Entertain U a sum of ₹ 9,000 per evening. Entertain U supplies snacks during the interval, free of charge to all the guests in the hall, including the VIP free guests. The snacks cost Entertain U ₹ 20 per person. Entertain U sells the remaining tickets and observes that for every one seat dertianded from the last level, there are 3 seats demanded from the middle level and 1 seat demanded from the VIP level. You may assume that in case any level is filled, the visitor buys the next higher or lower level, subject to availability.

(i) You are required to calculate the number of seats that Entertain U has to sell in order to break-even and give the category wise total seat occupancy at BEP.
(ii) Instead of the given pattern of demand, if Entertain U finds that the demand for VIP, Middle and Last level is in the ratio 2:2:5, how many seats in each category will Entertain U have to sell in order to break-even?
Answer:
(i) When demand in ratio 1 : 3 : 1

Weighted average contribution per seat as per std.
demand pattern = $\frac{1,000}{5}$ = ₹ 200

(ii) When demand in ratio 2 : 2 : 5

Weighted average contribution per seat as per demand pattern $\frac{1,500}{9}$ = ₹ 166.66
Number of Seats of BEP = $\frac{₹ 30,000}{166.67}$ = 180 seats

Question 23.
New Ltd. plans to completely manufacture a single product Z, whose selling price and variable manufacturing costs will be ₹ 100 per unit and ₹ 80 per unit respectively. If the complete production is done at its own factory, fixed machining costs will be ₹ 3,62,000 and fixed administration and selling overheads will be ₹ 30,000 for the production period. (Nov 2011, 5 marks)

Alternatively, the product can be finished outside by sub contracting the machining operations at ₹ 10 per unit, but this will entail an increase in the fixed administration overheads by ₹ 1,20,000, while fully avoiding the machining cost of ₹ 3,62,000.

Based on the above figures and assuming a production capacity of 30,000 units for the production period, advise with relevant supporting figures, from a financial perspective, for what volumes of market demand will:
(i) a manufacture be recommended at all?
(ii) a fully in-house production be recommended?
(iii) the sub contracting option be recommended?
Answer:

Point of Indifference = level of production where both options will have same outcome.
It can be calculated as:
Difference in Fixed cost = ₹ (3,92,000 – 1,50,000) = ₹ 2,42,000
Difference in contribution per unit = ₹ (20 – 10) = ₹ 10
Point of indifference = Diff. in FC/Diff in Contribution = 2,42,000/10 = 24,200 units
(i) If Market demand is above 15,000: manufacture is recommended
(ii) For Demand 24201 to 30000 units: Manufacture fully in-house.
(iii) For Demand 15000 to 24200 units: Sub-contract

Question 24.
Pigments Ltd. is a chemical factory producing joint products J, K and L at a joint cost of production of ₹ 9,60,000. The sales are: (Nov 2011, 5 marks)
J ₹ 60,000 units at ₹ 5 per unit,
K ₹ 20,000 units at ₹ 20 per unit and
L ₹ 40,000 units at ₹ 10 per unit.
The company seeks your advice regarding the following options available:- Option I: After the joint process, all of L can be further.processed to make 36,000 units of M, at an additional processing cost of ₹ 1,80,000 and M can be sold at ₹ 18 per unit.

Option II: The facilities used to convert L to M may be used to make 7,000 units of an additional product A, with a different raw material input. A can be made at an additional variable manufacturing cost of ₹ 12 per unit and will fetch ₹ 30 as the selling price, but the company will have to offer one unit of J as a free gift for each unit of A sold.
Evaluate the proposals using the ncremental cost approach.
Answer:

Question 25.
Quickcomp is a successful version of a software package that is widely used. Fastercomp is the next version, for which the development is complete and it is ready to be sold immediately in the market as budgeted. However, for Fastercomp, user manuals training modules and diskettes have not yet been made, whereas, for the Quickcomp version, these are overstocked by 5,000 units. Release of Fastercomp will render the Quickcomp version not saleable. The following information is provided: (Nov 2011, 6 marks)

From a purely financial perspective, the company wants your advice whether to delay the release of the new version by 2 months by when the inventory of the existing version would have sold out or to release the new version immediately. Support your advice with relevant figures.
Answer:

Question 26.
A company has decided to launch a new product X which is expected to have a demand of 10,000 units during the year at ₹ 160 per unit. The following information is furnished by the company: (May 2012, 5 marks)
(i) Material — The manufacture of one unit of X requires one unit of each of materials A, B and C.

(ii) Direct labour
Skilled labour is paid at ₹ 80 per hour. It takes 0.25 hours/unit. Skilled labour has to be drawn from another production line which has a contribution of ₹ 240 per unit, with each unit requiring 2 hours of skilled labour.
Unskilled labour — 2 hours/unit @ ₹ 56 per hour. There is abundant unskilled labour in the factory, but according to an agreement with the labour union, no unskilled worker can be retrenched.

(iii) Variable overhead – ₹ 10 per unit.
(iv) Fixed Costs – no increase.
Using relevant cost approach, you are required to find out the average variable cost per unit of X.
Answer:
Average Variable Cost per unit of X

Question 27.
XY Ltd. makes two products X and Y, whose respective fixed costs are F₁ and F₂. You are given that the unit contribution of Y is one fifth less than the unit contribution of X, that the total of F₁ and F₂ is ₹ 1,50,000, that the BEP of X is 1,800 units (for BEP of X, F₂ is not considered) and that 3,000 units is the indifference point between X and Y. (i.e. X and Y make equal profits at 3,000 unit volume, considering their respective fixed costs). There is no inventory build up as whatever is produced is sold.
You are required to find out the values of F₁ and F₂ and unit contributions of X and Y. (May 2012, 5 marks)
Answer:
Let C_x be the Contribution per unit of Product X.
So, Contribution per unit of Product Y = C_y = 4/5C_x = 0.8C_x
Given F₁ + F₂ = 1,50,000,
F₁= 1,800C_x (Break even volume x contribution per unit)
∴ F₂ = 1,50,000 – 1,800C_x.
3,000C_x – F₁ = 3,000 x 0.8C_x – F₂ or 3,000C_x – F₁ = 2,400 C_x – F₂ (Indifference point) .
i.e., 3,000C_x – 1,800C_x = 2,400C_x – 1,50,000 + 1,800 C_x
i.e., 3,000C_x = 1,50,000, Therefore C_x = ₹ 50/- (1,50,000 / 3,000)
∴ Contribution per unit of X = ₹ 50
Fixed Cost of X = F, = ₹ 90,000 (1,800 × 50)
∴ Contribution per unit of Y is ₹ 50 × 0.8 = ₹ 40 and Fixed cost of Y = F2 = ₹ 60,000 (1,50,000 – 90,000)
The value of F₁ = ₹ 90,000, F₂ = ₹ 60,000 and X = ₹ 50 and Y = ₹ 40

Question 28.
A company is operating at 60% of its capacity with a turnover of ? 43.20 lacs. If the company works at 100% capacity, the sales-cost relation is: (May 2012, 8 marks)
Factory cost is two thirds of sales value. Prime cost is 75% of factory cost Administration and selling expenses (75% variable) are 20% of the sales value. Factory overhead will vary according to operating capacity as given below:

The company has planned to operate at 80% of its capacity. Moreover, it has received an export order and its execution will involve 40% of the capacity. The prime cost of the order is estimated at ₹ 6.0 lacs and the shipping involved will be around ₹ 1.0 lac. Administration and selling expenses will be avoided on the export order. Taking the same percentage of profits as on the domestic sales, determine the minimum price to be quoted for the export order.
Answer:

Question 29.
Ezee Ltd makes two products, E and Z. All units produced are sold. There is no inventory build up. Production facilities may be used interchangeably for both the products. Sales units are the limiting factor. The following information is given: (May 2012, 8 marks)

For increase in quantities above 4,000 units for each product, there will be an increase in variable selling costs, (for the increased portion only), thereby reducing the contribution per unit to the following figures:

(i) For the present level, find the break-even point with the present product mix.
(ii) What is the minimum number of incremental units to be sold to recover the additional fixed cost of ₹ 47,500 to be incurred? (Present product mix need not be maintained):
(iii) If you are allowed to choose the best product mix for the incremental level, (while taking the present mix given in the first table above for the present level), what would be the individual product quantities and the corresponding total contributions, the total average contribution per unit and the total profits for the complete production?
Answer:
(i) Present Level:
Weighted average contribution per unit
(3,000 × 25 + 2,000 × 20)1(3,000 + 2,000) Or, (3 × 25 + 2 × 20)/(2 + 3)
= 23 ₹ /unit.
BEP = Present level Fixed cost/ weighted average Contribution per unit
= 46,000/23 = 2000 units,
or (E 1200 units and Z 800 units)

(ii) Minimum units for incremental level:
next 1,000 units of E get contribution of 25 × 1000 = 25,000
next 1,000 units of E or Z get 20/unit as Contribution = 20,000
next 125 units of E or Z get 20/unit as Contribution = 2,500
Total 2,125 units are the minimum requirement for 47,500
Incremental fixed cost
Minimum units required:
E = 2,000
Z = 125
Total = 2,125
Or
E = 1,000
Z = 1,125
Total = 2,125

(iii) Optimal profit – best mix :

Question 30.
A machine manufacturing company needs four components A, B, C and D. The components may be procured from outside. The cost, market price for the components and other information are given below: (May 2012, 8 marks)

There are constraints on the machine time in manufacturing all the components. Total machine hours available is only 12,000 hours.
It is possible to use the machine time in a second shift which will attract 20% extra wages and other fixed overheads at ₹ 6,000 for every 1,000 hours or part thereof.
With relevant supporting figures, advise the best course of action to maximize the profits.
(Note / Students need not work out the complete profitability statement).
Answer:

Hours required in 2nd Shift is 3250 hours / 1625 units of A
Contribution per unit for Product A in second shift
₹ 40 – ₹ 12 = ₹ 28 (Direct wages will go up by ₹ 12)
For every 1000 hours in second shift the Contribution from A would be ₹ 14,000 i.e., 1,000/2 × 28
The increase in Fixed Cost is ₹ 6,000. After 3,000 hours the Contribution will be only ₹ 250/2 × 28 i.e. ₹ 3,500, whereas the increase in fixed cost will be ₹ 6,000.
Hence, it is not advantageous to go beyond 3,000 hours in the second shift.

