CA Inter Taxation

The following are solutions to all five sub-parts (any four to be answered):

(a) Journal Entries in Cost Books under Non-Integrated System

In a Non-Integrated (Non-Integral) System, cost accounts are maintained independently of financial accounts. The Cost Ledger Control Account (also called General Ledger Adjustment Account) serves as the link account.

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(b) Advantages of Raising Funds by Issue of Equity Shares

Equity shares represent the permanent capital of a company. The key advantages of raising funds through equity are:

1. No Fixed Dividend Obligation: Dividends on equity are paid only when profits are sufficient and the board recommends them. There is no compulsion, unlike preference shares or debentures.

2. Permanent Capital: Equity capital is not repayable during the lifetime of the company, providing a stable, long-term financial base.

3. No Charge on Assets: Unlike debentures, equity does not create any mortgage or charge on the company's assets, leaving them free for future borrowings.

4. Enhances Borrowing Capacity: A strong equity base improves the company's creditworthiness and increases its capacity to raise debt at favourable terms.

5. Risk Bearing by Shareholders: Equity shareholders bear the ultimate business risk. This shields the company from mandatory obligations during downturns.

6. Voting Rights and Governance: Equity financing aligns ownership with management through voting rights, ensuring accountability.

7. No Interest Burden: Unlike debt, equity does not carry interest, reducing the fixed cost burden on the company.

8. Suitable for Long-Term Projects: Equity is ideal for financing projects with long gestation periods where regular cash outflows cannot be guaranteed.

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(c) Practical Applications of Marginal Costing

Marginal Costing is a technique where only variable costs are charged to cost units; fixed costs are treated as period costs. Its practical applications include:

1. Profit Planning: Helps management understand the relationship between cost, volume, and profit through Break-Even Analysis and P/V Ratio computation.

2. Pricing Decisions: Useful for setting minimum selling prices, especially for export orders or special contracts where price = marginal cost + contribution for fixed cost recovery.

3. Make or Buy Decisions: Compares incremental (marginal) cost of making with the purchase price to decide whether to manufacture in-house or outsource.

4. Sales Mix Decisions: Helps determine the most profitable mix of products by comparing contribution per unit of each product.

5. Key Factor / Limiting Factor Analysis: When resources are scarce, products are ranked by contribution per unit of limiting factor to maximise overall profit.

6. Accept or Reject Special Orders: A special order is accepted if the selling price exceeds marginal cost and contributes towards fixed costs, even if below total cost.

7. Shut Down or Continue Decisions: If a product's contribution is positive, it should continue even if it shows a net loss after fixed cost apportionment.

8. Effect of Change in Selling Price: Quickly quantifies the impact of price changes on contribution and break-even point.

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(d) Aging Schedule in the Context of Monitoring of Receivables

An Aging Schedule is a management tool used to monitor and control trade receivables (debtors). It classifies the outstanding debtors according to the length of time the amounts have been outstanding.

The schedule typically groups receivables into age buckets such as:
- 0–30 days (current)
- 31–60 days (overdue by 1 month)
- 61–90 days (overdue by 2 months)
- 91–120 days
- More than 120 days (potentially bad debts)

Significance and Uses:

1. Identification of Defaulters: Quickly highlights which customers have delayed payments beyond credit terms.

2. Estimation of Bad Debts Provision: A higher percentage of provision is applied to older debts, giving a more accurate estimate of irrecoverable amounts.

3. Evaluation of Credit Policy: If a large proportion of receivables are in older buckets, it signals that the credit policy needs tightening.

4. Collection Efforts: Enables the credit department to prioritise follow-up and collection actions on delinquent accounts.

5. Cash Flow Forecasting: Helps predict likely collection timings, aiding working capital management.

6. Comparison Over Periods: Comparing aging schedules across periods reveals whether the quality of debtors is improving or deteriorating.

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(e) Determination of Economic Batch Quantity (EBQ)

Economic Batch Quantity (EBQ) is the optimum batch size at which the total cost of production (setup cost + carrying cost) is minimised. It is analogous to EOQ but applies to manufacturing batches.

Costs Involved:
- Setup Cost (Batch Setup Cost): Cost incurred each time a new batch is set up (fixed per batch, decreases per unit as batch size increases).
- Carrying/Holding Cost: Cost of holding inventory produced (increases as batch size increases).

Formula:

EBQ = √[ (2 × D × S) / C × p / (p − d) ]

Where:
- D = Annual demand (units)
- S = Setup cost per batch (₹)
- C = Carrying/holding cost per unit per annum (₹)
- p = Production rate (units per annum)
- d = Demand/consumption rate (units per annum)
- p/(p−d) = Correction factor to account for simultaneous production and consumption

Logic: Since production and consumption happen simultaneously, inventory never builds up to the full batch size. The maximum inventory = Batch Size × (1 − d/p). Hence the correction factor adjusts the standard EOQ formula.

At EBQ, Total Setup Cost = Total Carrying Cost, giving the minimum total cost.

If production rate is ignored (instantaneous production assumed):
EBQ = √(2DS/C) — same as EOQ formula.

Final answer: EBQ balances setup costs against holding costs and is the batch size at which total production cost is minimised.