Best Course of action is:
(i) Purchase D from outside: 3,000 units.
(ii) Make B and C fully in-house in the normal shift, B:3,500 units, C:2,000 units.
(iii) Make and buy A as follows:
Normal shift: – 1,375 units
2nd shift: – 1,500 units
Purchase: – 125 units

Question 31.
PQR Ltd is considering introducing a new product at a price of ₹ 105 per unit. PQR Ltd’s controller has compiled the following incremental cost information based on an estimate of 1,20,000 units of sales annually for the new product: (May 2012, 8 marks)
Direct material cost – ₹ 36,00,000
Direct Labour cost – ₹ 24,00,000
Flexible manufacturing support – ₹ 12,00,000
Sales commission – 10% of sales
Capacity-related cost – ₹ 20,00,000
The average inventory levels for the new product are estimated as follows:
Raw materials : 2 months’ production
Work-in-progress (100% complete for Materials and 50% complete for labour and Flexible manufacturing support) : 1 month production Finished goods : 2 months’ production

Annual inventory carrying costs not included in the flexible manufacturing support listed earlier are estimated to be 12% of inventory value. In addition, the sales manager expects the introduction of new product to result in a reduction in sales of existing produpt from 3,00,000 to 2,40,000 units. The contribution margin for the existing product is ₹ 20 per unit.

Prepare a statement showing the budgeted impact on PQR’s profits on the introduction of the new product. Should the new product be introduced?
Answer:

Question 32.
If Moonlite Limited operates its plant at normal capacity it produces 2,00,000 units from the plant ‘Meghdoot’. The unit cost of manufacturing at normal capacity is as under: (Nov 2012, 5 marks)

Direct labour cost represents the compensation to highly-skilled workers, who are permanent employees of the company. The company cannot afford to lose them. One labour hour is required to complete one unit of the product.

The company sells its product for ₹ 200 per unit with variable selling expenses of ₹ 16 per unit. The company estimates that due to economic down turn, it will not be able to operate the plant at the normal capacity, at least during the next year. It is evaluating the feasibility of shutting down the plant temporarily for one year.

If it shuts down the plant, the fixed manufacturing overhead will be reduced to ₹ 1,25,000. The overhead costs are incurred at a uniform rate throughout the year. It is also estimated that the additional cost of shutting down will be ₹ 50,000 and the cost of re-opening will be ₹ 1,00,000.

Required:
Calculate the minimum level of production at which it will be economically beneficial to continue to operate the plant next year if 50% of the labour hours can be utilized in another activity, which is expected to contribute at the rate of ₹ 40 per labour hour. The additional activity will relate to a job which will be off¬loaded by a sister company only if the company decides to shut down the plant.
(Assume that the cost structure will remain unchanged next year. Ignore income tax and time value of money.)
Answer:
Contribution per unit

*[2,00,000 units × ₹ 7]
Indifference Point: ₹ 51,25,000/₹ 86 = 59,593 units
Minimum level of production to justify continuation = 59,594 units

Question 33.
A process industry unit manufactures three joint products: A, B and C. C has no realisable value unless it undergoes further processing after the point of separation. The cost details of C are as follows: (May 2013, 5 marks)

C can be sold at ? 37 per unit and no more.
(i) Would you recommend production of C?
(ii) Would your recommendation be different if A, B and C are not joint products?
Answer:
(i)

Cost incurred on Product ‘C’ upto point of separation is irrelevant for decision making as Product ‘C’ is a Joint Product. Joint Products are the result of same raw material and same process Operations.
Cost incurred after point of separation will be considered for decision making as specifically incurred for Product ‘C’.
Calculation of further processing cost:

Conclusion: Therefore, further processing of Product ‘C’ is recommended.

So further processing Product ‘C’ will contribute ₹ 17 per unit toward’ Joint Production Cost’.

(ii) If Product ‘C is not a joint product with same cost structure. In this case there will be negative contribution on production of Product ‘C’. The calculation is as follows:

Therefore, production of Product ‘C’ will not be recommended.

Question 34.
X Ltd. wants to replace one of its old machines. Three alternative machines namely M₁, M₂ and M₃ are under its consideration. The costs associated with these machines are as under: (May 2013, 5 marks)

You are required to compute the cost indifference points for these alternatives. Based on these points suggest a most economical alternative machine to replace the old one when the expected level of annual production is 1200 units.
Answer:
CalculatIon of Cost Indifference Points for three alternatives

From the above calculation, it is clear that at activity level below the indifference point the alternative (machine) with lower fixed cost and higher variable costs should be used.
If the activity level exceeds the indifference point, a machine with lower variable cost per unit (or higher contribution per unit) and higher fixed cost, is more profitable to operate.
At the activity level equal to the indifference point both machines are on equal footing. Hence from the above we conclude as follows:

. When the expected level of activity is 1.200 units i.e. more than 1,000 units, Machine M₁ should be used.

Question 35.
Better and Best Ltd. manufacture only one product. Production is regular throughout the year and the capacity of the factory is 150,000 units per annum. The summarized Profit and Loss Account for the year ended 31^st December is being reviewed by the Board of Directors. (May 2013, 12 marks)

(i) The Production Director proposed to reduce selling price to ₹ 9 in order to utilize full capacity.
(ii) The Sales Director proposed to increase selling price by 20 per-cent. By spending ₹ 2,25,000 on advertisement, sales will be increased to
1,20,000 units per annum.

(iii) The Personnel Director pleaded for a change in the method of wage payment. For the present piece rate of ₹ 1.50 per unit, a bonus scheme (for each 2% increase in production over the target, there would be an increase of 1% in the basic wage of each employee) will be implemented. A target of 2,000 units per week for the company will be set for 50 week year. Selling price increase by 10%. With an additional advertisement cost of ₹ 1,60,000, 20% increase in present sales will be achieved.

(iv) The Chairman felt that the packaging of the product required improvement. He wanted to know the sales required to earn a target profit of 10% on turnover with the introduction of an improved packing at an additional cost of 20 paise per unit (no change in selling price).
You are required to evaluate individually the proposals of each of the board member and give your recommendation.
Answer:
(i) Workings Note:
Full Capacity: ₹ 1,50,000 units p.a.
Current Capacity: ₹ 1,00,000 units p.a. which is equals to 66.67% of full capacity.
Existing Situation

Proposal (i) When selling Price is reduced to ₹ 9, Capacity Utilization 100%

Proposal (ii): When Selling Price is lo be increased by 20%, Additional Advertising Cost ₹ 2,25,000, Sales Volume 1,20,000 units per annum.

Proposal (iii): When Selling Price is to be increased by 10%, Additional Advertising Cost ₹ 1.60,000, 20% Increase in Present Sales and Bonus Scheme (for each 2% increase in production over the target, there would be an increase of 1% in the basic wages of each employee)

Working Note:
Present Labour Rate = ₹ 1.50 per unit
Target Production Volume = 2,000 units × 50 weeks = 1,00,000 units
Production above the target volume = 1,20,000 units – 1,00,000 units = 20,000 units or 20% of Target Production Volume Bonus (for each 2% increase in production over the target, there would be
an increase of 1% in the basic wages of each employee) = $\frac{1 \%}{2 \%}$ × 20%
= 10% increase in basic wages.
It means wages would be ₹ 1.65 (₹ 1.50 × 1.10) per unit.

Proposal (iv): When -Target Profit 10% on Turnover, Additional Packing Cost 0.20 paise per unit. No-Change in Selling Price, Sales Volume.
Let the sales volumes be K units

Profit equals to 10% of Turnover, It means:
→ 5K – 4,80000 = 10% of 10K
→ 4K = 4,80000
→ K = 1,20,000 units
Turnover = 1,20,000 units × ₹ 10
= 12,00,000
Profit = 10% of ₹ 12,00,000
= ₹ 1,20,000

Company should accept Proposai (ii).

Question 36.
A company has to decide whether to accept a special order or not for a certain product M in respect of which the following information is given: (Nov 2013, 5 marks)

Considering relevant costs, find out the minimum value above which the company may accept the order.
Answer:

Question 37.
A company can produce any of its 4 products, A, B, C and D. Only one product can be produced in a production period and this has to be determined at the beginning of the production run. The production capacity is 1000 hours. Whatever is produced has to be sold and there is no inventory buildup to be considered beyond the production period. Th following information is given: (Nov 2013, 5 marks)

What are the opportunity costs of A, B, C and D?
Answer:
Statement Showing Calculation of Opportunity Cost:

(*) Opportunity cost is the maximum possible contribution foregone by not producing alternative products i.e. if product A is produced then opportunity cost will be maximum of possible contribution from product B, C and D i.e. ₹ 32,000. Same is for Product B and D. In case of product C opportunity cost will be the maximum of possible contribution from product A, B and D i.e. ₹ 20,000.

Question 38.
Flyway Ltd. has hired an aircraft to specially operate between cities A and B. All the seats are economy class. (Nov 2013, 12 marks)
The following information is available:
Seating capacity of the aircraft : 260 passengers
Average number of passengers per flight : 240 passengers
Average one-way fare from A to B : ₹ 5,000 per passenger
Fuel costs per flight from A to B : ₹ 90,000
Food cost (A to B sector)(no charge to passenger) : ₹ 300 per passenger
Commission to travel agents (All tickets are through agents) : 10% of the fare
Annual lease costs allocated to each flight : ₹ 2,00,000
Ground services, baggage handling/checking in service costs per flight A to B : ₹ 40,000
Flight crew salaries per flight A to B : ₹ 48,000

There is an offer from another airlines operator, Haltgo Ltd. for a stop-over at destination D, which is on the way from A to B. Due to this, the flight will operate from A to D, then from D to B.

The following terms are considered for the stop-over:
50 seats from D to B will be booked by Haltgo at ₹ 2,700 per ticket, whether or not Haltgo is able to sell them to its customers. No agents’ commission is payable on these tickets. However, Snacks must be provided to these passengers also by Flyway Ltd. at no further charge to Haltgo or the passengers.

A maximum of 60 tickets can be sold by Flyway’s travel agents for the A to D sector at a fare of ₹ 3,000 per passenger.

Since the stop-over wastes more time, 25 of Flyway’s original passengers in the A to B sector will voluntarily drop out in favour of other airlines offering direct flights between A and B.

Due to the stop-over, fuel costs will increase from ₹ 90,000 to ₹ 1,35,000. Additional airport landing/baggage handling charges of ₹ 19,000 per stop-over will have to be incurred by Flyway Ltd.

Flyway Ltd. will have to serve snacks to all the passengers in the D to B sector at no charge to passengers. Each snack will cost Flyway ₹ 200. This will be in addition to the original food at ₹ 300 served in the A to D sector.

You may assume that fuel costs are not affected by the actual number of passengers in the flight, ignore non- financial considerations, additional wear and tear to aircraft due to extra landing/take-off.
Without considering Haltgo’s offer,
(i) What is the profit earned by Flyway Ltd. per flight from A to B?
(ii) What is the Break-even number of passengers for each flight from A to B? Considering the effects of Haltgo’s offer,
(iii) Evaluate whether Flyway should accept the offer.
(A detailed profitability statement is not essential. Only figures relevant for the cost-revenue analysis are required.)
Answer:
Statement Showing Allocation of Seats in the Aircraft .

Existing Situation Profit per Flight

(a) Break – even Number of Passengers = $\frac{\text { Total FixedCostperFlight }}{\text { Contribution perPassenger }}$

Proposed Situation
Contribution per Passenger (A to D)

Statement Showing Additional Revenue I Expenditure from Haltgo Ltd.’s Offer

(*) 240 Seats (existing) Less 210 Seats (proposed)
(#) All the passengers booked for destination A to D are also served food free of cost.
Flyway Ltd. will gain ₹ 13,000 (₹ 2,55,000 – ₹ 2,42,000) per flight if it accepts Haltgo’s offer.
Decision: Accept Haltgo’s offer.

Question 39.
PQR Ltd., a manufacturer of tool kits has just completed XY’s domestic order of 100 kits at a price of ₹ 1650 per kit. The details of cost for XY’s order are: (May 2014, 5 marks)

The company wishes to evaluate a special export order from Expo Ltd. of similar 300 kits at ₹ 1,600 per kit. For the export order, special packing has to be done at ₹ 20 per kit. An additional fixed inspection cost specific to this export order has to be incurred. The allocation of fixed overheads will be revised to increase by ₹ 25,000. Tools and Consumables above include special purpose tools costing ₹ 10,000 incurred for XY’s order and these can be reused for the export order and the remaining portion is variable. PQR Ltd. wishes to accept the export order at 10% profit on the selling price.

What should be the maximum amount that can be incurred as inspection cost for making such an acceptance possible?

If Expo Ltd. offers to take the products without inspection, what is the maximum discount (as a percentage of the existing export price) that PQR Ltd. can offer to retain its 10% profit on the revised selling price?
(Round off calculations to two decimal places.)
Answer:
Evaluation of Export Order:

Revised Selling Price = $\frac{1,400}{0.90}$ = 1,555.56
Discount = 1,600 – 1,555.55 = 44.45
Percentage of Discount is = $\frac{44.45}{₹ 1,600}$ × 100
= 2.78%
Hence, Maximum Discount of 2.78% can be offered to retain 10% of profit.

Question 40.
A company processes different products from a certain raw material. The raw material is processed in process I (where normal loss is 10% of input) to give products A and B in the ratio 3 : 2. B is sold directly. A is processed further in process II (where normal loss is 12.5% of output) to give products C and D in the ratio 5 : 3. At this point C and D have sale values ₹ 55 and ₹ 40 per kg respectively. C can be processed further in process IIIl with processing cost ₹ 3,95,600 and normal wastage 5% of input and then be sold at 66 per kg. D can be processed further in process IV with processing cost ₹ 3,82,500 and normal wastage 12.5% of output and then be sold at ₹ 55 per kg. The normal wastage of each process. has no realizable value. During the production period, 2,00,000 kgs of raw material is to be introduced into Process I.

Using incremental cost-revenue approach, advise whether sale at split-oft or further processing is better for each of the products C and D. (May 2014, 5 marks)
Answer:
Statement Showing Decision on Sale at – Split-off Point or After Further Processing

Decision:
C: It is advisable to go for further process and then sell product a because it gives more profitable result and the product revenue can be increased by 66,400.
D: It is advisable to sell directly rather than go for further process for more beneficial results of the product.

Question 41.
AXE Ltd. manufactures four products A, B, C and D. The following details are available for a production period: (May 2014, 10 marks)

Production facilities can be interchangeably used among the products. Labour availability in the assembly department Is limited to 2,20,000 hours for the production period. A local firm has offered to make any quantity of any of the products on a sub-contract basis at the following rates:

(i) Advise the management on how many units of each product are to be manufactured or subcontracted to fulfill maximum market demand. What would be the corresponding profits?
(ii) What is the minimum number of units to be produced to achieve break- even point?
(iii) What would you advise as the best strategy to maximize profits if assembly labour is not a limiting factor and if there is no compulsion to fulfill market demand?
(Only relevant figures need to be discussed. A detailed profitability statement is not required).
Answer:
(i) Assembly Labour is a Limiting Factor and to fulfill Maximum Market
Demand:
Computation of Contribution per unit and Contribution per assembly hour

It Is more profitable to sub-contract C, Since contribution is higher in sub -contracting, So it is profitable to sub – contract it.
Allocation of Assembly Hours on the basis of ranking
Produce A as much as possible = 40,000 units
Hours Required = 60,000 tirs (40,000 units × 1.5 hrs.)
Balance Hours Available = 160,000 hrs (2.20,000 hrs. – 60,000 hrs.)
Produce the Next Best = 30,000 units of D
Hours Required = 60,000 hrs (30,000 units × 2 hrs.)
Balance Hours Available = 1,00,000 hrs (1.60,000 hrs. e 60,000 hrs.)
Produce the Next Best = 50.000 UnIts of B $\left(\frac{1,00,000 \mathrm{hrs}}{2 \mathrm{hrs} / \mathrm{u}}\right)$

Computation of Profit on the basis of ranking

Decision:
AXE Ltd. can save fixed cost of ₹ 4,07,000 (₹ 12,50,000 – ₹ 8,43,000) if it keeps its production limited to 1,00,000 units. Whereas in this case AXE Ltd. has to subcontract 20,000 units of B to fulfill maximum market demand. Contribution Lost from subcontracting of 20,000 units, is amounting to ₹ 20,000 [20,000 units × (₹ 15 – ₹ 14)). Therefore optimum profit would be ₹ 22,97,000 [₹ 19,10,000 + ₹ 4,07,000 – ₹ 20,000].

Statement Showing Comparison between Production and Sub Contract units) and Profit

(ii) Break Even Point:
Statement Showing Recovery of Fixed Cost

Minimum number of units to be produced to achieve break-even point:
Product D = 30,000 units
Product A = 3,000 units
Accordingly, earliest BEP at 33,000 units

(iii) Assembly Labour is Not a Limiting Factor therefore Requirement to
Fulfill Maximum Market Demand:
Statement Showing Comparison of Contribution per unit
(Make Vs Sub-Contracting) .

Decision:
From the aforesaid analysis table it can be seen manufacturing of product A, B and D gives higher contribution per unit as compared to sub-contracting. So, AXE Ltd. should manufacture the entire quantity of product A, B and D and Subcontract the production of product C. However AXE Ltd. can save fixed cost of ₹ 4,07,000 (₹ 12,50,000 – ₹ 8,43,000) by limiting its production level to 1,00,000 units only. lñ this case AXE Ltd. will make 30,000 units, 40,000 units and 30,000. units of product D, A and B respectively. Whereas in this case AXE Ltd. has to subcontract 25,000 units of B to earn maximum profit.

Comparison between Production and Sub Contribution (units) and Profit – Best Strategy

Question 42.
RST Ltd. has provided the following summarized results for two years: (May 2014, 10 marks)

During the year ended 31 -3-2014 sale price has increased by 15% whereas material and overhead prices have increased by 15% and 5% respectively. You are required to analyse the variances of revenue and each element of cost over the year in order to bring out the reasons for time change in profit. Present a profit reconciliation statement starting from profits in 2012-13 showing the factors responsible for the change in profits in 2013-14.
Answer:
Statement Showing Reconciliation Between Budgeted Profit (F. Y. 2012 – 13] and Actual Profit [F. Y. 2013 – 14]

Computation of Variances ( In Lacs):
Sales Variances:
Price Variance = Actual Sales – Standard Sales
= ₹ 3,277.50 – ₹ 2,850.00
= ₹ 427.50 (F)
Volume Variance = Standard Sales – Budgeted Sales
= ₹ 2,850.00 – ₹ 3,000.00
= 150(A)
Sales Margin Variances
Sales Margin Price Variance = Sales Price Variance
= ₹ 427.50(F)
Sales Margin Volume Variance = Sales Volume Variance × Budgeted Net Profit Ratio
= ₹ 150(A) × $\left(\frac{₹ 200}{₹ 3,000}\right)$
= ₹ 10(A)
Material Variances
Material Price Variance = Standard Cost of Actual Quantity – Actual Cost
= ₹ 2,050.00 – ₹ 2,357.50
= ₹ 307.50 (A)
Material Usage Variance = Standard Cost of Standard Quantity for Actual Output – Standard Cost of Actual Quantity
= ₹ 1,900 – ₹ 2,050
= ₹ 150(A)

Variable Overhead Variances
Expenditure Variance = Budgeted Variable Overheads for Actual Hours – Actual Variable Overheads
Or
= Std. Rate per unit × Expected Output for Actual Hours Worked – Actual Variable Overheads
= ₹ 500 – ₹ 525
= ₹ 25(A)
Efficiency Variances = Standard Variable Overheads for Production – Budgeted Variable Overheads for Actual Hours
Or
= Std. Rate per unit × Actual Output – Std. Rate per unit × Expected Output for Actual Hours Worked
= ₹ 475 – ₹ 500
= ₹ 25(A)
Fixed Overhead Variances
Expenditure Variance = Budgeted Fixed Overheads – Actual Fixed Overheads.
= ₹ 300.00 – ₹ 367.50
= ₹ 67.50 (A)
Volume Variance = Absorbed Fixed Overheads – Budgeted Fixed Overheads
= ₹ 285 – ₹ 300
= ₹ 15(A)

Working Notes ( in lacs)
1.

Question 43.
Buildico, a company that builds houses presents the following facts relating to a certain housinf contract that it wishes to undertake: The CEO’s and Marketing Director’s food and hotel expenses of ₹ 3,750 were incurred for a meeting with a prospective client. (May 2014, 8 marks)

1200 kgs of raw material Z will be required for the house. Inventory of Z available us 550 kg. It was purchased at ₹ 580 per kg. It is used by Buildico in other projects. Its current market price is ₹ 650 per kg. Its resale value is ₹ 350 per kg.

The house will require 90 hours of engineer’s time. The engineers are paid a fixed monthly salary of ₹ 47,500 per engineer who can work 150 hours a month. Spare time is not available now and an engineer has to be hired for this house for one month. He cannot be used in any other project once he does this contract.

Buildico will use a special earthquake proof foundation material. This was developed by Buildico at a cost of ₹ 30,000 for some other project that had to be abandoned. If it does not use it in this project, it can use it in some other project and charge the client ₹ 50,000 for it.

A list of items is given below. You are required to name the type of cost and state whether it is relevant or riot in calculating the cost of the given housing project:

Answer:

Question 44.
Y Limited is a manufacturer of Cardboard boxes. An analysis of its operating income between 2012 and 2013 shows the following: (May 2014, 5 marks)

Y limited sold 4,00000 boxes and 4,20,000 boxes in 2012 and 2013 respectively. During 2013 the market for cardboard boxes grew 3% in terms of number of units and all other changes are due to company’s differentiation strategy and productivity. Compute how much of the change in operating income from 2012 to 2013 is due to the industry market size factor, productivity and product differentiation and also reconcile the profit of both years due to these factors.
Answer:

(W.N.1)
Market Size Factor Effect
[4,00,000 Units – (4,00,000 × 103%) units] × ₹ 10 = ₹ 1,20,000
₹ 10 = $\frac{40,00,000}{4,00,000}$
[(4,00,000 × 103%) units – 4,20,000 units] × ₹ 10 = ₹ 80,000

Alternative Answer
Reconciliation of Operating Income

Workings:
Increase in Sale of Cardboard Boxes 20,000 Boxes (4,20,000 Boxes – 4,00,000 Boxes). Out of which increase in Sales of 20.000 Boxes. 12,000 Boxes (3% of 4,00,000) is due to growth in market size, and the remaning 8,000 Boxes (20,000 Boxes – 12,000 Boxes) are due to an increase in market share.

W.N.1

W.N.2 .
Impact of Productivity on operating income:
= Cost Effect of Productivity Component in 2013
= ₹ 58,000 (F)

W. N. 3
Impact of Product Differentiation on operating Income:

Question 45.
On the basis of the following information determine the product-mix to give the highest profit if atleast two products are produced: (Nov 2014, 8 marks)

Only 9,200 Itouis are available for production at a cost of ₹ 20 per hour and maximum 50,000 kgs. of material @ ₹ 20 per kg., can be obtained. (Only product mix quantities are to be shown, calculation of total profit at that product mix not required to be shown)
Answer:
Calculatior of Contribution per Key Factor(s) for Various Products

From the above ranking(s) it is clear that:

Contribution per Unit is maximum in case of product Y & Z.
Contribution per Kg. of Raw Material also maximum in case of product Y & z.
Contribution per Machine Hour is maximum in case of product X & Z. Hence, product Z is common in all cases and priority shall be given for production of ‘Z’.

Balance resources should be divided between other two products X & Y.
Statement Showing Balance Resources for Product X & Y

The production of X & Y may be computed with the help of following equations by utilizing the balance resources:
20X + 12Y = 27,500 …………… (i)
3X + 5Y = 6,200 ………… (ii)
Then,

Y = 648.43 i.e. 648 units
Putting the value of Y in equation (ii)
3X + (5 × 648) = 6200
Or 3X = 2960
Or X = 986 units
Therefore the Product Mix s
X = 986 units
Y = 648 units
Z = 750 units

Question 46.
PO Limited manufactures and sells a range of products. For one of its products, it makes 2000 units of a component which has the following budgeted manufacturing cost: (May 2015, 5 marks)

Softech Limited has offered to supply the component at a guaranteed price of 25,000 per unit.

If the component is not manufactured by PQ Limited, a11 the direct labour thus released can be employed in increasing the production by 1600 units of an existing product K, which uses 50 of this type of direct labour hours per unit. K is sold for ₹ 45,000 per unit and has a marginal cost of production of ₹ 30,000 per unit and has sufficient market demand. The direct labour force cannot be retrenched or recruited for the next two production periods. From a financial perspective, using incremental cost analysis, would you advise PO Ltd. to make or buy the component for the forthcoming production period?
Answer:
Statement Showing “Incremental Analysis -Make or Buy (2,000 units)”

This analysis indicates that PO Limited will incur 4,000 per unit of additional cost by making the component. Therefore, PO Limited should buy the component from the Softech Limited.

Question 47.
Apex Limited manufactures two products, P and Q, using the same production facility. The following information is available for a production period: (May 2015, 12 marks)

P and Q can be produced only in batches of 100 units, and whatever is produced has to be sold or discarded. Inventory build-up is not possible from one production period to another. The total fixed costs for each level of production and directly attributable to P and Q are given below:

75,000 machine hours are available in the production period.
(i) Calculate the quantities of P and Q in the best product mix to achieve the maximum profit and compute the maximum profit.
(ii) What will be the opportunity cost of meeting P’s demand fully?
Answer:
(i) Statement Showing “Contribution / Machine Hour”

Allocation of Machine Hours on the basis of ranking
Produce ‘P’ as much as possible = 2,200 batches
Hours Required = 33,000 hrs (2,200 batches × 15 hrs.)
Balance Hours Available = 42,000 hrs (75,000 hrs. – 33,000 hrs.)
Produce (the Next Best) = 1,680 batches $\left(\frac{42,000 \mathrm{hrs} .}{25 \mathrm{hrs} .}\right)$
Statement Showing “Maximum Possible Contribution”

For producing additional batches above 2,000 batches of Product ‘P’ Apex Limited have to incur additional fixed cost of ₹ 5,20,000 to earn additional contribution of ₹ 2,00,000 (200 batches × ₹ 1,000) which is not beneficial. However, hours saved on 200 batches i.e. 3,000 hrs (200 batches × 15 hrs.) can be utilized for production of ‘O’ to the extent of 70 batches (1,750 batches i.e. maximum demand of ‘Q’ – 1.680 batches).

The contribution from producing additional 70 batches of Product ‘Q’ will be ₹ 84,000 (70 batches × ₹ 1,200). Accordingly best product mix will be 2,000 batches of ‘P’ and 1,750 batches of ‘Q’.

Statement Showing “Maximum Profit”

Question 48.
Rabi Ltd. is considering the discontinuance of Division C. The following information is given: (May 2015, 4 marks)

The rates of variable costs are 90% of the normal rates due to the current volume of operation. There is adequate market demand.

For any lower volume of operation, the rates would go back to the normal rates. Facilities released by discontinuing Division C cannot be used for any other purpose.

Evaluate the decision to discontinue Division C using relevant cost approach.
Answer:
As given in the question Rabi Ltd. is considering to discontinue the Division C perhaps by seeing the Division Cs income as it is a loss of ₹ 1,72.500. Discontinuance of Division C might be saving ₹ 4,14,000 on specific fixed costs to the company but due to this decision company will not only be losing ₹ 2,41,500 contribution from the Division C but also an additional burden of variable cost of ₹ 230,000 to Divisions A & B and Rabi Ltd. as a whole.

Let evaluate the decision of the Rabi Ltd. with the help of the Relevant Cost approach.

In a nutshell considering the above analysis we can conclude that the decision of discontinuing Division C will not be beneficial for the Rabi Ltd. and it should review its decision on the basis of relevant cost approach to reach at right decision.

Question 49.
The following are cost data for three alternative ways of processing work cases man office system: (Nov 2015, 5 marks)

Calculate cost indifference points. Interpret your result. State for what volumes of case will you prefer each of A, B and C.
Answer:
(i) Calculation of Cost Indifference Point

Question 50.
A and B are two customers of XYZ Electronics Ltd., a manufacturer of audio players. (Nov 2015, 5 marks)
Selling price per unit is ₹ 5,400. Its cost of production per unit is ₹ 4,420.
Additional costs are:
Order Processing Cost – ₹ 2,000 por order
Delivery Costs – ₹ 3,500 per delivery
Details of customers A and B for the period are given below:

The company’s policy is to give a discount of 5% on the selling price on orders for 50 units or more and to further give 8% discount on the undiscounted selling price if a customer uses his own transport to collect the order. Assume that production levels are not altered by these orders.
(i) You are required to analyse the profitability by comparing profit per unit for each customer.
(ii) Comment on the discount policy on delivery.
Answer:
(i) Calculation of Profitability Statement

(ii) Comment: Company is achieving lower profit per unit by giving further discount 8% as discount policy.

Question 51.
Answer the following: (Nov 2015, 4 marks)
(a) A company is planning a new product. Market research information suggests that 40000 units of the product can be sold at a maximum of ₹ 25 per unit. The company seeks a minimum mark-up of 25% on product cost. t is estimated that the lifetime costs of the product will be as follows:
(1) Research and development, design costs ₹ 1,50,000
(2) Manufacturing costs 16 per unit
(3) End of life costs ₹ 70,000
(4) Promotion and capacity cast ₹ 20,000.
Should the product be manufactured?
Answer:
Decision to manufacture a product or not Calculation of Product cost per unit

A product can be sold at ₹ 25 per unit, which is more than target selling price p.u.

Decision: Product should be manufactured.

Question 52.
Supreme Prakashan Ltd. is in the business of publishing a leading newspaper which has a wide customer base. It measures quality of service in terms of: (May 2016, 5 marks)
(i) Print quality
(ii) On time delivery
(iii) Number of damaged and unsold paper
To improve its business prospects and performance, the company is considering installing a scheduling and tracking system which involve an annual additional cost of ₹ 3,00,000 beside equipments costing ₹ 4,00,000 needed for the installation of system.

To purchase the equipment, company is planning to utilise the proceeds of an investment fetching an annual income @ of 9%.

Details regarding the present and future performance are given as under:

It is expected that each percentage increase in on time performance will result in revenue increase of ₹ 36,000 per annum. Required contribution margin is 40%.

Should Supreme Prakashan Ltd. install the new system?
Answer:
Should Supreme Prakashan Ltd. Install the New System?

(*) [ 36,000 × 12% / 1%]
By installing the scheduling and tracking system, the company will be able to save ₹ 36,800 per annum. Hence, the company should install the new system.

Question 53.
A company is considering three alternative proposals for conveyance facilities for its sales personnel who have to do considerable travelling, approximately 20,000 kilometres every year. The proposals are as follows: (May 2016, 5 marks)
(i) Purchase and maintain its own fleet of cars. The average cost of a car is ₹ 1,00,000.
(ii) Allow the Executive to use his own car and reimburse expenses at the rate of ₹ 1.60 per kilometre and also bear insurance costs.
(iii) Hire cars from an agency at ₹ 20,000 per year per car. The company will have to bear costs of petrol, taxes and tyres.

The following further details are available:
Petrol ₹ 0.60 per km
Repairs and maintenance ₹ 0.20 per km
Tyres ₹ 0.12 per km
Insurance ₹ 1,200 per car per annum
Taxes ₹ 800 per car per annum
Life of the car. 5 years with annual mileage of 20,000 kms
Resale value: ₹ 20,000 at the end of the fifth year.
Work out the relevant costs of three proposals and rank them.
Answer:
Statement Showing ‘Evaluation of Three Proposals’

Question 54.
A company manufactures a product Y in addition to other products by using the same machines in department A and department B. The usage details are: (May 2016, 8 marks)

Other Details are:
Value of Plant and Machinery in department A is ₹ 22 Lacs and in department B is ₹ 18 Lacs.
The Working Capital requirement of Product Y based on a target volume of output of 2,000 units per month is estimated at ₹ 2,72,800 per annum which is 40% of the potential capacity.

Required:
(i) Calculate the selling price of Product Y to ensure contribution equivalent to 25% of investment made.
(ii) If Product Y is a new product about to be launched in the market, on what basis should the price be fixed and what would be the minimum price?
(iii) If Product Y is a well established product, what should be the basis for price fixing and what would be the minimum price?
Answer:
(i) Workings
Statement Showing ‘Computation of Variable Cost’

Statement Showing ‘Desired Contribution on Working Capital’

Price of Product is ₹ 171.11 per unit.
[Variable Cost (₹ 151.60) + Contribution Required (₹ 19.51)]

(ii) If the Product Y is a new product about to be launched in the market, the strategy should be to penetrate the marloet by adopting ‘Penetration Pricing’ which could be as below as to recover ‘Variable Cost’ for the product which is ₹ 151.60.

(iii) If the Product Y is a well-established product, the company may be able to sell the product at price which also recover Fixed Cost apart from Variable Cost. Hence, the minimum price would be Total Cost o the Product i.e. ₹ 231/-
Variable Cost ………………. ₹ 151.60
Fixed Cost …………….. ₹ 79.40
Total Price ………….. ₹ 231.00
(*)

Note:
Fixed Charges Recovery is based on usage. Full Capacity is not being used by Product Y and Departments are also producing other Products using same Plant and Machinery.

Question 55.
XY Ltd. is manufacturing a consumer product and doing marketing through 200 depots all over the country. The company is considering closing down the depots and resorting to dealership arrangements. The total turnover of the company is ₹ 160 crores per annum. The following information is given for each depot: (May 2016, 8 marks)

The inventory carrying cost is 16% p.a. which is also the interest rate prevailing in the market for working capital finance. The other fixed cost per annum is ₹ 16 crores. Marketing through dealers would involve engaging dealers for each area. The dealers will assure minimum sales for each area. This would result in increasing the capacity utilization from 80% to 100%. At present the companys PN ratio is 20%. Marketing through dealers would involve payment of commission of 8% on sales. Half of the existing depot staff will have to be absorbed in the company. The dealer will deposit ₹ 3.20 crores with company on which interest at 12% p.a. will be paid.

You are required to work out the impact on profitability of the company by accepting the proposal.
Answer:
Comparative Profit Statement ‘Existing Vs Proposed Situation’

The above analysis shows that if Proposal is accepted, the Profit will increase from ₹ 1.92 Crores to ₹ 30.72 Crores.

It has been assumed that ‘total number of dealers’ are equal to ‘total number of depots’ i.e. 200.

Question 56.
A manufacturing unit of ABC Co. Ltd. has presented the following details: (May 2016,8 marks)
Average Units produced and sold per month – 2,40000
No. of workers – 80
Sales value – ₹ 60 Lacs
Contribution – ₹ 24 Lacs
Wage rate – ₹ 5 per unit
The production manager proposes to introduce a new automated machine due to which following changes will take place:

No. of units produced and sold are expected to increase by 20%.
No. of workers will be reduced to 60.
With a view to provide incentive for increased production, Production Manager intends to offer 1% increase in wage rate for every 3% increase in average individual output achieved.
Decrease in selling price by 2%.

Required:
Calculate amount of extra contribution after introduction of new automated machine and give your recommendations.
Answer:
Workings
Present Average Output per employees per month
= $\frac{\text { Total Present Output }}{\text { Total Number of Present Employees }}$
= $\frac{2,40,000 \text { units }}{80 \text { Employees }}$
= 3,000 units
Future Average Output per employees per month
= $\frac{\text { Total Future Output }}{\text { Total Number of FutureEmployees }}$
= $\frac{2,40,000 \text { units } \times 120 \%}{60 \text { Employees }}$
= $\frac{2,88,000 \text { units }}{60 \text { Employees }}$
= 4,800 units
Present Piece Work Rate = ₹ 5.00 per unit
Proposed Piece Work Rate = Present Piece Work Rate + Incentive
= ₹ 5.00 + ₹ 5 × 20%
= ₹ 6 per unit

Incentive*
1% Increase in ‘Wage Rate’ for – Every 3% Increase ¡n ‘Average Individual Output Achieved’
Change in Output (%) = $\frac{4,800 \text { units }-3,000 \text { units }}{3,000 \text { units }}$
= 60%
60%
Change in Wage Rate (%) = $\frac{60 \%}{3 \%}$ × 1%
= 20%
Present Sales Priçe per unit = ₹ 25.00 ( 60,00,000/ 2,40,000 units)
Proposed Sale Price per unit = ₹ 24.50 (₹ 25 – 2% × ₹ 25.00)
Present Variable Cost = ₹ 60,00,000 – ₹ 24,00,000
= ₹ 36,00,000

Present Variable Cost Excluding Wages per unit = $\frac{\text { Contribution }- \text { Wages }}{\text { Presentoutput(units) }}$
= $\frac{₹ 36,00,000-(2,40,000 \text { units } \times ₹ 5)}{2,40,000 \text { units }}$
= ₹ 10.00 per unit

Statement of ‘Extra Monthly Contribution’

Recommendations
The above analysis shows monthly increase in contribution amounting to ₹ 48,000. Hence, the production manager’s proposal should be accepted.

Question 57.
X Limited is a manufacturer of cardboard boxes. An analysis of its operating income between 2014 and 2015 shows the following: (Nov 2016, 5 marks)

X Limited sold 4,00,000 boxes and 4,20,000 boxes in 2014 and 2015 respectively. During 2015, the market for cardboard boxes grew 3% in terms of number of units and all other changes are due to company’s differentiation strategy and productivity. :

Required:
Compute how much of the change in operating income from 2014 to 2015 is due to the industry market size factor, productivity and product differentiation and also reconcile the profit of both years due to these factors.
Answer:
Reconciliation of Operating Income:

Working Note:
Total Increase in sale of cardboard Boxes, 20,000 Boxes (4,20,000 Boxes (-) 400,000 Boxes).

Out of this increase in sales of 20,000 Boxes, 12,000 Boxes (3% of 4,00,000) is due to growth in market size, and the remaining 8,000 boxes (20,000 boxes (-) 12.000 boxes) are due to an increase in market share.

Working Note – 1: Effect of Industry Market size Factor on operating income:
= Revenue and cost effect of growth component 2015 × $\frac{\text { Increaseinsales unit duetomarket growth }}{\text { Total growthsale unit }(2014,2015)}$
= ₹ 1.40,000 × $\frac{12,000 \text { Boxes }}{20,000 \text { Boxes }}$
= ₹ 84000 (F)
Working Note 2: Effect of Productivity on Operating Income:
= Cost effect of productivity Component in 2015
= ₹ 58,000 (F)

Working Note 3: Effect of Product Differentiation on Operating Income:

Question 58.
Some statements are given below. Identify name of the cost with examples and state whether it is relevant/non-relevant in decision making. (Nov 2016, 5 marks)
(i) Costs are historical costs which have already been incurred and cannot change by any decision made in future.
(ii) It is measure of benefits foregone by rejecting the second best alternative of resources in favour of the best.
(iii) It is portioning of cost which involves payments to outsiders i.e., it gives rise to cash expenditure as opposed to such costs as depreciation.
(iv) Total cost is changed (increase or decrease) due to change in the level of activity, technology or production process or method of production.
(v) Cost used in evaluation of a product to reflect the use of resources but that have no observable cost,
Answer:

Question 59.
G Ltd., produces and sells 95,000 units of ‘X’ in a year at its 80% production capacity. The selling price of product is ₹ 8 per unit. The variable cost is 75% of sales price per unit. The fixed cost is ₹ 3,50,000. The company is continuously incurring losses and management plans to shut-down the plant. The fixed cost is expected, to be reduced to ₹ 1,30,000. Additional costs of plant shut-down are expected at ₹ 15,000.
Should the plant be shut-down? Find the shut-down point in units and also in percentage of capacity level of production. (Nov 2016, 5 marks)

Question 60.
(a) A company manufactures four products. The annual demand for products, selling prices and variable production costs are as follows:

Other data:

(i) The variable overheads are absorbed on a machine hour basis at a rate of ₹ 1.20 per machine hour.
(ii) Fixed overheads total ₹ 46,84,000 per annum.
(iii) Production capacity available 8,15,000 machine hours per annum.
(iv) Products P, Q and R can be bought-in at ₹ 21.36 per unit, ₹ 24 per unit and ₹ 48 per unit respectively.
You are required to calculate the best product mix for the year and the resulting optimal profit.(Nov 2016, 8 marks)
Answer:
1. Computation of Best product mix and optimal profit:

Note: On comparison of “Make costs” with “Buying cost” of P, Q, R, S is observed that “Make” Costs are lower, and hence, it is preferable to make all 3 items as first preference.

3. Machine Hours Requirement Analysis:

Observation: Total requirement is 8,87,400 machine hour but production capacity available is 8,15,000 machine hours, so there is a short fall of 8,87,400 (-) 8,15,000 = 72,400 Hours. This means that either product P or Q or R has to be purchased from outside.

4. Make or Buy Decision

5. Statement Showing “Best Product Mix”

Balance quantity of R to be purchased 36,200 units (1,71,000 – 1,34,800)

6. Profitability Statement

Question 61.
A company manufactures three conponents, A, B and C. These components pass through machines P and Q. The machine hour capacity of Q is limited to 7800 hours a month. The company is interested in fulfilling the market demand to retain its market share. The following information is given:

Component B has to be made by the company. There is a supplier available for components A and C at ₹ 280 and ₹ 161 per unit respectively.
(i) Which component(s) and in what quantities should be purchased to minimize costs?
(ii) From a financial perspective, what do you need to ensure in order to justify your answer in (i) above? (May 2017, 5 marks)
Answer:
(i)

300 units of A required to be purchased but as the purchase price of A & C is lower than production cost company should purchase both component instead of manufacturing.

(ii) Total manufacturing cost of A is ₹ 302 and purchase cost ₹ 280, total manufacturing cost of C is ₹ 166 & purchase cost ₹ 161. In this case purchase of both product Is beneficiar to company provided company can avoid fixed cost relating to A & C.

Question 62.
XY Ltd. manufactures two types of mobile phones, X and Y. Due to severe competition, it has to reduce the prices for the next production period. The following information is provided:

For the next period the company wants the present PN ratio to be maintained and achieve a break-even for both the products at 400 units. What is the cost reduction programme envisaged? (May 2017, 5 Marks)
Answer:
Statement showing cost reduction programme envisaged (Reduction in fixed expenses product-wise)

So cost reduction program is envisaged in reduction of fixed cost from previous level by ₹ 2,00,000 in Mobile – X and ₹ 4,20,000 in Mobile – Y.

Notes:

In the absence of information it is assumed that the number of units to be sold for X and Y to break-even as well as the total number of units of X and Y to be sold during the year are same.
The revised P/V ratio are as per the previous year as given in the problem.

Question 63.
ABC Ltd. produces a gadget made up of special steel plates. The company gets an order for supply of 50,000 gadgets at a price of ₹ 680 per unit.
The gadgets are made of two halves (upper part and lower part) and then welded together.
The cost structure is:
Materials 15 kg. per half @ ₹ 10 per kg; Labour ₹ 60 per half.
Welding charges and fitting charges would be ₹ 20 per gadget.
The special steel plates are in short supply and ABC Ltd. has stock of only 750 Tons. A supplier has only the lower part and has offered to supply 50,000 numbers. Transportation and handling will cost ₹ 6 per half. (Consider 1 ton = 1000 kg)
ABC Ltd. could either execute its order to the extent of material available, or could fulfill the entire order by buying the lower part from the supplier. Evaluate both the options and find out the maximum price that ABC would be willing to pay the supplier per lower part if.
(i) it wants to retain the same level of profit per unit as in own manufacture.
(ii) if any additional revenue is preferred.
Present your calculations to the nearest rupee. (May 2017, 6 marks)
Answer:
ABC Ltd.
cost of Sheet of Gadget

(i) If ABC wants to retain the same level of profit per unit as in own manufacture, it has to achieve manufacturing cost of ₹ 440.

ABC will pay ₹ 204 per lower part to the supplier for retaining the same level of profit per unit.

(ii) Present Capacity Revenue is ₹ 60,00,000/- (25,000 units × ₹ 240)
If Supplier is used, 50,000 units of Gadgets can be sold.
For, Additional Revenue
Let Price for Lower Part per unit- ‘K’
50,000 units × {₹ 680 – (₹ K + ₹ 236*) > ₹ 60,00,000
50,000 units × {₹ 444 – ₹ K) > ₹ 60,00,000
K < 324
(*) Cost of Upper Part plus Transportation Cost plus Welding Charges An amount less than ₹ 324 will be paid for the lower part.

Question 64.
AB company produces three products X, Y and Z by using Indigenous and Imported raw materials. The relevant information available from the records of the Company is as under:

The Company also has an agreement to supply 1,000 units of Product X to a vendor which has to be executed. Out of direct materials, 60% is imported raw material and it is purchased at ₹ 24 per kg.
Prepare a statement showing Contribution of these three products assuming availability of importfed raw materials is restricted to 24,000 kgs per year. (Nov 2017, 5 marks)
Answer:
1. Statement showing Ranking Priority

2. Production Decision when Imported Material Available = 24000 kg.

Question 65.
UV Limited manufactures a product ZED. It currently operates at 70% capacity. It has received an export order which will utilize 50% of the capacity of the factory. The order has to be either taken in full or rejected totally. The order has to be executed at a price of ₹ 86 per unit and company has to incur additional cost of packing and forwarding of ₹ 2.50 per unit on the goods exported. Commission @ 3% will be payable to overseas agent.
Other information available is as under:

Following three alternatives are available to the management:
(i) Continue with the current domestic sale and reject the export order.
(ii) Accept the export order by reducing the domestic sale.
(iii) increase the capacity by 10% by installing a new machine costing ₹ 2,50,000. Fixed overheads will increase by ₹ 96,000. Opportunity cost of investment is 15%.

Overtime is to be paid at one and a half time the normal rate to meet the balance of the required capacity.
Required:
(i) Prepare Statement of profitability for each of the above three alternatives.
(ii) Which is the best alternative in terms of profitability? (Nov 2017, 8 marks)
Answer:
1. Analysis of Domestic Sale at 70% level (for computing variable and fixed Elements, and Direct Labour Cost):

2. Relevant Computations:

3. ProfIt Statement under different alternatives (amounts in ₹)

Observation : Option-3 is preferable is terms of profitability.

Question 66.
JC Company produces electronic product and factory is working in Special Economic Zone (SEZ). The expected capacity utilization is 60% and turnover for the year 2016-17 is ₹ 660 Pakh. If the company works at 100% capacity, the sales cost relationship will be as follows:
Factory cost: . 65 per cent of sales value
Prime cost : 75 per cent of factory cost
Selling and administrative cost : 20% of sales value and being 80% variable
The factory overheads will vary according to operating capacity in the following manner:

The Government of India gives 10% subsidy on the export order amount and it is expected that currency fluctuation trends will be positive by 8% in next financial year.

The Company receives an offer from abroad for a value of ₹ 150 lakhs. The prime cost of this order is estimated at ₹ 96 lakhs and selling and administrative expenses applicable to this order is ₹ 7,20,000. The order will occupy 40% of the capacity of the plant. To complete the export order, quality maintenance cost of ₹ 1,20,000 will also be incurred.

The Marketing Director estimates that the company’s own sales will increase to 80% of the capacity by the time of materialization of new order. The factory overheads will increase by ₹ 50.50 lakhs (for increase from 80% to 120% capacity).

The maximum demand in local market can be extended up to 120% with export order. The export order cannot accepted partly.

Required:
(i) Prepared a profitability statement at the capacity level of 60%, 80% and 100%.
(ii) Should the company accept the export order? (Nov 2017, 8 marks)
Answer:
(i)
Profitability Statement

(ii) The above computations show that JC Company should accept the export order since its acceptance would increase the operating profit of the concern by ₹ 22.1 lakhs (₹ 124.30 lakhs – ₹ 102.20 lakhs).

Question 67.
JM Ltd. is engaged in the manufacture of plastic bottles of a standard size. The factory has 5 machines of identical size, each capable of producing 40 bottles per hour. The variable cost per bottle is ₹ 0.32 and the selling price is ₹ 0.80 each. The company has received an offer from another company for manufacture of 40000 units of a plastic moulded toy.

The price per toy is ₹ 30 and the variable cost is ₹ 24 each. In case of the company takes up the job, it has to meet the expenses of making a special mould required for the manufacture of the toy. The cost of the mould is ₹ 1,00,000. The company’s time study analysis shows that the machines can produce only 16 toys per hour. The company has a total capacity of 10,000 hours during the period in which the toy is required to be manufactured. The fixed costs excluding the cost of construction of the mould during the period will be ₹ 10 Lakh.
The company has an order for the supply of 3,00,000 bottles during the period.

Required:
(i) Do you advise the company to take up the order for manufacturing plastic moulded toys during the time when it has an order in its book for the supply of 3,00,000 bottles. (May 2018, 3 Marks)
(ii) If the order for the supply of bottles increases to 4,00,000 bottles, will you advise the company to accept the order for the supply of plastic moulded toys? State the reasons. (May 2018, 3 Marks)
(iii) An associate company of JM Ltd. has idle capacity and is willing to take up the whole or part of the manufacturing of the plastic moulded toys on sub-contracting basis. The subcontract price inclusive of the cost of construction of mould is ₹ 28 per toy. Determine the minimum expected (May 2018, 4 Marks)
Answer:
Workings
Statement Showing “contribution /Machine Hour”

Advice on Supply of 3,00,000/ 4,00,000 Bottles
(i) JM Ltd. can accept plastic molded toy’s order as sufficient number of
hrs. i.e. 2,500 hrs. (10,000 hrs.- 3,00,000 bottles × 0.025 hrs.) are available and would be able to generate additional benefit of ₹ 3.50 per unit on 40,000 units of toys i.e. ₹ 1,40,000.

(ii) If the order for the supply of bottles increases to 4,00,000 bottles, then 2,500 more hrs. will be required to produce the additional bottles. JM Ltd. has to decide whether to utilize 2,500 hrs. for existing bottle order or for toy Order.

Machine time is limiting factor, Therefore, contribution per machine hour from both the activities (i.e. bottles and toys) should be calculated to decide whether the order should be accepted. Contribution per hour is more in case of toys (refer workings). Therefore, JM Ltd. should utilize the remaining 2,500 hours for manufacturing toys rather than to fulfil the order for supply of additional bottles.

Prioritizing production based on contribution per machine hour would maximize profits. However, existing order fulfilment is necessary for building long term and sustainable customer relationship. Developing and maintaining long term and intimate relationships with the profitable customers provides valuable benefits to the company as the relationships between company and customers grow, a customer who is satisfied with the company’s products and services, tends to commit the relationship, and buy more over time. Cost of keeping the existing customers is less expensive than the cost of acquiring new customers.

Hence, JM Ltd. should be taken into consideration long term supplier relation before accepting the toy order based on financial consideration as contribution per hour is more in case of toys. Further, company may also explore outsourcing opportunities for production of toys.

(iii) Minimum number of toys needed to be manufactured to justify the increase in fixed cost of ₹ 100,000 to make the mould is 25000 toys {1 .00,000/ (₹ 28 – ₹ 24). Thus, as long as company has excess capacity
available to manufacture more than 25,000 toys it s cheaper to produce than to buy from subcontractor.
Minimum Expected Excess Capacity hours to justify
= $\left(\frac{25,000 \text { toys }}{16 \text { toys }}\right)$
= 1,562.5 or 1,563 hours

Question 68.
Cool Air Ltd., manufactures and sells 25000 table fans annually. One of the components required for fans is purchased from an outside supplier at a price of ₹ 190 per unit. Annually it is purchasing 25000 components for its usage. The Production Manager is of the opinion that if all the components are produced at own plant, it is possible to maintain better quality in the finished product. Further, he proposed that the in-house production of the component with other items will provide more flexibility to increase the annual production by another 5000 units. He estimates the cost of making the component as follows :

The proposal of the Production Manager was referred to the Marketing Manager for his remarks. He pointed out that to market the additional units, the overall unit price should be reduced by 5% and additionally ₹ 1,00,000 p.m. should be incurred for advertising. Present selling price and contribution per fan are ₹ 2,500 and ₹ 600 respectively. No other increase or decrease in all other expenses as a result of this proposal will arise.
Since the making cost of the component is more than the buying cost, the Management asks you to :
(i) analyse the make or buy decision on unit basis and total basis.
(8 marks)
(ii) recommend the most profitable alternative. (Nov. 2018, 2 marks)
Answer:
(i) Alternative 1 :
Currently the company is manufacturing 25000 table fans annually. For the manufacturing of the table fans, one component is purchased @ ₹ 190 per unit from outside market.

Alternative 2 :
The company wishes to manufacture the component of table fan internally with a condition to increase the production units to 30000 annually. Additionally company incurs ₹ 1,00,000 per month to market the additional units.

Alternative 3:
The company wishes to manufacture the component of table fan internally but restricts the manufacturing of table fans to only 25000 units annually.

The following is the statement of cost of table fan on unit basis and totality basis for all the alternatives.
Statement showing cost of table fan on unit basis and totality basis for all the alternatives.

(ii) Conclusion :
Based on the workings, the ideal alternative should be Alternative 3 since, its contribution is highest amongst the other alternatives. However, based on the proposal provided by Institute, the suitable comparison will be between Alternative 1 and Alternative 2 concluding that the company should purchase from outside market to maintain a higher contribution from the selling of table fans.

Question 69.
A Company manufactures a single product, which requires three components. The company purchases one of the components from three supplier. DJ Ltd., PJ Ltd. and ZJ Ltd. The lollowng informations are available:

If the defectives are not detected they are utilized in production causing a damage of ₹ 200 per 100 units of the component, Total requirements is 12000 units of the components.

The company intends to introduce a system of inspection for the components on receipt. The inspecvon cost is estimated ot 26 per 100 units of the components. Such as inspection will be able to detect only 90% of the defective components received. No payment will be made for components found to be defective in inspection.

Required:
(i) Advice whether inspection at the point of receipt is justified. (Nov 2018, 8 Marks)
(ii) Which of the three supplier should be asked to supply? (Nov 2018, 2 marks)
Answer:
(i) A. Statement Showing Effective Cost before Inspection

B. Statement showing Effective Cost after Inspection

ADVICE Whether Inspection at the Point of Receipt is Justified:
On comparing the cost under situation. A and B shown above, we find that it will not be economical to install a system of inspection.

Further we also need to consider that presently many organizations are undergoing .Just in Time (JIT) implementation. JIT aims to find a way of working and managing to eliminate wastes in a process. Achievement of this is ensured through eliminating the need to perform incoming inspection. Inspection does not reduce the number of defects, it does not help in improving quality. In general inspection, does not add value to the product. It simply serves as a means of identifying defects the supplier has tailed to recognize subsequent to the manufacturing of the product.

As a matter of fact, organizations implementing JIT are seeking eventuay to eliminate the need for performing incoming inspecVcn activities through a combination of reducing the supplier base, selection through qualification and vendor development. Vendor development and its proper management seeks to assist the supplier who maintains an interest in striving to provide 100% defect-free materials and parts.

So, to decision whether inspection at the point of receipt is justified or not will also depend on Qualitative factors as well.

(ii) Conclusion:

As can be seen from above woddngs, it is Financially Feasible not to get the Inspection done as it results .in a higher cost.
Also, it is Better to order from Supplier ZJ as it results in Lowest Cost in totality and per unit. Also li has the lowest defect rate amongst all Suppliers, thereby lowering the defective Cost.

Question 70.
The President of Automation Limited, a 150 persons engineering company, decided it was time to fire the company’s biggest client. Although the client provided close to 60% of the company’s annual revenue, Automation Limited decided that dropping this client was necessary. The client was profitable.

The President of Automation Limited stated “We cannot be a great place to work without employees, and this client was bullying my employees. Its demands for turnaround were impossible to meet even with people working seven days a week. No client is worth losing my valued employees”.

The initial impact on revenues was significant. However, Automation Limited was able to cut costs and obtain new customers to fill the void. Moreover, the dropped client later gave Automation Limited two projects on more equitable terms.

Required:
(i) Discuss the reasons behind dropping of a profitable client by Automation Limited. (Nov 2019, 2 marks)
(ii) State three qualitative factors that management should consider in outsourcing and make or buy decisions. (Nov 2019, 3 marks)
Answer:
(i) In this case Automation Ltd. core about their employees as they feel of fear about losing their employees because of work pressure. Automation Ltd. feels that the employees are the most important asset for the company and this being main reason for dropping the client and care for employees.

(ii) While considering the decision to outsourcing the management should consider qualitative factors like

Quality of goods
Reliability of Suppliers .
Impact on the customers and suppliers etc.
Regularly of Demand
Risk of technological obsolescence.

Question 71.
SEZ Limited produces three products S, Q and L which use the same resources but in varying quantities. Product S uses one unit of component P which is purchased from outside suppliers at ₹ 120 per unit. Details of the three products are as follows:

Maximum availability of skilled labour is 16,200 hours. Other resources are sufficient to meet the annual demand/sales.
Engineering division of the company came forward with a proposal to make the component ‘P’ in house with the following costs break up:

For in-house making of the component ‘P’ there will not be any change in the annual fixed costs of the company. The company can either buy the component ‘P or make it in house.
Required:
Recommend the optimum productiOn plan and profit for the year. Show calculation in support of your answer. (Nov 2019, 10 marks)
Answer:
Calculation of contribution per unit contribution per hrs.
Option-1
SEZ Ltd. produces 3 products Product S, Product Q and Product L. Each unit of Product S requires one unit of component P, which is currently procured from the external market at ₹ 120 per unit. There is a constraint in terms of skilled hours available for production, the maximum available is 16,200 hours.
Given this constraint, the production plan should be based on the contribution derived per skilled labor hour spent on each product.

Calculation of skilled hour requirement for each of the products and component P

Note: When component P is manufactured, in-house Product S would require 1.5 hours of skilled labor hour per unit.
Contribution per unit and contribution per skilled hour (when component P is purchased)

Based on this, SEZ Ltd. would first produce Product S, then Product L and then Product Q. The constraint of 16,200 hours of skilled labor has to be taken into account while drawing up the production plan. Production plan as per above ranking will be as below:

First, 9,000 units Product S is produced, this requires 4.500 hours of skilled labor. After production of Product S, 11,700 hours of skilled labor remain. (16,200 hours – 4,500 hours). Next 7,800 units of Product L cari be produced.
for which the skilled hours used are 7,800 hours. The remaining 3,900 hours would be used to produce Product Q.
Volume of Product Q that can be produced in 3,900 hours = 3,900 / 1.5 hours per unit = 2,600 units.

Therefore, profitability of SEZ Ltd. when component P is purchased:

Option-2
Contribution when component P is manufactured in-house.
Note that Product S requires 0.5 hours and component P would require 1 hour of skilled labor per unit. If component P, a part of Product S is manufactured in-house, then Product S would in all require 1.5 hours of skilled labor per unit.
Based on this, contribution per unit and contribution per skilled hour if component P is manufactured is:

Note 1
Component P has a variable cost, sum of direct material + skilled labor + unskilled labor + variable overhead, given to be ₹ 90 per unit Each unit of Product S requires 1 more hour of skilled labor to manufacture component P. Skilled labor is a limited resource that costs ₹ 40 per hour. The savings SEZ Ltd. earns by manufactunng component P in-house is only ₹ 30 (external purchase Cost is ₹ 120 per unit – cost of manufacturing component P in-house is ₹ 90 per unit). Therefore, it is profitable to purchase component P from the external market.

For further analysis, the impact of producing component P in-house would be:
Based on the revised ranking. SEZ Ltd. would first produce Product L, then Product S and then Product Q. The production plan is component P is made in-house would be

First. 7800 units Product L is produced, this requires 7,800 hours of skilled labor. After production of Product L, 8,400 hours of skilled labor remain. (16,200 hours – 7,800 hours). The remaining 8,400 units would be used to
produce Product S. Volume of Product S that can be produced in 8,400 hours = 8,400/ 1.5 hours per unit = 5600 units. In this constraint, Product Q cannot be produced.

The profitability of SEZ Ltd. if component P is manufactured in-house:

Recommendation
When component P is purchased, annual profits would be ₹ 6,21,000. When component P is manufactured in-house, annual profits would be ₹ 64,000, a reduction of ₹ 557,000 per year. Therefore, component P has to be bought externally. Optimum production plan would be
Product S – 9,000 units Product Q – 2,600 units Product L – 7,800 units
The decision to outsource make or buy decision might have strategic implications for the SEZ and should be formulated from strategic perspective with senior management’s involvement.

Question 72.
‘Mahesh is a canteen contractor at Jamshedpur. He manages office canteen of 1,200 employees where tea and snacks are served between 9 am to 5 pm. He has employed four supervisors for managing cash. Mahesh pays ? 400 per working day to every supervisor.

The office remains closed on Saturday and Sunday. A sojution provider has approached Mahesh for managing Cash. He has advised Mahesh to install an automated payment mechanism for accepting payments through machines. Every employee of office will swipe smart card for making the payment. The complete system would cost ₹ 3,35,000 with working life of 4 years with annual maintenance of ₹ 60,000. Only one supervisor will be required after the installation of machines.

Required:
Advise Mahesh on his plan of installation of automated payment mechanism. (Ignore the time value of money.) (Nov 2020, 5 Marks)

Question 73.
ZAINA Private Limited is a manufacturing company of electrical equipment. The company is facing the possibility of a strike by its direct production workers engaged on the assembly of one of its machines. The Trade Union is demanding an increase of 8% backdated to the beginning of its financial year (1^st April), but the company expects that if a strike takes place, it will last four weeks after which the Union will settle for an increase of 6% similarly backdated.
The Machine whose production (Ceiling Fans) would be affected by the strike is sold to distributors at a discount of 25% from the current recommended selling price of ₹ 2,000.
The estimated costs for the Ceiling Fans are :

Direct labour comprises 60% of the variable production cost. The budgeted output is 30,000 Ceiling Fans in 50 working weeks per year. If the strike takes place, the following situations are expected by the company :

(a) Maintenance staff, whose wages are included in the fixed production costs, would be used to carry out an overhaul of the conveyor system using materials worth ₹ 50,000. This work would otherwise be undertaken by an outside contractor at a cost including materials ₹ 1,50,000.

(b) Sales of 500 Ceiling Fans would be lost to completion. The balance that could ordinarily have been produced during the strike period, could however, be sold, but these ceiling fans would have to be produced in overtime working which would be at an efficiency rating of 80% of the normal. This would also entail additional fixed costs of ₹ 40,000 and wage payments at time and one-half.

The Profitability of SEZ Ltd. if component P is manufactured In-house:

Recommendation
When component P is purchased. annual profits would be ₹ 6,21,000. When component P is manufactured in-house, annual profits would be ₹ 64,000, a reduction of ₹ 557,000 per year. Therefore, component P has to be bought externally. Optimum production plan would be Product S – 9,000 units Product Q – 2,600 units Product L – 7,800 units.

The decision to outsource make or buy decision might have strategic implications for the SEZ and should be formulated from strategic perspective with senior management’s involvement.

Question 74.
Mahesh is a canteen contractor at Jamshedpur. He manages office canteen of 1 ,200 employees wIere tea and snacks are served between 9 am to 5 pm. He has employed four supervisors for managing cash. Mahesh pays ₹ 400 per working day to every supervisor. The office remains closed on Saturday and Sunday.

A solution provider has approached Mahesh for managing Cash. He has advised Mahesh to Install an automated payment mechanism for accepting payments through machines. Every employee of office will swipe smart card for making the payment. The complete system would cost ₹ 3,35000 with working life of 4 years with annual maintenance of
₹ 60,000. Only one supervisor will be required after the installation of machines.

Required:
Advise Mahesh on his plan of installation of automated payment mechanism. (Ignore the time value of money.) (Nov 2020, 5 Marks)

Question 75.
ZAINA Private Limited is a manufacturing company of electrical equipment. The company is facing the possibility of a stflke by its direct production workers engaged on the assembly of one of its machines. The Trade Union is demanding an increase of 8% backdated to the beginning of its financial year (1 April), but the company expects that if a strike takes place, it will last four weeks after whæh the Union will settle for an increase of 6% similarly backdated.

The Machine whose production (Ceiling Fans) would be affected by the strike is sold to distributors at a discount of 25% from the current recommended selling price of ₹ 2,000.
The estimated costs for the Ceiling Fans are:

Direct labour comprises 60% of the variable production cost. The budgeted output is 30,000 Ceiling Fans in 50 working weeks per year. If the strike takes place, the following situations are expected by the company:
(a) Maintenance staff, whose wages are included in the fixed production costs, would be used to carry out an overhaul of the conveyor system using materials worth ₹ 50,000. This work would otherwise be undertaken
by an outside contractor at a cost including materials ₹ 1,50,000.

(b) Sales of 500 Ceiling Fans would be lost to completion. The ba’ance that could ordinarily have been produced during the strike period, could however, be sold, but these ceiling tans would have to be produced in overtime working which would be at an efficiency rating of 80% of the normal. This would also entail additional fixed costs of ₹ 40,000 and wage payments at time and one-half.

Required:
(i) Calculate the profit or loss with and without strike.
(ii) Taking, purely economic point of view, advise the management to allow the strike to go ahead, rather than agree to the Union’s demand.
(iii) list-Any two factors, not considered in yours above evaluation that may have adverse financial effects for the company, if the strike were to take place. (Nov 2020, 10 marks)

Question 76.
ABC Ltd. an Investment company undertakes share market research for its clients. To design a tailor made investment strategy for clients the designated team of staff takes 4 months. The team comprises involvement
of 3 divisions.

The variable costs of ABC Ltd are distributed among the 3 categories of staff in the following ratios

The contribution from each department would be at the following percentages:

For calculation of monthly revenue generated the value of worl executed is divided on the following lines:

The work executed by ABC Ltd in the month of April is ₹ 3,00,000, May ₹ 2,00,000, June ₹ 3,00,000 and in July ₹ 2,00,000.

Calculate the additional order to be received if the targeted contribution that the company wants to earn is ₹ 1.50,000 for the period April to July.
(You may assume that no fixed costs are relevant in arriving any calculations and the profit percentage of July is to be considered for calculating the additional order required in July.) (Jan 2021, 12 Marks)

Question 77.
Bharat Heavy Machinery Ltd. produces engines for the cars. Vanable cost per engine is ₹ 4,200. Market research has indicated that at a selling price of ₹ 7,400, no order will be received, but the demand for the engines will be increased by two units for every ₹ 400 reduction in the unit selling price below 7,400.
You are required to determine the unit selling price per engine that will maximize the profit of the company. (Jan 2021, 5 Marks)

Question 78.
Modem Packaging Corporation specialised in the manufacture of one litre plastic bottles. The firm has four moulding machines, each capable of producing 100 bottles per hour. The firm estimates that the
vanable cost of producing a plastic bottle is ₹ 20. The bottles are sold ₹ 50 each.

Management has been approached by a local toy company that would like the firm to produce a moulded plastic toy for them. The toy company is willing to pay ₹ 300 per unit for the toy. The variable cost to manufacture the toy will be ₹ 240. In addition. Modem Packaging Corporation would have to incur a cost of ₹ 20,00,000 to contract the needed mould exclusively for this order.

Because of more intricate shape of the toy, a moulding machine can produce only 40 units per hour. The customer wants 1,00,000 units. Assume that total capacity of all the four machines combined is 10,000 machine hours available during the period in which the toy company wants the delivery of toys. The firm’s fixed cost, excluding the cost to construct the toy mould, during the same period will be ₹ 2,00,00,000.

Required:
(i) It the management predicts thai the demand for its bottles will require the use of 7500 machine hours or less during the period, should the special order be accepted ? Give reasons. (Jan 2021, 3 Marks)

(ii) If the management predicts that the demand for its bottles will be higher than its ability to produce bottles, should the order be accepted? Why? (Jan 2021, 2 Marks)

(iii) If the management has located a firm that has just entered the moulded plastic business. This firm has considerable excess capacity and more efficient moulding machines and is willing to subcontract the toy job, or any portion of it for ₹ 280 per unit. It will contract its own toy mould.

Determine Modern Packaging Corporation minimum expected excess machine hour capacity needed to justify producing any portion of the order itself rather than subcontracting it entirely. (Jan 2021, 5 marks)